Initial Public Offerings: Guidance Needed on Disclosure of Underwriters'
Disciplinary Histories (Letter Report, 06/06/96, GAO/GGD-96-5).

GAO addressed concerns about the initial public offerings (IPO)
allocation process, focusing on: (1) the factors that influence
underwriters to sell IPO shares to institutional investors and
individual investors; (2) disclosure requirements concerning the history
of disciplinary actions taken against an underwriter; and (3) Security
and Exchange Commission (SEC) rules governing the IPO market.

GAO found that: (1) most underwriters primarily sell IPO to
institutional investors because of economic factors and their belief
that these investors can buy larger blocks of IPO shares, hold their
investments longer, and assume greater financial risk; (2) underwriters
market IPO to individual investors when their firms have a high
percentage of individual investor clients, the company is well known to
individual investors, or institutional investors have little interest in
the IPO; (3) SEC and National Association of Security Dealers (NASD)
give underwriters wide latitude in marketing and allocating IPO shares
among institutional and individual investors; (4) SEC does not require
companies to disclose in their prospectus certain information about
their underwriters' criminal or disciplinary histories except when
market manipulation and fraud are involved; (5) SEC and self-regulatory
organizations imposed 25 formal disciplinary actions for securities
violations on 13 of 34 underwriting firms for the 5-year period prior to
issuance of IPO; and (6) SEC could provide investors a better means of
assessing risks associated with IPO if it required companies to disclose
material information on underwriters' disciplinary histories in their
prospectus.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  GGD-96-5
     TITLE:  Initial Public Offerings: Guidance Needed on Disclosure of 
             Underwriters' Disciplinary Histories
      DATE:  06/06/96
   SUBJECT:  Securities regulation
             Financial institutions
             Brokerage industry
             Information disclosure
             Stocks (securities)
             Ethical conduct
             Crimes or offenses
IDENTIFIER:  National Association of Securities Dealers Central 
             Registration Depository
             
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Cover
================================================================ COVER


Report to the Chairman, Securities and Exchange Commission

June 1996

INITIAL PUBLIC OFFERINGS -
GUIDANCE NEEDED ON DISCLOSURE OF
UNDERWRITERS' DISCIPLINARY
HISTORIES

GAO/GGD-96-5

Initial Public Offerings

(233430)


Abbreviations
=============================================================== ABBREV

  CRD - Central Registration Depository
  IPO - initial public offering
  NASD - National Association of Securities Dealers
  SEC - Securities and Exchange Commission
  SRO - self-regulatory organization

Letter
=============================================================== LETTER


B-259973

June 6, 1996

The Honorable Arthur Levitt
Chairman, Securities and Exchange Commission

Dear Mr.  Levitt: 

Initial public offerings (IPO)--the sale of a company's securities to
the public for the first time--are a major source of funds for new
companies seeking to raise capital from the investment community. 
According to Securities and Exchange Commission (SEC) data, in 1994,
companies registered securities worth $25.9 billion to raise capital
through IPOs.  Companies typically use underwriters,\1 to assist them
in registering the IPO with SEC and raising equity capital from the
investment community.  We initiated this review because of concerns
raised by press reports that some underwriters were giving certain
investors preferential access to the IPO market and that some
companies were not disclosing material information, such as the
criminal and disciplinary histories of their underwriters, to
investors.  This report discusses (1) the factors that influence
underwriters to sell IPO shares to institutional investors or
individual investors and (2) disclosure requirements concerning the
history of disciplinary actions taken against an underwriter.  The
report also provides information, analysis, and a recommendation to
improve SEC's rules governing the IPO market. 


--------------------
\1 Underwriters are broker-dealers and/or investment bankers who,
singly or as a member of an underwriting group or syndicate, may
agree to purchase a new issue of securities from an issuer and
distribute it to investors or make a "best efforts" attempt to sell
the offering. 


   BACKGROUND
------------------------------------------------------------ Letter :1

The IPO process generally consists of three phases:  (1) developing
the information and documents for submission to SEC, (2) processing
these documents through SEC, and (3) marketing and selling the newly
public shares.  Before the initial sale of their stock is permitted,
companies are required to register the IPO with SEC.  Companies that
want the SEC to declare the IPO effective must first complete a
registration statement.  The registration statement is to contain
basic required information about the offering, such as the name of
the company, the number of shares to be publicly traded, and the
offer price.  The company then submits the registration statement and
a preliminary prospectus to SEC. 

