Commission Guidance Regarding Prohibited Conduct in Connection with IPO Allocations
summary
On April 7, 2005, the SEC issued interpretive guidance prohibiting underwriters from engaging in 'laddering'—conditioning IPO allocations on commitments to buy shares in the aftermarket—deeming such conduct market manipulation under Regulation M, regardless of intent or success, and citing prior enforcement actions against firms like J.P. Morgan, Goldman Sachs, and Morgan Stanley.
paragraph
On April 7, 2005, the SEC released interpretive guidance clarifying that underwriters violate Regulation M by inducing aftermarket purchases through tie-in agreements or other solicitations linked to IPO allocations, a practice known as 'laddering.' This prohibited conduct includes conditioning allocations on promises to buy shares at higher prices post-offering, encouraging customers to increase aftermarket bids, or rewarding investors with additional shares for aftermarket commitments. The SEC emphasized that such manipulation undermines market integrity and has been the basis of prior enforcement actions against major firms including J.P. Morgan, Goldman Sachs, and Morgan Stanley, and is illegal regardless of whether actual aftermarket transactions occur.
narrative
On April 7, 2005, the Securities and Exchange Commission issued interpretive guidance to reinforce prohibitions under Regulation M against manipulative practices in IPO allocations, particularly the practice known as 'laddering.' This conduct includes inducing aftermarket purchases by tying IPO allocations to commitments to buy shares at higher prices post-offering, soliciting expressions of aftermarket interest, proposing aftermarket prices, or rewarding customers with additional allocations for promising to support the stock after the offering. The SEC stressed that such activities artificially inflate demand, distort market pricing, and erode investor confidence, regardless of whether the aftermarket purchases actually occur or the underwriter intended to manipulate prices. These prohibitions build on prior enforcement actions against major firms like J.P. Morgan, Goldman Sachs, and Morgan Stanley during the late 1990s and early 2000s IPO boom. The guidance also clarified that while legitimate book-building and inquiries about long-term investment intent remain permissible, any solicitation designed to stimulate aftermarket demand during the restricted period is strictly prohibited. The SEC cited the 2003 IPO Advisory Committee Report and NASD Notice 03-72 as foundational to this update, urging firms to strengthen internal compliance and supervisory controls. The guidance was issued as part of a broader effort to restore market integrity following widespread abuses in IPO distributions and remains a key regulatory reference for underwriters today.
Classified pre-ipo-fraud(confidence 100%). EDGAR detection: forms S-1/Form D/1-A· recall 72% / precision 8%. detection rule →
Statutes
15 U.S.C. 77e15 U.S.C. 78o(b)17 CFR 242.100-10517 CFR 242.100(b)17 CFR 242.101(a)17 CFR 242.101(b)17 CFR 242.100(a)Section 5 of the Securities ActRule 10b-6
Parties
elizabeth marinoElizabeth Sandoeenforcement casesfile numberinterpretive releasejames brigaglianojoan collopyjonathan g. katzliza orrsecretary, securities and exchange commissionSecurities and Exchange Commission
Keywords
aftermarketregulationsecuritiesipodistributionofferingcustomersbids purchasesrestricted periodpurchasessecurities exchangeinducesharesimmediate aftermarketpurchase
Extracted insights
Dollar amounts 2
- $25.00M $25 million $10M–$100M
- $100K $100,000 $100K–$1M
Entities 11
- person elizabeth marino
- person Elizabeth Sandoe
- person enforcement cases
- person file number
- person interpretive release
- person james brigagliano
- person joan collopy
- person jonathan g. katz
- person liza orr
- agency secretary, securities and exchange commission
- agency Securities and Exchange Commission
Triples 18
- Securities And Exchange Commission published Interpretive Release On Prohibited Conduct In Connection With IPO Allocations
- Securities And Exchange Commission solicited Comments On Prohibited Conduct In Securities Distributions
- Interpretive Release effective date April 7, 2005
- Comments due date June 7, 2005
- File Number is S7-03-05
- Jonathan G. Katz is Secretary, Securities And Exchange Commission
- James Brigagliano is Assistant Director, Office Of Trading Practices
- Joan Collopy is Special Counsel, Office Of Trading Practices
- Elizabeth Sandoe is Special Counsel, Office Of Trading Practices
- Liza Orr is Special Counsel, Office Of Trading Practices
- Elizabeth Marino is Attorney, Office Of Trading Practices
- Securities And Exchange Commission brought Three Enforcement Cases Alleging Abuses In IPO Offering Process
- Enforcement Cases alleged Violations Of Regulation M In IPO Allocations
- Underwriters should avoid Tie-In Agreements And Solicitations Of Aftermarket Bids During Restricted Periods
- Underwriters should avoid Communicating That Aftermarket Interest Helps Obtain Hot IPO Allocations
- Underwriters should avoid Soliciting Customers For Immediate Aftermarket Orders Prior To Distribution Completion
- Underwriters should avoid Proposing Aftermarket Prices Or Encouraging Price Increases To Customers
- Underwriters should avoid Accepting 1 For 1 Aftermarket Purchase Commitments From IPO Allocation Recipients
Text layers
Extracted body text (49,425c)
SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 231, 241, and 271
[Release Nos. 33-8565; 34-51500; IC-26828; File No. S7-03-05]
Commission Guidance Regarding Prohibited Conduct in Connection with IPO Allocations
AGENCY: Securities and Exchange Commission.
ACTION: Interpretation; solicitation of comment.
SUMMARY: The Securities and Exchange Commission (Commission) is publishing this
interpretive release with respect to prohibited conduct in connection with securities distributions,
particularly with a focus on initial public offering (IPO) allocations. The Commission is
soliciting comment on the issues discussed here.
DATES:
Effective Date: April 7, 2005.
Comment Due Date: Comments should be received on or before June 7, 2005.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic comments:
• Use the Commission’s Internet comment form (http://www.sec.gov/rules/interp.shtml); or
• Send an e-mail to
[email protected]. Please include File Number S7-03-05 on the
subject line; or
• Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the
instructions for submitting comments.
Paper comments:
• Send paper comments in triplicate to Jonathan G. Katz, Secretary, Securities and
Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609.
All submissions should refer to File Number S7-03-05. This file number should be included on
the subject line if e-mail is used. To help us process and review your comments more efficiently,
please use only one method. The Commission will post all comments on the Commission’s
Internet Web site (
http://www.sec.gov/rules/interp.shtml). Comments are also available for
public inspection and copying in the Commission’s Public Reference Room, 450 Fifth Street,
NW, Washington, DC 20549. All comments received will be posted without change; we do not
edit personal identifying information from submissions. You should submit only information
that you wish to make available publicly.
FOR FURTHER INFORMATION CONTACT: Any of the following attorneys in the Office
of Trading Practices, Division of Market Regulation, Securities and Exchange Commission, 450
Fifth Street, N.W., Washington, D.C. 20549-1001, at (202) 942-0772: James Brigagliano,
Assistant Director; Joan Collopy, Special Counsel; Elizabeth Sandoe, Special Counsel; Liza Orr,
Special Counsel; or Elizabeth Marino, Attorney.
EXECUTIVE SUMMARY: The purpose of this release is to provide guidance under
Regulation M with respect to the process known as book-building, including the process for
allocating shares in initial public offerings (“IPOs”). The Commission recently brought three
enforcement cases alleging abuses in the offering process in contravention of Regulation M.
Based on these cases, the Commission seeks to highlight certain prohibited activities that
underwriters should avoid during restricted periods. These include:
• Inducements to purchase in the form of tie-in agreements or other solicitations of
aftermarket bids or purchases prior to the completion of the distribution.
2
• Communicating to customers that expressing an interest in buying shares in the
immediate aftermarket (“aftermarket interest”) or immediate aftermarket buying would
help them obtain allocations of hot IPOs.
• Soliciting customers prior to the completion of the distribution regarding whether and at
what price and in what quantity they intend to place immediate aftermarket orders for
IPO stock.
• Proposing aftermarket prices to customers or encouraging customers who provide
aftermarket interest to increase the prices that they are willing to place orders in the
immediate aftermarket.
• Accepting or seeking expressions of interest from customers that they intend to purchase
an amount of shares in the aftermarket equal to the size of their IPO allocation (“1 for 1”)
or intend to bid for or purchase specific amounts of shares in the aftermarket that are
pegged to the allocation amount without any reference to a fixed total position size.
• Soliciting aftermarket orders from customers before all IPO shares are distributed or
rewarding customers for aftermarket orders by allocating additional IPO shares to such
customers.
• Communicating to customers in connection with one offering that expressing an interest
in the aftermarket or buying in the aftermarket would help them obtain IPO allocations of
other hot IPOs.
SUPPLEMENTARY INFORMATION:
I. Introduction
Solicitations or other attempts to induce aftermarket bids or purchases during a
distribution undermine the integrity of the market as an independent pricing mechanism for the
3
offered securities by giving purchasers the impression that there is a scarcity of the offered
securities. This improper conduct by underwriters of IPOs erodes investor confidence in the
capital raising process. In recognition of the serious adverse impact of these activities, the
Commission has adopted rules, most recently embodied in Regulation M, which prohibit these
activities as a prophylactic matter.
1
Attempts to induce aftermarket bids or purchases during a Regulation M restricted
period, or a cooling-off period as it was known under its predecessor, Rule 10b-6, have always
been prohibited under these rules.
2
We first provided guidance under Rule 10b-6 concerning
abusive practices in connection with IPO allocations in 1961.
3
In 2000, the Division of Market
Regulation staff reminded underwriters that restricted period solicitations and tie-in agreements
for aftermarket purchases are prohibited conduct under Regulation M.
4
Recent enforcement
actions suggest that during the hot IPO market of the late 1990s and 2000, some underwriters
and other market participants failed to comply with Regulation M or previous guidance.
5
As a
1
Regulation M (17 CFR 242.100-105) generally prohibits inducements of any transactions other than those
necessary to conduct the offering. In the context of IPOs, the prohibition is generally discussed in terms of the
“aftermarket,”
i.e., trading after the distribution period is over. Regulation M is the successor to former Rules 10b-6,
10b-6A, 10b-7, 10b-8, and 10b-21, and includes the basic prohibitions of those rules.
