Is Spotify’s Direct Listing a Harbinger of Change in U.S. Capital Markets?


Spotify

Matt Levine over at Bloomberg View thinks that Spotify should charge everyone royalties. Not for the music, but for laying the framework for the large scale direct listing, which, as everyone knows by now, is supposed to be happening Tuesday on the New York Stock Exchange. By being the shiny unicorn that it is and by side-stepping the traditional IPO process, Spotify will potentially be setting a precedent for other companies to take a detour around the decades-old traditional IPO process. That process typically starts when the company hires expensive Wall Street bankers to evaluate it and the market and to come up with an arbitrary IPO price. The bankers then go on to convince insiders not to trade their shares for several months after the IPO, weigh down the company’s management with all sorts of requirements and prance around the globe for six months doing the dog and pony show (aka road show) for potential investors, all while charging a ridiculous amount in commissions so that in the end the company can become a public company and subject itself to being dissected by the media and the regulators. 

The Direct Listing Way

Surprisingly enough, Spotify said thanks, but no thanks, and decided to go its own way via the direct listing. In the direct listing, Spotify will not be raising new cash or issuing new stock. It will just be listing its existing shares on the NYSE and allowing its insiders to sell them if they so desire. There was no dog and pony show, and the management, although I am sure considerably charged by the preparation for the listing, got off easy in comparison to what it would have been required to do had the company chosen a full-blown IPO. What Matt Levine is suggesting and others in the market have been hoping or dreading (depending on whether they are on the banker side of the market) is that companies in the pipeline for a potential IPO might, looking at Spotify, also take the direct listing way out.

Which Way is the Market Going?

Regulators are also watching how all this will play out. Numerous panels at numerous conferences over the last two years have been bemoaning the decline of the traditional IPO, the longer lifespan of private companies before they go public, and the general unwillingness of companies to become public. Various reasons have been thrown out there, including the arduous and lengthy IPO process described above, the expense and headache of post-IPO periodic disclosures required of public companies, the loss of control by the company’s founders through the issuance of additional voting shares, the strength of the private sector that has been willing to dive into almost any new project with suitcases full of cash, etc., etc.

At a very lively roundtable discussion on March 29 at Columbia Law School that was presented in conjunction with the Bloomberg Law-sponsored New Special Study of the Securities Markets, panelists voiced strong viewpoints on the health of the public company market in the United States and the challenges of various market forces. Jeffrey Karpf of Cleary Gottlieb called out the onslaught of activist investors as one of the main, if not the main, deterrent to entry into the public company sphere. He said that public companies are now experiencing too much pressure from activist investors, and that founders of private companies watching from the sidelines are just not willing to open themselves up to such pressure. When listing other deterrents, Professor John C. Coffee, Jr., of Columbia Law School, mentioned the length of the IPO process and the difficulty of getting a high enough valuation in the public market vs. the private market. For unicorns that are flush with cash, he said it would be futile to raise extra funds through an IPO in a market in which such funds could not be gainfully invested and would only sit idle under the mattress awaiting projects yet unhatched. He categorized the decrease in the number of public companies over the years not as a failure of public markets, but rather as a success of the private sector.

Which Way are the Regulators Looking?

Whichever way they are looking, apparently they are not seeing properly to the public disclosure rules. According to Professor Hillary Sale of Washington University School of Law, the Management Discussion & Analysis (aka MD&A) section in public filings is far less valuable to investors than it should be. The U.S. Securities and Exchange Commission (SEC) sets the rules for disclosure, but in Ms. Sale’s opinion, does not follow through with sufficiently vigorous enforcement, letting the disclosure slide into a meaningless recitation of immaterial facts that obscure the big picture for investors. Ms. Sale referred to a recent explosion of legal actions being brought against companies based on misstatements or omissions in the MD&A. She called for the regulators to make up their minds on the kinds of information companies should be disclosing in their MD&A and step up their enforcement.

Professor Donald Langevoort of Georgetown Law School advocated for building a continuous disclosure regime and moving away from the outdated quarterly and annual periodic reporting structure. He implied that is it almost shameful in this day and age of technological capabilities to still allow companies to disclose material information at three-month intervals when it could be disclosed electronically as it becomes available. He also advocated for the risk factor disclosure to address probabilities, not possibilities. The newly appointed SEC Commissioner Robert J. Jackson, Jr., was on the panel, so it’ll be interesting to see if these admonitions percolate into new regulations somewhere down the road.

The Wrong and the Right Way

Commissioner Jackson and former Commissioner Daniel M. Gallagher addressed audience questions on the advent of cryptocurrencies, ICOs and the recent related regulatory crackdowns. It is no secret that various regulatory agencies, including the SEC and the Commodities Futures Trading Commission (CFTC), not to mention various state securities regulators, have been tripping over each other in attempts to peg the developing digital technologies and related market places into the existing square holes of securities and commodities laws. Commissioner Jackson echoed Chairman Jay Clayton’s view that tokens are essentially all securities and applauded the actions the SEC has taken to step up enforcement, disseminate information, and prevent fraud. He mentioned that digital securities exchanges have not yet seen the full brunt of regulatory action, but implied that that is coming down the path fairly soon. He said that the current state of the cryptocurrency market gives him a glimpse into the frightening world of fraud and lawlessness that would have existed had we not enacted our current securities laws.

The Future Way?

Aside from a few defying but uncertain glances from the student contingent in the room, the general feeling seemed to be that although the world of crypto is a legal minefield, it is also an irreverent fad that will disintegrate into nothingness soon enough. The panel did not pay much heed to the future of U.S. and world securities markets as augmented by blockchain, decentralized banking, or other futuristic concepts. Perhaps they were reserving a serious conversation on that topic for the future. Direct listings, on the other hand, were a different story. Professor Coffee expressed the hope that Spotify’s direct listing will catch on as a method and pave a new path for the elusive IPOs in the near future. Although not as exciting as the promise of world-wide decentralized regulation-free, border-free economy, watching Spotify’s performance over the next few days and what follows should prove exciting enough for now.