On May 16, 2017, SEC Commissioner Michael Piwowar gave the opening remarks to the SEC-NYU Dialogue on Securities Market Regulation. The focus of the SEC-NYU Dialogue was the current state of and outlook for the U.S. IPO market. Mr. Piwowar specifically spoke about reviving the U.S. IPO market.
The declining IPO market has been a topic of review lately, and was one of the main points discussed at the SEC’s Investor Advisory Committee meeting held on June 22. SEC Chair Jay Clayton weighed in at the Investor Advisory Committee, stating that he is “actively exploring ways in which we can improve the attractiveness of listing on our public markets, while maintaining important investor protections.” Mr. Clayton’s words echoed his statements made to the Senate confirmation hearing prior to his swearing in as chair.
This blog summarizes Commissioner Piwowar’s speech and of course offers my views and commentary.
Commissioner Piwowar’s Opening Remarks at SEC-NYU Dialogue on Securities Market Regulation
Benefits of an IPO
Commissioner Piwowar begins by talking about the well-known benefits of an IPO, which he articulates quite well, noting that going public gives a growing company access to the public equity market, allowing it to raise capital from a diverse group of investors (including unaccredited investors) and usually at a lower cost of capital than private offerings. Additional capital can be used to hire employees, develop new products and technologies, and expand operations.
Mr. Piwowar goes on to point out that “[T]he beneficial uses to which that capital may be put are even more pronounced for small companies because they tend to be more innovative than large companies and they account for a substantial percentage of the jobs created every year.” As an attorney practicing in the small-cap space, I couldn’t agree more.
IPO’s also give founders, entrepreneurs and early-stage investors an exit strategy for some or all of their investment. Importantly, IPO’s create a public stock which can be allocated and available to employees through stock options and grants. As Piwowar notes, “[T]hrough an IPO, such employees can access secondary market trading of the firm’s securities and therefore translate anticipated compensation to real dollars.”
He continues, “[A] vibrant IPO market also allows retail investors to add economic exposure from growing firms and industries to their investment portfolios, either directly or through vehicles such as mutual funds. As such, investors can share in the wealth created by these companies and enhance their overall risk diversification.”
IPO’s also work to enhance capital markets in the private marketplace by providing a form of competition to private-equity investors. If a company has a going public option, they may be able to negotiate better terms from a private investor.
The disclosure provided by public companies enhances the decision-making process for both investors and customers. In addition, third-party information, such as securities analysts’, layers with the disclosure provided by the company itself to offer information and therefore investor protection that is not available in the private markets.
Piwowar concludes his discussion on the benefits with this succinct statement: “[I]n a nutshell, a robust IPO market encourages entrepreneurship, facilitates growth, creates jobs, and fosters innovation, while providing attractive opportunities for investors to increase their wealth and mitigate risk.”
Decline in IPO’s and Suggestions for Improvement
However, unfortunately, the U.S. IPO market has declined dramatically in the last 15 years. Since 2000 the average number of IPO’s per year has been 135, whereas in the 1990s it was 457. The decline in IPO’s has been even more prevalent in the U.S., which used to account for between 30%-50% and now accounts for less than 10% of worldwide IPO’s.
Interestingly, Piwowar states that the substantial drop of IPO’s in the U.S. is primarily a result of a disappearance of small IPO’s. In the ’80s and ’90s, IPO’s for less than $30 million accounted for approximately 60% and 30% respectively of all IPO’s. Piwowar notes that Apple, Cisco and Genentech were all small IPO’s. However, now small IPO’s account for less than 10% of all IPO’s.
Although he does not have an answer as to what has caused the decline, there are many theories, including the increase in available private capital through hedge funds and private-equity sources. In addition, some secondary trading markets have developed for private shares (such as the NASDAQ Private Market, which I wrote about HERE). However, in my experience these secondary markets are only available for the trading of an elite group of companies and only to an even more elite group of investors.
