Speeding IPOs, outsourcing enforcement?

The Securities and Exchange Commission wants to boost initial public offerings - but may rely on the plaintiffs' bar to sue companies that stretch the rules.

The approach could shift more enforcement responsibility to private shareholder lawsuits - a notable twist, since litigation risk is often cited as a deterrent to going public, especially in this century.

James J. Moloney, director of the SEC's Division of Corporation Finance, said at a forum last week in San Francisco that he favors preserving investor protections but wants to make it easier - and much faster - for companies to go public when the market atmosphere is favorable.

The process for a company to go public lasts four to five months, with a lot of back and forth between companies, their lawyers and the SEC. Trimming that lengthy process is the goal.

"What we're trying to accomplish is to make it much more streamlined for a company to access the capital markets," Moloney said. "And if there is a false or misleading statement, if something's wrong, there's going to be the plaintiffs' bar. There's going to be us - enforcement - we can always come out and get you later."

Matthew C. Sferrazza, of counsel at Jeffer Mangels & Mitchell LLP in Los Angeles, said the SEC is planning to take a "lighter touch" to encourage more companies to go public but is not sure if it will boost initial public offerings.

"I think it may shift a little bit of where the bite for being sloppy or actually having potential fraud falls," he said. "The SEC has relied more on the plaintiffs' bar for detection and initial prosecution of issues, so they may end up taking that approach."

"This is prioritizing the facilitation of capital formation a little more, and the tradeoff will be a slight reduction in the SEC's direct protection of investors," Sferrazza added.

IPOs could get a boost - with a catch

Stephen Bainbridge, a professor at UCLA School of Law, is optimistic that the proposed changes would help revive the IPO market. But, he added, the plan to rely on post-IPO shareholder suits to catch corporate wrongdoers "is both ironic and a concession."

The problem with the current lag time in IPOs is that market conditions can change quite a bit while the SEC reviews the company's filing.

Moloney - who emphasized at the forum, sponsored by the UC Berkeley Center for Law & Business, that he was speaking only for himself - said things can change fast for pre-IPO companies due to geopolitical events or market slowdowns.

Robert W. Downes, a partner with Sullivan & Cromwell LLP who is co-head of the firm's Capital Markets Group, said companies worry about spending a lot of time preparing to go public only to have the market for public offerings slam shut.

"The IPO markets can stop on a dime," he said, citing not just the extreme example of the COVID-19 pandemic in 2020 but also the dramatic falloff in public offerings in 2022.

Companies can stay private longer

Downes said that companies have more ways to compensate employees to monetize equity and obtain acquisition currency than they did 10 to 20 years ago, especially Silicon Valley technology firms.

"They don't need to go public because they don't need the money," he said.

One structural change is the growth of venture capital funding, said Jay R. Ritter, an emeritus professor at Warrington College of Business at the University of Florida.

He said the SEC proposals are likely to have a modest impact on the IPO market because "it's hard to compete with the bigger players in many industries," especially in technology.

"The track record of small, standalone companies trying to grow organically has been unimpressive," Ritter added.

When Apple Computer went public in 1980, it had a 47-page IPO prospectus without a separate listing of risk factors, though some of the risks the company faced were mentioned. IPO prospectuses run hundreds of pages today, legal experts said.

Risk factors alone are often 60 to 70 pages long, in part to set up defenses against shareholder litigation in the future, even though critics say most of that consists of generic warnings.

The number of IPOs has declined in the 21st century. More than 300 companies went public each year on major U.S. exchanges between 1980 and 2000. But since then, the average number of traditional IPOs has been 114 per year.

Sferrazza said that while high-profile IPOs still will garner plenty of attention and SEC questions, he said the process could be slashed 30 to 60%, shaving a month off for smaller companies and encouraging them to go public instead of selling out to a larger corporation.

"If people hear it's easier to IPO now, they will consider that instead of a strategic private buyer," he said.

Even with regulatory changes, experts say the established system of private equity investments and M&A buyouts may limit how much IPO activity can rebound.

Voluntary quarterly reports?

One of Moloney's other proposals, which came from the president, is to make quarterly reports voluntary. He doesn't expect most large companies to take advantage of a possible proposal to allow companies to report on a semi-annual basis but said some corporations - such as life sciences firms and regional banks - may do so if a new rule goes into effect.