IPO

JOBS Act Symposium: Which of the Title 1 provisions has the biggest potential impact to incentivize IPO offerings and will it work?

This morning’s first panel features Robert BartlettReza Dibadj, and Martin Zwilling, discussing the JOBS Act’s Title I provisions for initial public offerings.

The panelists were asked to predict which part of Title 1 of the JOBS Act will have the biggest impact on IPO offerings?

Reza Dibadj discussed the way in which the JOBS Act allows emerging growth companies to escape the onerous accounting and reporting required by the Sarbanes-Oxley legislation. Furthermore, companies are taking advantage of the opportunity to withhold executive compensation information.

Martin Zwilling emphasized that any changes to the law which decrease the number of regulatory hoops that have to be jumped through is beneficial to the IPO process. Some companies have had to dramatically increase their personnel and time resources to comply with Sarbanes-Oxley.

Robert Bartlett looked to the statistics about the parts of the JOBS Act actually being employed to understand which parts of the act are most effective. A Skadden, Arps study concluded that emerging growth companies are taking advantage of withholding executive compensation but are  still revealing three or more years of financial records even though the legislation permits them to offer with only two years of reports. Seventy percent of emerging growth companies are also taking advantage of the ability to submit their prospective IPO offer to the SEC privately.

Stay with The Network for further updates from the Berkeley Business Law Journal JOBS Act Symposium.

JOBS Act Symposium: Do Entrepreneurs Prefer IPOs or M&A Exit Strategies?

Is the IPO market depressed because M&A is becoming the preferred exit strategy for entrepreneurs?

Martin Zwilling opened by commenting that entrepreneurs today prefer M&A, because private acquisition is not as burdensome or costly as preparing for an IPO.  In addition, many startups have recently seen “huge premiums” paid via M&A, so their bottom-line return might approximate that generated by an IPO.  Mr. Zwilling also noted that many companies, including Intel and IBM, are beginning to look to buy their technology instead of creating it on their own—essentially outsourcing some of their product development.

Entrepreneurs prefer M&A’s speed, which allows them to ‘cash out’ and move on to creating a new company—what entrepreneurs love to do in the first place.

Professor Bartlett agreed with Mr. Zwilling, but argued that the dynamic has been in place for a long time.  Still, he acknowledged that M&A is preferred for many startups because entrepreneurs and VCs can monetize their investments immediately, whereas the IPO process locks up capital for six months and subject them to considerable market risk.  Even once the company has gone public, both are often prevented from quickly selling their equities because they’re considered ‘insiders.’  Prof. Bartlett concluded, “The thumb has always been on the scale, in my assessment, on the side of M&A” because VCs simply have more control over the process.

Professor Dibadj suggested that entrepreneurs might have become a bit more sensitive to the substantial underwriting costs associated with an IPO, which pushes them towards merger instead.  Marin Zwilling agreed—adding that VCs prefer business models with M&A exit strategies than IPOs.

JOBS Act Symposium: What IPO problems did the JOBS Act set out to solve?

This morning’s first panel features Robert BartlettReza Dibadj, and Martin Zwilling, discussing the JOBS Act’s Title I provisions for initial public offerings.

The panelists were asked to discuss the problems with IPOs antecedent to the passage of the JOBS Act and the problems that the Act set out to solve.

Reza Dibadj provided statistical evidence to support the fact that IPOs have significantly declined in the 2000’s. There was a significant fear on the part of policy makers that IPOs were declining or going overseas costing jobs here. But what wasn’t clear was the causation of the IPO decline. Statistics do not confidently show the cause of the demise of the IPO market and whether entrepreneurs are just preferring mergers and acquisitions instead.

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JOBS Act Symposium: The IPO On-Ramp

This morning’s first panel features Robert BartlettReza Dibadj, and Martin Zwilling, discussing the JOBS Act’s Title I provisions for initial public offerings.

Professor Bartlett began with the political economy surrounding the legislation.  He noted the interaction between initial public offerings (“IPO”) and a well-functioning venture capital (“VC”) ecosystem.  Without accessible IPO requirements or other sources of secondary financing, many VCs may be unable to recover their invested capital or exit the market.  But when companies can sell equity to the public, VCs can recycle the capital—the VC ecosystem can then support more growing companies and, in turn, job creation.

