SEC walks back approval of LTSE as institutions debate benefits vs. risks
A new kind of long-term stock exchange initially approved by federal regulators now faces a less certain fate, as pension funds and other institutional investors try to figure out whether the benefits would outweigh the risk of giving too much control to founders of companies listing on it.
The idea behind Long-Term Stock Exchange Inc.'s proposed exchange is to reverse the downward trend of new companies going public, and to free companies and their boards from investor pressures to produce immediate results.
"The LTSE is designed to remove the short-term pressures that plague today's public markets and reorient companies and investors around long-term thinking," said founder and CEO Eric Ries in 2017 when announcing the concept, which is backed by prominent Silicon Valley investors. "Through brand new listing standards, software tools and advocacy, we're reinventing the public company experience with novel approaches to executive compensation, shareholder voting, disclosure practices, board and stakeholder policies, and community governance."
Among a roughly 50% decline in the number of public companies from 1996 to 2016, triple-digit increases in CEO compensation and a spike in activist investor campaigns, "we need a new approach to governance that benefits both companies and investors," Mr. Ries said in an October 2017 blog.
Efforts to reach to LTSE officials were unsuccessful.
The shift in focus to a company's long-term progress would come from giving investors more information, through listing standards that would include disclosures about a company's annual growth strategy and progress in meeting key milestones. The LTSE model also calls for new disclosures about stock buybacks, investments in human capital and research and development, and corporate policies on the company's impact on the environment and community and its approach to diversity.
Another key distinction is that quarterly guidance "is significantly restricted" to legally required reporting, with most disclosure made annually so companies are evaluated on the progress of their long-term strategy.
Prospects for LTSE being approved by the Securities and Exchange Commission looked bright earlier this year, when the division of trading and markets signed off on a proposal from Investors Exchange LLC to include LTSE as an optional listing category. Things changed June 29, when the SEC ordered a stay pending review by the commission itself after internal questions were raised.
The IEX proposal brought numerous comment letters of support, including one from Marcie Frost, CEO of the $344.4 billion California Public Employees' Retirement System, Sacramento, who wrote that "in our view, more long-term thinking is needed in the markets." That type of focus "will help ensure that company governance standards and policies are better aligned with share-owner interests" by providing a mechanism for transparency and regular disclosure."
A long-term stock exchange "might prove to be a surprisingly weighty contributor to changing the ethos of finance," said James Anderson, partner and head of global equities for Baillie Gifford & Co. in Edinburgh, in his comment letter, concluding that the firm with $256 billion under management would be "enthusiastic supporters."
More cautious support came from Aaron Bertinetti, senior vice president for research and engagement at Glass, Lewis & Co. in San Francisco, who supported the innovative approach but raised concern over how the proposed shareholder voting structure would protect all investors, not just company founders. LTSE would require companies to use tenured voting systems, with shareholder voting rights increasing over time, and company founders and other early investors seeing their votes multiply tenfold over 10 years.
A February research paper by professors at Vanderbilt University Law School and Columbia Business School looked at whether tenure voting is a better choice than dual-class stock, which is vehemently opposed by groups including the Council of Institutional Investors in Washington. With a database on institutional investor stock portfolio turnover rates to model how tenure voting would affect a company's control rights, the professors concluded it represents an intermediate form of voting control that does not guarantee management control but does give control to managers maintaining large equity stakes. Institutional investors "are likely to see it as an improvement over dual-class stock structures in terms of giving them corporate governance rights, although less advantageous to these shareholders' rights than a one-share, one-vote voting system," the paper concluded.
Questions from pension fund officials and other investors over how tenured voting and other issues would be handled by the long-term exchange led IEX to withdraw its proposal on Aug. 15 to give investors more time to study the rules and structure. Still, said IEX spokesman Gerald Lam, "we support their mission. We want to see more long-termism in the market."
LTSE officials then decided to go it alone, submitting their own SEC application Nov. 9 to be an exchange, which is open for public comments for 45 days. The SEC has up to 240 days to act on that application, which if approved, would allow the LTSE to accept National Market System stocks.
Pension funds and other institutional investors welcomed the original concept of a long-term, investor-focused stock exchange, but LTSE's current application offers few details, said Tyler Gellasch, executive director of Healthy Markets, an investor-focused non-profit organization in Washington whose members include many pension funds.
"LTSE was initially billed as improving listing standards to the benefit of long-term investors, but there were real questions about how it could work. Rather than address those questions, it seems like LTSE is simply applying to become just another stock exchange. Now the question is, what value does this have for investors or the marketplace, and that's hard to say. They could always apply to change their rules after becoming an exchange, but what those would look like remains unknown," Mr. Gellasch said.
Mr. Anderson of Baillie Gifford said his firm stands by its comments supporting the concept. "Indeed, we are disconcerted that they are apparently not shared by others who profess to be troubled by the problems of current quarterly finance capitalism. Experiences we have had suggest the need for relations of trust between investors and companies willing to think for the long term and for economic and social good rather than favoring traders, hedge funds and speculators. .
"The LTSE proposals are just the type of voluntary exploration of alternatives that are to be welcomed," Mr. Anderson said.
The SEC said it will grant LTSE's stand-alone application if it finds that rules and regulations are satisfied. Comment letters due in early 2019 are expected to have a lot to say about that.