In a recent paper, authors Onur Bayar, Thomas J. Chemmaur and Paolo Fulghieri consider whether allowing insiders with nonpublic information to disclose such information prior to selling their securities. The paper discusses the communications prohibitions applicable prior to, and in close proximity to, securities offerings, as well as some communications safe harbors. The authors set out a model for disclosures at different points in time prior to a securities offering. The paper concludes that even in the absence of an agency, like the Securities and Exchange Commission, that regulates disclosures, there are incentives for companies to self-regulate resulting in conservative disclosures. The authors further conclude that whether allowing disclosures prior to an equity offering is desirable depends on the proportion of Institutional investors who are able to verify the information (compared to retail investors that would not be able to test or verify disclosures). Finally, the authors also consider the nexus to the rules for bringing private securities lawsuits. Setting aside the authors’ thesis, it would seem prudent in light of the significant advances in technology since 2005 when securities offering reform last revamped the communications rules to revisit the safe harbors available to issuers.
In recent remarks, Commissioner Peirce commented on capital formation, repeating some statistics about the decline in the number of IPOs in recent years and the relatively small number of public companies (about 4,500). She noted that many companies are able to raise capital in private placements or exempt offerings; however, fewer investors are able to share in the growth of such companies that stay private. She noted a few regulatory impediments that may make becoming a public company less compelling. Among these impediments, Commissioner Peirce included the Sarbanes-Oxley Section 404(b) attestation requirement and the burden it places, especially on pre-revenue companies, Dodd-Frank Act-mandated disclosure requirements, such as those on conflict minerals, Dodd-Frank Act executive compensation requirements like the pay ratio rule, and the lack of regulation of proxy advisory firms. The Commissioner also commented on Regulation A, noting that as of the end of 2017, 185 Regulation A offerings had raised approximately $670 million in offering proceeds, and noting that the current offering threshold for Regulation A offerings may still be too low to be a meaningful stepping stone to an IPO. The Commissioner also raised a suggestion that has been raised by Commissioner Piwowar from time to time; that is, abandoning the accredited investor standard and allowing all investors to participate in exempt offerings. The full text of the remarks are available here.
A number of industry groups, including SIFMA, have joined to put forward recommendations to promote capital formation and assist more companies in going public or remaining public. Many of the measures suggested in the report have been presented previously, whether in the U.S. Treasury Report on capital markets or in bills introduced in, or passed by, the House Financial Services Committee. For example, the group suggests:
- That for issuers that meet the EGC definition, extending the on-ramp provisions of Title I of the JOBS Act from five to ten years;
- Amending Section 5 of the Securities Act in order to extend the ability to test-the-waters to non-EGC issuers;
- Extending the Sarbanes-Oxley Section 404(b) exemption from five to ten years for lower revenue EGCs; and
- Simplifying or eliminating the “phase out” provisions relating to EGC status.
The report also addresses research related issues and suggests:
- Amending the Securities Act Rule 139 safe harbor to eliminate the Form S-3 eligibility prong;
- Allowing research and banking colleagues to attend pitch meetings and reviewing the Global Research Analyst Settlement; and
- Studying the factors impacting the decision of most firms not to publish pre-IPO research.
Finally, the report addresses other measures, such as regulation of proxy advisory firms, short-selling, the baby shelf restrictions for smaller issuers, and financial reporting and market structure matters, not as closely tied to the IPO market.
