Spin Desk Underwriters Allocate IPOs for Potential Customers

Coincidentally or Otherwise, Work Follows For Investment Bank

By Michael Siconolfi, Staff Reporter
The Wall Street Journal

November 12, 1997

Joseph Cayre was ecstatic.

Holding an investment "road show" for a firm he heads that was about to go public, Mr. Cayre reveled in the first-day stock surge of an unrelated company, Pixar Animation Studios, that had just gone public itself. He boasted that he had just turned a quick $2 million profit on 100,000 Pixar shares, witnesses to the 1995 incident say.

Where did he get a huge chunk of one of the year's most coveted initial public stock offerings, one that surged 77% on its first day of trading? Robertson Stephens Inc., Pixar's lead investment bank, had allocated the shares to Mr. Cayre's personal brokerage account.

Less than a month later, Mr. Cayre's company used Robertson Stephens for its own initial public offering. After it had become publicly held, the company, GT Interactive Software Corp., hired Robertson Stephens to advise it on acquisitions. Robertson Stephens's total fees: more than $5 million.

Mr. Cayre says there was no quid pro quo. He hired Robertson Stephens simply because he liked an investment banker at the firm, he says. But he adds that he had personally asked Robertson Stephens's chairman, Sanford Robertson, for the 100,000-share Pixar allocation. "I believe it's good business," he says.

Good Customer

Mr. Robertson, for his part, says Mr. Cayre is "a very, very good client" who has a lot of money in funds run by Robertson Stephens. "We try to run an honest business. I don't see anything wrong giving a good client a new issue," Mr. Robertson says. He, too, sees no quid pro quo. However, when an internal debate arose within the investment bank about making such a big Pixar allocation, Mr. Robertson recalls that Mr. Cayre threatened to take his business elsewhere if he didn't get all 100,000 Pixar shares.

Such is the world of Wall Street's "spin desks." Many investment banks silently allocate chunks of hot new stocks to the personal brokerage accounts they hold for corporate executives and venture capitalists -- "spinning," or flipping, the shares on the day of the IPO for quick profits -- in an apparent bid for business from the executives" firms.

"It's like sand on a railroad wheel," says Edward McCann, a former senior technology banker at Hambrecht & Quist LLC, which is an active spin player. "It helps you get under way sooner and faster."

Crucial Distinction

This isn't just a matter of the big players getting the breaks. It is no news that underwriters make most of the shares in hot IPOs available not to the little-guy investor but to institutions, such as mutual-fund companies and pension funds, that provide a lot of trading commissions and other business. But there is a critical difference: Spin shares don't go to the corporate customer itself -- they go to individuals at the corporation who are in a position to sway the company's decisions.

"It's a bribe, no question about it," contends Robert Messih, a managing director at Salomon Inc., which doesn't have a brokerage arm or engage in spinning. "You pay them off and expect you're going to get treated in kind when they do the transaction."

Spin desks may violate regulatory rules. (The term is used by many bankers, though some say they haven't heard it.) The National Association of Securities Dealers requires investment banks to make a bona fide distribution of IPO shares and bars them from selling such shares to "any senior officer" of an "institutional-type account" who "may influence or whose activities directly or indirectly involve or are related to the function of buying or selling securities" for such institutional-type accounts.

But there hasn't been any enforcement action. In fact, officials at the NASD and Securities and Exchange Commission say they were unaware of spinning until contacted by a reporter. Roger Sherman, the NASD's enforcement chief, says such a practice "raises a host of potential problems," but each case would have to be assessed separately. NASD lawyer Gary Goldsholle adds that there could be a violation even without any finding of a quid pro quo.

No Problem

Cristina Morgan, Hambrecht & Quist's managing director of investment banking, isn't worried. The San Francisco firm is an active spin player, but she sees nothing wrong with the practice, likening it to such perks as free golf outings. "What we're talking about is trying to solicit business," Ms. Morgan says. "What do you think about taking them out to dinner? What do you think about that? We throw lavish parties with caviar. Is that not trying to influence them, their behavior? I suggest that it is." Allocating hot IPOs to corporate executives, she argues, is "not illegal. It's not immoral. It's a business decision."