The primary purpose of the prospectus is to inform the investing
public of all material information about the company and the security
being offered for sale.  For this reason, SEC rules require companies
to disclose in the prospectus detailed information about the company. 
Specifically, this detailed information is to include a description
of the company's business and the identity and experience of its
management, the risk factors in the company's operating history and
the nature of its business, the names of its current major
stockholders, and the company's financial statements.  In addition,
the company is required to disclose in the prospectus information on
its underwriting firm, including the members of the underwriting
syndicate,\2 any relationships between the underwriting firm and the
company, and whether the underwriting firm has had less than 3 years
of broker-dealer\3 experience. 

In reviewing the preliminary prospectus, SEC staff are to assess
whether the prospectus provides all material information about the
issuer, underwriter, and security being offered for sale.  SEC has
used a working definition, founded on court decisions, that considers
information material when there is a substantial likelihood that a
reasonable investor would consider it important in determining
whether to purchase a security.  In their assessment, SEC staff are
to use public and nonpublic sources of information to identify areas
in the preliminary prospectus that they believe to be incomplete or
inaccurate.  SEC staff are also to determine whether the financial
statements in the preliminary prospectus conform to generally
accepted accounting principles.  On the basis of its assessment, SEC
staff may request that the company revise the preliminary prospectus. 
When SEC requires no further revisions, the registration process is
complete, and IPO securities can be sold to investors.  The IPO
process is described more fully in appendix I. 

Underwriters play an important role throughout the IPO process. 
Companies typically use underwriters, along with lawyers and
accountants, to assist them in registering the IPO with SEC. 
Companies also rely on underwriters to help market and sell the IPO
to the investment community.  Underwriters can sell IPO shares by
either serving as an agent for the company or as owner of the shares. 
As an agent, the underwriter assumes no financial risk for the sale
of the IPO shares since the company retains ownership of the shares. 
Alternatively, the underwriter can purchase some or all of the newly
issued shares to resell to other investors at a maximum price known
as the "offer price." In this case, the underwriter, as the new owner
of the IPO shares, assumes financial risk for the issuance of the IPO
shares.  Underwriters also can be involved in market stabilization of
the price of the security during the sales period and the period
following the cessation of sales efforts in the offering. 

While underwriters play an important role in a smoothly functioning
IPO process, underwriters could adversely affect an investor's
investment risk through certain activities, such as fraud and market
manipulation, which are illegal, and favoritism, which is not.  For
example, an underwriter can profit from engaging in prohibited
practices, such as "free-riding" or "withholding." An underwriter
engaging in free-riding purchases securities with the intent of not
paying for them or with the intent of paying for them only if the
price goes up by the settlement date.  The underwriter can then sell
the securities at a price higher than the purchase price and the
sales proceeds can be used to cover the purchase obligation.  An
underwriter engaging in withholding can profit directly or indirectly
from a price rise on the sale of IPO shares by withholding a certain
number of shares from the market until the market price rises above
the offer price.  Withholding a sufficiently large number of shares
could cause the price to rise quickly in the period following the
cessation of the sales offering. 

Furthermore, underwriters could give certain investors an economic
advantage by favoring those investors over others in sales of IPO
shares at the initial offer price.  Many academic studies have found
that investors can profit from buying IPO shares at the offer price. 
According to a March 17, 1994, study by Prudential Securities, a
significant difference exists between the performance achieved by
investors able to buy at the offer price and the performance achieved
by investors who buy after the first day of trading. 

Both SEC and the National Association of Securities Dealers (NASD),
the self-regulatory body for broker-dealers, conduct periodic
examinations of broker-dealers' underwriting firms to detect rule
violations.  When violations are found, the regulators can impose a
variety of disciplinary actions.  For example, minor violations may
result in a letter of caution to the violator; more serious
violations can warrant a formal disciplinary action, such as a
suspension and/or a monetary fine.  Individual brokers and their
firms are required to report any formal disciplinary actions taken
against them to the Central Registration Depository (CRD).\4 These
disciplinary actions for violations related to the securities
business may be imposed by SEC, state regulators, self-regulatory
organizations (SRO), the courts, or employing firms. 


--------------------
\2 A syndicate is a group of underwriting firms that is formed to
sell stock to investors. 

\3 Broker-dealers combine the functions of brokers and dealers. 
Brokers are agents who handle public orders to buy and sell
securities.  Dealers are principals who buy and sell stocks and bonds
for their own accounts and at their own risk. 

\4 The CRD is an automated database operated by NASD and state
regulators that contains information regarding the disciplinary
history of member firms and individual brokers.  Originally
established as a centralized broker licensing and SRO registration
system, the CRD is now used by regulators and the industry to help
oversee brokers' activities. 


