Summary

Initial public offerings (IPO)--the sale of a company's stock to the public for the first time--are a major source of funding for new companies seeking to raise capital. According to the Securities and Exchange Commission (SEC), companies raising money through IPOs registered securities worth nearly $26 billion in 1994. Companies typically use underwriters to help them register the IPOs with SEC and raise equity capital from the investment community. The press has reported instances in which underwriters gave some investors preferential access to the IPO market and companies did not disclose material information to investors, such as the criminal and disciplinary histories of their underwriters. This report discusses (1) the factors that influence underwriters to sell IPO shares to institutional investors or to individuals and (2) disclosure requirements concerning the history of disciplinary actions taken against underwriters. GAO also discusses SEC rules governing the IPO market.

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.