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All eyes may be on the record-setting IPO of Chinese Internet firm, Alibaba, but the real IPO story for 2014 may be the significant number of IPOs this year involving smaller companies. The number of companies completing IPOs this year is on pace for the highest annual level since 2007, a surge in initial public offerings that, according to recent academic research, is due at least in part to the so-called IPO on-ramp procedures in the Jumpstart Our Business Start-Ups (JOBS) Act, which Congress enacted in 2012. Just the same, while most of the eligible companies appear to be taking advantage of the JOBS Act provisions, at least some commentators have raised concerns about the provisions’ long-term effects.
The JOBS Act’s IPO on-ramp procedures are designed to ease the process of going public for “emerging growth companies”(EGCs), which the Act defines as companies with annual revenues less than $1 billion. Under these provisions, EGCs may submit their draft registration statements to the SEC confidentially and only need to disclose their intention to list their shares 21 days before they start investor roadshows. The ECGs can also release just two years of audited financial statements, rather than the standard three, and need only disclose the compensation of the top three executives rather than the standard five.
Many companies are taking advantage of these JOBS Act provisions. According to a study by Ernst & Young cited in a recent Wall Street Journal article (here), almost 80% of ECGs filing for IPOs have used the confidential filing provisions, 90% took advantage of the reduced compensation disclosures and 45% are using the provision that allows them to file only two years of audited financials.
An August 26, 2014 paper from three academics suggests that the IPO on –ramp procedures are spurring companies to undertake and complete initial public offerings. In their paper entitled “The JOBS Act and IPO Value: Evidence that Disclosure Costs Affect the IPO Decision” (here), Michael Dambra of SUNY Buffalo, and Laura Casares Field and Michael Gustafson of Penn State report their findings that, controlling for market conditions, the JOBS Act provisions have boosted listings by 21 companies annually, a 25 percent increase compared to the average number of IPOs from 2001 to 2011, while at the same time IPOs in other developed countries have remained below their pre-2012 numbers.
The JOBS Act provisions have been a particular boon for companies in certain industries, particularly biotech and pharmaceutical companies, as well as technology, media and telecommunications. According to data compiled by Bloomberg (here), there were twice as many biotech IPOs in 2013 than in any year since 2004.
Another sector whose offerings have been boosted is foreign-domiciled companies. According to an August 29, 2014 post on the MoFo Jumpstarter blog entitled “The Rise of Foreign Issuer IPOs” (here), foreign issuers have proven to be particularly keen to take advantage of the JOBS Act provisions.
The blog post reports that of the 222 IPOs completed in 2013, 37 involved foreign issuers (including30 EGCs, or 13.5% of all 2013 IPOs), compared to 21 foreign issuers (including 12 EGCs, or 9.3% of all 2012 IPOs) among the 128 companies that completed IPOs in 2012.In 2014, as of the date of the blog post, there have already been 44 foreign issuer IPOs in the U.S., raising $10.3 billion. The foreign companies completing U.S. listing during 2014 includes companies from sixteen different countries, with the largest number (15) from the Cayman Islands and China (12). In addition to the companies that have already completed IPOs in 2014, there are in addition nine foreign issuers in registration.
According to a recent Wall Street Journal article (here), the early results for EGC IPO companies have been impressive. Nearly 20% of the ECGs that went public in 2013 started trading above their expected price range, compared with about 10% for big company IPOs. In addition, in their first three months of post-IPO trading, shares in companies with less than $1 billion in revenues gained 38% versus a 15% average gain from 2000 until the JOBS Act took effect, which also beat last year’s average three-month post-IPO gain of about 35% for bigger companies.
But while much of the news appears to be good, some apprehensions have started to emerge. As discussed in a September 15, 2014 Wall Street Journal article entitled “Relaxed Rules for Small-Company IPOs Raise Concerns” (here), some commentators have started to worry about a “JOBS Act effect” in which the ECGs lead off with a share price increase but “start to fizzle” within a year. The article notes that while the smaller company IPOs often begin with a rising stock price, the pattern of gains often then reverts to historical trends, in which larger-company IPOs turn in a better long-term performance. Thus, among 2013 IPOs, larger-company IPOs have posted average gains of 40%, while returns from smaller companies is about 38%, the same pattern as before the JOBS Act.
Among the issues that seems to be weighing on the smaller company stock are concerns relating to the reduced information the ECGs supply with the registration statements. The Journal article quotes one commentator as saying that “less information and less transparency are ultimately negative.” The article cites specific concerns about the smaller companies’ executive compensation disclosures. Another risk for investors is that ‘economic growth and low interest rates have fueled the stock market, potentially masking the true effects of the JOBS Act.” It could be, according to Lynn Turner, the SEC’s former Chief Accountant, years before it is clear if the JOBS Act’s exemptions were worth it.
I don’t know whether or not there actually is a “JOBS Act effect” or whether ECGs will in fact “start to fizzle.” There is no doubt that all companies, including ECG IPO companies, are enjoying the current benign market conditions, and there is no doubt that if, say, the Fed starts to raise interest rates, the market conditions could change for ECG IPOs along with everybody else.
But whether or not there is a JOBS Act effect, the one thing I know is that as the numbers of IPOs increases, the number of IPO-related lawsuits has also increased, as I documented in a recent post (here). When any IPO company has a stumble or hits an obstacle, the company’s share price tends to decline sharply. When that happens, a securities class action lawsuit often follows. It will be interesting to watch as the numbers of ECG IPO companies accumulates whether any lawsuits reference disclosure issues relating to the JOBS Act provisions. Another factor that will be interesting to watch is the extent to which the foreign issuer IPOs are drawn into IPO-related litigation.
In any event, given the typical post-offering lag between the IPO launch date and the usual timing of post-IPO litigation, it seems likely that as the numbers of IPOs have continued to grow during 2014, we will continue to see IPO-related litigation continue to accumulate at least into 2015.
Read other items of interest from the world of directors & officers liability, with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
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