[Federal Register Volume 70, Number 70 (Wednesday, April 13, 2005)]
[Rules and Regulations]
[Pages 19672-19677]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-7366]



[[Page 19671]]

-----------------------------------------------------------------------

Part VI





Securities and Exchange Commission





-----------------------------------------------------------------------



17 CFR Parts 231, 241, and 271



Commission Guidance Regarding Prohibited Conduct in Connection With IPO 
Allocations; Final Rule

  Federal Register / Vol. 70, No. 70 / Wednesday, April 13, 2005 / 
Rules and Regulations  

[[Page 19672]]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 231, 241, and 271

[Release Nos. 33-8565; 34-51500; IC-26828; File No. S7-03-05]


Commission Guidance Regarding Prohibited Conduct in Connection 
with IPO Allocations

AGENCY: Securities and Exchange Commission.

ACTION: Interpretation; solicitation of comments.

-----------------------------------------------------------------------

SUMMARY: The Securities and Exchange Commission (Commission) is 
publishing this interpretive release with respect to prohibited conduct 
in connection with securities distributions, particularly with a focus 
on initial public offering (IPO) allocations. The Commission is 
soliciting comment on the issues discussed here.

DATES: Effective Date: April 7, 2005.
    Comment Due Date: Comments should be received on or before June 7, 
2005.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/interp.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number S7-03-05 on the subject line; or
     Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609. All submissions should refer to File Number 
S7-03-05. This file number should be included on the subject line if e-
mail is used. To help us process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/rules/interp.shtml). Comments are also available for public inspection 
and copying in the Commission's Public Reference Room, 450 Fifth 
Street, NW., Washington, DC 20549. All comments received will be posted 
without change; we do not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly.

FOR FURTHER INFORMATION CONTACT: Any of the following attorneys in the 
Office of Trading Practices, Division of Market Regulation, Securities 
and Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-
1001, at (202) 942-0772: James Brigagliano, Assistant Director; Joan 
Collopy, Special Counsel; Elizabeth Sandoe, Special Counsel; Liza Orr, 
Special Counsel; or Elizabeth Marino, Attorney.
    Executive Summary: The purpose of this release is to provide 
guidance under Regulation M with respect to the process known as book-
building, including the process for allocating shares in initial public 
offerings (``IPOs''). The Commission recently brought three enforcement 
cases alleging abuses in the offering process in contravention of 
Regulation M. Based on these cases, the Commission seeks to highlight 
certain prohibited activities that underwriters should avoid during 
restricted periods. These include:
     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 that 
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.
     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.

SUPPLEMENTARY INFORMATION:

I. Introduction

    Solicitations or other attempts to induce aftermarket bids or 
purchases during a distribution undermine the integrity of the market 
as an independent pricing mechanism for the offered securities by 
giving purchasers the impression that there is a scarcity of the 
offered securities. This improper conduct by underwriters of IPOs 
erodes investor confidence in the capital raising process. In 
recognition of the serious adverse impact of these activities, the 
Commission has adopted rules, most recently embodied in Regulation M, 
which prohibit these activities as a prophylactic matter.\1\
---------------------------------------------------------------------------

    \1\ Regulation M (17 CFR 242.100-105) generally prohibits 
inducements of any transactions other than those necessary to 
conduct the offering. In the context of IPOs, the prohibition is 
generally discussed in terms of the ``aftermarket,'' i.e., trading 
after the distribution period is over. Regulation M is the successor 
to former Rules 10b-6, 10b-6A, 10b-7, 10b-8, and 10b-21, and 
includes the basic prohibitions of those rules. See Securities 
Exchange Act Release No. 38067 (December 20, 1996), 62 FR 520 
(January 3, 1997) (Regulation M Adopting Release). Recently, the 
Commission published for comment proposed amendments to Regulation 
M. Securities Exchange Act Release No. 50831 (December 9, 2004), 69 
FR 75774 (December 17, 2004) (Regulation M Proposing Release). See 
infra notes 6 and 11.
---------------------------------------------------------------------------

    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 under 
these rules.\2\ We first provided guidance under Rule 10b-6 concerning 
abusive practices in connection with IPO allocations in 1961.\3\ In 
2000, the Division of Market Regulation staff reminded underwriters 
that restricted period solicitations and tie-in agreements for 
aftermarket purchases are prohibited conduct under Regulation M.\4\ 
Recent enforcement actions suggest that during the hot IPO market of 
the late 1990s and 2000, some underwriters and other market 
participants failed to comply with Regulation M or previous 
guidance.\5\ As

[[Page 19673]]

a result, we find it appropriate to remind distribution participants 
and their affiliated purchasers that attempting to induce aftermarket 
bids or purchases during a restricted period violates Regulation M. 
Such guidance is necessary at this time to forestall improper conduct 
while continuing to promote legitimate underwriting practices that will 
facilitate capital formation.
---------------------------------------------------------------------------

