By Jerri-Lynn Scofield, who has worked as a securities lawyer and a derivatives trader. She now spends much of her time in Asia and is currently researching a book about textile artisans. She also writes regularly about legal, political economy, and regulatory topics for various consulting clients and publications, as well as scribbles occasional travel pieces for The National.
The Securities and Exchange Commission (SEC) under its new chair, Jay Clayton, has wasted no time in doubling down on deregulation.
From today, the agency’s Division of Corporation Finance will allow all companies to submit draft registration statements relating to initial public offerings (IPOs) for review on a nonpublic basis, according to this agency press release. This new policy extends a benefit previously available only to emerging growth companies (EGCs) under the Jumpstart Our Businesses Startup (JOBS) Act to all companies.
According to a memo to clients by white shoe law firm Sullivan & Cromwell:
In particular, for IPOs and other initial registrations, an issuer must confirm in a cover letter to the non-public draft submission that it will publicly file its registration statement and non-public draft submissions at least 15 days prior to any road show or, in the absence of a road show, at least 15 days prior to the requested effective date of the registration statement. For eligible follow-on offerings, the issuer must publicly file its registration statement and non-public draft submission at least 48 hours prior to any requested effective time and date.
These new procedures will be available not only for IPOs but will also apply to most offerings made in the first year after a company entered the public reporting system.
Crucially, as spelled out in the Sullivan & Cromwell memo:
The announcement also provides additional relief relating to required financial statements for non-EGC filers. In particular, similar to the relief extended to EGCs under the JOBS Act, a draft registration statement submitted confidentially may omit financial information that the issuer reasonably believes will not be required at the time the registration statement is publicly filed. Similarly, the staff will consider requests for waivers of required financial statements made under Rule 3-13 of Regulation S-X. This is consistent with recent remarks made by Mark Kronforst, the Division’s Chief Accountant, encouraging companies to speak with the staff and noting that waivers have been granted historically “in the vast majority of the cases.” The staff will also consider reasonable requests for expedited processing, and issuers are encouraged to discuss their transaction timeline in advance with the staff.
Note that note that Clayton was a Sullivan & Cromwell partner until he became SEC chair , as I discussed in these previous posts, Trump Selects Jay Clayton, S & C Partner, to Head SEC and Taking on Trump’s Agenda: Nine Tough Questions for SEC Chair Nominee Jay Clayton on the Eve of His Confirmation Hearings.
Interested readers can find further details in this SEC announcement, Draft Registration Statement Processing Procedures Expanded.
Unbalances SEC Mission?
The SEC has a tripartite mission: “to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation,” according to this basic summary, What We Do, on the SEC’s website.
Clayton pledged in his confirmation hearings to focus on the third objective, facilitating capital formation, as mentioned in this client memorandum that another esteemed white shoe law firm, Davis, Polk & Wardwell, wrote analyzing the new procedures.
In announcing the new policy, Clayton said:
By expanding a popular JOBS Act benefit to all companies, we hope that the next American success story will look to our public markets when they need access to affordable capital…. We are striving for efficiency in our processes to encourage more companies to consider going public, which can result in more choices for investors, job creation, and a stronger U.S. economy.
Yet the new system to extend the JOBS Act benefit inevitably comes at the expense of the agency’s mission to protect investors.
The rationale for the new policy is to goose a moribund IPO market. As The New York Times Dealbook column noted in S.E.C. Lets All Firms Keep Parts of I.P.O. Filings Secret:
The move by the commission follows several slow years in the market for new stocks. And fewer initial public offerings have meant fewer publicly traded companies. From a peak of 7,322 publicly traded companies in 1996, the total number of companies listed on the United States stock market has plunged by nearly half, according to research by Credit Suisse, aptly titled “The Incredible Shrinking Universe of Stocks.”
Is this goal worthwhile? In this short post, I won’t focus on that question.
What I’m more interested in examining is a second question: Can we expect the new procedures to produce the touted benefits? A brief review of the background to the JOBS Act– and its failure to do what it was promised it would achieve– suggests the answer to that second question is No.