See Securities Exchange Act
Release No. 38067 (December 20, 1996), 62 FR 520 (January 3, 1997) (Regulation M Adopting Release). Recently,
the Commission published for comment proposed amendments to Regulation M. Securities Exchange Act Release
No. 50831 (December 9, 2004), 69 FR 75774 (December 17, 2004) (Regulation M Proposing Release).
See infra
notes 6 and 11.
2
Regulation M defines the term restricted period in Rule 100(b) (17 CFR 242.100(b)). See infra note 11.
3
Securities Exchange Act Release No. 6536 (April 24, 1961) (stating that practice of distribution participants of
IPOs making “allotments to their customers only if such customers agree to make comparable purchases in the open
market after the issue is initially sold” violated Rule 10b-6).
4
Staff Legal Bulletin No. 10, “Prohibited Solicitations and ‘Tie-in’ Agreements for Aftermarket Purchases,”
August 25, 2000.
5
See SEC v. J.P. Morgan Securities, Inc., No. 1:03CV02028 (ESH) (Complaint) (October 1, 2003). See also
SEC v. Goldman Sachs Group, Inc., No. 05 SV 853 (SAS) (Complaint) (January 25, 2005); SEC v. Morgan Stanley
& Co., Inc., No. 1:05 CV 00166 (HHK) (Complaint) (January 25, 2005). In “hot” IPOs, investor demand
significantly exceeds the supply of securities in the offering and the stock trades at a premium in the immediate
4
result, we find it appropriate to remind distribution participants and their affiliated purchasers
that attempting to induce aftermarket bids or purchases during a restricted period violates
Regulation M. Such guidance is necessary at this time to forestall improper conduct while
continuing to promote legitimate underwriting practices that will facilitate capital formation.
II. Regulation M Prohibits Attempts to Induce Aftermarket Bids or Purchases
As a prophylactic rule, Regulation M precludes activities that could influence artificially
the market for an offered security.
6
Specifically, Rule 101
7
makes it unlawful for any
distribution participant
8
or its affiliated purchasers,
9
“directly or indirectly, to bid for, purchase,
or attempt to induce any person to bid for or purchase, a covered security”
10
during the
distribution’s restricted period.
11
Like its predecessor, Rule 10b-6, Regulation M is intended “to
aftermarket. See NYSE/NASD IPO Advisory Committee, Report and Recommendations
(
http://www.nasdr/com/pdf-text/ipo_report.pdf) (May 2003) (IPO Advisory Committee Report).
6
See Regulation M Adopting Release, supra note 1. On October 13, 2004, the Commission proposed
amendments that would extend the scope of Regulation M. Regulation M Proposing Release, 69 FR 75774. The
guidance provided in this release, which addresses misconduct that currently violates Regulation M, is consistent
with those proposed amendments.
7
17 CFR 242.101(a).
8
Distribution participants include underwriters, prospective underwriters, brokers, dealers, or other persons who
have agreed to participate or are participating in a distribution. 17 CFR 242.100(b).
9
Affiliated purchasers include, among others, persons acting, directly or indirectly, in concert with
distribution participants, issuers, or selling security holders in connection with the acquisition or
distribution of any covered security. 17 CFR 242.100(b).
10
A covered security is the security in distribution or any reference security. A reference security is any security
into which the security in distribution may be converted. 17 CFR 242.100(b).
11
17 CFR 242.101(a). Restricted period, as defined in Rule 100(b) of Regulation M, means: “(1) For any
security with an ADTV value of $100,000 or more of an issuer whose common equity securities have a public float
value of $25 million or more, the period beginning on the later of one business day prior to the determination of the
offering price or such time that a person becomes a distribution participant, and ending upon such person's
completion of participation in the distribution; and (2) For all other securities, the period beginning on the later of
five business days prior to the determination of the offering price or such time that a person becomes a distribution
participant, and ending upon such person's completion of participation in the distribution. (3) In the case of a
distribution involving a merger, acquisition, or exchange offer, the period beginning on the day proxy solicitation or
offering materials are first disseminated to security holders, and ending upon the completion of the distribution.” 17
CFR 242.100(b). Among other things, the proposed amendments to Regulation M would lengthen the “restricted
period” for IPOs beyond the current 5-day period, and update the ADTV and public float values in the definition of
5
assure that distributions of securities are free of the market effects of bids, purchases, and
inducements to purchase by those who have an interest in the success of a distribution.”
12
Regulation M therefore addresses direct and indirect market activity by distribution participants
and conduct by distribution participants “that causes or is likely to cause another person to bid
for or purchase covered securities.”
13
Attempts to induce bids or purchases of covered securities directed at aftermarket
transactions fundamentally interfere with the independence of the market dynamics that are
essential to the ability of investors to evaluate the terms on which securities are offered. Among
other things, attempts to induce aftermarket bids or purchases can give prospective IPO
purchasers the impression that there is a scarcity of the offered securities and the balance of their
buying interest therefore can only be satisfied in the aftermarket.
14
As discussed below, attempts
to induce aftermarket bids or purchases are prohibited throughout the restricted period.
restricted period to reflect changes in the value of the dollar since Regulation M’s adoption in 1996. The proposed
amendments would also incorporate into Regulation M’s restricted period definition the Commission’s long-
standing interpretation that valuation and election periods in connection with mergers, acquisitions, and exchange
offers are included in a restricted period. Regulation M Proposing Release, 69 FR 75774.
12
See Securities Exchange Act Release No. 21332 (September 19, 1984), 49 FR at 37572, Research Reports
(September 25, 1984). Similarly, the Regulation M Adopting Release states that Regulation M is “intended to
preclude manipulative conduct by persons with an interest in the outcome of an offering.” Regulation M Adopting
Release, 62 FR at 520. The scope of the prohibition is so comprehensive that a specific exception is included in
Regulation M to permit underwriters to solicit purchases of securities in the offering itself. 17 CFR 242.101(b)(9)
(excepting from Rule 101(a) “[o]ffers to sell or the solicitation of offers to buy the securities being distributed
(including securities acquired in stabilizing), or securities offered as principal by the person making such offer or
solicitation”).
13
Securities Exchange Act Release No. 33924 (April 19, 1994), 59 FR 21681 at 21687 (April 26, 1994)
(Regulation M Concept Release).
See 17 CFR 242.101(a) and Regulation M Adopting Release, supra note 1. See
also Americorp Securities, Inc., Securities Exchange Act Release No. 41728 (August 11, 1999) (broker-dealer firm
and CEO violated Rule 10b-6 by directing registered representatives to solicit and accept aftermarket purchase
orders for an IPO from numerous retail customers before the effective date of the IPO). See also SEC v. Wexler,
Securities Exchange Act Release No. 14489 (September 21, 1995);
P.N. MacIntyre & Co., Inc., Securities Exchange
Act Release No. 10694 (March 20, 1974) (broker-dealer firm violated Rule 10b-6 by bidding for, purchasing or
attempting to induce others to purchase securities in an offering underwritten by the broker-dealer firm before
completion of the firm’s participation in the distribution).
14
See Report of the Special Study of the Securities Markets of the Securities and Exchange Commission, H.R.
Doc. No. 88-95, pt. 1 at 520-21, 556 (1 Sess. 1963) (Special Study). The Special Study found that “[t]raders and
6
First, Regulation M applies to “attempts,” thus proscribing a distribution participant’s
conduct irrespective of whether it actually results in market activity by others.
15
It is the
inducement or the attempt to induce during the restricted period that Regulation M prohibits.
The induced activity (
i.e., aftermarket bids or purchases) may occur during or after the restricted
period, or indeed may never occur at all. Second, we have said that “inducement to purchase”
broadly refers to “activity that causes or is likely to cause another person to bid for or purchase
covered securities.”
16
The prophylactic prohibitions of Regulation M apply to such conduct
regardless of intent of the distribution participant or affiliated purchaser. Therefore, no proof of
scienter is necessary.
17
Whether particular conduct is a proscribed attempt to induce to bid for or
customers both stated that prior to the effective date [of the registration statement] retail firms received buy orders or
indications of interest from customers to purchase new issues at premium prices in the after-market and that these
orders were then transmitted to trading firms for execution in the after-market.” The Special Study then notes: “[I]f
broker-dealers are prospective underwriters or have agreed to participate in the distribution, they may, by soliciting
such orders, be attempting to induce customers to purchase the security prior to completion of the distribution and
thereby violate rule 10b-6 under the Exchange Act [now Rule 101 of Regulation M].”
See also Report of the
Securities and Exchange Commission Concerning the Hot Issues Markets at 37-38 (August 1984) (1984 Hot Issues
Report) (requiring customers who receive IPO allocations to purchase shares in the aftermarket stimulates demand
for the security and causes shares to trade at a premium in the aftermarket). As Staff Legal Bulletin No. 10.
discussed: “Solicitations and tie-in agreements for aftermarket purchases are manipulative because they undermine
the integrity of the market as an independent pricing mechanism for the offered security. Solicitations for
aftermarket purchases give purchasers in the offering the impression that there is scarcity of the offered securities.
This can stimulate demand and support the pricing of the offering.”
15
See SEC v. Burns, 614 F. Supp. 1360 (S.D.Cal. 1985), aff’d on other grounds, 816 F.2d 471, 477 (9
th
Cir. 1987)
(finding that “[s]o long as the participant attempted to induce purchases of those securities involved in the
distribution, and did so before he completed his participation in the distribution, the attempt to induce comes within
the scope of Rule 10b-6”).
See also Michael J. Markowski, Securities Exchange Act Release No. 44086 (March 20,
2001) (finding a Rule 10b-6 violation when a broker-dealer firm instructed its brokers to solicit aftermarket orders
during the distribution).
16
Regulation M Concept Release, 59 FR at 21687.
17
“Regulation M proscribes certain activities that offering participants could use to manipulate the price of an
offered security . . .. The Commission continues to believe that a prophylactic approach to anti-manipulation
regulation is the most effective means to protect the integrity of the offering process by precluding activities that
could influence artificially the market for the offered security.” Regulation M Adopting Release, 62 FR at 520.
See
also Regulation M Proposing Release, 69 FR at 75775 (stating “. . . Regulation M does not require the Commission
to prove in an enforcement action that distribution participants have a manipulative intent or purpose”).
7
purchase a covered security requires an analysis of all of the facts and circumstances surrounding
the distribution participant’s activity.
We are not addressing here the full spectrum of conduct prohibited by Regulation M.
