Possible SEC inquiry raises age-old bonds question
NEW YORK, March 3 (IFR) - A possible SEC investigation into how new bond issues are allocated has re-opened one of the longest-running debates in the capital markets: are bonds allocated to investors fairly?
The question has taken on new focus as bond issues have hit previously unimagined sizes, with Apple smashing the record at US$17bn last year before Verizon nearly tripled that at US$49bn.
Such enormous issues need large and potentially even massive investors to take on big chunks of the debt, which has raised new questions about who gets to buy them - and why.
"Banks do not look at allocating on a first-come, first-served basis, but on what would be in the best interests of the clients and the market," said one syndicate banker who asked not to be named.
"We really want to allocate it to investors who want the bonds and would help it to perform."
The issue is back in the news after Goldman Sachs said in a regulatory filing on Friday it was cooperating with inquiries into "allocations of and trading in fixed-income securities".
Sources said a number of banks, including Morgan Stanley and Citigroup, had also received enquiries about the allocation process. Goldman, Morgan and Citi all declined to comment.
"When market participants clamor for investigations or cry foul, the SEC tends to look but it does not mean that there was a violation of securities laws," said Jacob Frenkel, a partner at law firm Shulman Rogers and a former SEC lawyer.
"Exclusion from participation [in a bond or IPO offering] is typically not a violation of any securities laws," he told IFR.
"It is entirely in the discretion of the offering underwriter to allocate participation."
It remains unclear from the Goldman Sachs filing if the SEC is actually investigating bond allocation practices or was only inquiring about issues as a matter of course.
Still, the spectre of a possible investigation by US regulators - especially so soon after the mess of the financial crisis - is one that will give debt capital bankers a chill.
IN OR OUT?
Wall Street firms paid billions of dollars in regulatory fines in the 1990s over the allocation of IPOs, and most now have strict guidelines over how all securities are allocated.
"This is stuff we think about very carefully, that we analyze and talk about on a day-to-day basis, to make sure we are compliant with those rules," said another banker.
"I would be stunned if our competitors didn't have similar policies in place."
Even so, the process of how the underwriters of a new issue decide who gets to buy how many of the bonds remains largely opaque.
And as major players such as Pimco, one of the world's largest bond investors, and asset management giant BlackRock have become central to making the new breed of large bond issues feasible, some smaller investors have felt sidelined.
"As important as big guys like Pimco and BlackRock are, I believe there are enough orders to do deals without them in many ways," said one portfolio manager with less than US$500m of assets under management.
"Let's say there's a US$500m tranche, and Pimco wants all US$500m of it," he told IFR.
"If they only got US$35m to US$45m of it, syndicate desks and the issuing companies can easily find enough other investors to take up the rest."
But underwriters are naturally wary of smaller buyers who may want to quickly re-sell new bond issues - and thus lowering their value - instead of larger players who can afford to hold them for longer.
"Small to medium-sized accounts are frustrated that they don't get all that they want, but everyone's frustrated," another syndicate manager said.
"The Pimcos and the BlackRocks don't get all that they want either, and they'll complain about why we gave smaller guys bonds who could flip them."
Ironically, the perceived concentration of new issuance in the hands of a few behemoth investors is largely a by-product of intervention by regulators.
As the government stepped in after the financial crisis and forced banks to dismantle their proprietary trading desks, asset managers such as Pimco and BlackRock could only find liquidity through out-sized participation in the new issue process.
And some argue that the changed landscape - from tougher new regulations to larger sizes of both bonds and the investors who buy them - means it is all but impossible to create a hard-and-fast rule for allocations.
"Depending on demand for maturities, how many tranches are in the deal, the kind of securities offered, the credit fundamentals of the issuers, whether it's floating-rate or fixed, subordinated or senior ... there is a whole host of issues that go into it," another banker said.
"You literally cannot put an over-arching statement around the allocation process."