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May 31, 1999

Price-Fixing in IPO Market?

By Brian Garrity

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  • Price-Fixing in IPO Market?

An analysis underscores well-publicized charges that investment banks fixed some initial public offering fees at seven percent. While underwriting fees have fallen across the broad equity market, the seven percent standard for small IPOs has never budged.

Of the more than 2,100 IPOs of less than $100 million priced in the last four years, only 177 were priced below 7 percent, according to Securities Data, a unit of Boston's Thomas Financial. (Thomas Financial is the parent company of Securities Data Publishing, publisher of Traders Magazine.)

That level of consistency is at the heart of a U.S. Department of Justice investigation into charges of anti-competitive practices in the IPO market, as well as a class-action lawsuit against two dozen underwriters based on similar claims filed in November.

"The seven percent standard is not something which has been significantly eroded for the great bulk of the underwritings in that size range [of $100 million and below],"said Samuel Hayes, an economics professor at Harvard Business School.

Shareholder Lawsuits

The Justice Department's investigation was sparked by shareholder lawsuits. The litigation was inspired by an academic study in November. That study, by University of Florida economics professor Jay Ritter, revealed that more than 90 percent of deals with proceeds between $20 million and $80 million had spreads, or fees, of exactly 7 percent.

Certainly, IPO spreads are not as static as they first appear. They can average anywhere from just over four percent to over seven percent, depending on the size of the offering.

However, the smaller the deal, the bigger the fee. And, for deals under $100 million, spreads have been decidedly weighted at 7percent and above.

Last year's blockbuster run for IPOs bears this out. The average fee on deals between $50 million and $100 million was 6.8 percent in 1998 with average proceeds of $71 million-a four-year high.

Meanwhile, on IPOs below $50 million, the spread was 7.20 percent with an average proceed of $23.3 million. Both numbers are up slightly from a year ago. Deals between $50 million and $100 million averaged 6.68 percent in 1997, while those below $50 million carried an average fee of 7.17 percent.

For his part, Ritter said that the 7 percent standard is significantly more prevalent today than a decade ago, while most other banking fees, including secondary equity offerings, are competitively priced. "For deals between $20 million and $80 million there is no trend [in fee movement]," he said.

Although Ritter's work has been central in the legal action and Justice Department investigation so far, equity pros point out that price is often less important than other factors when choosing an underwriter. Price ranks a distant third behind research and coverage.

"Fees are pretty standard, but I don't see the point of this as a consumer protection issue or an antitrust issue," said Joe Bartlett, a securities attorney with Morrison & Forrester. "You don't pick an underwriter on the basis of price."