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SEC Commissioner Questions Individuals' IPO Restrictions

Individual investors should be freed from a longstanding brokerage-industry practice that effectively forces them to hold shares of initial public offerings as long as three months, said Isaac Hunt, commissioner of the Securities and Exchange Commission.

The system with which securities firms and brokers wield threats and penalties to discourage retail investors from "flipping," or selling their IPO shares for 30 to 90 days, is flawed and raises antitrust issues, Hunt said in a telephone interview last week. Hunt said he is considering bringing the issue before the agency and its staff in coming months, so other SEC officials may begin to weigh in.

Critics contend that restricting individuals' ability to trade out of IPO shares gives institutional investors an unfair opportunity to profit from the dramatic ascents of new offerings in their first few trading days. Brokerage firms argue the restrictions create a less volatile market.

John Coffee, a law professor and financial markets expert at the Columbia University Law School, however, says criticism of the retail-flipping restrictions will have to heighten before the SEC or Congress takes action to change the practice. "The pressure would have to get hotter," he says.

Missing the Exits
By the time most individual investors can sell IPO shares without penalty, their chance to take big profits has passed

Hunt may be doing just that, if he carries the issue further. "They ought to be able to sell when and if they choose," Hunt said, adding that he'd support the idea even if retail flipping were to result in some destabilization in the markets, something the securities industry argues the practice is intended to prevent. "I think it's something that needs to be rethought."

His opinion on flipping also tracks a pending federal class-action lawsuit filed in Manhattan Federal Court in 1998. That suit accuses 10 large Wall Street investment banks of a conspiracy that allows the firms and their favored institutional clients to reap millions of dollars in profits by preventing retail investors from flipping, while doing so themselves.

While Hunt wasn't familiar with the New York suit, the combination of the class-action suit and an SEC study that's been ongoing for more than a year illustrates a growing concern about individuals' participation in the new-issue market. Outside of some cautionary words by Chairman Arthur Levitt, the SEC has never addressed the issue of retail investor flipping of IPOs with an official policy.

The class-action suit, filed in U.S. District Court for the Southern District of New York, charges that the current IPO practice allows investment banks to trade IPO shares as they move sharply upward in price or freely unload them as they plummet -- while it leaves retail investors on the sidelines.

Restricting IPO flipping "is consistent with a great many things that are done on Wall Street that are best described as unfair, discriminatory and probably illegal," says Robert Parks, a professor of finance at Pace University's Lubin School of Business.

The investment banks defend the practice as a market-stabilizing mechanism that has been used for decades.

Hunt, a former dean of the University of Akron Law School and one-time acting general counsel for the U.S. Army, says the class-action suit was "interesting."

"I am not an antitrust lawyer, but it certainly, to a layman, would raise antitrust issues," he says.

The securities firms, including Salomon Smith Barney, Goldman Sachs (GS), Merrill Lynch (MER), Credit Suisse First Boston and Morgan Stanley Dean Witter (MWD), among others, have asked the court to dismiss the suit.

The suit expands on concerns raised by Levitt in a December speech in which he warned individual investors to "be careful about the new-issues game" because IPO shares often are being flipped by institutional investors, unbeknownst to retail investors.

Firms discourage flipping in a number of ways, but primarily lean on penalizing brokers whose clients quickly trade out of an IPO position. That penalty bid results in a loss of commission on the transaction. Brokers discourage individual investors from selling IPO shares before the penalty period has expired, and use access to future IPOs to enforce their will.

Investment banks sued in the pending federal case argue the practice of discouraging retail IPO swapping is well known and condoned by federal regulators.

"For decades the SEC has been aware that investors in public offerings might be discouraged from reselling their shares for 'varying periods, usually 30 to 60 days' after the offering, but has consciously decided not to prohibit such restrictions," the investment banks argued in a court filing last September.

Coffee, however, says the SEC's inactivity shouldn't be seen as an endorsement of the practice.

Still, public sympathy isn't likely to drive any loosening of restrictions on retail flipping. "I can't say that flipping is a good thing," Coffee says. "It's not easy to get indignant about the plight of flippers. It's not the same as the orphan or the widow."

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