The Securities and Exchange Commission (SEC) announced the filing in federal district court of separate settled civil injunctive actions against Morgan Stanley & Co. Incorporated (Morgan Stanley) and Goldman, Sachs & Co. (Goldman Sachs) relating to the firms' allocations of stock to institutional customers in initial public offerings (IPOs) underwritten by the firms during 1999 and 2000. Under the terms of the settlements, a judgment will be entered against each firm enjoining it from violating Rule 101 of the Commission's Regulation M and ordering each firm to pay a $40 million civil penalty. The settlement terms are subject to court approval.
In its complaints, the Commission alleges that Morgan Stanley and Goldman Sachs violated Rule 101 of Regulation M under the Securities Exchange Act of 1934 by attempting to induce certain customers who received allocations of IPOs to place purchase orders for additional shares in the aftermarket.
Stephen Cutler, Director of the Commission's Division of Enforcement said, "These cases underscore the Commission's resolve to ensure the integrity of IPO markets by prohibiting conduct that could artificially stimulate demand or higher prices in the aftermarket -- whether or not there is manipulative effect."
Antonia Chion, Associate Director of the Commission's Division of Enforcement remarked, "The case against Morgan Stanley serves as a reminder to underwriters that soliciting customers who have no interest in owning a stock long-term to buy in the immediate aftermarket, pushing customers to buy in the aftermarket at higher prices and other attempts to induce aftermarket purchases are not permitted."
Mark K. Schonfeld, Director of the Commission's Northeast Regional Office said, "The case against Goldman Sachs is about the integrity of the market. The conduct here created a risk of misinformation about the demand for an IPO. With this case, we are sending a message that we will protect the market from such potential influences."
Summary of the Enforcement Actions
The Commission's complaints against Morgan Stanley and Goldman Sachs, include the following allegations, which the firms neither admit nor deny:
During a restricted period, i.e., prior to Morgan's Stanley's completion of participation in the distribution of IPO shares, Morgan Stanley attempted to induce certain customers to make aftermarket purchases in violation of Rule 101 of Regulation M by engaging in the following activities.
- Morgan Stanley communicated to certain customers that expressing an interest in buying shares in the immediate aftermarket and buying shares in the immediate aftermarket would help them obtain good allocations of over-subscribed, hot IPOs. For instance, a sales representative told his customers that "Avanex [IPO] . . . could be one of the hottest IPOs of the year . . . . Another one that I will need [aftermarket] feedback on to get a good allocation." In addition, Morgan Stanley solicited aftermarket interest from certain customers who Morgan Stanley knew had no interest in owning the stock of the IPO companies long-term.
- Morgan Stanley proposed to certain customers the aftermarket price limits they should give to obtain a good IPO allocation. For instance, in the Avanex IPO (which Morgan Stanley priced at $36), a sales representative e-mailed his customer: "Aftermkt on [the Avanex IPO] goes into the 100's from lots of customers . . . . How is this for a strategy: put in aftermkt for $150, the stock runs to about $110, you buy it there - even if it pulls back and you lose some on the shares short term, you a) got more stock on the deal since your aftermkt was so freakin big b) if you[']re going to own it longer anyway so what if you buy at the peak on the first day and who[']s to say in this market the stock can[']t go even higher[.] The more outlandish the aftermkt, I would definitely figure the more stock you get."
- In some instances, Morgan Stanley encouraged customers to increase the prices they had originally told Morgan Stanley they were willing to pay in the aftermarket. For example, in the Webmethods IPO (which Morgan Stanley priced at $35), a sales representative reported to the head of syndicate: "[A customer is] in for 10% (20,000 would be great); aftermkt: $65; I am trying to push them higher and [another Morgan Stanley employee] will update you." The head of syndicate's notes reflect that the customer increased its aftermarket interest to $100. The customer received a 10,000 share allocation of Webmethods.
