Executive Summary
SIFMA Insights: US Equity Capital Formation Primer An exploration of the IPO process and listings exchanges
November 2018
SIFMA Insights Page | 1 Executive Summary
Contents
Executive Summary ...... 4 The Importance of Capital Formation ...... 5 Declining Number of US Listed Companies and IPOs ...... 9 Decreasing Number of Small Cap IPOs ...... 12 IPOs Not Keeping Pace with the Stock Market Run ...... 14 Factors Driving Companies to Remain Private or Delist ...... 16 Regulatory Dollar and Opportunity Costs ...... 18 Litigation Concerns ...... 19 Declining Research Coverage ...... 20 Market Structure Updates...... 22 Growth in Passive Investments ...... 24 Growth in Private Markets ...... 24 The IPO Process ...... 26 Detailing Steps in the IPO Process ...... 27 Alternatives to IPOs ...... 31 Direct Public Offerings ...... 31 Dutch Auction IPO ...... 32 Market Structure for Listings Exchanges ...... 33 Sector Breakout for Total IPOs ...... 34 Sector Breakout Across Exchanges ...... 36 Comparison to Other Regions ...... 37 Legislation and Regulation to Attempt to Boost Capital Formation ...... 39 Jumpstart Our Business Startups Act (JOBS, 2012) ...... 39 JOBS Act 2.0 (2015) ...... 41 Additional Related Regulations and Laws ...... 42 Markets in Financial Instruments repealing Directive (MiFID II, 2011) ...... 42 Sarbanes-Oxley Act (SOX, 2002) ...... 43 Appendix ...... 44 Industry Classifications ...... 44 Terms to Know ...... 46 Authors ...... 47
SIFMA Insights Page | 2 Executive Summary
SIFMA Insights Primers
The SIFMA Insights primer series is a reference tool that goes beyond a typical 101 series. By illustrating important technical and regulatory nuances, SIFMA Insights primers provide a fundamental understanding of the marketplace and set the scene to address complex issues arising in today’s markets.
The SIFMA Insights primer series, and other Insights reports, can be found at: https://www.sifma.org/insights
Guides for retail investors can be found at http://www.projectinvested.com//markets-explained
SIFMA is the leading trade association for broker-dealers, investment banks and asset managers operating in the U.S. and global capital markets. On behalf of our industry’s nearly 1 million employees, we advocate on legislation, regulation and business policy, affecting retail and institutional investors, equity and fixed income markets and related products and services. We serve as an industry coordinating body to promote fair and orderly markets, informed regulatory compliance, and efficient market operations and resiliency. We also provide a forum for industry policy and professional development. SIFMA, with offices in New York and Washington, D.C., is the U.S. regional member of the Global Financial Markets Association (GFMA). For more information, visit http://www.sifma.org.
This report is subject to the Terms of Use applicable to SIFMA’s website, available at http://www.sifma.org/legal. Copyright © 2018
SIFMA Insights Page | 3 Executive Summary
Executive Summary An initial public offering (IPO) is when a private company raises capital by offering its common stock (equity) to the public in the primary markets for the first time. Companies may need capital for various business purposes – invest in growth, fund mergers and acquisitions, etc. – and firms have several ways they can generate capital, including issuing IPOs. IPOs allow businesses to grow, innovate and better serve their customers.
The number of U.S. domiciled listed companies has been on the decline since the mid-1990s. While the number of listed companies peaked in 1996 at 8,090, the number is down to 4,336 as of the end of 2017, -46% since 1996. The regulatory environment also led to a decline in IPO deal value and number of deals. The number of IPOs peaked in 1996 at 860 but was down to 173 in 2017 (-80% from the peak, a -7% CAGR) and stands at 179 YTD (through October 2018). The number of small capitalization IPOs as a percent of the total has also declined post crisis. While in the low 90% range pre crisis, it remains in the low to mid 80% range over the past few years. The decline in the number of small cap IPOs implies fewer innovative American companies see the benefit of going public in today’s regulatory environment, which could have long-term negative effects on economic growth.
An SEC survey of CEOs showed that while 100% of participants noted a strong and accessible IPO market is important the U.S. economy and global competitiveness, only 23% felt the IPO market is accessible for small companies. Market participants, regulators, academics and legislators have weighed in over the years on the reasons for the decline in listed companies and number of IPOs. This report reviews several of the suggested factors, including: compliance burdens and costs, litigation concerns, declining research coverage, growth in passive investments and growth in private markets. We also look at proposals and suggestions to change equity market structure for low volume stocks to increase the efficiency of trading these stocks.
This report also explains the IPO process. Underwriting is the process during which investment banks (the underwriters) act as intermediaries, connecting the issuing company (issuer) and investors to assist the issuer in selling its initial set of public shares. The underwriters will work with the issuer to determine what the IPO should look like and the best time to bring the deal to the market. Underwriters guide the issuer through the process, not only handling all the required paperwork and performing a detailed analysis of the company, but also assisting management in addressing investor concerns to get investors interested in the deal.
Finally, this primer assesses the market structure for listings exchanges. When a company decides to go public, it will become listed on a national securities exchange. The listings exchanges have their own criteria for firms to qualify to list on their exchange (financial status, number and types of shareholders, percentage of public float after the IPO, etc.). The corporate listings business is highly competitive, with significant barriers to entry. As such, there are only two main listings exchanges in the U.S.: the New York Stock Exchange and Nasdaq.
SIFMA Insights Page | 4 The Importance of Capital Formation
The Importance of Capital Formation An initial public offering (IPO) is when a private company raises capital by offering its common stock (equity) to the public in the primary markets for the first time. Securities are issued at an established price, and the process is facilitated by investment banks acting as financial intermediaries. Shares then continue to trade in the secondary market on exchanges or other trading venues (please see SIFMA Insights: US Equity Markets Primer for details).
Companies may need capital for various business purposes – earlier stage companies need additional capital to grow to the next stage in the business life cycle, companies need capital to expand organically or via acquisition (product or regional diversification) – and firms have several ways they can acquire capital:
Why do companies How do companies need capital? acquire capital?
• Invest in organic growth • Issue equity and expansion plans, • Generate cash flow from including hiring employees operations to achieve strategic • Obtain bank loans, lines of objectives credit; issue debt or • Fund mergers and commercial paper acquisitions • Divest assets • Finance operations • Pay down existing debt
This report focuses on companies issuing IPOs to generate capital to grow their business. IPOs allow businesses to grow, innovate and better serve their customers. Further, being public adds another level of legitimacy to the business, as the requirements for public companies (earnings calls, public financial statements, etc.) provide transparency into the firm’s strategy, financials and overall state of the industry in which it competes. Going public also brings stability by providing a permanent and liquid source of capital. Additionally, an IPO can assist a private company in:
• Incentivizing and rewarding employees who have worked hard to get the startup running by providing liquidity opportunities, i.e. payouts at the IPO, helping employees generate wealth
• Marketing the company to new customers, partners or investors, especially if operating in a lesser known industry
SIFMA Insights Page | 5 The Importance of Capital Formation
• Generating currency – most private company’s shares are not valued as highly as they would be in public markets1 – to acquire other companies with stock (going public may make raising debt easier as well)
Looking to the SEC IPO Task Force August 2011 CEO Survey, the CEO’s interviewed noted the following reasons they chose to go public:
Why Go Public?
I: Survey of Post IPO Companies
Strengthen Balance Sheet 89%
Access to Capital 83%
Improve Brand 63%
Acquisition Currency 60%
II: Survey of Pre IPO CEOs
Competitive Advantage 84%
Cash for Growth 63%
Premium Valuation 61%
Source: SEC IPO Task Force August 2011 CEO Survey Note: Respondents could select multiple reasons, not meant to sum to 100%. I: Survey of post IPO companies – why go public? II: Survey of pre IPO CEOs – why target an IPO to finance growth.
1 There are exceptions, such as the unicorns (private companies valued at greater than $1 billion).
SIFMA Insights Page | 6 The Importance of Capital Formation
From an economic perspective, capital formation benefits the economy and promotes job growth. According to the same SEC report, on average since the 1970s, 92% of a company’s job growth occurs after the IPO, with most of that occurring within the first five years. The post IPO employment growth figure dropped to 76% on average for the 2000s, as shown in the chart below. (In another SEC survey of 35 CEOs going public in 2006 or later – 57% IT, 29% life sciences and 9% non-high tech companies – the average post IPO job growth figure was 86%.)
Post IPO Employment Growth 97% 100% 94% 92% 88% 90% 80% 76% 70% 60% 50% 40% 30% 20% 10% 0% 1970s 1980s Total 1990s 2000s Source: SEC IPO Task Force August 2011 CEO Survey (also sourcing Venture Impact 2007, 2008, 2009, & 2010 by IHS Global Insight)
IPOs provide ways for innovative startups to become market leaders – think Amazon, Starbucks or Apple – which create jobs and grow quickly, increasing their contribution to the economy. According to the same SEC study, public companies originally backed by venture capital represented 21% of total U.S. GDP from 2008-2010. Revenue growth at these same companies was 1.6% from 2008-2010, outpacing total U.S. sales growth of -1.5% for the same time period.
However, with an estimated 70% of IPOs sponsor backed, these private equity or venture capital sponsors will have a voice into the issuer’s decision to go public or not. An alternative for a small business to going public is to be acquired by a larger company. M&A exits have become the primary liquidity vehicle for venture investors to exit their positions, a reversal from the past where IPOs dominated. Looking at SEC data from 2001 to 2011, we estimate IPOs represented less than 20% of private company exit transactions each year. This figure was around 50%+ for most of the years in the 1990s.
Market participants note it is common for tech and life sciences firms to choose M&A, looking to be sold to a tech giant or big pharma firm rather than IPO. The sector breakout for the S&P 500 indicates information technology and health care represent 25.6% and 14.5% of the total companies respectively, cumulatively 40.1%. If this 40% were to represent a proxy for the percentage of private firms deciding to exit via M&A rather than IPO, this could represent a large part of the population lost to the public markets and therefore individual investors.
SIFMA Insights Page | 7 The Importance of Capital Formation
For individuals, IPOs provide an avenue for wealth creation. Private companies have a smaller number of shareholders than public companies, consisting of: early investors (founder, family and friends) and institutional and accredited investors (angel investors, venture capitalists, high net worth individuals). Most individual investors are locked out of not only the private markets but also the IPO process (for regulatory purposes)2. When a company IPOs, individual investors may only get access if their mutual funds or retirement plans – types of institutional investors – received allocation of shares in the IPO. Individual investors may then buy/sell stocks in the secondary markets to continue growing their investment portfolios.
2 Only accredited individual investors (income > $200K ($300K with spouse) in each of the prior 2 years or net worth >$1M, excluding primary residence) may participate in an IPO.
SIFMA Insights Page | 8 Declining Number of US Listed Companies and IPOs
Declining Number of US Listed Companies and IPOs The number of U.S. domiciled listed companies has been on the decline since the mid-1990s, as shown in the charts on the following pages.
