Plan to ease U.S. disclosure rules only half right

June 17, 2011

By Robert Cyran
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

A new plan to ease a U.S. disclosure rule that can be burdensome for private companies like Facebook gets it only half right. Tweaking, rather than gutting, the current requirements would be a better way to balance companies accessing capital with investor protection.

The current Securities and Exchange Commission rule, under which companies with 500 or more stockholders must publicly disclose their finances, can make firms that wish to remain private reluctant to give shares to too many employees. That takes away an important tool for luring new and potentially valuable workers.

And because once they have full disclosure obligations many companies see no reason not to go public, the rule can lead them to take their shares to public markets prematurely. That makes it hard for investors to analyze them and creates short-term performance pressures that can stifle young companies.

A bipartisan bill in Congress would raise the threshold to 1,000 investors and exclude from the count accredited investors institutions or high-net worth individuals — and employees.

Yet legislators should have legitimate investor protection concerns, too. There is already a thriving market in shares of private companies, especially new technology icons like Facebook. Operations such as SecondMarket and SharesPost allow employees and other insiders to sell shares in hot companies to accredited investors. These secondary markets are relatively new and cry out for scrutiny.

But there’s also the disclosure question. Demand Media, LinkedIn and Groupon have all been heavily traded while privately held. All the firms claimed to be profitable in recent years. But when they filed to go public, it turned out that by the SEC’s required standard measures, all three were losing money.

The problem is that hundreds or thousands of investors can’t really have inside knowledge. Forcing disclosure on companies costs them money, but markets experience even costlier friction if information isn’t freely available. Both 500 and 1,000 are arbitrary limits, and either is probably fine. And carving out employees sounds sensible.

But not counting institutions and wealthier investors toward the threshold figure smacks of favoring big money over small investors. Lawmakers should pick a number, carve out employees only — and scrutinize the activity on flourishing secondary markets.

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