Initial Public Offering (IPO) Restrictions, Conflicts of Interest, and Anti-Manipulation

With the mechanics of underwriting and exemptions covered, this section focuses on the rules designed to prevent abuse in the new-issue market: who can't buy IPOs, what conflicts must be disclosed, and how price manipulation is addressed during distributions.

Financial Industry Regulatory Authority (FINRA) Rule 5130 (Restrictions on Purchase of IPOs)

Certain restricted persons may NOT purchase shares in new equity IPOs:

• Members (broker-dealers) and their associated persons
• Broker-dealer personnel
• Finders and fiduciaries acting on behalf of the managing underwriter
• Portfolio managers (e.g., at banks, insurance companies, investment advisers)
• Immediate family members of the above who share a household or provide/receive material financial support

De Minimis Exemption

• An account is not considered restricted if restricted persons' beneficial interests do not exceed 10% of the account

Purpose

• Ensure a bona fide public distribution of IPO shares to the investing public
• Prevent industry insiders from scooping up hot IPO shares before public investors have access

FINRA Rule 5131 (New Issue Allocations and Distributions)

Rule 5131 targets specific abuses in IPO allocation:

• Prohibits spinning: Allocating IPO shares to executives or directors of investment banking clients as an inducement for business
• Prohibits quid pro quo allocations: Conditioning IPO allocations on the receipt of excessive compensation (e.g., requiring aftermarket purchases)
• Requires members to have written policies and procedures for IPO allocations

Exam Tip: Gotchas

"Spinning" is when an underwriter gives hot IPO shares to corporate executives to win future investment banking business. This is prohibited under Rule 5131. The exam may describe a scenario without using the word "spinning." Recognize the pattern.

FINRA Rule 5121 (Public Offerings with Conflicts of Interest)

Applies when a member firm has a conflict of interest in a public offering:

• The issuer is the member itself
• The issuer controls or is controlled by the member
• More than 5% of net proceeds go to the member

Requirements

• Prominent disclosure of the conflict
• One of the following safeguards:
  • A qualified independent underwriter (QIU) participates
  • The non-conflicted managing underwriter oversees the offering
  • Securities have a bona fide public market
  • Securities are investment grade rated

FINRA Rule 5141 (Fixed Price Offering)

• Members must sell securities in a fixed price offering at the stated public offering price during the distribution
• No sales above or below the fixed offering price while the syndicate is in effect

Regulation M (Anti-Manipulation)

Securities and Exchange Commission (SEC) Regulation M prohibits manipulative conduct during securities distributions.

Key Rules

Stabilization (Rule 104)

• The lead underwriter may place a stabilizing bid at or below the public offering price to prevent the market price from declining during distribution
• The stabilizing bid must be at or below the offering price; never above it
• Only one stabilizing bid is permitted at any time
• Must be disclosed in the prospectus

Exam Tip: Gotchas

A stabilizing bid can ONLY be placed AT or BELOW the public offering price; never above it. Stabilization is the ONLY form of legal price manipulation in the securities markets, and it must be disclosed in the prospectus.

Penalty Bids

• The lead underwriter may impose penalty bids, reclaiming the selling concession from a syndicate member whose customers sell (flip) shares in the immediate aftermarket
• Penalty bids discourage flipping and help maintain price stability after the offering