In any case, it is rampant. "It's as common as water, and you can have all you want" if you are a senior executive or venture capitalist at a company that potentially will do business with Wall Street, says David Cary, chief financial officer at i2 Technologies Inc., an Irving, Texas, software company.

He should know. Mr. Cary says he and other senior i2 Technologies executives were showered with shares in hot IPOs from several investment banks, including Hambrecht & Quist, which comanaged i2 Technologies' IPO in 1996. Mr. Cary says that in 1995 H&Q let him buy 400 shares of Netscape Communications Corp. at the offering price. He cashed in for a quick $5,000 profit.

His risk was as close to zero as it gets. That's because H&Q didn't allocate the shares to Mr. Cary's personal brokerage account until after Netscape shares had begun trading and were up sharply, Mr. Cary says.

He adds that H&Q took the action without even asking him. "All I know is I'd get a phone call saying, 'Hey, we got some shares for you.' "

Mr. Cary at first couldn't comprehend how easy it was to cash in. "The first couple of times, [firms] literally explained to me what they were doing: 'I'm giving you shares at the IPO price,' " he says. "Nobody ever does that," was his reply. The response, he says: "Yes, we do."

IPO allocations were so common at i2 Technologies that the company set a policy about receiving them. "Everyone on the executive team got the same share," Mr. Cary says. "It was a very rigid rule -- either give to all or none."

He says the stock didn't sway i2 Technologies' investment-bank choice when it went public. The company picked H&Q as a co-manager but used the larger Goldman, Sachs & Co. as lead manager. "A guaranteed $5,000 IPO 'friend of the firm' allocation won't do anything at all," he says. "It won't do anything to me."

Even so, Mr. Cary became uncomfortable with the practice, and last year i2 Technologies told its executives they could no longer accept spin shares.

Who Gets the Stock

Here is how the process works. Investment banks managing an IPO for a fledgling company line up buyers of the shares at the offering price. IPO shares are much sought-after, because a new stock frequently soars on its first day of trading, buoyed by buying from eager investors who didn't get in on the ground floor. Then the shares often slip back as demand abates.

The banks offer most of the shares to big institutional client companies. A small number, known as the "retail pot," are set aside for individuals, and spin shares typically come from this pot. That leaves even fewer IPO shares for the small investor with no connections.

Spinning got going in the 1980s and exploded during the 1990s bull market, as underwriters began competing fiercely to handle initial offerings. The practice "ain't going to stop," predicts A.B. "Buzzy" Krongard, a vice chairman of Bankers Trust New York Corp. "There's too much of a cause and effect."

Recently, however, Wall Street has seen a bit of a backlash. The National Venture Capital Association, a trade group, has cautioned members that taking such IPOs could lead to regulation of the venture-capital community.

And despite the easy money, a few people are just saying no. Besides Mr. Cary and others at i2 Technologies, they include officials of two venture-capital firms, Sequoia Partners in Menlo Park, Calif., and Greylock Management Corp. in Boston. "It doesn't seem to be the right thing to do," says Henry McCance, Greylock general partner.

After the Fact

Particularly bothersome to critics is the practice of providing an executive with a share allocation -- together with a quick, profitable sale -- after trading is under way. This is possible if a corporate executive has a discretionary account at an underwriting firm, which permits a broker there to trade for the executive.

"At its extreme," explains Frank Quattrone, chief executive of Deutsche Morgan Grenfell Inc.'s technology group in Menlo Park, "an IPO is priced Wednesday. Thursday morning, you call 25 venture capitalists and say, 'By the way, XYZ just went public at 15; it's now trading at 30. You just sold the allocation at 29 1/2 . I hope you're happy.' That to me is smarmy."

Consider the offer made to Gregory Hinckley. In 1995, Mr. Hinckley, then the chief financial officer of VLSI Technology Inc., a publicly held San Jose, Calif., chip maker, received a call from an administrative assistant at Needham & Co. in New York. The message: 1,000 shares of Oak Technology Inc. had been "reserved in your name," say two people familiar with the matter. With the newly public Oak shares already trading and up sharply, Mr. Hinckley's immediate, guaranteed profit would total nearly $10,000. He declined the offer.