Title I of the JOBS Act emerged out of an industry task force’s white paper, entitled “Rebuilding the IPO On-Ramp.”  It recommended an on-ramp for emerging growth companies (“EGCs”) using existing principles of scaled regulation.  The central principle was to lessen the regulatory and disclosure requirements for new companies – encouraging them to go public – by creating a new EGC category.  The transitional category that emerged applied generally to companies with less than $1 billion in annual revenue, for as long as five years.

Congress acted quickly, adopting most of the white paper’s recommendations.

EGCs are subjected to less cumbersome regulation while on the ‘on-ramp.’  For example, they need only include two years’ of audited financials in their regulatory statements (instead of three to five years).  Also, Title I allows EGCs and underwriters to communicate with qualified institutional buyers prior to filing regulatory statements; and companies considering an IPO can file a confidential registration statement, to protect sensitive information if they decide not to go public at that time.

Liveblogging from the 2013 BCLBE and BBLJ Symposium

The Berkeley Business Law Journal will be covering today’s symposium, The JOBS Act: Initiatives and Challenges of the New Legislation, hosted with the Berkeley Center for Law, Business and the Economy.

The event is taking place at Boalt Hall from 8:45a – 2:00p and will include two panel sessions:  First up, “The IPO On-Ramp” featuring discussion and insight from Robert BartlettReza Dibadj, and Martin Zwilling.  Our second panel, beginning at 11:00a, will critique the “Crowdfunding exception” for IPOs.  Earlier panelists will be joined by Eric Brooks and Mary Dent.

Visit The Network often to follow the event.  Our writers will be frequently posting throughout the morning.

BCLBE and BBLJ 2013 Symposium — The JOBS ACT: Initiatives and Challenges of the New Legislation

A new frontier in securities law, but how will people use it?

The Jumpstart Our Business Startups Act (JOBS Act) offers new avenues for investors and small companies to participate in the market.  Leaders in business and law will be gathering at the University of California, Berkeley, School of Law on March 15, 2013, to discuss the Act’s opportunities and risks.  The Berkeley Business Law Journal and Berkeley Center for Law, Business, and the Economy are proud to present their 2013 symposium—The JOBS Act: Initiatives and Challenges of the New Legislation from 8:45a – 2:00p at Boalt Hall.  Registration is required.  The symposium will bring together prominent speakers from the fields of law, securities regulation, and venture capitalism to discuss two critical areas of the Act.

The first panel session will explore “The IPO ON-Ramp.”  In response to the decrease in companies applying for initial public offerings, the JOBS Act incentivizes companies to make an offering and introduces a gradual five-year plan to scale up to full public status.  Panelists including Robert Bartlett and Reza Dibadj from UC Berkeley, School of Law, as well as Martin Zwilling from Startup Professionals, will discuss the reason for the decline in IPOs and whether the steps taken in the JOBS Act will arrest and reverse this decline.  The IPO ON-Ramp panel runs from 9:00 – 10:45a.  Further readings about the IPO panel discussion are available on the BCLBE website.

The second panel will discuss the widely-publicized “Crowdfunding” public offering exception.  The panelists will demystify the types of small money investments that are permitted under the crowdfunding exception.  Having discussed the newly permitted activities, the panel will engage in a cost-benefit discussion of the opportunity for new investment avenues weighed against the potential for fraud inherent in this up-tempo investment frontier.  Panelists from the first session will be joined by Eric Brooks from the SEC and Mary Dent from Silicon Valley Bank.  The “Crowdfunding” panel will present their thoughts from 11:00a – 12:45p.  More information on the Crowdfunding panel discussion is available on BCLBE’s website.

