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U.S. Securities and Exchange Commission


Litigation Release No. 19050 / January 25, 2005



The Securities and Exchange Commission (Commission) announced the filing of a settled injunctive action in federal district court against Morgan Stanley & Co. Incorporated (Morgan Stanley) relating to the firm's allocation of stock to institutional customers in initial public offerings (IPOs) it underwrote during 1999 and 2000. In settlement of this matter, Morgan Stanley has consented, without admitting or denying the allegations of the complaint, to a final judgment that would permanently enjoin Morgan Stanley from violating Rule 101 of the Commission's Regulation M and order it to pay a $40 million civil penalty. The settlement terms are subject to court approval.

In its complaint, the Commission alleges that Morgan Stanley violated Rule 101 of Regulation M under the Securities Exchange Act of 1934 by attempting to induce certain customers who received allocations of IPOs to place purchase orders for additional shares in the aftermarket. The complaint further alleges that Morgan Stanley did induce certain customers to place such orders during the new issues' first few trading days.

The Commission's complaint against Morgan Stanley, filed in the United States District Court for the District of Columbia, includes the following allegations:

Rule 101 of Regulation M, among other things, prohibits underwriters, during a restricted period prior to the completion of their participation in the distribution of IPO shares, from directly or indirectly bidding for, purchasing, or attempting to induce any person to bid for or purchase any offered security in the aftermarket. As a prophylactic rule, Regulation M is designed to prohibit activities that could artificially influence the market for the offered security, including, for example, supporting the IPO price by creating the perception of scarcity of IPO stock or creating the perception of aftermarket demand.

During the restricted period, i.e., prior to Morgan's Stanley's completion of participation in the distribution of IPO shares, Morgan Stanley attempted to induce certain customers to make aftermarket purchases in violation of Rule 101 of Regulation M by engaging in the following activities.

  • Morgan Stanley communicated to certain customers that expressing an interest in buying shares in the immediate aftermarket and buying shares in the immediate aftermarket would help them obtain good allocations of over-subscribed, hot IPOs. For example, a sales representative told his customers that the "Avanex [IPO] . . . could be one of the hottest IPOs of the year . . . . Another one that I will need [aftermarket] feedback on to get a good allocation."
  • Morgan Stanley solicited aftermarket interest from certain customers who Morgan Stanley knew had no interest in owning the stock of the IPO companies long-term. For instance, the syndicate desk was aware that one customer was "fast money," that is a trading account primarily engaged in day trading. Morgan Stanley nonetheless solicited aftermarket interest from the customer in every IPO. The only reason that the customer gave aftermarket interest and bought in the immediate aftermarket was because it understood from Morgan Stanley that this would help it get a good IPO allocation. For example, this customer received a 50,000 share allocation in the Transmeta IPO and bought 70,000 shares in the aftermarket on the first day of aftermarket trading. The customer flipped its allocation and aftermarket purchases that same day.
  • Morgan Stanley proposed to certain customers the aftermarket price limits they should give to obtain a good IPO allocation. For instance, in the Avanex IPO (which Morgan Stanley priced at $36), a sales representative e-mailed his customer:
  • Aftermkt on [the Avanex IPO] goes into the 100's from lots of customers . . . . How is this for a strategy: put in aftermkt for $150, the stock runs to about $110, you buy it there - even if it pulls back and you lose some on the shares short term, you a) got more stock on the deal since your aftermkt was so freakin big b) if you[']re going to own it longer anyway so what if you buy at the peak on the first day and who[']s to say in this market the stock can[']t go even higher[.] The more outlandish the aftermkt, I would definitely figure the more stock you get.

  • In some instances, Morgan Stanley encouraged customers to increase the prices they had originally told Morgan Stanley they were willing to pay in the aftermarket. For example, in the Webmethods IPO (which Morgan Stanley priced at $35), a sales representative reported to the head of syndicate: "[A customer is] in for 10% (20,000 would be great); aftermkt: $65; I am trying to push them higher and [another Morgan Stanley employee] will update you." The head of syndicate's notes reflect that the customer increased its aftermarket interest to $100. The customer received a 10,000 share allocation of Webmethods.
  • Morgan Stanley accepted customers' aftermarket interest that they would buy "1 for 1" (or some other ratio) in the aftermarket, meaning that the customers intended to buy in the aftermarket an amount of shares equal to (or greater than) their IPO allocation. The "1 for 1" or other similar aftermarket interest did not provide Morgan Stanley with information as to a customer's desired position size or whether a customer intended to be a long-term holder. Nonetheless, some customers who gave this type of aftermarket interest subsequently received allocations.

After the distribution of IPO shares was complete, some of Morgan Stanley's sales force made calls and solicited aftermarket orders from certain customers who had provided aftermarket interest. Morgan Stanley viewed favorably follow-through aftermarket buying in the first few days of trading. For example, a syndicate manger e-mailed a sales representative, "thanks for following up with the [aftermarket] feedback. i am glad to know that the account reciprocated with aftermarket. tell them to keep it up." In addition, after customers bought shares in the immediate aftermarket, some Morgan Stanley sales representatives at times referred to their customers' aftermarket buying as fulfilling their "promises" or "commitments." Further, Morgan Stanley monitored customers' aftermarket purchases in the first few days of trading. This conduct, taken as a whole, demonstrates that when Morgan Stanley previously had solicited aftermarket interest from these customers during the restricted period, it was attempting to induce customers to place aftermarket orders in the first few days of trading.

Morgan Stanley also violated Rule 101 of Regulation M in the Martha Stewart Living Omnimedia IPO by soliciting a 350,000 share aftermarket order from a customer before all the IPO shares had been distributed. On the morning of the Martha Stewart Living Omnimedia IPO, and before Morgan Stanley had announced that syndicate had broken, Morgan Stanley called a customer and told it that Morgan Stanley was concerned because there were no aftermarket orders on Morgan Stanley's trading desk. Morgan Stanley then asked the customer to place an aftermarket order. The customer agreed to Morgan Stanley's request and placed an aftermarket order for 350,000 shares in the period before syndicate broke. Morgan Stanley executed the order later in the day after trading began. The customer sold all of its IPO shares and the shares it had bought in the aftermarket that same day.

SEC Complaint in this matter


Modified: 01/25/2005