Rather, our discussion is focused on applying Regulation M to particular facts and circumstances
that we have observed occurring in the most recent hot IPO market and providing guidance on
some types of activities that are impermissible in light of the requirements of Regulation M.
III. Regulation M and IPOs
A. “Hot” IPO Periods
In the context of an IPO, Regulation M’s prohibition on attempts to induce bids and
purchases focuses on impermissible conduct during the restricted period that could stimulate
others to engage in transactions when the trading market in the newly issued securities first
commences (
i.e., the “aftermarket”). “Hot” IPO markets present special problems in this
context.
18
By definition, hot IPO markets are characterized by high levels of demand for an
allocation of the IPO shares in the original distribution, and therefore the shares are a valuable
commodity. Underwriters may therefore be tempted to demand, require, solicit, encourage, or
otherwise attempt to induce investors to engage in immediate aftermarket transactions in order to
obtain an allocation of IPO shares.
19
Such activity violates Regulation M and also may violate
the general antifraud and anti-manipulation provisions of the securities laws.
20
18
See IPO Advisory Committee Report at 1-2, stating:
In recent years, however, public confidence in the integrity of the IPO process has eroded
significantly. Investigations have revealed that certain underwriters and other participants in IPOs
at times engaged in misconduct contrary to the best interests of investors and our markets . . .
Instances of this behavior became more frequent during the IPO “bubble” of the late 1990s and
2000 . . ..
19
See IPO Advisory Committee Report at 1 (discussing underwriters’ misconduct during the IPO “bubble” of the
late 1990s and 2000).
8
The Special Study in 1963 that focused on the “hot issue” market from 1959-1961
21
found that “[i]n the pricing of new issues, underwriters could not help but be influenced by the
knowledge that the prices of many issues would subsequently rise in the immediate after-
market . . ..”
22
The Special Study identified a number of problems and abuses that resulted from
this knowledge, including the solicitation of aftermarket purchases.
23
The Special Study found
that, while it was often difficult to determine whether solicitation of purchases in the aftermarket
occurred prior to or immediately following the effective date of the offering, customers of certain
distribution participants engaged in significant market purchases on the first day of trading, thus
suggesting that the participants actively solicited or recommended purchases at least as early as
the notice of effectiveness.
24
Subsequent studies also discussed underwriters’ conduct in connection with IPOs.
25
We
issued a report in 1984 analyzing the hot issue market from 1980-1983.
26
Among other things,
the 1984 Report found that underwriters used “tie-in” arrangements requiring customers, as a
condition of participation in a hot issue offering, either to agree to purchase additional shares of
20
“Any transaction or any series of transactions, whether or not effected pursuant to the provisions of Regulation
M . . . remain subject to the antifraud and antimanipulation provisions of the securities laws. . ..” 17 CFR 242.100(a).
21
Special Study, pt. 1.
22
Special Study, pt. 1, at 554. See also IPO Advisory Committee Report, similarly noting that during the late
1990s and 2000, the “large first-day price increases affected the allocation process by creating a pool of instant
profits for underwriters to distribute.”
Id. at 1.
23
Special Study, pt. 1, at 520-21, 556. See supra note 14.
24
Special Study, pt. 1, at 556 (also finding that “[t]o add to the aftermarket excitement, some managing
underwriters arranged for solicitation of customers at premium prices through nonparticipating firms.”)
See also
David Clurman,
Controlling a Hot Issue Market, 56 Cornell L. Rev. 74, 76 (1970).
25
See, e.g., IPO Advisory Committee Report.
26
“Report of the Securities and Exchange Commission Concerning Hot Issues Markets” (August 1984)
(1984 Hot Issues Report).
9
the same issue at a later time, or to participate in another offering.
27
Most recently, the
NYSE/NASD IPO Advisory Committee issued a report in May 2003 discussing underwriters’
conduct during the IPO “bubble” of the late 1990s and 2000, a period in which there were an
unusually large number of IPOs that traded “at extraordinary and immediate aftermarket
premiums.”
28
The report found that among the most harmful practices that artificially inflated
aftermarket prices were “allocating IPO shares based on a potential investor’s commitment to
purchase additional shares in the aftermarket at specified prices,” which the report referred to as
“laddering.”
29
B. Book-Building
Book-building refers to the process by which underwriters gather and assess potential
investor demand for an offering of securities and seek information important to their
determination as to the size and pricing of an issue.
30
When used, the IPO book-building process
begins with the filing of a registration statement with an initial estimated price range.
Underwriters and the issuer then conduct “road shows” to market the offering to potential
investors, generally institutions. The road shows provide investors, the issuer, and underwriters
the opportunity to gather important information from each other. Investors seek information
27
1984 Hot Issues Report, at 37-39. “This practice stimulates demand for a hot issue in the aftermarket thereby
facilitating the process by which stock prices rise to a premium.”
Id. at 37-38. We have stated that “making
allotments to customers only if such customers agree to make some comparable purchase in the open market after
the issue is initially sold” may violate the anti-manipulative provisions of the Securities Exchange Act of 1934
(Exchange Act), particularly Rule 10b-6 (which was replaced by Rules 101 and 102 of Regulation M), and may
violate other provisions of the federal securities laws. Securities Exchange Act Release No. 6536 (April 24, 1961).
28
IPO Advisory Committee Report, at 1.
29
IPO Advisory Committee Report, at 2. The Report described “laddering” as inducing investors to give orders to
purchase shares in the aftermarket at pre-arranged, escalating prices in exchange for receiving IPO allocations, and
stating that “[t]his conduct distorts the offering and the aftermarket and impairs investor confidence in the IPO
process.”
Id. at 6.
30
See In re Initial Public Offering Securities Litigation, 241 F. Supp. 2d 281, 388 n. 106 (S.D.N.Y. 2003) (book-
building “entails the lead underwriter gathering and assessing potential investors’ demand for the offering”).
10
about a company, its management and its prospects, and underwriters seek information from
investors that will assist them in determining particular investors’ interest in the company,
assessing demand for the offering, and improving pricing accuracy for the offering. Investors’
demand for an offering necessarily depends on the value they place, and the value they expect
the market to place, on the stock, both initially and in the future. In conjunction with the road
shows, there are discussions between the underwriter’s sales representatives and prospective
investors to obtain investors’ views about the issuer and the offered securities, and to obtain
indications of the investors’ interest in purchasing quantities of the underwritten securities in the
offering at particular prices.
31
As the IPO Advisory Committee Report stated: “[C]ollecting
information about investors’ long-term interest in, and valuation of, a prospective issuer is an
essential part of the book-building process.”
32
By aggregating information obtained during this
period from investors with other information, the underwriters and the issuer will agree on the
size and pricing of the offering, and the underwriters will decide how to allocate the IPO shares
to purchasers.
33
Information that underwriters typically attempt to gather from prospective investors
during the book-building process for an IPO, whether in high demand or not, includes:
34
• A customer’s evaluation of the issuer’s products, earnings, history, management, and
prospects.
• A customer's valuation of the securities being offered.
31
See IPO Advisory Committee Report, at 5-6. Actual sales or contracts for sale are prohibited during the period
prior to the registration statement for the offering becoming effective. 15 U.S.C. 77e.
32
IPO Advisory Committee Report, at 6.
33
See IPO Advisory Committee Report, at 4 (stating “[t]he pricing of an IPO is a business decision reached by the
issuer in consultation with the underwriter”).
See also Jay R. Ritter, Initial Public Offerings, Contemporary Finance
Digest, Vol. 2, No. 1 (Spring 1998), pp. 5-30, at §7.1 at pp. 19-21.
34
This is not an exhaustive list of all the information gathered during the book-building process.
11
• The amount of shares a customer seeks to purchase
in the offering at particular price
levels (i.e., indications of interest or conditional offers to buy).
• Whether the customer owns similar securities in his portfolio.
• At what prices the customer expects the shares will trade after the offering is
completed (
e.g., where the stock will be trading three to six months after the offering).
• Whether the customer intends to hold the securities as an investment (be a long-term
holder), or, instead, expects to sell the shares in the immediate aftermarket (also
known as “flipping”).
• The customer’s desired long-term future position in the security being offered or in
the relevant industry, and the price or prices at which the customer might accumulate
that position.
C. The Application of Regulation M to Book-building Activities
While we recognize the importance of the book-building process in obtaining and
assessing demand for an offering and in pricing the securities, we remind market participants that
there is no “book-building exception” to Regulation M for inducing or attempting to induce
aftermarket bids or purchases.
35
Although a distribution participant’s obtaining and assessing
information about demand for an offering during the book-building process would not, by itself,
constitute an inducement or attempt to induce, accompanying conduct or communications,
including one or more of the activities described below, may cause the collection of information
to be part of conduct that violates Regulation M.
Underwriters and other distribution participants must take care that their activities do not
cross the line into prohibited attempts to induce aftermarket bids or purchases by prospective
investors or others. Regulation M’s proscription of attempts to induce bids and purchases
“covers activity that causes or is likely to cause another person to bid for or purchase covered
35
The exception in Rule 101(b)(9) of Regulation M for offers to sell or the solicitation of offers to buy the
security being distributed does not extend to inducements or attempts to induce bids or purchases in the aftermarket
while the distribution is occurring.
12
securities.”
36
The determination as to whether an activity or communication constitutes
legitimate book-building or an attempt to induce a bid or purchase in violation of Regulation M
depends on the particular facts and circumstances surrounding such activity or communication.
D. Prohibited Attempts to Induce
As we previously stated, the purpose of this release is to provide guidance under
Regulation M with respect to book-building and the process for allocating shares in IPOs. The
activities we emphasize are prohibited do not represent an exhaustive list of conduct that violates
Regulation M because the facts and circumstances of particular communications or activities will
determine whether there is a Regulation M violation. This release is a reminder that certain
conduct that causes or is likely to cause an undertaking, a promise, a commitment, or an
understanding on the part of a customer to make aftermarket bids or purchases of an offered
security, in relation to an expected allocation of IPO shares, is impermissible under Regulation
M. We are not suggesting however that conduct is improper simply because it ascertains an
investor’s interest in purchasing an issuer’s securities or leads to the development by an investor
of an interest in purchasing securities of an issuer, whether in the offering or the aftermarket,
including as a result of communications between the investor and a distribution participant
regarding the issuer or the offering.
