Underwriters and the Broken Chinese Wall: Institutional Holdings and Post-IPO Securities Litigation

We examine whether underwriters have an information advantage over other institutional investors in new public companies. We focus our attention on a sample of publicly traded firms that have become the target of an IPO-related securities class action lawsuit filed under Section 11 of the 1933 Securities Act between January 1991 and December 2006 and a matched sample of similar non-sued firms. We compare aggregate institutional holdings changes in sued and non-sued firms as well as holding revisions by different types of institutions that are classified based on their involvement in the IPO process. Our empirical evidence suggests that lead underwriters retain an information advantage in the firms they take public and that they capitalize on this information by closing out or reducing their holdings in sued firms prior to the eventual litigation date. At the same time, an examination of analyst opinions suggests that analysts affiliated with lead underwriters are somewhat reluctant to reduce their earnings forecasts or downgrade sued firms prior to the litigation date.