    \2\ Regulation M defines the term restricted period in Rule 
100(b) (17 CFR 242.100(b)). See infra note 11.
    \3\ Securities Exchange Act Release No. 6536 (April 24, 1961) 
(stating that practice of distribution participants of IPOs making 
``allotments to their customers only if such customers agree to make 
comparable purchases in the open market after the issue is initially 
sold'' violated Rule 10b-6).
    \4\ Staff Legal Bulletin No. 10, ``Prohibited Solicitations and 
``Tie-in'' Agreements for Aftermarket Purchases,'' August 25, 2000.
    \5\ See SEC v. J.P. Morgan Securities, Inc., No. 1:03CV02028 
(ESH) (Complaint) (October 1, 2003). See also SEC v. Goldman Sachs 
Group, Inc., No. 05 SV 853 (SAS) (Complaint) (January 25, 2005); SEC 
v. Morgan Stanley & Co., Inc., No. 1:05 CV 00166 (HHK) (Complaint) 
(January 25, 2005). In ``hot'' IPOs, investor demand significantly 
exceeds the supply of securities in the offering and the stock 
trades at a premium in the immediate aftermarket. See NYSE/NASD IPO 
Advisory Committee, Report and Recommendations (http://www.nasdr/com/pdf-text/ipo_report.pdf) (May 2003) (IPO Advisory Committee 
Report).
---------------------------------------------------------------------------

II. Regulation M Prohibits Attempts To Induce Aftermarket Bids or 
Purchases

    As a prophylactic rule, Regulation M precludes activities that 
could influence artificially the market for an offered security.\6\ 
Specifically, Rule 101 \7\ makes it unlawful for any distribution 
participant \8\ or its affiliated purchasers,\9\ ``directly or 
indirectly, to bid for, purchase, or attempt to induce any person to 
bid for or purchase, a covered security'' \10\ during the 
distribution's restricted period.\11\ Like its predecessor, Rule 10b-6, 
Regulation M is intended ``to assure that distributions of securities 
are free of the market effects of bids, purchases, and inducements to 
purchase by those who have an interest in the success of a 
distribution.'' \12\ Regulation M therefore addresses direct and 
indirect market activity by distribution participants and conduct by 
distribution participants ``that causes or is likely to cause another 
person to bid for or purchase covered securities.'' \13\
---------------------------------------------------------------------------

    \6\ See Regulation M Adopting Release, supra note 1. On October 
13, 2004, the Commission proposed amendments that would extend the 
scope of Regulation M. Regulation M Proposing Release, 69 FR 75774. 
The guidance provided in this release, which addresses misconduct 
that currently violates Regulation M, is consistent with those 
proposed amendments.
    \7\ 17 CFR 242.101(a).
    \8\ Distribution participants include underwriters, prospective 
underwriters, brokers, dealers, or other persons who have agreed to 
participate or are participating in a distribution. 17 CFR 
242.100(b).
    \9\ Affiliated purchasers include, among others, persons acting, 
directly or indirectly, in concert with distribution participants, 
issuers, or selling security holders in connection with the 
acquisition or distribution of any covered security. 17 CFR 
242.100(b).
    \10\ A covered security is the security in distribution or any 
reference security. A reference security is any security into which 
the security in distribution may be converted. 17 CFR 242.100(b).
    \11\ 17 CFR 242.101(a). Restricted period, as defined in Rule 
100(b) of Regulation M, means: ``(1) For any security with an ADTV 
value of $100,000 or more of an issuer whose common equity 
securities have a public float value of $25 million or more, the 
period beginning on the later of one business day prior to the 
determination of the offering price or such time that a person 
becomes a distribution participant, and ending upon such person's 
completion of participation in the distribution; and (2) For all 
other securities, the period beginning on the later of five business 
days prior to the determination of the offering price or such time 
that a person becomes a distribution participant, and ending upon 
such person's completion of participation in the distribution. (3) 
In the case of a distribution involving a merger, acquisition, or 
exchange offer, the period beginning on the day proxy solicitation 
or offering materials are first disseminated to security holders, 
and ending upon the completion of the distribution.'' 17 CFR 
242.100(b). Among other things, the proposed amendments to 
Regulation M would lengthen the ``restricted period'' for IPOs 
beyond the current 5-day period, and update the ADTV and public 
float values in the definition of restricted period to reflect 
changes in the value of the dollar since Regulation M's adoption in 
1996. The proposed amendments would also incorporate into Regulation 
M's restricted period definition the Commission's long-standing 
interpretation that valuation and election periods in connection 
with mergers, acquisitions, and exchange offers are included in a 
restricted period. Regulation M Proposing Release, 69 FR 75774.
    \12\ See Securities Exchange Act Release No. 21332 (September 
19, 1984), 49 FR at 37572, Research Reports (September 25, 1984). 
Similarly, the Regulation M Adopting Release states that Regulation 
M is ``intended to preclude manipulative conduct by persons with an 
interest in the outcome of an offering.'' Regulation M Adopting 
Release, 62 FR at 520. The scope of the prohibition is so 
comprehensive that a specific exception is included in Regulation M 
to permit underwriters to solicit purchases of securities in the 
offering itself. 17 CFR 242.101(b)(9) (excepting from Rule 101(a) 
``[o]ffers to sell or the solicitation of offers to buy the 
securities being distributed (including securities acquired in 
stabilizing), or securities offered as principal by the person 
making such offer or solicitation'').
    \13\ Securities Exchange Act Release No. 33924 (April 19, 1994), 
59 FR 21681 at 21687 (April 26, 1994) (Regulation M Concept 
Release). See 17 CFR 242.101(a) and Regulation M Adopting Release, 
supra note 1. See also Americorp Securities, Inc., Securities 
Exchange Act Release No. 41728 (August 11, 1999) (broker-dealer firm 
and CEO violated Rule 10b-6 by directing registered representatives 
to solicit and accept aftermarket purchase orders for an IPO from 
numerous retail customers before the effective date of the IPO). See 
also SEC v. Wexler, Securities Exchange Act Release No. 14489 
(September 21, 1995); P.N. MacIntyre & Co., Inc., Securities 
Exchange Act Release No. 10694 (March 20, 1974) (broker-dealer firm 
violated Rule 10b-6 by bidding for, purchasing or attempting to 
induce others to purchase securities in an offering underwritten by 
the broker-dealer firm before completion of the firm's participation 
in the distribution).
---------------------------------------------------------------------------

