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Part I General Aspects, 3 Stabilization and Underpricing in IPOs

Stefano Lombardo

From: Prospectus Regulation and Prospectus Liability

Edited By: Danny Busch, Guido Ferrarini, Jan Paul Franx

From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2021. All Rights Reserved. Subscriber: null; date: 09 May 2021

Subject(s):
Securities — Insider dealing — Market Abuse Directive (MAD)

(p. 49) Stabilization and Underpricing in IPOs

I.  Introduction

3.01  The Initial Public Offering of shares (IPO) with a Prospectus, now regulated by the Prospectus Regulation 2017/1129,1 is a complex procedure where the offering price determination (the price discovery mechanism) is subject to particular characteristics, dynamics, and constraints, specifically also with reference to possible activities of market manipulation and insider trading (market abuse).

3.02  The Market Abuse Regulation (MAR)2 applies not only to financial instruments already admitted to trading, but also to those for which a request for admission to trading has been made (Art. 2(1) MAR). The MAR provides, as the Market Abuse Directive (Art. 8, MAD),3 two exemptions from the prohibitions of insider dealing (and of unlawful disclosure of inside information, Art. 14 MAR) and of market manipulation (Art. 15 (p. 50) MAR). These exemptions are (Art. 5 MAR): (i) for trading in own shares in buy-back programmes; and (ii) for stabilization of securities.4 This chapter focuses on the second exemption, i.e. on the stabilization activity,5 which is usually realized in case of an IPO and of a secondary offering of shares (SEO) (on a regulated market or a multilateral trading facility (MTF)) and is regulated in detail by Commission Delegated Regulation 2016/1052, according to Article 5(6), MAR.6

3.03  More particularly, this chapter concentrates on stabilization activity during IPOs (in regulated markets) and is structured as follows. Section II ‘The Economics of IPOs’ (para. 3.04) offers a background to the economic theories of IPOs, analysing in particular the underpricing phenomenon (and its opposite, the overpricing phenomenon) and reports the main reasons, economists have developed for justifying the stabilization of IPO shares. For comparative purposes, section III ‘The US Regulatory Regime’ (para. 3.11) offers a short but useful analysis of the US system of IPO stabilization activity. Section IV ‘The European Regulatory Regime’ (para. 3.17) focuses on the detailed analysis of the European regulatory system as provided by the MAR and by Regulation 2016/1052, as integrated by other sources of relevant European regulation. Section V ‘Conclusion’ (para. 3.54) concludes.

II.  The Economics of IPOs

3.04  Even though the legal procedure of an IPO can diverge depending on the legal system and the type of trading venue, the economic structure and dimension of an IPO is the same everywhere, also because of internationally developed standards, particularly influenced by those originating from the US.7

(p. 51) 1.  The Structure of the IPO

3.05  Shares offered in an IPO can come either from selling shareholders (e.g. from the family controlling the company, private equity funds, etc.) or from a capital increase (with the subscription of new shares) of the issuer, or from a combination of both. During the entire IPO procedure, the company is assisted by a plurality of actors, i.e. gatekeepers playing a certification role about the quality of the company.8 Among these, particularly important are banks, which organize themselves in one or more syndicates that sell the shares to investors and are usually led by a managing underwriting bank (lead manager).9 According to the US nomenclature (and US English), there exist mainly three types of banking syndicates, with a different degree of risk taken and different types of compensation: (i) firm-commitment syndicates: where the banking syndicate buys ex ante the old shares from the selling shareholders/company or underwrites new shares and then resells them to investors; (ii) strict-underwriting syndicates: where the banking syndicate buys ex post the shares it is unable to sell to investors; and finally the (iii) best-effort syndicates: where the banking syndicate limits itself solely to selling the shares without taking any risk.10

3.06  Another characteristic of IPOs, worth mentioning for both economic and legal purposes, is the fact that the offering price at which the shares are offered to the public is a single price for all the investors involved.11 In other words, independently from the legal question in each jurisdiction about the possible permissibility of different prices for the different types of investors (particularly with respect to a possible differentiation between institutional investors and retail investors), the experience is that IPOs always have a single offering price.12 It is not possible here to evaluate the issue of the overall efficiency of this solution.13 One can only anticipate that with the bookbuilding system (p. 52) (on which see section II.2 ‘IPOs and Underpricing’, para. 3.07) the syndicating banks, being unable/unwilling to discriminate among investors on the offering price (as first influenceable variable in a supply–demand context), are able/willing to discriminate in the quantity of shares (as second influenceable variable) allocated to the different investors.

2.  IPOs and Underpricing

3.07  Independently from the legal structure of the IPO, two common phenomena are typical worldwide: (i) underpricing (or its opposite, overpricing); and (ii) long-run underperformance.14 The first phenomenon, underpricing, is the most important and the most studied both theoretically and empirically. Underpricing of an IPO means that the share price has a positive return (measured by the positive difference between the closing price on the first day of trading and the offering price)15 in the first day of trading. Underpricing is the normal result of a ‘good’ IPO.16 Underpricing is an indirect (transaction) cost of an IPO and represents, as economists say, ‘money left on the table’. Overpricing, on the other hand, is the negative return in the first day of trading and is the result of a ‘bad’ IPO.17

3.08  The most common theory to explain this typical phenomenon relates underpricing to the asymmetric information problem about the ‘true’ value of the company:18 either the company, or the syndicating banks, or some investors have more information about the ‘true’ value of the company.19 Inside this asymmetric information paradigm, some investors are considered to be crucial for explaining underpricing. There are two possible illustrative models. The first one is the so-called ‘winner’s curse model’ (which relies on a fixed-price offering), according to which some investors have more information about the value of a company and buy only good IPOs; to solve this adverse selection problem, all IPOs are underpriced in order to find enough investors.20

(p. 53) 3.09  The second, the predominant model, is the ‘information revelation model’, according to which institutional investors reveal to the syndicating banks the ‘true’ value of the company shares in an open price mechanism,21 more recently, typically based on the bookbuilding system.22 The IPO company is presented to institutional investors in roadshows and during the offering time the syndicating banks’ bookrunner (usually the lead manager) collects in its order book the quantity and quality of institutional investors’ indication of interests, i.e. non-binding orders.23 Indeed, institutional investors are able to process public information about the company disclosed in the IPO prospectus and have the correct incentive to reveal to the syndicating banks precious information about the ‘true’ value of the company, being remunerated by favourable shares allocations.24 This second model is promising, because bookbuilding has replaced almost worldwide the fixed-price offering system,25 also reducing the average level of underpricing of IPOs in comparison to fixed-price offerings.26

3.  Overpricing and Theories of Stabilization

3.10  As mentioned, overpricing is the opposite of underpricing: it is the negative return in the first day of trading. Overpricing can be corrected by the syndicating banks by stabilizing the shares’ price in the aftermarket (defined as the period of time after negotiation starts on the market and ending usually after thirty days). Stabilization is a form of (permitted) market manipulation because it artificially alters the normal development of the price in the aftermarket. It alters the normal game between supply and demand by stimulating artificial demand, with the effect of increasing the price. Stabilization usually occurs in the sense that a member of the syndicating banks, usually the lead manager (who becomes also stabilization manager) buys shares on the aftermarket and by stimulating (p. 54) demand tries to (artificially) increase the share price. There are some theories that (try to) explain (particularly with respect to the US regulatory regime) why underwriters stabilize IPO share prices.27 In short, stabilization is used (i) in order to support prices (i.e. in order to prevent/retard price fall), hence being a form of price manipulation used by underwriters to hide overpriced offerings, or even to permanently increase the aftermarket stock price; (ii) as a form of reward to investors, i.e. either to retail ones to compensate them for the adverse selection costs or to institutional investors for submission of truthful information during bookbuilding; (iii) as a form of reputation protection for underwriters to avoid a decrease in future underwriting revenues; (iv) as a form of profit maximization for underwriters; (v) as a form of risk transfer to naive investors who buy overpriced shares; (vi) as a bonding mechanism against aggressive pricing in case of bookbuilding; (vii) as a form of risk reduction against volume shocks, when the price collapses due to the impossibility of matching supply and demand.

