Lack of scrutiny not sitting well with experts uncomfortable over law's confidentiality rules
Not all IPOs are created equal.
Some industry experts are warning investors to remain cautious of a provision of the JOBS Act that allows companies with less than $1 billion in revenue to file for initial public offerings confidentially.
The most recent example of a company filing a secret IPO is Twitter Inc., which revealed its confidential filing in a tweet on Sept. 12. Through the stealth IPO, executives are hoping to delay the frenzied public scrutiny that faced companies like Facebook Inc., Groupon Inc. and Zynga Inc.
“Institutional investors want as much time as possible to analyze information,” said Jackie Kelley, Ernst & Young Americas IPO leader, based in Irvine, Calif. “So having these companies enter into a confidential filing process and not getting the information until three weeks before the road show, (investors) don't necessarily see that as an advantage from their perspective.”
According to a survey conducted by Ernst & Young, only 38% of U.S. institutional investors believe the confidential IPO clause is the biggest benefit of the Jumpstart Our Business Startups Act, which became law in April 2012. That provision allows smaller companies to file their IPOs confidentially, meaning businesses can have conversations with regulators outside of the public sphere and make corrections to their registration documents in private. Groupon, which went public before the confidential process was available, faced questions from the SEC about accounting methods, which created a string of bad publicity leading up to its stock offering.
“We had seen a gradual dwindling of companies wanting to go public because it required a lot of resources and was somewhat of a daunting process,” said Emily Mendell, vice president of communications for the Arlington, Va.-based National Venture Capital Association. The confidential filing clause “takes a lot of the scrutiny out of the filing process. You've seen examples of media frenzies around companies in the past, and they aren't always helpful.”
Twitter's structural and accounting methods will be temporarily shielded from financial analysts and journalists, but that means potential investors will be kept in the dark, too.
“People were embarrassed because the (Securities and Exchange Commission) would make them change or correct their filings, but that really does give you invaluable information when all the sudden you see a filing like Groupon that is totally misleading,” said Lynn E. Turner, former chief accountant at the SEC and current managing director at Los Angeles-based consulting firm LitiNomics. “It tells you a lot about the competency of the financial management of the company. Those conversations are important.”
Companies that elect to file a confidential IPO eventually reveal their financials — 21 days before their road show to investors — but any exchanges with regulators are attached to the back of the corrected documents, which can diminish some of the immediate transparency to investors.
“You see the cleaned-up, amended piece later on, and that hurts investors because the initial thing gives you a flavor of how investor-friendly the firm really is,” said Ed Ketz, associate professor of accounting at Pennsylvania State University, University Park, Pa.
Shortened time period
Another possible disadvantage of confidential filings, for both investors and companies, is the shortened time period for discussing the offering publicly, which could diminish some of the hype surrounding an IPO that often drums up more interest in the company.
“They used to have three or four months to get people excited, especially those with a good story to tell,” said Mark Arian, executive vice president of mergers & acquisitions solutions at New York-based Aon Corp. “Investment bankers say that the window is shortened now.”
In addition to keeping the filing process under wraps, filers also have the option to disclose only two years' worth of financial statements (instead of the three years required in a public IPO filing) and don't need to have their internal controls system audited for five years, which can also be a problem for investors.
“From an investor's perspective, there's a lot of value if you have a cleaner picture of the control system,” Mr. Ketz said. “With these confidential IPOs, even when the financial information is disclosed, they still don't have an audit of the internal control system, so you have less faith in what those numbers really mean.”
But the Ernst & Young survey said only 34% of companies that filed confidentially opted to disclose just two years of financial information, meaning most are more open about their finances.
“The intent of the provision was not to skirt public disclosure,” said David Fann, president and CEO of San Diego-based TorreyCove Capital Partners. “It's better not to have a protracted discussion in the public eye, and part of that is also related to not sharing that information with potential competitors. Investors still have three weeks to review its model and risk factors, which I think is plenty of time for some of these very sophisticated institutional investors.”
Ms. Mendell of the NVCA agreed the legislation was not meant to harm investors, though “this provision was written for the companies, it wasn't written for investors.”
The initial purpose of the provision was to spur job growth and encourage more companies to go public, but according to Ernst & Young, the number of successful IPOs has not significantly increased since the law was enacted. Although an estimated 250 companies have filed confidentially, there were only 133 effective IPOs overall in 2012, compared with 124 in 2011 and 160 in 2010.
“I don't think that (confidential filing) actually promoted IPOs,” Aon's Mr. Arian said. “If you were going to go public before, you were going to go public, but it's just made it easier and certainly a preferred pathway.”
Other factors that contributed to sluggish IPO growth were a weak economy, volatile markets and the high-profile poor performance of Facebook's IPO. Facebook's IPO initially performed poorly because of criticism over pricing and computer glitches at the Nasdaq during the first day of trading. The stock did not again reach its IPO price until more than a year after its May 2012 IPO.
Ms. Mendell of the NVCA said it could actually take a few years before the benefits of the JOBS Act are really felt, and both companies and investors should be patient. She also noted the volume of this year's venture-capital backed IPOs is already on track to outpace 2012. There were 49 venture-backed IPOs in all of 2012 vs. 49 venture-backed IPOs as of Sept. 23.
“Unless the market shuts down, we should surpass 2012,” Ms. Mendell said. “But in a healthy market, we want to see 100 venture-backed IPO's, so we still have a ways to go.”
Although the confidential clause will certainly increase the number of companies that pursue a public route, it won't necessarily increase the number of companies that ultimately succeed.
“It should increase the quantity of those hoping to go public, but it doesn't necessarily increase the quality,” Mr. Fann said. “Quality, not quantity, drives a favorable IPO market.” n
This article originally appeared in the September 30, 2013 print issue as, "Jobs Act IPOs need careful eye, some say".