    Attempts to induce bids or purchases of covered securities directed 
at aftermarket transactions fundamentally interfere with the 
independence of the market dynamics that are essential to the ability 
of investors to evaluate the terms on which securities are offered. 
Among other things, attempts to induce aftermarket bids or purchases 
can give prospective IPO purchasers the impression that there is a 
scarcity of the offered securities and the balance of their buying 
interest therefore can only be satisfied in the aftermarket.\14\ As 
discussed below, attempts to induce aftermarket bids or purchases are 
prohibited throughout the restricted period.
---------------------------------------------------------------------------

    \14\ See Report of the Special Study of the Securities Markets 
of the Securities and Exchange Commission, H.R. Doc. No. 88-95, pt. 
1 at 520-21, 556 (1 Sess. 1963) (Special Study). The Special Study 
found that ``[t]raders and customers both stated that prior to the 
effective date [of the registration statement] retail firms received 
buy orders or indications of interest from customers to purchase new 
issues at premium prices in the after-market and that these orders 
were then transmitted to trading firms for execution in the after-
market.'' The Special Study then notes: ``[I]f broker-dealers are 
prospective underwriters or have agreed to participate in the 
distribution, they may, by soliciting such orders, be attempting to 
induce customers to purchase the security prior to completion of the 
distribution and thereby violate rule 10b-6 under the Exchange Act 
[now Rule 101 of Regulation M].'' See also Report of the Securities 
and Exchange Commission Concerning the Hot Issues Markets at 37-38 
(August 1984) (1984 Hot Issues Report) (requiring customers who 
receive IPO allocations to purchase shares in the aftermarket 
stimulates demand for the security and causes shares to trade at a 
premium in the aftermarket). As Staff Legal Bulletin No. 10. 
discussed: ``Solicitations and tie-in agreements for aftermarket 
purchases are manipulative because they undermine the integrity of 
the market as an independent pricing mechanism for the offered 
security. Solicitations for aftermarket purchases give purchasers in 
the offering the impression that there is scarcity of the offered 
securities. This can stimulate demand and support the pricing of the 
offering.''
---------------------------------------------------------------------------

    First, Regulation M applies to ``attempts,'' thus proscribing a 
distribution participant's conduct irrespective of whether it actually 
results in market activity by others.\15\ It is the inducement or the 
attempt to induce during the restricted period that Regulation M 
prohibits. The induced activity (i.e., aftermarket bids or purchases) 
may occur during or after the restricted period, or indeed may never 
occur at all. Second, we have said that ``inducement to purchase'' 
broadly refers to ``activity that causes or is likely to cause another 
person to bid for or purchase covered securities.'' \16\ The 
prophylactic prohibitions of Regulation M apply to such conduct 
regardless of intent of the distribution participant or affiliated 
purchaser. Therefore, no proof of scienter is necessary.\17\ Whether

[[Page 19674]]

particular conduct is a proscribed attempt to induce to bid for or 
purchase a covered security requires an analysis of all of the facts 
and circumstances surrounding the distribution participant's activity.
---------------------------------------------------------------------------

    \15\ See SEC v. Burns, 614 F. Supp. 1360 (S.D.Cal. 1985), aff'd 
on other grounds, 816 F.2d 471, 477 (9th Cir. 1987) (finding that 
``[s]o long as the participant attempted to induce purchases of 
those securities involved in the distribution, and did so before he 
completed his participation in the distribution, the attempt to 
induce comes within the scope of Rule 10b-6''). See also Michael J. 
Markowski, Securities Exchange Act Release No. 44086 (March 20, 
2001) (finding a Rule 10b-6 violation when a broker-dealer firm 
instructed its brokers to solicit aftermarket orders during the 
distribution).
    \16\ Regulation M Concept Release, 59 FR at 21687.
    \17\ ``Regulation M proscribes certain activities that offering 
participants could use to manipulate the price of an offered 
security * * *. The Commission continues to believe that a 
prophylactic approach to anti-manipulation regulation is the most 
effective means to protect the integrity of the offering process by 
precluding activities that could influence artificially the market 
for the offered security.'' Regulation M Adopting Release, 62 FR at 
520. See also Regulation M Proposing Release, 69 FR at 75775 
(stating '' * * * Regulation M does not require the Commission to 
prove in an enforcement action that distribution participants have a 
manipulative intent or purpose'').
---------------------------------------------------------------------------

