Efforts to open IPOs to individuals stall

But since the deal closed a month ago, investors have found fewer IPO shares to go around--leading to customer complaints against Wit, a pioneer online investment bank, and its brick-and-mortar counterpart, SoundView.

Wit is not alone in finding that demand for shares at the initial offering price far outstrips supply. Many online brokerages, including giant Charles Schwab, have run into the same problem in recent months as the IPO market has remained red-hot.

However, Wit has made access to IPOs a cornerstone of its businesses and a major selling point when it comes to wooing customers. As a result, the shortfall has raised the ire of many.

Getting in on an IPO at the offering price is often a license to print money. Just this week, shares of Crayfish, a Japan-based provider of email services, soared 425 percent in their first day of trading.

Typically, the main benefactors of such big gains have been pension funds and other major investors that are allowed to purchase shares at the initial offering price. That began to change last year when online brokerages started offering a piece of the action to individuals as a way to attract more customers.

To bridge the supply-and-demand gap, Wit, Schwab and E*Trade have expanded their brokerage businesses to include underwriting IPO deals--moves designed to give them greater access to more IPO shares. Without this added role, the brokerages are merely part of a large syndicate of online and brick-and-mortar investment banks that share a small pool of IPO shares.

In Wit's case, this role has had no appreciable effect. In the first three deals it has co-managed since the SoundView acquisition, Wit has ended up holding fewer IPO shares than it usually receives as part of a syndicate.

"With one account, I have gotten around 21 (IPOs)," said one investor on an Internet bulletin board. "Lately, it has been pretty dry."

Jeff Hirschkorn, senior analyst with IPO.com, said he has received several calls from investors complaining that access to Wit's IPO shares has tightened since the merger.

Wit is aware of the customer complaints and says a solution is on the horizon.

"Clearly, investors are frustrated. There's no doubt about it," said Mark Loehr, head of investment banking for Wit SoundView, in reference to the three deals the company co-managed.

The supply squeeze stemmed from the small size of the deals, while the number of investors interested in participating in IPOs has more than doubled since November, he said.

Wit received an average of 100,000 shares in each of the three IPOs: MatrixOne, Switchboard.com and Register.com. Wit usually averages 200,000 shares, Loehr noted.

He said he anticipates the allocation to rise to an average of 250,000 shares per deal in the second quarter, when more than 30 IPOs are scheduled. He added that at least three of the deals will give Wit access to 1 million shares each.

Adding to the problem is that Wit also intentionally slowed the number of IPOs it participated in after announcing its merger plans with SoundView. With the merger now closed, Loehr said the company anticipates an increase on IPO shares going to its clients.

Although some critics have speculated that Wit is taking its IPO allocation and giving it to SoundView's institutional investors or high-net-worth investors, Loehr said it isn't so.

He explained that underwriters typically make IPO shares available to two sets of investors: some go to institutional investors, such as pension or mutual funds, while the remainder are earmarked for individuals.

At Wit, however, all the IPO shares it receives go to individual investors, which is what its business model was built on. When there is more demand than supply, Wit allocates shares based on a lottery system. A customer's trading volume or asset size are not used in determining who gets shares, Loehr said.

The allocation squeeze has also hit Schwab, which has virtually discontinued the practice of doling out IPO issues to individuals as it transitions to a role of underwriting deals through a consortium of brokerages and venture firms called Epoch.

Schwab is teaming with TD Waterhouse Group, Ameritrade Holdings, and venture firms Kleiner Perkins Caufield & Byers, Trident Capital and Benchmark Capital. Epoch will underwrite IPOs and sell those shares only to investors.

When Schwab unveiled Epoch in November, it began to distance itself from agreements it held with several investment banks to help distribute their IPO shares. Schwab spokeswoman Marta von Loewenfeldt said the brokerage had a hard time meeting investor demand for IPO shares based on the allocations it was receiving from the banks.

Schwab let the contracts expire, which has cut its IPO pipeline, until Epoch gets its operations running.

Von Loewenfeldt said investors will be better served in the long run with Epoch because it will give the online brokerage a larger allocation of IPO shares.

In the meantime, Schwab customers have gone from having access to nearly 100 IPOs last year to zero this year.