Getting KO’d After Investing in an Internet IPO
Both the U.S. Securities and Exchange Commission and the National Assn. of Securities Dealers have issued numerous advisories in recent months stating that investors should be cautious when buying potentially volatile stocks.
Initial public offerings, called IPOs, are particularly subject to huge price swings, and this is specially true with Internet issues.
In a May 4 speech SEC Chairman Arthur Levitt referred to “a [nameless] investor who didn’t take the time to appreciate what he was getting into and ended up losing his life savings in one fell swoop.”
“It seems that with every passing day, we come across one story more amazing than the other,” he said.
Just 16 days after this speech, the buying adventure of Thomas C. Digiammatteo, a Westside art dealer, certainly seemed to qualify as amazing, depressingly so.
On May 20, Digiammatteo used $317,000--funds he and two partners had to purchase art for resale--to buy 10,000 shares of an IPO by EToys, of Santa Monica, a leading Internet retailer of children’s products. The purchase was made through a margin account with a brokerage, which is to say on secured credit.
He says now that he had seen a television report that the opening price would be $30 a share.
But the opening price was $77.88, and by the time his order was executed, the price was $81.
Soon after that, the price began to fall, and in days was only $44.
In the meantime, Digiammatteo was stuck. He had made an $810,000 purchase with just $317,000 and, with the price slipping, his brokerage house, Waterhouse Securities, told him on May 25 that, given the terms of his margin account and SEC rules, unless he came up with $171,500 in two days, it would sell “sufficient” stock to “satisfy our . . . requirements.”
According to a lawsuit Digiammatteo has now filed for arbitration, Waterhouse didn’t even wait that long. The next day at 7 a.m., Waterhouse broker Matt Hay “called claimant [Digiammatteo] at his home and demanded that claimant agree to immediately liquidate his position and sell all of his shares of EToys stock.”
“When claimant asked if Waterhouse could wait until the stock recovered or at least wait a short period of time, Hay demanded that claimant put on his pajamas and bring in a sackful of money to the Waterhouse offices in Beverly Hills within minutes,” or the trade would take place, the suit alleges.
Almost immediately, Digiammatteo reports, Waterhouse began selling his EToys stock, and that day it got rid of all the shares at prices ranging from 43.94 to 44.31.
Digiammatteo not only lost all $317,000, but Waterhouse says it lost $51,074 and is demanding that he pay it that amount, plus its costs of defending against his lawsuit.
In a response to the suit, Waterhouse attorneys say that “Waterhouse was left with no choice other than to liquidate the account.”
Digiammatteo insists that he should get his money back and that the brokerage should pay all costs, because he didn’t have enough funds in his account to satisfy the terms of his margin account at the price of $81, and Waterhouse thus should not have executed his order.
I don’t know how the arbitrator may rule. But it seems clear that all this difficulty would have been avoided had Digiammatteo placed a limit order rather than a market order when he authorized a buy.
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A limit order puts boundaries on the price the buyer will pay. A market order is a directive to buy regardless of the price.
Waterhouse’s general counsel, Richard Neiman, told me Waterhouse has a tape-recording of a conversation between one of its brokers and Digiammatteo before he placed his order on his possibly placing a limit order.
“I listened to the tape of the conversation, and it’s clear that the customer understood the uncertainty of where the stock could open, and his opportunity to place a limit order,” Neiman said.
“We would never tell somebody he had to place a limit order. What we did say was he could place one. . . . He clearly understood what a limit price meant.”
Digiammatteo remembers the conversation differently. He said he called the brokerage, which was fairly new to him, for advice and asked if he should place a limit or market order. He could not recall the name of the broker.
“He told me that in order to be sure I got the stock, to place a market order,” Digiammatteo recalled.
He said that based on his experience with another brokerage he felt that Waterhouse would stop the purchase if the price were too high.
Neiman responded: “The broker told him there was no assurance as to where the stock would open, and if he was concerned . . . then he should place a limit order.
“He came back with $60 as an example, and our man said, then, ‘if you wanted assurance you would get the stock, you could place a market order,’ which he did.”
Suki Shattuck, director of investor relations at EToys, said that with Goldman Sachs as the lead underwriter, 9.6 million shares were sold on the IPO at a presale price of $20.
Shattuck said EToys received $180 million from the sale after paying commissions.
The pre-public sale price goes to customers chosen by the underwriting brokerages. The public cannot buy until the formal opening.
The original buyers received a paper profit exceeding $500 million on the first day of the public sale. Had the price been set at $60 by the underwriters, then EToys would have gotten three times more as its share of the sale.
I asked Shattuck whether EToys regretted that others made such a profit, while its return was $180 million. She declined comment.
The SEC said in a recent statement on “Why Individuals Have Difficulty Getting Shares” of IPOs, that “it is unclear how ‘hot’ the offering will be until close to [the time] . . . the shares start trading. Since ‘hot’ IPOs are in high demand, underwriters usually offer those shares to their most valued clients.”
Unfortunately for Digiammatteo, he was not one of those valued clients. He had to come in later, and he did not realize the risks.
Ken Reich can be contacted with your accounts of true consumer adventures at (213) 237-7060, or by e-mail at ken.reich@latimes.com