Looking at World Bank data from 1980 to 2017:
• The number of listed companies peaked in 1996 at 8,090, reaching an all-time low in 2012 at 4,102
• The number of listed companies is down 46% since 1996 to 4,336, a -3% CAGR
• The average number of listed companies over this time period is 5,833, with a three-year average of 4,349
A more granular look at World Federation of Exchanges data from 2003 to September 2018 shows us:
• The number of listed companies is down 11%, with an average of 5,253
• During the financial crisis, rapidly declining market capitalizations triggered automatic delistings. NYSE and Nasdaq both temporarily lowered minimum market capitalization requirements to prevent further delistings.
The regulatory environment also led to a decline in IPO deal value and number of deals, as shown in the charts on the following pages:
• The number of IPOs peaked in 1996 at 860
• The number of IPOs is down 80% from the peak to 173 in 2017, a -7% CAGR
• The number of IPOs averaged146 per annum the last three years, and the YTD count through October is 179, already greater than the 2017 total
• Deal value is down 47% from 1996 to 2017 (-3% CAGR), with U.S. domiciled companies deal value down 37% (-2% CAGR)
• The U.S. represented only 10% of total global IPOs in 2017, despite averaging 51% in the 1990s
• Post the JOBS Act, the number of IPOs did increase from 2012 to 2014. According to the U.S. Treasury’s report on capital markets, 87% of IPO filings since 2012 filed under the JOBS Act as EGCs. A SEC staff report noted small IPOs (firms seeking proceeds up to $30M) were 22% of all IPOs from 2012-2016, up from 17% from 2007-2011. However, IPO activity had been relatively muted since 2015, until this year.
Both the number of listed companies and IPO activity has been on an upward tend since the spring of this year – could we be turning a corner?
SIFMA Insights Page | 9 Declining Number of US Listed Companies and IPOs
Number of Listed Companies in the US # Trend Line 8,500 8,090 8,000
7,500 7,001 6,917 7,000
6,500
6,000 5,295 5,500 5,109 5,000 5,164 4,401 4,500 4,102 4,336
4,000
1981 1984 1987 1988 1990 1991 1993 1994 1997 2000 2003 2004 2006 2007 2009 2010 2013 2016 1980 1982 1983 1985 1986 1989 1992 1995 1996 1998 1999 2001 2002 2005 2008 2011 2012 2014 2015 2017
Changes in the Number of Listed Companies Driven by the Crisis & JOBS Act 6,100 1.0
5,985 0.9 5,900 0.8
5,700 0.7
0.6 5,500 5,413 5,414 5,303 5,334 0.5 5,300 0.4 JOBS 0.3 5,100 Act 0.2 4,900 4,986 0.1 Financial Crisis 4,877
4,700 Automatic Delistings 0.0
Jul Jul 10 Jul 15 Jul Jul 05
Apr 04Apr 06Oct 11Oct 14Apr Apr 09Apr Oct16
Jan Jan 03 Jan 08 Jun 08 Jan 18 Jun Jun 03 Jan 13 Jun 13 Jun 18
Mar 12Mar 17Mar Mar 07Mar
Feb 05Feb 10Feb Feb15
Sep Sep 04 Nov 08 Nov 13 Dec 15 Aug 17 Nov Nov 03 Dec 05 Aug 07 Sep 09 Dec 10 Aug 12 Sep 14
May06 May16 May11
Source: (top) World Bank, (bottom) World Federation of Exchanges Note: As of September 2018. U.S. domiciled companies listed on U.S. exchanges. The two charts are from different data sources, which use distinct criteria to calculate total number of listed companies.
SIFMA Insights Page | 10 Declining Number of US Listed Companies and IPOs
Decline in IPO Value ($B) and # of Deals 860 120 900 110 631 100 593 556 90 600 440 80 400 70 250 282 60 224 216 229 219 300 168 161 173 179 50 139 139 99 97 90 71 103 40 42 30 0 20 10
0 (300)
YTD
1995 1996 1997 1998 2003 2004 2005 2006 2007 2012 2013 2014 2015 1999 2000 2001 2002 2008 2009 2010 2011 2016 2017
US Firms Non-US Firms # Deals (RHS)
US Equity Markets Issuance
350
300
60 94 250 27 27 7 46 32 30 55 35 32 41 200 52 43 39 21 6 40 25 26 150 63 6 231 47 100 195 175 170 184 172 185 8 139 157 155 111 50 89
0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 YTD
Secondary Offerings ($B) Preferred Stock ($B) IPOs ($B)
Source: Dealogic Note: As of October 2018. U.S. domiciled companies listed on U.S. exchanges. Excludes BDCs, SPACs, ETFs, CEFs, and rights offers
SIFMA Insights Page | 11 Declining Number of US Listed Companies and IPOs
Decreasing Number of Small Cap IPOs The number of small capitalization (or cap, i.e. market cap) IPOs as a percent of the total has also declined post crisis. The decline in the number of small cap IPOs implies fewer innovative American companies see the benefit of going public in today’s regulatory environment. These startups and smaller innovative companies enable faster job creation and revenue growth to fuel the U.S. economy, as well as represent the next industry leaders. A continuous decline in small company IPOs could have long-term negative effects on economic growth.
The charts on the following pages indicate the number of small cap IPOs:
• Small cap is defined as deal value less than $2 billion (mid cap $2-$10 billion, large cap >$10 billion)
• Peaked in 2000 at 382, troughing in 2008 at 37
• The average was 153 from 2000 to 2017, with a three-year average of 124
• The number of small cap IPOs is down 63% since 2000, a -5% CAGR
The trends in the decline of small cap IPOs as a percent of total IPOs show:
• The average was 89% from 2000 to 2017; pre crisis, this average was 91%, now down to 86% post crisis
• This compares to essentially no change in large cap IPOs: 1.5% average, 1.6% pre crisis and 1.5% post
• The data for mid cap names actually shows improvement: 9% average, 7% pre crisis and 12% post
Comparing deal value split between less than $50 million and greater than or equal to $50 million, we note the following trends:
• Deals <$50 million averaged 119 per annum from 1990 to 2017, peaking in 1996 at 548 (troughing in 2009 at 5)
• Deals <$50 million declined 71% from 1990 to 2017, a -4% CAGR
• Deals >=$50 million averaged 151 per annum from 1990 to 2017, peaking in 1999 at 390 (troughing in 1990 at 16)
• Deals >=$50 million increased 725% from 1990 to 2017, a +8% CAGR
SIFMA Insights Page | 12 Declining Number of US Listed Companies and IPOs
Small Cap IPOs as a Percent of Total 50% 100% 95% 93% 94% 94% 91% 92% 95% 91% 90% 40% 89% 88% 88% 87% 90% 86% 86% 84% 85% 84% 84% 30% 81% 85% 80%
20% 16% 75% 14% 14% 15% 13% 12% 10% 10% 11% 11% 9% 70% 10% 8% 7% 7% 6% 6% 7% 5% 3% 4% 4% 65% 2% 1% 2% 1% 2% 1% 2% 2% 2% 1% 1% 0% 0% 1% 1% 1% 1%
0% 60%
YTD
2000 2004 2005 2009 2010 2011 2015 2016 2001 2002 2003 2006 2007 2008 2012 2013 2014 2017
Large Cap Mid Cap Small Cap (RHS)
IPOs Are Down… Particularly Smaller IPOs
900 844 800
700 619 584 600 547 504 500 447 438 390 400 350 275 241 300 211 209 215 216 206 158 153 158172 200 124131 91 94 98 86 82 63 100 33
0
YTD
1991 1993 1994 1996 1998 2000 2001 2003 2005 2007 2010 2012 2014 2017 1990 1992 1995 1997 1999 2002 2004 2006 2008 2009 2011 2013 2015 2016
Deal Size < $50M Deal Size >= $50M
Source: Dealogic Note: As of October 2018. U.S. domiciled companies listed on U.S. exchanges. Excludes BDCs, SPACs, ETFs, CEFs, and rights offers
SIFMA Insights Page | 13 Declining Number of US Listed Companies and IPOs
IPOs Not Keeping Pace with the Stock Market Run While the number of listed companies and IPOs declined, market cap for the U.S. equity markets continues to grow. As shown on the following page, we begin in 1993 with a market cap of $4.5 trillion. This has grown to $34.2 trillion as of September 2018, +654%.
Looking more closely at the significant market runup since 2013, we see IPOs are not keeping pace with stock price appreciation:
• Outside of a few peaks, IPO value averaged $11 billion per annum from 1Q09 to 3Q18; it was $12 billion as of 3Q18
• The JOBS Act was signed into law in April 2012, and there was a pop in 2Q12 to $23 billion in IPO value versus an average of $8 billion the prior three quarters
• IPO values were up from 2Q13 through 3Q14, as companies hurried to market to beat (what they thought would be) the end of the bull run
SIFMA Insights Page | 14 Declining Number of US Listed Companies and IPOs
35 Domestic Market Capitalization ($T) 34.2 $T Trend Line 30
25
23.7 20 17.5
15 14.0 10 10.5 10.1 5 4.7
0
Jan Jan 93 Jan 95 Jan 96 Jan 98 Jan 00 Jan 01 Jan 03 Jan 05 Jan 06 Jan 08 Jan 11 Jan 13 Jan 16 Jan 18 Jan Jan 97 Jan 99 Jan 02 Jan 04 Jan 07 Jan 09 Jan 10 Jan 12 Jan 14 Jan 15 Jan 17 Jan Jan 94
1/2/09 1/2/10 1/2/11 1/2/12 1/2/13 1/2/14 1/2/15 1/2/16 1/2/17 1/2/18 50 IPOs Not Keeping Pace with Stock Market Run 400%
41 40 320%
30 27 240% 25 23 23
20 17 18 160% 15 15 1515 14 14 13 13 12 12 11 9 9 10 7 7 8 7 7 80% 5 6 6 6 6 6 7 5 4 5 1 2 1 0 0%
IPOs ($B, LHS) Nasdaq Performance (RHS) S&P 500 Performance (RHS)
-10 -80%
2Q09 4Q09 2Q10 1Q11 3Q11 1Q12 3Q12 4Q12 2Q13 4Q13 2Q14 1Q15 3Q15 1Q16 3Q16 4Q16 2Q17 4Q17 2Q18 3Q09 1Q10 3Q10 4Q10 2Q11 4Q11 2Q12 1Q13 3Q13 1Q14 3Q14 4Q14 2Q15 4Q15 2Q16 1Q17 3Q17 1Q18 1Q09
Source: (top) World Federation of Exchanges, (bottom) Dealogic Note: As of September 2018. U.S. domiciled companies listed on U.S. exchanges. Excludes BDCs, SPACs, ETFs, CEFs, and rights offers
SIFMA Insights Page | 15 Factors Driving Companies to Remain Private or Delist
Factors Driving Companies to Remain Private or Delist As discussed above, companies have many reasons for wanting to go public. While companies still need capital – and we discussed earlier in this report the importance of capital formation to U.S. economic growth and job creation, in addition to wealth creation opportunities for individual investors – and view the IPO as an important event for their company, the CEO’s interviewed in the SEC survey swayed to the negative when assessing their IPO experience:3
• 100% agreed a strong and accessible IPO market is important to the U.S. economy The IPO Experience and global competitiveness; in a second survey, 94% agreed a strong and accessible Positive Negative IPO market is critical to maintain U.S. competitiveness
• 86% agreed it is not as attractive an option to go public today as in 1995; 85% agreed in a second survey
• 83% agreed going public has been a positive event (but not experience) in the company’s history
• 23% agreed the U.S. IPO market is accessible for small companies; in a second survey, 9% agreed the U.S. IPO market is currently easily accessible for small cap companies
• 17% agreed going public was a relatively painless experience
Many market participants, regulators, academics and legislators have weighed in over the years on the reasons for the decline in listed companies and number of IPOs. We grouped together results from several CEO interviews in the SEC survey report, noting managing communications restrictions appears in all three surveys, ranging from 88%
3 SEC IPO Task Force August 2011 CEO Survey. First survey = public company CEOs; second survey = pre-IPO CEO sentiments on U.S. IPO market. Econ = economy; compet = competitiveness.