    We are not addressing here the full spectrum of conduct prohibited 
by Regulation M. Rather, our discussion is focused on applying 
Regulation M to particular facts and circumstances that we have 
observed occurring in the most recent hot IPO market and providing 
guidance on some types of activities that are impermissible in light of 
the requirements of Regulation M.

III. Regulation M and IPOs

A. ``Hot'' IPO Periods

    In the context of an IPO, Regulation M's prohibition on attempts to 
induce bids and purchases focuses on impermissible conduct during the 
restricted period that could stimulate others to engage in transactions 
when the trading market in the newly issued securities first commences 
(i.e., the ``aftermarket''). ``Hot'' IPO markets present special 
problems in this context.\18\ By definition, hot IPO markets are 
characterized by high levels of demand for an allocation of the IPO 
shares in the original distribution, and therefore the shares are a 
valuable commodity. Underwriters may therefore be tempted to demand, 
require, solicit, encourage, or otherwise attempt to induce investors 
to engage in immediate aftermarket transactions in order to obtain an 
allocation of IPO shares.\19\ Such activity violates Regulation M and 
also may violate the general antifraud and anti-manipulation provisions 
of the securities laws.\20\
---------------------------------------------------------------------------

    \18\ See IPO Advisory Committee Report at 1-2, stating:
    In recent years, however, public confidence in the integrity of 
the IPO process has eroded significantly. Investigations have 
revealed that certain underwriters and other participants in IPOs at 
times engaged in misconduct contrary to the best interests of 
investors and our markets * * * Instances of this behavior became 
more frequent during the IPO ``bubble'' of the late 1990s and 2000 * 
* *.
    \19\ See IPO Advisory Committee Report at 1 (discussing 
underwriters' misconduct during the IPO ``bubble'' of the late 1990s 
and 2000).
    \20\ ``Any transaction or any series of transactions, whether or 
not effected pursuant to the provisions of Regulation M * * * remain 
subject to the antifraud and antimanipulation provisions of the 
securities laws * * *.'' 17 CFR 242.100(a).
---------------------------------------------------------------------------

    The Special Study in 1963 that focused on the ``hot issue'' market 
from 1959-1961 \21\ found that ``[i]n the pricing of new issues, 
underwriters could not help but be influenced by the knowledge that the 
prices of many issues would subsequently rise in the immediate after-
market * * * '' \22\ The Special Study identified a number of problems 
and abuses that resulted from this knowledge, including the 
solicitation of aftermarket purchases.\23\ The Special Study found 
that, while it was often difficult to determine whether solicitation of 
purchases in the aftermarket occurred prior to or immediately following 
the effective date of the offering, customers of certain distribution 
participants engaged in significant market purchases on the first day 
of trading, thus suggesting that the participants actively solicited or 
recommended purchases at least as early as the notice of 
effectiveness.\24\
---------------------------------------------------------------------------

    \21\ Special Study, pt. 1.
    \22\ Special Study, pt. 1, at 554. See also IPO Advisory 
Committee Report, similarly noting that during the late 1990s and 
2000, the ``large first-day price increases affected the allocation 
process by creating a pool of instant profits for underwriters to 
distribute.'' Id. at 1.
    \23\ Special Study, pt. 1, at 520-21, 556. See supra note 14.
    \24\ Special Study, pt. 1, at 556 (also finding that ``[t]o add 
to the aftermarket excitement, some managing underwriters arranged 
for solicitation of customers at premium prices through 
nonparticipating firms.'') See also David Clurman, Controlling a Hot 
Issue Market, 56 Cornell L. Rev. 74, 76 (1970).
---------------------------------------------------------------------------

    Subsequent studies also discussed underwriters' conduct in 
connection with IPOs.\25\ We issued a report in 1984 analyzing the hot 
issue market from 1980-1983.\26\ Among other things, the 1984 Report 
found that underwriters used ``tie-in'' arrangements requiring 
customers, as a condition of participation in a hot issue offering, 
either to agree to purchase additional shares of the same issue at a 
later time, or to participate in another offering.\27\ Most recently, 
the NYSE/NASD IPO Advisory Committee issued a report in May 2003 
discussing underwriters' conduct during the IPO ``bubble'' of the late 
1990s and 2000, a period in which there were an unusually large number 
of IPOs that traded ``at extraordinary and immediate aftermarket 
premiums.'' \28\ The report found that among the most harmful practices 
that artificially inflated aftermarket prices were ``allocating IPO 
shares based on a potential investor's commitment to purchase 
additional shares in the aftermarket at specified prices,'' which the 
report referred to as ``laddering.'' \29\
---------------------------------------------------------------------------