III.  The US Regulatory Regime

3.11  For comparative purposes, it is useful to analyse briefly the regulatory regime in the US, where stabilization is considered a form of permitted market manipulation according to Regulation M,28 introduced in 1997 in order to regulate securities offerings.29 In particular, Rule 104 of Regulation M provides for three types of IPO stabilization devices,30 regulating them in detail on a rule-based regulatory approach rather than, as it seems in the EU, on a standard-based approach.31

3.12  The first device is stabilization (pure stabilization). In this case, the lead manager supports the share’s price by buying shares (stabilizing bids) in the market in order to be able to complete the shares’ distribution.32 In other words, the syndicate temporally buys shares, the price of which is falling below the offering price (overpricing), simply in order to be able to sell them during the distribution at the offering price. It is useful to (p. 55) mention that this form of stabilization is no longer used in the US, because the banking syndicate typically ends when negotiations on the market start and the distribution has been completed.33

3.13  The second type of stabilization, the one still commonly used in the US, is the syndicate covering transaction (short covering).34 The syndicate typically completes the offering, by assuming a short position, later covering it by either (i) buying the shares in the aftermarket (in case of overpricing), so stabilizing (increasing) the price by a syndicate covering transaction (i.e. short covering); or (ii) by exercising the greenshoe option (in case of underpricing).

3.14  Historically, this stabilization type derives from the structure of section 5 SA. Indeed, the offering process is divided basically into three steps:35 (i) the pre-filing period, before the registration statement is filed with the SEC; (ii) the waiting period, starting with the registration and ending with the SEC authorization of the IPO; and (iii) the post-effective period, which starts when the SEC authorizes the offering and ends when the shares distribution is completed. Before the registration statement is authorized by the SEC, the selling of securities is prohibited, while the solicitation of unbinding orders is permitted. Solicitation occurs with a preliminary prospectus containing all relevant information ‘except for the omission of information with respect to the offering price, underwriting discounts or commissions, . . ., or other matters dependent upon the offering price’, determined by the bookbuilding procedure.36 After SEC authorization, a statutory prospectus with the final offering price (and other relevant information) is required for selling the shares to investors.37 Since during the waiting period there are only investors’ manifestation of interests (unbinding orders), once the registration statement becomes effective these may or may not lead to a final binding order. The problem is that in firm-commitment agreements, which are extremely risky for the syndicating banks, some investors may withdraw (renege) their unbinding orders, with the consequence that the banking syndicate has to keep in its portfolio reneged shares (so-called reneging costs). To avoid this problem, the syndicating banks allocate during the waiting period more shares among investors than the registered number of shares to be authorized by the SEC. This overallotment activity results in a syndicate short position.38 (p. 56) As mentioned, this short position (up to 15 per cent of the registered shares) is covered later, either by buying shares on the market (in case of overpricing), or by contracting with the company or a selling shareholder a greenshoe option, according to which the syndicate can buy shares at the offer price from one or both of them (in case of underpricing). In this way, from a historic perspective the problems deriving from section 5 SA structure have been shifted to the issuer.39 It is not possible here to evaluate the extent to which the mechanism between overallotment/greenshoe option is still used to minimize reneging costs, as was in the past, or for other purposes such as reputational issues or profit maximizing.

3.15  Finally, the third type of stabilization is penalty bids. According to Regulation M Rule 100, a penalty bid is an arrangement that permits the managing underwriter to reclaim a selling concession from a syndicate member in connection with an offering when the securities originally sold by the syndicate member are purchased in syndicate covering transactions. Indeed, it is usual for IPO investors to sell their shares in the first day(s) of trading (flipping) in order to monetize the profits deriving from underpricing or limit the loss deriving from overpricing.40 Penalty bids are a mechanism designed to manage the problems related to flipping.41

3.16  It is useful to end this short review of the US regulatory regime, pointing out that historically the three different types of stabilization developed (and are regulated in Regulation M) in order to minimize the risks the syndicating banks face in firm-commitment contracts. Indeed, in these types of underwriting contracts banks bear the risks associated with being able to sell all the shares during an IPO (or SEO). It is not possible here to evaluate from a theoretical perspective the question of the overall efficiency of this stabilization system that seems to shift the risks (and particularly also the underwriting risks) ultimately to the IPO company and to investors.42

(p. 57) IV.  The European Regulatory Regime

1.  Insider Trading and Market Manipulation

3.17  Article 5, MAR exempts stabilization from the prohibitions of Article 14, MAR (insider dealing and unlawful disclosure of inside information) and from those established by Article 15, MAR (market manipulation). It is necessary to briefly analyse these prohibitions in order to better understand the proper content and limits of legitimate behaviour in case of stabilization activity.43

3.18  Article 7, MAR provides the definition of inside information as being information:44 (i) of precise nature with respect to circumstances/events already realized or reasonably realizable, also with respect to intermediate steps in a protracted process; (ii) nonpublic; (iii) relating directly or indirectly to one or more issuers or to one or more financial instruments; (iv) which if made public would have a significant effect on prices, because a reasonable investor would be likely to use it for investment decisions. The prohibitions set out in Article 14, MAR relate to three possible forms of behaviour:45 (i) insider dealing (engaged or even attempted) (Art. 8 MAR); (ii) recommendation or inducement to another person in engaging in insider dealing (Art. 8 MAR); and (iii) unlawful disclosure of inside information (Art. 10 MAR). On the other hand, Article 17, MAR (ad-hoc disclosure) provides for the public disclosure of inside information as an incentive to reduce the probability of insider dealing by granting equal access to all investors to this information.46

3.19  Market manipulation is defined in Article 12, MAR in terms of activities, which are described in quite extensive terms and prohibited according to Article 15, MAR. Article 12, MAR describes (as the MAD did) market manipulation essentially according to two types of behaviours:47 (i) execution of a transactions or transaction-based market manipulation (Art. 12(a) and (b)); and (ii) dissemination/transmission of information or information-based market manipulation (Art. 12 (c) and (d)).

3.20  As will be explained in section IV.2 ‘The Notion and the Purpose of Stabilization’ (para. 3.21), from a practical perspective, stabilization activity in case of (public) offerings refers to behaviour, which can be properly included in the scope of Article 12(a) and (b), (p. 58) i.e. as a form of transaction-based market manipulation. It is necessary to mention that stabilization of IPO share prices as regulated by Article 5, MAR and Regulation 2016/1052 is a safe harbour, but Recital 12 MAR points out that stabilizing financial instruments which would not benefit from the exemptions under MAR should not in itself be deemed to constitute market abuse. From this Recital, it follows that the European regulatory philosophy of stabilization uses a standards-based approach (rather than a rules-based one, as in the US) that gives national authorities discretion to apply the rule. In this context, to avoid possible confusion, one has also to differentiate between (i) the safe harbour of stabilization (and buy-back programmes) of Article 5, MAR, which provides exemptions for both market manipulation and insider trading; and (ii) accepted market practices (Art. 13 MAR) which, from a systematic perspective, differ because they are exempted only from market manipulation and follow particular procedural rules for their identification.

2.  The Notion and the Purpose of Stabilization

3.21  Article 3(2)(d), MAR defines stabilization as the purchase or offer to purchase securities which is undertaken by a credit institution or an investment firm in the context of a significant distribution of such securities exclusively for supporting the market price of those securities for a predetermined period of time due to a selling pressure in such securities.48 This definition mentions two possible permitted actions, namely the purchase or the offer to purchase securities, which are included, as mentioned, in the definition of transaction-based manipulation (Art. 12(1)(a) and (b) MAR).49 The purchase (or the offer to purchase) is carried out with the intention of supporting the market price of the securities, which are subject to selling pressures (i.e. to overpricing).

3.22  The definition of stabilization incudes furthermore the notion of significant distribution, which is an autonomous notion according to Article 3(2)(c), MAR and represents the context in which stabilization can be legitimately pursued. A significant distribution means an initial or secondary offering that is distinct from ordinary trading both in terms of the amount in value of the securities to be offered and the selling method to (p. 59) be employed.50 This notion includes both IPOs and SEOs, which require a formal offering procedure and a prospectus to be published.51

3.23  While Recital 11 MAR provides quite a general justification for stabilization, arguing that it can be legitimate for economic reasons and on this basis should be exempted from market abuse, it is Recital 6 of Regulation 2016/1052 that specifies the justification of stabilization. It explains that stabilization is intended to provide support for the price of an initial or secondary offering of securities during a limited period of time if the securities come under selling pressure, thus alleviating sales pressure generated by short-term investors and maintaining an orderly market in those securities. As explained, an IPO can end with underpricing or overpricing, but the closing price of the first day of trading usually includes also the flipping activity, which is the normal behaviour of those investors that decide to capitalize the profit deriving from the underpricing or to limit the loss deriving from overpricing, simply by selling the securities. The Recital seems to refer to flippers when it mentions short-term investors and legitimates stabilization as a possible solution for flipping that ends in overpricing, i.e. when the selling activity of IPO investors is not absorbed by sufficient demand on the aftermarket.

3.24  The second part of Recital 6 tries to give further justification to stabilization, including the interests of some market actors. Stabilization contributes to greater confidence of investors and the issuers on financial markets. This statement implicitly assumes that the equilibrium price (the overpricing price) of the first negotiations after trading starts could not be the ‘right’ one and should be properly corrected by a form of manipulation, i.e. by permitting the syndicating banks to buy on the aftermarket. This artificial demand is considered to be beneficial for the integrity of the market. This economic reasoning is quite ambitious and could be considered not perfectly in line with an economic theory that considers the market efficient and able to correctly price the share already after the first negotiations.52

3.25  Recital 6 continues by mentioning the interests of both the investors who have purchased the shares during the distribution and issuers, whose interests are apparently protected by the stabilization activity. This Recital thus excludes from the interests protected those of the investors who buy on the aftermarket shares whose price is artificially increased (i.e. manipulated) by the stabilization activity. For these investors, some substantial rules related to stabilization (i.e. to the manipulatory activity) and disclosure requirements are provided as a form of protection.

(p. 60) 3.26  The Recital also seems to exclude the interests of syndicating banks from the interests the stabilization activity is legitimately allowed to protect. It has been noted that in the US regulatory regime, the stabilization activity (the three types) historically developed in order to minimize the different risks associated with public offerings of securities with firm-commitment agreements, where the risk the underwriters have to deal with was (is) very high. The purpose of stabilization as explained in the Recital seems to exclude (or include only indirectly) the interests of the syndicating banks as those to be protected.

3.  The Notion of Ancillary Stabilization

3.27  The stabilization activity that can be performed by the syndicating banks in order to support a declining market price (i.e. in case of overpricing) is supported by two instruments, which define the notion of ancillary stabilization. Ancillary stabilization is functional to the facilitation of the stabilization activity during a significant distribution (Art. 1(e) Regulation 2016/1052) because it provides resources and hedging for stabilization activity (Recital 10 Regulation 2016/1052): Ancillary stabilization includes: (i) the exercise of the overallotment facility; or (ii) the exercise of the greenshoe option. It is useful to analyse the two notions (and the others related to them) with the preliminary indication that the meaning of the various notions can be more properly understood through an understanding of their economic functionality, as the systematic definitions are hindered by the divergences in the linguistic versions of the relevant provisions produced in some Member State languages (also in the context of other rules, such as the Markets in Financial Instruments II package, ‘MIFID II package’).

4.  The Notion of Overallotment Facility and of Allotment

3.28  Article 1(f), Regulation 2016/1052 defines the overallotment facility as a clause in the underwriting agreement or lead management agreement which permits acceptance of subscriptions or offers to purchase a greater number of securities than originally offered.53 This notion includes two relationships.

3.29  The first is between the offeror (as defined in Art. 1(c) Regulation 2016/1052) and the syndicating banks and relates to the underwriting agreement or lead management agreement between the offeror and the syndicating banks.54 These two types of agreement are not precisely defined and their meaning is not completely clear. It appears (p. 61) more plausible that they refer to the same type of agreement, with the former referring to the relationship between the offeror and the complex of the syndicating banks, while the latter refers to the relationship between the offeror and only the lead manager and not to two different types of agreement. In any case, according to the systematic of the MIFID II Directive,55 in very general terms the underwriting agreement and the lead management agreement belong (i) to Annex I, section A number 6 and/or 7;56 and (ii) to Annex I, section B number 6, services related to underwriting.

3.30  Notwithstanding these interpretative difficulties, the stabilization mechanic requires a particular clause in the contractual relationship between offeror and syndicating banks. This clause provides the possibility of offering investors more securities than originally planned and disclosed in the prospectus, in order to end up with a short position that creates the correct incentives to stabilize the price in case of overpricing.57

3.31  The second relationship the provision refers to is the one between the syndicating banks and investors. From this perspective, the notion of overallotment facility permits acceptance of subscriptions or offers to purchase a greater number of securities than originally offered.58 Again, the notions of acceptance of subscriptions and offer to purchase are not defined from a contractual perspective. For their definition, it is necessary to introduce the notion of allotment defined by Article 1(d), Regulation 2016/1052. Allotment is defined as the process or processes by which the number of securities to be received by investors who have previously subscribed or applied for them is determined. This definition seems to stress the fact that there was either a previous investor subscription or a previous investor application to be defined by a final mechanism (the process/processes) that decides the final allocation.

3.32  On the basis of this definition of allotment, the terms ‘acceptance of subscriptions’ and ‘offers to purchase’ seem to refer to the possible nature of the offering. Indeed, the nature of the offering can be in terms of (i) an offering with investors’ binding orders; or (ii) an invitatio ad offerendum with simple investors’ unbinding orders. In this context, the term ‘acceptance of subscriptions’ appears to refer to an offering with investors’ binding (p. 62) orders,59 while the term ‘offers to purchase’ seems to refer to the invitatio ad offerendum (with simple investors’ unbinding orders or simple manifestation of interests, i.e. a simple application). The offerings (IPO and SEO, with the complication of pre-emptive rights) differ from Member State to Member State according to the contract law of each legal system.60 This interpretation could be more in line with the notion of allotment, which includes, as mentioned, a previous subscription or an application (and not a purchase).61 This interpretation, which is the more plausible from a literal perspective, is nevertheless problematic from a second comparative perspective. Indeed, as mentioned in paragraph 3.14, the overallotment facility was developed and was (is?) used in the US to manage the reneging costs deriving from investors unbinding orders in firm commitment agreements in a regulatory context where investors simply apply for shares in the first stage of the offering. If there are already subscriptions (in terms of binding orders), there is by definition no risk of the syndicating banks having to manage the investors’ reneging costs. For this reason, the European stabilization regime seems to enlarge the possibility of creating the stabilization resources (deriving from the allotment facility) also in case of investors’ subscriptions and not only simple unbinding applications. It is difficult to assess the extent to which the syndicating banks in Europe use the overallotment facility in IPO without the reneging costs problem. An empirical study related to Italy has shown that (ancillary) stabilization (i.e. the overallotment facility) is used only in the case of a global offering with a private placement to institutional investors according to Regulation S, Rule 144A SA. In this case, the problem of the reneging costs is potentially present, confirming the intuition that stabilization is not primarily used in the interests of the issuer/investors/market but in the interests of the syndicating banks.62

5.  The Notion of Greenshoe Option

3.33  Article 1(g), Regulation 2016/1052 provides the notion of greenshoe option as an option granted by the offeror in favour of the investment firm(s) or credit institution(s) involved in the offer for the purpose of covering overallotments, under the terms of (p. 63) which such firm(s) or institution(s) is (are) allowed to purchase up to a certain amount in securities at the offer price for a certain period of time after the offer of securities. The greenshoe option, first used in the US in 1963, helps to cover the short position created by the syndicating banks in case of IPO underpricing. It is in fact more convenient to buy the shares necessary to cover the short position coming from the overallotment from selling shareholders or from the IPO company at the offering price, instead of buying them on the aftermarket at a higher price.

6.  The Substantive Rules for Stabilization: The Stabilization Period

3.34  Article 5, MAR and Regulation 2016/1052 provide some rules to limit the manipulative character of the stabilization activity. Recalling their standard philosophy as explained by Recital 12 MAR, more particularly Article 5, MAR allows stabilization only for a limited period of time (Art. 5(4)(a) MAR). The stabilization period (Art. 5 Regulation 2016/1052) is structured differently in the case of IPOs and in the case of SEOs.63 In an IPO, the period starts with the date of negotiations starting on the trading venue and ends after thirty days.

3.35  IPOs benefit from an exemption to this general rule in case of trading prior to the commencement of trading on a trading venue. This provision refers to the grey market (or ‘when issued trading’ according to Recital 7 Regulation 2016/1052)64 that is allowed by some Member States (as in the United Kingdom)65 but is forbidden in the US system.66 In any case, trading occurring during the grey market (or when issued trading) has to be carried out according to the applicable rules of the trading venue on which the securities are to be admitted to trading, including any rules referring to public disclosure and trade reporting. In this particular case, the starting point for stabilization is the moment of the adequate public disclosure of the final price of the securities.

3.36  In this context, it has to be mentioned that Article 17, Prospectus Regulation permits the omission of information concerning the final offer price and/or amount of securities to be offered to the public. This is typical with the open price system based on the bookbuilding procedure, which is today the predominant mechanism of selling securities in IPOs, as already mentioned in section II.2 ‘IPOs and Underpricing’ (para. 3.07). Indeed, the prospectus only reports an open range with the indication of a minimum and a maximum price determined on the basis of several (accounting (p. 64) and management) methods. Taking account of this element, Article 17, Prospectus Regulation provides some safeguards for the protection of investors (as stressed by Recital 55 of the Prospectus Regulation, which refers to the market practice).

3.37  It is alternatively provided that either (i) the acceptance of the purchase or subscription of securities may be withdrawn for not less than two working days after the final offer price and/or amount of securities to be offered to the public has been filed; or that (ii) information is disclosed in the prospectus about (a) the maximum price and/or the maximum amount of securities, as far as they are available; or (b) the valuation methods and criteria, and/or conditions in accordance with which the final offer price is to be determined and an explanation of any valuation method used. In any case, the final offer price and amount of securities shall be made public according to Article 21(2), Prospectus Regulation.

3.38  Article 17, Prospectus Regulation allows for the adaption of the contractual characteristics of the offering that are determined by the civil law systems of the single Member States to an open price system (based on the bookbuilding mechanism), which has the important aim of decreasing the average level of underpricing, so increasing the efficiency of the IPO procedure. At the same time, it should also be mentioned that the withdrawn right activates the reneging costs problem that the overallotment facility tries to solve.

3.39  In this context of price formation and bookbuilding system, Commission Delegated Regulation 2017/56567 has notably introduced some constraints (as additional requirements to the general requirements on conflict of interests) on the behaviour of the syndicating banks in terms of the management of possible conflict of interests deriving particularly from the syndicating activity.68 Given the practical impossibility of analysing here such a complex issue that is strongly connected with the contract law system of each Member State, only a very short overview is provided.69 Recital 57 provides a kind of general clause of good behaviour in favour of all the involved parties,70 Recital 58 specifies that the pricing process, including bookbuilding, is not detrimental to the (p. 65) issuer’s interests,71 while Recital 59 concentrates on the allotment process.72 Article 38 specifies some requirements before the underwriting contract is signed, particularly with respect to ‘. . . (b) the timing and the process with regard to the corporate finance advice on pricing of the offer; (c) the timing and the process with regard to the corporate finance advice on placing of the offering; (d) details of the targeted investors, to whom the firm intends to offer the financial instruments’.

3.40  Article 39 sets rules on conflict of interests related to possible underpricing or overpricing of an issue or involvement of relevant parties in the process, particularly with respect to the fact that (i) the pricing of the offer does not promote the interests of other clients or firm’s own interests, in a way that may conflict with the issuer client’s interests; and (ii) the prevention or management of a situation where persons responsible for providing services to the firm’s investment clients are directly involved in decisions about corporate finance advice on pricing given to the issuer client. Furthermore, Article 39.2 specifies also information to be provided to the IPO company about pricing and the possible stabilization activity.73 Article 40 focuses on requirements in relation to placing prohibiting some practices that may distort the integrity of the market.

3.41  It is difficult to assess the real meaning of the Recitals and of the briefly mentioned relevant Articles (see also Arts 41–43) in terms of the efficiency of the bookbuilding procedure. As a price discovery mechanism, it alleviates problems of asymmetric information because there is an economic difference between informed institutional investors who have to be compensated for revealing precious information about the true value of the IPO company and uniformed (retail) investors. As already mentioned in paragraph 3.09, worldwide IPOs are characterized by a single price, the same for all types of investors. Since it is not possible (or major actors are not willing) to discriminate in the price, discretionary allocation among investors is the only possible alternative. Not surprisingly, the economic literature studying the positive effects of the bookbuilding procedure exposes the tension between, on the one hand, syndicating (p. 66) banks’ discretion and, on the other, possible investor discrimination. It is difficult to say whether the rules on the conflict of interests are able to prevent and solve this tension by finding an efficient equilibrium among the several variables existing.

7.  The Substantive Rules for Stabilization: The Price Conditions

3.42  In IPOs (and in SEOs), the stabilization activity can be done only with the upper limit of the offering price (Art. 5(4)(c) MAR and Art. 7(1) Regulation 2016/1052).74 This limitation is functional to alleviate the manipulative character of stabilization that alters the normal development of the price in the aftermarket by creating an artificial price. Recital 11 of Regulation 2016/1052 provides some insights as to the price conditions for stabilizing and the liquidation of shares purchased during the stabilization activity. Both stabilization and liquidation should be carried out to minimize market impact and with due regard to prevailing market conditions. This general clause allows some freedom for the syndicating banks with a general limitation in terms of alleviating the manipulative character of stabilizing and liquidation, i.e. by minimizing their artificial impact. Recital 11 of Regulation 2016/1052 continues by stating that selling securities acquired through stabilization purchases, including selling in order to facilitate subsequent stabilization activity, should not be deemed for the purposes of price support. This statement appears tautological if one thinks that stabilization is a purchase or an offer to purchase (and not sell) precisely in order to create an artificial increase of the price but at the same time takes into consideration the manipulative character of the stabilization activity. The Recital ends with a general statement where subsequent trading (both in terms of the sales of shares acquired for stabilization and subsequent purchases) should be considered abusive even if it does not benefit from the exemption provided under the MAR. Given the standard-based approach, national authorities enforcing the rules of stabilization activity have significant discretional powers and considering also Recital 12 MAR, it appears that underwriters enjoy a flexible legal environment in which to implement stabilization activity.

8.  The Substantive Rules for Ancillary Stabilization

3.43  Ancillary stabilization in terms of the overallotment facility and the greenshoe option is considered instrumental to the stabilization activity by creating the hedging resources underwriters use to stabilize. Article 8, Regulation 2016/1052 provides for conditions to be respected for ancillary stabilization. Again, these conditions are deemed to be necessary (despite a standard-based approach) in order to limit the manipulative character (p. 67) of stabilization activity that creates an artificial price by stimulating demand for shares with a declining price on the aftermarket.

  1. (a)  Overallotment of securities is allowed only during the subscription period and at the offering price. From the contractual perspective between the syndicating banks and the investors, the overallotment facility includes the postponement of the selling–purchasing settlement (and the delivery of the shares). Indeed, those investors who receive overallotted shares have to wait for their delivery that negotiations start on the market. In case of overpricing, the stabilization activity permits to buy the shares on the aftermarket and their delivery to investors, while in case of underpricing the delivery of the shares is granted from the exercise of the greenshoe option.

  2. (b)  The naked short position (i.e. the short position not covered by the greenshoe option) shall not exceed 5 per cent of the original offer. This limitation is functional to stress the strong connection between overallotment facility and greenshoe option as hedging activity functional to stabilization. Indeed, it serves to limit the manipulative character of possible purchases on the aftermarket covering the short position not covered by a corresponding greenshoe. In this case, the possible danger is that the purchasing activity of the syndicating banks would increase the shares price even above the offering price that is the limit for stabilization and/or that the quantity of shares offered would no longer be limited and transparent in amount.

  3. (c)  The greenshoe option shall be exercised by its beneficiaries only where securities have been overallotted, which preserves the integrity of the market. This is because, in the case of a greenshoe option without an overallotment, the effect would be to allow the underwriters to buy ex post when negotiation starts with underpricing, an amount of shares from the offeror, thus increasing de facto the dimension of the offer with the effect, by selling these shares, of decreasing the price on the aftermarket.

  4. (d)  The greenshoe option and the overallotment to 15 per cent of the offer are limited, meaning that the total overallotment (covered plus naked) can be 20 per cent of the offer.

  5. (e)  The greenshoe option has an exercise period which is the same as the stabilization period (i.e. normally thirty days).

  6. (f)  The exercise of the greenshoe option has to be disclosed to the market in a very detailed way, including the date of exercise and the nature of the securities involved.

9.  The Disclosure Regime for Stabilization

3.44  Disclosure of the stabilization activity is an important tool to alleviate the manipulatory character of this intervention, which artificially alters the natural development of the (p. 68) share price on the aftermarket and potentially compromises market integrity (Recital 8, Regulation 2012/1052). Article 5(4)(b) and 5(5), MAR, as well as Article 6, Regulation 2016/1052, detail the rules for adequate public disclosure and reporting obligations.75

3.45  This disclosure and reporting system is based on three steps, which accompany stabilization, before it takes place, during its realization, and after its completion. It is necessary to start the analysis by saying that for efficiency reasons Article 6(5), Regulation 2016/1052 requires the appointment of either the issuer, the offeror, and any entity undertaking the stabilization or the person acting on their behalf, as the one central point for public disclosure and for interaction with the competent authorities. The praxis of stabilization is such that, among the syndicating banks, the lead manager is also the major stabilization actor of the offering, becoming the stabilization manager.

3.46  Before the start of the IPO (or SEO), the person delegated shall ensure adequate information of (i) the fact that stabilization may not necessarily occur and that it may cease at any time; (ii) the fact that stabilization transactions aim to support the market price of the securities during the stabilization period; (iii) the beginning and the end of the stabilization period, during which stabilization may be carried out; (iv) the identity of the entity undertaking the stabilization, unless unknown at the time of disclosure, in which case it shall be subject to adequate public disclosure before the stabilization begins; (v) the existence of any overallotment facility or greenshoe option and the maximum number of securities covered by that facility or option, the period during which the greenshoe option may be exercised, and any conditions for the use of the overallotment facility or exercise of the greenshoe option; and (vi) the place where the stabilization may be undertaken including, where relevant, the name of the trading venue(s).

3.47  In the context of disclosure before the offering starts, it has to be mentioned that the same Prospectus Regulation regime requires the reporting of the possible future stabilization activity in the delegated acts.76 This means that investors are ex ante informed that in event of overpricing the syndicating banks may intervene by supporting the share price.

3.48  During the stabilization period, the person appointed shall ensure adequate public disclosure of the details of all stabilization transactions no later than the end of the seventh daily market session following the date of execution of such transactions. This rule makes clear that the stabilization activity in terms of purchase or offer to purchase is carried out as a manipulatory activity, with the market knowing nothing as to the exact (p. 69) moment of execution. The investor that sells the shares as a counterpart of the stabilization manager is not aware of the increased price at which the transaction takes place, also because the counterpart’s identity is unknown.

3.49  After the end of the stabilization period, but within one week, the person appointed shall ensure adequate public disclosure of the following information: (i) whether or not the stabilization was undertaken; (ii) the date on which stabilization started; (iii) the date on which stabilization last occurred; (iv) the price range within which stabilization was carried out, for each of the dates during which stabilization transactions were carried out; (v) the trading venue(s) on which the stabilization transactions were carried out, where applicable. This information will be historical information, possibly with a limited price impact, given the fact that the price will have already discounted the impact of the stabilization activity. Nevertheless, it will signal to the market the exact amount of the stabilization activity and/or the exercise of the greenshoe option.

3.50  Finally, Article 6(4) and (5), Regulation 2016/1052 provides for keeping records of stabilization activity and for notifying stabilization activity to competent authorities.

10.  Insider Trading and Stabilization

3.51  It has been mentioned several times that from an operational perspective stabilization is a form of (permitted) transaction-based market manipulation, because it includes the purchase of securities or the offer to purchase securities. This operative qualification raises the question of the relationship between stabilization and insider trading because the safe harbour also includes protection from insider trading. This relationship is a complex one and in order to be explained has to take into consideration also the ratio legis of the prospectus regime.77

3.52  The market abuse regime applies to listed companies in the case of SEOs and to IPO companies, i.e. those companies which require an admission to trading (Art. 2(1) MAR). The safe harbour granted to stabilization in terms of exemption from the prohibition of market manipulation and insider dealing and unlawful disclosure of inside information as well as the existence of an ad-hoc disclosure of inside information (Art. 17 MAR) has in any case to be matched with the prospectus regime. Indeed, the prospectus is the document where full disclosure about the IPO company (SEO company) is required in order to alleviate (minimize) the asymmetric information problem related to IPOs. The prospectus regime does not tolerate a deviation from full disclosure of information and a possible exemption from market manipulation and insider trading and, as mentioned above, does also include a short reference to the possibility of future stabilization. Indeed, the MAR applies also to IPO companies in the phase before negotiation starts on the market, but the application for admission to trading (p. 70) has been made. In this very delicate phase (the pre-marketing phase, which is not uniformly regulated in the EU but with the provisions of some conflict-of-interests rules already mentioned), the EU regulatory regime does not provide exemption from market manipulation and insider trading. Indeed, in Europe also the bookbuilding procedure could be scrutinized in terms of market manipulation and insider trading (and the conflict-of-interests rules).78 The MAR excludes the stabilization activity from market abuse. The stabilization activity can be carried out only during the stabilization period, which starts, as already mentioned, when negotiation starts on the market or when the offering price is made public in case of when-issued securities. In this context, it has to be pointed out that—in terms of inside information—the only relevant information included in the safe harbour relate to the bookbuilding phase and the allotment phase and to investors behaviours/strategies. In this phase, the bookrunner collects the (unbinding) orders and allots the shares to investors and is able to understand the mood of the market, when negotiation starts being able to have at least an impression about who is selling and generating pressures on the price. In other words, the only inside information which is covered by the safe harbour is information about the investing behaviours/strategies of the (allotted) investors (in particular, of institutional investors) and not inside information about the IPO company, which is always covered by full disclosure: before the IPO, by the Prospectus Regulation (including also the supplements to the prospectus of Article 23) and by Article 17, MAR (which applies to financial instruments to be admitted to trading) and after negotiations start by Article 17, MAR.

3.53  Another kind of inside information relates to the stabilization activity itself. A person cannot legitimately exploit the information related to the occurring stabilization activity by trading on the share. This behaviour is not covered by the safe harbour, which covers only legitimately carried out stabilization activity.79

V.  Conclusion

3.54  This chapter has analysed the stabilization activity in IPOs taking into consideration its economic dimension and a comparison with the US regulatory regime. It has been stressed that in the US, stabilization has traditionally been developed and regulated in order to protect the interests of the syndicating banks and is applied on a rule basis. In (p. 71) Europe, stabilization is regulated in terms of the relationship between overallotment facility, stabilization, and the greenshoe option with the aim of protecting market and investors’ interests and is applied on a standard-based approach. This relationship relies on legal definitions which are not completely clear in their meanings and are possibly applied in the single Member States to adapt to the contractual different solutions they adopt in order to manage the IPO. Furthermore, Recital 12 MAR supports the interpretation of flexibility because certain forms of behaviour not covered by the conditions provided should not in themselves be considered market abuse.

3.55  Given this picture, it is not possible here to assess the overall result of the European regulation of stabilization in terms of efficiency and in terms of regulatory convergence or divergence in relation to the practical application of the rules in the single Member States.(p. 72)

Footnotes:

1  Regulation (EU) 2017/1129 of the European Parliament and of the Council of 14 June 2017 on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market, and repealing Directive 2003/71/CE, 2017, L168/12 (Prospectus Regulation).

2  Regulation (EU) 565/2014 of the European Parliament and of the Council of 16 April 2014 on market abuse (market abuse regulation) and repealing Directive 2003/6/EC of the European Parliament and of the Council and Commission Directive 2003/124/EC, 2003/125, and 2004/72/EC, 2014, OJ L173/1. For a first commentary of the MAR, see Marco Ventoruzzo and Sebastian Mock (eds), Market Abuse Regulation (Oxford: OUP, 2017).

3  Directive 2003/6/EC of the European Parliament and of the Council of 28 January 2003 on insider dealing and market manipulation (market abuse), 2003, L96/16. On the MAD, see Guido A. Ferrarini, ‘The European Market Abuse Directive’, Common Market Law Review (2004) 41, 711.