SIFMA Insights Page | 16 Factors Driving Companies to Remain Private or Delist
for public companies to 60% for post-IPO survey responses. Throughout the lifecycle – pre IPO, post IPO, established public company – restrictions on communications are always top of mind for CEOs. According to the three surveys shown below, this concern appears to grow as companies move deeper into their public life. This points to both regulatory requirements and litigation concerns as deterrents to going public.
• Administrative burden scores quite high, for both public reporting (92%) and regulatory compliance (89%)
• On the cost side, accounting and compliance as well as SOX and other requirements score high (86% and 80% respectively)
• The opportunity cost of reallocating the CEO’s time also scores very high (91%)
• Both size and vibrancy of investor universe and breadth and consistency of research coverage score high as well (88% and 81% respectively)
IPO Challenges and Concerns with Going Public
SURVEY I: Public Company CEO Survey Administrative Burden of Public Reporting 92% Reallocation of CEO's Time 91% Administrative Burden of Regulatory Compliance 89% Managing Communications Restrictions 88%
SURVEY II: Post-IPO CEO Survey Accounting & Compliance Costs 86% Post IPO Liquidity 83% SOX & Other Regulatory Risks 80% Public Disclosure Impact on Business 72% Meeting Quarterly Performance Expectations 66% Managing Communications Restrictions 60%
SURVEY III: Pre-IPO CEO Survey Size & Vibrancy of Small Cap Investor Universe 88% Breadth & Consistency of Research Coverage 81% Costs/Risks of SOX and Other Requirements 80% Lack of Long-Term Investors 77% Managing Communications Restrictions 71%
Source: SEC IPO Task Force August 2011 CEO Survey Note: Respondents could select multiple reasons, not meant to sum to 100%. I: Survey of public company CEOs – most significant IPO challenges. II: Survey of post-IPO CEOs – biggest concerns about going public. III: Survey of pre-IPO CEOs – concerns regarding implications of going public.
SIFMA Insights Page | 17 Factors Driving Companies to Remain Private or Delist
In the remainder of this section, we walk through various arguments provided by market participants, legislators, academics and regulators for the decline in IPOs.
Regulatory Dollar and Opportunity Costs The SEC study showed the average cost of going public is $2.5 million, with another $1.5 million per annum to remain public. These costs include SOX compliance and other legal and accounting expenses.
Initial Outlay Ongoing Costs Per Annum
$3-4M, >$4M, 6% 3%
>$4M, 14% $1-2M, <$1M, 35% 14% $3-4M, $1-2M, 20% 46%
$2-3M, 31% $2-3M, 31%
Source: SEC IPO Task Force August 2011 CEO Survey There is an old investment banking adage, once a company has $100 million in annual revenue and two quarters of profitability it is time to consider going public. Looking at the figures above, this means almost half of the $100 million revenue companies looking to IPO should expect to spend 1%-2% per annum just on SOX, legal and accounting costs to adhere to regulations for public companies. In 2017, the average earnings before interest, taxes and depreciation and amortization (EBITDA, a normalized proxy for ongoing profitability) for the S&P 500 was $261.9 million, or 21.3% of total revenue. Extrapolating this percent to a company with $100 million in revenue, SOX, legal and accounting costs would represent a 4.7%-9.4% hit to EBITDA.
What this analysis does not show is the opportunity cost of compliance to regulations for public companies. Quarterly earnings take a substantial amount of time and staff to comply. Firms must: prepare fully compliant presentations; update this information on their public website; perform the conference call; spend time with analysts and investors after the call; etc. Management must also spend time meeting with analysts and investors throughout the year, commonly called non-deal roadshows, as well as presenting at multiple industry conferences. These actions are business as usual and do not include any one-off items that might require a disclosure of a Form 8-K, etc.
This is all time a CEO must spend away from running the business. It is costly to IPO and remain public – in terms of both dollar amount and management’s time – something management of a company must balance with the benefits and returns of going public.
SIFMA Insights Page | 18 Factors Driving Companies to Remain Private or Delist
Litigation Concerns In December 1995, the U.S. Congress passed the Private Securities Litigation Reform Act (PSLRA) to try to prevent meritless securities lawsuits. Since PSLRA (through January 2014), 4,226 federal securities class actions have been filed alleging trillions of investor losses, with over 40% of the companies listed on U.S. exchanges experiencing a class action lawsuit.4 For the 1,456 settled securities fraud class action cases during this time period, the aggregate settlement amount was $68 billion. However, the study showed news of the lawsuit destroyed $262 billion in shareholder value (includes cases where news of the lawsuit occurred within 30 trading days after the end of the class period), almost four times as much as the settlements, given a cumulative stock price drop of 4.4%.
This figure excludes the 2,457 dismissed or not yet settled securities class action lawsuits during this time period. The study estimates this group lost $701 billion in shareholder value. This figure is potentially underestimated since the study focused on losses since the lawsuit announcement date. Investors actually anticipate lawsuit filings earlier than this date, once the company issues corrective disclosures to financial statements which typically lead to class action lawsuits. Additionally, this figure does not incorporate other negative impacts on shareholders (and the economy), such as: reduced firm innovation and investment, higher insurance premiums for corporations and a more conservative approach to voluntary corporate disclosures.
As has been reported by various sources5, litigation concerns are accused of driving away the potentially largest IPO in history (if/when it happens). The latest market commentary on the anticipated Saudi Aramco IPO – expected to raise ~$200 billion, creating a ~$2.0 trillion market cap company – is that it is potentially looking to list on an Asian exchange. The reason noted is that a New York listing – despite having the deepest pool of investors – risks class action lawsuits based upon violations of U.S. regulations on how and when to make disclosures (there are strict rules on reserves and data disclosures for oil companies). Legal advisors to the company noted that, in addition to potential class action lawsuits, the U.S. has “aggressive” shareholder lobby groups.
This could make its assets in the U.S., including Motiva, open to legal action. Motiva Enterprises is a fully owned affiliate of Saudi Refining Inc. (controlled by Saudi Aramco), headquartered in Houston, Texas and operating as a U.S. company. Motiva operates three refineries (1.1 million barrels of crude oil per day), including the largest oil refinery in the U.S., Port Arthur Refinery (0.6 million barrels per day). It also holds stakes in 34 refined product storage terminals (19.8 billion barrels storage capacity). It generates $3.5 billion in revenue per annum and employs 2,300 people in the U.S. Litigation could put its current operations and growth plans to invest in the U.S. – develop a petrochemicals business, increase refining capacity and expand commercial operations – in jeopardy.6
4 U.S. Chamber of Commerce Institute for Legal Reform “Economic Consequences: The Real Cost of U.S. Securities Class Action Litigation”. 5 One such source includes CNN: https://money.cnn.com/2018/03/08/investing/saudi-aramco-ipo-new-york-london/index.html 6 Source (for Motiva data): company reports
SIFMA Insights Page | 19 Factors Driving Companies to Remain Private or Delist
Declining Research Coverage For many asset managers to hold a stock, it needs to have coverage by research analysts. After the 2003 global research settlement, resources to support sell side research declined, at a time when industry consolidation and decreasing commissions were already pressuring the cash equities business. As shown below, cash equities revenues at the largest investment banks are down 16% from FY12 to FY17:
Trends in Equities Revenues ($B) Prime Derivatives Cash F&O 50 45 40 11.4 35 12.1 11.3 9.5 9.2 30 11.0 25 5.0 20 15 10 5 0 FY12 FY13 FY14 FY15 FY16 FY17 1H18 Source: Coalition, SIFMA estimates Note: Based on revenues from the 12 largest investment banks. Prime = prime services; derivatives = equity derivatives; F&O = futures & options
As revenues declined, it became more difficult for analysts to pick up coverage of small and mid cap names. Junior or emerging analysts looking to launch coverage would present a business case to management – for example, the recommended company develops a niche product which competes in that segment with a larger company covered by the senior analyst, so the new coverage would complement the coverage of the larger stock – and management would have to make a call based on a cost/benefit analysis. It was not always an easy case to win. Now, the growth in passive investments and MiFID II make the economics even harder. (Please see the additional regulations and laws section at the end of this report for details on MiFID II.)
Research headcount and budgets are down, creating a vicious cycle as many institutional investors cannot invest without research coverage. As shown on the next page, the number of research analysts is down 10% (from 2012 to 2016) and budgets are down 51% (from 2008 to 2016) at the largest investment banks:
SIFMA Insights Page | 20 Factors Driving Companies to Remain Private or Delist
Declining Numbers in Sell Side Research Budget ($B) # Analysts (RHS) 9,000 6,800 8,200 6,634 8,000 6,600 7,000
6,000 6,282 6,400 5,000 4,000 6,200 4,000
3,000 6,000
2,000 5,981 5,800 1,000
0 5,600 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: Financial Times (citing Coalition for headcount), The Economist (citing Frost Consulting for budget), SIFMA estimates Note: Headcount = number analysts at the 12 largest investment banks globally. Budget = research budgets at “major” investment banks. Numbers not directly stated in the articles were estimated.
As shown below, the number of analysts covering a stock is linear from small cap to large cap companies. It is therefore logical that as the number of research analysts continues to decline the impact will be proportionately larger on small caps. Market participants indicate the average company with a market cap of $500 million or less used to have three to four analysts covering it; this figure is moving downward to one to two analysts.
Analyst Coverage by Market Cap % Total Companies # Analysts, Mean # Analysts, Median 25% 18 16 20% 14 12 15% 10 8 10% 6 5% 4 2
0% 0
>$10B
$1-$5B
$5-$10B
$0-$25M
$25-$50M $50-$75M
$75-$100M
$700M-$1B
$200-$500M $500-$700M $100-$200M Source: SEC Office of Economic Analysis Note: Data includes 6,754 companies from Vickers, I/B/E/S & Compustat as of December 31, 2004 (market cap as of March 31, 2005); excludes ADRs. The number of sell-side analysts is the number of 1-year ahead earnings forecasts; missing values for number of analysts are set equal to zero.