IV. Commission Guidance
The Commission has determined in the context of recent enforcement actions that the
following activities and conduct during the Regulation M restricted period violated Regulation
M:
37
36
Regulation M Concept Release, 59 FR at 21687.
37
The Commission has recently brought enforcement cases alleging violations of Regulation M. See SEC v.
Morgan Stanley & Co., (Compl.) (2005); SEC v. Goldman Sachs & Co., (Compl.) (2005); SEC v. J.P. Morgan
13
1. Inducements to purchase in the form of tie-in agreements
38
or other solicitations of
aftermarket bids or purchases prior to the completion of the distribution.
2.
Communicating to customers that expressing an interest in buying shares in the
immediate aftermarket (“aftermarket interest”) or immediate aftermarket buying would
help them obtain allocations of hot IPOs. The focus of this communication is clearly to
attempt to induce customers to bid for or purchase securities in the immediate aftermarket
in return for an allocation. However, inquiring as to customers’ desired future position in
the longer term (for example, three to six months) and the price or prices at which
customers might accumulate that position, without reference to immediate aftermarket
activity, does not, without more, fall within this violative conduct.
3.
Soliciting customers prior to the completion of the distribution regarding whether and at
what price and in what quantity they intend to place immediate aftermarket orders for
IPO stock.
39
Where the sales representative inquires whether the customer intends to
place orders in the immediate aftermarket, and if so, at what prices and quantities, the
clear expectation and understanding is that the customer will submit aftermarket orders at
Securities, Inc., (Compl.) (2003). See also Michael J. Markowski, supra note 16 and Securities Exchange Act
Release No. 6536,
supra note 3 (describing violations of Rule 10b-6, the predecessor to Regulation M).
38
In this context, tie-in agreements are agreements or contracts for the purchase of shares in the aftermarket in
exchange for an allocation. Such contracts may also violate the antifraud provisions of the Securities Act of 1933
(Securities Act) and the Exchange Act, and Section 5 of the Securities Act.
See Special Study, pt.1, at 521 n.93.
See also Staff Legal Bulletin No. 10. The solicitation of a tie-in is prohibited, irrespective of whether an agreement
or contract to purchase results.
39
We note that the district court in In re Initial Public Offering Antitrust Litigation, 287 F. Supp. 2d 497 (S.D.N.Y.
Nov. 3, 2003), appeal pending,
Billing v. Credit Suisse First Boston, Nos. 03-9284, 03-9288 (2d Cir.) stated that
“inquiries of customers or others interested in purchasing Class Securities concerning the number of shares that such
person would be willing to purchase in the aftermarket and the prices such person would be willing to pay for the
shares” are actions that are “expressly permitted during the ‘road show’ period.” Id. at 508. However, no provision
of the federal securities laws expressly permits the conduct described in the quotations during the “road show”
period. In fact, depending on the facts and circumstances, if the “road show” period overlaps with a restricted
period defined in Regulation M, then such actions may represent attempts to induce aftermarket bids or purchases in
violation of Rule 101 of Regulation M.
14
the prices and quantities discussed if the customer receives an allocation of shares.
However, inquiring as to a customer’s desired future position in the longer term (for
example, three to six months), and the price or prices at which the customer might
accumulate that position without reference to immediate aftermarket activity, does not,
without more, fall within this violative conduct. Soliciting aftermarket interest from
customers that the distribution participant knows, or should know, have no interest in
long-term holdings of the stock of IPO companies, may show that the firm or salesperson
was attempting to induce aftermarket activity.
4.
Proposing aftermarket prices to customers or encouraging customers who provide
aftermarket interest to increase the prices that they are willing to place orders in the
immediate aftermarket. Proposing aftermarket prices to customers creates the impression
of a strong offering demand and a scarcity of offering shares, which can facilitate a
distribution. Encouraging customers who provide aftermarket interest to increase the
price level at which they were willing to place orders in the aftermarket conveys to
customers that bidding for or purchasing in the immediate aftermarket at price levels
higher than their own initial price level or higher than other customers’ aftermarket price
levels is expected in consideration for an allocation or an improved allocation in the IPO.
Communication to customers of information obtained from third parties regarding their
valuation of an issuer or the offering price is not violative where the conduct would not
be likely to cause the customer to express an interest in paying a higher price in the
immediate aftermarket. Encouraging an increase in prices, including by communication
of prices of aftermarket interest of third parties would be viewed as improperly
15
conveying to a customer that a commitment in the aftermarket at higher price levels is
expected as described above.
5.
Accepting or seeking expressions of interest from customers that they intend to purchase
an amount of shares in the aftermarket equal to the size of their IPO allocation (“1 for 1”)
or intend to bid for or purchase specific amounts of shares in the aftermarket that are
pegged to the allocation amount without any reference to a fixed total position size. By
seeking this type of aftermarket interest from customers, the underwriter would be
attempting to induce customers to place orders or buy in the aftermarket. In contrast, it is
possible that a customer could express a desire to purchase in the aftermarket without
prompting from the salesman. Where the customer’s statement is spontaneous, there
may be no “attempt to induce” by the salesperson. However, if, for example, there had
been a prior course of dealing between the firm and the investor through which the firm
communicated that the investor was expected to provide this type of aftermarket price
and quantity information, the seemingly spontaneous statement of an intention to make
aftermarket purchases may in fact have been induced by the firm. In any event, whether
or not the customer’s statement is spontaneous, if a sales representative accepts a
customer’s offer to purchase shares in the immediate aftermarket that is expressly linked
to the receipt of an allocation, this is a prohibited tie-in agreement and violates
Regulation M.
40
40
By accepting such a commitment, the firm also may violate Section 5 under the Securities Act. See Special
Study, pt.1, at 521 n.93.
See also note 38 supra. In contrast, for example, where a sales representative rejects the
offer to make aftermarket purchases linked to the receipt of an allocation, and informs the customer that firm policy
prohibits allocations on that basis, the firm would not have engaged in activity that constitutes a prohibited tie-in
agreement in violation of Regulation M, notwithstanding that the customer ultimately was allocated IPO shares.
16
6. Soliciting aftermarket orders from customers before all IPO shares are distributed or
rewarding customers for aftermarket orders by allocating additional IPO shares to such
customers. If all of the IPO shares have not been distributed, an underwriter is still in a
restricted period and prohibited from attempting to induce aftermarket activity.
41
By
soliciting orders or rewarding customers who place orders in the immediate aftermarket
with additional IPO shares in the same offering, the underwriter is improperly stimulating
aftermarket purchases during the restricted period.
7.
Communicating to customers in connection with one offering that expressing an interest
in the aftermarket or buying in the aftermarket would help them obtain IPO allocations of
other hot IPOs. In this scenario, the broker would be inducing or attempting to induce
aftermarket bids or purchases by linking an expectation of aftermarket bids or purchases
to the customer’s desire to receive allocations in future hot IPOs. However, determining
that a customer is or may be a long-term investor in the securities of an issuer or one or
more other issuers and communications with a customer in connection with that
determination do not, in and of themselves, violate Regulation M, whether or not a
customer engages in aftermarket bids or purchases.
41
The definition of restricted period in Rule 100 of Regulation provides that a restricted period ends upon “such
person’s completion of participation in the distribution.” In the Adopting Release the Commission stated, “[u]nder
Regulation M, a person determines when its completion of participation in the distribution occurs based on the
person’s role in the distribution. An underwriter is deemed to have completed its participation in a distribution when
its participation has been distributed . . . and after any stabilization arrangements and trading restrictions in
connection with the distribution have been terminated. The definition contains a provision that an underwriter’s
participation is not deemed to be completed, however, if a syndicate overallotment option is exercised in an amount
that exceeds the net syndicate short position at the time of such exercise.” Regulation M Adopting Release, 62 FR
at 522.
17
Each of the above activities is an improper attempt to induce investors to bid for or
purchase covered securities in the aftermarket in order to receive IPO allocations.
42
These
solicitations or attempts to induce aimed at aftermarket transactions tend to: (1) create offering
demand; (2) cause artificial aftermarket price escalation; and (3) erode market integrity. As we
have stated before, when offerings are sold based upon an artificially manufactured perception of
scarcity and priced on stimulated buying pressure, IPO investors are unable to evaluate the
offering to determine that it has been appropriately priced.
43
Moreover, other investors who bid
for or purchase shares in the aftermarket would not know that the aftermarket demand had been
stimulated by the underwriters’ unlawful conduct.
In addition, certain conduct occurring after the restricted period, while not of itself illegal,
could be evidence that a distribution participant attempted during the restricted period to induce
customers to bid for or purchase stock in the aftermarket.
44
Recent enforcement cases contain
examples of such activity including: (1) follow-up solicitations for immediate aftermarket orders
from customers who had provided aftermarket interest earlier;
and (2) tracking or monitoring
customers’ aftermarket purchases to see whether they had followed through on their aftermarket
interest.
45
We recognize that there are legitimate reasons to monitor customer activity.
42
We note, however, that allocating offering shares in an amount less than the investor’s indication of interest for
shares in the offering in response to a solicitation to purchase in the offering would not, in and of itself, be
considered an attempt to induce aftermarket purchases.
43
See 1984 Hot Issue Report, at 37-39.
44
As discussed above, while aftermarket transactions can serve as evidence that there had been an attempt to
induce aftermarket bids or purchases, such evidence is not required to establish an attempt to induce in violation of
Regulation M. Additionally, oral attempts to induce aftermarket activity can be evidenced in a variety of ways. See,
e.g., Americorp, Inc., Securities Exchange Act Release No. 41728 (August 11, 1999) (broker dealer representatives
prepared order tickets for aftermarket orders prior to the IPO becoming effective).
45
For example, the sales representative may call the investor when aftermarket trading begins and ask why an
order had not been received from the investor; or the investor may be informed that he is being penalized for not
making aftermarket purchases by being denied allocations in future IPOs.
18
However, tracking customers’ aftermarket purchases in the first few days of trading following an
IPO could be evidence supporting a claim that the customers’ expressions of desire to purchase
in the aftermarket were induced.
V. Policies and Procedures
Underwriters should have effective policies and procedures to detect and prevent
prohibited solicitations, tie-in agreements, and other attempts to induce aftermarket bids or
purchases during the Regulation M restricted period.