- Morgan Stanley accepted customers' aftermarket interest that they would buy "1 for 1" (or some other ratio) in the aftermarket, meaning that the customers intended to buy in the aftermarket an amount of shares equal to (or greater than) their IPO allocation.
Morgan Stanley's conduct after the distribution of IPO shares was complete, taken as a whole, demonstrates that when Morgan Stanley had solicited aftermarket interest from customers during the restricted period, it was attempting to induce them to place aftermarket orders in the first few days of trading. Morgan Stanley solicited aftermarket orders by making follow-up calls to customers who had provided aftermarket interest. Morgan Stanley viewed favorably follow-through aftermarket buying in the first few days of trading. Some Morgan Stanley sales representatives referred to their customers' buying in the immediate aftermarket as fulfilling their "promises" or "commitments." Further, Morgan Stanley monitored customers' aftermarket purchases in the first few days of trading.
Morgan Stanley also violated Rule 101 of Regulation M in the Martha Stewart Living Omnimedia IPO by soliciting a 350,000 share aftermarket order from a customer before all the IPO shares had been distributed.
During restricted periods, Goldman Sachs attempted to induce, or induced, certain customers to make aftermarket purchases of IPO stock in violation of Rule 101 of Regulation M by engaging in the following activities:
- Goldman Sachs communicated to certain customers that Goldman Sachs considered purchases in the immediate aftermarket to be significant in the determination of IPO allocations. Goldman Sachs informed certain customers that Goldman Sachs verified whether customers placed orders to purchase stock in the immediate aftermarket following an IPO. For instance, Goldman Sachs showed one customer an "Underwriting Aftermarket Report" that reflected, among other things, the customer's previous aftermarket purchases on IPOs underwritten by Goldman Sachs. Similarly, one customer sent an email to portfolio managers at her company relaying the information she had received from Goldman Sachs:
Goldman Sachs . . . has told me that for now, all their small techy deals will be subject to close scrutiny with regard to flippers. AMO's [aftermarket orders] will be watched for follow-thru on indicated intentions. . . .
During conversations or courses of dealing that included the preceding subjects, Goldman Sachs sales representatives asked certain customers during restricted periods whether, and at what prices and in what quantities, they intended to place orders to purchase IPO stock in the immediate aftermarket.
- Goldman Sachs encouraged certain customers that had provided "aftermarket interest" (expressions of interest in buying shares in the aftermarket) to increase the prices they said that they would pay in the aftermarket. Some customers responded by expressing higher prices than they were originally willing to pay in the immediate aftermarket, in part, because they believed from their communications with Goldman Sachs sales representatives that this would improve their chances of receiving favorable allocations of IPO stock.
- Goldman Sachs sought and/or accepted aftermarket interest from customers based solely or in relevant part on the amount of their prospective allocations. For example, a Goldman Sachs sales representative often suggested to one customer that he indicate that he would buy two to three times his allocation in the immediate aftermarket and did so on the CoSine IPO. The day before CoSine opened for trading, the sales representative sent an email to his ECM liaison informing him that the customer "will buy between 2-3x their allocation in the after market."
Through such questions and statements about aftermarket orders during restricted periods, Goldman Sachs communicated to certain customers hopeful of obtaining IPO allocations (including customers that did not have a genuine interest in long-term ownership of the stock being offered) that indications of intentions to place orders in the immediate aftermarket, and/or the aftermarket orders themselves, would increase their likelihood of receiving favorable allocations of IPO stock. As a result of Goldman Sachs's communications concerning aftermarket orders, and because some customers wanted to obtain IPO allocations that they reasonably believed they could "flip" for large profits, certain customers indicated intentions to place orders and/or placed orders to purchase IPO stock in the immediate aftermarket of certain offerings. Goldman Sachs engaged in a combination of some or all of the foregoing types of communications to certain customers in connection with the IPOs of CoSine, Marvell, and WebEx, Inc.