Sell side analysts play a critical role in guiding investors’ investment decisions. Decreased coverage creates concerns investors are not as well informed and would, therefore, not be able to adjust quickly to shifts in market trends or updates to company fundamentals or growth trajectories. This is particularly true for small cap companies, which now have fewer analysts to help explain their story to investors. This can be a deterrent to going public.
SIFMA Insights Page | 21 Factors Driving Companies to Remain Private or Delist
Market Structure Updates In the U.S. equity markets, low volume stocks are classified as those with ADV less than 100,000. For NMS stocks of all types, 50% are low volume, while just under 30% of all corporate stocks currently listed on U.S. exchanges are low volume. The low volume corporate stocks represent 15% of total NMS stocks, but <1% of total NMS trading volume. For ETPs, low volume represents 18% of all NMS stocks, but <0.5% of total NMS trading volume. In a SEC equity market structure roundtable7 held in April this year, Brett Redfearn, Director of the Division of Trading and Markets, noted, “in general, securities with lower volumes exhibit wider spreads, less displayed size than higher volume securities, and that can lead to higher transaction costs for investors.”
U.S. equity markets currently have a single market structure for all securities – large, mid and small cap. The SEC continues to analyze whether a single structure is appropriate for all types of companies and investors. They are utilizing formal market test pilots and hosting roundtables with market participants to discuss ideas to make it easier to trade these stocks, allowing exchanges to innovate to serve issuers and investors and repatriate liquidity back onto exchanges. Some of the ideas include:
• Tick Size Pilot – The two-year tick size pilot was designed by the SEC to assess the impact of wider minimum quoting and trading increments (tick sizes) on the liquidity and trading of small cap stocks. Many believed a wider tick increment might improve liquidity for smaller cap stocks, potentially increasing the number of market makers trading the stocks, research analysts covering the stocks and overall trading in these names. The pilot expired on September 28, and the SEC is reviewing the results. Back at our Equity Market Structure conference in April, SEC’s Redfearn indicated increasing tick sizes “may not make sense for the long haul,” but we might learn the relative changes in trading costs associated with wider spreads and the costs/benefits associated with a trade-at provision, via the collected data.
• Roundtable on Market Structure for Thinly-Traded Securities – This roundtable assessed: (1) challenges in market structure for low volume stocks – maintaining fair and orderly markets, why trading tends to occur off-exchange; (2) potential improvements in market structure for low volume stocks – would limiting unlisted trading privileges (UTP8) provide a better opportunity for exchanges to innovate to serve less liquid securities, would any solutions need imposed restrictions on off-exchange trading to succeed, how to address possible monopolistic pricing if competition is restricted; and (3) examining low volume exchange-traded products – how differ from stocks, would solutions for stocks work for ETPs.
Additionally, market participants continue to suggest ideas to be considered to increase capital formation, particularly for smaller companies. Some of these ideas include:
7 Roundtables are a form of academic discussion where participants agree on a specific topic to discuss and debate. Participants in the SEC roundtables include: SEC commissioners and staff, senior managers from the exchanges, academics and representatives from broker-dealers, market makers, trading firms, asset managers and other market participants. The SEC also allows for submission of public questions/comments via their website. 8 A right under the Securities Exchange Act of 1934 permitting securities listed on any national securities exchange to be traded by other exchanges.
SIFMA Insights Page | 22 Factors Driving Companies to Remain Private or Delist
• Venture exchanges – Venture exchanges have been discussed as an option in the U.S. for trading smaller and startup company stocks to increase liquidity for early stage investors in these companies. These are companies which would not meet the criteria and standards to list on a main stock exchange, given a lack of history on the firm’s financial performance. The intent is these companies eventually graduate to trading on the main stock exchanges. Several other countries (U.K., Italy, Canada, among others) already utilize venture exchanges. For example, TMX Group in Canada operates a venture exchange, the TSX Venture Exchange (TSXV), to help companies access the public markets earlier in their growth stage. Graduating from TSXV is a way to eventually begin trading on the Toronto Stock Exchange (TSX), as an alternative to waiting to IPO later in the company’s life. In 2017, TSXV represented 24% of all capital formation revenue for the Toronto Exchange Group (64% Toronto Stock Exchange, 12% other issuer services). Currently, TSXV graduates represent around 31% of TSX listed stocks.9
• Nasdaq report – In February 2018, Nasdaq published its blueprint to revitalize equities markets. One idea discussed is to give small and medium growth issuers the choice to consolidate liquidity on a single exchange and suspend UTP. Nasdaq believes creating a market for smaller securities where liquidity is concentrated should reduce volatility and increase trading efficiency. It could also allow for other market structures to develop (ex: intraday auctions to bring together supply and demand). Nasdaq notes off- exchange trading represents 38% of small and medium growth company trading, providing value for the trading of these stocks, especially for blocks and price-improved trades. Additionally, Nasdaq indicates it would be important to ensure “fair and reasonable” pricing if UTP is revoked, so as to not advantage the exchange. Further, Nasdaq’s report notes, while every stock trades with the same standard tick sizes, today’s technology makes this standardization unnecessary. The exchange suggests implementing intelligent tick sizes for small and medium growth companies, with the ability to trade on sub-penny, penny, nickel or dime increments. They suggest transparent and standardized methodologies could be used to determine optimal tick sizes to increase liquidity for these securities. Another suggestion in the report was to consider establishing a rebate/fee structure for market makers to incentivize tight spreads, which should lead to lower trading costs and increase trading efficiency.
9 As of June 2018; excludes CEFs, ETPs and SPACs.
SIFMA Insights Page | 23 Factors Driving Companies to Remain Private or Delist
Growth in Passive Investments Over the last 12-18 months, ETFs as a percent of total U.S. cash equities volumes averaged 18.7%. Since 97% of U.S. domiciled ETFs are index-based, ~18% of the market is in passive investments which trade less frequently. Some market participants attribute this growth (along with MiFID II) as part of the reason behind the decline in research for small and midcap companies. A lack of research is considered a deterrent to companies considering an IPO.
In addition to potentially contributing to the decline in IPOs, market participants note a strong primary market for single stocks is a contributor to building a healthy ecosystem for ETF investment products. As of FY17, 81% of U.S. domiciled ETFs were equities, meaning individual stocks are the underlying assets for these products. As with single stocks, vigorous issuance should promote efficient secondary markets.
Growth in Private Markets Since the global financial crisis, private markets have been readily available for companies. In the private markets, companies can obtain access to capital to grow their businesses with less administrative work than adherence to public company reporting and other requirements. There is also less fear of litigation. Without this scrutiny, the founders and management can take more risk in their quest for innovation and growing the company. In private companies, the founders’ and general partners’ (deals are typically structured as limited partnerships) expertise, desire to grow and hard work are essential to the company’s success. They generally seek limited partner funding to spread the risk, enabling them to focus on growing the company.
Private equity (PE) firms enter deals with the expectation of a high-returning exit in a short to medium turnaround time period, and they are paid via a return on their investment once selling the company. As PE firms fund many transactions with debt – which they payoff with free cash flow generated from the acquired company – the low interest rate environment has provided ample low-cost funds for these firms to take on deals. On the purchase side, low rates spur demand and the accompanying easy capital increases competition for buying assets, increasing deal prices.
Regardless of where the PE firm nets out on the rate impact, a concern around the use of private markets is there is no guarantee they will remain robust. Public capital markets have more stable long-term investors and market makers to keep markets functioning efficiently, in addition to a robust regulatory structure supporting these markets. Without this structural support, some market participants wonder about the longevity and stability of private equity investments, particularly under times of economic or market stress. As interest rates change, PE firms can pull support for small companies and startups and look for other higher-yielding investments.
SIFMA Insights Page | 24 Factors Driving Companies to Remain Private or Delist
Private Markets Provide Alternative to Going Public 900 5,000 4,422 4,421 804 4,266 4,386 800 4,500 4,000 700 3,590 3,550 3,463 3,167 599 594 3,500 600 548 2,855 2,806 519 2,781 3,000 500 456 439 2,500 2,021 400 1,920 368 327 339 292 2,000 300 241 1,500 200 142 1,000 100 500 0 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 YTD
Deals ($B) # Deals (RHS)
Private Markets Appealing to Smaller Companies (# Deals) 5,000 <$25M $25M-$100M $100M-$500M $500M-$1B $1B-$2.5B $2.5B+
4,500
4,000
3,500
3,000
2,500
2,000
1,500
2,089 1,000 1,836 1,972 1,911 1,370 1,457 1,543 1,591 1,094 1,270 1,089 1,297 500 805 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 YTD
Source: PitchBook (as of 2Q18), SIFMA estimates
SIFMA Insights Page | 25 The IPO Process
The IPO Process Underwriting is the process during which investment banks (the underwriters) act as intermediaries connecting the issuing company (issuer) and investors to assist the issuer in selling its initial set of public shares. Typically companies issue 20-30% of its shares to the public (free float), albeit this varies by the company’s stage in the business lifecycle, industry, etc. Investors may consider the deal riskier the lower the issued float, unless it is a “hot” IPO (for example, Facebook issued only ~11%), which could lower the demand for the IPO.
There are several types of common underwriting agreements, including:
• Best Efforts Agreement – Underwriters do not guarantee the amount of money to be raised for the issuer. Rather, underwriters agree to make a best effort to sell the shares on behalf of the issuer. The underwriters do not hold the liability of reselling the shares.
• Firm Commitment – Underwriters purchase the whole offering from the issuer and resell the shares to investors. This is the most common type of underwriting agreement, as it guarantees the issuer a fixed amount of money will be raised. The underwriters hold the liability of reselling the shares.
• Syndicate – While not a type of agreement per se, we note IPOs can be managed by a single underwriter, i.e. sole managed, or by a group of managers, a syndicate. In a syndicate, one investment bank is chosen as the lead manager or book runner. This bank chooses the other members of the syndicate, forming strategic alliances to ensure each investment bank sells a fixed amount of the IPO. This diversifies the risk (or liability) across a group of firms.
The underwriters will work with the issuer to determine what the IPO should look like and the best time to bring the deal to the market. Underwriters guide the issuer through the process, not only handling all of the required paperwork and performing a detailed analysis of the company, but also assisting management in addressing investor concerns to get investors interested in the deal. For an investment banking team, timing of the IPO process itself will vary by deal, taking from 6 months to much longer. The pre-IPO process and winning the mandate will also take many months (really years to build relationships with issuers). The length of time will vary by deal, size of issuer and complexity of the deal. For example, a typical financial audit for a startup can take 30 days. This can grow to 60 to 120 days for a large operating company. The SEC review of the registration statement can take 60 to 120 days, assuming no complications. The stock exchange review – looking at the number of shareholders, amount of capital invested, shareholders’ control of public float, etc. – can range from two weeks to three months. While this indicates the amount of time spent by an investment banking team up to the IPO date, post IPO support from the sales and trading staff and research analysts will be ongoing.
