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PLAY FAIR IN THE IPO MARKET
America's IPO market is the envy of the world. Last year, hundreds of entrepreneurs and small companies raised $57.5 billion in new capital through initial public offerings, generating economic growth and jobs.
But while the IPO market is great at generating capital, that doesn't mean it is fair, especially to small investors. Sure, people are free to invest in small-capitalization mutual funds that do a lot of IPO buying. Many do. Yet when it comes to the really "hot" deals, where big money is made fast, the little people don't stand much of a chance. They have a hard time getting into the IPO game. Worse, when they can actually buy stock, small investors tend to get stuck in dicier deals and discouraged from bailing out as prices weaken.
A two-month BUSINESS WEEK investigation shows that the IPO market is heavily skewed toward institutional players and against the individual (page 84). Whether it's in allocation of stock, reporting of important company information, or simply trading, the average investor is put at a severe disadvantage, while the institutions make a killing.
Take allocation. Wall Street syndicate managers say institutions, such as mutual funds and pension funds, get to buy 80% of the really sizzling IPO deals. An additional 5% to 10% of the stock is used by the corporate issuer to repay favors to vendors, employees, and big customers. The rest is parceled out to brokers. The little guy? Forget it.
Access to information is even more skewed. The individual investor has to make do with a dry IPO prospectus with very few real numbers. The big guys get invited to private "road shows" promoting the offering where management talks about the deal and future earnings. Small investors are cordially disinvited. So is the press.
The most egregious offense is in trading. When underwriters worry that an IPO deal might be a stinker, they make sure that a much higher percentage of the stock is offered to individuals. People tend to hold equities and not trade them, thus propping up the price. But brokerage firms go one step further and actively discourage selling of the IPO stock through the "syndicate penalty bid." Brokers whose customers sell or "flip" their IPO stock quickly risk having their commissions taken away. That gives them a strong incentive to talk their clients into holding their stock. These "penalty" bids aren't applied to large institutions that decide to sell.
What to do? The IPO market is a marvel at capitalizing young companies. The last thing the country needs is new regulation choking off this engine of growth. But a good dose of sunshine would go a long way toward making the IPO market fairer--and, indeed, more efficient in the long run.
First, give everyone, individuals and institutions alike, as much information as possible. So open up the road shows. Let in the people, let in the press. Heck, let in the cameras, and put it on cable TV. Call it, (what else?) "Road Show."
Second, end penalty bids. This is simply an outrageous concept that pits the self-interest of the broker against the self-interest of the small investor. People should want to hold on to their stocks solely because of long-term value.
Third, increase access to all IPO deals for individuals. One study shows that 90% of the returns in common stock offerings are earned on the first day. Let small investors as well as big investors enjoy that kind of "risk."
None of these changes requires Arthur Levitt Jr. at the Securities & Exchange Commission to pass a single new regulation. The Securities Industry Assn. can police its own members. It's past time to end the sucker game in IPOs for the individual investor.