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The Week in Review: FB, BNY Mellon, and Cybersecurity

Facebook (FB) has cleared an important legal hurdle, as a S.D.N.Y. district court dismissed a lawsuit regarding its fumbled IPO last May.  The plaintiffs had argued that CEO Mark Zuckerberg and other directors should be liable for selectively disclosing negative measures of the company’s performance.  Judge Sweet disagreed.  Unsurprisingly, a Facebook representative said they were “pleased with the court’s ruling.”  For more, see CNBC.

The IRS won a major case in U.S. Tax Court earlier this week, and the ruling could cost the Bank of New York Mellon more than $800 million.  The dispute arose from Structured Trust Advantaged Repackaged Securities (STARS) – essentially manufactured tax shelters marketed by the bank.  In ruling against BNY Mellon, the Court held the STARS program was a “subterfuge for generating, monetizing and transferring the value of foreign tax credits.”  For more, see the Wall Street Journal.

In a follow-up to a previous Network post, President Obama has signed an executive order on cybersecurity.  However, the President’s order does not reach tough new regulations on private companies, falling short of last year’s proposed legislation, and does not allow for broad information sharing with government intelligence agencies as proposed by CISPA.  Congressional reaction to the executive order is yet to be determined—some commentators view the move as taking pressure off Congress to act on cybersecurity this term, but even President Obama, in his State of the Union address last night, addressed the need for a comprehensive law.  For more, see CNET and BBC.

Why Increasing Tick Sizes May Lead to More Dark Pools Instead of More IPOs

Today, the SEC will convene a much-anticipated roundtable examining the current regime of penny-priced tick sizes on U.S. stock markets.  A principal purpose of the roundtable is to explore whether the transition to penny-priced quotations in 2001 (known as “decimalization”) has harmed liquidity in the securities of small and middle-sized companies.  The general theory, initially advanced in this Grant Thornton white paper, is that when securities were quoted in sixteenths of a dollar, trading spreads were kept artificially wide given the fact that bid-ask spreads could be no less than $0.0625 per share, creating large profit margins for dealers making markets in U.S. equities.  Such market-making profits, so the argument goes, were then used to support trading operations and analyst research in thinly-traded securities and the securities of newly-public firms.  In this fashion, the argument continues, the higher trading costs associated with fractional-quoting were actually part of a healthy ecosystem for nurturing the market for IPO stocks and smaller company securities more generally.

According to this theory, one way to bring back the IPO market is to undo the harm decimalization caused this ecosystem by increasing the tick size, or minimum price variation (MPV), when quoting the securities of smaller issuers.  It is an argument that has gained considerable support over the past year, as reflected in both Section 106(b) of the JOBS Act (which required the SEC to study the effects of decimalization on the liquidity of smaller firms) and the draft recommendations of the SEC Advisory Committee on Small and Emerging Companies (which recommends a “meaningful increase in tick size as a necessary step toward encouraging the reestablishment of an infrastructure designed to increase liquidity for small public companies.”)  And based on the agenda for today’s roundtable, a reasonable bet would be to see some form of pilot study being implemented in which the securities of certain firms must be quoted in an increment greater than $0.01.

While it is heartening to see the SEC take an empirically-driven approach to capital market reform, new research by Justin McCrary and myself underscores the need for the SEC to assess this issue especially carefully and for any policy changes to take place within an incremental framework.  In our working paper, Shall We Haggle in Pennies at the Speed of Light or in Nickels in the Dark? How Minimum Price Variation Regulates High Frequency Trading and Dark Liquidity, we document how modification of the penny-based system of stock trading will likely have simultaneous and opposite effects on the incidence of both high frequency trading (HFT) and the trading of undisplayed (or “dark”) liquidity (what we refer to as “trading hidden liquidity” or THL).  Specifically, in the event of an increase in the MPV, our research strongly suggests we can expect to see both an increase in off-exchange trading in venues such as dark pools and a decrease in HFT.