   RESULTS IN BRIEF
------------------------------------------------------------ Letter :2

Most underwriters we contacted primarily target institutional
investors in the marketing and sale of IPO shares.  According to
officials we interviewed at 10 underwriting firms, 9 of the firms
market and sell IPOs primarily to institutional investors, rather
than individual investors.  The nine firms' estimated sales to
institutional investors ranged from 60 to 90 percent--at a large
underwriting firm with both institutional and individual clients and
at a small underwriting firm with few individual clients,
respectively.  Those firms that marketed primarily to institutional
investors did so because of economic factors and their judgment that
institutional investors are better able to (1) buy large portions of
IPO shares, (2) hold the investment for the long term, and (3)
withstand the risk of investing in companies with no history of
public trading.  Underwriters allocated IPO shares to individual
investors when (1) the underwriting firm had a high percentage of
individual investor clients, (2) the company or industry related to
the IPO had a high level of market recognition among individual
investors, and/or (3) there was low demand for the IPO among
institutional investors.  Except for rules relating to fraud and
market manipulation, SEC rules do not address the process used in
allocating IPO shares, which allows underwriters to determine how
best to allocate IPO shares. 

The primary purpose of the prospectus is to inform investors of all
material information about a company so investors can assess the risk
of purchasing the company's securities.  SEC rules require that
companies disclose in the prospectus, for the 5-year period preceding
the IPO, certain information about the criminal and disciplinary
histories of its officers and directors that are material to an
evaluation of their ability or integrity.  However, SEC does not
require companies to disclose similar information about the
companies' underwriters, even though underwriters have important
roles throughout the IPO process and could affect an investor's
investment risk by engaging in prohibited activities, such as
manipulating the price of IPO shares.  In examining the disciplinary
records of 34 underwriting firms, we found that 13 of these firms had
a total of 25 formal disciplinary actions imposed by SEC and SROs for
securities violations, some of which included cases of free-riding or
withholding.  While all of the violations we identified may not be
considered material or relevant to IPO offerings, information about
such violations could have a bearing on an investor's evaluation of
the riskiness of the investment.  By requiring companies to include
in their prospectus material information about their underwriter's
disciplinary history, SEC could provide investors a better means of
assessing the risks associated with IPO offerings. 


   OBJECTIVES, SCOPE, AND
   METHODOLOGY
------------------------------------------------------------ Letter :3

To obtain information on the factors that influence underwriting
firms' allocation of IPO shares between institutional and individual
investors, we interviewed SEC officials responsible for market
regulation to determine what rules, if any, govern the allocation of
IPO shares.  We also reviewed NASD rules to identify those affecting
the IPO allocations process. 

We also randomly sampled 50 of the 952 IPOs that SEC processed from
January 1, 1993, to June 30, 1994.  For each of these offerings, we
identified the underwriting firm from an SEC listing of IPOs. 
Thirty-four\5 underwriting firms were associated with these 50 IPOs. 
Of these 34 firms, we judgmentally selected 10 firms to obtain a
better understanding of the IPO process and the factors that
influence the distribution of IPO shares.  Of the 10 firms selected,
6 were large underwriting firms that were each responsible for over
$1 billion in IPOs, and 4 were smaller underwriting firms that were
each responsible for under $1 billion in IPOs between January 1993
and June 1994. 

To obtain a perspective on underwriting practices from other than New
York firms, 2 of the 10 firms were located outside of New York.  One
of the two underwriting firms was located in Atlanta, and the other
was located in Baltimore.  For each of the underwriting firms, we
interviewed senior officials responsible for selling IPO shares to
investors.  We visited officials at the New York and Baltimore
underwriting firms; however, we interviewed officials at the Atlanta
firm over the telephone.  During these interviews, we discussed the
IPO allocation process, the pricing of IPOs, and the disclosure of
information about underwriters' disciplinary histories. 

To determine disclosure requirements for underwriting firms'
disciplinary histories, we first identified existing disclosure
requirements that could pertain to underwriting firms.  We discussed
these requirements with SEC officials responsible for processing IPO
registrations in Washington, D.C., and New York.  We also discussed
these requirements with officials from the underwriting firms during
our conversations on the IPO allocation process. 

We obtained the disciplinary histories of the 34 underwriting firms
in our sample from the CRD.  Specifically, we obtained information on
(1) formal disciplinary actions taken against the 34 underwriting
firms for the 5-year period preceding the issuance of the IPO and (2)
specific securities violation(s) that gave rise to such actions.\6 We
obtained and reviewed the prospectus for each of the 50 IPOs in our
sample to determine what types of information were disclosed.  In
reviewing the prospectus, we determined that information concerning
the underwriter's disciplinary history was not disclosed.  We
discussed the disciplinary actions and related violations with SEC
officials and the 10 underwriting firms' officials to obtain their
views about the benefits from and any concerns about disclosure of
such information in the prospectus. 