It is also important to note, the IPO can be withdrawn at any time prior to pricing. Frequently, companies will run a dual track process, including: (1) underwriters begin the IPO process, due diligence, etc.; and (2) a private equity firm shops the company for an outright sale, i.e. the company will not go public. Market participants estimate ~70% of IPOs are sponsor backed and these private equity or venture capital sponsors will therefore have a voice into the issuer’s decision to go public or not. Market participants indicate one out of every five deals brought to an
SIFMA Insights Page | 26 The IPO Process
investment bank are withdrawn prior to the IPO pricing date. Yet, the underwriters still have to perform all of the work and outlay the money for its own due diligence labor, outside accounting services and third party legal fees (estimated at $1-2 million per annum, whether the deals go live or not).
The underwriters take on the risk and opportunity cost (time that could have been spent on another deal or project) without a guarantee of deal completion.
Detailing Steps in the IPO Process Sample IPO Deal
Note: This is a general description, and timing can vary by deal. Firms may use different procedures or terminology. The research analysts’ due diligence and launch of coverage is performed separately from the work by the investment banking team.
• Pre-IPO Process – Investment bankers meet with the company to discuss what they believe the firm is worth and how much stock they can reasonably sell. They are also updating the issuer on what value-add their firm brings to the table, such as: industry expertise, reputation or IPO track record, quality of research department and/or distribution capabilities (sales and trading capabilities, institutional client relationships, retail investor distribution). Relationship building between the investment bank and the issuer prior to the IPO will vary significantly based on prior association and other factors such as those described above. Timing of this stage will vary as well.
• Mandate / Initial Stage – The issuing company selects the investment banks to underwrite its offering, based on the factors listed above. A bank’s past relationship with an issuer will also be a factor in choosing both the lead and additional underwriters. The issuer plays a role in determining the number of underwriters
SIFMA Insights Page | 27 The IPO Process
in the syndicate. Most IPOs have at least a few book runners and a few more investment banks in the syndicate as co-managers (either due to past relationships or different distribution capabilities). Investment bankers will also select the auditor and meet with the listings exchanges (NYSE, Nasdaq) in this phase.
• Due Diligence – The due diligence process begins with the kick-off meeting, attended by all parties: company management, accountants and auditors, lawyers and the investment bankers of the underwriters. This meeting sets the scene for who is responsible for what and the timing for the filing. Then the ongoing due diligence will begin.
o Investment Banking Team – Investment bankers will analyze company financials, strategy and operations. They will study industry trends to determine the future state of the industry. They will make customer calls – asking about their relationship with the company, if they have plans to increase/decrease business, etc. – to determine the company’s reputation in the marketplace.
o Legal Team – Lawyers will review contracts, registration forms, etc., as they begin preparing the registration statement.
o Accounting Team – Accounts and auditors will need to vet the company’s historical financial statements, tax returns, etc. A formal financial audit must be performed.
• Drafting & Filing – During this stage, the investment bankers will develop all necessary legal documentation and file the required SEC documents. This includes:
o Engagement Letter – This is a standard letter determining the relationship between the issuer and underwriters and setting deal terms. It notes the gross spread (underwriting discount), equal to the sale price of the issue sold minus the purchase price of the issue bought by the underwriters. This fee paid to the underwriting syndicate covers costs to take the company public plus service commissions for the underwriters. Typically, 20% of the gross spread is used to cover IPO costs (legal counsel, road show expenses, etc.), with another 20% paid to the lead underwriter and the remaining 60% (the selling concession) split among the rest of the syndicate in proportion to the number of shares sold.
o Letter of Intent – This legal document states the investment banks’ commitment to the issuer to underwrite the IPO. It also states the issuer’s commitment to provide all relevant information and cooperate in the due diligence process. It often includes an agreement to provide the underwriter a 15% overallotment option (ability to sell more shares than the number originally agreed upon, up to a set percentage; often called a greenshoe option). It does not include the final offering price.
o Underwriting Agreement – Once the securities are priced, the underwriting agreement is executed. The underwriters are now contractually bound to purchase the shares from the issuer at the
SIFMA Insights Page | 28 The IPO Process
specified price (depending upon whether it is a best efforts or firm commitment deal agreement).
o Registration Statement (S-1) – After a complete review of the issuing company, referred to as due diligence, the registration document is prepared. This document ensures investors have adequate information to perform their own due diligence prior to investing. It contains the historical financial statements of the company, management backgrounds, insider holdings, ongoing legal issues and pertinent IPO information, including the ticker to be used once listed. It is split into the prospectus, the public document distributed to all investors, and private filings, or information for the SEC to review but not distributed to the public. (During this stage, investment bankers will also respond to any comments or questions from the SEC.) After the prospectus is filed with the SEC and before the IPO, the issuer's communications with investors about the deal are restricted while the SEC reviews the documentation. This cooling off period typically lasts 20 days.
• Final Preparations – During this stage, the investment bankers will respond to any additional comments from the SEC. They will also be preparing for the roadshow. Once the investment bankers finalize the valuation of the company, they will receive Board of Directors approval from the issuer.
• Execution – After receiving the “go/no-go” decision from the issuer, the initial prospectus10 document is filed and used by underwriters and the issuer to market – or explain the company’s story to investors – the IPO during a road show to investors interested in buying shares in the offering. This marketing period typically lasts around two weeks and enables underwriters to gauge the demand for the shares. As investors state how many shares they would be willing to buy and at what price, this information is used in pricing the shares.
• Pricing – Once approved by the SEC, an effective date is set for the IPO. One day prior to this date, underwriters and the issuer will determine the offering price, or the price the shares will be sold to the public, and the number of shares to be sold. The stock is priced at the market clearing level, based on demand gauged during the road show and other market factors. The price is set to attempt to ensure the issue is fully subscribed by investors. After the deal is priced, underwriters (along with issuer input) will allocate shares to investors. The objective is to maximize allocation to investors who will remain on as long-term holders of the stock and promote a liquid after-market.
• Research Team Role – Research analysts will begin their due diligence separately from the investment banking team. Management and the investor relations team of the issuer will meet with all of the research analysts in the sector to run through the company’s strategic plans and financial statements. Analysts will develop their financial models and write their initiation of coverage research reports. In this stage, the analyst develops his or her investment thesis for the company and how it will rank against peers in the
10 This is often referred to as the red herring document, which is an initial prospectus for investors containing company details but not inclusive of the effective date or the offering price.
SIFMA Insights Page | 29 The IPO Process
sector, i.e. stock recommendations. At the same time (but separately) the investment banking team is running the road show, research analysts will also be speaking with clients interested in taking part in the IPO about company fundamentals, growth potential and how the company stacks up against the rest of his/her coverage universe. The stock recommendation is not issued at this time.
• Stabilization – Once the IPO is priced and the stock begins trading on exchange, the underwriters’ job is not finished. They must provide market stabilization for the stock price for a short period of time after the IPO. For example, if order imbalances exist, i.e. the buy and sell orders do not match, underwriters will purchase shares at a certain level below the offering price to rectify the imbalance. Underwriters are responsible for providing liquidity, or market making, to maintain orderly markets immediately after the IPO.
• Trading – Underwriters will continue to make a market in the stock after the stabilization period. Market makers are firms which stand ready to buy and sell stocks on a regular and continuous basis at a publicly quoted price, i.e. facilitate trading (buying and selling) of the stock in the secondary markets and maintain liquidity in the stock. Market making will be an ongoing function of the trading desks.
• Analyst Research – Once an IPO opens, it trades as an uncovered stock, i.e. no analyst coverage. The SEC mandates a quiet period on research recommendations, lasting 10 days (formerly 25 days). Analysts will launch research coverage on the stock after this quiet period ends, making for a noisy trading day when all of the coverage reports come out.
SIFMA Insights Page | 30 Alternatives to IPOs
Alternatives to IPOs
Direct Public Offerings As an alternative to a traditional IPO, a direct public offering (DPO, also known as a direct placement or direct listing) is where the company offers its securities directly to the public, without the use of underwriters as with an IPO. Since the company is selling existing shares, there is no dilution to existing shareholders and no capital is raised. The terms of the deal are up to the issuer, including: offering price, effective date, length of offering period, minimum investment per investor, limit on the number of securities an investor can buy, etc. A DPO can be attractive to companies with an established and loyal customer base and commonly raises less than $1 million (albeit sometimes up to $25 million).
The process is typically less expensive and less time consuming than an IPO. Yet, a DPO is not without costs. Bank of America estimates DPO costs can range from $50,000 to $125,000 to cover expenses11, including: marketing (traditional or social media ads, the roadshow with investors, etc.), attorney and accountant fees. Additionally, if there are a large number of shares to sell or timing is crucial, the issuer may recruit a broker to sell a portion of the shares to its clients on a best effort basis.
Preparing a DPO can last days to a few months. Similar to an IPO, the issuer develops an offering memorandum, goes on a roadshow, and files documents to securities regulators under the Blue Sky Laws of each state it will conduct the DPO (regulatory approval can take weeks to months, depending on the state). Most DPOs do not require the issuers to register with the SEC, as they qualify for an exemption (for example: Rule 504 under SEC Regulation D notes companies may not have to register with the SEC if raising less than $1 million or if all investors are in the same state). The issuer will then run a tombstone ad to announce the offering to the public, and the offering closes once all securities are sold or the closing date of the offering period. A DPO will still have to meet regulatory requirements of exchanges if it wants to trade on an exchange.
While potentially a shorter time period and less expensive, the company’s stock could end up being less liquid than with an IPO. Lower liquidity means it will be harder for investors to sell or trade their positions and could also make the stock more volatile, at least in the early stages (worsened by the fact that the underwriting syndicate is not there to stabilize the stock price after the IPO). The company will also most likely not have the same research coverage as with IPO stocks, whose syndicate investment banks begin covering the stock after the quiet period ends. This all makes it more difficult to attract investors in the DPO unless you are a “hot” name.
While DPOs have been around for decades, they are not very common. One well known example was the ice cream company Ben & Jerry’s, raising $750,000 from 1,800 investors in 1984 by selling shares directly to Vermont residents. Ben & Jerry’s utilized Reg A to allow them to advertise the offering, with the slogan “get a scoop of the action”. With this money, the company built a new plant and expanded distribution, allowing them to IPO the following year, raising $5.8 million. Traditionally, it is small companies in industries such as food, tech and biotech
11 Source: Bank of America website
SIFMA Insights Page | 31 Alternatives to IPOs
which go public via DPO. In April of this year, Spotify became the first large company to list via a DPO, closing around a $26 billion market cap on the day of its DPO.
Dutch Auction IPO A Dutch auction, also is known as a descending price auction or a uniform price auction, is a price discovery process which can be used in an IPO to figure out the optimum price for a stock offering (the U.S. government also uses this process for the public offering of Treasuries). The price is not set by the underwriters. Instead, the company determines the number of shares they would like to sell and the price is determined by the bidders. Buyers submit a bid with the number of shares they would like to purchase at a specified bid price. A list is created, with the highest bid at the top. Once all the bids are submitted, the allotted placement is assigned to the bidders from the highest bids down, until all of the allotted shares are assigned. However, the price that each bidder pays is based on the lowest price of all the allotted bidders, or essentially the last successful bid. A Dutch auction encourages aggressive bidding because the nature of the auction process means the bidder is protected from bidding a price that is too high.