Background: JOBS Act Benefit and IPOs
First, a bit of background on the benefit. This is yet another example in which the seeds for a Trump deregulatory policy were planted during the administration of his predecessor, and its roots and shoots were then well watered.
Both Yves and Bill Black have written extensively on the JOBS Act travesty. Let’s review some of their previous posts so readers can better understand why extending elements of the JOBS Act– indeed, doing anything other than repudiating it is such a bad idea. Not only did the legislation seriously weaken securities law protections, but it has failed to produce much in the way of the benefits promised when it was enacted.
Let me start with a short excerpt from this 2012 post from Yves, Why You Should Hate the “Jumpstart Obama’s Bucket Shops” Act.
Obama seems determined to roll back the few remaining elements of the New Deal. As we’ve recounted, he’s keen to cut Medicare and Social Security; he said as much in a dinner with leading conservative luminaries shortly after his inauguration. And his JOBS Act, which guts securities law protections on smaller stock offerings, is touted as a way to increase employment by helping to fund smaller businesses. In reality, the only jobs it is likely to create will be due to the resulting explosion in stock scamsters and bucket shop operators.
Amar Bhide, who has written the classic, The Origin and Evolution of New Businesses, has decisively debunked the idea underlying the Obama Bucket Shop act, which is that public stock offering are an important source of funding for new businesses. The problem is, as Bhide explained, is that academics focus on the easy to study but relatively inconsequential venture capital funded companies which look to IPOs as an exit. Bhide found that only 1% of new and young businesses were funded by venture capital. Similarly, his multi-year study of Inc 500 companies found that a comparatively small portion had VC backing, and even then, many got VCs in at a late stage, not because they needed the money but having the “right” VCs would lead to a much bigger premium when they went public.
Next, in this 2012 post, Bill Black on How the Jumpstart Obama’s Bucket Shops Act is Just Another in a Long Series of Fraud-Promoting Legislation, Bill Black summarized the recent disastrous trajectory of legislation that promotes rather than deters fraud. The JOBS Act is only one of several sorry examples Black discusses. In particular:
We are living with a public policy for financial regulation that closely resembles a ratchet. With rare exceptions immediately following fraud epidemics that become scandals, regulatory policy only moves in one direction further loosening restrictions. The more crises these failed anti-regulatory policies create, the looser the regulations become and the more severe the crises become. We are destroying our economy and other nations, particularly in Europe, are following our lead with equally self-destructive results.
We’re seeing exactly this pattern recur with the latest SEC extension to the JOBS Act’s loosening of IPO regulation by extending the policy pioneered in the JOBS Act to all companies.
And, I should add, this is despite evidence that the JOBS Act wasn’t all that effective in promoting IPOs at all– which is consistent with what Yves wrote above and is supported by Bhide’s research. Yves elaborated on exactly this issue in her 2016 post Quelle Surprise! SEC’s “Make the World Safer for Fraudsters” JOBS Act Does Little to Help Companies Raise Money.
Allow me to quote extensively from that post, because it raises the obvious question here– if the JOBS Act’s relaxation of IPO rules wasn’t all that successful in helping companies raise capital, why should the SEC be doubling down on the policy? This is an especially important, since the policy isn’t costless, and indeed further erodes what used to be a safe and sound securities law framework.
Over to Yves:
And indeed, as the Wall Street Journal reports today, very little has in fact been raised by companies using the new filings established by the JOBS Act. It’s not hard to imagine that one big deterrent is the fact that these firms are exempt from having their financial statements audited. Honestly, you need to have your head examined if you are going to make an investment to people you do not know personally and would not (from a practical standpoint) be able to sue if you suspected misconduct. The Journal attributes the meager level of JOBS Act fundraising to the fact that many states have so-called blue sky laws that also require that securities offerings include audited financial statement. But I have to believe that at least as big an obstacle is friends, family, and professional advisors of prospective investors in these ventures warning them that the risks are far too large to justify taking the plunge.
