Thursday, September 12, 2019

House subcommittee examines whether private offering exemptions are barrier to IPOs and retail investment

By John Filar Atwood 

The rapid growth of private markets and the decline in IPOs over the past few decades have given rise to a number of legislative proposals aimed at improving investment opportunities for retail investors. The House Financial Services Subcommittee on Investor Protection, Entrepreneurship and Capital Markets met today to discuss some of those bills and whether private offering exemptions create a barrier to IPOs and retail investment.

Subcommittee Chair Carolyn Maloney (D-NY) noted that private markets are now more than twice the size of public markets—in 2018 issuers raised $2.9 trillion in exempt offerings compared to $1.4 billion through public offerings. This raises questions such as whether Congress should permit retail investors to participate in private markets, and whether private offerings are actually better investment opportunities or not, she said. The SEC has relaxed the rules around private markets for decades, and it is time to ask whether it has gone too far in deregulating, Maloney added.

Mike Pieciak, Vermont commissioner of Financial Regulation and past president of the North American Securities Administrators Association, testified that NASAA is concerned that the current regulatory regime has gone too far in favoring private capital raising over public markets. However, he does not believe the solution is to encourage retail investors to get into the private markets.

Definition of accredited investor. Pieciak is not in favor of the proposals in the Fair Investment Opportunities for Professional Experts Act that would expand the definition of “accredited investor,” allowing more investors to access exempt offerings. NASAA is deeply concerned over the lack of information about private markets, he said. Public information is essential to the proper functioning of the markets, so Congress should work to reinvigorate and grow the public markets rather than encourage retail investors to enter the private markets, he added. 

Elisabeth de Fontenay, a law professor at Duke University, said that research suggests that retail investors would do worse if they were allowed into private markets. In the private markets, there are unregistered, unregulated investments with poor return prospects, she noted. In response to questions from Alexandria Ocasio-Cortez (D-NY), she acknowledged that retail investors would not have access to a reasonable valuation in private market, would have no audited financial statements, and would not be notified if a private company is under investigation.
In de Fontenay’s view, legislative proposals should encourage more companies to go public. This may require reversing the provisions of the JOBS Act that allow companies to stay private indefinitely, she advised.

JOBS Act changes. Renee Jones, a law professor at Boston College, agreed with de Fontenay, stating that the most effective way for Congress to shore up shrinking public equity markets is to reverse the JOBS Act amendments to Section 12(g). Section 12(g) allows unicorns (private companies with greater than $1 billion in market capitalization) to delay an IPO indefinitely, allowing important companies to operate in secrecy, she stated.

Congress should at least impose minimum disclosure obligations for companies of a certain size with dispersed ownership patterns, Jones testified. This reform would increase pressure for an IPO or sale, and provide needed information for investors considering purchasing shares, she said.

Doug Ellenoff, a partner at Ellenoff Grossman & Schole LLP, said the he favors the proposal to broaden the definition of “accredited investor” but would not support any changes to the JOBS Act. Private markets and public markets exist for very different reasons and constituents, he noted, and regulators should ensure that both are operating well with minimum regulation. In his view, companies should be allowed to remain private if they so choose, regardless of their size.

Cost of being public. Ellenoff emphasized that the cost of being public is burdensome. A meaningful percentage of a company’s profits go to preparing initial disclosures, he noted, and that money is out of pocket before a company knows whether its offering will be successful.

Subcommittee member Trey Hollingsworth (R-Ind) related a story about the CEO of a newly-public Indiana company who told him that it is very costly to be a public company. The CEO estimated that his company was spending $12.5 million per year to be public. Hollingsworth said that newly public companies need a runway where costs increase as a company grows rather than being hit with the high costs immediately.

Report to Congress. Witnesses also discussed the merits of a bill that would require the SEC to submit a report to Congress about private securities offerings. Among other things, it would require the Commission to conduct an impact study before proposing or adopting any change to a rule regarding either exempt offerings or reporting requirements for public companies.

While several panelists supported the legislation, Ellenoff does not. He noted that the SEC has already begun an effort to harmonize the offering framework by issuing a concept release in June. Any legislation in this area might get in the way of the SEC’s efforts, he said, and encouraged Congress to just let the Commission do its job.