SEC Offers Guidance on IPO Allocations

By Stephen T. Adams and Ettore A. Santucci

The SEC recently offered interpretive guidance to underwriters with respect to the allocation of securities and prohibited conduct under Regulation M, particularly with respect to IPO allocations. The release is a reminder that certain conduct that causes or is likely to cause an undertaking, promise, commitment or understanding on the part of a customer to make aftermarket bids or purchases of an offered security, in relation to an expected allocation of shares in an offering, is impermissible under Regulation M. The interpretive guidance offers several examples of permissible book-building activities and distinguishes them from activities prohibited by Regulation M. The interpretive guidance cautions underwriters that they should have effective policies and procedures to detect and prevent solicitations, tie-in agreements, and other attempts to induce aftermarket bids or purchases in violation of Regulation M.

Regulation M prohibits underwriters and their affiliated purchasers from bidding for, purchasing, or attempting to induce any person to bid for or purchase an offered security during the "restricted period." Currently the restricted period begins one or five business days prior to determination of an offering price for the security and ends upon a person’s completion of participation in the distribution.¹ The SEC notes that attempts to induce aftermarket bids or purchases during a Regulation M restricted period, or a cooling-off period as it was known under its predecessor, Rule 10b-6, have always been prohibited. The SEC reiterates that Regulation M applies to "attempts" to induce any person to bid for or purchase an offered security in the restricted period. Accordingly, an underwriter’s conduct can violate Regulation M irrespective of whether it actually results in market activity by others. Further, the induced activity (i.e., aftermarket bids or purchases) may occur during or after the restricted period, or indeed may never occur at all.

The SEC acknowledges the importance of the book-building process in obtaining and assessing demand for an offering and in pricing the offered securities. The SEC also notes that the collection of information (e.g., whether the customer is a long- term holder or the prices at which the customer might add shares to its position) in the book-building process serves a legitimate purpose. However, the SEC notes that there is no "book-building exception" to Regulation M for inducing or attempting to induce aftermarket bids or purchases. Although an underwriter obtaining and assessing information about demand for an offering during the book-building process does not, by itself, constitute an inducement or attempt to induce, accompanying conduct or communications, including one or more of the activities described below, may cause the collection of information in the book-building process to be part of conduct that violates Regulation M.

Underwriters must ensure that their activities do not cross the line into prohibited attempts to induce aftermarket bids or purchases by prospective investors or others. Regulation M’s proscription of attempts to induce bids and purchases "covers activity that causes or is likely to cause another person to bid for or purchase covered securities." The determination as to whether an activity or communication constitutes legitimate book-building or an attempt to induce a bid or purchase in violation of Regulation M depends on the particular facts and circumstances surrounding such activity or communication.

The SEC has determined in the context of recent enforcement actions that the following activities and conduct during the Regulation M restricted period violated Regulation M.

• Inducements to purchase in the form of tie-in agreements or other solicitations of aftermarket bids or purchases prior to the completion of the distribution;

• Communicating to customers that expressing an interest in buying shares in the immediate aftermarket ("aftermarket interest") or immediate aftermarket buying would help them obtain allocations of hot IPOs;

• Soliciting customers prior to the completion of the distribution regarding whether and at what price and in what quantity they intend to place immediate aftermarket orders for IPO stock;

• Proposing aftermarket prices to customers or encouraging customers who provide aftermarket interest to increase the prices at which they are willing to place orders in the immediate aftermarket;
• Accepting or seeking expressions of interest from customers that they intend to purchase an amount of shares in the aftermarket equal to the size of their IPO allocation ("1 for 1") or intend to bid for or purchase specific amounts of shares in the aftermarket that are pegged to the allocation amount without any reference to a fixed total position size;

• Soliciting aftermarket orders from customers before all IPO shares are distributed or rewarding customers for aftermarket orders by allocating additional IPO shares to such customers; and

• Communicating to customers in connection with one offering that expressing an interest in the aftermarket or buying in the aftermarket would help them obtain IPO allocations of other hot IPOs.

In addition, certain conduct occurring after the restricted period, while not of itself illegal, could be evidence that an underwriter attempted during the restricted period to induce customers to bid for or purchase stock in the aftermarket.

The SEC states that underwriters should have effective policies and procedures to detect and prevent prohibited solicitations, tie-in agreements and other attempts to induce aftermarket bids or purchases during the Regulation M period. Firms should implement policies that, at a minimum, prohibit and monitor for the activities discussed in the release. Procedures and systems for applying policies should be in place so that sales representatives and other firm employees are reasonably supervised with a view to preventing and detecting improper attempts to induce aftermarket bids or purchases during a restricted period. Firms also should take corrective action if breaches occur.

Michael S. Turner contributed to the preparation of this article

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