Roughly a year after the passage of new rules making it easier for fledgling businesses to tap U.S. capital markets, just a handful of them have succeeded in doing so…
The new rules, known as Reg A+, reduce the legal and reporting requirements for making these offerings. The rules, which took effect last June, grew out of the 2012 Jumpstart Our Business Startups Act, or JOBS Act, aimed at spurring business growth and employment….
According to the Securities and Exchange Commission, 94 companies had filed to raise a total of $1.7 billion under Reg A+ as of early June. Of those, 45 offerings seeking to raise a total of $785 million have qualified to raise funds, and just a few have actually completed their offerings…
Among the biggest problems for the companies trying to raise funds is that they aren’t prepared for the amount of marketing needed to attract a big enough pool of potential investors…
Many other companies have found it tougher than expected to attract investor interest. “There has been some level of magical thinking,” said Ron Miller, chief executive of StartEngine, an online platform that hosts Reg A+ offerings. “Founders have perceived that there is this pent-up demand for investment in startup and tech companies” and that investors “would come out of the woodwork.”…
The new rule “very definitely is something that would work well for somebody who doesn’t need it, a company with a really big brand name,” said ralliBox founder David Kneusel. “But it is not something that is startup-oriented.”
FOIA and Unequal Access to Information
One issue raised by Davis, Polk in the client memorandum cited above is that some nonpublic information submitted to the SEC under the new system may be accessible via a Freedom of Information Act (FOIA) request:
[B]ecause the staff’s willingness to accept this new set of draft registration statements on a nonpublic basis is not grounded in statute, these draft registration statements are subject to discovery under the Freedom of Information Act by the press, competitors and others.
Now, that “and others” surely includes some investors. By making FOIA requests, they would thereby get access to the nonpublic information contained in the draft registration statement submitted to the SEC.
This would seem to create a two-tier system for getting access to information, with the higher tier comprising those who made FOIA requests and had early access to information submitted during the nonpublic review process, and the lower tier comprising everybody else. Such a tiered system would seem to violate a basic provision of the securities laws, as explained by the SEC in its What We Do,:
The laws and rules that govern the securities industry in the United States derive from a simple and straightforward concept: all investors, whether large institutions or private individuals, should have access to certain basic facts about an investment prior to buying it, and so long as they hold it. To achieve this, the SEC requires public companies to disclose meaningful financial and other information to the public. This provides a common pool of knowledge for all investors to use to judge for themselves whether to buy, sell, or hold a particular security. Only through the steady flow of timely, comprehensive, and accurate information can people make sound investment decisions.
It seems to me to be deeply problematic of release of investment information is staggered, given, in the first instance, to those who submit a FOIA request, and later to everyone else– even if everyone has access to the information when the deal is formally launched.
Little Public Buy Side Pushback
I’ve yet to see much buy side pushback against the new policy, and I’m not sure why that’s been the case. I can’t see that having less information– particularly early access to financial statements– would make the job of investment managers any easier.
Perhaps some of these have cottoned onto the idea that they may be able to get information via FOIA. I’m not so sure about this explanation– it seems to me that banking on getting necessary timely information, using the vagaries of the FOIA process, is at best a tenuous assumption– especially if, the Sullivan & Cromwell memo’s construal of the SEC Chief’s Accountant’s remarks on the SEC staff’s willingness to grant waivers of required financial statements is correct.
I am surprised we’ve not seen more buy side squawking about the new policy.
The SEC is one of the few administrative agencies that have enough commissioners now in place– three out of the full component of five– to conduct is business– in contrast to other agencies that cannot regulate at the moment, as I discussed in this post, Business Chafes at Uncertainty Created by Unfilled Seats on Regulatory Commissions. But if this policy from the Clayton SEC is the start, that’s not necessarily a good thing.
The latest policy did not emerge from a vacuum, a general phenomenon I indeed discussed in this post, in which the headline states the bottom line: Mary Jo White Leaves Behind a Weakened SEC for Trump to Weaken Further. It’s useful to remind readers that the intial JOBS Act isn’t something that Trump or his minions conjured up: and without the “Jumpstart Obama’s Bucket Shops” Act in place, Clayton’s SEC wouldn’t be able to promote its progeny.