Was IPO Frenzy Rigged?

Remember those high-flying stocks sold for the first time in the 1990s, the ones that soared from $20 a share to $100 a share in hours?

Some insiders now say the great price leaps for these "initial public offerings" - IPOs - were the result of insider agreements designed to force prices artificially high. The scam is called "laddering."

Rumors of laddering have been widespread, Scott Pelley reports, but investigations have been hamstrung by a lack of witnesses.

Nicholas Maier was in the thick of the IPO frenzy. In the 1990s, he worked for an investment firm called Cramer and Co. His job was to buy those hot new stocks for the firm. He says he routinely participated in laddering, which had the effect of helping brokerage houses or investment banks artificially inflate stock prices.

"I know for a fact that it became such a commonplace activity that I did the same thing with most of the major investment banks, " he says.

In those same years, Blythe Berents' job was to sell IPO shares for the brokerage firm of Hambrecht & Quist in Boston. A 10-year professional on Wall Street, she said she saw prices artificially inflated in insider deals between the firm and some of its clients. She said the firm was involved in launching up to seven new stocks a week and pushing up prices artificially was standard.

"Yeah, it was a game," she says. "And the retail investor really got left in the dark."

Hundreds of lawsuits allege the prices were inflated by "laddering," designed to make a new company, even a weak one, look like a sure bet.

It works like this: A brokerage bringing a new company to market for the first time privately calls its best clients and offers a big allocation of this stock at its lowest price - say, $10 a share - if the client agrees in advance to buy more shares at higher and higher prices - for example, an order at $20 a share, another order at $40 and finally an order at $100.

Buying these shares after the stock starts trading is called "buying in the aftermarket."

"They make a winner out of a loser and then, inevitably, the small guy at home watching on the PC wants to participate and comes into the market," says Maier.

Of course, there was plenty of investor greed fueling the overall rise in prices. But Berents says artificially inflating the price at the beginning helped a stock reach the stratosphere.

"It creates a certain buzz," she says. "The CEO might end up on CNBC the morning of trading. And they'll say, 'You've got a really hot stock. And look where it's trading now.' And that would get the retail buyers interested. And say, 'Well, gee, maybe I should put my money in this.' Not knowing what's really going on behind the scenes is that maybe that stock has been driven up by this sort of artificial buying that a lot of people committed to simply to get a good allocation."

After two years at Cramer and Company, Maier was in charge of buying hot new IPO shares. He says low price shares were handed out by major brokerages as a bribe or kickback to get buyers like him to play along with the laddering scheme.

"I never would have bought that stock at $80, at $100 without that direct kickback to me," he says.

What about the average investor, at home trading on his PC in his kitchen?

"There was something in the gut of my stomach that just told me that something was wrong here," Maier says, "that somebody was getting hurt."

Those who say they got hurt by the practice include Mike Szymanowski, a plumber from Erie, Pa.; Allen Taylor, an optometrist in Syracuse, N.Y.; and Tom Kenney, a programmer from New Jersey. They're suing major brokers, saying laddering defrauded them out of their savings.

Taylor estimates he lost hundreds of thousands of dollars and now has to work six and seven days a week to recoup his savings. He invested in China.com months after it came to market. Its IPO price was $20. On opening day, it jumped to $45, then to $67. Now, after a stock split of four for one, it's about $2.

Szymanowski was attracted to a company called Turnstone Systems. He bought into it months after it opened because it looked like there was huge demand. Its lowest price was $29; on its first day, it leaped to $106 and then ended at $97. Now, after a two for one split, it's about $3.

"I guess what I'm looking for from the professionals is the truth, you know," says Szymanowski. "And I don't think those people told the truth."

"You know that there are people watching this interview saying to themselves, 'Hey, nobody ever said the stock market was a risk-free game. You gambled. You tried to get rich. You lost. That's the way it works.'" Pelley said to Tom Kenney.

"Correct, OK. In an honest market, okay. Not where people are lying, cheating, and giving misinformation. I can accept loss. But not when it's fixed," Kenney said.

More than 300 class action lawsuits have alleged laddering by major brokerages. The suits are so large, worth perhaps billions of dollars, that some worry they could cripple Wall Street.

Mel Weiss, a lawyer handling some of the suits, says his clients are suing about 40 different investment-banking firms from all over the country.

