Analysis: Soaring IPOs Raise Bubble Concerns

(Reuters) – The frothy market for Internet IPOs is raising the specter of a bubble, underscoring how little has changed despite lawsuits and investigations in the wake of the 1990s dot-com craze.

In the past five weeks, investors clamoring for newly public Internet companies have driven up shares of career networking site LinkedIn Corp and two search engines, Russia’s Yandex NV and China’s Renren Inc. Renren has since fallen below its offering price.

And on Thursday, online coupon website Groupon Inc filed papers with regulators to press on with its highly anticipated initial public offering. Investors are still awaiting announcements from Facebook and Twitter.

The last stampede into Internet stocks ended with billions of dollars of losses. After eight years of litigation, underwriters including Bank of America Corp, Citigroup Inc, Credit Suisse Group AG and Goldman Sachs Group Inc reached a $586 million settlement in 2009 to resolve hundreds of investor lawsuits.

Critics at the time said the underwriters rigged the market against mom-and-pop investors to drum up fees and curry favor with corporate insiders. The banks denied wrongdoing.

Plaintiffs’ lawyers in the last round of litigation are paying close attention to the new wave of IPOs.

“We are watching very carefully to make sure the shenanigans of the dot-com bubble are not repeated a decade later, and that new tricks are not invented to cause the same implosion,” said Stanley Bernstein, a partner at Bernstein Liebhard and lead lawyer for investors in the IPO settlement.

The judge in that case awarded $170.1 million of fees to the plaintiffs’ law firms, court records show.
Much about the IPO market remains the same as it was a decade ago, with controversial practices still in place.

Typically in an IPO, a syndicate of investment banks allocates shares to institutional investors and retail customers. Some shares go to brokerages, which distribute them to clients. Banks keep commissions based on the value of shares sold.

In litigation over the 1990s tech bubble, investors complained of practices known as spinning and laddering.

In spinning, banks distribute underpriced shares of hot IPOs to favored executives not affiliated with the newly public company, winning their good will and perhaps their future business should the price jump higher once trading begins.

Critics believe this cheats retail investors who later buy post-IPO shares at inflated prices.

Laddering requires IPO investors to buy more shares once trading begins. Critics complain this can create false momentum, allowing ladderers to sell at artificially high prices at other investors’ expense, while boosting bank commissions.

Another questionable practice was banks pushing analysts to set unrealistic price targets for companies going public.

In 2003, then-New York Attorney General Eliot Spitzer reached a civil settlement with 10 Wall Street banks that banned spinning and mandated independent analyst research. The banks did not admit wrongdoing.

While changes to address analysts’ conflicts took hold in the industry, a long-expected industry-wide spinning ban has yet to take effect. And laddering was not addressed.

Another problem is soft-dollar commissions, in which institutional investors pay more on other trades so they can get more IPO shares, said University of Florida finance professor Jay Ritter. He said this creates favoritism in how shares are allocated.

Still, legal experts say investors may face an uphill fight in court should the latest crop of hot IPOs later wilt. This is in part because practices that appear unfair can be perfectly legal under federal securities law.

“”All the law says is that if you sell securities, you have to provide investors with all the information they need to make informed decisions,” said St. John’s University School of Law professor Michael Perino. “It is not an insurance policy against market losses.”

But banks need to heed concerns about potential conflicts, said former U.S. Attorney Bill Leone, who oversaw a federal probe of IPO spinning in the telecommunications industry.

“My advice to the underwriting community would be to anticipate now how those conflicts and their conduct would be observed through that lens of hindsight,” said Leone, who is now a partner at law firm Faegre & Benson in Denver.

Despite concerns about the IPO process, alternatives have struggled to take hold.

The modified Dutch auction-based “OpenIPO,” in which the highest bidders get shares at the same, publicly offered price, never took off even though Google Inc used it for its 2004 IPO.

Rules on spinning proposed by the Financial Industry Regulatory Authority were to take effect last month.

But the U.S. Securities and Exchange Commission agreed on May 18 to delay implementation by four months to give Wall Street time to comply. The rules should take effect before Facebook’s IPO, which analysts believe could occur in April.

That may be faint comfort for investors who lose money.

“Remedies that investors have when they purchase IPOs really haven’t changed much in the last 80 years,” said St. John’s professor Perino. “IPO booms happen regularly. Nothing we put in regulations is going to change that basic market phenomenon.”

(By Jonathan Stempel; additional reporting by Clare Baldwin; Editing by Lisa Von Ahn)