SEC to allow direct listings to raise cash

Hot tech companies and other startups will soon be permitted to raise money on the New York Stock Exchange without paying big underwriting fees to Wall Street banks, a move that threatens to upend how U.S. initial public offerings have been conducted for decades.

The Securities and Exchange Commission said Tuesday it had approved the NYSE's plan to allow so-called primary direct floor listings. The change marks a major departure from traditional IPOs, in which companies rely on investment banks to guide their share sales and stock is allocated to institutional investors the night before a listing. Instead, companies will be able to raise capital by selling shares directly on the exchange.

The SEC sign-off follows months of wrangling, including a decision made earlier this year to halt consideration of the proposal at the request of the Council of Institutional Investors, a group that represents major pension funds and endowments. CII had argued that the plan eroded investor protections and might make it more difficult for shareholders to sue over material misstatements or omissions made during the IPO process.

NYSE rejected those criticisms and disputed that the changes will increase risks to investors — arguments that ultimately won out. Getting the rule done under SEC Chairman Jay Clayton, who was appointed by President Donald Trump, might prove important for the exchange and Silicon Valley. That's because there's no guarantee an SEC chief picked by President-elect Joe Biden would approve NYSE's proposal.

To date, direct listings were really only an option for companies that wanted to give early investors or management the opportunity to cash out by selling stock. In September, workplace management software maker Asana Inc. and Palantir Technologies Inc., the data-mining company founded by billionaire Peter Thiel, used the strategy to go public.

Now that the SEC is allowing firms to raise fresh capital through direct listings, both critics and backers agree that they could become much more popular.

One reason why startups and their venture capital backers might favor direct listings is that there could be less of a gap between the offering price set by bankers and the pop that often ensues on the first day of trading. For instance, Airbnb Inc. opened at $146 a share during its IPO earlier this month, a much higher valuation than its $68 listing price. That arguably cost the company and its early investors $4 billion.

Even if banks don't underwrite direct listings, they'd still be expected to make fees advising companies that go public. As an example, Palantir paid out tens of millions of consulting fees as part of its offering, according to a regulatory filing.

Under NYSE's plan, when stock changes hands once trading commences, new shares will get priority over secondary ones. This will give companies a better chance at reaching their fundraising goals. Venture capitalists have long advocated for greater use of direct listings, in part because the arrangements don't require investors to wait for lockup periods to expire before they can sell their shares.

“We are disappointed that the SEC order permitting the NYSE to go ahead with its plan to allow direct floor listings failed to give adequate consideration to investor worries about liability and corporate governance that are exacerbated by the expansion of direct listings,” the CII said in an emailed statement.

In August, CII General Counsel Jeff Mahoney informed the SEC that CII intends to petition for a review of the decision. In an earlier comment letter, Mr. Mahoney said that investors may be subject to greater risk and have fewer protections with the change, and that the SEC failed to show sufficient basis for approving it.

P&I staff writer Hazel Bradford contributed to this story.