Penalty Bid

What Is a Penalty Bid?

A penalty bid is an offer to partake in a initial public offering (IPO), in which the buyer is disincentivized from selling their shares not long after the purchase.

In particular, penalty bids determine that if the investor "flips" the shares inside a predefined period of time, the broker who handled their purchase order will be punished. The broker then has the option to give that penalty to their client.

Understanding Penalty Bids

At the point when the demand for an IPO exceeds its supply, the price of the recently issued shares frequently rises soon after the shares start trading. Given this fact, it tends to be enticing for investors to look for allocations from their brokers to participate in impending IPOs, not on the grounds that they are excited about the long-term possibilities of the stock, however just on the grounds that they wish to sell the shares soon after the IPO to secure a quick gain.

Regulation of Penalty Bids

The treatment of penalty bids by underwriters and brokers is illustrated by the Securities and Exchange Commission (SEC) in Regulation M. One illustration of these rules is Rule 104, which specifies that parties engaged with setting penalty bids for new IPOs must unveil those bids with the self-regulatory organization (SRO) responsible for managing the IPO.

On the off chance that an adequate number of early investors were to act thusly, it could force the lead underwriter of the IPO to buy back the as of late designated shares during the initial stabilization period of the IPO to keep the share price from declining too seriously from the increased selling pressure from early investors. To relieve this risk, the underwriters impose punishments on investors who sell their shares inside a predetermined period of time following the IPO.

Technically, these punishments are exacted against the investors' brokers, who then, at that point, have the option of giving the cost to the investor. In practice, in any case, it is more normal for the broker to pay the actual penalty. In particular, brokers regularly pay this penalty by returning some or all of the commission income they earned from the IPO back to the underwriting syndicate. In any event, a broker whose client demands selling their IPO shares inside the prohibited time period wouldn't be satisfied with that client, and they might reject that client from future allocations to IPOs that are in high demand.

Real World Example of a Penalty Bid

Sandra is an investor who appreciates participating in highly anticipated IPOs. She has found that the shares of these companies frequently increase in value in practically no time following the IPO, and she is anxious to profit from this fact by investing in the impending IPO of XYZ Enterprises.

While communicating this interest to her broker, Sandra was educated that in the event that she is given an allocation to the IPO of XYZ Enterprises, her investment would be viewed as a penalty bid. The broker cleared up for her that, along these lines, she ought to shun selling the shares inside a predetermined period of time. Assuming she neglects to do as such, the broker would be punished and the cost of this penalty might be given to her.

That's what sandra understood, despite the fact that she may not be forced to pay the direct financial cost of the penalty, there is a decent chance that she would be excluded by her broker from future IPOs on the off chance that she sells her shares rashly.

Highlights

• They are intended to safeguard IPO investors from the selling pressure that could emerge from early investors selling their shares not long after the IPO transaction.
• As their name recommends, penalty bids are offers to participate in an IPO which carry punishments for selling the purchased shares too quickly.
• In spite of the fact that penalty bids are imposed on brokers, they are frequently given to their customers either directly or by excluding those clients from future IPOs.