April 26, 2012
JOBS Act Forum: Steven Davidoff
Posted by Usha Rodrigues

From Steven Davidoff:

I must admit to being a bit persnickety when it comes to the JOBS Act.  I think that whatever the outcome, Congress legislated without much thought or coherence.  The example of small IPOs comes to mind.  Congress ignored the evidence that decimalization and the demise in analyst coverage caused the decline in small IPOs, a decline which occurred BEFORE Sarbanes-Oxley.  Instead public interests groups and the editorial page of the Wall Street Journal successfully turned it into a question of Sarbanes-Oxley and its over-regulation.

I’m also affected by the experience with foreign private issuers which I wrote about in a 2010 article for a University of Cincinnati symposium:  Rhetoric and Reality: A Historical Perspective on the SEC's Regulation of Foreign Private Issuers.  There I argued that the rhetoric of Sarbanes-Oxley led the SEC to deregulate the foreign private issuer rules.  Similar to what occurred with the JOBS Act, the drop in foreign listings in the United States was linked to Sarbanes-Oxley and the rise of the low regulation AIM market.  The SEC was forced to respond to this rhetoric.

In reality, as I show in the article, the U.S. was and is largely the world’s only competitor for these listings, and the market came roaring back when BRIC nations began searching for Western IPO outlets, not when the SEC acted to deregulate the market.  I also predicted at the time that this deregulation would lead to problems with Chinese issuers, and sure enough I am right (sorry for the all the self-referential credit, but hey, I take what I can get and will stop now).  The SEC is now talking about reregulating and the AIM market has collapsed. And that is why I don’t like the IPO on-ramp provisions – I’m not sure that they will do anything, don’t address the specific causes of the small IPO crisis and are repeating at some level the mistakes with the foreign issuer process.  Still, in the vein of John C. Coates IV’s testimony on the Bill, I’m willing to admit that it is worth letting these provision go forward as an experiment as there are real complaints about the requirements of being public these days.  The JOBS Act doesn’t solve them all but does address some of them.   (Brett McDonnell and Erik Gerding have some more thoughtful points on the legislative process earlier in this forum.) 

But all of this is griping about the IPO On-Ramp provisions. 

As for the private capital raising parts, I’m more optimistic about markets and market participants adapting.  The crowd-funding exemption has interesting potential particularly since it preempts most state blue sky laws something which Rules 503 and 504 do not (that is why almost all issuers use Rule 506 as Rutheford B. Campbell has documented).  Second, as Andrew Schwartz from Colorado recently noted at a symposium at Ohio State law school, it can also be used for debt (Andrew’s paper from the symposium will be a must read about the future of this exemption).  In a low trust environment, it may very well be that crowd-funding functions but not for equity.  We’ll see. (Robert Thompson has his own thoughts about the future of crowd funding here and Joan Heminway has more on these provisions here.  Joan by the way has been one of the leaders in the academic charge on this provision.)

Beyond crowd-funding, the new $50 million exemption under Section 3(b)(2) looks to be about as useful as Regulation A is (not much) and likely to fail for the same reasons.  Too much information is required and there is no blue sky preemption when other avenues like Rule 506 do preempt and have lower information preparation requirements, at least when you go to accredited investors.  Not to mention Congress didn’t trust the SEC to get the requirements for its use right so over-legislated the parameters for this exemption.  You don’t believe me?  Take a look at this summary of 3(b)(2)’s legislative provisions.  Crowd-funding also has some serious barriers in the burdens Congress hard-wired into the provision, including background checks and a requirement that trades occur on a platform. 

So what would have been the best changes?  Outside the private capital-raising arena, the first thing I would do is substantially pare down the general solicitation rules for IPOs.  They’re a mess right now as you can see from trying to use, read or teach Rule 433.  I’m still not sure about reducing disclosure and other Sarbanes-Oxley requirements, so will have to defer to others on this. 

Then for private offerings, let Rule 506 allow for the inclusion of up to a certain amount of unaccredited investors without the bar on general solicitation or the information requirements.   The latter requirement is particularly burdensome and essentially requires prospectus level disclosure if you include unaccredited investors.  Then give the SEC the power to tinker with the rules on a going-forward basis and add protections for fraud that don’t stifle the exemptions unless necessary.  In essence, truly have a crowd-funding experiment, but address the fraud problem through initial monitoring and revision.  And it is all about allowing issuers to easily access unaccredited investors, since Rule 506 right now allows for such access to accrediteds.  It’s about allowing equal access to capital in the right situation.

OK – so now I’m being overly optimistic

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