On the second panel of the Securities and Exchange Commission (SEC)’s 31st annual Government-Business Forum on Small Business Capital Formation, three experts presented their views on issues generally outside the scope of the Jumpstart Our Business Startups (JOBS) Act.
John Borer, head of investment banking at The Benchmark Co., presented the perspective of an investment banker, proclaiming that the market for traditional initial public offerings (IPOs) is “broken” due to poor aftermarket performance and incomplete offerings. He dismissed the JOBS Act as making some changes, but not resolving the problems with the IPO market.
He lamented that many of the firms that used to populate the IPO business for issues under $50 million have consolidated, that companies have been stressed by the burden of providing required information, that new issues have been priced below the midpoint of the predicted ranges and that companies have other exit options, such as selling themselves.
Borer added that hundreds of companies have gone public over the last decade through shell companies, although this option now has a stigma due to its extensive use by Chinese companies. In response, the process has been made tougher, and companies have moved to other options, such as private placements and shelf registrations, with the deals often being done overnight and being “public” offerings in name only. The latest alternative is called a confidentially marketed IPO (CM-IPO), a form of private placement that begins with filing a Form S-1 and can enable over-the-counter trading in a reasonable time.
Robert Bartlett, a professor at the University of California, Berkeley School of Law, contends that the JOBS Act “fundamentally changes the distinction between a public and a private company.” It tries to establish a distinction based on the number of shareholders, but “it does not address the fact that a lot of companies have no mandatory public disclosure.”
He estimated that 3,124 companies are now in this “no-information domain,” and the number is growing. The result has been uncoordinated federal-state obligations for disclosure by broker-dealers. This is problematic because state registration requirements often come with a remedy that allows the investor to rescind the deal. Lawyers generally will not give opinions on compliance with state blue sky laws.
According to Bartlett, the absence of disclosure ultimately leads to overpricing of securities. He recommends that provisions be made for sales to qualified persons who have disclosure and access, while less-sophisticated investors could benefit from price discovery. Also, preemption of state blue sky laws could be offered as an inducement for companies to provide “voluntary” disclosure.
At this point, Meredith Cross, director of the SEC division of corporation finance, interjected that under the conditions described by the panelists, “bad things are bound to happen,” and the SEC could return to a regulatory scheme similar to that of 1964.
Ann Yvonne Walker, a partner at Wilson Sonsini Goodrich & Rosati in Palo Alto, Calif., discussed the provision of the JOBS Act that requires the SEC to study to possible use of Regulation S-K to simplify the cost of registration for emerging-growth companies.
As usual, the issue is what has to be disclosed.
Silicon Valley practitioners have been calling for a change that would make disclosure more “principles-based” and less reliant on making detailed disclosures, such as order backlogs, which have become less significant with changes in inventory management practices. She cited disclosure of derivative activities as one that “only accountants understand,” and she made the same observation regarding disclosure of the extent of share dilution, which averages 80 percent.
She recommended elimination of “this page of accounting mumbo-jumbo.” Another target of Walker’s critique was disclosure of material contracts, because she said it is difficult to interpret what constitutes materiality. She concluded with the prediction that coming years could see an extensive movement for companies to go private.
The panelists did not express the issue this way, but implicit in the presentations is the question of whether it is too difficult, under the scrutiny that modern technology enables, to administer securities markets in a manner that affords investors the protection they are increasingly coming to demand.
Robert Feinberg served on the staff of the House Banking Committee for the 10 years that encompassed the savings-and-loan debacle and the beginning of its migration to the banking sector. Subsequently, he has consulted on issues related to the crisis for law firms, accounting firms, securities firms and trade associations.
Feinberg holds a BS.E. from the Wharton School and a J.D. from the Law School of the University of Pennsylvania. He has drafted dissenting views on landmark banking legislation, contributed to a financial blog and written hundreds of reports for clients to document the course of the financial crisis as it has unfolded over the past three decades.
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