Although often conflated within the popular press, HFT and THL reflect two distinct types of trading strategies that have distinct consequences for price discovery and market liquidity.  In terms of strategy, traders focusing on HFT typically seek to profit from discrete, short-lived pricing inefficiencies by rapidly bidding on and selling securities, customarily through pre-programmed algorithms.  The emergence of so-called “maker/taker” fee structures at stock exchanges—whereby limit order providers are paid a “maker” rebate and traders using market orders are assessed a “taker” fee—creates an additional profit opportunity for such traders provided they can position their limit orders at the top of exchanges’ order books.  For firms engaged in HFT, minimizing the latency of processing information and entering orders is therefore of paramount importance to profitability.  In contrast, a firm focusing on THL will generally seek to profit by providing liquidity to investors without the necessity of publishing public bids or paying exchange access fees, thus minimizing the price impact and cost of the transaction.  Access to investors looking for liquidity—rather than speed of trading per se—is accordingly a primary goal of those engaged in THL.

Despite the recent focus on changing tick sizes, there has been remarkably little focus on how each of these strategies is intimately connected with the rules governing the MPV.  As was revealed following decimalization, smaller tick sizes have led to both a surge in market message traffic as prices dispersed across more price points as well as a dramatic reduction in quoted spreads.  Both developments favor algorithmic trading strategies capable of processing quickly large flows of order messages, while reducing the costs of rapidly trading in and out of positions.  With respect to THL, larger tick sizes create the opportunity for larger spreads and, consequently, larger profits for those firms that can capture them by trading against marketable orders from individuals and institutions seeking immediate liquidity.  In this regard, dark pools and broker-dealer internalizers are aided by a technical rule concerning how the penny-pricing requirement is actually implemented:  Although it is prohibited for anyone to quote (i.e., post an order) at other than a penny-increment, it is perfectly fine to execute a trade in subpenny increments.  Using this flexibility to execute subpenny trades, a dark pool or internalizer can thus offer price improvement over the National Best Bid or Offer (NBBO) available at conventional stock exchanges (even if the improvement is as little as $0.0001 per share).  In this fashion, dark pools and broker-dealer internalizers have both the incentive and the means to trade directly with incoming marketable orders rather than route them to exchanges.

To examine empirically how changes in the MPV might have these effects on the incidence of HFT and THL we turned to a peculiar quirk in the ban on sub-penny pricing described in the previous paragraph.  In particular, the ban on sub-penny quotations (Rule 612 of Regulation NMS) only applies to equity orders priced at or above $1.00 per share, thus creating a sharp distinction in tick size regulation between those orders priced just above $1.00 per share and those priced just below it. Using a regression discontinuity (RD) research design, we can therefore identify in a clean, parsimonious way how changes in tick size regulations can affect the incidence of these two forms of trading.  For our data, we used the NYSE’s Trade and Quote database, focusing on the 300 million trades and the 3 billion updates to exchanges’ best published bids and asks made during 2011 for securities that traded below $2.00 per share at some point in 2011.

Overall, our results are strongly consistent with the hypothesized effect of MPV on both THL and HFT.  To measure THL, we examined for each completed trade the market center at which it occurred, using trades reported to a FINRA Trade Reporting Facility (TRF) as our measure for THL.  The figure below presents our RD estimates of the effect of subpenny quoting on the incidence of such off-exchange trading.  In the figure, the x-axis represents a transaction’s reported trade price truncated to two-decimal places, and the circles represent the fraction of all reported trades reported to a FINRA TRF at each such price.  The solid line plots fitted values from a regression of the fraction of TRF trades on a fourth-order polynomial in two-decimal price (the point estimate and standard error are in the legend).  As the figure indicates, trades executed at prices immediately above $1.00 per share revealed a sharp increase of 8.6 percentage points in the percent of trades reported to a TRF facility. Because all other market centers reflect stock exchanges, this translates to a corresponding decrease of 8.6 percentage points in the incidence of transactions on the public exchanges.

With respect to HFT, we examined (among other things) the incidence of “strategic runs” within the quotation data at each price point truncated to two-decimal places.  Notably, the TAQ data does not permit tracking individual orders since it covers only updates to each exchange’s best bid or offer (BBO), but evidence of such strategic runs nevertheless appears in the TAQ data to the extent they affect an exchange’s BBO, which is continually updated by the exchanges to reflect the new orders that change it.  Accordingly, we measure for each second of the trading day the rate of BBO updates for each security in our sample (a “security-second”).  As might be expected in the (for modern financial markets) relatively quiet corner of penny stocks, the vast majority of security-seconds experienced no update of an exchange’s BBO.  In particular, over 90% of the security-seconds in the sample showed no BBO updates, with higher-priced orders generally being more likely to have at least one BBO update per second.   As shown in the figure below, RD analysis of security-seconds having at least one BBO update by two-decimal order price reveals that this trend was generally continuous at the $1.00 cut-off.

