For years, economists, regulators, and investors have struggled with a steady, precipitous decline in public offerings.
Fewer companies proceeding with IPOs means that Main Street investors lose opportunities to be a part of the prosperity that cutting-edge companies offer.
As he settles into his new role as chairman of the Securities and Exchange Commission, Jay Clayton wasted no time tackling the IPO dilemma head on.
Earlier this month, he announced that the Commission will extend a benefit currently offered to emerging growth companies (EGCs) under the JOBS Act to all private companies seeking to issue public shares.
The Division of Corporation Finance will now permit all companies, on a voluntary basis, to submit draft registration statements relating to initial public offerings for review on a non-public basis. The process will be available for IPOs as well as most offerings made in the first year after a company has entered the public reporting system. It will take effect on July 10, 2017.
“This is an important step in our efforts to foster capital formation, provide investment opportunities, and protect investors,” Director of the Division of Corporation Finance Bill Hinman, said in a June 30 statement. “This process makes it easier for more companies to enter and participate in our public company disclosure-based system.”
Among other criteria, an EGC is defined as an issuer with total annual gross revenues of less than $1 billion during its most recently completed fiscal year.
Permitting all companies to submit registration statements for non-public review will, the SEC hopes, provide companies with more flexibility to plan their offering. The non-public review process after the IPO may also reduce the potential for lengthy exposure to market fluctuations that can adversely affect the offering process and harm existing public shareholders.
By requiring a public filing period prior to the launch of marketing, the process incorporates a feature of the EGC review process that provides an opportunity for the public to evaluate those offerings.
“By expanding a popular JOBS Act benefit to all companies, we hope that the next American success story will look to our public markets when they need access to affordable capital,” Clayton said in a statement. “We are striving for efficiency in our processes to encourage more companies to consider going public, which can result in more choices for investors, job creation, and a stronger U.S. economy.”
Clayton elaborated on that mission during a July 12 speech at the Economic Club of New York.
“Evidence shows that a large number of companies, including many of our country’s most innovative businesses, are opting to remain privately held,” he said. “I met with a broad group of businesses at different stages of capital-raising and heard firsthand about the regulatory requirements and other considerations that factor into their decision to stay private or go public. One message was loud and clear: Private markets operate well in many sectors and, in these areas, they offer a very attractive alternative to the public markets.”
“This is an important step in our efforts to foster capital formation, provide investment opportunities, and protect investors. This process makes it easier for more companies to enter and participate in our public company disclosure-based system.”
Bill Hinman, Director, Division of Corporation Finance
“We need to increase the attractiveness of our public capital markets without adversely affecting the availability of capital from our private markets,” he added.
There are plenty of reasons why an IPO may not be desirable by a successful private company that has moved past its days as an EGC. One factor, of course, is the burden of regulation, compliance costs, and mandated disclosures.
FREQUENTLY ASKED QUESTIONS
The following is from a list of “frequently asked questions” published by the Securities and Exchange Commission regarding the voluntary submission of draft registration statements.
On June 29, 2017, the Division of Corporation Finance announced that it would accept certain draft registration statements for nonpublic review. The Division has prepared these questions and answers to address preliminary questions about the expanded procedures. The answers to these questions are not rules, regulations or statements of the Commission. Further, the Commission has neither approved nor disapproved them.
How should an issuer that is not able to rely on Securities Act Section 6(e)(2) submit its draft registration statement and indicate that it is doing so for nonpublic review?
It should use EDGAR submission type DRS. Detailed instructions on how to prepare and submit draft registration statements are in Volume II of the EDGAR Filer Manual. The current instructions apply to all draft registration statements; they are not limited to submissions by Emerging Growth Companies. Pending further updates to the Filer Manual, all issuers should follow these instructions.
The confidentiality provisions of Securities Act Section 6(e)(2) are limited to certain draft registration statements of Emerging Growth Companies. An issuer relying on the Division’s policy should consider requesting confidential treatment under Rule 83 (17 CFR 200.83) for its draft registration statement and associated correspondence when seeking a nonpublic review.
The Division announcement instructs issuers that do not have EDGAR access codes to check the JOBS Act § 106 box on the Form ID when applying for the necessary codes. Is there any legal significance to checking that box when the issuer is not an Emerging Growth Company?
No. Checking the box merely helps us preserve the nonpublic status of an issuer’s drafts until the issuer publicly files them.
How should an issuer convey its agreement with the public filing guidelines in the Division’s June 29, 2017 announcement?
