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.
Over the past year, proxy advisory firms, major index providers, and the SEC’s Investor Advisory Committee have weighed in on the growing number of companies with dual-share classes. Today, 9% of the S&P 100 and 8% of the Russell 300 are comprised of companies with dual-class structures. The Council of Institutional Investors has assembled and published a list of public companies with dual-class structures. During a recent program hosted at the Weinberg Center, titled “Snap Judgment: The Legal and Investment Issues Associated with Non-Voting Stock,” participants debated whether courts should step in and consider dual-class structures.
Traditionally, courts will defer to the business decisions of a company with independent directors that act in good faith having undertaken reasonable care. However, some participants noted that the business judgment rule has been premised on the notion that stockholders could remove a board with which they disagreed. In instances in which stockholders cannot hold boards of directors accountable by exercising voting rights, participants argued that it might be appropriate for courts to take on greater responsibility for shareholder protection through more active intervention. Of course, it could be argued that stockholders could simply sell their securities.
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.
Nasdaq Inc. plans to propose a rule to the Securities and Exchange Commission (SEC) that, if adopted, would allow stock exchanges (such as Nasdaq Inc. and the New York Stock Exchange) to provide smaller public companies with the option of limiting the trading of their listed securities to a single stock exchange. Presently, numerous secondary stock exchanges facilitate trading in public company securities even though the securities are separately listed on the company’s primary stock exchange. The proposed rule would likely increase total trading volume on the smaller public company’s primary stock exchange and, as a result, has the potential to increase the smaller public company’s liquidity and access to capital. Securities trading on private venues is not expected to be impacted by the proposed rule. Allowing more trading options for smaller public companies appears consistent with SEC Chairman Jay Clayton’s stated goal of making the U.S. stock market more desirable and attractive for smaller public companies. The SEC is requesting public comment on the proposal.
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 SEC’s Investor Advisory Committee made a number of recommendations to the Division of Corporation Finance, principally aimed at enhanced disclosure requirements, related to dual class structures. Specifically, Committee recommends that the Division:
- Require public companies that have dual class or other entrenching governance structures to prominently and clearly disclose: the numerical relationship between the amount of common equity or its equivalent economic beneficial ownership interest held by any person entitled to control or direct the voting of five percent or more of shares entitled to voting rights in the election of directors or the equivalent body (“ownership interests”), and the amount of voting rights held or controlled by such a person (“voting rights”), which the Committee refers to as “wedge” disclosure risks arising from the dual class structure and the inherent conflicts of interest; and risks arising from the exclusion of the stocks of companies with dual class structures from certain broad-based indices;
- Monitor shareholder disputes arising out of non-traditional governance structures to identify trends, especially those arising from conflicts of interest; and
- For issuers of non-voting stock, consider adding disclosure requirements to Form 10-K that would provide all information equivalent to that ordinarily included in a Schedule 14A, to the extent of the Commission’s authority.
In the meantime, the FTSE Russell is once again reviewing the inclusion of non-voting or minority voting shares in its indices. Voting-based bans from index inclusion have generated some controversy with some, including SEC representatives, suggesting that governance by index rules may itself be problematic.