Should the SEC try to boost the IPO market?

By Felix Salmon
April 11, 2011
Clare Baldwin and Sarah Lynch are unambiguous: "As US regulators review rules on shares issued by private companies," they write, "they must not make it too easy for hot Internet companies such as Facebook or Twitter to avoid the scrutiny that goes along with an initial public offering."

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Clare Baldwin and Sarah Lynch are unambiguous: “As US regulators review rules on shares issued by private companies,” they write, “they must not make it too easy for hot Internet companies such as Facebook or Twitter to avoid the scrutiny that goes along with an initial public offering.”

They’re talking, of course, about the letter which SEC chairman Mary Schapiro sent to Darrell Issa on Wednesday. It’s a long and pretty boring document, and it’s certainly not as revolutionary as some of the press coverage would make you think. Jean Eaglesham, who broke the news without printing the letter, set the tone of the subsequent discussion by saying that the SEC review “could remake the way American start-ups raise capital,” “would upend the normal path for fledgling companies to raise funds,” and “could shut out many ordinary investors from one of the fastest-growing market sectors.”

But it’s hard to see anything in the letter which really supports Eaglesham’s reading. Mostly the letter is dry and legalistic, and in fact it takes pains to say that “the Commission seeks to minimize the costs of being a public company in the United States and provide a regulatory environment that encourages companies considering going public.” The part of the letter which talks about revisiting the 500-shareholder rule makes it clear that any change is overdue in any case, given how the rule isn’t having its intended effect:

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All of this seems much more like a common-sense view of a rule which hasn’t really been updated since it was enacted in 1964, and much less like a revolutionary attempt to kill the IPO market by making it particularly attractive to stay private. Certainly there doesn’t seem to be any point in forcing companies to give out options, or phantom stock, or stock appreciation rights, or other such weird and wonderful inventions, just as a means of getting around a rule which has been around for half a century and is showing its age.

And it’s easy to overstate what exactly goes on in places like SecondMarket:

The SEC is wrestling with the needs of private companies to raise capital against the investing public’s need to make informed decisions.

The issue has jumped into the spotlight as Wall Street banks and electronic markets offer investors a chance to buy and actively trade stakes in hot Internet companies such as Facebook, Twitter, Groupon and Zynga before they go public.

Investors are indeed being offered the chance to buy stakes in companies like Facebook — although Facebook is sui generis and is much more of an outlier than it is typical. But as far as I know, no one is actively trading any of these properties. The auctions come up irregularly, they often require shareholders to hold on to their stock for a period of years, and the trading costs are very high — on the order of 5% per trade. Meanwhile, Goldman’s attempt to come up with a private exchange where shares could be actively traded has fizzled embarrassingly, and never attracted any hot internet companies.

As Jason Zweig says, there’s a good reason retail investors are barred from investing in private placements: they are very risky and dangerous things. But global high net worth individuals are increasingly interested in buying in to such placements, and the SEC has no real reason to stop them from doing so. I’m not a fan of this development. But that doesn’t mean I think the SEC should keep its rulebook in 1964, just because doing so might allow companies to prosper in private hands a bit longer.

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