From the moment Jay Clayton took the helm of the SEC, he has expressed a desire to increase the number of U.S. companies that are listed for public trading. In his first public speech, he noted the 50 percent decline in the total number of U.S.-listed public companies over the last two decades, and cited “increased disclosure and other burdens” as one of the factors prompting companies that “only a decade ago would have been all but certain candidates for the public markets” to remain private.
The Commission’s regulatory agenda under Chairman Clayton to date has been relatively modest, utilizing some policy changes by the Division of Corporation Finance to expand some JOBS Act benefits beyond so-called emerging growth companies, and some proposed streamlining of Regulation S-K disclosures. It may be appropriate to ask, however, how many small and mid-sized companies are actually being deterred from entering the public markets due to regulatory burdens? How much does it really cost to fill out an S-1, as compared to conducting a private offering, and how much more does a public company pay to comply with its periodic reporting duties than a comparably-sized private company pays to keep its investors apprised of its operations?
We also have more than five years of experience with the JOBS Act “IPO on-ramp.” The on-ramp, featuring a decrease in regulatory requirements for a rather generously titled group of “emerging growth companies,” certainly bears no resemblance to the always-clogged entranceways to I-95 here in Washington. While companies that have decided to go public have been responsive to some JOBS Act provisions, such as the ability to submit confidential draft registration statements, the measure has produced no noticeable uptick in public offerings.
Certainly the robust private capital markets have played a significant role in the downturn in IPOs, but there are other market structure issues at play as well. SEC Commissioner Robert Jackson tackled a major structural problem that deters many small and mid-sized companies from seeking public capital in a recent speech at an event co-hosted by the Greater Cleveland Middle Market Forum.
Commissioner Jackson called out the “extraordinarily high fees” charged by investment banks in connection with middle-market IPOs. He cited his own research, and the work of Professor Jay Ritter of the University of Florida, and pointed out that from 2001 to 2016, in more than 96 percent of mid-size IPOs, the issuer paid a fee of exactly 7 percent. Not approximately 7 percent, not a little more than 7 percent, in the range of 7 percent, but exactly 7 percent.
“With the deck stacked against them, it’s no wonder that middle-market IPOs have been on a steady decline,” Commissioner Jackson said. “The fees founders pay for an IPO also function as a tax, taking precious capital away from investment, research, and job creation.”
The commissioner observed that talk of the cost of being a public company is commonplace, but that there is almost no discussion in this space of the cost of becoming a public company.
He noted that this fee has remained constant over the years despite technological improvements that should have made the financing process more competitive and efficient, and remains unchanged without regard to factors such as the size of the issuer, the industry involved, the complexity of the offering or other characteristics. According to Commissioner Jackson, this uniformity indicates “a disconnect between the fee charged and the actual costs of a given IPO—as well as the need for more competition in the space.”
The current IPO process has many consequences and disadvantages for ordinary investors, according to the commissioner. Because high IPO fees may deter smaller companies from accessing the public markets during their growth stage, ordinary investors, who are usually invested through mutual funds, miss out on this growth potential and are only offered investment choices in mature companies with limited growth potential. In addition, investment banks often underprice shares in order to realize a “pop,” or a positive return on the first day of public trading. A good first trading day generates positive press for the offering, and rewards the institutional investors who subscribed to the sale of the initial shares. This practice generally excludes retail investors, however, and the proceeds from the first trading day make the initial investors happy but amount to money left on the table for the issuer. A 7 percent commission and an underpriced offering can certainly contribute to making the private markets look like a more appealing option for many mid-sized issuers.
The commissioner concluded by suggesting that it is essential to move beyond the red-tape focus of the current IPO discussion to examine market-based solutions. As an opening bid, he called for the SEC to consider more robust disclosure rules regarding both the direct and indirect costs of an IPO. He called for the SEC to consider requiring underwriters to prominently disclose the total costs of taking the company public, including costs related to IPO pricing policies. The commissioner concluded by saying that “if you want more cars on the road, lower the entrance toll.”
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