JOBS Act Resulting in Easier IPO Roadmap but at Investors' Cost

It has been five months since the April 5 passing of the JOBS Act. We have seen the IPO roadmap quickly evolve, as a number of qualifying companies took advantage of reduced disclosure requirements and the option to privately file initial registration statements. Investment banks' research practices are changing too, but regulatory uncertainty and legal worries generally keep research from being published on or around the IPO date. All in, we find recent changes to the IPO process as somewhat positive for the qualifying companies seeking to go public, modestly negative for the investment community, and neutral to the investment banks.

One of the main facets of the JOBS Act was to help companies more easily raise money by making the IPO process less costly and burdensome. Among other reforms, the JOBS Act eliminated many provisions founded in the Sarbanes-Oxley Act of 2002 for “emerging growth companies” with under $1 billion in annual revenue in an effort to reduce disclosure requirements in registration statements. There are seven such provisions:

1. A requirement to present only two years of audited financial statements and two years of related Management's Discussion and Analysis (MD&A);
2. A exemption to provide less than five years of selected financial data;
3. A exemption from the auditor attestation requirement in the assessment of the company's internal controls over financial reporting;
4. An exemption from the adoption of new or revised financial accounting standards until they would apply to private companies;
5. An exemption from compliance with any new requirements adopted by the Public Company Accounting Oversight Board requiring mandatory audit firm rotation or a supplement to the auditor's report in which the auditor would be required to provide additional information about the audit and the financial statements of the issuer;
6. Reduced disclosure about the company's executive compensation arrangements pursuant to the rules applicable to smaller reporting companies; and
7. No requirement to seek non-binding advisory votes on executive compensation or golden parachute arrangements

We dug into each of the 56 publicly-filed registration statements (S-1s or F-1s) issued since early April to see how the JOBS Act's passage has already altered disclosures. The following are our key findings and related ramifications:

• Thirty-eight companies (68%) qualified as an "emerging growth company" since revenue generated in the most recent fiscal year exceeded $1 billion. We expect the percentage of firms qualifying for this exemption to tick up toward 90% as we believe a number of companies have quickly taken advantage of the option to privately file with the SEC.
• Of these 38 companies, only one (Five Below (FIVE)) has completely opted out of the reduced disclosure requirements. While noteworthy, we speculate that the firm was already set or nearly set to satisfy prior requirements given that its April 18th initial filing came only two weeks after the JOBS Act passage.
• About half of the "emerging growth companies" reported a full five years of select financial data and 32 of 38 explicitly opted out of the new or revised financial accounting standard option. We applaud the companies that present a longer historical data snapshot than ultimately required, as we believe investors then have increased ability to ascertain companies' underlying growth trends, normalized profitability, and performance across economic cycles--when five years of data are presented versus two or three at other companies.
• With Five Below as an exception to all the provisions, and Southcross Energy Partners SXE as an exception to the two year audited financials option, all companies either plan or are considering taking advantage of provisions #1, #3, #5, #6 and #7 above. The cost to go public for these firms should initially be lower, which could ultimately lead to somewhat accelerated plans to make the public leap. However, we believe a lack of internal control requirements could lead to increased accounting irregularities that could beset companies and investors alike.
• Four firms were able to go public in under six weeks from the date of their initial S-1 public filing, compared to the typical three to four month review period (pre-JOBS Act). National Grocers by Vitamin College (NGVC) was the first with an accelerated IPO timeline when it went public on July 25, only 37 calendar days after its S-1 was first made public. Performant Financial (PFMT), Manchester United (MANU), and Hi-Crush Partners later followed with public offerings only 38 days after their S-1s were first released. Companies certainly benefit from (a) delayed sharing of detailed company information with competitors, and (b) avoidance of potentially embarrassing dialogue (now private) with the SEC concerning inclusion and presentation of financial data. However, the time investors have to conduct thorough analysis on the company under review falls by around two-thirds. We expect a greater proportion of IPOs to come from companies which filed registration statements less than six weeks prior to launch.

As it pertains to the IPO process, the second key facet of the JOBS Act is that it rolls back several of the 2003 Global Settlement reforms that separated Wall Street research analysts and their investing banking counterparts. In our original piece dated April 16, we feared that the 40-day mandated “quiet period” would be replaced by potentially biased and promotional pre-IPO research by the investment banks.

Instead, the industry has unofficially reverted to the 25-day research blackout period that was in place prior to the Global Settlement. In an Aug. 22 post, the SEC guided that the JOBS Act does not amend or modify the Global Settlement in regards to conflicts of interest between the firms' research and investment banking functions. This means that analysts from the 10 affected firms (including five of the six busiest underwriters of U.S. IPOs in 2012) will continue to be barred from attending meetings with both the companies and the bankers who arrange the deals, as the JOBS Act now allows. While non-Settlement firms are free from these restrictions and can publish research at any time, most deals are led by the affected firms who can dictate industry practices.

We breathe a temporary sign of relief as the often overhyped IPOs are potentially peddled only 15 days sooner and not at a time that can lead to overly dramatic first day price spikes for highly sought after IPOs. The underwriting banks could still petition the SEC to change the rules concerning IPO research, but we think there is a good chance we do not go back to the Wild West days of a decade ago given a healthy degree of legal worries from overly optimistic research and a limited analyst resource set.