SDR Investors alleges that the parties engaged in market manipulation and gave false and misleading information regarding the company's initial public offering, according to a PlanetRx filing with the Securities and Exchange Commission on Tuesday.
In February, PlanetRx said it would get out of the mainstream online pharmacy business, and instead focus on prescriptions for cancer, HIV and transplant patients. The Memphis, Tenn.-based company officially stopped selling goods through its Web site on March 12.
The suit alleges that information provided to prospective investors did not disclose facts regarding after-market purchases and undisclosed commissions.
SDR alleges that the underwriters, in allocating PlanetRx IPO shares, required their clients to purchase additional shares in the open market at pre-determined prices above the IPO price. Those shares were to be purchased sometime after the stock began trading, otherwise known as after-market.
"We have market manipulation going on," said Saul Roffe, a New York lawyer representing SDR Investors. "It wasn't an investment decision these clients were making but a forced decision. By buying the stock in the after-market like this, they were forcing an uptick in the price.
PlanetRx, which had its IPO priced at $16 a share in October 1999, closed at $26 on its first trading day. But the stock quickly began its perpetual descent the following day and now trades over the counter around 28 cents.
SDR Investors also alleges that the underwriters, in exchange for PlanetRx IPO shares to its clients, received undisclosed commissions from those clients for handling transactions involving other stocks.
"The stock wasn't fairly distributed, because of these kickbacks. My client couldn't get any stock from these underwriters and had to buy in the after-market," Roffe said.
Goldman Sachs, the lead underwriter, and co-managers Merrill Lynch, the former BancBoston Robertson Stephens and Salomon Smith Barney were the investment banks named in the suit. Salomon and Goldman declined to comment, and the two other underwriters did not immediately return phone calls.
Also named in the suit was PlanetRx and current directors David Beirne and Michael Moritz, along with former chief executive William Razzouk and former director Christos Cotsakos. SDR Investors said the directors and the company should have disclosed these alleged arrangements in the various documents filed with the SEC.
Calls to PlanetRx seeking comment were not returned. But according to the company's SEC filing, the company "is in the process of reviewing the suit and intends to respond in a timely manner...The company is unable to predict the outcome of the suit and its ultimate effect, if any, on the company's financial condition."
One investment banker, whose company is not involved in the suit, said it is a common practice among investment banks to find clients who are willing to buy more shares in the after-market if the IPO is hot.
If demand exceeds supply, bankers will often ask clients if they are willing to be long-term holders, rather than flipping the stock once it goes public, said the banker, who requested his name not be disclosed.
SDR is a hedge fund, which typically uses such investment strategies as shorting stocks. That calls for borrowing shares at one price and betting the stock price will fall, allowing the investor to buy shares at the cheaper price. The investor then uses these new shares to replace those borrowed from the brokerage and nets the gain between the price of the borrowed shares and those recently purchased.
"It's never a formal agreement, just a discussion," the banker said. "A client may say they're willing to buy the stock at $10 but willing to go as high as $15. I know if I price the stock at $12, they'll likely buy more in the after-market up to $15."
The banker added that institutional investors rarely ever receive as much stock as they would like in an IPO allocation and, as a result, have to go to the after-market to amass as large of a stake they would like in a company.
"It's good for the company and the market. Companies want to have long-term holders in the stock and it reduces volatility," he said.
SDR, which filed the suit in U.S. District Court in the Southern District of New York, is seeking class-action status.