FINRA fines IPO Process

FINRA announced a $5 million fine against Morgan Stanley Smith Barney this week related to its retail IPO sales practices.  The internal issues arose as a result of Morgan Stanley's completion of its $9.4 billion acquisition of Smith Barney from Citigroup last year, after a four-year buyout process.  The merged brokerage business apparently did not have proper procedures in place surrounding its IPO sales process and, according to FINRA, it failed to properly distinguish between "indications of interest" (the term used primarily by Morgan Stanley) and "conditional offers" (the term used primarily by Smith Barney).  When the two units were merged, the terms were used interchangeably, and no training was undertaken to teach the unit's brokers about the differences between them. 

Conditional offers to buy shares in an IPO turn into binding transactions unless an investor revokes their purchase order after final IPO documents have been filed, whereas indications of interest only turn into binding transactions if they are reconfirmed by the investor after the IPO documents get final regulatory approval.  The salient issue for FINRA was the investor's opportunity to review final offering documents before making a purchase.

Interestingly, the fine itself is procedural, rather than rising out of customer complaints, and is quite large compared to other similar procedural penalties.  The sales practices surrounding the placement of shares in 83 different IPOs from February 16, 2012 to May 1, 2013 were affected by the lack of clarification between the two terms.  This includes the Facebook IPO, for which Morgan Stanley was the lead underwriter.  Morgan Stanley has since stated that 26% of its Facebook shares were sold to retail investors.  Morgan Stanley led all underwriters globally in IPO fees in 2013, and neither admitted nor denied FINRA's charges, but accepted the fine and noted that they "have enhanced our practices on this point".

Facebook itself struggled to achieve a positive return for 15 months after its IPO, and has begun falling again recently (see chart below).  For comparison, the S&P 500 is up over 44% for the same time period.

{image_1}