IPOs

How IPOs give the 'illusion of diversity' with underwriters, while paying minority-owned firms less

Key Points
  • It's common for initial public offerings to include minority-, women- and veteran-owned business enterprises as underwriters.
  • But a CNBC analysis found those "MWVBE" firms' fees are about 12 cents on the dollar — when compared with other smaller firms with "passive" roles.  
  • On average, between 2016 and the first half of 2020, MWVBE's received 0.69 percent of the fee pool, the CNBC analysis found, using S&P Global Market Intelligence data.
A view of the New York Stock Exchange (NYSE) is seen at Wall Street on June 29, 2020 in New York City.
Angela Weiss | AFP | Getty Images

Warner Music Group Corp., the label for artists like Ed Sheeran and Cardi B, went public last month with 28 underwriters. More than a third of those firms were so-called MWVBEs, a special designation that stands for minority/women/veteran-owned business enterprises.

The $2 billion initial public offering paid out $79 million in fees, more than half of which went to the bulge-bracket banks that served as the lead underwriters for the deal. Middle-market firms took home between $694,309 and $1.4 million (with the exception of Raine Securities, which made $173,578). The lowest fee bracket for the Warner Music IPO — and almost every deal — was reserved for the 10 MWVBEs, which each generated $104,147 apiece.

 It's common for initial public offerings — especially those that are conducted by consumer-facing companies — to include MWVBEs in an effort to diversify the underwriting syndicate. Despite an increasing number of minority-owned firms on the cover of prospectuses, their fees on average over the last five years are meager — about 12 cents on the dollar — when compared with other smaller firms that tend to have similar "passive" roles, a CNBC analysis found. 

"For the consumer-facing companies, it gives the illusion of diversity and inclusion but without meaningful inclusion in the fee pool," said Jim Reynolds, chairman and chief executive officer of Loop Capital, a minority-owned firm that underwrites equity offerings. 

On average, between 2016 and the first half of 2020, MWVBEs each took home about $167,620 per IPO and secondary offering they underwrote, according to data from S&P Global Market Intelligence collated by CNBC. Middle-market firms over that same period earned an average $1.4 million per deal — more than eight times that of MWVBEs, the data showed. 

The way an equity underwriter earns fees is by buying a certain number of shares from the offering and selling them to investors, while capturing a spread. The more shares an underwriter is given, the more fees they generate. 

There are several roles an underwriter can have. In the simplest form, though, they are divided between active and passive. Larger banks tend to be hired as active book runners because they have more expansive investor relationships and can sell more shares. The bulge-bracket firms also provide advice to the issuer and can contribute value after the offering with more manpower in trading, lending and research. 

Passive bookrunners have less interaction with the issuer for the day-to-day process. Their primary role is to receive shares and sell them to investor clients. MWVBEs and boutique banks are typically hired as passive bookrunners. 

To be sure, MWVBEs do tend to be smaller than some of the boutique, middle-market firms that serve alongside them as passive bookrunners. But even though their roles are often similar, MWVBEs are almost always allocated the fewest shares and take home less fees as a result. 

Over the last few years, however, amid greater calls for equality among women and minorities, issuers have been adding more MWVBEs to their banking lineup. So far in 2020, diverse brokerages were a part of 41% of the U.S.-listed IPOs, according to data from Refinitiv. That's double the proportion from 2019, the Refinitiv data showed, and the trend has been increasing over the last three years. 

Less than 1% of the fee pool

But greater visibility has not translated into more fees for each of the MWVBEs. In fact, the CNBC analysis revealed that the portion of fees that is allocated to each minority, women and veteran-owned firms has remained little changed over the last two decades. 

Only in rare instances do MWVBEs receive anything more than 1% of the fee pool. On average, between 2016 and the first half of 2020, it was 0.69 percent, according to the CNBC analysis, using S&P Global Market Intelligence data. Middle market firms, in contrast, each received about 22 percent on average. 

Issuers often see this practice of adding MWVBEs to the syndicate as a "feel-good, check-the-box" idea, Citigroup Vice Chairman Raymond McGuire said last month in remarks at the Economic Club of New York. "But is it anything material? No," McGuire said. 

McGuire, in his talk, highlighted the special-purpose acquisition company, or SPAC, that billionaire hedge fund manager Bill Ackman is currently marketing — which could be the largest of its kind, raising $6.5 billion. 

Bill Ackman, founder and CEO of Pershing Square Capital Management.
Adam Jeffery | CNBC

McGuire said the SPAC was "extraordinary" because Ackman had the "courage and conviction to include minority firms as co-managers, with 365 basis points of fees — 20% fees to that group." (365 basis points equals 3.65 percent, per firm). Citigroup is the lead underwriter for the SPAC, Pershing Square Tontine Holdings.

The SPAC is the first, high-profile test for MWVBEs, giving them a more prominent role. CastleOak Securities, Loop Capital Markets, Ramirez & Co. and Siebert Williams Shank, each minority-owned, will serve as "co-lead managers" right under Citigroup, Jefferies and UBS. Academy Securities and Roberts and Ryan, which are veteran owned, as well as women-owned C.L. King & Associates are co-managers. 

Pershing Square Tontine's SPAC is expected to start trading this week, a person with knowledge of the timeline said. If it goes smoothly, it could bolster the case for MWVBEs to seek out more prominent roles in future deals. 

 "We are big proponents of including value-added MWBE firms in all aspects of financial services," said Dana Telsey, chief executive officer of Telsey Advisory Group, a women-owned firm that underwrites equity offerings. "We hope there is continued momentum and that the senior management teams of the largest banks push their organizations to include diversity in all types of their transactions."