E*Trade Tweaks Its Policy For Reining In IPO 'Flipping'
By ANDREW FRASER
THE WALL STREET JOURNAL INTERACTIVE EDITION
E*Trade Group Inc. has made a subtle but noticeable change to its policy regarding how it will punish customers who cash out shares of initial public offerings less than 30 days after receiving them -- using language that suggests a tougher stand against IPO flipping.
The shift comes as federal and state regulators continue probes into ways in which brokerage firms seek to prevent individuals from flipping IPOs, although the investigations aren't focusing specifically on online brokers. Regulators, meanwhile, are concerned that antiflipping policies are unfair to individual investors.
An E*Trade official played down the change -- casting it as a meaningless adjustment in wording. Flipping refers to selling shares of IPOs shortly after they begin trading in the market. IPOs that are in strong demand often race higher when they begin trading, and a quick sale can generate a big profit. But brokerages often try to rein in these rapid sales.
E*Trade, Palo Alto, Calif., posted a new antiflipping notice on its Web site (www.etrade.com) last week. It announced that before awarding IPO shares, it will review customers' accounts to gauge their compliance with the firm's antiflipping policy. The firm says customers "with a history of short holding periods will receive lesser allocation priority" for future deals -- or essentially be sent to the back of the line. That's important because hot deals go fast.
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In the past, E*Trade's policy had said simply that the firm "would prefer that customers hold their allocated shares for at least 30 days," adding that customers "with a record of short holding periods may be excluded from future offerings."
E*Trade, the No. 2 online broker in the U.S. behind Charles Schwab Corp., has never threatened to prevent customers from selling IPO shares whenever they want, and that hasn't changed.
But being placed at the back of the line, especially for a hot IPO, almost guarantees that a customer won't get any shares because the demand by online investors at E*Trade and other Web brokers far exceeds supply. The coveted investments generally have been reserved for professional money managers and brokers' very wealthy clients, who still get most of the shares available.
Online investors have long speculated that E*Trade is lax in enforcing its policy against customers who flip IPOs. Many posted messages on the Internet that they were able to get new allocations even though they had a history of flipping. But now there is concern among investors that E*Trade may be tightening up.
Underwriters abhor flipping, because it tends to make a stock more volatile and depresses its price after an initial run-up, angering issuers. For online brokerages, the pressure to curb flipping is particularly great because if too many customers flip, the firms run the risk of being shut out of the "syndicate" selected to distribute IPO shares.
Indeed, E*Trade explained in the notice on its Web site that its ability to obtain IPO shares could be affected by flipping.
"The rationale for allocating shares to customers who tend to hold for longer periods is that it helps E*Trade get access to more offerings and more shares as issuers of new stock seek to build stability in the aftermarket," E*Trade said in the notice.
But an E*Trade spokesman, who declined to be identified, said that flipping by customers so far hasn't caused E*Trade any problems with underwriters. He maintained E*Trade just wanted to explain the reason for its antiflipping policy, adding that most of the firm's clients hold their shares for an extended period.
Nevertheless, discouraging flipping is "important because underwriters and an issuing company will bring up that subject every time," the spokesman said.
SEC Launches Probe Into IPO Flipping as State Regulators Fire First Volley (Aug. 20, 1998)
On-Line Firms Move to Quash 'Flipping' of Initial Offerings (Aug. 13, 1998)
Wall Street Boosts Penalty Imposed on IPO 'Flips' (July 31, 1998)
State Regulators Begin Probe of Big Brokers' Penalty Bids (July 10, 1998)
Small Investors Face Double Standard From Brokers When Investing in IPOs (June 26, 1998)
An executive of another online brokerage firm, who also declined to be quoted by name, said investment banks that underwrite new stocks would withhold shares from a firm "if it didn't represent high quality distribution as represented by the behavior of its customer base."
E*Trade isn't the only brokerage that tries to prevent its clients from flipping an IPO. At Schwab, for example, flipping an IPO within 30 days will get you barred from future deals for six months. At Fidelity Investments and Wit Capital, investors also risk being barred from future deals if they sell their IPO allocations too quickly. Big full-service brokerages often penalize brokers whose clients flip an IPO.
Regulators are looking at the disparity between the way institutional investors and individuals are treated regarding flipping. Big full-service brokerage firms routinely allow institutional clients to quickly flip IPOs at will, while trying to persuade individual customers to hold on to IPOs. The antiflipping dictum often conflicts with the interests of investors, many of whom are drawn to IPOs because of the potential for big, fast profits. If profits aren't grabbed quickly, they may evaporate.
One of the major concerns of regulators is the penalty brokers face if their clients flip. Regulators want to know if firms have fully disclosed their policies to investors. They want to ensure that investors are aware of brokers' self-interest when they advise against flipping IPO shares.
The North American Securities Administrators Association, an umbrella group of state securities regulators, and the U.S. Securities and Exchange Commission launched probes into securities firms' antiflipping policies after The Wall Street Journal highlighted the issue last summer. The SEC didn't immediately respond to calls about the status of its probe. NASAA officials said they expect to issue a report on their inquiry within the next month.
Deborah Bortner, director of securities for Washington state and chairwoman of the NASAA committee looking at the issue, says there is evidence of a disparity in the way securities firms handle flipping by institutions and individuals. But she added this was her personal opinion and that she didn't "think the flipping policy rises to the level of an unfair and dishonest and unethical practice."
Robert D. Terry, assistant commissioner of securities in Georgia and author of the coming NASAA report, says "There is certainly the potential for unfairness in the system."
"Whether it is unfair and whether that rises to the level of a problem that regulators can and should be able to intervene in -- that's something we would just have to take a look at more closely," he says.
E*Trade toughened the language of its antiflipping policy as it joined other Web brokers in shifting from a first-come, first-serve process for awarding IPO shares to a lottery system many believe is fairer. Many investors have complained on the Internet and to regulators that under the first-come, first-serve method, they are shut out of the IPO party minutes after the door opens.
Under the new system, E*Trade will allow investors a window of at least two hours to submit orders for allocations in a given IPO. Those shares will then be allocated randomly to investors after a review of their accounts for compliance with the antiflipping policy. The new policy went into effect June 8. E*Trade said it had received numerous complaints from investors who said they could never get shares under the old procedure. The firm said it hopes "the new procedure will result in an even broader spread of public offering shares" among its clients.
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