The issuer should convey its agreement to those guidelines in a cover letter to its draft registration statement.
How may an issuer submit a Rule 83 request for confidential treatment with respect to a draft registration statement?
Issuers seeking confidential treatment for draft registration statements submitted pursuant to the Division policy may make their request electronically using submission type DRSLTR when they submit their electronic draft registration statement. If they do so, it is not necessary to also send paper copies of the request and the materials to the Division or to the SEC’s Freedom of Information Act Office.
An issuer should include a legend at the top of each page of the electronically submitted draft registration statement indicating that it has requested confidential treatment for the draft registration statement pursuant to Rule 83.
For an issuer that uses the Division’s expanded nonpublic submission process, when must it publicly file its registration statement and what does the issuer have to file with it?
An issuer conducting an initial public offering of securities or an initial registration of a class of securities must publicly file its registration statement, the initial nonpublic draft registration statement and all draft amendments thereto at least 15 days before it conducts its road show or, if there is no road show, at least 15 days before the effective date.
An issuer conducting an offering prior to the end of the twelfth month following the effective date of its initial Securities Act registration statement must publicly file its registration statement and its non-public draft submission of the registration statement no later than 48 hours prior to any requested effective date and time.
As is the case for all filed registration statements, the first publicly filed registration statement should be complete, including signatures, signed audit reports, consents, exhibits and accompanied by any required filing fees.
Should an issuer identify information for which it intends to seek confidential treatment when it submits its responses to staff comments on draft registration statements?
Yes. In its response letters, an issuer should appropriately identify information for which it intends to seek confidential treatment upon public filing to ensure that the staff does not include that information in its comment letters.
Growth Company omits from its publicly filed registration statement financial information that it reasonably believes will not be required to be included in the registration statement at the time of the contemplated offering, will the staff process it?
No. A registration statement must conform to the applicable rules and forms in effect on the initial filing date. The relief provided by Section 71003 of the FAST Act is not available to issuers other than Emerging Growth Companies.
We will, however, process a draft registration statement that is substantially complete except for financial information the issuer reasonably believes will not be required at the time the registration statement is publicly filed.
Is an issuer required to sign a draft registration statement?
A submission of a draft registration statement is not required to be signed by the registrant or by any of its officers or directors, nor is it required to include the consent of auditors and other experts, as it is not filed with the Commission. Upon public filing, are the previous nonpublic submissions required to be signed and to include consents?
When is the Securities Act registration filing fee due if an issuer submits a draft registration statement for nonpublic review?
The filing fee is due when the registration statement is first filed publicly on EDGAR. The statutory provision requiring payment of a registration fee under the Securities Act, Section 6(b), applies at the “time of filing a registration statement.” The voluntary submission of a draft registration statement is not a filing of a registration statement, so the filing fee is not due at that time.
Will the staff publicly release its comment letters and issuer responses to staff comment letters on nonpublic draft submissions after the registration statement is effective?
Yes. Consistent with our practice in all filing reviews, the staff will publicly release its comment letters and issuer responses to staff comment letters on EDGAR no earlier than 20 business days following the effective date of a registration statement.
May a Canadian issuer filing under the Multi-Jurisdictional Disclosure System take advantage of these accommodations?
May an asset-backed securities issuer take advantage of these accommodations?
May an issuer use the draft submission process to submit a draft post-effective amendment to an effective registration statement?
May an issuer that is not an Emerging Growth Company use test-the-waters communications with QIBs and institutional accredited investors pursuant to Securities Act Section 5(d)?
Does the submission of the draft registration statement constitute a filing for purposes of the prohibition in Section 5(c) against making offers of a security in advance of filing a registration statement?
If an issuer submits a draft registration statement for nonpublic review, may it make a public communication about its offering in reliance on the Securities Act Rule 134 safe harbor?
No. The Rule 134 safe harbor is not available until the issuer files a registration statement that satisfies the requirements of Rule 134.
If an issuer submits a draft registration statement for nonpublic review, may it make a public communication about its offering in reliance on the Securities Act Rule 135?
Yes, but a public statement about its offering may affect whether the Commission can withhold the draft registration statement in response to a request under the Freedom of Information Act.
As was seen during Mark Zuckerberg’s public debate over taking Facebook public, there is also a hesitancy to surrender a wunderkind CEO’s vision to a board of directors and shareholders.
The latter has led to increasingly complex share structures that are designed to offer greater flexibility to corporate founders and their managerial picks.
In March, Snap Inc., the parent company of Snapchat, moved forward with a $3.9 billion initial public offering.
