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JOBS Act Bad News for IPO Investors

Jeremy Glaser
Heather Brilliant, CFA

Jeremy Glaser: For Morningstar, I am Jeremy Glaser. Earlier this month, President Obama signed into law the JOBS Act, which among other things tried to make it easier for companies to raise capital but will have unintended consequences for investors. I am here today with Morningstar vice president of global credit and equity research, Heather Brilliant, to take a closer look.

Heather, thanks for joining me.

Heather Brilliant: Thanks for having me, Jeremy.

Glaser: So let's start by taking a closer look at this act. Obviously, it covers a lot of different areas. It's a bit of an omnibus; the legislators just kind of threw everything but the kitchen sink in there. But particularly to IPOs, what are some of the different parts of the bill that you think are going to have an impact to average investors?

Brilliant: Well, I think there are a couple of unintended consequences. Provisions that are in the bill, we think, actually reduce the disclosure that these companies will have to provide around a possible IPO. Also these provisions possibly even make the research available of lesser quality than it was before, if that's possible.

Glaser: So let's take a look at some of the specific provisions. A lot of them have to do with a company filing its S-1 before it goes public. What are some of the changes that we're going to see there?

Brilliant: So a company right now has to file an S-1 a good three to four months before it would like to go public. It has to make that available to the public so that other independent research firms or outside participants can evaluate the company, as well, and outside investors can do their own analysis. Under this new provision, companies with less than a $1 billion in revenue will be able to file the S-1 a mere 21 days before their road show starts, so you'd literally have less than a month before the IPO to will evaluate the company. On top of that, regulators are actually going to require fewer years of disclosure around how the company's been doing. So it will be a lot harder for analysts and for investors to get a sense of what does this company look like.

Glaser: Now what about financial control? Is the act going to make it easier for companies to go public, not having to get their auditors to sign off on the entire system? Any changes there?

Brilliant: Yes. The SEC is no longer requiring a formal auditor signoff in terms of internal controls. So what that means is take a situation like Groupon, where you saw a mere one quarter after going public that it had some issues with internal controls--even after having been formally reviewed--that showed the company was not all squeaky clean. Those kind of things are likely to happen a lot more frequently under this new JOBS Act.

Glaser: So you mentioned that investors are only going to have about 21 days from the S-1 until potential IPO. What are the implications for the research then? How is that going to work out in real life, do you think?

Brilliant: So the only people who will have more than 21 days of disclosure will be the investment banks doing the IPO, and in the past those investment banks have been prohibited from writing research. Well, under the JOBS Act those investment banks will be able to publish research around these smaller companies going public, and so what that means is that you will have the banks who are underwriting the deal will have an incentive to make the deal look particularly good, being the primary conduits for research around these companies. The goal is that that would increase transparency because there will be more research around some IPOs. There might be more research, but we think the quality will be low enough and the incentives will be great enough to inflate the IPO that we would expect to see even more IPOs fizzle than we've seen already.

Glaser: Given some of these changes, does that affect the way that Morningstar thinks about IPO investing and thinks about whether it's advisable to get into a company when it first comes public?

Brilliant: As a nonbank, we will not have any information until 21-days before the IPO. So, we'll have less time to evaluate the IPOs we look at. On top of that, we expect to like them less. The reason why this Act could be good for companies is that the investment banks might be able to get a more full price for the company, but that means less return potential for investors. So already, you see many, many companies pop on the day of the IPO only to fizzle thereafter. We would expect that to be an even more common occurrence.

Glaser: It sounds like this act might achieve its goal of making it easier for companies to go public, but it might make it a little bit less attractive for those who are actually investing with those IPOs?

Brilliant: Yes, that's right.

Glaser: Well, Heather thanks so much for joining me today.

Brilliant: Thanks for having me Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser.