Courtesy of Pam Martens.
Yesterday, at 1:29 p.m., the following headline appeared at the on-line Wall Street Journal: “Morgan Stanley Distributes Facebook IPO Profits.” The headline was curious, because at 11 a.m. Facebook was trading at 19 bucks a share, exactly half its initial public offering (IPO) price in May. (The stock closed at $19.05, a nickel beyond half its IPO price of $38.)
The article was written by Lynn Cowan, an outstanding veteran Wall Street reporter. Cowan writes the “IPO Outlook” column for the Wall Street Journal, graduated magna cum laude from Montclair State University and received a Master’s degree in journalism from Columbia University. If Cowan says Morgan Stanley had profits to distribute, she must be on to something.
As it turns out, the profits, according to Cowan, were a whopping $100 million or thereabouts and were not fees or commissions from the IPO underwriting but trading profits from what effectively amounts to Morgan Stanley covering its short position in Facebook as the stock plumbed new lows over its three month downward spiral.
As Cowan explains: “In IPOs, underwriters are allowed to sell about 15% more shares than the total deal size to investors the night before a stock begins trading. This creates a short position of shares sold that the banks don’t actually own, and it can stay on the bankers’ books for 30 days. The short position is created to allow underwriters to stabilize the stock in its early days of trading.”
Here’s the heads they win, tails you lose part of the benign sounding stabilization process for IPOs as reported by Cowan: “If investors are selling the stock after the IPO launches, pushing the price lower, bankers can step in and buy shares at the IPO price in an attempt to keep it from falling below its issue price. This also serves to cover their short positions. If a short position remains on their books and the stock keeps falling—which was the case with Facebook on subsequent trading days—the underwriters can continue to cover their short positions by buying back shares at prices below the IPO price, netting a profit.”
But what if an IPO goes in the other direction, up instead of down? “There is no risk to the banks in this effort. If the stock only trades up, the short position is covered when banks exercise what is known as an overallotment option, buying more shares from the newly public company at the IPO price.” The words “minting money” come readily to mind.
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