Allocating a Hot New Issue
Your firm is a joint bookrunner on a $600 million initial public offering. The deal is heavily oversubscribed, with demand at 12 times the available shares. Allocation policy gives priority to long-only institutional accounts that have held positions for at least 12 months, with a cap of 10% of the deal per account. A large hedge fund that has traded actively with the firm and generates significant commission revenue requests a 15% allocation. A long-only pension client that has been a stable holder requests 8%. A new institutional client, onboarded two weeks ago, requests 5% and offers to route future brokerage to the firm. The syndicate desk also wants to allocate shares to a fund whose portfolio manager is a personal friend of the lead banker.
1. Evaluate each allocation request against the stated policy and against fair-and-equitable allocation principles.
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The hedge fund's request for 15% exceeds the 10% cap and conflicts with the stated priority for long-term holders. Revenue and trading activity are legitimate commercial considerations in allocation, but they cannot override the disclosed policy or the cap. The fund should receive no more than 10%, and the desk should document why it received that amount relative to other accounts.
The pension client's 8% request is within the cap and consistent with the long-hold priority. It should be considered on the merits and, if demand is 12 times, scaled in line with the allocation methodology rather than granted in full automatically.
The new client's 5% request is the most sensitive. A two-week-old relationship with an offer to route future brokerage looks like an inducement to allocate hot-issue shares in exchange for order flow, which is a conflict and can be a form of spinning. The client should be treated on the same terms as comparable accounts, and the offer of future business should be disregarded or explicitly documented as not influencing the allocation.
The friend's fund is a clear conflict. The banker should be recused, the allocation should be reviewed by compliance, and the fund should receive no preferential treatment.
2. What process should the firm follow to document and approve allocations, and what should it disclose?
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The firm should apply its written allocation policy consistently, with a documented rationale for each account: the account's investment profile, holding period, prior participation, and the size of its indication. Any deviation from the policy, such as a smaller allocation to a large indication, should be recorded with reasons. The allocation committee should include representatives from syndicate, compliance, and a control function independent of the banking relationship, and the friend's fund should be excluded from the lead banker's influence entirely.
The firm should disclose to clients the general allocation methodology and any conflicts, including that the firm considers relationship history and that employees may have personal relationships with clients. It should not disclose other clients' allocations. The new client's offer of future brokerage should be documented and declined as a basis for allocation. Records should be retained for regulatory review, and the firm should be prepared to show that allocations were fair and equitable and not used to reward order flow or personal connections.