What is Spinning?

The term spinning refers to the act of offering preferred customers shares in an initial public offering (IPO) by a brokerage firm or underwriter in order to keep or obtain their business. Spinning theoretically benefits the underwriter or brokerage firm, as well as the preferred customer to whom the shares are offered. The practice of spinning, also called IPO spinning, is both illegal and unethical. The act of spinning has nothing to do with spinning off—when a company breaks off one of its segments or divisions into a separate entity.

Key Takeaways

  • Spinning is the act of offering preferred customers shares in an initial public offering by a brokerage firm or underwriter in order to keep or obtain their business.
  • Investment brokerage houses can secure a quid pro quo type of arrangement by spinning.
  • Spinning gives firms and underwriters a chance to profit and keep business favorable, while clients can make gains by investing in hot IPO stocks.
  • Spinning is both illegal and unethical, and can result in heavy fines for individuals and/or companies.

Understanding Spinning

Spinning is a lucrative means of enticing the business of large companies. By swaying the decision of the top executives, investment brokerage houses can secure a quid pro quo type of arrangement. Firms or underwriters offer clients underpriced shares of an IPO—normally those that are of a popular issue—in order to get new business. This way, the firm offering the shares cultivates loyalty and/or a broader client base. Meanwhile, the preferred customer enjoys benefits like equity gains that come with investing in a dynamic new public company.

Since IPO gains often mostly happen in the first day of trading, demand is very strong for hot IPO shares that can be easily flipped on the first day of trading for a sizable profit for the underwriting broker. IPOs create instant profits for underwriters to distribute, particularly during the dotcom boom of the late 1990s. Some underwriters took the opportunity to allocate shares to their friends in the business in the hopes of garnering future investment banking business from them.

The practice is now now been ruled illegal as it has been judged to be theft by favoritism, and is also considered to be bribery. The social harm that now is outlawed entails the wrongful delivery of the monetary value of the discounts to preferred investors selected by securities firms. The startup company selling the IPO could have obtained a higher price by selling directly to ordinary investors if the securities firm had not sold them to selected investors at a discount. Individuals or companies that are found in violation may be heavily fined.

Spinning is both illegal and unethical.

Special Considerations

According to a 2009 study by professors Xiaoding Liu and Jay R. Ritter of the University of Florida, spinning actually accomplishes its goals. Liu and Ritter found that spun IPOs had first-day returns 23% greater than similar IPOs. The average first-day profit received from hot IPO allocations by the executives was found to be $1.3 million. The ratio of these numbers indicates that only 8% of the incremental amount of money left on the table flows back to the executives being spun.

In addition, the companies that were offered IPOs switched underwriters only 6% of the time, compared to 31% of the time for companies that were not offered IPOs. However, the study's authors also noted that "since 2001 the spinning of corporate executives has largely ceased in the U.S. This is due to both a regulatory crackdown and a dearth of hot IPOs to allocate."

Example of Spinning

Goldman Sachs and Meg Whitman, former CEO of eBay were embroiled in a conflict of interest scandal that was considered to be spinning dating back to the early 2000s. While she was CEO, Whitman was appointed as a Goldman Sachs board member in 2001. Her appointment supposedly gave her access to information about IPOs of hot stocks, and she was named in a congressional investigation into spinning. During the probe, it was alleged that Goldman Sachs and other companies used tactics to trade IPOs of hot stocks for other investment business. Whitman resigned from the board, and ended up settling a lawsuit that pertained to money she made from IPO purchases.