Reforming IPOs won't cure buyer stupidity

The Insider

Your Money

February 08, 2004|By BILL BARNHART

AS ADLAI Stevenson III once said when launching a bid for public office, "The sap is rising."

Eager investors may feel the same urge, now that the market for initial public offerings of stock is showing signs of life.

Exposes of corruption on Wall Street sparked reform proposals that promise to purge the worst abuses in allocating IPO shares.

Meanwhile, several respectable IPO prospects are in the pipeline, led by a likely share offering by Internet search engine Google Inc.

But despite regulatory efforts, your chance of getting in on the ground floor of a hot IPO are no better now than they were a few years ago, when almost any dot-com company sprinted out of the IPO gate.

Moreover, pending reforms and a more substantial crop of IPO candidates this year should not convince you that potential returns on IPOs have improved.

But "you can't tell people not to get exuberant and make stupid investment decisions," said securities lawyer Tom Murphy of McDermott Will & Emery.

Reforms under consideration by the National Association of Securities Dealers, the self-regulatory arm for stockbrokers and dealers, address three abuses:

Investment banks that underwrite IPOs would be barred from awarding shares to favorite clients in return for business or threatening to withhold an IPO allocation unless unrelated business is generated.

Underwriters would be forced to provide more information to companies issuing IPO shares about the potential demand for the shares and what price will be set for the initial offering.

Brokers could not accept "market" orders from customers for IPO shares on the first day of trading, when share price volatility may stray far from underlying market value.

Of these proposals, which are expected to be submitted this year for approval by the Securities and Exchange Commission, the restriction on first-day market orders hits closest to home for most investors and has generated the most opposition on Wall Street.

It's hard to feel sympathy for companies that find their IPO shares were sold cheaply so that underwriters could give a windfall to the underwriters' friends.

"Going public for the first time is like getting married for the first time," said Daniel Weaver, professor of finance at Rutgers University. Cost is not a major consideration, he said.

Under-priced IPOs are a cost that companies eat because they want Wall Street to maintain a strong market in their shares after the IPO. But under pricing creates the price swings that ensnare naive investors in the first day of trading.

William Hambrecht, chief executive of W.R. Hambrecht & Co. and a leading advocate for IPO reform, doesn't see much change. Underwriters have angry customers who didn't get the big payoff they were expecting in the late 1990s, he said.

"The tendency to under price is just as great as it was in the bubble," he said.

Regulatory reforms will not solve the investor's biggest problem with IPOs. The Motley Fool, an investment advice Web site, says it best:

"If you're able to get your hands on some IPO shares, it probably means that nobody else wants them, and you shouldn't either."

Bill Barnhart is a financial columnist for the Chicago Tribune, a Tribune Publishing newspaper. E-mail him at yourmoney@tribune.com.

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