
Rigging the IPO game - brnstz
http://www.nytimes.com/2013/03/10/opinion/sunday/nocera-rigging-the-ipo-game.html
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danmaz74
The (not so) funny thing is that this has been a very well known problem
for... ever. I'm reading "The House Of Morgan: An American Banking Dynasty and
the Rise of Modern Finance" by Ron Chernow - highly recommended - and you can
find the same mechanisms and scandals (with little variances) dating back at
least to the 1920s.

Mixing trading and underwriting in the same firm is bound to create enormous
conflicts of interest, no matter how tall the internal "Chinese walls" between
departments are. This is imho definitely a place where strong regulations and
strong checks are needed.

~~~
001sky
Great point. Glass-Stegal was 1930's. But some people never learn...

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bedhead
I've been on the buy-side for many years and the IPO market is a joke. Every
time an IPO pops +20% it's irrefutable evidence that the banks are either
incompetent and/or untruthful. I remain mystified that companies, particularly
the hot issues like LinkedIn, ProtoLabs, et al, dont opt for auctions. It's
the 8th wonder of the world.

The other solution would be to be to have an adjustable underwriting fee that
declines depending on how much the stock is up using the ~5 day average
closing price after the IPO. If the stock was up some percent over the IPO
price, say 40%, the underwriting fee would drop from 7% to 1%. Over 50%? No
fees. Something along those lines would keep the banks honest. You failed
(purposefully or not) to price the offering correctly and needlessly
transferred hundred of million in wealth from the company to trading clients?
Fine, you dont get paid.

For the hot issues, trust me, there is still plenty of demand. Tons. You
really think no one would buy Splunk at $35, that an IPO would fail? It
happens millions of times per day already in the secondary market, so clearly
there's more than enough demand. The difference would be that the hedge funds
who generate utterly insane commission dollars wouldn't have an interest in
the offering...it would be more buy-and-hold guys subscribing, and those folks
just aren't that profitable for the bank trade desks. I used to work at one of
these big funds and I've seen this all first hand and it's ridiculous.

~~~
Evbn
GOOG popped over 100%, with its auction.

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bedhead
I remember Google's IPO vividly. Google's stock price didnt pop much. It
priced at $85 and hit $100 the first day of trading. It hung around $100 for a
few weeks and then started moving steadily higher throughout the fall, in
large part because they reported an insane third quarter. The auction had
other problems but the pricing was largely fine.

I'm talking about first day pops. These are situations that are clearly
mismanaged. A stock that's supposedly worth $20 at 5pm on Tuesday is magically
worth $35 at 9:30am on Wednesday despite nothing having changed. No supposedly
functional market should be that inefficient. Unfortunately it's by design.

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libovness
Reading this immediately made me think of what Facebook did _right_ with their
IPO. Uninformed observers criticized them for overpricing their IPO, while in
reality (unlike LinkedIn, eToys) they succeeded in raising as much cash as
they could (for more: [http://blogmaverick.com/2012/09/04/facebook-handled-
their-ip...](http://blogmaverick.com/2012/09/04/facebook-handled-their-ipo-
exactly-right/))

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calhoun137
Goldman didn't do what they are being accused of, and if they did there is
nothing wrong with it. Besides, the best way to prevent this sort of thing
from ever happening again is to not punish anyone, except possibly the guy who
blew the whistle.

~~~
paulrademacher
Also in the article, Goldman Sachs notes that these documents are a _decade_
old. How could you trust (or even care about) a document from that long ago?

~~~
notahacker
The following decade does add the amusing perspective that the "undervalued"
shares were worthless a couple of years later. I wonder if they can dredge up
documents finding that Goldman Sachs was aware that its grotesque
undervaluation with respect to the market demand it was fuelling was
simultaneously a grotesque overvaluation with respect to eToys' fundamentals.
It would be funny if they tried to use "worried about the long term potential"
as a defence.

~~~
yummyfajitas
I guarantee that if you look hard, you can find either an analyst or trader at
GS who thought both of these things. That's because GS is a large bank full of
many divisions, quite a few of whom are chinese walled from each other.
(Admittedly, some of the chinese walling has happened in past 10 years...)

Banks are fragmented and individual portions of the bank don't always agree
with each other.

Fun fact: a certain large bank (I won't say which one) is spending ~$10-90M on
an internal matching engine. This is because they spend millions on
unnecessary transaction costs - trader A wants to go long and trader B wants
to go short, both of them hit the public markets rather than simply trading
with each other.

