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Hot IPOs Like Facebook: Who Gets Them And Why

 May 16, 2012 01:31 PM


(By Rich Bieglmeier) When Facebook (FB) commences trading on Friday, many investors will experience the frustrated feeling of being left out. While the bailed out boys on Wall Street will head to the Hamptons after pocketing millions from Facebook's IPO, the average investors will do what they always do with hot IPOs, watch from the sidelines shaking their heads in disbelief and asking, "Why can't I ever get a piece of that easy money."

Let's take you behind the scenes at what happens in the run up to a hot IPO from an ex-broker's view.

In my time as a broker at a major BD, the hot IPOs were always difficult to be a part of as institutions get to eat as much as they want first. The money managers route a lot of trades and commissions to the firm, and IPOs that pop are part of the payback. Of course the firms publicly declare this as untrue and shuffle all the paperwork necessary to appease the regulators, but you can bet your %$# that's what happens.

Then, the highest commission producing brokers get stock, to give their accounts that generate the most commissions, or to lure a big fish in house. There is no easier way to get a stubborn prospect to transfer part or all of their account from a competing firm than to bribe them with "free" money.

I can also guarantee you that the phones have been lighting up for weeks at all the underwriters' offices with folks making all sorts of promises to get a piece of the Facebook IPO. And if it's oversubscribed, as the recent addition of shares and price hike suggests, stockbrokers are scrambling, now make that begging for bigger allotments.

If they are lucky enough to get ‘em, odds are their office managers have given them an ultimatum, "move them" (sell) within a certain timeframe or lose them. No matter what, they'll be accounted for within minutes, most brokers have clients who have given them "permission" to put hot IPOs in their account "unsolicited." (Again, it's a practice that will be denied, but it happens for sure.) The faster they are allocated, the sooner the "please, please, can I have more" cycle repeats.

Meanwhile, every broker at the underwriting firm has nearly, if not all of their clients calling and asking for shares. Let's say your broker gets 2,000 shares to give to clients and coerce new customers to open an account. How do the shares get divvied up?

First and foremost, "A" clients get stock first. What's an "A" client? Typically, for the broker's book of business, they are within the largest 10% in terms of money under management, are in the top 10% of commission generators, and are easy to get along with. Clients who have the big account and don't generate commissions or complain too much, you can forget about it.

Next up on the list are prospects and current clients with the potential to be "A" clients. They have large, active accounts elsewhere, and a hot IPO is just the ticket needed to jump start the relationship and build good will.  Of course, quid pro quo is outlawed by the regulators, but any broker who gives away his/her chips for free is stupid or a newbie, and you can believe that.

By the time some "A" and potential "A" clients are taken care of, the average broker is out of IPO stock, and guess where that leaves most investors? Chasing an odd lot at a discount broker.

Many might be wondering how can I get stock if I'm not an "A client and don't have the potential to be one. A good question with an easy answer, referrals. If you like your broker and you think he/she is doing a good job, tell your friends. Clients that give referrals are in a special class regardless of account size.

Another way to participate is to own companies like GSV Capital Corp (GSVC). GSV is a publicly traded investment fund that seeks to invest in high-growth, venture-backed private companies. They provide financing to companies like Facebook, Groupon, Twitter… before they come public. By owning shares of GSV Capital, you indirectly own what's in their portfolio. So, when hot IPO CEOs ring the opening bell, you have a chance to take part in all the fun too.

Now you know what it's like behind the curtain, at least when I was in the race, albeit nearly a decade ago. However, my friends in the biz tell me it's no different today.

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