46
Firms should implement policies that, at
a minimum, prohibit and monitor for the activities discussed in this release. Procedures and
systems for applying policies should be in place so that sales representatives and other firm
employees are reasonably supervised with a view to preventing and detecting improper attempts
to induce aftermarket bids or purchases during a restricted period. Firms also should take
corrective action if breaches occur.
VI. General Request for Comment
We will continue to monitor developments in IPO allocation practices. We invite anyone
who is interested to submit written comments on this release. Additionally, the Commission
solicits comment generally concerning underwriter conduct in connection with IPOs and other
distributions. The Commission will take these comments into consideration as it considers future
rulemaking.
List of Subjects
46
See, e.g., Exchange Act Section 15(b)(4)(E), 15 U.S.C. 78o(b)(4)(E). See also NASD Rule 3010(a) (requiring
member firms to establish and maintain a system to supervise the activities of each registered representative and
associated person that is reasonably designed to achieve compliance with applicable NASD rules, federal securities
laws and rules); NASD Notice to Members 03-72,
Request for Comment on Regulatory Approaches to Enhance IPO
Pricing Transparency (November 2003); IPO Advisory Committee Report, at 6, 19 (encouraging underwriters to
develop effective internal policies and procedures to prevent prohibited secondary market activity and
recommending that underwriters impose additional requirements to promote the highest standards of conduct,
including: (1) enhanced periodic internal review by the underwriter of its IPO supervisory procedures; and (2) a
heightened focus on the IPO process in SRO examinations for investment banking personnel).
19
17 CFR Parts 231, 241, and 271
Securities.
Amendments to the Code of Federal Regulations
For the reasons set out in the preamble, the Commission is amending Title 17, chapter II
of the Code of Federal Regulations as set forth below:
PART 231 – INTERPRETATIVE RELEASES RELATING TO THE
SECURITIES ACT OF 1933 AND GENERAL RULES AND REGULATIONS
THEREUNDER
Part 231 is amended by adding Release No. 33-8565 and the release date of April 7, 2005
to the list of interpretive releases.
PART 241 – INTERPRETATIVE RELEASES RELATING TO THE SECURITIES
EXCHANGE ACT OF 1934 AND GENERAL RULES AND REGULATIONS
THEREUNDER
Part 241 is amended by adding Release No. 34-51500 and the release date of April 7,
2005 to the list of interpretive releases.
20
PART 271 – INTERPRETATIVE RELEASES RELATING TO THE
INVESTMENT COMPANY ACT OF 1940 AND GENERAL RULES AND
REGULATIONS THEREUNDER
Part 271 is amended by adding Release No. IC-26828 and the release date of April 7,
2005 to the list of interpretive releases.
By the Commission.
Margaret H. McFarland
Deputy Secretary
Dated: April 7, 2005
21OCR text (49,472c · tika · 95% conf)
SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 231, 241, and 271
[Release Nos. 33-8565; 34-51500; IC-26828; File No. S7-03-05]
Commission Guidance Regarding Prohibited Conduct in Connection with IPO Allocations
AGENCY: Securities and Exchange Commission.
ACTION: Interpretation; solicitation of comment.
SUMMARY: The Securities and Exchange Commission (Commission) is publishing this
interpretive release with respect to prohibited conduct in connection with securities distributions,
particularly with a focus on initial public offering (IPO) allocations. The Commission is
soliciting comment on the issues discussed here.
DATES: Effective Date: April 7, 2005.
Comment Due Date: Comments should be received on or before June 7, 2005.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic comments:
• Use the Commission’s Internet comment form (http://www.sec.gov/rules/interp.shtml); or
• Send an e-mail to [email protected]. Please include File Number S7-03-05 on the
subject line; or
• Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the
instructions for submitting comments.
Paper comments:
• Send paper comments in triplicate to Jonathan G. Katz, Secretary, Securities and
Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609.
All submissions should refer to File Number S7-03-05. This file number should be included on
the subject line if e-mail is used. To help us process and review your comments more efficiently,
please use only one method. The Commission will post all comments on the Commission’s
Internet Web site (http://www.sec.gov/rules/interp.shtml). Comments are also available for
public inspection and copying in the Commission’s Public Reference Room, 450 Fifth Street,
NW, Washington, DC 20549. All comments received will be posted without change; we do not
edit personal identifying information from submissions. You should submit only information
that you wish to make available publicly.
FOR FURTHER INFORMATION CONTACT: Any of the following attorneys in the Office
of Trading Practices, Division of Market Regulation, Securities and Exchange Commission, 450
Fifth Street, N.W., Washington, D.C. 20549-1001, at (202) 942-0772: James Brigagliano,
Assistant Director; Joan Collopy, Special Counsel; Elizabeth Sandoe, Special Counsel; Liza Orr,
Special Counsel; or Elizabeth Marino, Attorney.
EXECUTIVE SUMMARY: The purpose of this release is to provide guidance under
Regulation M with respect to the process known as book-building, including the process for
allocating shares in initial public offerings (“IPOs”). The Commission recently brought three
enforcement cases alleging abuses in the offering process in contravention of Regulation M.
Based on these cases, the Commission seeks to highlight certain prohibited activities that
underwriters should avoid during restricted periods. These include:
• Inducements to purchase in the form of tie-in agreements or other solicitations of
aftermarket bids or purchases prior to the completion of the distribution.
2
• Communicating to customers that expressing an interest in buying shares in the
immediate aftermarket (“aftermarket interest”) or immediate aftermarket buying would
help them obtain allocations of hot IPOs.
• Soliciting customers prior to the completion of the distribution regarding whether and at
what price and in what quantity they intend to place immediate aftermarket orders for
IPO stock.
• Proposing aftermarket prices to customers or encouraging customers who provide
aftermarket interest to increase the prices that they are willing to place orders in the
immediate aftermarket.
• Accepting or seeking expressions of interest from customers that they intend to purchase
an amount of shares in the aftermarket equal to the size of their IPO allocation (“1 for 1”)
or intend to bid for or purchase specific amounts of shares in the aftermarket that are
pegged to the allocation amount without any reference to a fixed total position size.
• Soliciting aftermarket orders from customers before all IPO shares are distributed or
rewarding customers for aftermarket orders by allocating additional IPO shares to such
customers.
• Communicating to customers in connection with one offering that expressing an interest
in the aftermarket or buying in the aftermarket would help them obtain IPO allocations of
other hot IPOs.
SUPPLEMENTARY INFORMATION:
I. Introduction
Solicitations or other attempts to induce aftermarket bids or purchases during a
distribution undermine the integrity of the market as an independent pricing mechanism for the
3
offered securities by giving purchasers the impression that there is a scarcity of the offered
securities. This improper conduct by underwriters of IPOs erodes investor confidence in the
capital raising process. In recognition of the serious adverse impact of these activities, the
Commission has adopted rules, most recently embodied in Regulation M, which prohibit these
activities as a prophylactic matter.1
Attempts to induce aftermarket bids or purchases during a Regulation M restricted
period, or a cooling-off period as it was known under its predecessor, Rule 10b-6, have always
been prohibited under these rules.2 We first provided guidance under Rule 10b-6 concerning
abusive practices in connection with IPO allocations in 1961.3 In 2000, the Division of Market
Regulation staff reminded underwriters that restricted period solicitations and tie-in agreements
for aftermarket purchases are prohibited conduct under Regulation M.4 Recent enforcement
actions suggest that during the hot IPO market of the late 1990s and 2000, some underwriters
and other market participants failed to comply with Regulation M or previous guidance. 5 As a
1 Regulation M (17 CFR 242.100-105) generally prohibits inducements of any transactions other than those
necessary to conduct the offering. In the context of IPOs, the prohibition is generally discussed in terms of the
“aftermarket,” i.e., trading after the distribution period is over. Regulation M is the successor to former Rules 10b-6,
10b-6A, 10b-7, 10b-8, and 10b-21, and includes the basic prohibitions of those rules. See Securities Exchange Act
Release No. 38067 (December 20, 1996), 62 FR 520 (January 3, 1997) (Regulation M Adopting Release). Recently,
the Commission published for comment proposed amendments to Regulation M. Securities Exchange Act Release
No. 50831 (December 9, 2004), 69 FR 75774 (December 17, 2004) (Regulation M Proposing Release). See infra
notes 6 and 11.
2 Regulation M defines the term restricted period in Rule 100(b) (17 CFR 242.100(b)). See infra note 11.
3 Securities Exchange Act Release No. 6536 (April 24, 1961) (stating that practice of distribution participants of
IPOs making “allotments to their customers only if such customers agree to make comparable purchases in the open
market after the issue is initially sold” violated Rule 10b-6).
4 Staff Legal Bulletin No. 10, “Prohibited Solicitations and ‘Tie-in’ Agreements for Aftermarket Purchases,”
August 25, 2000.
5 See SEC v. J.P. Morgan Securities, Inc., No. 1:03CV02028 (ESH) (Complaint) (October 1, 2003). See also
SEC v. Goldman Sachs Group, Inc., No. 05 SV 853 (SAS) (Complaint) (January 25, 2005); SEC v. Morgan Stanley
& Co., Inc., No. 1:05 CV 00166 (HHK) (Complaint) (January 25, 2005). In “hot” IPOs, investor demand
significantly exceeds the supply of securities in the offering and the stock trades at a premium in the immediate
4
result, we find it appropriate to remind distribution participants and their affiliated purchasers
that attempting to induce aftermarket bids or purchases during a restricted period violates
Regulation M. Such guidance is necessary at this time to forestall improper conduct while
continuing to promote legitimate underwriting practices that will facilitate capital formation.
II. Regulation M Prohibits Attempts to Induce Aftermarket Bids or Purchases
As a prophylactic rule, Regulation M precludes activities that could influence artificially
the market for an offered security.6 Specifically, Rule 1017 makes it unlawful for any
distribution participant8 or its affiliated purchasers,9 “directly or indirectly, to bid for, purchase,
or attempt to induce any person to bid for or purchase, a covered security”10 during the
distribution’s restricted period.11 Like its predecessor, Rule 10b-6, Regulation M is intended “to
aftermarket. See NYSE/NASD IPO Advisory Committee, Report and Recommendations
(http://www.nasdr/com/pdf-text/ipo_report.pdf) (May 2003) (IPO Advisory Committee Report).
