For this reason, SEC rules require companies to disclose in the prospectus detailed information about the company. Both SEC and the National Association of Securities Dealers (NASD), the self-regulatory body for broker-dealers, conduct periodic examinations of broker-dealers’ underwriting firms to detect rule violations. When violations are found, the regulators can impose a variety of disciplinary actions. Objectives, Scope, and Methodology

To obtain information on the factors that influence underwriting firms’ allocation of IPO shares between institutional and individual investors, we interviewed SEC officials responsible for market regulation to determine what rules, if any, govern the allocation of IPO shares. Specifically, we obtained information on (1) formal disciplinary actions taken against the 34 underwriting firms for the 5-year period preceding the issuance of the IPO and (2) specific securities violation(s) that gave rise to such actions. Underwriters said they allocated their IPO shares predominantly to institutional investors because of economic factors and their business judgment that institutional investors are better suited for IPOs than individual investors. According to the underwriters we interviewed, they preferred to allocate IPO shares to institutional investors because they believed that these investors are better able than individual investors to buy large blocks of IPO shares, assume financial risk, and hold the investment for the long term. The underwriter has a high percentage of individual clients. Pressure from individual investors can cause underwriters to allocate IPO shares to these investors. To help investors more fully assess their IPO investment risk, we believe it is important for companies to disclose in the prospectus material information on the criminal and disciplinary histories of their underwriter. In contrast, SEC does not specifically require disclosure of material information about the underwriter’s disciplinary history in the prospectus. Description of the Initial Public Offering Process

The initial public offering (IPO) process consists of three phases: (1) developing the information and documents for submission to the Securities and Exchange Commission (SEC), (2) processing these documents through SEC, and (3) marketing and selling the newly public shares.
Why GAO Did This Study

GAO addressed concerns about the initial public offerings (IPO) allocation process, focusing on: (1) the factors that influence underwriters to sell IPO shares to institutional investors and individual investors; (2) disclosure requirements concerning the history of disciplinary actions taken against an underwriter; and (3) Securities and Exchange Commission (SEC) rules governing the IPO market.

What GAO Found

GAO found that: (1) most underwriters primarily sell IPO to institutional investors because of economic factors and their belief that these investors can buy larger blocks of IPO shares, hold their investments longer, and assume greater financial risk; (2) underwriters market IPO to individual investors when their firms have a high percentage of individual investor clients, the company is well known to individual investors, or institutional investors have little interest in the IPO; (3) SEC and the National Association of Securities Dealers (NASD) give underwriters wide latitude in marketing and allocating IPO shares among institutional and individual investors; (4) SEC does not require companies to disclose in their prospectus certain information about their underwriters' criminal or disciplinary histories except when market manipulation and fraud are involved; (5) SEC and self-regulatory organizations imposed 25 formal disciplinary actions for securities violations on 13 of 34 underwriting firms for the 5-year period prior to issuance of IPO; and (6) SEC could provide investors a better means of assessing risks associated with IPO if it required companies to disclose material information on underwriters' disciplinary histories in their prospectus.