    \25\ See, e.g., IPO Advisory Committee Report.
    \26\ ``Report of the Securities and Exchange Commission 
Concerning Hot Issues Markets'' (August 1984) (1984 Hot Issues 
Report).
    \27\ 1984 Hot Issues Report, at 37-39. ``This practice 
stimulates demand for a hot issue in the aftermarket thereby 
facilitating the process by which stock prices rise to a premium.'' 
Id. at 37-38. We have stated that ``making allotments to customers 
only if such customers agree to make some comparable purchase in the 
open market after the issue is initially sold'' may violate the 
anti-manipulative provisions of the Securities Exchange Act of 1934 
(Exchange Act), particularly Rule 10b-6 (which was replaced by Rules 
101 and 102 of Regulation M), and may violate other provisions of 
the federal securities laws. Securities Exchange Act Release No. 
6536 (April 24, 1961).
    \28\ IPO Advisory Committee Report, at 1.
    \29\ IPO Advisory Committee Report, at 2. The Report described 
``laddering'' as inducing investors to give orders to purchase 
shares in the aftermarket at pre-arranged, escalating prices in 
exchange for receiving IPO allocations, and stating that ``[t]his 
conduct distorts the offering and the aftermarket and impairs 
investor confidence in the IPO process.'' Id. at 6.
---------------------------------------------------------------------------

B. Book-Building

    Book-building refers to the process by which underwriters gather 
and assess potential investor demand for an offering of securities and 
seek information important to their determination as to the size and 
pricing of an issue.\30\ When used, the IPO book-building process 
begins with the filing of a registration statement with an initial 
estimated price range. Underwriters and the issuer then conduct ``road 
shows'' to market the offering to potential investors, generally 
institutions. The road shows provide investors, the issuer, and 
underwriters the opportunity to gather important information from each 
other. Investors seek information about a company, its management and 
its prospects, and underwriters seek information from investors that 
will assist them in determining particular investors' interest in the 
company, assessing demand for the offering, and improving pricing 
accuracy for the offering. Investors' demand for an offering 
necessarily depends on the value they place, and the value they expect 
the market to place, on the stock, both initially and in the future. In 
conjunction with the road shows, there are discussions between the 
underwriter's sales representatives and prospective investors to obtain 
investors' views about the issuer and the offered securities, and to 
obtain indications of the investors' interest in purchasing quantities 
of the underwritten securities in the offering at particular 
prices.\31\ As the IPO Advisory

[[Page 19675]]

Committee Report stated: ``[C]ollecting information about investors'' 
long-term interest in, and valuation of, a prospective issuer is an 
essential part of the book-building process.'' \32\ By aggregating 
information obtained during this period from investors with other 
information, the underwriters and the issuer will agree on the size and 
pricing of the offering, and the underwriters will decide how to 
allocate the IPO shares to purchasers.\33\
---------------------------------------------------------------------------

    \30\ See In re Initial Public Offering Securities Litigation, 
241 F. Supp. 2d 281, 388 n. 106 (S.D.N.Y. 2003) (book-building 
``entails the lead underwriter gathering and assessing potential 
investors'' demand for the offering'').
    \31\ See IPO Advisory Committee Report, at 5-6. Actual sales or 
contracts for sale are prohibited during the period prior to the 
registration statement for the offering becoming effective. 15 
U.S.C. 77e.
    \32\ IPO Advisory Committee Report, at 6.
    \33\ See IPO Advisory Committee Report, at 4 (stating ``[t]he 
pricing of an IPO is a business decision reached by the issuer in 
consultation with the underwriter''). See also Jay R. Ritter, 
Initial Public Offerings, Contemporary Finance Digest, Vol. 2, No. 1 
(Spring 1998), pp. 5-30, at Sec.  7.1 at pp. 19-21.
---------------------------------------------------------------------------

    Information that underwriters typically attempt to gather from 
prospective investors during the book-building process for an IPO, 
whether in high demand or not, includes: \34\
---------------------------------------------------------------------------

    \34\ This is not an exhaustive list of all the information 
gathered during the book-building process.
---------------------------------------------------------------------------

     A customer's evaluation of the issuer's products, 
earnings, history, management, and prospects.
     A customer's valuation of the securities being offered.
     The amount of shares a customer seeks to purchase in the 
offering at particular price levels (i.e., indications of interest or 
conditional offers to buy).
     Whether the customer owns similar securities in his 
portfolio.
     At what prices the customer expects the shares will trade 
after the offering is completed (e.g., where the stock will be trading 
three to six months after the offering).
     Whether the customer intends to hold the securities as an 
investment (be a long-term holder), or, instead, expects to sell the 
shares in the immediate aftermarket (also known as ``flipping'').
     The customer's desired long-term future position in the 
security being offered or in the relevant industry, and the price or 
prices at which the customer might accumulate that position.

