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Public Demand for New Issues Outstrips Supply

Touting that their mission is to democratize the process, online investment banks have been popping up on the Internet to distribute shares of initial public offerings to retail investors.

Touting that their mission is to democratize the process, online investment banks have been popping up on the Internet to distribute shares of initial public offerings to retail investors. Wit Capital which pioneered the concept two years ago, has been followed by E*Offering, an investment banking subsidiary of E*Trade.

In June, FBR.com began distributing new issues and secondaries underwritten by its parent, Friedman, Billings, Ramsey & Co., a 10-year old Arlington, Va.-based investment bank which focuses on institutional customers. The company said it would offer up to 20% of all its IPO stock allocations to the public via the FBR.com Web site.

In June, FBR.com moved to an 80-seat call center to serve the customers much better, developed a computer-generated random selection process to allocate IPOs, and it outsourced the hosting of its Web site. It also licensed trading software from its clearing firm, BHC Securities.

"Our mission is to democratize the investing process and the IPO distribution process for the individual investor online," says Suzanne Richardson, president of FBR.com. But just how democratic the process is, is up for debate.

Though online brokers and the new online investment banks are attempting to level the playing field, individual investors are complaining that they’re not getting access to the deals, especially true with the hot Internet IPOs.

Given these complaints, the Securities & Exchange Commission is looking into the veracity of their advertising. In a letter written in May, SEC chairman Arthur Levitt said that "in the short time that online brokers have been offering IPOs ... we have received numerous complaints. It appears that firms are advertising IPO opportunities without explaining that the firm has a limited number of IPO shares to offer." In the letter, Levitt urged online brokers to "clarify that the high demand for a limited allocation of shares may make it unlikely that any single investors will be able to participate, or participate as fully as expected." To make the process fair, online firms such as FBR.com use a computer-generated random selection process to allocate 100 shares at a time, to investors, which is a common practice," says Dan Burke, senior brokerage analyst at Gomez Advisers in Concord, Mass.

Despite their noble intentions, the online IPO distributors are not getting enough supply because they are not the lead underwriters on the sought after deals. "They haven’t been particularly successsful simply because it’s difficult for them to gain a lot of stock to appease individuals who wish to participate in the deals," says Burke. He notes, "Wit Capital, for instance, is often times in the selling group or in the participation phase of the deal. They’re not always a co-manager or lead underwriter–so they’re kind of at the whims of what the lead managers want to allocate them."

One Wit customer, commenting on the Gomez.com IPO message board said: "Very frustrating deal with Wit. Wit has been quietly taking advantage of the customers." The person, signed Viv from TX, went on to accuse Wit of receiving customer assets, earning interest on their money and in return, "providing them with very little IPO opportunity."

In response to such complaints, Ronald Readmond, vice chairman, president and co-CEO of Wit Capital, casts doubt on the credibility of message boards. "Message boards are great places to complain because they’re totally anonymous," says Readmond who notes that the comments are often "specifically intended to move stocks." He adds the reason that investors don’t get IPOs "is that you don’t put your orders in fast enough, you don’t reconfirm quickly enough or you don’t meet the suitability tests to even purchase an IPO." He adds, "Those are unsophisticated people who don’t understand investment in IPOs."

But other comments on the Gomez site criticize Wit for not responding to e-mails, lacking knowledgeable staff to answer questions, being slow to execute orders and generally being ill equipped to handle customer service.

As for the complaints about service, Readmond says, "demand can be vertical in the Internet space, almost infinite demand that you have to respond to instantaneously," adding that the firm is beefing up its telephony to manage inbound call traffic as well as putting in technology, training people and outsourcing where it can.

Burke and a spokesman for the SEC both say it’s unfair to single out Wit because all retail investors, regardless of whether they use an online broker or not, have trouble getting access to IPOs. Online brokers that sell IPOs include Schwab, Fidelity, E*Trade, DLJ Direct and Discover Brokerage.

But some online brokers are blatantly implying that individuals will have access to IPOs if they open a brokerage account with a $2,000 minimum. "That’s why we are looking into this," admits the SEC spokesman.

Meanwhile, Richardson contends that her firm has an advantage over competitors such as Wit Capital. "Because FBR (the parent) is either lead or co-manager we have a supply of stock that we can distribute," she says.

Readmond disagrees, pointing out that FBR.com is held hostage to its parent "Freeman, Billings Ramsey and the quality of the deals that they have brought to market," adding, "they are not a top tier underwriter." By contrast, "Wit focuses on the quality of the company and we are agnostic about who the lead underwriter is," says Readmond citing Merrill Lynch, DLJ, Bear Stearns, Morgan Stanley, and Hambrecht & Quist. He contends that Wit has "been in more deals than anyone else," and "they’ve been top tier transactions." Indeed, that looks to be true. FBR was involved with a total of 15 deals this year through August 5, but was lead manager in only five IPOs, namely Corporate Executive Board, Proxicom, Careerbuilder, CAIS Internet and The MIIX Group. By contrast, Wit was involved in 42 IPOs, of which it was a co-manager in 21, and was a syndicate member in the other 21. This was more than double the number of securities offerings it made available to its customers from the first quarter, reports the July 20 earnings release.

According to a spokeswoman for Wit, "in every deal that’s posted on the site, we’ve gotten shares." She also points that in the company’s 2nd quarter earnings report, the total shares underwrittten by Wit totalled 6.48 million, of which 5.97 million were retained by the company for sale to its customers–a 301% increase above the 1.49 million shares retained in the first quarter.

Although Goldman Sachs owns a 20% equity stake in Wit Capital, it was widely reported that Wit did not receive an allocation when Goldman went public in May. Yet, on Wit’s Web site, the Goldman IPO is listed among the previous offerings in 1999 and 1998 that Wit has been involved with, in addition to other hot Internet deals such as eBay, Stamps.com, Juniper Networks, Vertical Net and Wit Capital’s own IPO in June.

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio

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