IPO Allocation and the Pull of Commission Revenue
Priya Raman is a portfolio manager at Meridian Wealth, where the written IPO allocation policy states that oversubscribed issues are distributed pro rata across eligible discretionary accounts in proportion to order size. A new issue is 3.2 times oversubscribed. Raman allocates 55% of her allotment to the Dalton Family Trust, which generated 38% of Meridian's trailing brokerage commissions; 30% to three prospective clients she is courting; 10% to her brother-in-law's account, which compliance has flagged as a personal conflict; and the remaining 5% pro rata across 40 other accounts. She documents the rationale as 'relationship building.' She also routes all IPO-related trades to a broker whose research she relies on, without written documentation or disclosure.
1. Which CFA Institute Standards are engaged, and did Raman's allocation satisfy the fair-dealing obligation? Would a pre-established, disclosed allocation policy have made the allocation acceptable?
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Standards engaged
- III(B) Fair Dealing - clients must be treated fairly, which requires an objective, pre-established allocation method applied consistently.
- VI(A) Disclosure of Conflicts and VI(B) Priority of Transactions - the brother-in-law account.
- I(B) Independence and Objectivity - the stated motive is revenue retention, not client suitability.
Analysis. Meridian had a written pro-rata policy. Raman departed from it in a single direction: toward the commission-generating client and toward accounts whose future revenue she wants. That is the paradigm fair-dealing failure - it is not that some clients received more shares, but that the deviation was driven by revenue and relationship considerations rather than the stated rule. A disclosed family account does not cure preferential treatment; disclosure addresses conflicts, not unequal dealing.
Would a different policy help? Yes, but only if the policy is written before the allocation, disclosed to clients, based on objective factors (account size, eligibility, client-directed restrictions, prior allocation history), and applied without exception. A policy saying 'we favor our largest commission payers' would be disclosed but still inconsistent with the duty to act in each client's interest; fee-tiering may be used only where it is a genuine, disclosed account characteristic and not a reward for order flow.
2. Is it permissible to weight IPO allocations toward clients who generate the most commission revenue, provided the practice is disclosed to all clients?
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Disclosure is necessary but not sufficient. The test is whether the factor is a legitimate, client-relevant characteristic of the account or a reward for the client's own brokerage spending.
- If the firm's disclosed policy treats a large account differently because of size, custody arrangements, or investment mandate, and the policy is applied consistently, that can be defensible.
- If the firm is effectively paying for order flow with allocations of a scarce, underpriced asset, the firm is putting its own revenue above fair treatment of other clients, and disclosure does not fix it. The other clients cannot consent meaningfully to a benefit they never receive.
Raman's file should also be tested for the reverse problem: did any account lose an allocation it would have received under the policy? The answer determines the scale of the breach and any remediation owed.
3. Evaluate the broker-directed trading arrangement and state the corrective actions Raman and Meridian should take.
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The arrangement. Directing all IPO-related flow to a broker whose research she uses converts client brokerage into a benefit for the manager without documented client benefit, an undisclosed conflict, and a plausible breach of the duty to seek best execution under III(A) Loyalty, Prudence and Care. Soft-dollar research is permitted only where it benefits clients, is documented, and is disclosed; the absence of documentation is itself the failure.
Corrective actions
- Suspend the allocation deviation and re-run the allocation strictly under the written policy; consider whether compensation to disadvantaged accounts is warranted.
- Remove the brother-in-law account from any allocation where Raman exercises discretion; independent review of all allocations.
- Document the brokerage arrangement: what research was received, how it benefits the affected accounts, and the commission rate versus execution-only alternatives.
- Disclose the conflict to clients and to the board; retain records.
- Escalate to compliance rather than self-remediating silently - the manager's own judgement is the thing under review.