The new U.S. JOBS Act is not, strictly speaking, about jobs. It’s about making initial public offerings for modest-sized businesses much less complicated and costly. Which is probably good news for small to medium-sized businesses looking to grow, for investment bankers looking to land more deals – and, yes, maybe for job creation at those businesses, too.
But investors may be the ones getting jobbed. We’ve seen the kind of IPOs that spring from this sort of regulatory framework before, during a little thing called the dot-com bubble, and they’re not the kind we really need to see again.
The Jumpstart Our Business Startups (JOBS) Act – signed into law by President Barack Obama two weeks ago – contains a series of initiatives that ease regulatory requirements on the way that smaller companies can raise capital from investors. Some of the changes are catch ups with modern technology, such as the new rules allowing start ups to recruit investors via “crowd funding” – raising capital via the Internet. (Previously, you could raise money through crowd funding, but contributors couldn’t receive shares – their contributions would essentially be donations.) Other rules exempt smaller start-ups from regular filings with the Securities and Exchange Commission, thus removing a costly and time-consuming bundle of red tape for a small business.
Among the most striking rule changes, though, are those that affect bigger, more advanced-stage companies that are pursuing stock-market IPOs through investment banks. These are the so-called “emerging growth companies” – firms with less than $1-billion in annual revenue. (A recent Bloomberg editorial said that more than 90 per cent of companies going public would slide under this remarkably high bar.)
Emerging growth companies will now be exempt from an outside audit of their internal accounting controls for up to five years after they go public. Their management will be permitted to promote their IPOs to prospective investors prior to filing a prospectus – and they won’t be held accountable if the information in pre-prospectus presentations and brochures is inaccurate or misleading. And investment banks will be allowed to publish research reports on emerging-growth IPOs that they are themselves underwriting.
In short, the JOBS Act unwinds some of the key investor protections put in place under the Sarbanes-Oxley and Dodd-Frank laws, as well as the restrictions on investment bankers’ research contained in the Wall Street settlement of the conflict-of-interest scandals that arose in the dot-com bubble.
“People have apparently forgotten just how crooked the IPO market was during the tech boom,” wrote financial-industry critic Matt Taibbi of Rolling Stone, in a recent blog post on the magazine’s website.
Perhaps the abuses have slipped from people’s minds, but the aftershocks on the IPO market haven’t escaped the industry’s notice. The small IPO is on life support.
In the 1990s, IPOs of $50-million (U.S.) or less represented more than half of all IPOs in the U.S. market. In 2011, they accounted for less than 15 per cent. Bloomberg recently noted that the number of IPOs for companies with less than $50-million in annual sales is down more than 80 per cent since 2001.
But when we’re waxing nostalgic about the heyday for small-cap IPOs, let’s remember the IPOs we’re remembering. Many of them were lousy, under-scrutinized, overhyped disasters that cost investors dearly.
“Over 70 per cent of the IPOs during that period were unprofitable companies, many of which went out of business,” said Kathleen Shelton Smith, chairman of IPO research and investing firm Renaissance Capital LLC, in testimony to a U.S. Senate hearing on the JOBS legislation last month. “The bursting of the Internet bubble devastated IPO investors, causing losses of 49 per cent and 61 per cent in 1999 and 2000, respectively, far worse than the rest of the equity market.”
Ms. Smith argues that it was these deep losses – and not over-regulation – that undermined the small-cap IPO market. It wasn’t that issuers and underwriters weren’t willing to sell new issues, it was that investors didn’t like the risk of buying them.
And the JOBS Act will only heighten that risk again.
“The most powerful fix for the IPO market would be to improve returns for IPO investors,” Ms. Smith argued. “Waiving certain disclosure and stock-promotion rules that could result in misallocating capital to weak and fraudulent companies will only endanger the recovery of the IPO market.”