Our work was performed in New York, Baltimore, and Washington, D.C.,
between May 1994 and August 1995 in accordance with generally
accepted government auditing standards. 

We obtained written comments from SEC on a draft of this report, and
we have reprinted their letter in appendix II.  SEC's comments are
summarized and evaluated at the end of this report. 


--------------------
\5 Nine of the 34 underwriting firms were responsible for 2 or more
offerings. 

\6 We used a 5-year period because SEC uses the same time frame for
requiring companies to disclose in the prospectus the criminal and
disciplinary actions taken against the company's officers and
directors.  Our CRD search was limited to information about the lead
underwriting firm.  We did not obtain the history of brokers employed
by the lead firm or by other syndicate members. 


   INSTITUTIONAL INVESTORS
   OBTAINED LARGEST PORTION OF IPO
   SHARES FOR SAMPLED FIRMS
------------------------------------------------------------ Letter :4

In marketing and selling IPO shares, underwriting firms primarily
target institutional investors rather than individual investors. 
According to officials we interviewed at 10 underwriting firms, 9 of
the firms sold the largest portion of IPO shares to institutional
investors, such as pension funds, mutual funds, and money managers. 
Estimates of sales to institutional investors by officials of the
nine underwriting firms ranged from 60 to 90 percent--at a large
underwriting firm with both institutional and individual clients and
at a small underwriting firm with few individual clients,
respectively.  An official at the 10th underwriting firm said his
firm sold primarily to individual investors.  This underwriting firm
was unlike the other nine in that it had few institutional clients. 

Underwriters said they allocated their IPO shares predominantly to
institutional investors because of economic factors and their
business judgment that institutional investors are better suited for
IPOs than individual investors.  According to the underwriters we
interviewed, they preferred to allocate IPO shares to institutional
investors because they believed that these investors are better able
than individual investors to buy large blocks of IPO shares, assume
financial risk, and hold the investment for the long term.  Officials
at nine underwriting firms said they sold largely to institutional
investors because these investors had the financial resources to
purchase large blocks of stock.  This practice was important to these
officials because they were concerned that unsold shares could be a
source of financial losses should the market price fall below the
offer price. 

Furthermore, these officials believed that IPOs are more suitable for
large institutional investors than for individual investors because
institutional investors are more able to assume the risk of declining
share values than individual investors who may not have the financial
resources to hold shares in an IPO when share values decline.  Some
underwriting firm officials expressed concern that individual
investors may be more likely to take a quick profit by selling their
stock within the first days or weeks of the offering when the price
of the IPO shares may be at its highest. 

Underwriting firm officials cited the following factors as affecting
their decision to allocate IPO shares to individual investors. 

  -- The underwriter has a high percentage of individual clients. 
     Underwriting firms with a high percentage of individual investor
     clients were more likely to allocate a portion of the IPO shares
     to these investors.  An official at one underwriting firm we
     interviewed estimated that his firm sold 80 percent of its IPO
     shares primarily to individual investors because its client base
     primarily included individual investors.  Officials of another
     underwriting firm told us that even if there were sufficient
     demand to sell an entire IPO to institutional investors, it was
     company practice to allocate a portion to its individual
     investor clients.  The officials explained that they had adopted
     this practice to satisfy the demands of their individual
     investors. 

  -- Investor recognition of company and industry may stimulate
     interest in an IPO.  Pressure from individual investors can
     cause underwriters to allocate IPO shares to these investors. 
     Officials at all of the underwriting firms with whom we spoke
     told us that they expect greater individual investor interest in
     an IPO when the company or the company's product or industry is
     widely recognized and little individual investor interest when
     the company is not well known.  For example, at one underwriting
     firm an official told us that the IPO of a popular retail
     gourmet coffee establishment generated significant individual
     investor demand.  Although the entire IPO could have been sold
     to institutional investors, the underwriting firm designated a
     portion of the offering to individual investors to maintain
     their goodwill and ensure they remain as clients.  The same
     official told us of another IPO issued by a company with limited
     individual investor recognition.  This IPO involved a freight
     consolidator company that was known only to a small number of
     institutional investors.  Rather than educate individual
     investors and improve their knowledge of the company, the
     underwriting firm sold the entire IPO to the few institutional
     investors. 

