Why is it So Hard for Me to Get Shares of an IPO?

Let's say that there is a hot Initial Public Offering hitting the market soon. You know that the offering is going to be a strong one, and you know that the stock is going to trade much higher from its initial pricing point. You have a substantial amount of money sitting in your trading account. The Initial Public Offering is going to be for millions and millions of shares, and you figure that there shouldn't be too much of a problem buying a big chunk of shares before the stock is released for trading.

You e-mail your broker and they respond saying that you have been denied the request to buy shares in the Initial Public Offering. What gives?

First off, you need to realize that there is nothing "fair" about this process. Brokers will allot shares to whomever they want. The SEC has no say over the IPO share allotment process, and says so right on their website. Brokers can sell shares of an IPO to whomever they want.

To understand how you are able to obtain shares, you need to fully understand how an IPO works. IPO's are brought to the public through an "underwriting syndicate", a group of institutions who will purchase the shares from the issuing company and then sell them to the public. Underwriters may include companies such as Goldman Sachs or Morgan Stanley.

So let's say that Goldman Sachs purchases 1 million shares as part of their underwriting agreement. They have the choice of allotting the shares to whomever they want to, and they will normally give them to their best and wealthiest clients if the IPO is expected to be a strong one. Fair? No. The way it is? Yes. If you had a client who was generating you tens of thousands in commissions per year and had assets of $5 million, wouldn't you give them the hot IPO's? I know that I would.

When all is said and done, there are normally not that many shares of the IPO left (after the best clients have been taken care of). That leaves only a few scraps left on the table, and you have to remember that hundreds, maybe thousands of other people at your brokerage have the same idea as you. Everyone wants shares, and there just won't be that many to go around when all is said and done. I mean, who wouldn't want some of the upcoming Visa IPO?

Next up, and this goes into the "unfair" category, brokers will further pick and choose who they will allot the shares of the IPO to. They will sometimes require a minimum cash balance in your account (with biggest balances obviously being treated better). They will sometimes give precedent to active traders within the firm (those who generate more commissions). And sometimes they will allot shares to those who subscribe to their "premium" services (again, those who spend money will be rewarded).

If you bought an IPO in the past and decided to flip it for a quick profit, then the broker may put you on an IPO "black list" and not sell you shares in the future. If you are able to buy shares before they go to market, and then you flip them on the first day of trading for a nice profit, then don't expect to receive shares again.

Brokers are looking for clients who will be willing to hang on to their shares for a while. It doesn't look good if all of the broker's clients dump all of their shares on the first day of trading - it will create weakness in the stock, and how will it look to the company who is going public if one of their underwriter's clients are dumping all of their shares?

There is nothing "fair" about the process. The SEC doesn't have any say, because the brokers are purchasing the shares as underwriters, and why shouldn't they be able to do with the shares as they please? It's just the nature of the beast. If you have a balance of $2,000 in your account and rarely trade, don't expect to receive an allotment of the next hot IPO, because you probably won't get it.

Filed under: Stock Market Education | General Knowledge




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