In 2004, Google (now Alphabet Inc.) decided to go with a Dutch auction IPO. In its regulatory filings, Google stated, “Many companies going public have suffered from small initial share float and stock price volatility that hurt them and their investors in the long run…we believe our auction-based IPO will minimize these problems.” Another reason for the choice of the Dutch auction is Google's business model was based on algorithmically auctioning advertising space alongside search results. Given its unique (at the time) business model, the company decided it also made sense to choose a different kind of auction to create its shareholder base. Its offering closed with a market capitalization of over $27 billion.
However, the success of Google did not set a new trend for untraditional IPOs, as the Google deal remains an anomaly.
SIFMA Insights Page | 32 Market Structure for Listings Exchanges
Market Structure for Listings Exchanges When a company decides to go public, it will become listed on a national securities exchange. The listings exchanges have their own criteria – in addition to the requirements by the SEC for a company to go public – for firms to qualify to list on their exchange. These quantitative requirements typically analyze the financial status of a company (revenue, income, cash flows, operating history, etc.), as well as the number and types of shareholders, the amount and value of publicly held shares after the IPO and the percentage of public float. As discussed earlier in this report, under UTP stocks listed on one exchange may then be traded on other exchanges in the U.S.
The corporate listings business is highly competitive, with significant barriers to entry. As such, there are only two main listings exchanges in the U.S., the New York Stock Exchange12 (NYSE) and Nasdaq. As of June 2018, Nasdaq lists 3,004 companies and NYSE 2,292.13 These incumbents have long track records and therefore strong brand power to attract new issuers. On an ongoing service basis, these exchanges can tout not only their trading capabilities, but also the additional offerings attached to a listing: investor relations services, use of conference and meeting space, data analytics tools, etc.
While the ability to experience the ringing of the bell on the day of your IPO provides incentives for corporates to list – and has the potential cachet to outweigh offerings of lower listing fees by newer exchanges – the same is not true for exchange-traded products (ETPs). There is not the feeling of ownership as with a corporate listing, which brings down barriers to entry. This is why Bats Global Markets (BATS; now owned by Cboe Global Markets/CBOE) – which listed its own stock when it IPOd in 201614 – has kept its strategic focus on listing ETPs rather than single stocks.
In light of these barriers to entry, market participants 1990s 2000s 2010s % Change do not expect significant changes to the listings Nasdaq environment. (That said, the Investors Exchange # deals 3,215 950 641 -80.1% (IEX) received listing approval and plans to test its $ billion 139 111 99 -28.3% corporate listings process in 2018.) As shown in the NYSE table, Nasdaq listed 641 deals in the 2010 decade, # deals 779 431 525 -32.6% $ billion 155 219 222 43.8% with deal value totaling $99 billion. For the same time Total period, NYSE listed 525 deals, with deal value totaling # deals 3,994 1,381 1,166 -70.8% $222 billion. This represents an 80% and 33% decline $ billion 293 329 322 9.7% in the number of deals for Nasdaq and NYSE respectively since the 1990s, or -71% in total.
Source: Dealogic Note: As of June 2018. U.S. domiciled companies listed on U.S. exchanges. Excludes BDCs, SPACs, ETFs, CEFs, and rights offers. Excludes IPOs trading on OTC bulletin (pink sheets). Includes dual listed IPOs, where one of the exchanges in U.S. based.
12 Intercontinental Exchange (ICE) owns the NYSE exchanges, as well as other exchanges and clearing houses across the globe. 13 Source: World Federation of Exchanges; U.S. domiciled companies only 14 CBOE transferred its primary stock exchange listing from Nasdaq to its own exchange in September 2018.
SIFMA Insights Page | 33 Market Structure for Listings Exchanges
Sector Breakout for Total IPOs The following charts show each sector as a percent of total IPOs for that time period:
• For both 2017 and YTD (as of June), Healthcare leads the way at 25% and 37% respectively, followed by Computers & Electronics (24% and 25%) and Finance (10% and 9%) • In the 2010s, it was 27% Healthcare, 23% Computers & Electronics and 10% Finance • In the 2000s, Computers & Electronics lead at 26%, followed by Healthcare at 17% and Finance at 10.5% • In the 1990s, it was 26% Computers & Electronics, 14% Healthcare and 8% Telecommunications
Current Environment YTD 2017 2010s
Defense 0.1% Utility & Energy 0.6% 0.8% Aerospace 0.1% Food & Beverage 0.6% Forestry & Paper 0.1% Dining & Lodging 0.8% 0.6% Publishing 0.2% 4.5% Consumer Products 0.6% Textile 0.3% 0.8% Agribusiness 0.3% Telecommunications 1.2% Mining 0.7% Metal & Steel 1.2% Machinery 0.9% Leisure & Recreation 0.8% 1.2% Auto/Truck 1.1% 1.5% Insurance Metal & Steel 1.1% Food & Beverage 1.1% Mining 1.8% 0.8% Consumer Products 1.1% Machinery 1.8% Leisure & Recreation 1.3% Chemicals 0.8% 1.8% Insurance 1.5%
Auto/Truck 1.8% Telecommunications 1.5% 2.3% Dining & Lodging 1.8% Transportation 2.4% 1.5% Construction/Building 1.9% Retail 2.4% Chemicals 2.1% Real Estate/Property 3.0% Transportation 2.2% 0.8% Construction/Building 3.0% Retail 2.4% 5.3% Professional Services 5.9% Utility & Energy 2.5% Professional Services 3.2% Real Estate/Property 7.1% Real Estate/Property 5.7% 5.3% Oil & Gas 7.1% Oil & Gas 7.2% Finance 9.1% 10.1% Finance 10.1% 25.0% Computers & Electronics 23.7% Computers & Electronics 22.9% 37.1% Healthcare 26.7% Healthcare 25.4%
Source: Dealogic (as of June 2018). U.S. domiciled companies listed on U.S. exchanges. Excludes BDCs, SPACs, ETFs, CEFs, and rights offers)
SIFMA Insights Page | 34 Market Structure for Listings Exchanges
2000s 1990s
Holding Companies 0.1% Defense 0.1% Forestry & Paper 0.2% Agribusiness 0.1% Textile 0.2% Holding Companies 0.2% Defense 0.2% Mining 0.3% Agribusiness 0.2% Forestry & Paper 0.4% Aerospace 0.2% Aerospace 0.5% Auto/Truck 0.5% Publishing 0.6% Publishing 0.6% Textile 1.3% Mining 0.6% Metal & Steel 1.4% Machinery 0.8% Utility & Energy 1.4% Leisure & Recreation 0.8% Chemicals 1.4% Metal & Steel 0.9% Insurance 1.6% Food & Beverage 1.0% Auto/Truck 1.6% Construction/Building 1.4% Machinery 1.7% Chemicals 1.4% Food & Beverage 1.9% Consumer Products 1.5% Construction/Building 2.3% Dining & Lodging 1.6% Dining & Lodging 2.4% Utility & Energy 2.7% Transportation 2.5% Retail 2.8% Oil & Gas 2.9% Insurance 3.4% Leisure & Recreation 3.0% Transportation 3.5% Consumer Products 3.3% Real Estate/Property 4.8% Real Estate/Property 3.4% Oil & Gas 4.9% Retail 5.3% Professional Services 5.2% Professional Services 5.8% Telecommunications 7.3% Finance 6.9% Finance 10.5% Telecommunications 7.9% Healthcare 17.1% Healthcare 13.7% Computers & Electronics 25.6% Computers & Electronics 26.2%
Source: Dealogic Note: As of June 2018. U.S. domiciled companies listed on U.S. exchanges. Excludes BDCs, SPACs, ETFs, CEFs, and rights offers
SIFMA Insights Page | 35 Market Structure for Listings Exchanges
Sector Breakout Across Exchanges The following charts show the sector breakout for IPOs by each exchange:
• Nasdaq (NDAQ) has decreased its proportion of tech IPOs, from 31%/32% in the 1990s/2000s to 20% in the 2010s; Healthcare IPOs now represent 46% of the total in the 2010s • NYSE now has Tech (20%), Oil & Gas (17%) and Real Estate (14%) at the top in the 2010s; Tech listings have more than doubled since the 1990s, from 8% to 20%
NDAQ 1990s NDAQ 2000s NDAQ 2010s
Other, Other, Retail, 17.2% 20.7% 2.3% Other, Tech, Tech, 31.4% 31.8% 31.7% Dining & Prof. Serv., Lodging, 5.3% 2.3% Healthcare, Finance, 45.8% 12.4% Telecom, Healthcare, 6.3% Finance, Healthcare, Prof. Serv., 15.9% 11.4% 24.5% Tech, 6.6% 19.9% Finance, 7.1% Telecom, 7.2%
NYSE 1990s NYSE 2000s NYSE 2010s
Real Real Estate, Estate, Tech, 15.0% 15.1% 19.9% Other, Healthcare, 35.1% Other, 9.1% Finance, 46.6% 12.4% Other, Tech, Oil & 8.3% Gas, 52.6% Oil & Gas, 16.9% 11.3% Real Tech, Estate, Finance, 8.8% Healthcare, 14.0% 7.7% 4.9% Oil & Gas, Finance, Healthcare, 5.9% 7.3% 9.1%
Source: Dealogic Note: As of June 2018. U.S. domiciled companies listed on U.S. exchanges. Excludes BDCs, SPACs, ETFs, CEFs, rights offers & IPOs trading on OTC bulletin (pink sheets). Includes dual listed IPOs, if one exchange is U.S. based. Tech = Computers & Electronics; Prof. Serv. = Professional Services.
SIFMA Insights Page | 36 Comparison to Other Regions
Comparison to Other Regions Comparing the environment in the U.S. from 2003 to 2017, we note the following similarities and differences to other regions in terms of number of listed companies. While the number of U.S. companies was down 12%:
• Americas – Canada was also down 12% and Brazil was down 15%
• AsiaPac – Other countries were up: 189% in China, 113% in Hong Kong, 71% in Japan, 50% in Singapore, 48% in Australia and 8% in New Zealand
• Europe – The U.K. was down 27% and Switzerland was down 9%; conversely, the EU was up 5% and Oslo Bors was up 4%
US versus Other Countries in the Americas 6,000 US Canada Brazil (RHS) 400
5,500 390
380 5,000 370 4,500 360 4,000 350
3,500 340
3,000 330
Jan Jan 03 Jan 04 Jan 05 Jan 10 Jan 11 Jan 12 Jan 13 Jun 18 Jan Jan 07 Jan 08 Jan 09 Jan 14 Jan 15 Jan 16 Jan 17 Jan Jan 06 Source: World Federation of Exchanges, SIFMA estimates Note: As of June 2018. Domestic companies listed on domestic exchanges. U.S. = NYSE, Nasdaq; Canada = TSX, TSXV; Brazil = B3.
