More Evidence of the Ravages of Sarbox: U.S. Private Placements Overtake IPOs

The regulatory regime governing the U.S. equity markets is in trouble. Deep trouble. I've written about this extensively, most recently in a piece concerning Goldman Sachs' new private market for institutional investors, GSTrUE. In brief, I concluded that any regulatory regime that pushes blue-chip potential issuers such as Oaktree Capital Management to avoid going public has fundemental problems. I felt pretty confident in my logic and my conclusions. And just yesterday the Financial Times ran a story that only bolsters my arguments with these fascinating and damning statistics:

Straight public equity offerings on the three largest US stock exchanges - the New York Stock Exchange, Nasdaq and the American Stock Exchange - raised $154bn last year, while offerings involving so-called 144A private placements raised $162bn.

It marks the first time deals involving private capital raisings have raised more than basic public offerings. In 2005, when IPOs on the three largest exchanges raised $147bn, deals with private placements raised just $101bn.

The story then goes on to discuss many of the same issues I raised in my post earlier this week, driving home the dampening effect that Sarbanes-Oxley is having on the perceived attractiveness of the U.S. public equity markets:

Companies, particularly from outside the US, view such private deals as a way to avoid burdensome Sarbanes-Oxley legislation and gain quick, cheap access to US capital markets without the need to even register securities with the US Securities and Exchange Commission.

And, apparently, I'm not alone in my concerns or of the potentially tectonic effect that GSTrUE and other private pools of liqudity could have on U.S. exchanges; the Nasdaq itself is looking to launch an automated market to handle the trading in these new private offerings:

It (the increase in private placements) also comes as Nasdaq, the second largest US stock exchange, prepares to launch an automated market dedicated to such private placements.

Bob Greifeld, Nasdaq's chief executive, said the launch of the new platform, planned for June, could be "the most important development for the equity market since 1971 [when Nasdaq was founded]".

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Nasdaq's Portal and the Goldman System, known as TrUE, will be exclusively available to institutional investors.

Such institutions are increasingly the dominant player in the global trading landscape, serving as the top stock holders for many leading public companies.

This final point, a point which I raised in my earlier post, is absoutely critical when assessing the magnitude of the threat posed by these alternative exchanges. The retail investor is not the driving force in the equity markets here or abroad, and given the structure of U.S. regulatory doctrine once one crosses into the realm of the "accredited investor" there is much one can do on a private basis. Like start a private exchange. Or many private exchanges. If GSTrUE is successful, as I expect it will be, is there any doubt that Morgan Stanley and the like are close behind? And with the great leap forward in low latency trading technology, what is stopping a flow aggregator like Nasdaq or any ECN from pooling the deals originated on these private exchanges and enabling them to be traded more broadly? In fact, I am almost certain that this is how it will play out. So, to recap, if:

• You have a massive pool of institutional liqudity in need of high-quality product; AND

• You have a sea of high-quality companies that would like liquidity but are put off by the regulatory demands of going public in the U.S.; AND

• You have innovative investment banks structuring these early deals between high-quality issuers and high-quality, leading-edge investors willing to buy a new and untested product; AND

• You have ECNs with capacity that can pool flow across these private exchanges and centralize trading, clearing and settlement in order to broadly and efficiently distribute product; THEN

• You get a withering U.S. new issues market that will slowly and inexorably die on the vine.

I know this isn't pretty. But I'm not sure that there is a more likely scenario than the one I just painted. Congress and the SEC would wake up and dial back Sarbox. And that would help. But the question remains: will it be too little, too late?

Comments

[ko]

Sirs,

I believe the point our fine blogger was trying to make (and if he wasn't the one I will posit) is this: Sarbox was created FOR the retail investor, not the institutions. As another commenter above (perhaps below depending on posting order) said, institutions absolutely have an information advantage already over the retail investor. Generally they have the ability to: view the company's books; meet with key people at the firm; view proprietary, or expensive research materials; and then have the man/brainpower to process that information...Retail investors have none of these advantages. Therefore, by companies moving away from the public markets the law of unintended consequences play out: the common man now has fewer companies to choose invest in.

On another note, and to touch on my friend above's hedge fund analogy, why is it that all these vehicles (HFs, Private Markets, etc) should be made for HNW/Inst investors only? If hedge funds do provide superior returns due to their informational advantage why does it make sense to prevent people from participating in them? While i would assume a strong correlation exists between wealth and so called "sophistication" the SEC has no problem allowing a person to poor their life savings into high-beta companies, or all into one stock. Has that fact protected anyone? Wouldn't we want to protect people by ensuring they are educated about the value of diverification? I'm sure the Enron employees wished they hadn't kept all their savings in their stocks. Yet the SEC never commented on that part of the "scandal".

This is a bit of a rant, but i had to comment. I look forward to your comments.

Best,
ko

[Charlie]

GsTrue and the Nasdaq Portal are only following and expanding upon the trend started by a relatively unknown company called the "PPX" Private Placement Exchange (http://www.ppxonline.com ) *note: the company has nothing to do with the NYPPE...

Comments from Nasdaq spokesmen regarding the new "portal" sound as if they've been lifted right from the home page of the PPX...

PPX has been in operation since late 2005, and has quietly worked toward a stated goal of 150,000 members (registered reps, fund managers, etc)... This is huge, when you consider what it represents: one in four registered persons... They too have a service called "Secondary Salon" that allows funds, etc to divest portfolio assets in private... Now while I haven't seen any billion dollar sales there, there are many in 2-60MM range...

I read that they've gotten tentative approval to launch in the UK...

Why is it that the Goldmans of this world get so much press for one transaction? Well, because they're Goldman.

But what may be much more interesting is the trend in smaller middle market and SLC capital formation... And the fact that the big boys have taken notice and entered the game - but they are currently the followers, not the leaders (though this may change :)

[Seth]

The institutional investors are the dominant market players but it seems they are also the ones who want the most information about their investments (compared with the retail investor). I would say the increased exchange requirements benefit these larger, more due diligence intensive investors, because of an increased ability to better process larger amounts of information (Not from a loss of working capital in companies due to the extra costs of burdens). I love the innovation on these new ideas and exchanges. It will be interesting to see how information flows around the participants involved and who will be able to take advantage of them. It seems certain large participants would be able to have great advantages over others. Think back to your post on FIG, how would have issuance of these shares played out on TrUE and how would they be valued today?

[Yaser Anwar]

Sir-

Judging from the trend and your article, Sarbux has created the market for innovations like GSTrUE, isn't that a good thing? I mean if one door closes, another opens.

How is this trend different from the innovation of the hedge fund structure? I think it's not. Why? Alfred Jones noticed the need to go long and short because mutual funds just wouldn't cut it for investing due to their restrictions.

Now, Sarbux is giving way to innovations like GSTRuE which will be utilized by institutional investors (and maybe HNW and UHNW clients), much like HFs were open for inst. investors and UHNW clients of the '49 and fwd era. Maybe it's not as bad as everyone thinks 'cause as you've said before the 'Culture of Money' breeds innovation, which Wall Street is great at. Thoughts?

If MS et al come out with GSTRuE like innovations and other private exchanges, How do you think exchanges will react to this?

Look fwd to your opinion, thank you.

Yaser