C. The Application of Regulation M to Book-Building Activities

    While we recognize the importance of the book-building process in 
obtaining and assessing demand for an offering and in pricing the 
securities, we remind market participants that there is no ``book-
building exception'' to Regulation M for inducing or attempting to 
induce aftermarket bids or purchases.\35\ Although a distribution 
participant's obtaining and assessing information about demand for an 
offering during the book-building process would 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 to be part of conduct 
that violates Regulation M.
---------------------------------------------------------------------------

    \35\ The exception in Rule 101(b)(9) of Regulation M for offers 
to sell or the solicitation of offers to buy the security being 
distributed does not extend to inducements or attempts to induce 
bids or purchases in the aftermarket while the distribution is 
occurring.
---------------------------------------------------------------------------

    Underwriters and other distribution participants must take care 
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.'' \36\ 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.
---------------------------------------------------------------------------

    \36\ Regulation M Concept Release, 59 FR at 21687.
---------------------------------------------------------------------------

D. Prohibited Attempts To Induce

    As we previously stated, the purpose of this release is to provide 
guidance under Regulation M with respect to book-building and the 
process for allocating shares in IPOs. The activities we emphasize are 
prohibited do not represent an exhaustive list of conduct that violates 
Regulation M because the facts and circumstances of particular 
communications or activities will determine whether there is a 
Regulation M violation. This release is a reminder that certain conduct 
that causes or is likely to cause an undertaking, a promise, a 
commitment, or an understanding on the part of a customer to make 
aftermarket bids or purchases of an offered security, in relation to an 
expected allocation of IPO shares, is impermissible under Regulation M. 
We are not suggesting however that conduct is improper simply because 
it ascertains an investor's interest in purchasing an issuer's 
securities or leads to the development by an investor of an interest in 
purchasing securities of an issuer, whether in the offering or the 
aftermarket, including as a result of communications between the 
investor and a distribution participant regarding the issuer or the 
offering.

IV. Commission Guidance

    The Commission has determined in the context of recent enforcement 
actions that the following activities and conduct during the Regulation 
M restricted period violated Regulation M:\37\
---------------------------------------------------------------------------

    \37\ The Commission has recently brought enforcement cases 
alleging violations of Regulation M. See SEC v. Morgan Stanley & 
Co., (Compl.) (2005); SEC v. Goldman Sachs & Co., (Compl.) (2005); 
SEC v. J.P. Morgan Securities, Inc., (Compl.) (2003). See also 
Michael J. Markowski, supra note 16 and Securities Exchange Act 
Release No. 6536, supra note 3 (describing violations of Rule 10b-6, 
the predecessor to Regulation M).
---------------------------------------------------------------------------

    1. Inducements to purchase in the form of tie-in agreements \38\ or 
other solicitations of aftermarket bids or purchases prior to the 
completion of the distribution.
---------------------------------------------------------------------------

    \38\ In this context, tie-in agreements are agreements or 
contracts for the purchase of shares in the aftermarket in exchange 
for an allocation. Such contracts may also violate the antifraud 
provisions of the Securities Act of 1933 (Securities Act) and the 
Exchange Act, and Section 5 of the Securities Act. See Special 
Study, pt. 1, at 521 n. 93. See also Staff Legal Bulletin No. 10. 
The solicitation of a tie-in is prohibited, irrespective of whether 
an agreement or contract to purchase results.
---------------------------------------------------------------------------

    2. 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. The focus of this communication is clearly to attempt to induce 
customers to bid for or purchase securities in the immediate 
aftermarket in return for an allocation. However, inquiring as to 
customers' desired future position in the longer term (for example, 
three to six months) and the price or prices at which customers might 
accumulate that position, without reference to immediate aftermarket 
activity, does not, without more, fall within this violative conduct.
    3. 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.\39\

[[Page 19676]]

Where the sales representative inquires whether the customer intends to 
place orders in the immediate aftermarket, and if so, at what prices 
and quantities, the clear expectation and understanding is that the 
customer will submit aftermarket orders at the prices and quantities 
discussed if the customer receives an allocation of shares. However, 
inquiring as to a customer's desired future position in the longer term 
(for example, three to six months), and the price or prices at which 
the customer might accumulate that position without reference to 
immediate aftermarket activity, does not, without more, fall within 
this violative conduct. Soliciting aftermarket interest from customers 
that the distribution participant knows, or should know, have no 
interest in long-term holdings of the stock of IPO companies, may show 
that the firm or salesperson was attempting to induce aftermarket 
activity.
---------------------------------------------------------------------------

    \39\ We note that the district court in In re Initial Public 
Offering Antitrust Litigation, 287 F. Supp. 2d 497 (S.D.N.Y. Nov. 3, 
2003), appeal pending, Billing v. Credit Suisse First Boston, Nos. 
03-9284, 03-9288 (2d Cir.) stated that ``inquiries of customers or 
others interested in purchasing Class Securities concerning the 
number of shares that such person would be willing to purchase in 
the aftermarket and the prices such person would be willing to pay 
for the shares' are actions that are ``expressly permitted during 
the `road show' period.'' Id. at 508. However, no provision of the 
federal securities laws expressly permits the conduct described in 
the quotations during the ``road show'' period. In fact, depending 
on the facts and circumstances, if the ``road show'' period overlaps 
with a restricted period defined in Regulation M, then such actions 
may represent attempts to induce aftermarket bids or purchases in 
violation of Rule 101 of Regulation M.
---------------------------------------------------------------------------