In a recent speech, Commissioner Jackson focuses on the traditional IPO 7% spread, which he refers to as a “tax.” From time to time, such as in the correspondence between Congressman Issa and then Securities and Exchange Chair Schapiro and in academic literature, questions have been raised regarding the IPO book building process and “IPO underpricing”; however, I don’t think an SEC Commissioner has previously taken on this topic. The speech cites to Professor Jay Ritter’s work and notes that the Commissioner’s staff undertook an effort to look at more recent data, which included data from more than 700 middle market IPOs over a 15-year period beginning in 2001. There is a link to the supplemental research (you may access here). The following chart illustrates the study findings from 2001 to 2016:
Larger companies are able to use their bargaining power to negotiate lower spreads, Commissioner Jackson observes. While this is true, it’s also important to consider that the market dynamics for larger companies going public are quite different. Their securities tend to be purchased more broadly by institutional investors and there is more liquidity in their stocks. Commissioner Jackson suggests that the “middle market tax” may be another deterrent for smaller and middle market companies to defer or avoid undertaking IPOs. The Commissioner also draws a connection to the availability of private capital. However, in practice, private capital is more readily available for the largest tech companies and not as readily available for smaller and middle market companies. For example, more mezzanine or late-stage private placements are completed for tech companies and for larger cap companies generally (across industries) than are completed for smaller and midcap biotech and life sciences companies. The smaller and midcap life science companies, to the extent that they can complete private placements, rely on dedicated sector investors and insiders and almost “must” go public in order to raise substantial amounts of capital. Larger companies have many more financing choices. Going public, I would argue, is more important to smaller and midcap companies. While, of course, it is important to consider all of the many factors that may be at play that affect the IPO market, the underwriting spread may have the least effect on a company’s decision. Additional disclosure regarding “underpricing” is unlikely to have an effect on the IPO dynamics. Studying research coverage and the lack of institutional investor participation in smaller IPOs may be more directly impactful for smaller and midcap companies.
Today, Bill Hinman, Director of the Commission’s Division of Corporation Finance testified to the House Financial Services Subcommmittee. Mr. Hinman provided an overview of the Division’s ongoing projects and its priorities. He noted that the Commission remains focused on capital formation related initiatives designed to promote interest in having more companies undertake IPOs. In this regard, for the first time, he mentioned that the Division is considering rules extending the ability to test-the-waters to non-emerging growth companies. Extending the test-the-waters provisions to non-EGCs has been a measure that has been included in various proposed bills that have garnered strong bipartisan support on the House side.
Mr. Hinman also reported on measures affecting smaller companies. Mr. Hinman provided market updates on Regulation A offerings (since the amendments in 2015, 78 issuers have raised approximately $670 million in 185 offerings) and Rule 506(c) (noting $147 billion has been raised in reliance on generally solicited offerings under Rule 506). Mr. Hinman indicated that the Staff would be conducting retrospective reviews of these new exemptions. Mr. Hinman noted that the Division is considering recommendations that would expand the accredited investor definition. This is interesting given that amendments to the definition had not appeared as a high priority in the Commission’s regulatory agenda. He also signaled that the Division is considering harmonizing or rationalizing the exempt offering rules, which had been suggested by practitioners for some time now.
Addressing upcoming priorities, Mr. Hinman again mentioned the proposed changes to the smaller reporting company definition, the disclosure effectiveness initiative, the resource extraction payments rule, and possible revisions to the conflict minerals rule. The written testimony is available here.
Chair Clayton focused his testimony on the Commission’s plans with respect to the fiscal year 2019 budget requests, and provided some commentary regarding the best interests rule proposal. The written testimony is available here.
Recently, SIFMA held its Equity Market Structure conference, which addressed a broad range of issues. Of course, conference participants addressed market structure concerns that may affect a company’s decision to undertake an IPO or to remain public and pointed to recent statistics, reprinted below. The Securities and Exchange Commission has also undertaken discussions regarding equity market structure issues. Representatives from the Commission recently spoke at a University of Chicago-sponsored symposium commenting on the Treasury Department report recommendations to review market structure issues. The Commission has had the tick pilot in operation for some time providing for wider tick increments for smaller companies as a means of improving liquidity. While the pilot is set to expire early in the fall, it is clear that tick size increments alone are not a solution to achieve greater liquidity in the trading of stocks of smaller companies. For many companies considering an initial public offering, while listing rules, tick sizes and liquidity may factor into their considerations, these usually do not figure prominently in their decision making. It is interesting that the Treasury Department report recommendations regarding equity research rules have not received more attention by the Commission or by other market participants given that research coverage (and not market structure) concerns are top of mind for management of emerging growth companies.
The first quarter of 2018 saw increased year-over-year IPO activity, according to a recent report published by EY. A total of 36 IPOs were completed in 1Q2018, raising $12.8 billion in proceeds. This was a 44% increase in number of deals and a 17% increase in proceeds compared to 1Q2017. U.S. IPOs made up 12.5% of the 287 IPOs that were completed globally, which raised $42.8 billion in proceeds. The median IPO size for this first quarter was $140 million, with the three IPOs over $1 billion.