  -- There is insufficient demand for the IPO from institutional
     investors.  Underwriters may target individual investors when
     there is insufficient institutional demand for the IPO.  An
     official of an underwriting firm, who usually sold IPOs
     exclusively to institutional investors, told us of a situation
     that forced the firm to sell shares to individual investors.  In
     marketing the IPO, officials at the underwriting firm determined
     that institutional investor interest was insufficient to sell
     the entire issue.  (According to the officials, the issue's
     profit potential was too low.) To locate purchasers for the
     remaining shares, the underwriting firm extended its marketing
     efforts to individual investors.  These efforts were successful
     and enabled the underwriting firm to sell the entire IPO to a
     combination of institutional and individual investors. 

Under existing SEC and NASD rules, underwriters generally have wide
latitude in deciding how best to market and allocate IPO shares. 
Except for rules governing fraud and manipulation of securities
offerings,\7 SEC rules do not address the allocation of IPO shares. 
NASD has an interpretive rule prohibiting free-riding, withholding,
and sales to certain insiders under certain market conditions. 
Officials from underwriting firms told us that they discouraged these
practices, but enforcing such policies, especially among syndication
partners, can be difficult. 

According to an SEC official, SEC has received a number of complaints
from individual investors about their lack of access to the IPO
market.  In response to these complaints and press articles about
sales of IPO shares to insiders by underwriters, SEC conducted a
limited study of the IPO allocation process in 1994.  The purpose of
the study, according to SEC officials, was to study whether firms had
a reasonable basis for allocating shares.  SEC officials told us they
interviewed underwriters as part of their study and discussed the
allocation process.  On the basis of these interviews, SEC officials
observed that underwriters' allocation practices generally reflected
the companies' clientele; therefore, if the company dealt primarily
with institutional investors, most of its IPOs were generally made
available to institutional investors.  However, if underwriters had a
substantial retail client base, they were more likely to make IPOs
available to individual investors.  Thus, in the SEC's officials'
views, these practices appeared to be based on reasonable business
judgment. 

SEC officials also observed that institutional investors have the
financial resources to buy more shares and handle more risk, which is
important because IPOs involve companies with no previous history as
publicly traded firms.  In addition, institutional investors are
often better able to hold investments for the long term. 
Furthermore, the underwriters SEC interviewed pointed out that
traditional distinctions between individual investors and
institutional investors have become blurred in today's market
environment.  Individual investors have invested substantial amounts
in institutional investment entities, such as pension and mutual
funds, and can gain access indirectly to the IPO market by investing
money in these entities. 

According to an SEC official, SEC has chosen, thus far, not to
address the IPO allocation process in rulemaking.  Among the reasons
SEC cited for not addressing this issue were the complexity of the
issues involved and the difficulty of crafting rules that would be
reasonable and enforceable. 


--------------------
\7 SEC's principal antimanipulation rules that apply to securities
offerings are Rules 10b-6, 10b-7, and 10b-8.  These rules are
designed to prevent the offering's price from being influenced
improperly by persons who have a significant interest in the
offering.  In 1994, SEC solicited public comment on a broad range of
issues dealing with antimanipulation regulation in light of
significant changes in the securities markets and distribution
practices in recent years.  On April 11, 1996, SEC proposed new rules
and announced a 60-day comment period. 


   DISCLOSURE OF MATERIAL
   INFORMATION ABOUT UNDERWRITERS'
   DISCIPLINARY HISTORIES COULD
   BENEFIT INVESTORS
------------------------------------------------------------ Letter :5

Securities regulation is based on the concept of full and fair
disclosure.  The assumption is that investors will be able to make a
more rational and informed evaluation of the relative risk and reward
of a particular investment if they have free and equal access to
information about that investment.  Rules under the Securities Act of
1933 and the Securities Exchange Act of 1934 require the issuer and
the underwriter to take reasonable steps to make a preliminary
prospectus available to investors who have expressed an interest in
purchasing the security.  The prospectus is to contain material
information about the company issuing the security.  The prospectus
is also to contain material information concerning the offering and
firms that participate in the offering.  SEC rules specifically
require a company registering an IPO to report, for the 5 years
preceding the issuance of the IPO, information on the criminal and
disciplinary histories of its officers and directors that is material
to an evaluation of the individuals' ability and integrity.  However,
SEC rules currently do not specifically require that companies report
similar information about firms underwriting the offering, even
though underwriters have important roles throughout the IPO process
and could affect an investor's investment risk by engaging in
prohibited activities, such as manipulating the price of IPO shares. 
SEC has used its more general authority under the Securities Act of
1933 to require additional disclosure from certain underwriters who
had Commission enforcement proceedings against them.  These
proceedings generally involved cases in which the companies were
either in financial trouble or had been involved in pervasive fraud. 

