So you think that actually contributed to manipulating the process in the
IPO and driving the price up?
Randall Smith: Manipulating is a legal term, and I wouldn't want to draw a
conclusion about that, because that's what the regulators are looking at. But
it would certainly tend to move the stock in that direction, sure. ...
Susan Pulliam: One of the things that's really interesting about this case is
that it involves practices that have been around for years. I mean, this is
sort of standard operating procedure in the IPO process. You've allocated
shares to your best clients. And, often, as an indication that they were a good
client, they'd buy in the aftermarket. But the thing that I think regulators
are looking at is whether or not industry practices crossed over a line and
these agreements became something that violated securities laws during the big
Define that line. ...
Susan Pulliam: The IPO process, who gets IPO shares, has always been an unfair
process. IPO shares have always gone to Wall Street's best customers. But the
question is whether or not Wall Street began demanding something in return
because there were so many good customers lined up to get these shares. ...
The line as the regulators seem to see it is whether or not there was a quid
pro quo. If you're demanding payments in exchange for an IPO allocation, that
crosses over a line that may violate securities laws.
Chairman of the Securities and Exchange Commission from 1993 to 2001.
If an investor, a large mutual fund, is receiving an allocation in an IPO on
the understanding that they will make certain purchases or pay higher
commissions in the aftermarket, is that a serious violation?
Hypothetically, if that investor, that recipient of an IPO, was required to pay
extraordinary commissions on non-related transactions or required to make
specific aftermarket purchases, I believe that, hypothetically, you could
consider that a manipulative action.
That manipulates the price of a stock.
It could. ...
We've been told that some people in the investment banking community have
come forward to the SEC and laid out their practices -- the laddering,
excessive commissions. ... Will these allocation tie-ins, laddering, etc. -- is
this something that is provable?
I can't comment on a specific investigation. But I can say to you that --
again, on a hypothetical basis -- this kind of allegation would be very
difficult to prove; not impossible, but difficult. And that's so because you
would have to have hard evidence of conversations, of transactions, of other
elements of fraud. I think that's possible. But I don't think it's something
that you can readily assume that the investigation will necessarily and
certainly lead to a resolution.
Executive editor of Fortune magazine and the author of A Piece of the
Action: How the Middle Class Joined the Money Class (1994).
Can you explain the allocation system as it has traditionally existed?
The allocation system has been problematic. ... The historic way to do it is to
give the largest allocations to your biggest customers. So Fidelity is going to
get a large allocation. Janus is going to get a large allocation. All the big
growth tech funds from very, very large hedge funds will get large allocations.
That is the system as it existed. And Fidelity, even at three cents a share, is
going to be paying gigantic commissions to everybody on the street, because
they have a trillion dollars in America's assets, and they trade a ton of stock
What is an allocation?
An allocation is basically a portion of an IPO that goes to your firm. You are
given the right to buy x number of shares at the minute -- and I do mean the
minute -- this company goes public. Afterwards, you can do anything you want.
You can sell it on the first day, or you can put it in your pocket and hold it
for the next five years. ...
Is this the best way to allocate shares? ... Should it really be the investment
banks' best customers? Or should there be some system devised to find people
who will be long-term shareholders and have the best interests of the company
at heart? Should IPO allocations be about giving big customers a one-day
profit? You know? That's a worthy question. ...
Can you answer it?
I can't. How do you find who are the best shareholders? It's not corrupt to
give it to your best customers, to your biggest customers. ...
The reason there's a "scandal," quote unquote, is because smaller firms ...
have been able to, in effect, jump to the front of the line and get much larger
allocations than they would be normally allotted, by paying gigantic
commissions, a dollar a share instead of three cents a share. That's why
there's a so-called scandal. Is that system any worse than just meting it out
according to who's the biggest customers? In other words, the so-called
scandalous way of allocating is a lousy way to allocate. But the normal way of
allocating isn't so great either. ...
This seems to be the grandest irony of all. The Internet comes along and it
promises democratization. It's all about you and me get equal access to the
same information at the same time. That was the promise. And now we're
investigating a scandal in which the bankers playing by the old rules decided
who was included, who was excluded, who got information, who didn't get
Democratization has been going on in this country, financially, since the
1970s. And people do have a lot more information than they used to, and they
can make better decisions, and they can trade stock more easily; all of that is
But if the events of Internet mania proved anything, they proved that Wall
Street is still a club; that insiders still have enormous advantage over the
rest of us; and all the technology and all the democratization has simply not
been able to trump that one fact.