4  In the previous regulatory regime, the two exemptions were regulated in detail by Commission Regulation (EC) 2273/2003 of 22 December 2003 implementing Directive 2003/6/EC of the European Parliament and of the Council as regards exemptions for buy-back programmes and stabilization of financial instruments, 2003, L336/33. For buy-back programmes, see Mathias M. Siems and Amedeo De Cesari, ‘The Law and Finance of Share Repurchases in Europe’, Journal of Corporate Law Studies (2012) 12, 33; for stabilization activity in IPOs, see Stefano Lombardo, ‘The Stabilisation of the Share Price of IPOs in the United States and the European Union’, European Business Organization Law Review (2007) 8, 521; Dmitri Boreiko and Stefano Lombardo, ‘Stabilisation Activity in Italian IPOs’, European Business Organization Law Review (2011) 12, 437; Stefano Lombardo, Quotazione in borsa e stabilizzazione del prezzo delle azioni (Milano: Giuffrè, 2011).

5  In this chapter, the words ‘stabilization’ and ‘stabilisation’ have the same meaning and are considered the same.

6  Commission Delegated Regulation (EU) 2016/1052 of 8 March 2016 supplementing Regulation (EU) 596/2014 of the European Parliament and of the Council with regard to regulatory technical standards for the conditions applicable to buy-back programmes and stabilization measures, 2016, L173/34. On stabilization (and buy-back programmes) in the new regulatory regime of MAR, see for a first introduction, Sebastian Mock, ‘Exemptions for Buy-Back Programmes and Stabilization’, in: Ventoruzzo and Mock (n. 2), 154–68.

7  See Alexander P. Ljungqvist, Tim Jenkinson, and William J. Wilhelm Jr, ‘Global Integration in Primary Equity Markets: The Role of US Banks and US Investors’, Review of Financial Studies (2003) 16, 63. The literature on the economics of IPOs is extensive, with studies covering both theoretical and empirical topics for many countries. For general introductions, see Jason Draho, The IPO Decision: Why and How Companies Go Public (Cheltenham: Edward Elgar, 2004); Tim Jenkinson and Alexander P. Ljungqvist, Going Public: The Theory and Evidence on How Companies Raise Equity Finance (Oxford: OUP, 2001); Jay R. Ritter and Ivo Welch, ‘A Review of IPO Activity, Pricing and Allocations’, Journal of Finance (2002) 57, 1795; Jay R. Ritter, ‘Differences between European and American IPO Markets’, European Financial Management (2003) 9, 421. With respect to European IPOs, see the contributions in Mario Levis and Silvio Vismara (eds), Handbook of Research on IPOs (Cheltenham: Edward Elgar, 2015).

8  Reinier H. Kraakman, ‘Gatekeepers: The Anatomy of a Third-Party Enforcement Stategy’, Journal of Law, Economics, and Organization (1986) 2, 53; Ronald J. Gilson and Reinier H. Kraakman, ‘The Mechanism of Market Efficiency’, Virginia Law Review (1984) 70, 549, 613.

9  For the US, the relational choice is analysed by Chitru S. Fernando, Vladimir A. Gatchev, and Paul A. Spindt, ‘Two-Sided Matching: How Corporate Issuers and their Underwriters Choose Each Other’, Journal of Applied Corporate Finance (2013) 25, 103.

10  It is also possible to have combinations of the three. See Samuel N. Allen, ‘A Lawyer’s Guide to the Operation of Underwriting Syndicates’, New England Law Review (1991) 26, 320. On the structure of compensation, see for the US, where fees converge to 7 per cent of the value of the offering, Husuan-Chi Chen and Jay R. Ritter, ‘The Seven Percent Solution’, Journal of Finance (2000) 55, 1105; for the lower level of European fees, see Sami Torstila, ‘What Determines IPO Gross Spread in Europe?’, European Financial Management (2001) 7, 523; Mark Abrahamson, Tim Jenkinson, and Howard Jones, ‘Why Don’t US Issuers Demand European Fees for IPOs?’, Journal of Finance (2011) 56, 2055.

11  There can be a discount (of e.g. 5 per cent) for some investors (e.g. customers or employees of the company) on the basis of equal treatment rules, but always based on the single offering price.

12  This fact is typically not studied by economists, who consider it as given and normal. For the US, see Sean J. Griffith, ‘The Puzzling Persistence of the Fixed Price Offering: Implicit Price Discrimination in Ipos’, in University of Connecticut School of Law Working Paper Series, 2005, also at disposal on http://www.ssrn.com. For the European Union, Article 8, Prospectus Directive 2003/71/EC and now Article 17, Prospectus Regulation refer to the final offer price (singular), as do other rules (see e.g. Art. 5.1(b) Regulation 2016/1052 referring to the final price (singular)). The continuous reference of EU legislation to an offering final price (singular) maybe proves the impossibility of setting different prices for different investors, and is a situation that can be evaluated by everyone in the European and national context.

13  Theoretically, following the so-called ‘Law of One Price’, one could argue that the single price is the result provided by the market to anticipate possible arbitrage mechanisms between the two different prices that would in any case reach a single price. On the Law of One Price in financial markets, see Owen A. Lamont and Richard H. Thaler, ‘The Law of One Price in Financial Markets’, Journal of Economic Perspectives (2003) 17, 191.

14  On underpricing, see the excellent introduction by Alexander P. Ljungqvist, ‘IPO Underpricing’, in: B. Espen Ebcko (ed.), Handbook of Corporate Finance: Empirical Corporate Finance, Vol. 1 (Amsterdam: Elsevier, 2007), 375. For underpricing in an alternative market, see Miguel À. Acedo-Ramírez and Francisco J. Ruiz-Cabestre, ‘IPO Characteristics and Underpricing in the Alternative Investment Market’, Applied Economic Letters (2017) 24, 485. The long-run underperformance of IPO shares means that on average their return underperforms the market return for a period of three to five years after the IPO, see Ljungqvist, ‘IPO Underpricing’, 385.

15  For example, the price switches from €10 (the offering IPO price) to €11 with an underpricing of 10 per cent.

16  Statistical data for an international comparison among several countries is provided by Timothy Loughran, Jay R. Ritter, and Kristian Rydqvist, ‘Initial Public Offerings: International Insights’, Pacific-Basin Finance Journal (1994) 2, 165.

17  For example, the price switches from €10 (the offering IPO price) to €9 with an overpricing of 10 per cent.

18  See Liungsqvist (n. 14), 384. Other theories to explain underpricing are (i) institutional theories; (ii) agency costs theories; (iii) behavioural finance theories.

19  So, underpricing depends on which of these actors has more information, Liungsqvist (n. 14), 400 for the company and 396 for the syndicating banks.

20  On this model, see Kevin Rock, ‘Why New Issues are Underpriced’, Journal of Financial Economics (1986) 15, 187.

21  See Lawrence M. Benveniste and Paul A Spindt, ‘How Investment Bankers Determine the Offer Price and Allocation of New Issues’, Journal of Financial Economics (1989) 24, 343.

22  For the book-building system, see Lawrence M. Benveniste and William J. Wilhelm Jr, ‘Initial Public Offering: Going by the Book’, Journal of Applied Corporate Finance (1997) 10, 98.

23  See e.g. Francesca Cornelli and David Goldreich, ‘Bookbuilding and Strategic Allocation’, Journal of Finance (2001) 56, 2337; Francesca Cornelli and David Goldreich, ‘Bookbuilding: How Informative is the Order Book?’, Journal of Finance (2003) 58, 1415.

24  For instance for the US, see Reena Aggarwal, Nagpurnanand R. Prabhala, and M. Puri, ‘Institutional Allocation in Initial Public Offerings: Empirical Evidence’, Journal of Finance (2002) 57, 1421; also for Europe and other countries, see Alexander P. Ljungqvist and William J. Wilhelm Jr, ‘IPO Allocations: Discriminatory or Discretionary?’, Journal of Financial Economics, (2002) 75, 167; more recently, Tim Jenkinson, Howard Jones, and Felix Suntheim, ‘Quid Pro Quo? What Factors Influence IPO Allocations to Investors?’, Journal of Finance (2018) 73, 2303.

