In light of the
substantial flaws in the IPO process revealed by the Facebook IPO, Chairman Darrell
Issa (R-CA) of the House Oversight Committee wants to begin a dialogue with the
SEC to fundamentally transform the regulation of the IPO process. In a letter
to SEC Chair Mary Schapiro, Chairman Issa emphasized that Congress must revisit
the Securities Act of 1933, which has given investment banks almost 60 years to
enjoy what is essentially flawed legislation fraught with conflicts of interest
and incentives to misprice shares. Among other things, he asked the SEC to take
advantage of the vast technological improvements to protect investors while
unleashing capital formation. More broadly, given the fierce global competition
for capital, he noted, the continued protection, over-regulation and coddling
of US financial firms will lead to a weakening of US financial markets.
The oversight chair
then posed a series of specific questions that he wants Chairman Schapiro to
answer by July 3, 2012. The Committee on Oversight and Government Reform is the
principal oversight committee of the House with broad authority to investigate
any matter at any time under House Rule X.
Chairman Issa asks
if the exercise of substantial initial pricing discretion provided to
underwriters and issues in the 1933 Act can lead to pricing errors and
conflicts of interest. Specifically, he asks if the pricing discretion
exercised in the Facebook IPO harmed retail investors. Regarding underpricing
and allocations, he asked the SEC to provide a summary of internal or external
research the Commission has relied on with regard to IPO overpricing and
underpricing throughout the past 20 years. The oversight chair also wants to
know if the vast majority of shares go to institutional investors and wants to
see summary data on the allocation of IPO shares over the past 20 years to
institutional investors.
The House leader
also had a number of questions regarding barriers to communicating with
investors. He noted that the Securities Act enables underwriters to determine
the price of the issuance while they develop support from select potential
investors under protection from public debate on the issuers’ valuation. The
protection from public debate arises out of the restrictions to communicate
outside of the prospectus. These communications restrictions generally fall
within the quiet period. Separately Securities Act Rule 175, in the view of
Chairman Issa, fails to properly carve out analyst research reports made by on
or behalf of an issuer from Rule 10b-5 liability. As a result of Rule 175, he
averred, analyst research is withheld from retail investors.
It seemed to him
that the liability construct provided under Securities Act Rule 175 needlessly
prevents ordinary investors from receiving valuable information on IPOs. Chairman
Issa asked the SEC if it recognizes that the quiet period rules and liability
under Rule 175 provide institutional investors an informational advantage over ordinary
investors. Similarly, he asked the Commission if the quiet period is more and
more difficult to enforce given the advances in information technology.
Specifically, he requested SEC comment on the costs and benefits of enforcing
restrictions on communication in light of current technology. More broadly, he
wants to know if the restrictions on communication in the Securities Act
inhibit price discovery in the IPO process.
Chairman Issa also
asks the SEC to explain how restricting the access of ordinary investors to
marketing materials from an issuer protects them. He queries if the quiet
period is intended to protect ordinary investors from themselves.
He also questioned if analysts working in the research departments of brokerage firms suffer potential liability under Rule 175(a) if their analysis fails to accurately predict the performance of an IPO issuer. He asked if the SEC believes that it is reasonable to expect that analyst estimates are accurate ex-post and that any liability should be associated with something as unrealistic as predicting the future. Further, he wonders if subjective requirements for a reasonable basis and good faith open the door to needless and excessive litigation and prevent ordinary investors from receiving valuable information.
He asks the SEC if
it believes that, under the Section 27A safe harbor for forward-looking information,
these same analysts can provide earnings estimates for public companies without
being subject to liability if their earnings fail to meet the estimates. The
SEC should explain the substantive basis for treating analysts of an IPO issuer
differently than the analysis of a public company. Finally on this theme,
Chairman Issa asks the SEC if it would, consistent with Section 27A, consider
amending Rule 175 to provide a broad safe harbor for forward-looking
information about the issuer.
On the issue of
market price and fair market value, Chairman Issa asks for an explanation on
why the SEC considers market price to be the best determinant of market value
and contrast this approach with the non-market approach applied to traditional IPOs.
He asks if the common post-IPO pop in share price reflects artificial underpricing
and whether the pop reflects positively or negatively on securities market
efficiency. He queries if the SEC has the authority to impose a market-based IPO
price determination process without legislation.
Further, the SEC
should address whether a market-based auction model would eliminate the pricing
discretion exercised by the underwriter and the issuer. More particularly,
would the SEC ask Congress for the complete abandonment of the non-market based
approach provided by the 1933 Act in favor of a market-based approach, such as
a Dutch auction that the issuer opens to all market participants. The SEC is
requested to provide the Committee with information on whether allowing short
selling within the Dutch auction could act to eliminate concerns over puffing by
opening up the IPO to a broader set of initial investors.