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Legislators Push 'Fundamental Transformation of the IPO Process'

Joe Mont | June 21, 2012

Amid a controversial initial public offering by Facebook, and on the heels of JOBS Act legislation intended to be a regulatory-easing “on-ramp” for public launches, Congressional lawmakers are asking the Securities and Exchange Commission to take part in a “discussion regarding the fundamental transformation of the IPO process.”

A letter to SEC Chairman Mary Schapiro, penned by Rep. Darrell Issa (R., Calif.) on behalf of the House Oversight and Government Reform Committee, goes so far as to urge changes to the Securities Act of 1933, the blueprint for U.S. regulatory efforts that created both the SEC and longstanding IPO-related regulations.The correspondence, dated June 19, was obtained and printed on Wednesday by the Wall Street Journal.

The letter builds a case that investment banks no longer be allowed to set IPO prices, a practice known as “book building. Instead, all companies would take part in a “Dutch Auction,” where unrestricted order-taking sets prices via market demand.

It bears noting that Issa was an outspoken proponent of the JOBS Act, despite critics who countered that the confidentiality and scaled disclosure provisions afforded to Emerging Growth Companies ($1 billion or less in annual revenue) eroded protections for individual investors. Nevertheless, his letter focuses on how the role of institutional investors, as illustrated in the pricing of Facebook's IPO, and insufficient disclosures harmed those very same investors.

“In the week preceding the IPO, underwriters held a ‘roadshow' for investors, all while in-house analysts were simultaneously downgrading their forecasts,” Issa wrote. “These new forecasts were not directly disclosed during the roadshow. Nonetheless, consistent with the law, investors were privileged with the negative information.”

Issa wrote that the Securities Act of 1933 places substantial discretion at the hands of underwriters and establishes a “non-market-based” approach. A concern is “the ability of underwriters to dictate pricing while only indirectly considering market supply and demand in their price evaluation.”

Another issue raised is whether rules pertaining to roadshows and the “quiet period” restrictions on communicating beyond the prospectus undercut mainstream investors. Underwriters have the ability to develop support from select, potential investors while protected from a public debate over the issuers' valuation, Issa wrote, citing “limited public information regarding valuation issues that preceded the Facebook IPO" and the inadequate content of S-1 filings.

Among the questions posed to Schapiro in the letter, with a July 3 deadline for responses:

  • Did the exercise of pricing discretion in the Facebook IPO harm retail investors?
  • Do communication restrictions within the Securities Act inhibit price disclosure in IPO prices?
  •  Does the SEC recognize that the ‘quiet period' rules and legal liability provide institutional investors with an informational advantage over ordinary investors?
  • How does restricting ordinary investors' access to marketing materials from an issuer protect them? Is the quiet period intended to protect ordinary investors from themselves? Is “puffing,” or misleading investors with exaggerated marketing, the Commission's primary concern?
  • Does the Commission expect that “puffing” of an issuer would be likely offset by differing views that can be “quickly and efficiently” publicized in online articles, blogs and social media?
  • Section 105 of the JOBS Act enables broker dealers to publish research reports relating to Emerging Growth Companies. Is it the Commission's interpretation that research related to Emerging Growth Companies will still be subject to Rule 175?
  • Does this mean that, even in the case of these relatively smaller companies that seek to go public, retail investors will suffer the same informational disadvantage?