Oversubscribed IPO Allocation and Underwriter Gifts
Ravensworth Advisors manages $4.2 billion for 1,150 accounts. A syndicate desk allocates 90,000 shares of an oversubscribed initial public offering to the firm; total client demand was 310,000 shares. The firm's written policy, unchanged since 2016, calls for pro rata allocation across eligible accounts but gives the CIO discretion to deviate. Portfolio manager D. Okafor allocates 40% of the shares to six accounts that pay the highest advisory fee and 10% to an account belonging to a consultant who recently steered a $60 million mandate to Ravensworth. The remaining 50% is spread thinly across other accounts; roughly 400 eligible accounts receive nothing. Okafor also accepted two tickets to a tennis final, face value $900, from the underwriter. The CIO asks compliance whether the allocation can stand.
1. Identify the Standards of Professional Conduct implicated by the allocation and determine whether the allocation can stand.
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Breach - Standard III(B), Fair Dealing. Clients must be treated fairly and objectively. The allocation was driven by fee level and by the expectation of future business, not by an objective, pre-stated method. The firm's discretionary clause does not cure this: a written policy that permits arbitrary preference is itself inconsistent with III(B), and following an inadequate policy is not a defense.
The referral account is the most serious element. Allocating shares to reward a consultant who delivered a mandate converts a fiduciary allocation into compensation for business development. The other 400 eligible accounts were disadvantaged by that decision.
Verdict: the allocation cannot stand. Compliance should:
- Reconstruct the allocation pro rata to all eligible accounts based on demand, respecting rounding and suitability limits.
- Where trades already settled, unwind or make whole the shortchanged accounts, and document the remedy.
- Disclose the error to affected clients in writing and self-report to the PCS if the conduct is judged a violation of the Code.
- Suspend the PM's allocation authority pending review; a pattern of fee- or referral-based allocation may also implicate Standard I(A) (knowledge of the rules) and the firm's supervisory obligations.
2. How should the firm treat the tennis tickets from the underwriter?
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Standard I(B), Independence and Objectivity. A gift from an underwriter - a party with a commercial interest in the firm's allocation decisions - creates a conflict. The relevant tests are the value, the giver's relationship to the firm's business, and whether the recipient's judgment could be, or could appear to be, affected.
At $900 per ticket the amount is modest, but the source is a counterparty in an allocation decision, which is precisely the setting where appearance matters. The correct treatment:
- Disclose in writing to the employer (compliance or the CIO) - this is the minimum, non-negotiable step.
- Determine whether firm policy permits acceptance; most policies require pre-clearance for anything above a nominal threshold and prohibit gifts from parties involved in allocation decisions.
- If acceptance was not pre-cleared, decline or return the tickets, or reimburse their value, and record the incident.
Accepting without disclosure would breach I(B); accepting after disclosure but contrary to policy is a separate compliance failure. The PM should also recuse himself from allocation decisions involving that underwriter until the matter is closed. The fact that the gift was small does not make it permissible - the issue is the inducement, not the price.
3. Draft the core policy changes the firm should adopt, and state what must be disclosed to clients.
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Policy content:
- An allocation policy that is objective, written, applied consistently, and disclosed to clients before allocation events.
- Prohibit any allocation criterion tied to fee level, account size beyond suitability limits, referral history, or the personal relationships of staff.
- Define eligibility up front (account opened and funded before the offering is announced; position size limits relative to account assets).
- Specify a pro rata method with a defined rounding convention, and a documented process for any deviation, approved by compliance in advance.
- Require pre-clearance and annual attestation for gifts and entertainment, with a monetary threshold and a prohibition on gifts from underwriting counterparties during allocation windows.
- Require the PM to disclose any personal interest in an issuer or in an account receiving an allocation.
Client disclosure: the existence and mechanics of the allocation policy, the fact that allocations may be limited and partial, and - for the affected accounts - the specific correction and compensation. The CIO and compliance should also confirm that the senior managers responsible for supervision understood their obligations under Standard IV(C); a policy left unreviewed since 2016 is evidence of a supervisory gap, not just a drafting gap.