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Pricing of New Issues
Chapman, Spira & Carson - Disscusion

From: Al Danzig
Date: 2/25/99
Time: 7:41:16 AM
Remote User:


I was a founding stockholder of a company that ultimately had to go public because we were in need of financing and were in what Wall Street parlance, perceived to be a hot industry. It did not take too long before we had several Brokerage firms interested in underwriting our company and ultimately signed with one of them. They determined the amount of money we would receive from the offering by giving the company what they called a market cap.

Effectively what they did was to determine what they thought the value of the company would be by multiplying the number of shares to be outstanding after the underwriting by the price that they were going to bring the issue at. When we asked how they came up with that number they gave us what seemed to be a logical answer. We were not earning any money but we had substantial potential and were in a hot industry. If it weren't for those factors they couldn't do the underwriting at all. They indicated that they deducted market cap for our inexperience and were doing us a favor at the price they were referring to. Our general counsel who represented us in those discussions did not seem to understand what they were talking about and it is now apparent that security's counsel should have represented us early on.

We were also told that the underwriter would be getting warrants on our stock in addition to the fees that they were charging, which we later found out to be the maximum that the NASD allowed.

When the day was over, the stock opened at a large premium and then went much higher. It now is selling at about three times the price that it went public at only a short time ago.

We received the money that we were supposed to get and I guess everything went as well as could be expected except for the fact that we got the feeling that the broker was not representing our company but was more interested in his clients (the customers of the brokerage firm) making a big score. It seems to me that the broker was representing two parties with very different interests and choose to sell us down the river in favor of his brokerage customers.

The broker claims that he did not have a clue as to what the stock would open up at and they were just making an educated guess based on econometric models to determine a fair price. They indicate that they were as surprised as we were when it opened at such a large premium.

Our response was that they knew exactly where the stock would open because they had the "book". They knew how many buy orders they had in the aftermarket and how many sell orders. A simple mathematical equation would show at what price the number of buy orders and sell orders would equal each other. The also had something called a "green shoe" which allowed them to sell additional shares should the demand become too great. Additionally, we were told later that there are services on Wall Street for traders that specialize in buying "new issues" that were predicating what our stock would sell at over a month before it opened. These services were uniformly accurate within 1/4 of a point.

It would seem that the broker was not interested in getting our company the most money for the fewest number of shares. He was interested in making his clients a score at our expense. We were proud to have a stock that did so well in the market and yet, in the cold light of the day it seems that our pocket was being picked while we were enjoying our 15 minutes of fame. It seems that everyone but us knew that we had a really hot deal and we feel compromised.

To make matter even worse, the Underwriter made us sign a three-year investment banking agreement for a lot of money before he would do the deal. We contracted to pay him a month fee to do nothing much at all and gave him the rights to do any financing that we required during the next three years. Now we are stuck with major payments to the firm over a protracted period of time and we feel like suckers. If we need money in the meantime, I wonder how bad he is going to sock it to us next time. At that point we can't even go somewhere else if we don't like the terms. We are now contractually obligated to a broker that did not fairly represent us and will have this parasite hanging around like a noose around or necks for years.

Is there anything that we can or should do about this predicament? Make us feel better and tell me that everyone gets screwed like that on Wall Street so we don't feel doubly stupid.

Last changed: March 17, 2000