Mr. Hinckley confirms that he has been approached "periodically" with offers of spin shares, and he says they are "enough probably to influence" some executives to direct business to the investment banks. Mr. Hinckley, now chief financial officer of Mentor Graphics Corp. in Wilsonville, Ore., won't say much more about what he calls Wall Street's version of a "modern morality play." But he adds: "My view is you don't ever screw around with your integrity for pocket change -- and this was pocket change. It wouldn't influence me."

Pressure on Underwriter

Unlike Mr. Hinckley, VLSI Technology Chairman Alfred Stein accepted more than 1,000 shares of Oak Technology from Needham, a person close to the transaction says. And when Salomon Brothers later arranged a stock offering for VLSI, Mr. Stein demanded that Salomon assign Needham -- which was a minor member of the syndicate -- more of the shares to sell, according to Salomon's Mr. Messih.

"If it were left to his doing, he would have paid Needham more than the co-managers," an incredulous Mr. Messih says. "We told him, 'You can't do that; it's not appropriate.' " Salomon didn't let Needham have the increased allocation.

Despite repeated requests, Mr. Stein will "remain unavailable for comment," says VLSI's public-relations director. As for Needham, its chairman, George Needham, says, "Those things can happen." But he adds that his firm now has formally banned spinning. "Our policy is not to do this stuff," Mr. Needham says. "The practice really smells."

Too Few Shares

Yet some investment bankers say they are penalized if they don't keep pace in allocating IPO shares to executives. Andrew "Flip" Filipowski, president and chief executive of Platinum Technology Inc. of Oakbrook Terrace, Ill., complained about his IPO allocations a few years back in a private meeting with investment bankers at Robertson Stephens. In a suite at the Stanford Court hotel in San Francisco, Mr. Filipowski told Michael McCaffery, Robertson's president and chief executive, there was a "problem" in the relationship, witnesses say.

"You're giving me 500 and 1,000 shares, and H&Q is giving me 5,000 and 10,000 shares on a deal," Mr. Filipowski told Mr. McCaffery, the witnesses say. "Even when they can't contact me, they give me stock and sell it."

Robertson Stephens -- recently bought by BankAmerica Inc. -- does use spin shares, but its executives contend the firm won't go so far as to allocate them at the offering price after trading has begun. Mr. McCaffery shot back: "If H&Q wants to do that for you, they can. But it's legally wrong, morally wrong, and we're not going to do it."

Bringing In DLJ

H&Q and Robertson Stephens had comanaged Platinum Technology's IPO. But after the hotel talk, Platinum reduced Robertson Stephens's role, eventually picking rival Donaldson, Lufkin & Jenrette Inc. to join H&Q as a lead manager.

Mr. McCaffery referred a call to a spokeswoman, who said the executive recalled the incident but "would never have said it wasn't legal."

Mr. Filipowski says he has no recollection of the hotel discussion, but he denies pressuring Robertson Stephens. "That uncategorically can't be," he says. He says the reason he cut Robertson Stephens's role was that it "had really dropped the ball a lot" in covering his company.

Platinum's other original co-manager, H&Q, has let Mr. Filipowski in on 20 to 25 IPOs over the years in his discretionary account there, he estimates, although he says he didn't get in on the red-hot Netscape and Pixar issues. "The last time I got a special deal as far as I can remember was 200 shares of Boston Chicken," Mr. Filipowski says, and that was from a different investment bank.

H&Q's Ms. Morgan scoffs that these deals are too small to sway an executive like Mr. Filipowski, because "Flip is worth zillions." Mr. Filipowski agrees that IPO allocations have "absolutely nothing" to do with which underwriters Platinum uses. In view of how well off executives are, "it doesn't take too many brain cells to know that 200 or 500 shares don't count for diddly squat," Mr. Filipowski says. "I don't think I've ever gotten 5,000 shares -- even after begging extensively to everyone."

Netscape at Offer Price

Still, whether by coincidence or otherwise, IPO allocations sometimes are made just before executives or directors select investment banks. In August 1995, Morgan Stanley allocated 1,000-share blocks of the Netscape IPO to some executives at Arbor Software Corp. of Sunnyvale, Calif., according to several people familiar with the matter. Arbor was about to pick an underwriter for its own IPO. It chose Morgan Stanley.