Item 401 of SEC Regulation S-K provides companies specific guidance
on what information the prospectus must contain about the criminal
and disciplinary histories of the companies' officers and directors. 
Information that companies are to report includes bankruptcy filings,
criminal convictions, pending criminal actions, civil judgments, and
SEC disciplinary actions.  While federal securities laws generally
require companies issuing securities to disclose all material
information about the underwriter participating in the issuance,
Regulation S-K does not provide any specific guidance on what aspects
of an underwriter's disciplinary history are material. 

The disclosure in the prospectus of information about an
underwriter's disciplinary history could help investors more fully
assess the underwriter's ability and integrity as well as the
riskiness of investing in the IPO.  Our search of the CRD found that
13 of the 34 underwriting firms we sampled had 25 formal disciplinary
actions, collectively, that related to past underwriting activities
for the 5-year period before the issuance of the IPO.  None of these
actions was disclosed in the prospectuses we reviewed.  Of the 13
underwriting firms, 1 had 5 violations, 2 had 4 violations, 2 had 2
violations, and 8 had 1 violation. 

A frequent violation was of the NASD rule that prohibits underwriting
firms from withholding IPO shares from public distribution if the
market price rises above the offer price.  This rule was designed to
prevent underwriting firms, and others associated with the offering,
from directly or indirectly profiting from the price rise.  Four of
the 13 underwriting firms were cited for violating this rule. 

Another frequent violation concerned underwriting firms that
improperly overstated the orders for and the sales of new debt issues
of government-sponsored enterprises.\8 By manipulating these
statistics, the underwriting firms attempted to maintain or increase
their share of future offerings.  Nine of the 13 underwriting firms
were among the 98 brokers that SEC, jointly with other federal
regulatory organizations, fined in 1992 for violating these rules. 

Other violations in our sample for which formal actions were taken
included the following: 

  -- Three underwriting firms were cited for failing to finalize
     trades with other syndicate members within specified time
     periods. 

  -- Two underwriting firms were cited for performing an inadequate
     search of the company's finances and business activities. 

  -- One underwriting firm attempted to improperly influence the
     pricing of an impending public offering. 

  -- One underwriting firm was cited for selling unregistered
     securities. 

SEC officials and officials at all of the firms with whom we met
agreed that the prospectus should disclose all of the information
investors need to assess the risk of the offering.  However, the
officials did not believe that all information about an underwriter's
disciplinary history should be disclosed in the prospectus.  Instead,
they believed that if there were to be requirements on disclosing
information about the underwriter, that information should be
material to an investor's decision on investing in the IPO and to an
assessment of risk.  While agreeing that investors have a right to
know about an underwriter's disciplinary history, officials
associated with two underwriting firms expressed reservations about
disclosing such information in the prospectus.  Officials at the two
firms said that SEC's Broker-Dealer Form already requires the
reporting of extensive information about an underwriter's criminal
and disciplinary history and that this information is available to
the public.  An official at another underwriting firm suggested that
the prospectus, instead of disclosing information on an underwriter's
disciplinary history, should inform investors that they could obtain
this information by contacting NASD or state securities regulators. 

To help investors more fully assess their IPO investment risk, we
believe it is important for companies to disclose in the prospectus
material information on the criminal and disciplinary histories of
their underwriter.  A requirement that companies disclose information
on underwriters is similar to information already required to be
reported on officers and directors of the issuing companies and
should not be a difficult or costly task.  Underwriting firms should
have ready access to detailed knowledge of all formal disciplinary
actions that regulatory organizations have imposed against them.  In
addition, they could access the CRD through on-site computer
terminals or telephone NASD to ensure the completeness of their
information. 

We believe the suggestion that SEC's Broker-Dealer Form could serve
as the disclosure vehicle to investors is not the preferred option,
because the information reported on the Broker-Dealer Form is not as
readily accessible to investors as the prospectus.  The other
suggestion was to use the prospectus as a vehicle to inform investors
about the availability of information from NASD or state regulators. 
While this could serve as an additional source of information to
investors, adding this information to the prospectus would mean that
investors would have to contact NASD, request information about the
underwriter, and scan the information to determine which violations
and disciplinary actions are material to their investment decision. 
In some cases, the information about the underwriter could be quite
lengthy and difficult to interpret. 

Differences of opinion exist as to the types of disciplinary actions
and violations that are material to an investor's decisionmaking on
the IPO.  While the violations we identified were serious enough to
warrant reporting to the CRD, some may not have been relevant and
others may not have been serious enough to be considered material to
an investor's decisionmaking about an IPO.  In the absence of
specific guidance, many underwriting firms may conclude that their
disciplinary history does not warrant disclosure to investors.  For
example, officials at the 10 underwriting firms we interviewed
believed that some of the actions we identified were not serious
enough to be considered material and ought not be reported.\9 SEC
could provide guidance clarifying what information relating to an
underwriting firm's disciplinary history is material and, therefore,
required to be reported. 


