The way that initial public offerings have been traditionally placed in the market harkens back to bygone days where paper was king. We’re finally looking to modernize this process.
One of the real obstacles for companies going public is the long and expensive process of getting a stock from the private side to offering their shares in public exchanges such as the NYSE and Nasdaq. We’ve already gotten a glimpse of the modern version of this, and we’re about to see more of this in the coming year.
The U.S. Securities and Exchange Commission, or SEC, has authority over both securities and exchanges, thus the name. While one of their primary goals is to protect the interest of investors, especially when it comes to promoting transparency, they prefer a very bloated approach to this, and anyone who has ever seen a full prospectus will readily attest to this.
Even the short version of these are extraordinarily tedious and go way beyond what virtually all investors want to know prior to investing in a stock. There are certain types of investments such as private equity, where the risks are greater, but these investments are considerably opaquer than public stocks, and if anything, we need more transparency, not less, with them.
Investments which are by their nature illiquid require a stronger commitment and we do need to use more care in ensuring that investors are well appraised of the circumstances of the investments that they are considering. Publicly traded stocks, at least those of at least modest size, are considerably liquid, and especially with the electronic platforms of today, where you can exit your positions in a flash of an eye.
Another distinction with public stocks traded on secondary markets is that you aren’t really investing in the company, at least directly, you are investing in public perceptions of companies, and there is a real difference. With private shares, how the company does is the whole ballgame, and while we may think that the same thing is true with public stocks, the fact that you can invest in them wisely without knowing anything about the company, and just trade the market’s response, speaks to the difference.
The risk of misinformation is therefore greater with private than with public equity, and we need to ensure that what is required is proportional to the actual need. Need doesn’t enter the discussion very much, and the SEC and other regulators are infamous for their overzealousness.
We need to rethink our approach to securities regulation and take a practical view of how we may protect investors but not seek to do so with an ad nauseum approach, and even dare to weigh the benefits of a regulation with its costs, at least once we surpass the minimum threshold. We do need to prevent misrepresentation and require concise and factual accounts, to ensure the proper balance between disclosure and expediency, although the latter has not been a goal historically.
We especially need to be aware of the potential of accounting trickery, which we see from time to time with established public companies, and avoid anything else which may materially misrepresent a company’s standing and results. This is not something we can afford to back off on, but there are other things that are not really meaningful that adds time and expense to the process of initiating public offerings, pandering to levels of microscopic examination that are well beyond what is actually used.
The SEC has recently shown a willingness to relax their stringent requirements a bit and this is certainly a move in the right direction for everyone. The biggest part of all this is the requirement for what is called the road show, where investment banks that underwrite the issues actually hit the road to pitch the IPO to institutional investors.
Times Have Really Changed Over the Last 40 Years Since Electronic Trading
In spite of this being now an archaic process, this is still how it is done, with the exception of a couple of 2019 IPOs that have taken advantage of the new relaxed standards to offer their shares to the public directly, bypassing the traditional process altogether. This is the wave of the future, and relies on the fact that people buy stocks directly, versus in the old days where you had to go to a full-service broker to buy all stocks.
Things have changed remarkably since the ticker tape days though, and IPO rules are finally being updated to reflect this. We actually use a direct approach ultimately anyway, after we’ve gone through a long process that was designed and required at one time, but decades have passed since.
One of the biggest improvements with direct placement is that this takes IPOs from the realm of the investing elite and places it squarely in the hands of everyday investors. You don’t need a huge account to warrant being handed out treats, where high value clients get an opportunity to buy these shares at usually a big discount to their actual value. This actually runs contrary to what regulators and markets should be striving for, to provide equal access and not tolerate inside exchanges that benefit the few over the many.
The principle that this violates is not unlike the one that we object to when seeking to curtail inside trading, where people are afforded an advantage based upon undue and unnatural access. Institutional investors do carry a lot of clout to be sure, but this is not a reason to not only allow them to get a special advantage by being offered these shares so much more cheaply than the market gets them, and especially not as a requirement.
This is not even about their clients getting this discount, it is the firms themselves benefiting that is the real issue, whether they pass on their benefits to preferred clients or not, although that does serve to expand the problem. People complain about unequal distribution of wealth, and while there isn’t much that we can do about this without violating principles of capitalism, we certainly should not be encouraging more by creating and sustaining an inner circle like this.
Direct Investing is IPO 2.0
If this was all required, and it certainly was at one time, then we could portray it as a necessary evil, but this is far from the case today. Some have wondered why companies cannot just throw their floats to the masses on opening day, after the required vetting of their issues by regulators, and the response has always been that it isn’t this simple. As it turns out though, it really is this simple or at least should be.
There are still some issues to manage with direct listings though. With traditional listings, companies would issue a certain number of shares before they hit the market and this was a known quantity. With direct investing, since the company is placing the shares in the market themselves, with the help of underwriters and exchange officials, our speeding up this process also removes the normal lead time that we have to decide whether additional shares will dilute things in a manner we do not prefer.
It turns out that this objection results out of confusion not fact, but unless we realize that the impact of news these days is immediate, we will miss this. If we have a year to prepare or merely seconds, the announcement itself is what moves markets, not the dilution, as we price stocks by way of what is on the horizon, not just what is at our feet. This is just something that we have to bear regardless, just like we have to with any other matter which materially affects stock prices.
There is one difference here with direct listings though, which is the ability for companies to introduce IPOs more gradually. This will require our attention, due to the potential effect of these surprises, but we can just set limits on this and also have companies declare their intentions over the near term at the outset. This is indeed not a time for additional uncertainty, and we already have rules such as the lock-out period to provide protection while new stocks are in their infancy, and even though this goes against principles of free exchange, it is at least felt to be worth this cost.
Whether or not that is actually justifiable may be another matter, as this does involve a bias to the long side by regulators, even though this bias is so strong that we not only may not notice it or deem it completely appropriate. In any case, those who wish to speculate that this may artificially increase a stock’s price will have their day, once these periods expire and the stock is left to fend for itself.
Both the NYSE and the Nasdaq are on board with this, and it makes sense that they would since this would have their exchanges playing a greater role in the implementation process, as well as promoting more IPOs in general due to its greater speed to market and lower costs.
Everyone wins but the institutions with this scheme. Since their disadvantage is created by removing the unfair advantage that has been bestowed upon them, this is actually a sorely needed remediation that stands alongside the other benefits, the lower costs, greater speed and efficiency, and the levelling of the playing field that direct listings accomplish.
We are now seeing the SEC slowly raising its crusty hand in favor of modernizing the IPO process, which has been a long time coming. Better late than never though.