Observations for the SEC

The following is excerpted from an email from David Weild to a senior SEC official, part of an ongoing discussion. 

Thank you for the quick response and the thoughts of your colleagues.   

Let’s diverge for a moment from the question of accounting costs.     

The reason why we care about the impact of Sarbanes-Oxley and the accounting profession is because it affects the “health” of the IPO market. This begs the question:  What is the “absolute health” of the IPO market in the United States compared to prior years? 

Answer: The “absolute health” of the US IPO market leaves much to be desired. 

We ran the attached analysis of IPO Issuance Broken Down By Transaction Size (1991 to 2007 YTD).  The document carries an internal title of “The IPO Market Has Been Compromised: What can be done to reverse the damage?” We used a “pure” census of corporate offerings (companies “listed” on the NYSE, NASDAQ or AMEX) in the United States from 1991 to 2007 YTD (September 25).  The sample set is “pure” in the sense that it excludes SPACs (blank-check companies), business development companies, closed-end funds, REITs and limited partnerships to focus on operating companies. We have identified two periods: “Pre-bubble” (1991-1996) and “Post-bubble” (2001-2007). The period of the “Bubble” is in between these two periods.  

As the exhibit makes obvious (I’m sure you’ll agree), smaller IPOs (those in the $0 to $75 million range) are very much under-represented (one could say nearly “wiped out”) post-Bubble. Given the fact that venture capital and private equity funds have in the aggregate much more capital to invest than they did in the pre-bubble period, a “reasonable man” would expect that the number of IPOs in the post-Bubble period should be higher (not lower).  The question of why the number of IPOs is not higher, fully six years after the Bubble, is an important question. I submit that there is no question that accounting costs and Sarbanes-Oxley costs are a primary (maybe not the only) factor in the diminution of initial public offerings in the United States. We know this because over the last several years we have consistently heard from private equity and venture capital professionals that they are forced to sell companies to acquirers because the hurdle to go public has been raised.  

According to the SEC’s website under “What we do”, the SEC states that its mission is three-fold: 

“. [1] to protect investors, [2] maintain fair, orderly, and efficient markets, and [3] facilitate capital formation.” 

“Capital formation” starts with the initial public offering of operating companies as a founding pillar (the other two being entrepreneurs and venture funding) of US innovation, economic growth, technology leadership and job formation.  While the SEC has made great strides in protecting investors and creating efficient markets (some would say “overly” efficient markets given that “traders” have increasingly displaced “investors.”), the SEC has gone backwards in its mission to facilitate capital formation through IPOs.  Anecdotal evidence of policies that, rather than “facilitate” capital formation, may actually be inhibiting IPO capital formation can be seen in the current tsunami of interest in creating institutional-only 144A marketplaces to circumnavigate the IPO market (e.g., NASDAQ’s “Portal,” Goldman Sachs’ “GSTrUE,” “Restricted Stock Partners” and “OPUS-5”).   

My reactions to the specific thoughts of your colleagues: 

• “Maybe the treasury faca and our faca should receive?” — By all means, please forward our input along. I would appreciate any detail you could provide on these advisory committees, and we would be honored to serve and contribute in any meaningful way. 
• “I’m not sure that investors would agree that [accounting] firms are providing “worse service”” — This is not the point.  The point is, “When is the cure worse than the disease?” — We’ve reached that point. We need to strike a better balance. 
• “Support for the assertions would be helpful. Data should be easy to develop.”  — In addition to the IPO issuance data provided above, we are examining new issue costs on IPOs for 2007 and a sample of corporate IPOs from 1999. We’ll revert to you with those numbers when we have them.
• “The issue of whether they are thriving seems open to debate (for example, I’m not sure that BDO would agree).” — Again, the point is not really how much money the accounting industry is earning but, rather, is our system inhibiting capital formation?  Please note that because of the reliance on the “Big 4” to do SEC Audits (PricewaterhouseCoopers, Ernst & Young, Deloitte Touche and KPMG) it does not surprise me that firms like BDO Seidman and Grant Thornton have not been the primary beneficiary of this “windfall.” 
• “Further as it relates to U.S. competitiveness it might make sense to consider whether investment banking fees undermine U.S. competitiveness for example, consideration of investment banking fees in the U.S. compared to other markets, such as the U.K.” – This question, in my view, is not worth an investment of anyone’s time.  We have to ask, “What is different about our markets today that has resulted in the loss of smaller IPOs?” For the entire period of 1991-2007, small IPOs have generally had a 7% gross spread (fees to the investment banks). That has not changed.   Furthermore, we’re not asking the question, “Are our markets more or less competitive than the UK?”  There are serious deficiencies in the LSE’s AIM market, for example.   We hope the SEC would aspire to “absolute” greatness in capital formation, not “relative” greatness. 

By way of background for your colleagues, Al Berkeley (Chairman & CEO of Pipeline Trading and former President of NASDAQ), Wick Simmons (former Chairman and CEO of NASDAQ) and Prof. John Coffee are all on the Board of our sister-company. Capital Markets Advisory Partners or “CMA Partners” is led by four principals who have 100 years of combined practical experience in equity capital formation.  In addition to understanding market structure (and the regulatory process) through time spent at NASDAQ (then controlled by the NASD), we have each spent many years working within equity capital markets groups at major Wall Street firms and have drafted, structured, marketed, priced and traded hundreds of IPOs, follow-ons and other equity-related instruments. We help issuers and financial sponsors achieve better outcomes in the capital markets. 

As indicated, I did post the body of the prior email I sent to you on Private Equity Hub which is frequented by many in the Venture and Private Equity communities. There are several comments already which you might like to see.  I have received additional comments which, with permission, I will forward along as I believe they also shed “real world” insight into these issues. 

Best Regards and with Great Respect for the Staff at the SEC, 

Dave Weild
Chairman – CMA Partners