The deck appears to be stacked against small firms seeking capital, small brokers and even small investors. A recent SEC-NYU Dialogue on Securities Market Regulation, titled ‘Reviving the US IPO Market’, held at NYU’s Salomon Center on May 10, 2017 , confirmed these points.
But despite the gloom and doom forecast for IPOs by conference panelists, I think there are some steps regulators can take to help the smaller market participants, and improve the IPO process and the efficiency of capital markets along the way.
One of the first points the panels explored was the link between IPO activity and market health. The first panel, including a number of Economics professors, concluded, as we all know, that IPO activity is down sharply from peak levels, which is bad for the markets. To use an analogy, envision that the middle class is disappearing , as the path to the upper classes becomes increasingly difficult to navigate and the former strivers give up. I say this because the data is indicating that smaller companies are coming to similar conclusions and are not going public. Consequently, there are fewer options in which people can invest. The large corporations such as Facebook, Google and Microsoft survive and thrive, and only the unicorns such as Uber, Airbnb and the recent Snap can come public. From my viewpoint in the industry for decades, the panel confirmed a direct correlation between the trends in the IPO market and the downsizing of the brokerage business in general. In the late 1990s, the market featured 50-60 capable underwriters, many independent research houses and a stable of market makers and specialists. Today? There are 7-8 large banks with capital markets operations and 20-30 other banks that do underwritings poorly. There are very few independent analysts, and many more high frequency traders , who spoof the markets instead of helping investors allocate the nation’s capital .
The second panel pointed out that, behind the scenes of the capital-raising industry, new owners of capital have emerged, with different objectives and time frames that ultimately may pose a risk to innovation. The panelists once again pointed out some of the obvious: more money is in private hands, private markets (PE companies buying and selling to one another) and private companies than 20 years ago. Chris Cooper, a very smart Global CFO of Sequoia Capital, argued that these changes are beneficial because his firm runs billions of dollars not just from rich people but also for pension funds, mutual funds (with IRA money) and public employee funds. He says the ‘average Joe’ is benefiting from this PE and VC investing, even though it has stymied the IPO markets. He is correct, but the issue is more complex. I believe there are still problems with corporations and professional money managers buying these small firms, as opposed to allowing them to grow on their own and potentially take on more risk than a professional money manager might allow. Slowing the growth of this group of companies could well lead to the loss of innovation. For example, what if Google was bought out by IBM or GE before its IPO ? Do you think we would have Waymo? My guess is no. Still Steven Bochner, a partner from Wilson Sonsini Goddrich & Rosati, seems to think that the IPO world should pick up later this year. Both Mr. Cooper and Adam Smith of KKR also believe more companies will come to public markets than we’ve seen, as the private markets are saturated and to make money in the take over world is very difficult right now. We shall see.
The third panel, led by Rick Fleming, an Investor Advocate at the SEC, addressed the future for IPOs — and continued to paint the bleak picture. The panel reiterated points already made: if you are not a big player with good money behind you and a solid longevity plan, then don’t look to the U.S. public markets for help raising money. This third group was supposed to discuss ‘How to Revive the IPO Market’, and I think every panel’s lack of ideas for revival was the biggest failure of the day. Not one person made a suggestion to the audience about anything that they thought might even help the IPO business gain momentum. The panels all decided that regulation was needed (think President Trump will listen to that?) but that the SEC should un-handcuff new issuers . And no one talked about current markets or its participants and what could be done.
So despite the promise of the day’s topic, the symposium ended up being a place where everyone was willing to complain and few were able to forecast any change. No one brought up the topic of the IPO market in 2000 and the internet bubble, with its flurry of questionable companies that went public, as a bad thing. No one said anything about the Banking Act of 1933, better known as Glass-Steagall. Now I am no politician, and whether bringing back a 37-page document (Dodd-Frank is over 1,000 pages) would be good or not is not my end goal. I do know that having the SEC help sustain the brokerage industry should be a priority if Washington really wants to help the IPO markets. And re-enacting at least elements of Glass-Steagall could help accomplish this by separating the super large banks from the investment banking world.
If we are trying to revive the IPO markets, why not discuss the penny stock problem on the Street? Or how about the currently tangled clearing situation? These are problems and issues for small- and mid-size brokers within the brokerage industry. These issues are linked very closely to the IPO market: a risky IPO that doesn’t go well and gets little industry support ends up a penny stock too quickly, with no markets or banks to help clear and trade these securities. Opportunities are lost.
Regulations are necessary in our business, and fraud is the elephant in the room that too many in our industry shrug off trying to market and sell these smaller companies. With the internet and social media as tools, perhaps vetting could be done by smaller players, without as much compliance bagg age. Is a qualified investor going to buy into a company with no website, officers who have been in jail or a corporate resolution in the Caribbean? It’s time to open the doors a little and set logical standards that companies can meet and investors can search. Indeed, this is already being done in the unregulated crowd-funding world online.
I would also like to suggest a new market designation of professional investor. The SEC has two choices right now: an investor is retail, or if the investor has more than $100 million under management, then the investor is institutional (qualified investors are for investment purposes, but not considered by the SEC for brokerage firms dealing with their customers). That’s a big gap. For example, if a customer is worth $10 million and is a professional trader and has an issue, then the SEC looks at such that person as retail. This needs to change. Europe has a program that could encourages transparency within the investment community and could be a model. In Europe, an investor can become regulated by the FCA simply by applying and paying nominal fees. With FCA accreditation, investors can open accounts quickly at major global financial institutions. The US needs to be able to designate all the professional players in its market as such. I think this type of program should relieve some of the litigation issues with the small IPOs.
In closing, I also want to ask the following: Do we want to help the IPO markets or do we want to further the advancement of the largest and strongest companies only? As a whole, it seems the government (all administrations) are trying to oversee just the huge banks — JP Morgan, Citi, Bank of America, Goldman and Morgan Stanley in particular. Smaller firms and outside players are then left to roll up into larger firms, whose basic business plan is only to tend to the segments, including the largest customers and investors. That’s despite the notion that small companies and small investors are the backbone of the US economy. If a real conversation is to take place with the SEC and all of the market participants on stage that day at NYU, then the seminar organizers should be sure to invite panel representatives from the small- or mid-sized firms who service these smaller investors and companies. I am available.
Kevin Schultz is the Chairman of Triad Securities Corp in New York, NY, a 40-year-old full service brokerage firm. His views are personal and statements of opinion, and do not necessarily reflect the views of Triad Securities Corp. Triad Securities Corp. is registered with the SEC and a member of FINRA.