SIFMA Insights Page | 37 Comparison to Other Regions
US versus Countries in Europe US EU UK Switzerland (RHS) Oslo Bors (RHS) 6,500 310
6,000 290 5,500 270 5,000 4,500 250 4,000 230
3,500 210 3,000 190 2,500 2,000 170
1,500 150
Jan Jan 03 Jan 04 Jan 05 Jan 10 Jan 11 Jan 12 Jan 13 Jun 18 Jan Jan 07 Jan 08 Jan 09 Jan 14 Jan 15 Jan 16 Jan 17 Jan Jan 06
US versus Countries in AsiaPac US Australia Japan Hong Kong China New Zealand (RHS) Singapore (RHS) 6,000 600 5,500 550 5,000 500 4,500 450 4,000 400 3,500 350 3,000 300 2,500 250 2,000 1,500 200 1,000 150
500 100
Jan Jan 03 Jan 04 Jan 05 Jan 10 Jan 11 Jan 12 Jun 18 Jan Jan 06 Jan 07 Jan 08 Jan 09 Jan 14 Jan 15 Jan 16 Jan 17 Sep Sep 04
Source: World Federation of Exchanges, London Stock Exchange Group, SIFMA estimates Note: As of June 2018. Domestic companies listed on domestic exchanges, except Italy includes foreign listings. U.K. = London Stock Exchange Main Market, AIM; Oslo Bors = Norway and other Nordic countries; EU27 = Austria, Euronext (Belgium, Netherlands, France, Portugal), Cyprus, NASDAQ OMX Nordic Exchange (Denmark, Finland, Sweden; not in EU are the remaining Nordic and Baltic countries), Germany, Greece, Hungary, Ireland, Luxembourg, Malta, Slovenia, Spain and Italy (Borsa Italia Main Market and AIM). China = Shanghai, Shenzhen.
SIFMA Insights Page | 38 Legislation and Regulation to Attempt to Boost Capital Formation
Legislation and Regulation to Attempt to Boost Capital Formation Legislators and regulators are constantly looking to spur capital formation, with the objectives to: get individual investors more access to invest in public companies; and bring companies public earlier in their lifecycle before valuations get too high in the private markets.
Jumpstart Our Business Startups Act (JOBS, 2012) https://www.sec.gov/spotlight/jobs-act.shtml https://www.gpo.gov/fdsys/pkg/BILLS-112hr3606enr/pdf/BILLS-112hr3606enr.pdf
Catalyst: Decline in small company IPOs
Objective: Encourage business startups and improve access to public capital markets for emerging growth companies (newly established term)
Details:
In April 2012, the JOBS Act was signed into law. With the objective of boosting small company IPOs to create more jobs and stimulate the economy, it was an effort to ease regulatory burdens for smaller companies and facilitate capital formation. This act made amendments to Securities Act of 1933 and the Securities Exchange Act of 1934, including:
• Title I – Reopening American Capital Markets to Emerging Growth Companies: Title I established a new definition for an emerging growth company (EGC), defined as an issuer: (a) with total annual gross revenues of less than $1 billion during its most recently completed fiscal year, (b) that does not have greater than $700 million in public float following the IPO and (c) has not sold common equity securities as of December 8, 2011 (the first sale of equity securities is not limited to a company’s initial primary offering; for example, offering common equity in an employee benefit plan would constitute a sale of equity securities). A company may continue to be an EGC for the first five fiscal years following the IPO, unless: total annual gross revenues reach $1.07 billion or more, it issued greater than $1 billion in non-convertible debt in the past three years or it becomes a large accelerated filer. EGCs are authorized to include less narrative disclosures, particularly around executive compensation, and provide audited financial statements for two years versus the standard three. EGCs do not need auditor attestation to SOX and can defer complying with certain changes in accounting standards. Further, EGCs may use test-the-waters communications with qualified institutional and accredited investors during its IPO. Title I also eased restrictions on communications between a research analyst and a potential investor during an EGC IPO, as well rules prohibiting research analysts from participating in communications with the EGC management team when other associated persons of a broker-dealer are in attendance.
• Title II – Access to Capital for Job Creators: Title II revised prohibitions under the Securities Act against general solicitation and advertising. These rules cease to apply to Rule 506 offerings, if all purchasers are accredited investors, or to Rule 144A offerings, if the securities are only sold to qualified institutional buyers.
SIFMA Insights Page | 39 Legislation and Regulation to Attempt to Boost Capital Formation
Title II also provided exemptions from broker-dealer registration for securities offered under Rule 506 if the entity only maintains a platform offering, selling, purchasing or negotiating securities or permits general solicitation/advertising.
• Title III – Crowdfunding: Crowdfunding is the raising of capital from a large number of investors whose individual investments are limited. Title III permits crowdfunding by U.S. domiciled issuers if the aggregate amount sold, including amounts sold pursuant to crowdfunding in the prior 12 months, is not greater than $1 million. Additionally, the total amount sold to an individual investor, including amounts sold pursuant to crowdfunding in the prior 12 months, cannot exceed: the greater of $2,000 or 5% of the investor’s annual income or net worth, if the investor’s annual income or net worth is less than $100,000; or 10% of the investor’s annual income or net worth not to exceed $100,000, if the investor’s annual income or net worth is greater than $100,000. The transaction must be conducted through an intermediary, and the issuer is required to comply with SEC disclosure and filing obligations, limitations on advertising, limitations on compensating promoters and disclose results of operations and financial statements not less than annually.
• Title IV – Small Company Capital Formation: Title IV expanded exemptions from registration under Section 3(b) of the Securities Act, building on Regulation A (exemptions from certain registration requirements for public offerings of securities not exceeding $5 million in any one-year period). There are two tiers of offerings under Regulation A+: Tier 1, for securities offerings up to $20 million in a 12-month period; and Tier 2, for securities offerings up to $50 million in a 12-month period. Rules for offerings under Tier 1 and Tier 2 speak to issuer eligibility, offering circular contents, testing the waters and bad actor disqualification. The filing process for all offerings aligns practices for registered offerings and creates additional flexibility for issuers, while establishing an ongoing reporting regime for certain issuers. Tier 2 issuers are required to include audited financial statements in their offering documents and to file annual, semiannual and current reports with the SEC on an ongoing basis. With the exception of securities that will be listed on a national securities exchange, purchasers in Tier 2 offerings must either be accredited investors or be subject to certain limitations on their investment. Tier 2 offerings are not required to register with state securities regulators and are therefore exempt from state Blue Sky reviews. Tier 2 offerings may be sold to non-accredited investors, if no more than: (a) 10% of the greater of annual income or net worth; or (b) 10% of the greater of annual revenue or net assets at fiscal year end (non-natural persons). This limit does not apply to securities that will be listed on a national securities exchanges.
• Title V – Private Company Flexibility and Growth and Title VI – Capital Expansion: Under the JOBS Act, issuers are not required to register under Section 12(g) of the Securities Act until it has over $10 million in assets and a class of equity securities (other than exempted securities) held of record (excluding securities received in an employee compensation plan) by either 2,000 persons or 500 persons who are not accredited investors. An issuer that is a bank, bank holding company or savings and loan holding company is required to register a class of equity securities if it has greater than $10 million in total assets and the securities are held of record by 2,000 or more persons, and they may terminate or suspend registration if the securities held of record are by fewer than 1,200 persons.
SIFMA Insights Page | 40 Legislation and Regulation to Attempt to Boost Capital Formation
JOBS Act 2.0 (2015) https://www.congress.gov/114/bills/hr22/BILLS-114hr22enr.pdf https://www.sec.gov/news/pressrelease/2016-6.html
Catalyst: Decline in small company IPOs
Objective: Ease regulatory burdens for small companies to facilitate capital formation
Details:
In December 2015, the Fixing America’s Surface Transportation Act (FAST Act) was signed into law. This act represents JOBS Act 2.0, as it included several provisions to enhance the JOBS Act. The focus was on improving access to the capital markets for small businesses by easing regulatory burdens, without removing investor protections. It included the following changes to reporting and disclosures, among others:
• TITLE LXXI – Improving Access to Capital for Emerging Growth Companies: This section reduced the number of days an EGC must publicly file its IPO registration statement before its roadshow to 15 from 21 and established a grace period for EGCs that lose their EGC status while in registration for their IPO (actively in the SEC review process), allowing EGC rules to apply throughout the process. If the EGC loses its EGC status during the confidential review of its draft IPO registration statement, it would need to publicly file a registration statement to continue the review process and comply with current non-EGC regulations. This section also permitted smaller reporting companies to use forward incorporation by reference to update information in a Form S-1 or Form F-1 after the registration statement is declared effective. This enables the IPO prospectus to stay current through the automatic inclusion of the issuer’s current and future filings, avoiding costs and delays associated with updates via prospectus supplements or post-effectiveness amendments. This section further enabled EGCs to omit from their IPO registration statements certain historical financial information otherwise required by Regulation S-X, provided: the omitted financial information relates to a historical period that the EGC reasonably believes will not be required to be included in the Form S-1 or Form F-1; and the registration statement is amended to include all financial information required by Regulation S-X prior to the distribution of a preliminary prospectus to investors.
• TITLE LXXII – Disclosure Modernization and Simplification: This section permitted companies to submit a summary page on Form 10-K, as long as each item on the summary page includes a cross-reference to the related material in Form 10-K. It simplified Regulation S-K (reporting requirements for SEC filings for public companies), scaling or eliminating certain requirements to reduce the burden on all public companies, except large accelerated filers, while still providing all material information to investors. This section also called for the elimination of provisions under Regulation S-K, for all issuers, that are duplicative, overlapping, outdated or unnecessary. The act simplified the disclosure provisions under Regulation S-K to modernize and simplify it in a manner that reduces costs and burdens on issuers, including: a company-by-company approach to eliminate boilerplate language and static requirements; and methods of information delivery and presentation that discourage repetition and the disclosure of immaterial information.
SIFMA Insights Page | 41 Additional Related Regulations and Laws
Additional Related Regulations and Laws
Markets in Financial Instruments repealing Directive (MiFID II, 2011) https://www.esma.europa.eu/policy-rules/mifid-ii-and-mifir
Catalyst: Updates to MiFID (applicable since November 2007)
Objective: Strengthen investor protection and make financial markets more efficient, resilient and transparent
Details:
Financial markets in the European Union had been operating under the Markets in Financial Instruments Directive (MiFID) since November 2007. MiFID was meant to increase the competitiveness of Europe’s financial markets by creating a single market for investment services and activities and to ensure a high degree of harmonized protection for investors in financial instruments. In June 2014, the Markets in Financial Instruments repealing Directive and the Markets in Financial Instruments Regulation (MiFID II and MiFIR) were published in the EU Official Journal. The objective was to ensure fairer, safer and more efficient markets and facilitate greater transparency for all market participants, including: new reporting requirements to increase the amount of information available and reduce the use of dark pools and OTC trading; rules governing high-frequency-trading to impose a strict set of organizational requirements on investment firms and trading venues; and provisions regulating non-discriminatory access to central counterparties, trading venues and benchmarks to increase competition.