    4. Proposing aftermarket prices to customers or encouraging 
customers who provide aftermarket interest to increase the prices that 
they are willing to place orders in the immediate aftermarket. 
Proposing aftermarket prices to customers creates the impression of a 
strong offering demand and a scarcity of offering shares, which can 
facilitate a distribution. Encouraging customers who provide 
aftermarket interest to increase the price level at which they were 
willing to place orders in the aftermarket conveys to customers that 
bidding for or purchasing in the immediate aftermarket at price levels 
higher than their own initial price level or higher than other 
customers' aftermarket price levels is expected in consideration for an 
allocation or an improved allocation in the IPO. Communication to 
customers of information obtained from third parties regarding their 
valuation of an issuer or the offering price is not violative where the 
conduct would not be likely to cause the customer to express an 
interest in paying a higher price in the immediate aftermarket. 
Encouraging an increase in prices, including by communication of prices 
of aftermarket interest of third parties would be viewed as improperly 
conveying to a customer that a commitment in the aftermarket at higher 
price levels is expected as described above.
    5. 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. By seeking this type of aftermarket interest from 
customers, the underwriter would be attempting to induce customers to 
place orders or buy in the aftermarket. In contrast, it is possible 
that a customer could express a desire to purchase in the aftermarket 
without prompting from the salesman. Where the customer's statement is 
spontaneous, there may be no ``attempt to induce'' by the salesperson. 
However, if, for example, there had been a prior course of dealing 
between the firm and the investor through which the firm communicated 
that the investor was expected to provide this type of aftermarket 
price and quantity information, the seemingly spontaneous statement of 
an intention to make aftermarket purchases may in fact have been 
induced by the firm. In any event, whether or not the customer's 
statement is spontaneous, if a sales representative accepts a 
customer's offer to purchase shares in the immediate aftermarket that 
is expressly linked to the receipt of an allocation, this is a 
prohibited tie-in agreement and violates Regulation M.\40\
---------------------------------------------------------------------------

    \40\ By accepting such a commitment, the firm also may violate 
Section 5 under the Securities Act. See Special Study, pt. 1, at 521 
n. 93. See also note 38 supra. In contrast, for example, where a 
sales representative rejects the offer to make aftermarket purchases 
linked to the receipt of an allocation, and informs the customer 
that firm policy prohibits allocations on that basis, the firm would 
not have engaged in activity that constitutes a prohibited tie-in 
agreement in violation of Regulation M, notwithstanding that the 
customer ultimately was allocated IPO shares.
---------------------------------------------------------------------------

    6. 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. If all of the IPO 
shares have not been distributed, an underwriter is still in a 
restricted period and prohibited from attempting to induce aftermarket 
activity.\41\ By soliciting orders or rewarding customers who place 
orders in the immediate aftermarket with additional IPO shares in the 
same offering, the underwriter is improperly stimulating aftermarket 
purchases during the restricted period.
---------------------------------------------------------------------------

    \41\ The definition of restricted period in Rule 100 of 
Regulation provides that a restricted period ends upon ``such 
person's completion of participation in the distribution.'' In the 
Adopting Release the Commission stated, ``[u]nder Regulation M, a 
person determines when its completion of participation in the 
distribution occurs based on the person's role in the distribution. 
An underwriter is deemed to have completed its participation in a 
distribution when its participation has been distributed * * * and 
after any stabilization arrangements and trading restrictions in 
connection with the distribution have been terminated. The 
definition contains a provision that an underwriter's participation 
is not deemed to be completed, however, if a syndicate overallotment 
option is exercised in an amount that exceeds the net syndicate 
short position at the time of such exercise.'' Regulation M Adopting 
Release, 62 FR at 522.
---------------------------------------------------------------------------

    7. 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 this 
scenario, the broker would be inducing or attempting to induce 
aftermarket bids or purchases by linking an expectation of aftermarket 
bids or purchases to the customer's desire to receive allocations in 
future hot IPOs. However, determining that a customer is or may be a 
long-term investor in the securities of an issuer or one or more other 
issuers and communications with a customer in connection with that 
determination do not, in and of themselves, violate Regulation M, 
whether or not a customer engages in aftermarket bids or purchases.
    Each of the above activities is an improper attempt to induce 
investors to bid for or purchase covered securities in the aftermarket 
in order to receive IPO allocations.\42\ These solicitations or 
attempts to induce aimed at aftermarket transactions tend to: (1) 
Create offering demand; (2) cause artificial aftermarket price 
escalation; and (3) erode market integrity. As we have stated before, 
when offerings are sold based upon an artificially manufactured 
perception of scarcity and priced on stimulated buying pressure, IPO 
investors are unable to evaluate the offering to determine that it has 
been appropriately priced.\43\ Moreover, other investors who bid for or 
purchase shares in the aftermarket would not know that the aftermarket 
demand had been stimulated by the underwriters' unlawful conduct.
---------------------------------------------------------------------------