In contrast, analysis of those security-seconds where a BBO was updated with significant frequency reveals a sharp increase in the incidence of such strategic runs below the cut-off.  The next figure, for instance, provides our RD estimates for the incidence of security-seconds where the BBO was updated at least fifty times per second.  Consistent with the previous figure, the rate of these strategic runs generally declines from $2.00 to $1.00 where it reveals a discontinuous upward jump from .02% of all security-seconds to .1% of all security seconds, highlighting the negative relationship between the size of the MPV and the incidence of HFT.

In sum, these findings suggest that current proposals to increase the MPV may very well entail significant, unanticipated structural changes in the nature of how equity trading occurs on U.S. markets.  To be sure, many of these changes in trading such as the higher incidence of THL would actually be consistent with a core objective of Section 106(b) of the JOBS Act insofar as they would increase the profitability of market-making in affected stocks.  However, our finding that these market-making profits are generally captured by dark pools and internalizers causes us to question how these enhanced profits will translate into additional analyst coverage and sales support for emerging growth companies.  For instance, most dark pools and the two largest internalizers by volume—Citadel Investments and Knight Capital—do not offer sell-side analysis or advisory services.  Moreover, the new retail price improvement (RPI) programs at major U.S. stock exchanges—which seek to allow exchanges to compete with internalizers through establishing de facto dark pools to capture trading spreads—only further undermine the theorized benefits for IPO firms of larger tick sizes given that the beneficiaries of such programs (i.e., stock exchanges and RPI participants) are also not known to provide market support for emerging growth companies.  To the extent the SEC chooses to implement a pilot program modifying tick sizes, coupling such a program with increased disclosures concerning which broker-dealers are reporting trades to a FINRA TRF could help ascertain whether the appropriate market participants are benefiting from the wider spreads.

 

Facebook’s Woes Continue

Since being the first American company to makes its debut (albeit a rocky one) on the NASDAQ stock exchange with a $100 million valuation, Facebook’s stock has lost more than half of its value. As of August 23, 2012, Facebook’s value was $41.95 billion.

In its earnings report a few weeks ago, the Facebook team—CEO, Mark Zuckerberg and CFO, David Ebersman—tried to restore market faith in the stock by emphasizing the growing subscriber base, especially among mobile users. Analysts, however, are concerned that Facebook may not be able to exploit the growing mobile use of its platform. While the number of Facebook users has continued toward one billion, Facebook has yet to find a way to monetize increased mobile access through advertising. While Facebook has experimented with various options, none appears to satisfy investor skepticism.

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The SEC’s Limit Up – Limit Down Rule Can Help Markets, But Does It Go Far Enough To Address High-Frequency Trading?

The BATS IPO was an ironic disaster. BATS, a stock exchange that billed itself as the future of stock trading, botched the IPO of its own stock, which was supposed to be listed on the BATS exchange beginning March 23rd. According to the company, the failure was caused by a software bug, and not by high-frequency trading algorithms, as some have speculated. Not only did the failure cause BATS to abandon its own IPO, it also rattled shares of Apple, mirroring the events of the 2010 Flash Crash.

While the IPO was an embarrassment for BATS, it put the SEC’s regulatory response to the Flash Crash on display. The 2010 Flash Crash was a series of events that caused the Dow Jones Industrial Average to plummet more than 700 points in a matter of minutes, only to recover within a half hour. In response to the Flash Crash, single stock circuit breakers were established to curb the effects of extreme market volatility. By most accounts, single stock circuit breakers have been effective in restoring order to markets after numerous test runs during other “mini flash crashes,” hitting a high of 51 in December of 2011.

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