A veteran investment banker, he is the founder, chairman, and CEO of W.R.
Hambrecht & Co., an online investment bank that has developed an innovative
"Dutch auction" IPO.
What is wrong with the way in which investment banks were doing business
during the bubble?
The IPO market, when it really heated up three or four years ago, created an
unsustainable volatile situation in the marketplace, where it became too easy
to raise money, and it became too easy to underwrite almost anything and raise
the money. On top of that, because it was such a hot market that gave such high
valuations to untested companies, it was very easy for underwriters to -- "take
advantage" is maybe the wrong word -- but I think underwriters' economic
agendas started to determine who would get the stock.
Instead of a situation where you're hired as an underwriter to place the stock
with people who are going to be the long-term shareholders, when you get into
volatile hot markets where you get this unusual first-day trading profits,
there's a tremendous propensity to give that stock to your best client. And
they in turn sell it and take a quick profit, and then the long-term buyer, the
guy you wanted in the first place, ends up buying it in the volatile
And it happens only when you get into these really hot markets. But it also
creates an atmosphere where an underwriter's sales force is, in effect, giving
away guaranteed profit. And if you're giving away guaranteed profit, you
probably at some point in the food chain are going to have some deal made that
returns something to the underwriter.
What would that be?
It's classically been commissions. In other words, the best clients of
investment firms are firms who trade the most and in effect pay big commissions
in trades. So they would be naturally listed as the best clients of the firm.
But what's wrong with best customers getting the biggest allocations?
Nothing, if it's in the normal course of business. I think the SEC is on record
as saying that an underwriter has a perfect right to place the stock with his
good customers. I think what happens sometimes, though, is that it moves beyond
that ... to where there is a sort of rate of return given back to someone who
creates a certain amount of profit.
There's a very thin line that divides ethical behavior and to move over into
behavior that's not in the best interests of the company or the final buyer or
even the underwriter. ...
Let's talk hypothetically, if the banks are using the IPOs as a form of
bribery, to bribe people to give them kickbacks, is this just a form of
cynicism? Or how do we understand that?
First of all, if that's what they truly did, if that's all it was, if it was
just a straight kickback, I think it's very clear that that was illegal. You
know there is that prospectus requirement that an underwriter disclose all the
compensation he gets for an offering, both direct and indirect. So if nothing
else, you've violated a prospectus requirement.
But beyond that, I'd say it's unethical, and it's bad business practice, and I
don't think you'll find anybody at the SEC or the NASD that wouldn't say that,
if that's what happened, that that isn't illegal. The problem is there's this
thin line between that and taking care of your best customers. And I think
that's going to be up to the courts and the SEC and everyone else to decide who
stepped over that line or not.
And I don't know. That's going to come out in the wash.
Senior partner at the Manhattan law firm of Milberg Weiss Bershad Hynes & Lerach, he has filed 110 lawsuits against scores of companies and seven leading
So who was doing this?
Well, the allegations in our complaint name many of the biggest investment
banks; which is different from historical allegations of this type where fringe
players were the ones who were engaged, or at least they were the ones that
were being fingered.
Now there are investigations that are ongoing with respect to CS First Boston,
Morgan Stanley, Merrill Lynch -- I mean, these are the biggest players. And
that's what makes this so shocking -- that it could infect even institutions of
that size -- Goldman Sachs. These are revered institutions in Wall Street. But
the profit from these activities became so enormous that the temptation to do
it was just overwhelming. ...
So what is different [this time] and how upset should people be about
I think they should be very upset, because the investment banker is supposed to
be a watchdog in the role of the underwriter. It's supposed to do due
diligence. It's supposed to protect its customer. It has a know-your-customer
rule. It has been invested with the ability to make money if it does the right
thing by the investor. It is supposed to be looking for quality; or if it's not
quality, to tell all of the truth about the product, so people can make an
informed investment decision. ...
But here we're dealing with a market manipulation by, not the issuer, but the
underwriter, by the investment banking community. And that's the scary thing --
that the investment banking community that has a fiduciary responsibility and a
statutory responsibility to protect the customer is actually creating the
artificiality in the market.
home · introduction · ipo game · crying foul · beyond the bubble · historical perspectives
discussion · interviews · readings & links · producer's chat
FRONTLINE · wgbh · pbs online
some photographs copyright ©1998 sam bailey
web site copyright 1995-2013 WGBH educational foundation