    \42\ We note, however, that allocating offering shares in an 
amount less than the investor's indication of interest for shares in 
the offering in response to a solicitation to purchase in the 
offering would not, in and of itself, be considered an attempt to 
induce aftermarket purchases.
    \43\ See 1984 Hot Issue Report, at 37-39.
---------------------------------------------------------------------------

    In addition, certain conduct occurring after the restricted period, 
while not of itself illegal, could be evidence that a distribution 
participant attempted during the restricted period to induce customers 
to bid for or purchase stock in the aftermarket.\44\ Recent

[[Page 19677]]

enforcement cases contain examples of such activity including: (1) 
Follow-up solicitations for immediate aftermarket orders from customers 
who had provided aftermarket interest earlier; and (2) tracking or 
monitoring customers' aftermarket purchases to see whether they had 
followed through on their aftermarket interest.\45\ We recognize that 
there are legitimate reasons to monitor customer activity. However, 
tracking customers' aftermarket purchases in the first few days of 
trading following an IPO could be evidence supporting a claim that the 
customers' expressions of desire to purchase in the aftermarket were 
induced.
---------------------------------------------------------------------------

    \44\ As discussed above, while aftermarket transactions can 
serve as evidence that there had been an attempt to induce 
aftermarket bids or purchases, such evidence is not required to 
establish an attempt to induce in violation of Regulation M. 
Additionally, oral attempts to induce aftermarket activity can be 
evidenced in a variety of ways. See, e.g., Americorp, Inc., 
Securities Exchange Act Release No. 41728 (August 11, 1999) (broker 
dealer representatives prepared order tickets for aftermarket orders 
prior to the IPO becoming effective).
    \45\ For example, the sales representative may call the investor 
when aftermarket trading begins and ask why an order had not been 
received from the investor; or the investor may be informed that he 
is being penalized for not making aftermarket purchases by being 
denied allocations in future IPOs.
---------------------------------------------------------------------------

V. Policies and Procedures

    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 restricted period.\46\ Firms should implement policies 
that, at a minimum, prohibit and monitor for the activities discussed 
in this 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.
---------------------------------------------------------------------------

    \46\ See, e.g., Exchange Act Section 15(b)(4)(E), 15 U.S.C. 
78o(b)(4)(E). See also NASD Rule 3010(a) (requiring member firms to 
establish and maintain a system to supervise the activities of each 
registered representative and associated person that is reasonably 
designed to achieve compliance with applicable NASD rules, federal 
securities laws and rules); NASD Notice to Members 03-72, Request 
for Comment on Regulatory Approaches to Enhance IPO Pricing 
Transparency (November 2003); IPO Advisory Committee Report, at 6, 
19 (encouraging underwriters to develop effective internal policies 
and procedures to prevent prohibited secondary market activity and 
recommending that underwriters impose additional requirements to 
promote the highest standards of conduct, including: (1) enhanced 
periodic internal review by the underwriter of its IPO supervisory 
procedures; and (2) a heightened focus on the IPO process in SRO 
examinations for investment banking personnel).
---------------------------------------------------------------------------

VI. General Request for Comment

    We will continue to monitor developments in IPO allocation 
practices. We invite anyone who is interested to submit written 
comments on this release. Additionally, the Commission solicits comment 
generally concerning underwriter conduct in connection with IPOs and 
other distributions. The Commission will take these comments into 
consideration as it considers future rulemaking.

List of Subjects in 17 CFR Parts 231, 241, and 271

    Securities.

Amendments to the Code of Federal Regulations

0
For the reasons set out in the preamble, the Commission is amending 
Title 17, chapter II of the Code of Federal Regulations as set forth 
below:

PART 231--INTERPRETATIVE RELEASES RELATING TO THE SECURITIES ACT OF 
1933 AND GENERAL RULES AND REGULATIONS THEREUNDER

0
Part 231 is amended by adding Release No. 33-8565 and the release date 
of April 7, 2005 to the list of interpretive releases.

PART 241--INTERPRETATIVE RELEASES RELATING TO THE SECURITIES 
EXCHANGE ACT OF 1934 AND GENERAL RULES AND REGULATIONS THEREUNDER

0
Part 241 is amended by adding Release No. 34-51500 and the release date 
of April 7, 2005 to the list of interpretive releases.

PART 271--INTERPRETATIVE RELEASES RELATING TO THE INVESTMENT 
COMPANY ACT OF 1940 AND GENERAL RULES AND REGULATIONS THEREUNDER

0
Part 271 is amended by adding Release No. IC-26828 and the release date 
of April 7, 2005 to the list of interpretive releases.

    By the Commission.

    Dated: April 7, 2005.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 05-7366 Filed 4-12-05; 8:45 am]
BILLING CODE 8010-01-P