25  The third price-setting system is an open system based on (Dutch) auction, which is not so diffused and was used, for instance, in the IPO of Google in 2004, on which see Anita I. Anand, ‘Is the Dutch Auction IPO a Good Idea?’, Stanford Journal of Law, Business & Finance (2006) 12, 233; for a comparison between auction and bookbuilding, see Zhaohui Chen, Alan D. Morrison, and William J. Wilhelm Jr, ‘Another Look at Bookbuilding, Auctions, and the Future of the IPO Process’, Journal of Applied Corporate Finance (2014) 26, 19.

26  Theoretical models analyse the optimal use of the bookbuilding system under different conditions, see e.g. Lawrence M. Benveniste and William J. Wilhelm, ‘A Comparative Analysis of IPO Proceeds under Alternative Regulatory Environments’, Journal of Financial Economics (1990) 32, 173; Ann E. Sherman, ‘IPOs and Long-Term Relationship: An Advantage of Book Building’, Review of Financial Studies (2000) 13, 697; Ann E. Sherman and Sheridan Titman, ‘Building the IPO Order Book: Underpricing and Participation Limits with Costly Information’, Journal of Financial Economics (2002) 65, 3.

27  A useful review is provided by Tim Jenkinson and Howard Jones, ‘The Economics of IPO Stabilization, Syndicates and Naked Shorts’, European Financial Management (2007) 13, 616; see also William J. Wilhelm Jr, ‘Secondary Market Stabilization of IPOs’, Journal of Applied Corporate Finance (1999) 12, 78.

28  After some rules introduced in 1934, the SEC first regulated stabilization in 1940 and then again in 1955. See in general George S. Parlin and Edward Everett, ‘The Stabilization of Securities Prices’, Columbia Law Review (1949) 49, 607; William Ward Foshay, ‘Market Activities of Participants in Securities Distributions’, Virginia Law Review (1959) 45, 907.

29  See SEC, Anti-Manipulation Rules concerning Securities Offerings; Final Rule, Friday, January 3, 1997, in Federal Register, Vol. 62, No. 2, 519–50.

30  For a proposal of Reform of Regulation M, SEC, Amendments to Regulation M: Anti-Manipulation Rules concerning Securities Offerings: Proposed Rule, Friday, 17 December 2004, in Federal Register, Vol. 69, No. 242, 75774–95.

31  Louis Kaplan, ‘Rules versus Standards: An Economic Analysis’, Duke Law Journal (1992) 42, 557. Regulation M is integrated by Item 508(i) (plan of distribution: stabilization and other transactions) of Regulation S-K to disclose ex ante in the registration statement, among others, also information about stabilization activity. Financial Industry Regulation (FINRA) Rule 5190 specifies other requirements.

32  According to Regulation M Rule 100, ‘stabilize’ or ‘stabilizing’ means the placing of any bid, or the effecting of any purchase, for the purpose of pegging, fixing, or maintaining the price of a security.

33  See Reena Aggarwal, ‘Stabilization Activities by Underwriters after Initial Public Offerings’, Journal of Finance (2000) 55, 1075, 1082.

34  According to Regulation M Rule 100, a syndicate covering transaction means the placing of any bid or the effecting of any purchase on behalf of the sole distributor or the underwriting syndicate or group to reduce a short position created in connection with the offering.

35  See e.g. Thomas L. Hazen, The Law of Securities Regulation (St Paul: West Academic Publishing, 2016), 74; James D. Cox, Robert W. Hilman, and Donald C. Langewoort, Securities Regulation. Cases and Materials (New York: Wolters Kluwer, 2013), 155.

36  See Hazen (n. 35), 99.

37  See Hazen (n. 35), 103.

38  While originally the overallotment option was used in order to minimize the reneging costs, the greenshoe option to cover the risks associated with the overallotment option was introduced only in 1963. See Chris J. Muscarella, John W. Peavi III, and Michael R. Vetsuypens, ‘Optimal Exercise of the Over-Allotment Option in IPOs’, Financial Analysts Journal (1992) 48, 76; Craig G. Dunbar, ‘Overallotment Option Restrictions and Contract Choice in Initial Public Offerings’, Journal of Applied Corporate Finance (1997) 3, 251; Robert S. Hansen, R. Beverly, and Vahan Janjigian, ‘The Over-Allotment Option and Equity Financing Flotation Costs: An Empirical Investigation’, Financial Management (1987) 16, 24; J. F. Cotter and R. S. Thomas, ‘Firm Commitment Underwriting Risk and the Over-Allotment Option: Do We Need Further Legal Regulation?’, Securities Regulation Law Journal (1998) 26, 245.

39  The limit to the exercise of the greenshoe option was 10 per cent but since 1983 it has been fixed by the National Association of Securities Dealers (NASD) (FINRA) at 15 per cent of the registered shares; see Rules 5110 (and 5190), http://www.finra.org.

40  For a recent general review of the economics of flipping with an empirical analysis of the Indian IPO market, see Suman Neupane et al., ‘Do Investors Flip Less in Bookbuilding than in Auction IPOs?’, Journal of Applied Corporate Finance (2017) 47, 253.

41  See Lombardo (n. 4), 38.

42  The IPO company could be considered the cheapest cost avoider and for this reason should bear the risks associated with the underwriting system of a firm commitment contract, which with the open price system and the bookbuilding procedure has granted an average reduction of underpricing.

43  For a general introduction to the topics, see Marco Ventoruzzo, ‘The Concept of Insider Dealing’, in: Ventoruzzo and Mock (n. 2), 13–32; Sebastian Mock, ‘The Concept of Market Manipulation’, in: Ventoruzzo and Mock (n. 2), 33–46.

44  See Marco Ventoruzzo and Chiara Picciau, ‘Inside Information’, in: Ventoruzzo and Mock (n. 2), 175–207.

45  See Jesper Lau Hansen, ‘Insider Dealing’, in: Ventoruzzo and Mock (n. 2), 208–53; Chiara Mosca, ‘Unlawful Discourse of Inside Information’, in: Ventoruzzo and Mock (n. 2), 275–96; Jesper Lau Hansen, ‘Prohibition of Insider Dealing and of Unlawful Disclosure of Inside Information’, in: Ventoruzzo and Mock (n. 2), 326–31.

46  See Alan Pietrancosta, ‘Public Disclosure of Inside Information and Market Abuse’, in: Ventoruzzo and Mock (n. 2), 47–62 and 343–84.

47  On the MAD, see Ferrarini (n. 3), 724; for the definition of market manipulation in the MAR, see Arad Reisberg, ‘Market Manipulation’, in: Ventoruzzo and Mock (n. 2), 309–18; for the prohibition of market manipulation in the MAR, see Sebastian Mock, ‘Prohibition of Market Manipulation’, in: Ventoruzzo and Mock (n. 2), 332–36.

48  Article 3(2)(a), MAR defines securities, including shares and other securities equivalent to shares, bonds, and other forms of securitized debt or securitized debt convertible or exchangeable into shares or into other securities equivalent to shares.

49  The stabilization of securities can also be pursued by means of a transaction of associated instruments (Art. 5(4) and 3(2)(d) MAR), where associate instruments are defined by Article 3(2)(b), MAR, which includes some financial instruments (admitted or traded on a trading venue or not) as (i) contracts or rights to subscribe for, acquire, or dispose of securities; (ii) financial derivatives of securities; (iii) where securities are convertible or exchangeable debt instruments, the securities into which such convertible or exchangeable debt instruments may be converted or exchanged; (iv) instruments which are issued or guaranteed by the issuer guarantor of the securities and whose market price is likely to materially influence the price of the securities, or vice versa; (v) where the securities are securities equivalent to shares, the shares represented by those securities, and any other securities equivalent to those shares.

50  Article 2(d), Prospectus Regulation provides the notion of ‘offer of securities to the public’ as a communication to persons in any form and by any means, presenting sufficient information on the terms of the offer and the securities to be offered, so as to enable an investor to decide to purchase or subscribe for those securities with the specification that the definition includes also the placing of securities through financial intermediaries.

51  While Regulation 2273/2003 included in the notion of significant distribution an initial or secondary offer publicly announced, the requisite of public announcement has been eliminated in Regulation 2016/1052, apparently with the result that it can be also a private placement.

52  The initial price discovery of IPOs, i.e. the time after negotiations start on the market, is analysed by Reena Aggarwal and Pat Conroy, ‘Price Discovery in Initial Public Offerings and the Role of the Lead Underwriter’, Journal of Finance (2000) 52, 2903.

