May 4, 1999
Similarities Between IPO Probe
And Nasdaq Case Are Limited
By RANDALL SMITH
Staff Reporter of THE WALL STREET JOURNAL
NEW YORK -- For some Wall Street executives, the sequence of events
is chillingly familiar.
An academic study spotlights market-price anomalies. The study sparks
investor litigation. A government investigation begins looking for evidence
of collusion.
That is what happened in the mid-1990s in the
Nasdaq Stock Market, where a few dozen
dealers, accused of keeping trading "spreads"
between bid and asked prices artificially wide,
eventually settled for a total of more than $1 billion.
This also is the scenario that some investors believe could be unfolding
in
the lucrative market for initial public stock offerings. An academic study
in
November found an unusual uniformity of fees charged for moderate-size
IPO stock deals at 7%. Investors quickly sued. And now the same team
that pursued the Nasdaq case at the Justice Department is asking questions
about possible collusion on IPO fees.
But that is essentially where the similarity ends, at this point. There
are
many differences between Nasdaq and the IPO market, which could make
the IPO probe more difficult for both regulators and plaintiff lawyers
to
pursue successfully.
The biggest one is that the Nasdaq dealers moved quickly to settle after
they were forced to produce tapes of their traders threatening, cajoling
and
bullying other traders to adjust their bids to keep spreads wide at
customers' expense.
Is It Sometimes 'Collusion Street'?
Recent accusations of collusion in the securities industry:
Market
(year)
Investigation
Status
Nasdaq
dealers
(1994)
Nasdaq Stock Market's
biggest market-making
firms accused of
price-fixing, first spotted
by two professors in
1994.
Justice Department settled
with firms in 1996; investors
who had sued the firms
settled in 1997 for a total of
more than $1 billion.
Bonds
(1999)
Investors and regulators
say securities firms control
bond pricing information.
Bill recently passed
committee of the House
mandating SEC to create
systems to distribute
corporate bond pricing
information.
Options
(1999)
Justice Department
investigates whether
options exchanges restrain
competition.
Pending.
IPO
Underwriting
(1999)
The Justice Department is
looking for evidence of
price-fixing of IPO fees.
Preliminary-inquiry stage after
academic study showed 90%
of IPOs between $20 million
and $80 million carry 7% fee.
"What settled the Nasdaq case at that $1 billion-plus level was not simply
the study, important though that was," said John Coffee, who specializes
in
securities law at Columbia University's law school and served as an expert
witness in the Nasdaq settlement. "It was the telephone tapings [that]
showed Nasdaq dealer after dealer threatening reprisals to other dealers
who narrowed the quote inside of the normal 1/4-point spread."
Will similar evidence come to light of such conduct by Wall Street's elite
investment bankers? Edward Fleischman, a former commissioner of the
Securities and Exchange Commission now with Linklaters & Paines,
doubts it.
"Maybe it's because the trading community is rougher and the
investment-banking community is more kid-gloved," he said, "but I would
be extraordinarily surprised if there's anything like that kind of smoking
gun
in this one."
The trading-desk tapes were made routinely to settle disputes; comparable
tapes of investment bankers' colloquies aren't known to exist.
Not every IPO has a 7% fee, of course. Corporate issuers launching large
IPOs often have the leverage to negotiate smaller IPO rates. And there
are
other industries with seemingly "standard" rates: Real-estate brokers,
for
instance, often receive 6% sales commissions. But real-estate commissions
at all levels increasingly are discounted.
Nevertheless, building a case of IPO collusion wouldn't necessarily require
videotaped handshakes in a smoke-filled room. As the civil lawsuit filed
last November by the firm of Kirby McInerney & Squire LLP put it,
investment bankers could discipline firms that chose to compete on price
by keeping them out of membership in so-called syndicates of firms that
join to underwrite most deals.
Without offering any evidence that such a scenario had occurred, the
complaint said: "For a given IPO, the non-lead underwriters may threaten
to exclude from syndicate membership in future IPO offerings a lead
manager that proposes to charge a fee lower than the standard 7%."
Columbia's Mr. Coffee says that kind of threat can help point to improper
conduct in civil antitrust cases. "You don't have to have two people in
a
motel room saying 7% [if] you can show behavior that strongly supports
the existence of some kind of implicit agreement."
One person close to the Justice Department probe said the department is
sifting for evidence of active collusion on price by underwriters, or,
in the
absence of direct collusion, any evidence of retaliation against companies
that have gone outside the implicit pricing zone. The same person also
said
the inquiry parallels the Nasdaq probe, with much the same set of pricing
issues and allegations.
It's a complicated issue and a difficult allegation to prove, this person
said.
Is there an agreement, or simply a case of price leadership? He added that
the probe is only at a preliminary stage, and that the investigation is
likely to
take a long time. Still, issuance of civil subpoenas to major Wall Street
securities firms seeking information about their IPO fees means the
department is taking the allegations seriously.
What's more, the IPO-pricing probe also differs from both the Nasdaq
case and another high-profile antitrust case against Microsoft Corp. in
lacking, so far, a clearly defined business group with grievances against
the
subject of the probe.
At Nasdaq, rival dealers tried to make money by making bids inside the
quarter-point spread; some helped gather evidence of improper conduct
by other traders. And the Microsoft case, also brought by the Justice
Department, has featured testimony from smaller rival software companies
claiming to have been injured by Microsoft's market dominance.
The study behind the IPO case, by Hsuan-Chi Chen and Jay R. Ritter of
the University of Florida, offers a variety of more benign explanations
in
addition to "the possibility of implicit or explicit collusion" for the
high
frequency of 7% spreads for deals between $20 million and $80 million.
Other factors could be more important to companies selling their stock
in
an IPO, the study notes. These include the quality of the securities firms'
research on their industry, the underwriters' prestige and track record,
the
price level the IPO may fetch at the offering, and where the stock will
trade
once trading begins.
For many companies that sell stock in IPOs, investment bankers note, the
magnitude of a difference between a fee of 7% or 5% pales when
compared with the range of possible offering prices, as well as how much
the stock rises immediately after the offering price is set. Most IPOs
historically have been priced so they can increase by about 15%, more or
less, on the first day of trading.
Nor would most companies have an incentive to complain. The fortunes of
public companies hinge on their stock price, which is heavily dependent
on
Wall Street research. And if they have any notion of selling more stock
after the IPO, as most do, they wouldn't necessarily be inclined to come
forward.
Mr. Ritter said in an interview Sunday that he had talked to a litigation
consultant in Silicon Valley before releasing his study. The consultant,
he
said, asserted that companies that had sold stock in IPOs were
unanimously not interested in pursuing such a complaint.
Garrett Rasmussen, a specialist in antitrust law at Patton Boggs LLP in
Washington, notes another potential obstacle to finding improper collusive
activity. "There are so many lawyers involved in the IPO process, it's
so
lawyer-intensive, I suspect you're never even going to find conversations
about rates."
Several Wall Street lawyers recalled that 50 years ago, the government
ignominiously lost an epic antitrust case against 17 securities firms led
by
Morgan Stanley & Co. The U.S. had charged that the firms were colluding
to monopolize the underwriting business via an elaborate hierarchy that
precluded poaching each other's clients, said Samuel L. Hayes, a finance
professor at the Harvard Business School.
After that setback, Mr. Hayes recalled, the underwriting system remained
largely intact for many years -- until some "nontraditional" firms outside
the
system, such as Merrill Lynch and Salomon Brothers, forced their way in
"by having distribution power that could not be denied."
--John R. Wilke in Washington contributed to this article.