Rules for investment research payments under MiFID II, which went live on January 3, 2018, seek to increase transparency and prove best execution (trading) by unbundling payments for execution and research. The regulation is expected to drive many changes in the industry, including:
• Behavioral – Institutional investors must pay directly for investment research (traditionally offered for “free” from a P&L perspective as it was bundled with other sales and trading commissions)
• Logistical – Firms must substitute commission-sharing for direct payment accounts
• Strategic – Firms must establish pricing schemes for research offerings without disrupting traditional services provided to and relationships with institutional clients
While MiFID II is technically a European regulation, financial services is a global business. Many non-European financial institutions are having to run MiFID II rules across all regions, rather than establish separate compliance and operational regimes across regions.
SIFMA Insights Page | 42 Additional Related Regulations and Laws
Sarbanes-Oxley Act (SOX, 2002) https://www.congress.gov/bill/107th-congress/house-bill/3763 https://www.sec.gov/info/smallbus/404guide/intro.shtml
Catalyst: Accounting malpractice in the early 2000s (Enron Corporation, Tyco International, WorldCom)
Objective: To improve financial disclosures by corporations and prevent accounting fraud
Details:
In July 2002, the Sarbanes-Oxley Act was passed to weed out corporate accounting fraud by holding management of and auditors to public companies accountable to assess and attest to internal controls for financial reporting, as well as other changes, including.
• Section 404 holds CEOs personally responsible for errors in accounting audits, requiring corporate executives to certify the accuracy of financial statements personally. If the SEC finds violations, CEOs could face 20 years in jail. It also made managers maintain adequate internal controls and procedures for financial reporting. Companies' auditors had to attest to these controls and disclose material weaknesses. There was an exemption for non accelerated filers with market cap of $75 million or less.
• SOX created the Public Company Accounting Oversight Board to oversee the accounting industry and set standards for audit reports, requiring all auditors of public companies to register with them. This entity investigates and enforces compliance of these auditing firms and prohibits accounting firms from doing consulting business with the companies they are auditing (excluding tax consulting).
• It banned company loans to executives and directors, with certain exemptions (standard credit card or other type of loans made to the general public on similar market terms).
• SOX gave protections to employees (and contractors) reporting fraud against their employers. Companies cannot change the terms and conditions of employment, reprimand, fire or blacklist whistleblowers.
• SOX established rules around research analysts' potential conflicts of interest, including: restricting the approval of research reports by persons either engaged in investment banking activities or not directly responsible for investment research; limiting the supervision and compensatory evaluation of research analysts to personnel not engaged in investment banking activities; prohibit retaliation against a research analyst as a result of unfavorable research adversely affecting the investment banking relationship; and separating research analysts from the review, pressure or oversight of personnel involved in investment banking activities. SOX also directed research analysts and broker-dealers to disclose specified conflicts of interest.
SIFMA Insights Page | 43
Appendix
Industry Classifications General Industry Group Specific Industry Group General Industry Group Specific Industry Group Aerospace Aircraft Finance Accounts Receivables/Factoring Agribusiness Agriculture Acquisitions/Restructurings Auto/Truck Manufacturers Automobile Mobile Homes Capital Pool Companies Parts & Equipment Commercial & Savings Banks Repair Credit Cards Sales Development Banks/Multilateral Agencies Chemicals Diversified Home Equity Loan Fertilizers Investment Banks Plastic Investment Management Specialty Leasing Companies Computers & Electronics Components Manufactured Homes Measuring Devices Miscellaneous Memory Devices Mortgages/Building Societies Miscellaneous Provincial Banks Networks Savings & Loan PCs Special Purpose Vehicles Peripherals Student Loan Semiconductors Food & Beverage Alcoholic Beverages Services Beer Software Canned Foods Construction/Building Air Conditioning/Heat Confectionary Cement/Concrete Dairy Products Commercial Building Flour & Grain Engineering/R&D Meat Products Infrastructure Miscellaneous Maintenance Non-Alcoholic Beverages Miscellaneous Wholesale Items Residential Building Forestry & Paper Packaging Retail/Wholesale Pulp & Paper Wood Products Raw Materials Consumer Products Cleaning Products Healthcare Biomed/Genetics Cosmetics & Toiletries Drugs/Pharmaceuticals Footwear Health Management Organizations Furniture Hospitals/Clinics Glass Instruments Household Appliances Medical/Analytical Systems Miscellaneous Miscellaneous Services Office Supplies Nursing Homes Precious Metals/Jewelry Outpatient Care/Home Care Rubber Practice Management Tobacco Products Tools Holding Companies Conglomerates Defense Contractors/Products & Services Insurance Accident & Health Dining & Lodging Hotels & Motels Brokers Restaurants Life Multi-line Property & Casualty Source: Dealogic
SIFMA Insights Page | 44
General Industry Group Specific Industry Group General Industry Group Specific Industry Group Leisure & Recreation Film Retail Apparel/Shoes Gaming Automobile Parts & Related Products Computers & Related Services Convenience Stores Machinery Electrical Department Stores Farm Equipment Home Furnishings General Industrial Jewelry Stores Machine Tools Mail Order & Direct Material Handling Miscellaneous Printing Trade Pharmacies Metal & Steel Distributors Supermarkets Processing Telecommunications Cable Television Products Equipment Mining General Radio/TV Broadcasting Oil & Gas Diversified Satellite Exploration & Development Services Field Equipment & Services Telephone Pipeline Wireless/Cellular Refinery/Marketing Textile Apparel Manufacturing Royalty Trust Home Furnishings Professional Services Accounting Mill Products Advertising/Marketing Miscellaneous Funeral & Related Transportation Air Freight/Postal Services Legal Airlines Management Consulting Airports Miscellaneous Equipment & Leasing Personnel General Logistics/Warehousing Printing Rail Schools/Universities Road Security/Protection Services Travel Agencies Ship Publishing Books Utility & Energy Diversified Diversified Electric Power Newspapers Gas Periodicals Hydroelectric Power Real Estate/Property Development Nuclear Power Diversified Waste Management Operations Water Supply REIT Source: Dealogic
SIFMA Insights Page | 45
Terms to Know
FINRA Financial Industry Regulatory Authority SEC Securities and Exchange Commission
IPO Private company raises capital buy offering its common stock to the public for the first time in the primary markets Bought Deal underwriter purchases a company's entire IPO issue and resells it to the investing public; underwriter bears the entire risk of selling the stock issue
Best Effort Deal Underwriter does not necessarily purchase IPO shares and only guarantees the issuer it will make a best effort attempt to sell the shares to investors at the best price possible; issuer can be stuck with unsold shares Follow-On Offering (Follow-on public offering) Issuance of shares to investors by a public company already listed on an exchange Direct Listing (Direct placement, direct public offering) Existing private company shareholders sell their shares directly to the public without underwriters. Often used by startups or smaller companies as a lower cost alternative to a traditional IPO. Risks include, among others, no support/guarantee for the share sale and no stock price stabilization after the share listing.
Underwriting Guarantee payment in case of damage or financial loss and accept the financial risk for liability arising from such guarantee in a financial transaction or deal Underwriter Investment bank administering the public issuance of securities; determines the initial offering price of the security, buys them from the issuer and sells them to investors. Bookrunner The main underwriter or lead manager in the deal, responsible for tracking interest in purchasing the IPO in order to help determine demand and price (can have a joint bookrunner) Lead Left Bookrunner Investment bank chosen by the issuer to lead the deal (identified on the offering document cover as the upper left hand bank listed) Syndicate Investment banks underwriting and selling all or part of an IPO Arranger The lead bank in the syndicate for a debt issuance deal
Pitch Sales presentation by an investment bank to the issuer, marketing the firm’s services and products to win the mandate Mandate The issuing company selects the investment banks to underwrite its offering Engagement Letter Agreement between the issuer and underwriters clarifying: terms, fees, responsibilities, expense reimbursement, confidentiality, indemnity, etc. Letter of Intent Investment banks’ commitment to the issuer to underwrite the IPO Underwriting Agreement Issued after the securities are priced, underwriters become contractually bound to purchase the issue from the issuer at a specific price Registration Statement Split into the prospectus and private filings, or information for the SEC to review but not distributed to the public, it provides investors adequate information to perform their own due diligence prior to investing The Prospectus Public document issued to all investors listing: financial statements, management backgrounds, insider holdings, ongoing legal issues, IPO information and the ticker to be used once listed Red Herring Document An initial prospectus with company details, but not inclusive of the effective date of offering price
Roadshow Investment bankers take issuing companies to meet institutional investors to interest them in buying the security they are bringing to market. Non-Deal Roadshow Research analysts and sales personnel take public companies to meet institutional investors to interest them in buying a stock or update existing investors on the status of the business and current trends. Pricing Underwriters and the issuer will determine the offer price, the price the shares will be sold to the public and the number of shares to be sold, based on demand gauged during the road show and market factors Stabilization Occurs for a short period of time after the IPO if order imbalances exist, i.e. the buy and sell orders do not match; underwriters will purchase shares at the offering price or below to move the stock price and rectify the imbalance Quiet Period (Cooling off period) The SEC mandates a quiet period on research recommendations, lasting 10 days (formerly 25 days) after the IPO
Reg S-K Regulation which prescribes reporting requirements for SEC filings for public companies Reg S-X Regulation which lays out the specific form and content of financial reports, specifically the financial statements of public companies Form S-1 Registration statement for U.S. companies (described above) Form F-1 Registration statement for foreign issuers of certain securities, for which no other specialized form exists or is authorized Form 10-Q Quarterly report on the financial condition and state of the business (discussion of risks, legal proceedings, etc.), mandated by the SEC Form 10-K More detailed annual version of the 10Q, mandated by the SEC Form 8-K Current report to announce major events shareholders should know about (changes to business & operations, financial statements, etc.) Greenshoe Allows underwriters to sell more shares than originally planned by the company and then buy them back at the original IPO price if the demand for the deal is higher than expected, i.e. an over-allotment option Tombstone A plaque awarded to celebrate the completion of a transaction or deal
ETF Exchange-Traded Fund; pooled investment vehicles holding an underlying basket of securities (equities, bonds, etc.), publicly traded CEF Closed-End Fund; pooled investment fund, launched through an IPO with a fixed number of shares publicly traded BDC Business Development Company; unregistered closed-end investment company, invests in small and mid-sized businesses SPAC Special Purpose Acquisition Company; publicly traded buyout company, raises funds in a blind pool through an IPO to acquire a private company Rights Offer Rights offered to existing shareholders to purchase additional stock (subscription warrants) in proportion to existing holdings
Investors Institutional Asset managers, endowments, pension plans, foundations, mutual funds, hedge funds, family offices, insurance companies, banks, etc.; fewer protective regulations as assumed to be more knowledgeable and better able to protect themselves Individual Self-directed or advised investing; some considered accredited investors: income > $200K ($300K with spouse) in each of the prior 2 years or net worth >$1M, excluding primary residence
SIFMA Insights Page | 46 Authors
Authors Author Katie Kolchin, CFA Senior Industry Analyst SIFMA Insights
Contributor T.R. Lazo Managing Director, Associate General Counsel Equities
SIFMA Insights Page | 47