6 See Regulation M Adopting Release, supra note 1. On October 13, 2004, the Commission proposed
amendments that would extend the scope of Regulation M. Regulation M Proposing Release, 69 FR 75774. The
guidance provided in this release, which addresses misconduct that currently violates Regulation M, is consistent
with those proposed amendments.
7 17 CFR 242.101(a).
8 Distribution participants include underwriters, prospective underwriters, brokers, dealers, or other persons who
have agreed to participate or are participating in a distribution. 17 CFR 242.100(b).
9 Affiliated purchasers include, among others, persons acting, directly or indirectly, in concert with
distribution participants, issuers, or selling security holders in connection with the acquisition or
distribution of any covered security. 17 CFR 242.100(b).
10 A covered security is the security in distribution or any reference security. A reference security is any security
into which the security in distribution may be converted. 17 CFR 242.100(b).
11 17 CFR 242.101(a). Restricted period, as defined in Rule 100(b) of Regulation M, means: “(1) For any
security with an ADTV value of $100,000 or more of an issuer whose common equity securities have a public float
value of $25 million or more, the period beginning on the later of one business day prior to the determination of the
offering price or such time that a person becomes a distribution participant, and ending upon such person's
completion of participation in the distribution; and (2) For all other securities, the period beginning on the later of
five business days prior to the determination of the offering price or such time that a person becomes a distribution
participant, and ending upon such person's completion of participation in the distribution. (3) In the case of a
distribution involving a merger, acquisition, or exchange offer, the period beginning on the day proxy solicitation or
offering materials are first disseminated to security holders, and ending upon the completion of the distribution.” 17
CFR 242.100(b). Among other things, the proposed amendments to Regulation M would lengthen the “restricted
period” for IPOs beyond the current 5-day period, and update the ADTV and public float values in the definition of
5
assure that distributions of securities are free of the market effects of bids, purchases, and
inducements to purchase by those who have an interest in the success of a distribution.”12
Regulation M therefore addresses direct and indirect market activity by distribution participants
and conduct by distribution participants “that causes or is likely to cause another person to bid
for or purchase covered securities.”13
Attempts to induce bids or purchases of covered securities directed at aftermarket
transactions fundamentally interfere with the independence of the market dynamics that are
essential to the ability of investors to evaluate the terms on which securities are offered. Among
other things, attempts to induce aftermarket bids or purchases can give prospective IPO
purchasers the impression that there is a scarcity of the offered securities and the balance of their
buying interest therefore can only be satisfied in the aftermarket.14 As discussed below, attempts
to induce aftermarket bids or purchases are prohibited throughout the restricted period.
restricted period to reflect changes in the value of the dollar since Regulation M’s adoption in 1996. The proposed
amendments would also incorporate into Regulation M’s restricted period definition the Commission’s long-
standing interpretation that valuation and election periods in connection with mergers, acquisitions, and exchange
offers are included in a restricted period. Regulation M Proposing Release, 69 FR 75774.
12 See Securities Exchange Act Release No. 21332 (September 19, 1984), 49 FR at 37572, Research Reports
(September 25, 1984). Similarly, the Regulation M Adopting Release states that Regulation M is “intended to
preclude manipulative conduct by persons with an interest in the outcome of an offering.” Regulation M Adopting
Release, 62 FR at 520. The scope of the prohibition is so comprehensive that a specific exception is included in
Regulation M to permit underwriters to solicit purchases of securities in the offering itself. 17 CFR 242.101(b)(9)
(excepting from Rule 101(a) “[o]ffers to sell or the solicitation of offers to buy the securities being distributed
(including securities acquired in stabilizing), or securities offered as principal by the person making such offer or
solicitation”).
13 Securities Exchange Act Release No. 33924 (April 19, 1994), 59 FR 21681 at 21687 (April 26, 1994)
(Regulation M Concept Release). See 17 CFR 242.101(a) and Regulation M Adopting Release, supra note 1. See
also Americorp Securities, Inc., Securities Exchange Act Release No. 41728 (August 11, 1999) (broker-dealer firm
and CEO violated Rule 10b-6 by directing registered representatives to solicit and accept aftermarket purchase
orders for an IPO from numerous retail customers before the effective date of the IPO). See also SEC v. Wexler,
Securities Exchange Act Release No. 14489 (September 21, 1995); P.N. MacIntyre & Co., Inc., Securities Exchange
Act Release No. 10694 (March 20, 1974) (broker-dealer firm violated Rule 10b-6 by bidding for, purchasing or
attempting to induce others to purchase securities in an offering underwritten by the broker-dealer firm before
completion of the firm’s participation in the distribution).
14 See Report of the Special Study of the Securities Markets of the Securities and Exchange Commission, H.R.
Doc. No. 88-95, pt. 1 at 520-21, 556 (1 Sess. 1963) (Special Study). The Special Study found that “[t]raders and
6
First, Regulation M applies to “attempts,” thus proscribing a distribution participant’s
conduct irrespective of whether it actually results in market activity by others.15 It is the
inducement or the attempt to induce during the restricted period that Regulation M prohibits.
The induced activity (i.e., aftermarket bids or purchases) may occur during or after the restricted
period, or indeed may never occur at all. Second, we have said that “inducement to purchase”
broadly refers to “activity that causes or is likely to cause another person to bid for or purchase
covered securities.”16 The prophylactic prohibitions of Regulation M apply to such conduct
regardless of intent of the distribution participant or affiliated purchaser. Therefore, no proof of
scienter is necessary.17 Whether particular conduct is a proscribed attempt to induce to bid for or
customers both stated that prior to the effective date [of the registration statement] retail firms received buy orders or
indications of interest from customers to purchase new issues at premium prices in the after-market and that these
orders were then transmitted to trading firms for execution in the after-market.” The Special Study then notes: “[I]f
broker-dealers are prospective underwriters or have agreed to participate in the distribution, they may, by soliciting
such orders, be attempting to induce customers to purchase the security prior to completion of the distribution and
thereby violate rule 10b-6 under the Exchange Act [now Rule 101 of Regulation M].” See also Report of the
Securities and Exchange Commission Concerning the Hot Issues Markets at 37-38 (August 1984) (1984 Hot Issues
Report) (requiring customers who receive IPO allocations to purchase shares in the aftermarket stimulates demand
for the security and causes shares to trade at a premium in the aftermarket). As Staff Legal Bulletin No. 10.
discussed: “Solicitations and tie-in agreements for aftermarket purchases are manipulative because they undermine
the integrity of the market as an independent pricing mechanism for the offered security. Solicitations for
aftermarket purchases give purchasers in the offering the impression that there is scarcity of the offered securities.
This can stimulate demand and support the pricing of the offering.”
15 See SEC v. Burns, 614 F. Supp. 1360 (S.D.Cal. 1985), aff’d on other grounds, 816 F.2d 471, 477 (9th Cir. 1987)
(finding that “[s]o long as the participant attempted to induce purchases of those securities involved in the
distribution, and did so before he completed his participation in the distribution, the attempt to induce comes within
the scope of Rule 10b-6”). See also Michael J. Markowski, Securities Exchange Act Release No. 44086 (March 20,
2001) (finding a Rule 10b-6 violation when a broker-dealer firm instructed its brokers to solicit aftermarket orders
during the distribution).
16 Regulation M Concept Release, 59 FR at 21687.
17 “Regulation M proscribes certain activities that offering participants could use to manipulate the price of an
offered security . . .. The Commission continues to believe that a prophylactic approach to anti-manipulation
regulation is the most effective means to protect the integrity of the offering process by precluding activities that
could influence artificially the market for the offered security.” Regulation M Adopting Release, 62 FR at 520. See
also Regulation M Proposing Release, 69 FR at 75775 (stating “. . . Regulation M does not require the Commission
to prove in an enforcement action that distribution participants have a manipulative intent or purpose”).
7
purchase a covered security requires an analysis of all of the facts and circumstances surrounding
the distribution participant’s activity.
We are not addressing here the full spectrum of conduct prohibited by Regulation M.
Rather, our discussion is focused on applying Regulation M to particular facts and circumstances
that we have observed occurring in the most recent hot IPO market and providing guidance on
some types of activities that are impermissible in light of the requirements of Regulation M.
III. Regulation M and IPOs
A. “Hot” IPO Periods
In the context of an IPO, Regulation M’s prohibition on attempts to induce bids and
purchases focuses on impermissible conduct during the restricted period that could stimulate
others to engage in transactions when the trading market in the newly issued securities first
commences (i.e., the “aftermarket”). “Hot” IPO markets present special problems in this
context.18 By definition, hot IPO markets are characterized by high levels of demand for an
allocation of the IPO shares in the original distribution, and therefore the shares are a valuable
commodity. Underwriters may therefore be tempted to demand, require, solicit, encourage, or
otherwise attempt to induce investors to engage in immediate aftermarket transactions in order to
obtain an allocation of IPO shares.19 Such activity violates Regulation M and also may violate
the general antifraud and anti-manipulation provisions of the securities laws.20
18 See IPO Advisory Committee Report at 1-2, stating:
In recent years, however, public confidence in the integrity of the IPO process has eroded
significantly. Investigations have revealed that certain underwriters and other participants in IPOs
at times engaged in misconduct contrary to the best interests of investors and our markets . . .
Instances of this behavior became more frequent during the IPO “bubble” of the late 1990s and
2000 . . ..
19 See IPO Advisory Committee Report at 1 (discussing underwriters’ misconduct during the IPO “bubble” of the
late 1990s and 2000).
8
The Special Study in 1963 that focused on the “hot issue” market from 1959-196121
found that “[i]n the pricing of new issues, underwriters could not help but be influenced by the
knowledge that the prices of many issues would subsequently rise in the immediate after-
market . . ..”22 The Special Study identified a number of problems and abuses that resulted from
this knowledge, including the solicitation of aftermarket purchases.23 The Special Study found
that, while it was often difficult to determine whether solicitation of purchases in the aftermarket
occurred prior to or immediately following the effective date of the offering, customers of certain
distribution participants engaged in significant market purchases on the first day of trading, thus
suggesting that the participants actively solicited or recommended purchases at least as early as
the notice of effectiveness.24
Subsequent studies also discussed underwriters’ conduct in connection with IPOs.25 We
issued a report in 1984 analyzing the hot issue market from 1980-1983.26 Among other things,
the 1984 Report found that underwriters used “tie-in” arrangements requiring customers, as a
condition of participation in a hot issue offering, either to agree to purchase additional shares of
20 “Any transaction or any series of transactions, whether or not effected pursuant to the provisions of Regulation
M . . . remain subject to the antifraud and antimanipulation provisions of the securities laws. . ..” 17 CFR 242.100(a).
