IPO probe targets cozy deals between traders and brokers
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Traders who worked at PTJP, a self-described hedge fund in a lower Manhattan office, snared thousands of shares in VA Linux Systems, CacheFlow, Red Hat, Theglobe.com, Corvis, MP3.com and dozens of other companies before they began trading. The profits were instant — as much as 897 percent for VA Linux and no less than 109 percent for MP3.com, according to PTJP traders.
In return, brokers at the securities firms that took the companies public demanded, or expected, a payback for allowing an investor to buy IPO , the traders said.
For PTJP and the underwriters, it was a great way to make money in the greatest bull market, as the Nasdaq composite index rallied 460 percent in the five years through March 1, 2000.
"I can't say whether it was illegal, but it certainly was unethical," said Sam Hayes, a Harvard Business School finance professor and author of seven books on capital markets.
"It undermines investor confidence because they were giving special preference to certain investors for a kickback. And that's what it was, a kickback."
And that's why Bruan, a white-haired 57-year-old with a ripple or two of muscle on his 6-foot-3-inch frame, finds himself at the center of a federal investigation of IPOs led by the Securities and Exchange Commission and the U.S. Attorney in Manhattan.
At least nine of Wall Street's largest securities firms have received subpoenas or requests for information in an industrywide investigation that may determine whether the firms violated the law by receiving cash disguised as commissions in return for a piece of the next hot IPO.
Some brokers at the big investment banks asked PTJP traders to pay commissions as much as eight times the customary rate on unrelated trades or to buy shares in secondary stock offerings in less demand, according to five former traders at PTJP and Worldco, a brokerage run by the Bruan family. They spoke on the condition that they wouldn't be identified.
Brokers also granted IPO allocations after ensuring that traders would later purchase additional shares, the PTJP traders said. That practice is barred by regulators because it can artificially inflate stock prices.
One of the traders said he thought he had to generate enough business to return as much as half the profits reaped on IPOs to the investment banks.
Bruan, who has been a cooperating witness, may help investigators determine whether IPO underwriters violated securities laws. Braun and his attorney declined to comment for this story.
The banks, including Credit Suisse First Boston, Lehman Brothers Holdings, Morgan Stanley Dean Witter and J.P. Morgan Chase have denied wrongdoing or said they are cooperating with the investigation.
Credit Suisse late last month fired three brokers who had a say in awarding IPO shares, for what the firm said were violations of its policies.
Four firms — Morgan Stanley, Credit Suisse, Goldman Sachs Group and Bear Stearns — served as the lead underwriters on the IPOs named by the PTJP traders. Spokesmen for the companies declined to comment.
In all, 16 securities firms were involved in the offerings.
Bruan's company of more than 60 traders worked in an office where tiles dangled from the ceiling and fast-food remnants littered many desks, each with a computer that could be shared by as many as three traders.
It wasn't uncommon for some trades to move through businesses set up to conceal the identity of the firm.
The practice included the use of U.S. Postal Service boxes in Midwestern states, a PTJP trader said.
Some of Bruan's traders were recent college graduates. Others had experience managing millions of dollars for hedge fund investors.
In 1999, four were convicted or accused felons, including Joseph Teseo, 32, and Philip Teseo, 29, who pleaded guilty that year in a scheme to manipulate IPOs. The Teseos declined comment.
Bruan's brother-in-law Christopher Carajohn said he used the office office in the firm's early years as a trading base. Carajohn is a former director of a London commodities company and was convicted in the U.K. in 1987 of a 2 million-pound swindle.
Vincent Calcagno, PTJP's chief financial officer, issued a statement in May, when Bruan was named in news reports as cooperating with the federal investigation. He said PTJP "is committed to fair and honest financial practices in every transaction it undertakes" and "holds itself to the highest ethical standard."
"To the extent that PTJP received allocations of initial public offerings, it did so consistent with longstanding industry practices," Calcagno said.
The IPO frenzy began in earnest in November 1998, when shares of Theglobe.com, a company that allows Internet users to set up their own home pages, surged more than sevenfold on the first day they were traded. Investment banks soon brought hundreds of companies to market. They set a price for the IPO shares, sold them to selected buyers and released them for public trading that almost invariably drove up the price. Millions of investors jockeyed to be among the chosen.
PTJP traders drew on contacts at investment banks or, in a variation of the Wall Street mating dance, they cold-called the banks, seeking to enlist so-called institutional brokers to service their accounts and barter commissions for IPOs.
They also targeted brokers who worked with wealthy individuals.
One trader recounted getting more than 7,500 shares in Internet music distributor MP3.com. Credit Suisse First Boston arranged the offering, selling an 18 percent stake in the San Diego-based company in July 1999.
The trader said he had longstanding relationships with CSFB brokers that were cemented by his willingness to return a quarter to half of his IPO profits in the form of commissions, a practice he followed with other banks as well.
The trader said he was regularly solicited by the brokers to buy shares in secondary offerings, the sale of blocks of stocks in companies that have already gone public.
The banks earn fees from the companies selling the shares.
The secondary offerings were less desirable than IPOs because they didn't offer the potential for large, immediate gains. The trader said he bought shares in numerous secondary offerings, choosing those he thought were the best investments.
As the MP3.com IPO approached, the trader said he requested as many as 50,000 shares and was satisfied with the 7,500-plus allocation he got.
His shares valued at $28 jumped to $92 when trading began, peaked at $105 that day and closed at $63.31. He said he generally sold IPO shares at their opening price.
Another trader described winning shares in the VA Linux, Corvis and CacheFlow IPOs by cultivating relationships with brokers who had a voice in IPO allocations.
The trader paid commissions of as much as 12 cents a share, double the normal rate, and agreed to buy shares in any secondary offering brokers were selling.
Without those purchases, the trader said, the brokers would have cut off access to IPOs.