Among those who accepted a Netscape allocation from Morgan Stanley and flipped the shares for a quick profit was Stephen Imbler, Arbor's chief financial officer. He says the allocation had no effect on investment-bank selection. "There was no tie," he says. "We picked Morgan Stanley partially because they're a tier one banker -- for their marquee value."

Arbor board member Douglas Leone, a venture capitalist at Sequoia, turned down the offer to buy Netscape shares. In an interview, Mr. Leone says, "I can't speak for what the other board members did or didn't do, but I will tell you I felt uncomfortable accepting 1,000 shares of a hot stock."

He adds, "I was going into a board meeting 24, 48 hours later, where I knew a number of bankers were going to be vying for the business" of managing Arbor's own IPO. But he says Arbor's selection of Morgan Stanley wasn't "swayed" by the Netscape windfall.

A 1,000-share Netscape block gained more than $30,000 in value its first day. "As it turns out, I left a great deal of money on the table," Mr. Leone says. "But I felt good about it." A spokeswoman for Morgan Stanley, now known as Morgan Stanley, Dean Witter, Discover & Co., declines to comment.

Working With Montgomery

It helps if an executive's company does a lot of business with the investment bank. Take the relationship between Montgomery Securities and Jamie Coulter, chairman of Lone Star Steakhouse & Saloon Inc. Lone Star, of Wichita, Kan., has tapped Montgomery as sole manager of four stock offerings, including its 1992 IPO. Montgomery, now a unit of NationsBank Corp. and known as NationsBanc Montgomery Securities Inc., earned millions in fees.

Montgomery has let Mr. Coulter in on numerous IPOs. In one case, according to a former Montgomery broker, Mr. Coulter, his family and business associates were allocated as much as 15,000 shares of President Riverboat, a Davenport, Iowa, casino company whose IPO Montgomery handled. The broker says the shares were flipped for Mr. Coulter for a quick profit on the first trading day.

"How do you know that?" Mr. Coulter demanded, when asked about it. "It's a private matter. I don't know if I got that or not." Two weeks later, he called back to say his personal President Riverboat allocation was 1,500 shares, not 15,000. "He had no control over the shares allocated to the individual family-member accounts," says Mr. Coulter's assistant, Christopher Wettig.

Mr. Coulter says he has a discretionary brokerage account at Montgomery but doesn't get "an inordinate amount of IPOs." He has received "1,000 or 1,500 shares of an IPO," he says, but "can't remember getting as many as 15,000 except in one instance, and it wasn't Riverboat."

Mr. Coulter says his firm continues to tap Montgomery because of a longstanding relationship. "They handled our IPO at a time that other investment-banking firms of their stature wouldn't take us public," he says.

Thomas Weisel, chairman of NationsBanc Montgomery Securities, says, "We do allocate IPOs, hot or otherwise, to our better clients. But they're not postdated," or allocated after the stock has started trading. He says there is "zero" tie between the allocations and subsequent corporate-finance activity handled by Montgomery, adding: "What we do with Jamie Coulter for his private account is only information between him and his counterpart at Montgomery."

Cayre's Shares

Occasionally, spats break out over spin shares. Mr. Cayre of GT Interactive Software got into one with Robertson Stephens before GT went public. New York-based GT was majority-owned by Mr. Cayre and his family, with significant minorities held by others, including venture capitalists. Mr. Cayre, its founder, had a commitment from Robertson Stephens for 100,000 shares of the Pixar IPO, and he was livid when the investment bank tried to pull back from the allotment at the 11th hour.

Mr. Cayre yelled at Mr. Robertson: "What kind of bank are you? How can I trust you? I expect every single share." He threatened to steer his business elsewhere if Robertson Stephens didn't play ball.

"I think I remember that," Mr. Robertson says. He concedes there was internal opposition to such a big Pixar allocation.

Actually, Mr. Cayre says, he wanted even more than the 100,000-share allocation. He says he tried to pry additional Pixar shares from Robertson Stephens for his children. He didn't get them.

But there are other deals. Over the years, the video-game CEO figures, investment banks have let him in, personally, on roughly 400 initial public offerings. "Every banker has given me great IPOs," he says.

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