One of those investment banks was Hambrecht & Quist, which is now part of J.P. Morgan/Chase. H & Q brought roughly 140 new companies to market between 1995 and 2000, and earned roughly $750 million dollars in fees. Some of those new companies were shaky, Berents says, and her firm knew it.

"We would tell our clients that," she recalls. "We'd say, 'Look this is too early, we know it, but we need your help.'"

"If a company came to you and said, 'Look, I'll participate in the aftermarket. I'll participate for $20 a share,' but you wanted $30 what would you tell them?" Pelley asked Berents.

"It's not going to work at $20. All the buyers, the big buyers are in at 30. So if you want stock, you've gotta come up to $30," Berents responded.

"So they're not gonna get their allocation on the ground floor…if they don't come up to the price that you want?" Pelley asked.

"They might get a, they might get maybe a thousand shares," Berents told him. "They might get a very small allocation, if anything. But if they're not gonna be a significant factor in the aftermarket trading, they're not gonna get significant allocation."

"And they understood that?" Pelley asked.

"We made it clear to them, yes," Berents said.

Until last year, Arthur Levitt was chairman of the Securities and Exchange Commission. 60 Minutes II told Levitt what Berents had said.

"I think that agreement is tantamount to commercial fraud. It's manipulative. It distorts the market for that stock. It misleads investors," Levitt responded.

Levitt says that under the law, brokers, or investment bankers, have a clear line that they cannot cross.

"It's legitimate for an investment banker to ask whether a buyer will be supportive of the stock over a period of time," he says. "That's a fair and reasonable expectation to avoid having buyers who buy in only to sell out the next day. It's when you get specific and say, 'Will you buy at this price and continue to buy at that price' that you have a manipulative practice that violates the securities laws."

Laddering and its effect on the market is under investigation by the SEC and New York Attorney General Elliot Spitzer.

"We hear all these terms, laddering, spinning, kickbacks. How have you found they're all related?" Spitzer said.

"Well, they're all part of one effort to play games with the marketplace," Spitzer said.

"Is the effect of all this focused just on these tech stocks, the telecoms, the dot-coms, or did it have an effect on the broader market?" Pelley asked.

"It affected the broader market. I think the most egregious examples are in the tech sector because that's where there was the greatest volatility," Spitzer said.

"But was that in some sense fuel for the rest of the market?" Pelley asked.

"Absolutely," Spitzer said. "It then carried – just the way helium was being pumped into a balloon - the tech sector carried the entire market with it, pumped it up to a level that - where it should not have been. And then, as these as cracks began to emerge, the whole thing collapsed."

It collapsed on families all across the nation, like Ed Wolfe, whose family lives in the Amish country of Ohio. Retiring after 32 years at the nearby Rubbermaid plant, he says he gave more than $300,000 – all he had saved - to a Merrill Lynch broker to invest. He says he gave the broker clear instructions: very little risk. But the broker put most of the money into hyper-inflated tech stocks, many of the kind that were allegedly being laddered.

He says he lost two-thirds of the money in a year and a half.

Merrill says that Wolfe's money went into the tech funds because Wolfe wanted the income.

Back at work as a truck driver, Wolfe has filed a complaint against Merrill saying that his broker put his savings in risky fund without his knowledge.

"I will not feel bad if he would walk in the shoes that he created with me, and walk in that mess of feeling lifeless and lonely and stripped of everything you worked for all your life," Wolfe says of his broker.

"Is there going to be a time when we see brokers, brokerage managers and analysts led out of buildings in handcuffs?" Pelley asked Spitzer.

"I imagine so. I think that there will be criminal actions and I don't say that with any great joy. But I think it is probably going to be part of the process of restoring the public's confidence in the marketplace," Spitzer said.

Maier, who quit Cramer and Co. to become a writer, has already told what he knows to the SEC. The Cramer firm declined an interview, but in a letter to 60 Minutes II wrote that their "purchases of IPO shares were based on sound investment analysis and were at all times lawful and appropriate."

Berents was laid off and is now working with refugees in West Africa, putting Wall Street's ways far behind her.

J.P. Morgan/Chase, which now owns H & Q, declined an interview, but wrote: "We believe the allegations made by your program are totally false and that your sources have clear biases."