~~~
notahacker
Quite right, and a weakness of the original article is it doesn't make it
clear how closely connected the "sales representatives" clamouring for repeat
business were to the original IPO.

I'm intrigued by the possibility that an individual person closely connected
with pricing the IPO might have expressed a view akin to: "we've got to set a
sub-market price to ensure our institutional investors make a killing on the
first day, _because this stock will be in trouble once the hype dies down_ "

But still, that was over a decade ago, and I'm sure no investment banker would
ever be so cynical today...

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YokoZar
Is there a reason more companies don't do what Google did and simply sell the
initial shares by dutch auction? Even without the perverse incentives, I can't
see any possible advantage to hiring a wall street bank to guess a price and
allocate it to only a fraction of the market.

~~~
danmaz74
Being underwritten by a well known and respected bank will raise your brand on
the financial market. At least if you're not a Google or Facebook...

~~~
acchow
This is the 21st century. Startup CFOs need to start realizing that this is
unnecessary and the democracy of the internet is more than enough to "raise
your brand" legitimately.

~~~
ihsw
There's no such thing as the democracy of the internet, that's just a new term
for 'blogosphere.'

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driverdan
The line I find most telling:

> ...Goldman has argued that, contrary to popular belief, underwriters do not
> have a fiduciary duty to the companies they are underwriting.

Why would _anyone_ use a financial institution who doesn't think they have a
fiduciary duty to their clients?

~~~
brown9-2
A common thing you read in articles like this (and I think Michael Lewis has
mentioned it a few times) is that when clients go to Goldman Sachs, they know
that Goldman is going to screw them somehow, but that the outcome in the end
is still better than what they would get from any other investment bank.

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pedrocr
Reading this brought me back to all the comments surrounding the Facebook IPO.

There were a bunch of people using the fact that the stock didn't pop and that
they had to use the greenshoe to prop up the price as a sign of failure when
in fact it was really a way to approximate the dutch auction process by
overselling and then pulling back to get to market equilibrium.

Then there were all the investors saying they were hurt by the IPO because it
didn't pop and they couldn't sell it a few hours after buying it, so they took
a loss. They then argued that this was a bad move because now Facebook stock
had a bad name in the markets which would hurt more long-term than if they had
just submitted to common practice by giving them some free profits for doing
no work.

The old days of making 4x returns in a few hours of busy work on a trading
terminal must have been really nice.

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erikpukinskis
Naive question from someone who knows next to nothing about IPOs:

Why not just divide the shares up amongst the existing shareholders, and just
let them sell them normally on the market? Then the company/founders/vcs can
just sell shares at whatever pace they want to, at whatever fair market value
is.

It seems like the only possible outcome of a single day sale is information
asymmetry, which means _someone_ will always get "screwed".

~~~
dreamdu5t
> a single day sale is information asymmetry

There is no such thing as information symmetry between any person, or in any
trade. No two people on the planet have the same information.

> which means someone will always get "screwed".

Both parties always benefit from the trade, or the trade would not have taken
place. Unless someone is deliberately misrepresenting information (fraud),
then nobody gets "screwed" by trade.

~~~
sliverstorm
_There is no such thing as information symmetry between any person_

 _Both parties always benefit from the trade, or the trade would not have
taken place_

How can you say these two things, right at the same time? Does the former not
contradict the latter?

~~~
gsmaverick
They are not necessarily related. Information symmetry just means that both
parties know exactly the same information and neither knows more or less than
the other. In a scenario where one or both parties have information that is
not accessible to the other they can still engage in a trade in which each
party, at least believes, it is better off given their information. A
neutral/third-party observer may not come to the same conclusion but that is
not relevant to this scenario.

