Despite highly publicized charges that they've violated antitrust laws by conspiring to fix prices, Wall Street investment banks have continued to consistently charge around 7% to underwrite smaller initial public offerings, the author of an influential study on the issue has found.
The underwriters' steadfastness diverges sharply from the almost immediate reaction by
market makers to a federal investigation of potential collusion to maintain wide spreads.
It may be largely because IPO issuers, eager to cash in on the IPO boom and fearful of angering the powerful underwriters, haven't demanded lower fees, concludes
University of Florida
finance professor Jay Ritter. Issuers, who are in the best position to complain about the fees should they choose to, have effectively been distracted from that issue by questions they have about underpricings of their initial public offerings, he says.
That distraction creates a double benefit for underwriters because not only are they able to maintain the 7% fees, but they actually make more money through underpricing IPOs, Ritter says.
The losers, some observers say, are investors.
The issuers' silence will keep the industrywide standard fee from falling anytime soon, meaning that investors will continue footing the bill for hefty fees, they say.
The issue first gained widespread attention after Ritter completed a study in late 1998 that found underwriters charged exactly 7% for 90% of the IPOs that raised between $20 million and $80 million. A decade earlier that fee held on just 30% of those IPOs, the study found.
Since the pricing question came to the forefront with Ritter's study, a federal class-action suit and a
investigation of possible antitrust violations -- all more than six months ago -- securities firms haven't cut their fees, and have profited by underpricing IPOs, Ritter says.
The industry says competition remains robust among investment bankers. Bankers compete on factors other than price, namely distribution capacity, research support and name recognition.
"I haven't gotten the impression that investment banking firms feel that the heat is on, either from lawyers or the Justice Department or, more importantly, from the issuers," Ritter says.
And the fee situation isn't likely to change, predicts Samuel Hayes, a finance professor at the
Harvard Business School
. "It may well be that they won't ever be competing on price," he says.
The Justice Department is continuing its probe, disclosed in May, but won't elaborate. "We're looking at the possibility of anticompetitive practices in underwriting services for initial public offerings," a department spokeswoman says.
Securities Industry Association
, a trade group that represents underwriters, insists competition is intense among its firms. The group says, as it did when the federal probe was announced: "Underwriting fees are a function of this highly competitive market."
One hurdle for federal investigators and the class-action plaintiffs is the reticence of issuers to complain about the bankers who have helped make shareholders and executives rich.
Hayes says issuers are wary of criticizing underwriters' fees because they may work with the firms again, on secondary issues or bond sales. "These issuers don't want to be the skunk at the lawn party," he says
Ritter says issuers also are fearful of bringing on unfavorable analyst coverage if they pipe up about the fees.
Ritter also thinks there's part of the explanation that's as much psychological as fiscal.
Issuers of IPOs that skyrocket beyond their initial offering price leave far more money "on the table" than they pay in fees. To issuers, that potential windfall overshadows the cut that goes to the investment banks through fees, he says.
The amount left on the table is the value an issuer might have received had the offering been priced at the level reached at the end of the first trading day.
In the past year, the difference between the fees and money left on the table has grown, dramatically.
Between 1990 and 1998, companies that went public paid $13 billion in IPO fees to investment banks and left $27 billion on the table, Ritter concluded in a paper he co-authored with
University of Notre Dame
finance professor Tim Loughran earlier this month.
In 1999 alone, though, issuers paid $4 billion in fees, and left $37 billion on the table, Ritter says.
As far as investment banks profiting by underpricing IPOs, Ritter says the firms dole out underpriced IPO shares to favored clients. When the IPO prices soar, clients return the favor by bringing trading and other business back to the underwriter.
Nonetheless, the lack of participation in the suit by issuers may help the defendants -- investment banks -- in the class-action suit, now pending in U.S. District Court for the Southern District of New York. The class action, brought by investors who bought into newly issued stocks, is a consolidation of other lawsuits that investors in IPO stocks filed late last year.
"Although plaintiffs allege a conspiracy to fix the amount of the underwriting discount that issuers give to defendants and purport to represent a class of issuers, no issuer plaintiff has appeared," the defendants say in a court filing earlier this year.
The securities firms also argue the plaintiffs in the suit don't have any proof of a written or oral agreement to fix IPO fees and label the claims "a lawsuit in search of defendants."