21 Special Study, pt. 1.
22 Special Study, pt. 1, at 554. See also IPO Advisory Committee Report, similarly noting that during the late
1990s and 2000, the “large first-day price increases affected the allocation process by creating a pool of instant
profits for underwriters to distribute.” Id. at 1.
23 Special Study, pt. 1, at 520-21, 556. See supra note 14.
24 Special Study, pt. 1, at 556 (also finding that “[t]o add to the aftermarket excitement, some managing
underwriters arranged for solicitation of customers at premium prices through nonparticipating firms.”) See also
David Clurman, Controlling a Hot Issue Market, 56 Cornell L. Rev. 74, 76 (1970).
25 See, e.g., IPO Advisory Committee Report.
26 “Report of the Securities and Exchange Commission Concerning Hot Issues Markets” (August 1984)
(1984 Hot Issues Report).
9
the same issue at a later time, or to participate in another offering.27 Most recently, the
NYSE/NASD IPO Advisory Committee issued a report in May 2003 discussing underwriters’
conduct during the IPO “bubble” of the late 1990s and 2000, a period in which there were an
unusually large number of IPOs that traded “at extraordinary and immediate aftermarket
premiums.”28 The report found that among the most harmful practices that artificially inflated
aftermarket prices were “allocating IPO shares based on a potential investor’s commitment to
purchase additional shares in the aftermarket at specified prices,” which the report referred to as
“laddering.”29
B. Book-Building
Book-building refers to the process by which underwriters gather and assess potential
investor demand for an offering of securities and seek information important to their
determination as to the size and pricing of an issue.30 When used, the IPO book-building process
begins with the filing of a registration statement with an initial estimated price range.
Underwriters and the issuer then conduct “road shows” to market the offering to potential
investors, generally institutions. The road shows provide investors, the issuer, and underwriters
the opportunity to gather important information from each other. Investors seek information
27 1984 Hot Issues Report, at 37-39. “This practice stimulates demand for a hot issue in the aftermarket thereby
facilitating the process by which stock prices rise to a premium.” Id. at 37-38. We have stated that “making
allotments to customers only if such customers agree to make some comparable purchase in the open market after
the issue is initially sold” may violate the anti-manipulative provisions of the Securities Exchange Act of 1934
(Exchange Act), particularly Rule 10b-6 (which was replaced by Rules 101 and 102 of Regulation M), and may
violate other provisions of the federal securities laws. Securities Exchange Act Release No. 6536 (April 24, 1961).
28 IPO Advisory Committee Report, at 1.
29 IPO Advisory Committee Report, at 2. The Report described “laddering” as inducing investors to give orders to
purchase shares in the aftermarket at pre-arranged, escalating prices in exchange for receiving IPO allocations, and
stating that “[t]his conduct distorts the offering and the aftermarket and impairs investor confidence in the IPO
process.” Id. at 6.
30 See In re Initial Public Offering Securities Litigation, 241 F. Supp. 2d 281, 388 n. 106 (S.D.N.Y. 2003) (book-
building “entails the lead underwriter gathering and assessing potential investors’ demand for the offering”).
10
about a company, its management and its prospects, and underwriters seek information from
investors that will assist them in determining particular investors’ interest in the company,
assessing demand for the offering, and improving pricing accuracy for the offering. Investors’
demand for an offering necessarily depends on the value they place, and the value they expect
the market to place, on the stock, both initially and in the future. In conjunction with the road
shows, there are discussions between the underwriter’s sales representatives and prospective
investors to obtain investors’ views about the issuer and the offered securities, and to obtain
indications of the investors’ interest in purchasing quantities of the underwritten securities in the
offering at particular prices.31 As the IPO Advisory Committee Report stated: “[C]ollecting
information about investors’ long-term interest in, and valuation of, a prospective issuer is an
essential part of the book-building process.”32 By aggregating information obtained during this
period from investors with other information, the underwriters and the issuer will agree on the
size and pricing of the offering, and the underwriters will decide how to allocate the IPO shares
to purchasers.33
Information that underwriters typically attempt to gather from prospective investors
during the book-building process for an IPO, whether in high demand or not, includes:34
• A customer’s evaluation of the issuer’s products, earnings, history, management, and
prospects.
• A customer's valuation of the securities being offered.
31 See IPO Advisory Committee Report, at 5-6. Actual sales or contracts for sale are prohibited during the period
prior to the registration statement for the offering becoming effective. 15 U.S.C. 77e.
32 IPO Advisory Committee Report, at 6.
33 See IPO Advisory Committee Report, at 4 (stating “[t]he pricing of an IPO is a business decision reached by the
issuer in consultation with the underwriter”). See also Jay R. Ritter, Initial Public Offerings, Contemporary Finance
Digest, Vol. 2, No. 1 (Spring 1998), pp. 5-30, at §7.1 at pp. 19-21.
34 This is not an exhaustive list of all the information gathered during the book-building process.
11
• The amount of shares a customer seeks to purchase in the offering at particular price
levels (i.e., indications of interest or conditional offers to buy).
• Whether the customer owns similar securities in his portfolio.
• At what prices the customer expects the shares will trade after the offering is
completed (e.g., where the stock will be trading three to six months after the offering).
• Whether the customer intends to hold the securities as an investment (be a long-term
holder), or, instead, expects to sell the shares in the immediate aftermarket (also
known as “flipping”).
• The customer’s desired long-term future position in the security being offered or in
the relevant industry, and the price or prices at which the customer might accumulate
that position.
C. The Application of Regulation M to Book-building Activities
While we recognize the importance of the book-building process in obtaining and
assessing demand for an offering and in pricing the securities, we remind market participants that
there is no “book-building exception” to Regulation M for inducing or attempting to induce
aftermarket bids or purchases.35 Although a distribution participant’s obtaining and assessing
information about demand for an offering during the book-building process would not, by itself,
constitute an inducement or attempt to induce, accompanying conduct or communications,
including one or more of the activities described below, may cause the collection of information
to be part of conduct that violates Regulation M.
Underwriters and other distribution participants must take care that their activities do not
cross the line into prohibited attempts to induce aftermarket bids or purchases by prospective
investors or others. Regulation M’s proscription of attempts to induce bids and purchases
“covers activity that causes or is likely to cause another person to bid for or purchase covered
35 The exception in Rule 101(b)(9) of Regulation M for offers to sell or the solicitation of offers to buy the
security being distributed does not extend to inducements or attempts to induce bids or purchases in the aftermarket
while the distribution is occurring.
12
securities.”36 The determination as to whether an activity or communication constitutes
legitimate book-building or an attempt to induce a bid or purchase in violation of Regulation M
depends on the particular facts and circumstances surrounding such activity or communication.
D. Prohibited Attempts to Induce
As we previously stated, the purpose of this release is to provide guidance under
Regulation M with respect to book-building and the process for allocating shares in IPOs. The
activities we emphasize are prohibited do not represent an exhaustive list of conduct that violates
Regulation M because the facts and circumstances of particular communications or activities will
determine whether there is a Regulation M violation. This release is a reminder that certain
conduct that causes or is likely to cause an undertaking, a promise, a commitment, or an
understanding on the part of a customer to make aftermarket bids or purchases of an offered
security, in relation to an expected allocation of IPO shares, is impermissible under Regulation
M. We are not suggesting however that conduct is improper simply because it ascertains an
investor’s interest in purchasing an issuer’s securities or leads to the development by an investor
of an interest in purchasing securities of an issuer, whether in the offering or the aftermarket,
including as a result of communications between the investor and a distribution participant
regarding the issuer or the offering.
IV. Commission Guidance
The Commission has determined in the context of recent enforcement actions that the
following activities and conduct during the Regulation M restricted period violated Regulation
M:37
36 Regulation M Concept Release, 59 FR at 21687.
37 The Commission has recently brought enforcement cases alleging violations of Regulation M. See SEC v.
Morgan Stanley & Co., (Compl.) (2005); SEC v. Goldman Sachs & Co., (Compl.) (2005); SEC v. J.P. Morgan
13
1. Inducements to purchase in the form of tie-in agreements38 or other solicitations of
aftermarket bids or purchases prior to the completion of the distribution.
2. Communicating to customers that expressing an interest in buying shares in the
immediate aftermarket (“aftermarket interest”) or immediate aftermarket buying would
help them obtain allocations of hot IPOs. The focus of this communication is clearly to
attempt to induce customers to bid for or purchase securities in the immediate aftermarket
in return for an allocation. However, inquiring as to customers’ desired future position in
the longer term (for example, three to six months) and the price or prices at which
customers might accumulate that position, without reference to immediate aftermarket
activity, does not, without more, fall within this violative conduct.
3. Soliciting customers prior to the completion of the distribution regarding whether and at
what price and in what quantity they intend to place immediate aftermarket orders for
IPO stock.39 Where the sales representative inquires whether the customer intends to
place orders in the immediate aftermarket, and if so, at what prices and quantities, the
clear expectation and understanding is that the customer will submit aftermarket orders at
Securities, Inc., (Compl.) (2003). See also Michael J. Markowski, supra note 16 and Securities Exchange Act
Release No. 6536, supra note 3 (describing violations of Rule 10b-6, the predecessor to Regulation M).
38 In this context, tie-in agreements are agreements or contracts for the purchase of shares in the aftermarket in
exchange for an allocation. Such contracts may also violate the antifraud provisions of the Securities Act of 1933
(Securities Act) and the Exchange Act, and Section 5 of the Securities Act. See Special Study, pt.1, at 521 n.93.
See also Staff Legal Bulletin No. 10. The solicitation of a tie-in is prohibited, irrespective of whether an agreement
or contract to purchase results.
39 We note that the district court in In re Initial Public Offering Antitrust Litigation, 287 F. Supp. 2d 497 (S.D.N.Y.
Nov. 3, 2003), appeal pending, Billing v. Credit Suisse First Boston, Nos. 03-9284, 03-9288 (2d Cir.) stated that
“inquiries of customers or others interested in purchasing Class Securities concerning the number of shares that such
person would be willing to purchase in the aftermarket and the prices such person would be willing to pay for the
shares” are actions that are “expressly permitted during the ‘road show’ period.” Id. at 508. However, no provision
of the federal securities laws expressly permits the conduct described in the quotations during the “road show”
period. In fact, depending on the facts and circumstances, if the “road show” period overlaps with a restricted
period defined in Regulation M, then such actions may represent attempts to induce aftermarket bids or purchases in
violation of Rule 101 of Regulation M.
