Regulation: Bankers enraged by Jobs Act IPO rules
Research rules resurrect conflicts of interest; Cost savings ‘compromise safety’
The Jumpstart Our Business Start-ups (Jobs) Act, which was passed by the US Congress in April, introduced several rule changes designed to encourage small businesses back into the IPO market.
Such firms have largely abandoned IPOs during the past four years because of the costs of filing and the lack of research coverage. It is hoped this Act will entice them back – and in the process create more jobs.
Bankers, however, are livid with the new rules. “This Act turns the clock back on securities laws,” claims one New York-based head of ECM.
Under the new regulations, companies deemed small enough to be considered emerging growth may now go public with two years of financial statements rather than three. Also if in future legislation mandates auditor rotation, that requirement won’t apply to emerging growth companies. Such firms also do not have to go into as much detail on executive compensation as larger companies are required to.
“The US IPO market is considered one of the safest in the world and now these rules will set us back in protecting investors,” says the banker.
|Joel Trotter, Latham
& Watkins, Jobs Act
Not radical changes Joel Trotter, partner at Latham & Watkins who was on the task force for the Act, says that these changes are not radical, and were developed with input from investors. He adds that IPO investors consulted said that they only look at the current audited year and previous year’s financials when investing in a company. “No one debates that the extra year of financial statements is a significant extra cost, whereas it doesn’t yield any meaningful information to investors in a company growing at 30% per year, and this approach was based on existing SEC rules for smaller reporting companies, where the SEC had made a similar judgment about the additional financial information.” Trotter also notes that the companies would need to add one year of financial statements in each future year, so that in three years they would present three years of audited financial statements and five years of selected financial data.
Another area of contention is that emerging growth companies can choose to file confidentially while they consider going public, and can wait until one month before an IPO date before publicly revealing all information.
“Investors will have about a third of the time to learn a company and become comfortable with making an investment in an IPO,” says James Krapfel, equity analyst at Morningstar.
Critics of the Act argue that if companies are allowed to file confidentially then they are likely to do so, whether or not they intend to go public at the end of the filing. “IPOs don’t make banks a ton of money to begin with, and now we’ll be expected to help a company prepare for an IPO with perhaps no likelihood of it happening,” says one.
However, Trotter says it allows smaller companies to keep their intellectual property safe. “Almost 75% of companies that file for an IPO don’t end up going public, yet they’ve disclosed all their information to their competitors. That is a disincentive to filing in the first place and is a reason that M&A has taken over from IPOs as a way for small businesses to go to the next stage of their development,” he says. He also points out that foreign companies have been operating under the same SEC staff policy for many years.
The new rules regarding research have also resulted in much criticism from the banks. The Act eradicates the post-deal blackout period for research, allowing publication before the deal. It is designed to encourage an increase in research reports on smaller companies and therefore encourage more investment. But critics say pre-deal research is a conflict of interest.
“Research analysts will feel pressured to publish favourable research to please the underwriting bankers,” says Krapfel. “That could artificially prop up share prices until investors realize that the company is unlikely to live up to its illustrated potential.” He says while it will encourage companies to go public, it will have the disadvantage of making the IPO market “more frothy”.
The Act incorporates enhanced liability to make analysts more accountable for their reports, but bankers say it will be too costly in terms of compliance to make any pre-deal research worth their while. “It’s right back to the internet days where research is unreliable, conflicts of interest are huge and companies are going public that shouldn’t be,” grumbles a banker.
However, one equity portfolio manager at a large institutional investor suggests bankers are enraged because the changes will hit their bottom line. “Research doesn’t make them any money,” says the manager. “They make it all in sales and trading – so having only large companies go public is in their interest. But it’s not in ours. We want to have more opportunities to invest. And also, the Act enables us to have a longer dialogue with companies before they publicly announce an IPO so we can better understand them.”
Trotter says it is crucial that small companies be encouraged back to the public markets. “It’s not fair to say that smaller companies shouldn’t be public,” he says. Many household-name companies today were fledgling startups when they had their IPOs.”
The largest gripe among bankers seems to be that investment banks were not included in the discussions around the rules. The Taskforce, comprised of venture capitalists, public investors, entrepreneurs, academics and investment bankers, released its report last October, and draft legislation was introduced in Congress last December. Those involved in the legislation say many industry participants provided input throughout the process, although some were asked to comment but gave it short shrift as yet another set of rules that would take years to pass.
“I don’t think they realized it was a self-executing statute – not a rule that would require agencies to write more rules and follow a very long process,” says one lawyer. “It’s not Dodd-Frank.”