Over the past year and half, we’ve seen the rise of special-purpose acquisition companies (SPACs) and direct listings as popular alternatives to traditional individual public offerings (IPOs) for taking companies public. This change has prompted regulatory scrutiny by both the Securities and Exchange Commission and Congress. On May 24, the House Financial Services Committee held a hearing about “going public” that focused on recent trends in SPACs, direct listings, traditional IPOs, and how the regulatory and investor protection framework applies to each.
There is bipartisan consensus that it’s better for our capital markets and retail investors to encourage the formation of more public companies, though each side has different ideas about how to achieve this goal. The decline in the number of public companies is concerning. Having fewer public companies reduces competitiveness and increases wealth inequality, as companies stay private longer and those private market investment opportunities are often limited to high-wealth and institutional investors.
SPACs and direct listings offer a number of benefits compared to a traditional IPO, including a faster and cheaper process, less regulatory scrutiny, and more certainty about pricing.They also address many of the friction points with the traditional IPO process—including the underpricing of shares in an IPOs and a lengthy process that slows time to market. With a SPAC, a company undergoes the IPO process with a goal of using the funds they raise to acquire or merge with an operating company. After the merger, or the de-SPAC transaction, the end result is a public operating company; the process avoids some of the disclosure requirements and liability concerns associated with the traditional IPO process.
With a direct listing, a company goes public by selling existing shares to the public without undertaking the traditional IPO process, often relying on an auction process rather than an underwriting process to determine an initial offering price. Direct listings are generally used by companies that do not need to raise primary capital, though the SEC recently approved a process to allow companies to raise capital through a direct listing.
Many policymakers expressed investor protection concerns with the current regulatory structure applied to SPACs. There was consensus among the witnesses that there should be regulatory parity between SPACs and IPOs on forward-looking statements to prevent regulatory arbitrage. Legislative proposals to address SPAC liability concerns and increase disclosures could garner bipartisan support, though Congress may wait to take its cue from the SEC—which is also looking at the issue—before moving forward.
Democrats mainly used the hearing to focus on investor protection concerns about SPACs and discuss frictions in the traditional IPO process. Republican members used most of their time discussing ways to ease the burdens of going public and expanding access to the private markets for retail investors. While many of the ideas brought up by Republicans have seen some level of bipartisan support in the past, it seems unlikely that these measures move forward given the opposition expressed by investor groups and Democratic SEC commissioners.
Traditional IPOs vs. SPACs vs. direct listings
Traditional IPOs now compete against SPACs and direct listings. Policymakers support competition, seeing it as the market responding to the availability of these choices—but many have concerns about investor protection with SPACs.
Policymakers and witnesses generally agreed that there needs to be a level regulatory playing field to prevent arbitrage. While the results of a SPAC merger and a traditional IPO are functionally equivalent, SPACs currently enjoy a safe harbor from Section 11 of the Securities Act, which requires strict liability for inaccuracies in forward-looking statements. This enables SPAC sponsors to promote their future prospects, while companies going through the traditional IPO route have more constraints around describing their potential future.
In addition to the unlevel playing field, there were a number of other concerns about investor protection with SPACs:
- Data shows divergent investment returns for SPAC sponsors and other groups of investors as compared to retail investors: SPAC sponsors, hedge funds, and PIPE investors do well, while retail investors in post-merger public companies have underperformed.
- There are a number of misaligned incentives with SPAC structures. The sponsor has a strong financial interest to complete a merger even if it is a bad deal. Early IPO investors can vote to merge and then are free to dispose of their shares, resulting in an essentially risk-free transaction.
- SPAC disclosures are complex and opaque and should be improved.
Encouraging more small companies to go public
Members of Congress used the hearing to push a number of policy objectives to encourage more private companies to enter the public markets. These included simplifying the quarterly reporting structure and expanding companies’ eligibility to qualify as an emerging growth company (EGC) from 5 years to 10 years to facilitate the on-ramp into public markets..
There was also discussion on how the one-size-fits-all equity market structure does not work well for all companies. Policymakers discussed Ideas to improve liquidity and volume for small-cap companies included allowing small companies to opt out of unlisted trading privileges (UTP), the creation of venture exchanges, and new ways to expand research coverage.
Expanding access to private markets for retail investors
While it was agreed that policymakers should focus on encouraging more companies to go public, policymakers disagree on whether to expand retail investor access to private markets. Supporters of expanding access to private markets in a responsible manner recommend Congress codify and build on recent efforts by the SEC to expand the accredited investor definition to reflect the investor’s professional knowledge and expertise. Another proposal encourages ways to expand fund-level investment opportunities to give retail investors access to the private markets with the benefit of professionally managed funds, such as retirement funds or closed-end funds. These ideas are unlikely to get sufficient bipartisan support in the near-term, but the case can be built over time.
Policymakers are increasingly focused on capital markets to better understand the path to going public, the volatility in the markets, and the role private markets play in capital formation. Congress will continue to exercise oversight and drive the debate, but the SEC is expected to drive the actual policy changes; SEC Chair Gensler noted in recent testimony that they are dedicating significant resources to addressing emerging issues in this space.
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