--------------------
\8 Government-sponsored enterprises are congressionally chartered
enterprises that help capital raising for certain economic sectors,
such as agriculture and housing. 

\9 Each of the previously mentioned violations was identified by one
or more of the underwriters as not serious. 


   CONCLUSIONS
------------------------------------------------------------ Letter :6

Investors require material information on an IPO to make an informed
investment decision.  SEC rules require companies to disclose in the
prospectus material information on their businesses, finances,
operations, and officers and directors.  SEC provides specific
guidance on what information about the criminal and disciplinary
histories of a company's officers and directors must be disclosed. 
In contrast, SEC does not specifically require disclosure of material
information about the underwriter's disciplinary history in the
prospectus.  Because of the important role underwriters play in the
IPO process, material information about an underwriter's disciplinary
history would be useful to investors.  Having certain information,
including formal disciplinary actions taken by SEC, state regulators,
and SROs for securities violations arising from past underwriting
activities, would enable investors to use these factors in their
investment decisions and allow them to better assess the risks of the
IPO.  In the absence of a specific disclosure requirement, investors
may not receive information that may be critical to their investment
decisions. 


   RECOMMENDATIONS TO THE SEC
   CHAIRMAN
------------------------------------------------------------ Letter :7

To improve disclosure to investors who purchase IPOs, we recommend
that the SEC Chairman amend SEC Regulation S-K and IPO registration
forms to require that companies disclose in the prospectus
information about the underwriter's disciplinary history that is
material to assessing the risk of an IPO investment, and provide
guidance on the type of information that is material.  SEC should
also incorporate a statement in the prospectus that tells investors
how to obtain additional information from NASD on the underwriter's
disciplinary history. 


   AGENCY COMMENTS AND OUR
   EVALUATION
------------------------------------------------------------ Letter :8

SEC staff provided written comments on a draft of this report, and
these comments are included in appendix II.  SEC agreed that
investors need adequate information to make an informed investment
decision and that among the necessary items of disclosure would be
information relating to any material disciplinary actions taken
against the principal underwriters.  However, SEC does not believe
there is a need for a specific requirement for material disclosures,
similar to that involving directors and officers of the offering
company.  SEC believes more detailed information is necessary for
company officers and directors because, unlike the underwriter, they
have an ongoing role to play with the offering company.  SEC also
believes it provides for sufficient disclosure requirements for those
underwriters with a history of disciplinary problems through its more
general authority under the Securities Act of 1933.  SEC officials
showed us recent examples of prospectuses with extensive disclosures
SEC had required from underwriters who had Commission enforcement
proceedings against them.  The staff did agree that, for those
investors who desired more information, it may be appropriate to
recommend a rule requiring prominent disclosure in prospectuses on
how to obtain information from the CRD. 

The prospectuses with extensive disclosure SEC staff provided us
generally involved cases in which the companies were either in deep
financial trouble or had been involved in pervasive fraud.  In those
cases, SEC's actions to require additional disclosure were probably
appropriate.  However, our concern is that this disclosure threshold
may be too high.  Many of the cases we cite in our report did not
involve allegations of fraud, but we believe there are investors who
would find the disciplinary information pertinent in making an
informed investment decision.  Thus, we still believe there should be
an affirmative disclosure requirement for underwriters with
disciplinary histories and that SEC should provide guidance on this
disclosure.  For the reasons cited by SEC, the disclosure
requirements probably do not have to be as elaborate as those for
officers and directors, so we modified our recommendation
accordingly. 


---------------------------------------------------------- Letter :8.1

As you know, the head of a federal agency is required by 31 U.S.C. 
720 to submit a written statement of actions taken on these
recommendations to the Senate Committee on Governmental Affairs and
the House Committee on Government Reform and Oversight not later than
60 days after the date of this letter and to the House and Senate
Committees on Appropriations with the agency's first request for
appropriations made more than 60 days after the date of this letter. 

We will provide copies of this report to the Senate Committee on
Banking, Housing and Urban Affairs and its Subcommittee on
Securities; the House Committee on Commerce and its Subcommittee on
Telecommunications and Finance; and other interested parties and
Members of Congress.  Copies will be available to others upon
request. 

This report was prepared under the direction of Helen H.  Hsing,
formerly Associate Director, Financial Institutions and Markets
Issues.  Other major contributors are listed in appendix III.  If you
have any questions about this report, please contact me on (202)
512-8678. 

