E-Trade's announcement that it was offering shares in the much-anticipated initial public offering of Internet pioneer GeoCities drew plenty of interest, but many customers soon found out they weren't 'suitable' for such an investment.
"It just seemed like a scam at the end," said Eric Rasmussen, a regional sales manager for Nikkei Business Publications and customer of E-Trade. After answering a series of personal questions, including his annual income, Rasmussen said he was deemed unfit to purchase shares of GeoCities at the $17 offering price.
On its debut Tuesday, GeoCities, a Santa Monica, Calif., Web-site host, surged to $37 5/16 from an offer price of $17.
E-Trade Securities President Kathy Levinson said the online broker was merely following the suitability rules on the books at the National Association of Securities Dealers, a self-policing organization that oversees the securities industry and the Nasdaq market.
According to NASD general counsel Alden Adkins, the organization's rules require that brokers who recommend, or advertise, stocks take some steps to ensure that the risk profile of the investor is appropriate for the investment. "In any IPO, people who are selling the IPO are all deemed to be making a recommendation," Adkins said.
Unlike suitability requirements for other investments thought to be high-risk, such private placements, the suitability requirements for IPOs are vague and open to interpretation by the brokers.
Levinson declined to discuss exactly how the brokerage determined investor suitability. Nor would she disclose how many shares E-Trade was allocated in the GeoCities IPO.
She did say, however, that demand for the promotion was so strong that the company stopped accepting applications last Friday. "We were well oversubscribed," Levinson said.
The issue of suitability is just one more source of frustration for average retail investors like Rasmussen who are typically forbidden from participating in an IPO but provide a lot of the price support for a new issue after the stock starts trading.
In a e-mail response to a complaint from Rasmussen, an E-Trade customer service representative wrote: "To protect the integrity of the approval process, we are unable to provide more specific information about individual profiles. However, IPOs are considered to be highly speculative investments and this type of trading would be comparable to buying an option on a stock."
Rasmussen and other rejected investors were free to buy GeoCities when it opened for trading on Nasdaq at 33 a share. "You can't buy at $18 but you can buy at $40?" Rasmussen mused before GeoCities began trading.
The difference, according to NASD general counsel Alden Adkins, is that in one case the investor is making his own decision to invest in a stock and in the other is being encouraged to do so by a broker. "Maybe I'm too much of a lawyer, but it makes perfect sense to me,"said.
E-Trade's Levinson said price has nothing to do with the suitability requirements. In options trading, for example, a customer could spend only $100 to buy a contract, but the purchase still falls under the suitability requirements, she said.
Many investors who don't understand the IPO process have been burned by putting in what's called a "buy at market open" order for a hot new issue, unaware that the price the stock begins trading at will be significantly higher than the offering price. The problem has become much more acute with the popularity of the online brokers, since investors no longer have to go through a live person to place such an order.
Levinson said E-Trade customers cannot place an order to buy a new stock until after it starts trading and they get a sense of how expensive the stock has become. After that, however, all customers - even those that were unsuitable for buying shares at the offering price - can purchase the newly public stock.
Other online brokers that have given investors shares in IPOs, such as Wit Capital and Charles Schwab, also have suitability requirements. Schwab, for instance, only gives shares of IPOs to its most frequent traders or those with accounts of $1 million or more.
In a letter to CBS.MarketWatch.com, Wit Capital founder Andrew Klein said his firm allows investors to buy up to 10 percent of their net worth or income, whichever is greater, in shares of IPOs. Allocations are then doled out on a first-come, first- serve basis.
"Firms like Schwab and E-Trade may like to continue to maintain that their rules are driven by NASD requirements. But that is simply not supported by the facts," Klein wrote.
Written By Darren Chervitz