Piwowar also points to changes in the economic environment due to globalization and consolidations, including an increase in mergers and acquisitions of pre-public companies. He also points to cheaper debt financing; however, I disagree that cheap debt financing is available for smaller companies, including those that would complete smaller IPO’s. Many of the numerous articles and publications by renowned U.S. economist Lawrence “Larry” Summers and editorial content by publisher Steve Forbes discuss the systemic problem of lower interest rates, together with hyper-regulation (mainly Dodd-Frank), creating a system where cheap debt is available to those companies on the high end of the food chain, that don’t need the money, while none is available to start-ups, development-stage or small businesses in general.
This is a topic I intend to write on more, especially now that there is a growing movement for change, including that which is potentially supported by Piwowar himself, who has been a vocal supporter of small businesses and reduced regulation in the past.
Piwowar also points to regulatory changes as contributing to the downward trend in IPO’s, noting that the Sarbanes-Oxley Act of 2002 imposed higher regulatory burdens on smaller public companies. Piwowar observes that “[D]ecimalization and Regulation NMS changed the economics of market making for small company stocks and left fewer market makers willing to organize a market for small stocks post-IPO.” The increase in registration thresholds under Section 12(g) of the Securities Exchange Act implemented by the JOBS Act may also have an impact (for more information, see HERE). Piwowar’s insights into these issues are, in and of themselves, a step in the right direction toward improvement.
Piwowar also points to Crowdfunding and Regulation A as deterring the IPO market by providing alternatives. However, I note that Regulation A+ is generally used as a going public transaction and rather than being labeled as an alternative to an IPO, should be considered as a type of smaller IPO and lauded for its effective increase in IPO’s (going public transactions). For my most recent overview of Regulation A, see HERE.
Piwowar points to the lack of underwriters for smaller IPO’s, a problem that the entire industry is well aware of. However, Piwowar blames the consolidation in investment banking and brokerage services for this problem, whereas I think the issue runs much deeper into the system itself. I believe that the U.S. regulatory and trading system has reduced the available compensation for underwriters to complete smaller IPO’s and for market makers to support their stock in the secondary market to the point of outweighing the risks of completing transactions.
A legislatively supported venture market would improve the system dramatically. See my article HERE. I also note that the OTC Markets has a platform in place and a desire to be such a venture market. However, as of today, it has failed to receive the legislative support necessary to make the effective changes needed to the system. Unfortunately, I believe that the SEC has historically been pessimistic and contrary to the OTC Markets and micro-cap space. Certainly, the recent white paper which I reviewed HERE was so.
A fundamental shift in this viewpoint could result in not only supporting and improving the economy overall by supporting small businesses, but also in reducing and combatting micro-cap fraud, which is a common goal for everyone in the industry, including legitimate businesses and entrepreneurs, investors, the OTC Markets, and service providers such as attorneys, accountants and auditors, and investment bankers. I do believe that there are many individuals, both in the private and public sectors, that agree with this view. For example, I believe that the SEC Advisory Committee on Small and Emerging Companies, many of the attendees at the SEC Government-Business Forum on Small Business Capital Formation, and the supporters of the JOBS Act, FAST Act and numerous part of the Financial Choice Act are of like mind. See more HERE and HERE.
Moreover, I’m certain that Piwowar has not included information on going public transactions on the OTC Markets in his analysis. Certainly, he has not included Regulation A+. I believe that there is a steady and constant stream of small companies going public on OTC Markets through direct IPO’s, Regulation A+, reverse mergers or alternative public offerings, and direct resale registration of existing shareholder securities. My firm is very active with these transactions, which have shown no sign of slowing down.
Piwowar seems committed to supporting changes that will help improve the IPO market. He notes that while acting chairman of the SEC, he implemented inflation adjustments to the definition of an emerging-growth company and to the thresholds under Regulation Crowdfunding. See HERE for a summary of those changes. I note that he also trimmed the SEC subpoena power, as discussed HERE.
Chair Clayton has expressed the same commitment to supporting U.S. public markets, including for smaller companies.