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Re: Pricing of New Issues
Chapman, Spira & Carson - Discussion

From: Robert A. Spira
Date: 2/25/99
Time: 9:01:01 AM
Remote User:

Comments

Al, you are dead right, the greatest conflict between two parities since the snake talked Eve into eating the apple, is the pricing that is done by the sole judge and jury in a new issue, the underwriter. Although you may not see it that way, there are several mitigating factors. The first is what we on Wall Street call the "you are only as good as your last deal" syndrome. People that buy new issues are like lemmings following each other, often to destruction. They are always looking for the hottest underwriting house in an uncompromising effort to get something for nothing.

Brokers relish being in that position because the lemmings bring with them substantial "other" brokerage business. Naturally, as with any business, you are going to favor your best customers. The most profitable area of a brokerage house is usually their corporate finance department and they reward these folks with hot new issues till the cows come home. Also well rewarded are those people that generate substantial commissions on a regular basis. Another less visual group that gets in on the act is the underground hedge fund. These are professionals, usually dealing for themselves that make a living just buying new issues. These guys can tell you within an 1/8 of a point where any deal on the "Street" is going to trade at. These folks are often called upon by the underwriter to take down stinkers as well as the hot deals. When the underwriter is stuck with a lemon, he's got to make it look at least reasonably good, so he goes to the hedge funds and makes them an offer, you take down this deal and you can have what you want in my next one, which is going to a big premium. The hedge fund knows exactly what the next deal is going to do and it doesn’t take a brain surgeon for them to accurately determine how good the offer is. In most cases it is excellent.

If the underwriter gets stuck with a succession of clunkers, the lemmings will stop jumping off his cliff; they will look for his competition's cliff to their aerial act from. Thus, it is most import to the very survival of a brokerage house to have a succession of premium offerings. Sometimes in order to insure their success, underwriters will not allow the stocks that were purchased to be sold for a period time. Another hook is to make the clients that buy new issues double up on them when they are released. Both of the scenarios create the image of a hot dealmaker. Many of the firms that specialized in these tactics are no longer with us, but in spite of the fact that their principals are wealthy beyond imagination, they are banned from the security industry. Poor souls are crying all the way to the bank, and not to worry, a new crop comes in to replace the old just like growing wheat.

So we can see that it is important for the Underwriter to appear successful, if not, he would not have been able to sell your deal to the public. Thus, if he wasn't trying so hard to make every transaction a success you would not have been able to go public through that broker. You could have chosen someone else you say. Understand we are talking about an industry in which someone once said that 80% of the firms at the end of ten years are either out of business or have a different name. For people that are telling others their secrets of investing and how to run businesses, the brokerage industry does not really know how to run itself.

For many years, nepotism flourished in the industry because until May 1, 1975, we had fixed commission rates. Thus, although there were small differences between firms, you could be the same stocks at the same prices with the same commission wherever you had your account and for the most part, there was little reason to change. Today, savvy investors pay rates no more than 10% of what was universal only several decades ago. The commission business, once the mainstay of the industry is now, for the most part, a loss leader.

The securities industry at that time did not do a lot of underwriting or for that matter a lot of principal business. Economics and competition created new avenues to make profits for brokers, but only the quick and the smart survived the May Day blood bath. Some learned that you could take some money from over here and put it over there and when the day was over the firm what have made a couple of extra bucks. The area in which acting like a modern day "Robin Hood" has been the most pervasive is that of the pricing of new issues. The taking from the rich of "Corporate American" and giving to the poor investors that are struggling to survive. Brokers have not been beyond when pricing secondary issues, waiting till the New York Stock Exchange had closed and then rigging the price on the Pacific Coast to create whatever they desired and would make them the most money, a high or lower closing, consolidated price.

Al, this is the system and some of the warts are part of it. Everyone but you knew that it was the greatest conflict of interest going, but if you went to a regulator and complained, the underwriter would be able to show three ways from Sunday that he not only did your offering, but did you a favor by getting you so much money. The game is not exact, it is theoretical and there are no definitively correct answers. If the terrain were level and everything was priced optimally, there could literally be no financing for emerging companies and where would we be today with Microsoft, Intel and the like. Money that has been found between the cracks is part of what has made the system what it is and that is exactly where our business school graduates are taught to look.

The system is faulty and frail, but until something else comes along that is better I can't help. Next time have a good securities lawyer do your negotiating, not general counsel.


Last changed: March 17, 2000