14
the prices and quantities discussed if the customer receives an allocation of shares.
However, inquiring as to a customer’s desired future position in the longer term (for
example, three to six months), and the price or prices at which the customer might
accumulate that position without reference to immediate aftermarket activity, does not,
without more, fall within this violative conduct. Soliciting aftermarket interest from
customers that the distribution participant knows, or should know, have no interest in
long-term holdings of the stock of IPO companies, may show that the firm or salesperson
was attempting to induce aftermarket activity.
4. Proposing aftermarket prices to customers or encouraging customers who provide
aftermarket interest to increase the prices that they are willing to place orders in the
immediate aftermarket. Proposing aftermarket prices to customers creates the impression
of a strong offering demand and a scarcity of offering shares, which can facilitate a
distribution. Encouraging customers who provide aftermarket interest to increase the
price level at which they were willing to place orders in the aftermarket conveys to
customers that bidding for or purchasing in the immediate aftermarket at price levels
higher than their own initial price level or higher than other customers’ aftermarket price
levels is expected in consideration for an allocation or an improved allocation in the IPO.
Communication to customers of information obtained from third parties regarding their
valuation of an issuer or the offering price is not violative where the conduct would not
be likely to cause the customer to express an interest in paying a higher price in the
immediate aftermarket. Encouraging an increase in prices, including by communication
of prices of aftermarket interest of third parties would be viewed as improperly
15
conveying to a customer that a commitment in the aftermarket at higher price levels is
expected as described above.
5. Accepting or seeking expressions of interest from customers that they intend to purchase
an amount of shares in the aftermarket equal to the size of their IPO allocation (“1 for 1”)
or intend to bid for or purchase specific amounts of shares in the aftermarket that are
pegged to the allocation amount without any reference to a fixed total position size. By
seeking this type of aftermarket interest from customers, the underwriter would be
attempting to induce customers to place orders or buy in the aftermarket. In contrast, it is
possible that a customer could express a desire to purchase in the aftermarket without
prompting from the salesman. Where the customer’s statement is spontaneous, there
may be no “attempt to induce” by the salesperson. However, if, for example, there had
been a prior course of dealing between the firm and the investor through which the firm
communicated that the investor was expected to provide this type of aftermarket price
and quantity information, the seemingly spontaneous statement of an intention to make
aftermarket purchases may in fact have been induced by the firm. In any event, whether
or not the customer’s statement is spontaneous, if a sales representative accepts a
customer’s offer to purchase shares in the immediate aftermarket that is expressly linked
to the receipt of an allocation, this is a prohibited tie-in agreement and violates
Regulation M.40
40 By accepting such a commitment, the firm also may violate Section 5 under the Securities Act. See Special
Study, pt.1, at 521 n.93. See also note 38 supra. In contrast, for example, where a sales representative rejects the
offer to make aftermarket purchases linked to the receipt of an allocation, and informs the customer that firm policy
prohibits allocations on that basis, the firm would not have engaged in activity that constitutes a prohibited tie-in
agreement in violation of Regulation M, notwithstanding that the customer ultimately was allocated IPO shares.
16
6. Soliciting aftermarket orders from customers before all IPO shares are distributed or
rewarding customers for aftermarket orders by allocating additional IPO shares to such
customers. If all of the IPO shares have not been distributed, an underwriter is still in a
restricted period and prohibited from attempting to induce aftermarket activity.41 By
soliciting orders or rewarding customers who place orders in the immediate aftermarket
with additional IPO shares in the same offering, the underwriter is improperly stimulating
aftermarket purchases during the restricted period.
7. Communicating to customers in connection with one offering that expressing an interest
in the aftermarket or buying in the aftermarket would help them obtain IPO allocations of
other hot IPOs. In this scenario, the broker would be inducing or attempting to induce
aftermarket bids or purchases by linking an expectation of aftermarket bids or purchases
to the customer’s desire to receive allocations in future hot IPOs. However, determining
that a customer is or may be a long-term investor in the securities of an issuer or one or
more other issuers and communications with a customer in connection with that
determination do not, in and of themselves, violate Regulation M, whether or not a
customer engages in aftermarket bids or purchases.
41 The definition of restricted period in Rule 100 of Regulation provides that a restricted period ends upon “such
person’s completion of participation in the distribution.” In the Adopting Release the Commission stated, “[u]nder
Regulation M, a person determines when its completion of participation in the distribution occurs based on the
person’s role in the distribution. An underwriter is deemed to have completed its participation in a distribution when
its participation has been distributed . . . and after any stabilization arrangements and trading restrictions in
connection with the distribution have been terminated. The definition contains a provision that an underwriter’s
participation is not deemed to be completed, however, if a syndicate overallotment option is exercised in an amount
that exceeds the net syndicate short position at the time of such exercise.” Regulation M Adopting Release, 62 FR
at 522.
17
Each of the above activities is an improper attempt to induce investors to bid for or
purchase covered securities in the aftermarket in order to receive IPO allocations.42 These
solicitations or attempts to induce aimed at aftermarket transactions tend to: (1) create offering
demand; (2) cause artificial aftermarket price escalation; and (3) erode market integrity. As we
have stated before, when offerings are sold based upon an artificially manufactured perception of
scarcity and priced on stimulated buying pressure, IPO investors are unable to evaluate the
offering to determine that it has been appropriately priced.43 Moreover, other investors who bid
for or purchase shares in the aftermarket would not know that the aftermarket demand had been
stimulated by the underwriters’ unlawful conduct.
In addition, certain conduct occurring after the restricted period, while not of itself illegal,
could be evidence that a distribution participant attempted during the restricted period to induce
customers to bid for or purchase stock in the aftermarket.44 Recent enforcement cases contain
examples of such activity including: (1) follow-up solicitations for immediate aftermarket orders
from customers who had provided aftermarket interest earlier; and (2) tracking or monitoring
customers’ aftermarket purchases to see whether they had followed through on their aftermarket
interest.45 We recognize that there are legitimate reasons to monitor customer activity.
42 We note, however, that allocating offering shares in an amount less than the investor’s indication of interest for
shares in the offering in response to a solicitation to purchase in the offering would not, in and of itself, be
considered an attempt to induce aftermarket purchases.
43 See 1984 Hot Issue Report, at 37-39.
44 As discussed above, while aftermarket transactions can serve as evidence that there had been an attempt to
induce aftermarket bids or purchases, such evidence is not required to establish an attempt to induce in violation of
Regulation M. Additionally, oral attempts to induce aftermarket activity can be evidenced in a variety of ways. See,
e.g., Americorp, Inc., Securities Exchange Act Release No. 41728 (August 11, 1999) (broker dealer representatives
prepared order tickets for aftermarket orders prior to the IPO becoming effective).
45 For example, the sales representative may call the investor when aftermarket trading begins and ask why an
order had not been received from the investor; or the investor may be informed that he is being penalized for not
making aftermarket purchases by being denied allocations in future IPOs.
18
However, tracking customers’ aftermarket purchases in the first few days of trading following an
IPO could be evidence supporting a claim that the customers’ expressions of desire to purchase
in the aftermarket were induced.
V. Policies and Procedures
Underwriters should have effective policies and procedures to detect and prevent
prohibited solicitations, tie-in agreements, and other attempts to induce aftermarket bids or
purchases during the Regulation M restricted period.46 Firms should implement policies that, at
a minimum, prohibit and monitor for the activities discussed in this release. Procedures and
systems for applying policies should be in place so that sales representatives and other firm
employees are reasonably supervised with a view to preventing and detecting improper attempts
to induce aftermarket bids or purchases during a restricted period. Firms also should take
corrective action if breaches occur.
VI. General Request for Comment
We will continue to monitor developments in IPO allocation practices. We invite anyone
who is interested to submit written comments on this release. Additionally, the Commission
solicits comment generally concerning underwriter conduct in connection with IPOs and other
distributions. The Commission will take these comments into consideration as it considers future
rulemaking.
List of Subjects
46 See, e.g., Exchange Act Section 15(b)(4)(E), 15 U.S.C. 78o(b)(4)(E). See also NASD Rule 3010(a) (requiring
member firms to establish and maintain a system to supervise the activities of each registered representative and
associated person that is reasonably designed to achieve compliance with applicable NASD rules, federal securities
laws and rules); NASD Notice to Members 03-72, Request for Comment on Regulatory Approaches to Enhance IPO
Pricing Transparency (November 2003); IPO Advisory Committee Report, at 6, 19 (encouraging underwriters to
develop effective internal policies and procedures to prevent prohibited secondary market activity and
recommending that underwriters impose additional requirements to promote the highest standards of conduct,
including: (1) enhanced periodic internal review by the underwriter of its IPO supervisory procedures; and (2) a
heightened focus on the IPO process in SRO examinations for investment banking personnel).
19
17 CFR Parts 231, 241, and 271
Securities.
Amendments to the Code of Federal Regulations
For the reasons set out in the preamble, the Commission is amending Title 17, chapter II
of the Code of Federal Regulations as set forth below:
PART 231 – INTERPRETATIVE RELEASES RELATING TO THE
SECURITIES ACT OF 1933 AND GENERAL RULES AND REGULATIONS
THEREUNDER
Part 231 is amended by adding Release No. 33-8565 and the release date of April 7, 2005
to the list of interpretive releases.
PART 241 – INTERPRETATIVE RELEASES RELATING TO THE SECURITIES
EXCHANGE ACT OF 1934 AND GENERAL RULES AND REGULATIONS
THEREUNDER
Part 241 is amended by adding Release No. 34-51500 and the release date of April 7,
2005 to the list of interpretive releases.
20 PART 271 – INTERPRETATIVE RELEASES RELATING TO THE
INVESTMENT COMPANY ACT OF 1940 AND GENERAL RULES AND
REGULATIONS THEREUNDER
Part 271 is amended by adding Release No. IC-26828 and the release date of April 7,
2005 to the list of interpretive releases.
By the Commission.
Margaret H. McFarland
Deputy Secretary
Dated: April 7, 2005
21