Sincerely yours,

James L.  Bothwell
Director, Financial Institutions
 and Markets Issues


DESCRIPTION OF THE INITIAL PUBLIC
OFFERING PROCESS
=========================================================== Appendix I

The initial public offering (IPO) process consists of three phases: 
(1) developing the information and documents for submission to the
Securities and Exchange Commission (SEC), (2) processing these
documents through SEC, and (3) marketing and selling the newly public
shares.  Various alternative requirements apply under certain
conditions; for example, different requirement apply for companies
that meet SEC small business criteria. 

Corporations may have several motivations for offering their
securities to the general public.  For example, they may view the IPO
process as a means to raise capital for expansion or special projects
or to replace debt with equity.  Another motivation may stem from the
desire of existing shareholders to sell their holdings to the general
investment community. 

Corporations usually use an underwriting firm to assist in preparing
the documents and getting the IPO statement declared effective. 
Underwriting firms may also assume some of the financial risks
involved in selling the IPO.  For example, in what is known as "firm
commitment offerings," the underwriting firm agrees to purchase all
of the IPO shares from the company.  Purchasing all of the IPO shares
subjects the underwriting firm to the risk that it may be unable to
sell some or all of these shares.  If the underwriting firm believes
that it will be difficult to sell the new issue, it can reduce its
risks by agreeing to a "best efforts offering." Under the best
efforts offering, the underwriting firm does not commit itself to the
purchase of the entire offering. 

In addition to the underwriting firm, lawyers and certified public
accountants assist in preparing sections of the registration
statement and prospectus.  Each of these parties has special
responsibilities for ensuring the accuracy and completeness of these
documents. 

The registration statement contains basic information about the
offering, such as the name of the company, the number of shares to be
publicly offered, and the offering price.  The prospectus contains
detailed information about the company, including a description of
its business, the identity and experience of its management, the
factors in the company's operating history and the nature of its
business, and the current major stockholders.  The prospectus also
contains the company's financial statements. 

After their completion, the prospectus and registration statement are
submitted to SEC for review.  SEC neither approves or disapproves the
securities, nor does it verify the accuracy or adequacy of the
information in these documents.\10 However, SEC does identify areas
for amplification, clarification, or supplementation on the basis of
information from the prospectus, newspapers, and periodicals and on
the basis of SEC staff knowledge of accounting rules and practices,
industry trends, and regulatory requirements.  SEC asks the company
to respond to each of its areas of concern. 

After addressing these comments and making any appropriate revisions,
the company resubmits the prospectus and registration statement to
SEC.  At this point, SEC may have a second set of comments that may
require a second revision of the documents.  This submission, review,
and revision process is repeated until SEC has no further comments. 

The first version of the prospectus contains the approximate number
of shares to be publicly offered.  This version also contains the
range of possible offering prices.  The final prospectus, with the
final offering price, is completed either the day before or the day
of the start of public trading. 

When SEC no longer has any comments on the registration statement and
prospectus, it notifies the company of the effective date of the
offering.  On the effective date, the underwriting firm purchases the
shares from the company and resells the shares to institutional and
individual investors at the offering price.  After the effective
date, the investors are free to sell the shares at the
market-determined price. 

Underwriting firms use a variety of techniques to help them set the
offer price.  For example, they compare new companies' financial
history and prospects to those of similar companies whose stock is
already publicly traded.  Underwriting firms also meet with investors
to assess the extent of their interest in the offering.  These
meetings, often called "road shows," also give investors the
opportunity to question management about the company's finances,
products, and operations. 

The underwriting firms frequently set the offer price at a level
somewhat below their estimate of the market price.  The variance is
intended to provide investors with an incentive for purchasing the
IPO shares.  Officials at underwriting firms told us that this
variance may range from near 0 percent, when they expect the IPO to
have high investor interest, to 25 percent, when less interest is
expected. 

Although federal law prohibits any sales of securities before the
effective date, investors may furnish underwriting firms with
"expressions of interest" in the offering.  On the effective date,
investors are asked to convert their expressions of interest into
commitments to purchase.  Investors who purchase securities may
resell their securities after the registration is effective. 



(See figure in printed edition.)Appendix II

--------------------
\10 SEC requires that a notice to this effect be placed on the first
page of the prospectus. 


COMMENTS FROM THE SECURITIES AND
EXCHANGE COMMISSION
=========================================================== Appendix I



(See figure in printed edition.)


MAJOR CONTRIBUTORS TO THIS REPORT
========================================================= Appendix III

BOSTON/NEW YORK FIELD OFFICE

Bernard D.  Rashes, Assistant Director
Gary Roemer, Evaluator-in-Charge
Philip F.  Merryman, Evaluator


*** End of document. ***