Shareholders Sue VA Linux As IPO Practices Are Called Into Question

The piling on is under way for VA LinuxLNUX, the software company that became a symbol of the initial public offering craze a year ago. It's now threatened with becoming a poster child for everything that went wrong with late 1990s IPOs.

Since late January, at least 18 federal lawsuits have been filed against VA Linux, claiming the Fremont, Calif.-based company conspired with its investment bankers in a kickback scheme to drive up the price of its shares in what was the largest percentage gain in at least a decade for a stock in its first day of trading. Those suits, which seek certification as class actions, also name the lead underwriter of the VA Linux IPO, Credit Suisse First Boston, as a defendant.

VA Linux went public at $30 a share on Dec. 9, 1999 and closed that day at $239.25, a 698% increase. The stock closed Friday at $3.44.

And now, VA Linux has been roped into a larger investigation by the Securities and Exchange Commission of the practices of investment banking firms in a number of initial public offerings, centering on how the banks allocated the prized IPO shares and what they may have demanded from the recipients of the shares in return.

Not the Target

Linux wouldn't comment on the shareholder suits. But the company says it's convinced it's not the primary target of the SEC investigation, after receiving a subpoena from the agency in December.

"The SEC contacted us. They asked for some documents regarding our IPO, which we provided," said Patrick Fossenier, VA Linux's director of investor relations. "Based on that we believe, we're very confident, that we're not the focus of the SEC investigation."

Credit Suisse also acknowledged the SEC investigation of the allocation of IPO shares. "We are cooperating fully with the governmental inquiries," the firm said in a statement. "Such allocations can be based on a variety of considerations, such as an investor's interest in the issue, its demonstrated knowledge of the issuer and the industry and the nature and extent of an investor's brokerage relationship and trading activity. We believe that our allocation considerations are consistent with those employed by others in the industry."

Credit Suisse also is a defendant in a separate suit filed on March 9, which alleges it and six other investment banking firms violated antitrust laws by requiring recipients of IPO shares to pay inflated commissions and to help shore up artificially high prices on IPOs.

The List

Other defendants charged in that suit, filed by the New York law firm Lovell & Stewart, are: Salomon Smith Barney, Morgan Stanley Dean Witter MWD, Merrill Lynch MER, Lehman Brothers LEH, Goldman Sachs GS and BancBoston Robertson Stephens, now called Robertson Stephens.

Credit Suisse said the allegations in that suit are without merit and vowed to vigorously defend against them. The other firms named as defendants declined to comment.

The VA Linux initial public offering is a prime example of market manipulation in an IPO by investment banks, their customers and the issuing firm, said Steven Schulman, a partner in the law firm Milberg Weiss Bershad Hynes & Lerach, which specializes in filing shareholder suits, and has sued VA Linux and CSFB over the VA Linux IPO. Because certain favored customers of the investment banks agreed to buy shares in a new issue at inflated prices in the aftermarket (in return for getting an allocation of the shares at the initial offering price) the share prices to which the IPO eventually soared were actually driven by artificial market forces, Schulman said.

"That is a manipulation and its purpose and effect, and it's illegal, is to cause a squeeze that pushes up the stock price very rapidly," he said. "It's an interrelated very lucrative set of arrangements that went on."

VA Linux Stock Slide VA Linux had the largest percentage gain of any IPO in a decade when it went public on Dec. 9, 1999

The developing situation regarding the IPOs now -- with the SEC investigation underway and lawsuits working their way through the courts -- presents a stark contrast for VA Linux, a company whose Linux-based software and services were seen at the end of 1999 as possible competitors for Microsoft's MSFT ubiquitous Windows computer operating system.

To Prakesh Patel, an analyst with W.R. Hambrecht, VA Linux is an unwitting victim, not only of the investment banks' IPO practices, but also of the gang-like psychology of investors lawsuits. Hambrecht was not an underwriter of the VA Linux IPO, and Patel said Hambrecht was not allocated VA Linux IPO shares. However, Hambrecht was a venture capital investor in VA Linux before the IPO, he said.

"Once something like this happens, a lot of class actions jump on the bandwagon," Patel said. He added that Linux was a mere observer as its IPO allocation deals were done.

Unscathed?

Patel predicted Linux will emerge unscathed from the lawsuits, but said publicity over the suits and the SEC probe may be driving away some investors.

The recent litigation concerning VA Linux and the IPO arrangements isn't the first time investment banking firms have been challenged on their dealings in IPOs.

In the late 1990s, the Justice Department began an investigation into whether investment banks conspired to fix fees they charged on issues of IPOs. Those fees also were the subject of a class-action suit against the firms at the time. A federal judge in Manhattan last month ruled in favor of the investment banks and dismissed the suit.