Should the SEC Take Action to Expand Private Share Offerings?
Republicans in Congress want the SEC to raise the 500-shareholder threshold that separates a private from public-offering of stock, or else change the rule so that more sophisticated investors who understand the markets will not count toward the total. The SEC is considering whether to ease the decades-old requirement that private companies with 500 or more shareholders make lengthy financial disclosures and a rule prohibiting closely held companies from advertising their shares, known as the "general solicitation" ban. The 499-owner limit, which applies to firms with more than $10 million in assets, was created to ensure that shareholders get sufficient information about their investments. House Republicans argue that restrictions on private-stock sales and the costs of complying with SEC rules for public stock offerings are negatively affecting companies' ability to raise capital.
In my previous blog on the LinkedIn IPO, I warned that inflated post-IPO stock prices following the LinkedIn IPO, and the prospect of the same happening with similar public offerings that are expected such as at Facebook, might create the same kind of pressure to manipulate reported earnings that we saw during the dark days of Enron and WorldCom. Past history tells us that too many top executive never seem satisfied with merely meeting financial analysts' earnings expectations. Revenue manipulations occur all too often to enhance reported earnings, drive up the stock price, and enable the top executives to cash in on lucrative stock options. I fear that any loosening of the 500-shareholder limit on private placements will add fuel to the fire that lays dormant right now but just needs a spark to set it off ablaze once again.
Am I an alarmist? Wouldn't it be a good thing for the SEC to loosen the rules and facilitate growing companies' access to America's investment capital? At a recent congressional hearing, SEC Chairman Mary Schapiro was pressed to make regulatory changes to help small and medium-sized companies more easily raise capital without going public. Rep. Darrell Issa (R-Calif.), chairman of the House Committee on Oversight and Government Reform, pressed the cause of businesses that want to tap investors for money but are far from eager to make the many financial disclosures demanded of companies traded on the stock market. Now, when companies amass 500 or more shareholders of record they are required to register with the SEC and make an array of disclosures, including how much money they are making or losing and how much they pay their top executives.
What's wrong with this picture? Why should honest companies that act with integrity be concerned about making financial disclosures including those about executive compensation? What ever happened to financial transparency as the goal of financial reporting? Moreover, why should the SEC even entertain this argument in deciding whether to relax the current rules? After all, its regulatory mission is to protect investor interests above all else. Schapiro hit the nail on the head at the hearing when she said: "Too often, investors are the target of fraudulent schemes disguised as investment opportunities...and that such frauds accounted for 22% of the commission's enforcement cases in fiscal year 2010."
You may recall that Goldman Sachs pulled the Facebook private offering on January 17 because of concern that '''immense media attention''' could violate SEC rules limiting marketing of private securities. Issa contends the decision showed that private capital formation in the U.S. is increasingly difficult. He believes that reversing this trend and efficiently attracting capital to the best investment opportunities in the U.S. is a critical step that would facilitate a widespread economic recovery and the long-term viability of our global market position. The SEC sharpened its focus on how unlisted companies raise money after Goldman halted a planned offering of as much as $1.5 billion in Facebook Inc. shares to U.S. investors. The foreign placement that followed was hugely successful and many investment bankers lament the lost opportunity for Facebook to tap into domestic capital markets.
The SEC's job is not to facilitate the process of raising investment capital in the U.S. The fact is some private companies are deliberately trying to avoid the disclosure and other laws enacted over time to protect the interests of the investing public, and Facebook is a prime example. Even if we concede that it may be a better economic policy for America to not limit the opportunity for private companies to remain private and raise capital without full disclosure, I believe companies like Facebook and Twitter, and all other private companies that choose to raise more funds privately rather than go public, have forfeited the right to set the rules of the game. They are part of a pursuit of self-interests system that encouraged their brethren to make risky investments with the public's money and that directly led to the financial meltdown of 2008. These technology and predecessor telecommunications companies and their investment bankers gamed the system and took actions that caused so much economic pain and personal misery for so many in the investing public -- that very same public the SEC is sworn to protect.
Blog by Steven Mintz, aka Ethics Sage, May 25, 2011