The healthcare sector accounted for 25% of IPOs by the numbers and the technology sector accounted for 25% of all proceeds raised. The top five most active sectors by number of IPOs included healthcare with nine IPOs, raising $0.7 billion; energy with six IPOs raising $1.8 billion; technology with four IPOs, raising $3.2 billion; consumer products with four IPOs, raising $1.7 billion; and real estate with three IPOs, raising $2.7 billion.
Of the 36 IPOs in the first quarter of 2018, 20 elected to be listed on the Nasdaq and 16 on the NYSE. 2018 has also seen 28 new public IPO registration filings, including filings by a number of high-profile technology unicorns according to EY.
To read more, see EY’s Global IPO trends: Q1 2018 report.
Authors Michael Dambra, Laura Casares Field, Matthew T. Gustafson and Kevin Pisciotta recently published a paper, “The Consequences to Analyst Involvement in the IPO Process: Evidence Surrounding the JOBS Act,” which reviews research analyst involvement post-JOBS Act in offerings. The authors consider whether participation by affiliated analysts in securities offerings affects their research by evaluating analyst activity relating to EGCs. The control group used are non-EGC issuers. The authors conclude that pre-IPO participation increases analyst optimism resulting in less accurate reports. While the paper presents interesting data regarding the value of research, it is difficult to gauge the differences that were observed pre- and post-JOBS Act in research involvement. Compliance policies for firms, including many not subject to the analyst settlement, prevent analyst participation in the offering process. There has been little to no practical effect from the JOBS Act relaxation of certain research activities in relation to EGCs. To the extent that there is greater “optimism” with respect to EGCs, it is difficult to isolate and attribute such sentiment to analyst involvement.
Last year, the Staff of the Division of Corporation Finance announced that it would expand its acceptance of draft registration statement submissions from emerging growth companies to all companies seeking a review of their registration statement. This expansion of the confidential registration statement review process was made available for both initial public offerings (“IPOs”) and those offerings within one year of a public company’s IPO. Notwithstanding the expanded availability, the process of the non-public, confidential review was left unchanged requiring issuers to publicly file the confidentially submitted registration statement (and other nonpublic draft submissions) at least 15 days prior to any marketed offering presentation or at least 15 days prior to the requested effective date of the registration statement.
As a result of the aforementioned expanded confidential review process, on March 16, 2018, the Staff of the Division of Investment Management announced that it will similarly accept draft registration statements that are submitted by a business development company (“BDC”), even if the BDC does not qualify as an emerging growth company, for nonpublic, confidential review. The Division also will similarly accept for nonpublic, confidential review draft registration statements relating to offerings that are submitted by BDCs within one year of an IPO.
A copy of the Division of Investment Management’s announcement is available here.
In a recently published paper written by Marshall Lux and Jack Pear titled “Hunting High and Low: The Decline of the Small IPO and What to Do About It,” the authors observe that initial public offerings undertaken by smaller companies (those below $100 million) have declined disproportionately compared to those of larger companies. Similarly, while there has been an overall decline in the number of U.S. public companies, the decline of smaller public companies has been more significant. According to the article, in the 1990s, small IPOs comprised 27% of all capital raised in public markets, while since 2000 they have represented only 7% of all capital raised. Based on a survey of literature, the authors identify five related principal causes for the decline, including analyst coverage trends, buy-side trends, a shift from active to passive investment strategies, the growth in private capital, and increasingly burdensome regulation. The authors have a number of recommendations, including the following: amending the definition of smaller reporting company (SRC), which already was proposed by the Securities and Exchange Commission; extending the emerging growth company on-ramp to ten years from five years; increasing the shareholdings required to bring a shareholder proposal; allowing companies to include mandatory arbitration provisions for shareholder-issuer disputes; and simplifying the disclosure framework. While it is clear how an extension of the on-ramp provisions and amendments to the SRC definition relate to, or would affect, smaller IPOs, the paper does not explain the rationale for the shareholder proposal or the mandatory arbitration provision changes and the nexus to reinvigorating smaller public offerings. It would have been interesting to have seen recommendations relating to research coverage, particularly since the authors identify changes in research coverage trends as a root cause of the decline of smaller public offerings.