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November 1, 2002

Were Tech IPOs Rigged?

By Britt Tunick

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  • Were Tech IPOs Rigged?

Imagine, if you will, that you lived in an age when there really were initial public offerings-and great demand for them, to boot. Imagine you wanted to increase the pricing of a particular IPO. Your solution may well have been to simply cut the number of shares available.

At least that's the approach some underwriters may have taken with technology IPOs at the height of the Internet bubble, according to an upcoming study on the topic.

"We find indications that underwriters artificially inflated underpricing levels during the bubble period by simultaneously increasing offer prices and decreasing shares," concluded the study, "An Examination of the Characteristics of Pre-Offer Revisions in IPOs," co-authored by Irv DeGraw, a professor of finance at Eckerd College in St. Petersburg, Fla.

Internet Bubble

Of the 559 technology IPOs completed between 1999 and 2000, at the height of the Internet bubble, 28.1 percent of the deals ultimately ended up offering fewer shares to the public than initially planned and priced above the ranges originally registered at the Securities and Exchange Commission. That's no coincidence, according to DeGraw. He pointed to the fact that, in the prior nine years, only five percent of technology IPOs shared the same pattern - a combination of share reduction and higher price.

"That says manipulation," DeGraw said. "During the bubble, when the offering price was above the range and the number of shares reduced, the average first-day return was 141 percent - the absolute highest of any category during that period."

Issuers typically want the highest possible price for their offerings, and investors the lowest, forcing underwriters to walk a fine line in the pricing process - gauging an IPO's offering price in its pre-marketing stage by polling potential investors to determine exactly what the market will bear. But DeGraw believes that by intentionally reducing the number of shares available in an offering - thus ensuring that there will be substantial demand for both the deal and its early secondary trading underwriters - underwriters were able to inflate the prices tech issuers actually received for IPOs during the Internet boom.

"If you push the price too high, you're not going to sell any of it, and if you push the price too low, you'll have difficulties because you'll lose your offering companies," he said. "On the other hand, the number of shares is something that is relatively invisible and is completely under your control."

One example he cited is Luminant Worldwide Corp., which provides Internet and electronic-commerce professional services. Before the company went public with an $84.6 million offering in 1999, it reduced the number of shares it originally filed with the SEC by 69.2 percent, according to the report.

It's that change that DeGraw believes is part of the reason underwriters were ultimately able to price the deal at $18 per share. That was considerably above its initially stated range of $11 to $13 per share.