“In the latest effort to clean up Wall Street practices that hurt investors, a major U.S. securities regulator is proposing a sweeping new set of rules to crack down on investment banks that improperly dole out valuable share offerings to favored customers,” writes Randall Smith in today’s The Wall Street Journal.

“The proposals unveiled Sunday by the National Association of Securities Dealers would attempt to bar brokers from allocating shares in hot initial public offerings in exchange for kickbacks from investors or future business from corporate clients. The abuses, which were most prevalent before the Internet bubble burst in 2000, are usually tilted in favor of the large clients of Wall Street firms. They hurt small investors by making IPO shares more difficult to obtain and manipulating the market to drive up those share prices.”

“Many of the abuses covered by the proposals are already banned by existing NASD regulations, and several securities firms have either been sanctioned or are being investigated for such practices. But NASD officials said the new rules are more specific and would require firms to adopt procedures to ensure compliance. The proposals also would require investment banks for the first time to disclose to regulators a limited amount of now-secret data on whether their corporate clients received shares in other IPOs.”

“Taken together, the proposals are the most serious regulatory effort in decades to rein in an area that has allowed Wall Street firms — especially during the Internet-driven bull market of 1999-2000 when IPOs routinely double or tripled in price on their first day of trading — to hand out the equivalent of free money and get something of value in return. Most of the abuses involve Wall Street’s efforts to extract some form of improper quid pro quos for the IPO profits.”

“‘These proposed rules will clearly identify unacceptable conduct associated with IPO allocation and distribution,’ said Robert R. Glauber, chairman and chief executive of NASD, whose board approved them after reviewing current industry practices.”

“Abuses in IPOs and other practices on Wall Street and in corporate boardrooms have come to be seen as a hallmark of the stock-market bubble of the late 1990s. Now, in the teeth of a severe bear-market downturn and a wave of corporate scandals, curtailing such practices has become part of a broadening agenda for corporate overhaul. This includes efforts by Congress and the Securities and Exchange Commission to address such issues as accounting reform and conflicts of interest by Wall Street analysts. Mr. Glauber acknowledged that the NASD’s new rules are part of an effort ‘to reassure investors and rebuild investor confidence.’”

“The new rules’ impact will depend on their final wording and enforcement, and how Wall Street alters its practices to ensure compliance. After public comment, they must be approved by the SEC, which oversees the NASD, the self-regulatory organization that supervises broker-dealers.”

“Mr. Glauber said the new rules emerged following several regulatory probes of improper IPO practices over the past few years, some of which are continuing. NASD officials said Sunday they have a half dozen IPO probes under way.”

“In the most prominent action, the Credit Suisse First Boston unit of Credit Suisse Group agreed in January to pay $100 million in penalties to the NASD and the SEC for improperly sharing IPO profits with about 100 hedge funds that paid the firm outsize commissions in exchange for shares in hot IPOs. That now-completed IPO probe contributed to the ouster in July 2001 of Allen Wheat, then chief executive of CSFB.”

“In one example of how that practice worked, Ascent Capital, an investment fund in Denver, received from CSFB 17,950 shares of VA Linux Systems Inc., whose IPO set the record for first-day price gains by rising 698% in December 1999. Ascent, which saw paper profit of $3.8 million from the transaction, sent CSFB trades on big blocks of several other stocks on the same day at astronomical commissions of as much as $2.70 a share that added up to $500,000, according to people close to the case.”

“The NASD said Sunday a proposed ban on quid pro quos “would prohibit the allocation of IPO shares in exchange for excessive compensation relative to the service provided by the underwriter.” This would bar not only IPO allocations in return for inflated commissions but also in return for the customer “paying up” for any other service.”