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How IPOs give the ‘illusion of diversity’ with underwriters

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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.

This content was originally published here.

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