Will you get rich on E-Trade? Probably not

From...

March 17, 2000
Web posted at: 8:21 a.m. EST (1321 GMT)

by Evan Schwartz

(IDG) -- When you buy a lottery ticket or enter a sweepstakes or even play the slots in Vegas, the odds of winning are stated somewhere during the transaction. The print may be fine or even partially hidden, but at least the players can find out whether their chances are 10 to 1, 1,000,000 to 1, or somewhere in between.

But when it comes to "investing" in Internet IPO shares via the Web sites of electronic brokers, no disclosure of the odds is made. I'm not talking about the chance that the stocks will go up at the opening bell. They almost always do ö often by 100 percent or more. I'm talking about the odds of getting your hands on the shares in the first place.

And since these golden shares are distributed according to a lottery system, I believe E-Trade, Wit Capital and others that claim to be democratizing the IPO process should disclose how many shares they are distributing for each deal. Do they have 500,000 shares to dole out, or just 500? What are the odds of getting any?

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After the inevitable online frenzy of demand for a Net IPO, the frenzy itself is often used by underwriters as rationale for increasing the offering's price, further enriching bankers and insiders while the masses are left with little or nothing.

Recently, I undertook a little research project to try to unravel the mystery of online IPO allocations. I completed the "eligibility profile" at E-Trade and opened an account at Wit Capital. Then I started submitting conditional offers for almost every IPO in site.

I requested shares in 12 companies, including relative unknowns like Chordiant, Lante, Appropos, Witness, Turnstone and Onvia, as well as better known names like Organic, Buy.com and Palm. For all of these stocks, the first trade was at least double the offering price. How exciting! But for all my efforts, I got exactly zero shares in these dozen deals.

"You're having very poor luck," said Helen Lin-Murphy, E-Trade's senior manager of investment banking. "Our average customer is more successful than that."

Lin-Murphy explained that a lottery system is the most equitable way to parcel out shares. Until last year, it was done on a first-come, first-serve basis, which led to logistical problems and complaints.

The only stipulation, she added, is that those who receive IPO shares are asked not to sell them for the first month. Those found "flipping" are banned from further IPO allocations for the next 60 days.

But what about me? I've never flipped ö I've never had anything to flip. Why am I coming up with the goose egg every time? Bad luck, Lin-Murphy kept insisting.

But is it? I asked her how many individuals submit requests in a hot IPO. She said there were usually "tens of thousands." And the allocation E-Trade received from the deal's lead underwriters? Typically, she said, it's in the "single-digit thousands" but it can be several hundred thousand.

OK, then, let's do some math. Say 40,000 people request shares in a typical deal, and E-Trade has 4,000 to distribute. The winners are typically granted 100 shares. So the math is simple: When there are 40 winners out of 40,000, it means the odds of receiving shares are 1,000 to 1.

In that light, my luck no longer seems so bad ö I got dinged from only 12 offerings. Given the odds, I shouldn't fret about my misfortune until I'm rejected from 1,000 deals. And what are the odds at Wit Capital? Somewhat better, according to Mark Loehr, Wit's head of investment banking. Wit typically allocates 200,000 shares on deals it comanages, and as much as 50,000 for other deals. With a usual 30,000 requesting shares in each IPO, the odds of getting 100 shares is 15 to 1 for comanaged deals, and 60 to 1 for others. In hot IPOs, where the demand is higher, the odds are worse.

E-Trade, Wit Capital and others should disclose exactly ö or even approximately ö how many shares they have to sell for each deal. Then we "investors" can determine whether we are wasting our time only to become data points for bankers looking for evidence that their latest money-losing Net concept has "pop" and "buzz" and all that other fake fervor.

Evan I. Schwartz is the author of Digital Darwinism.

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