~~~
sliverstorm
So what you mean is both parties _think_ they benefit

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shalmanese
Why can't companies do a slow rolling IPO? So say you sell 1M shares on day 1
at $20 which is what your underwriters price you at. Then 2M shares on day 2
at market price. Then 4M on day 3 and 8M on day 4 etc.

~~~
chollida1
The biggest reason is the rules of the exchanges. All exchanges have minimum
requirements for the outstanding float, share price, market value,etc.

The rules aren't terribly stringent, and if you can stay above this then it
might work.

The problem is no underwriter would take an IPO for a million shares at say
$10/share. It's just not something that they can make money on.

This would require a new type of low cost underwriter.

Alos remember, the reason why we can set a price on the stock is that we know
the float ahead of time and we can estimate what the company is worth.

How can you price a share if the amount of tradable shares is materially
changing each day?

~~~
acchow
> The problem is no underwriter would take an IPO for a million shares at say
> $10/share. It's just not something that they can make money on.

If you're offering a small fraction of the outstanding float, you don't need
an underwriter because you've elected to reduce your risk. If markets are
unfavourable, you raise less. Oh well. You've kept plenty of shares to try
again next time.

We need to get over this "go big or go home" mentality.

~~~
chollida1
I see your point, the problem is that if you don't do a road show, then no
fund is going to invest in you, with google/facebook hyped companies excepted.

With out an institutional investor( Buy side) your stock will have a hard time
getting any traction.

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Narkov
Why would a company agree to be "IPO'd" for such a low price? Doesn't the
company and its shareholders need to accept some blame here?

Fair enough that the bankers may have nefarious intent and they shouldn't get
away with it but agreeing to such a shitty deal out of ignorance is pretty
stupid.

~~~
robryan
One of the reasons the company is taking on these underwriters of the IPO is
because they don't actually know how much the company is going to be valued at
in the market? GS would be in a way better position with their experience to
know this.

If they didn't play both sides of this market it would be in their interest to
price is as accurately as possible.

~~~
azm1
Should not the company hire some kind of professional(s) who will observe both
sides(mostly the bank) and provide objective feedback? It seems like they were
jumping into unknown territory without any knowledge. I really can't believe
all companies go IPO blind like I get impression from the article.

~~~
ahi
Most companies think they are hiring those professionals when they go with GS.
Forcing GS to state very clearly that they do not have any fiduciary
responsibility to their clients is kind of a bfd.

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rooshdi
“If you think eToys got screwed, what do you think happened to the country?”

Sad.

~~~
tatsuke95
> _"“If you think eToys got screwed, what do you think happened to the
> country?”_

I don't think this guy has a clue what "happened to the country". He doesn't
even seem to understand his own state of affairs.

~~~
joezydeco
_“What Wall Street did to us in 1999 pales in comparison to what they did to
the country in 2008,” he said."_

I think he understands just fine.

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kmfrk
I remember the article that basically made me care about IPOs was this story
about the IPO of Microsoft:
[http://features.blogs.fortune.cnn.com/2011/03/13/inside-
the-...](http://features.blogs.fortune.cnn.com/2011/03/13/inside-the-deal-
that-made-bill-gates-350000000/).

It's long as winter, but it actually made IPOs very relatable, not to mention
exciting.

It gives you a good understanding of the circus surrounding the offering
price.

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topherjaynes
When I read articles like this it's always centered around the bigger
companies like Goldman and such, are there smaller companies who can handle
taking an IPO public? I mean these guys are a business and need to make money,
but feel like a smaller firm would be more transparent and willing to work
with you and not for their other more well established clients.

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DenisM
To this who ask "why not use an auction", there's been some research on that:
[http://insight.kellogg.northwestern.edu/article/why_do_ipo_a...](http://insight.kellogg.northwestern.edu/article/why_do_ipo_auctions_fail)

In short, game theory strikes again: lazy auctioneers bid high blindly and
hope that others will do the actual research to set the end price fairly, but
those others have less incentive to do research because they are getting
priced out by the lazy bums anyways. Another problem is that some bidders
irrationally assume that a more popular stock is more valuable, so they too
contribute to overpricing. As a result, sophisticated investors are staying
away from auctions.

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Tycho
Are GS losing business due to this constant negative press which they get?

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javajosh
Are there any startups - or even startup concepts - that have a chance to
disrupt entities like Goldman Sachs? How is it that a firm with such a
reputation keep getting new business and very high fees?

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rumcajz
Why isn't the price of a share set up to an unrealistically high value on the
first day? The price would eventually go down to match the proper value of the
share.

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olefoo
This article should be read by anyone who wants to understand why things are
the way they are now.