53  The notion of overallotment facility presents some variations in the Italian, German, French, and Spanish linguistic versions of Regulation 2016/1052. Italian: facoltà di sovrallocazione; German: Überzeichnung; French: faculté de surallocation; Spanish: instrumento de sobreasignación.

54  The linguistic versions of Regulation 2016/1052 present the following patterns: Italian: contratto di sottoscrizione o contratto di collocamento; German: Emissions-bzw Garantievertrag; French: convention de prise ferme ou de l’accord de gestion du placement; Spanish: acuerdo de suscripción o en el acuerdo de gestión principal.

55  Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending 2002/92/EC and Directive 2011/61/EU (2014) OJ L173/349.

56  The versions of section A in the four languages are: English: (6) Underwriting of financial instruments and/or placing of financial instruments on a firm commitment basis; (7) Placing of financial instruments without a firm commitment basis; Italian: 6) Assunzione a fermo di strumenti finanziari e/o collocamento di strumenti finanziari sulla base di un impegno irrevocabile. 7) Collocamento di strumenti finanziari senza impegno irrevocabile; German: (6) Übernahme der Emission von Finanzinstrumenten und/oder Platzierung von Finanzinstrumenten mit fester Übernahmeverpflichtung; (7) Platzierung von Finanzinstrumenten ohne feste Übernahmeverpflichtung; French: (6) Prise ferme d’instruments financiers et/ou placement d’instruments financiers avec engagement ferme; (7) Platzierung von Finanzinstrumenten ohne feste Übernahmeverpflichtung; Spanish: 6) Aseguramiento de instrumentos financieros o colocación de instrumentos financieros sobre la base de un compromiso firme. 7) Colocación de instrumentos financieros sin base en un compromiso firme.

57  The proper set of incentives at stake can also be analysed with respect to the type of underwriting agreement between the offeror and the syndicating banks: stabilization is more important for the syndicating banks in case of an agreement where the risk is supported by them, i.e. by the firm commitment agreement.

58  Italian: accettare sottoscrizioni o offerte di acquisto; German: Zeichnungs-oder Kaufangebote; French: les souscriptions ou les offres d’achat; Spanish: aceptación de suscripciones u ofertas para comprar.

59  This interpretation relies on the fact that the term ‘subscription’ refers both to the subscription of new shares coming from a company capital increase during the IPO and to the subscription of old shares coming from selling shareholders, which is technically not a subscription but a purchase. Otherwise, an alternative but less plausible interpretation, would be that the term ‘acceptance of subscriptions’ refers to a capital increase of the IPO company and the creation of new shares that have to be subscribed by the investors, while the term ‘offers to purchase’ refers to the selling of old shares coming from previous holders, which seems to replicate Article 17(1)(a), Prospectus Regulation that refers to (i) the acceptances of the purchase and to the acceptance of subscription so taking into consideration the case of the selling shareholders and the capital increase.

60  See for instance for Germany, Stefano Lombardo, ‘Invitatio ad Offerendum und Overallotment und Greenshoe Option in Deutschland’, in: Thomas Eger et al. (eds), Internationalisierung des Rechts und seine ökonomische Analyse (Internationalization of the Law and its Economic Analysis). Festshrift für H.-B. Schäfer zum 65. Geurtstag) (Wiesbaden: Gabler, 2008), 537–45 and for Italy, Paolo Giudici and Stefano Lombardo, ‘La tutela degli investitori nelle IPO con prezzo di vendita aperto’, Rivista delle società (2012) 57, 907.

61  Article 17(1)(a), Prospectus Regulation refers to (i) the acceptances of the purchase and to the acceptance of subscription, so taking into consideration the case of the selling shareholders and the capital increase.

62  See Boreiko and Lombardo (n. 4).

63  In the case of debt securities and other cases, Article 5(3), Regulation 2016/1052 provides for more complex rules. In an SEO, being already negotiated on a trading venue as in the case of the grey market, the stabilization period starts on the date of adequate public disclosure of the final price and ends thirty days after the date of allotment.

64  See e.g. Francesca Cornelli, David Goldreich, and Alexander Ljungqvist, ‘Investor Sentiment and Pre-IPO Markets’, Journal of Finance, 2006, 61, 1187.

66  Rule 105 of Regulation M eliminates the possibility of creating a grey market before negotiations officially start.

67  Commission Delegated Regulation (EU) 2017/565 of 25 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive (2017) OJ L87/1.

68  That offerings of securities, and particularly IPOs can be extremely delicate has been previously stressed by the SEC in 2005; see SEC, Commission Guidance regarding Prohibited Conduct in Connection with IPO Allocations; Final Rule, Wednesday, 13 April 2005, in Federal Register, Vol. 70, No. 70, 19672–7.

69  On conflict of interests in the MiFID context, see the very general introduction by Stefan Grundmann and Philipp Hacker, ‘Conflict of Interests’, in: Danny Busch and Guido Ferrarini (eds), Regulation of the EU Financial Markets. MiFID II and MiFIR (Oxford: OUP, 2017), 165.

70  Recital 57:

Given the specificities of underwriting and placing services and the potential for conflicts of interest to arise in relation to such services, more detailed and tailored requirements should be specified in this Regulation. In particular, such requirements should ensure that the underwriting and placing process is managed in a way which respects the interests of different actors. Investment firms should ensure that their own interests or interests of their other clients do not improperly influence the quality of services provided to the issuer client. Such arrangements should be explained to that client, along with other relevant information about the offering process, before the firm accepts to undertake the offering.

71  Recital 58: ‘Investment firms engaged in underwriting or placing activities should have appropriate arrangements in place to ensure that the pricing process, including bookbuilding, is not detrimental to the issuer’s interests.’

72  Recital 59:

The placing process involves the exercise of judgement by an investment firm as to the allocation of an issue, and is based on the particular facts and circumstances of the arrangements, which raises conflicts of interest concerns. The firm should have in place effective organisational requirements to ensure that allocations made as part of the placing process do not result in the firm’s interest being placed ahead of the interests of the issuer client, or the interests of one investment client over those of another investment client. In particular, firms should clearly set out the process for developing allocation recommendations in an allocation policy.

73  Article 39.2:

Investment firms shall provide clients with information about how the recommendation as to the price of the offering and the timings involved is determined. In particular, the firm shall inform and engage with the issuer client about any hedging or stabilisation strategies it intends to undertake with respect to the offering, including how these strategies may impact the issuer clients’ interests. During the offering process, firms shall also take all reasonable steps to keep the issuer client informed about developments with respect to the pricing of the issue.

74  Article 7(2), Regulation 2016/1052 defines the price limitations in case of debt instruments.

75  Adequate public disclosure is defined in Article 1(b), Regulation 2016/1052 in terms of making information public in a manner which enables fast access and complete, correct, and timely assessment of the information by the public, in accordance with the mentioned provisions. Furthermore, Recital 8 specifies that market integrity requires the adequate public disclosure of stabilization measures.

76  See Commission Delegated Regulation (EU) 2019/980 of 14 March 2019 supplementing Regulation (EU) 2017/1129 of the European Parliament and of the Council as regards the format, content, scrutiny, and approval of the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market, and repealing Commission Regulation (EC) No. 809/2004, 2019, L166/26 has provided the ex ante disclosure of the possible stabilization activity, for instance in point 6.5 of Annex XI.

77  See Lombardo (n. 4), 179.

78  The allotment is defined by Article 1(d), Regulation 2016/1052 in terms of process or processes by which the number of securities to be received by investors who have subscribed or applied for them is determined. Notwithstanding the fact that from a contractual perspective this definition is not completely clear with respect to the terms subscribed and applied, it is important to stress that the allotment itself is covered by the prohibition of market manipulation and insider trading. This is particularly significant with the bookbuilding procedure and the possible behaviour of the syndicating banks to inflate the offering price (i.e. to manipulate it) in the knowledge of inflating it, possibly shifting the expensive shares to ignorant retail investors and to intentionally overpricing the IPO. On these problems, see Giudici and Lombardo (n. 60). In other words, the bookbuilding/allotment procedure in Europe is covered by the MAR in the interests of the integrity of the capital market.

79  On the point see also Mock (n. 6), 156.