It immediately faced the wrath of investor advocates over the fact that only non-voting shares in the company were offered to investors.
Public shareholders of Class A common stock will have no say in the running of Snap. Co-founders Evan Spiegel, chief executive, and Bobby Murphy, chief technology officer, owned 44 percent of total outstanding shares in the company prior to the IPO. They will, however, continue to control more than 90 percent of all votes even if their ownership interest dilutes over time. Control of the company will only change once both founders either die or voluntarily give up their shares.
In many ways, Snap’s approach to corporate governance shouldn’t come as a total shock. Tech companies, in particular, have increasingly favored tiered voting structures in recent years, with dual-class and multi-class share structures built around limited public voting rights.
Google/Alphabet, Alibaba, Facebook, Groupon, Zillow, Under Armour, and LinkedIn are among the companies where the majority of company control resides with owners of superior shares granted greater voting rights than the class of publicly owned stock. Objectives in doing so include giving founders—often lauded as visionaries—greater say in how their companies are run, with the ability to be nimble and pursue long-term strategies otherwise endangered by the short-term performance demands of typical shareholders.
Last month, Blue Apron Holdings, a meal-kit delivery company, faced similar backlash. The Council of Institutional Investors urged the company to not issue shares that give investors no voting rights, and to adopt a single class of shares with equal voting rights.
“The plan to go public with a triple-class structure that will severely limit its accountability to public shareholders,” CII warned.
“Public companies should provide all shareholders with voting rights proportional to their holdings; newly public companies that do not should sunset the unequal structure over a reasonable period of time,” Ken Bertsch, CII’s executive director said in a letter to Blue Apron’s lead independent director, CEO and general counsel.
CII has urged the main providers of stock market indexes—FTSE Russell, MCSI and S&P Dow Jones—to bar non-voting share classes from their indexes.Are there a lot of companies that have more than a billion dollars in revenues that are looking to go public? The answer isn’t entirely clear.
“As we’ve seen in the research, the vast majority of filers since the JOBS Act qualify as emerging growth companies, which makes sense,” says Gerald Guarcini, the practice leader of law firm Ballard Spahr’s securities group.
“If you find the proverbial unicorn that has $2 billion dollars in revenues and is still a private company, maybe they want to be a private company,” he says. “The fact they are able to file confidentially and work out some kinks with the SEC, probably wouldn’t prompt them to go pubic if they weren’t already thinking about it.”
“There is always a give and take, and you have to wonder whether loosening some of the disclosure requirements would be a positive in that regard,” Guarcini adds, citing disclosure obligations that began multiplying under the Sarbanes-Oxley Act.
The management discussion and analysis section of annual reports are “becoming a monstrosity,” as are ever-growing compensation disclosures, he says. Post-SOX, many thought the cost of new rules and regulations would cause a spate of going private transactions, but that “didn’t really happen.”
And, even if lessening the compliance burden helps encourage companies to go public, there is a “yin and a yang” and investor protection groups are likely to protest what they perceive as “secret filings,” Guarcini says.
“The activists are certainly out there,” he adds. “You need to engage with them with shareholder outreach because the alternative is that they are going to really going to make your life miserable.”
Control is always something that comes up when companies think about going public, says Ryan Wilkins, a shareholder at the Stradling law firm.
“We have seen dual-class stocks come back to an extent in recent years,” he says. “Issuers continue to have takeover defense provisions in their governing documents. There are definitely are ways IPO issuers can protect themselves and have the founders maintain control if that is a main concern.”
Why aren’t more companies going public? They may not need to.
“It used to be that you would go public because that was how you had access to capital, or if you wanted to grow and needed money for acquisitions,” Wilkins says. “Now, we have seen the public fundraising market become more sophisticated and many of the stronger private companies don’t have trouble raising money. The impetus for going public goes away or is at least mitigated.”
Nevertheless, Wilkins thinks the SEC’s efforts may help encourage going public. “It is fairly uncommon for companies that are above a billion dollars to go public, but nonetheless these accommodations are available and companies will view them as helpful,” he says.
The SEC’s most recent rule change is just one piece of a larger puzzle.
“The way I look at it is as an overall package of changes,” Wilkins says, referencing the JOBS Act and FAST Act, both of which had capital formation goals at their core. “The current set of guidelines furthers the work the SEC has done. It is the cumulative set of changes that is impactful.”
“It is exciting to think about the prospect of more smaller companies having the ability to go public with a path that is easier and shorter,” he adds. “It is ultimately good for the economy.”