SEC Proposes IPO Allocation Reforms
The Securities and Exchange Commission this week proposed amendments to Regulation M that would prohibit certain market activities that undermine the integrity and fairness of the offering process, particularly with respect to the allocation of Initial Public Offerings (IPOs). The amendments would also enhance the transparency of underwriters' aftermarket activities.
Adopted in 1996, Regulation M governs the activities of underwriters, issuers, selling security holders, and others in connection with offerings of securities. Regulation M is designed to prohibit activities that could artificially influence the market for the offered security, including for
example, supporting the IPO price by creating the perception of scarcity of IPO stock or creating the perception of aftermarket demand.
The proposed amendments would:
- Lengthen the "restricted period" for IPOs beyond the current 5-day period. The restricted period is the time period during which distribution participants must refrain from activity that could stimulate the market for the security in distribution. Under the proposal, the restricted period for an IPO generally would begin when the issuer reaches an understanding with an underwriter to proceed with a distribution.
- Require syndicate covering bids, indicating that the underwriter is buying shares to cover its short position, to be publicly disclosed to the market, similar to what is required for stabilizing bids under the current Rule.
- Prohibit the use of penalty bids, which also can function as an undisclosed form of stabilization. Penalty bids occur when an underwriter reclaims a selling concession from a syndicate member if the offering security is immediately sold by the initial purchaser.
- Adopt a new rule under Regulation M that would expressly prohibit certain IPO abuses that occurred in the late 1990's and in other "hot issue" periods, including conditioning or "tying" an allocation of shares on an agreement by the customer to buy shares in another less desirable ("cold") offering, or to pay excessive trading commissions on unrelated securities transactions.
- Require recordkeeping in connection with the rule's "de minimis exception," which excepts inadvertent bids and purchases during the restricted period that total less than 2% of the distributed security's average daily trading volume ("ADTV"). Frequent reliance on the exception could indicate that a firm's compliance policies and procedures are inadequate to achieve compliance with Regulation M.
- Update the ADTV value and public float value thresholds (which are used to determine a security's restricted period and the availability of the exception for actively-traded securities) to reflect the increase in market value since Regulation M's adoption in 1996.
The comment period for the proposals will end 60 days from the date of publication of the proposed rules in the Federal Register. The full text of the detailed release concerning this proposal will be posted to the SEC Web site as soon as possible.