Report and Recommendations of the NYSE/NASD IPO Advisory Committee
Report and Recommendations of the NYSE/NASD IPO Advisory Committee

Fairness, integrity and efficiency make the U.S. capital markets the most successful in the world. In the past decade, more than 5,600 domestic and foreign enterprises raised an aggregate of over $500 billion through IPOs in U.S. markets. These IPOs served as an engine for corporate growth and active participation by all sectors of the investment community, from venture capitalists to large institutions and individual investors.

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; at least some of this misconduct was unlawful. Instances of this behavior became more frequent during the IPO ‘‘bubble’’ of the late 1990s and 2000, a period in which an unusually large number of offerings traded at extraordinary and immediate aftermarket premiums. These large first-day price increases in turn affected the allocation process by creating a pool of instant profits for underwriters to distribute. Some did so improperly — in exchange for a share of these profits, or perhaps for a promise of future business. In turn, some institutional investors were willing to participate in improper arrangements in order to receive the essentially guaranteed profit that ‘‘hot’’ IPOs came to represent. Among the most harmful practices that have given rise to public concern are:

  • ‘‘Spinning’’: Certain underwriters allocated ‘‘hot’’ IPO shares to directors and/or executives of potential investment banking clients in exchange for investment banking business.
  • Artificial Inflation of Aftermarket Prices: Some underwriters engaged in inequitable or unlawful tactics to support aftermarket prices and boost aftermarket demand. These included, for example, (1) allocating IPO shares based on a potential investor’s commitment to purchase additional shares in the aftermarket at specified prices and (2) imposing penalties on retail brokers in connection with immediate ‘‘flipping’’ by retail IPO investors but not by other categories of IPO participants (such as institutions).
  • Unlawful Quid Pro Quo Arrangements: Underwriters unlawfully allocated IPO shares based on a potential investor’s agreement to pay excessive commissions on trades of unrelated securities.
  • Biased Recommendations by Research Analysts: With their compensation and promotion tied to the success of their firms’ investment banking business, some research analysts apparently agreed to issue and maintain ‘‘buy’’ recommendations on certain stocks despite aftermarket prices that jumped to multiples of their IPO prices.

Exacerbating the loss of confidence in our IPO process is the widespread perception that IPOs are parceled out disproportionately to a few, favored investors, be they large institutions, powerful individuals or ‘‘friends and family’’ of the issuer.

The New York Stock Exchange, Inc. (the ‘‘NYSE’’) and NASD (together, the "SROs") convened this Committee at the request of Harvey L. Pitt, then-Chairman of the U.S. Securities and Exchange Commission (the "SEC"), to "review the IPO underwriting process, particularly price setting and allocation practices, in light of recent experience, and to recommend to the securities industry community such changes as may be necessary to address the problems that have been observed." As part of its review, the Committee evaluated input from a cross-section of the investment and academic community. In fulfilling our mandate, we did not endeavor to mirror the efforts, or assume the role, of regulatory enforcement authorities. Rather, we examined and evaluated the entire IPO process from the perspective of its various participants.

Our 20 recommendations follow four basic themes:

  1. The IPO process must promote transparency in pricing and avoid aftermarket distortions.
  2. Abusive allocation practices must be eliminated.
  3. Regulators must improve the flow of, and access to, information regarding IPOs.
  4. Regulators must encourage underwriters to maintain the highest possible standards, establish issuer education programs regarding the IPO process and promote investor education about the advantages and risks of IPO investing.

Our proposals complement various legislative and regulatory initiatives, including the announced Global Settlement among regulators and major investment banks, the Sarbanes-Oxley Act of 2002 and related SEC rules, new SRO rules dealing with analyst conflicts, proposed NASD rules regarding activities of registered representatives and pending NYSE and Nasdaq rules relating to corporate governance.