Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. It's been a few months since the JOBS Act became law. What impact has that had on the IPO market, and should investors still be skeptical of the reduced disclosure? I'm here today with James Krapfel, our IPO analyst, to take a closer look at these questions. James, thanks for joining me.
James Krapfel: Thanks for having me, Jeremy.
Glaser: Just to refresh our memories, what exactly is the JOBS Act? What are some of the major provisions as it affects the IPO market?
Krapfel: By way of background, the JOBS Act was passed by President Obama on April 5. It was meant to ease the regulatory burden of companies looking to raise capital especially as it pertains to the IPO market. So, the JOBS Act applies to companies with less than $1 billion in annual revenue, and there are six main provisions of the act. All of them are kind of tied to less disclosure regarding executive compensation as well as reduced financial data required as part of disclosures and the registration statements. Instead of three years of audited financial statements, you only need two now. Also you don't need five years anymore for selected financial information in the S-1s. So, now, you're only seeing two or three years of selected financial data for the companies.
Glaser: Have we seen a big rush of these smaller companies take advantage of these new provisions and come to market, or has it had more of a negligible impact?
Krapfel: It's been a very quick change in the industry with companies filing to go public. All but one company has made use of at least one of the provisions of the JOBS Act, and that being Five Below. The other 37 companies that qualify as emerging-growth companies have used at least one of the provisions. We've seen most of the companies, however, opt out of the provision that allows them to not adopt new or edited financial accounting standards. So, that is one that they continue to adopt. As accounting standards change, they will continue with that. And about half of the companies are still presenting five years of selected financial data, so that's good to see.
Glaser: Let's talk about research. I know certainly one of our concerns when the JOBS Act was passed was this collapse of the so-called quiet period before IPOs would come to market. What have we see in terms of sell-side research before some of these smaller IPOs come to market?
Krapfel: With the Global Settlement Act of 2003, that changed the quiet period from 25 days to 40 days for investment firms' research analysts from publishing research on companies that those underwriting firms have marketed. So, we're little bit fearful that, that would go away and that the investment banks could write research on companies in, on or around the actual IPO date, but so far that has not happened to our delight. There is an unofficial 25-day quiet period that the investment banks are adhering to right now. I think part of that is due to some legal uncertainty with the investment banks publishing potentially biased or overly optimistic research that could prove to be overly optimistic. Also, there was a recent SEC statement that said that the JOBS Act does not overrule the Global Settlement of 2003, which separates the investment banks' analysts from the salespeople. So, the research analysts are barred from attending meetings with the company's management as well as the analysts at the same time. I think that's leading to a little hesitation in the companies to publish research too soon.
Glaser: What's the bottom line for investors here? Has this reduced disclosure affected the way that we think about recommending IPOs or investors should think about investing in IPOs?
Krapfel: Well, the IPO market was already fairly rated against individual investors. We believe that passage of JOBS Act made things marginally worse. For one, there is only two years of audited financial statements versus three before, which makes it more difficult to evaluate the firm's performance. Also, there's a lack of auditor attestation over internal controls which could lead to accounting irregularities and even potential frauds, so that's a negative. And also the JOBS Act allows firms to privately file with the SEC, and they only have to publicly file until three weeks before they being the roadshow. So, effectively that reduces the window from the company filing to going public from around three to four months to as little as five weeks.
Glaser: Certainly with those changes, it becomes even more difficult to really evaluate those companies, and it sounds like it's better to wait on the sidelines and potentially wait for a fall in price before entering some of those names.
Krapfel: I think that's a good guidance to adhere to.
Glaser: So James, thanks so much for talking with me today.
Krapfel: Thanks for having me.
Glaser: For Morningstar, I'm Jeremy Glaser.