IPO Allocation and a Cross-Trade with the Proprietary Book
Summit Trust manages the Summit Philippine Equity UITF and a proprietary trading book. An IPO of 2 million shares is allocated to the trust department. The UITF's investment policy allows IPO participation; the proprietary book is permitted to trade equities. The fund manager allocates 60% of the shares to the UITF, 30% to a pension client, and 10% to the proprietary book. The IPO trades 25% above offer on day one. The proprietary book sells its entire allocation at the opening, while the UITF buys 300,000 more shares in the secondary market at the inflated price. Later that week, the UITF sells a bond to the proprietary book at 99.50; the prevailing dealer bid is 98.75. The fund manager says the cross-trade saved brokerage and the IPO allocation was 'pro-rata by assets.'
1. Evaluate the IPO allocation and the manager's 'pro-rata by assets' justification.
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The allocation is conflicted. A limited IPO allocation should be distributed under a pre-approved, documented policy that prioritises client accounts and treats them fairly. Giving 10% to the bank's proprietary book while client funds also want the shares creates an incentive to favour the bank. 'Pro-rata by assets' is not enough if the policy was invented after the allocation or if it ignores client mandates, cash availability, and concentration limits.
The day-one sale by the proprietary book while the UITF bought more at the inflated price is a serious red flag. It suggests the fund may have supported the price after the bank exited, or that the manager used client flows to benefit the proprietary position. Compliance should review order records, communications, and the timing of the trades. The manager should have pre-cleared the conflict, documented the allocation rationale, and probably excluded the proprietary book from the IPO to avoid the appearance of front-running.
2. Evaluate the cross-trade of the bond at 99.50 when the dealer bid is 98.75.
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A cross-trade between a client fund and the bank's proprietary book is a related-party transaction that requires exceptional care. Even though the fund sold at a higher price than the dealer bid, the trade was not at an independent market price and was not the result of best execution. The proprietary book may have overpaid, or the fund may have received a price that embeds a hidden benefit or compensation. Either way, the manager's duty of loyalty is compromised.
The manager should not arrange the trade without a written policy, independent pricing, disclosure, and approval. Many firms prohibit cross-trades between client and proprietary accounts altogether. The 'saved brokerage' explanation is not sufficient. Compliance should reconstruct the negotiation, compare the price with multiple dealer quotes, and determine whether the fund or the proprietary book was disadvantaged. The trade should be unwound or adjusted to an independent market price, and the rationale should be documented.
3. Recommend the remediation, disclosure, and control changes the trustee should require.
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The trustee should reverse or adjust the cross-trade so the affected account is made whole, and independently review the IPO allocation and the UITF's secondary purchases. If the fund bought shares to support the price after the proprietary sale, the fund should be compensated for any loss. The matter should be reported to the board, compliance, and the BSP if material. The fund manager should be removed from conflicted decisions pending review, and the proprietary book should be restricted from trading around client orders.
Control changes should include a written IPO allocation policy approved in advance, a prohibition or strict pre-clearance for cross-trades, independent best-execution checks, and a conflicts register. The bank should separate proprietary and trust trading desks and monitor personal and proprietary trades around client flows. Training should emphasise that client interests come first. The trustee should also disclose the conflict and remediation to affected clients in a balanced way, without minimising the breach.