Saturday, November 20, 2021

Public, But Limited

I’ve blogged a couple of times on the eroding distinction between private and public companies – “private is the new public,” as Matt Levine likes to say (though Prof. Ilya Beylin does not agree that the erosion is so drastic).  Which is why I was struck by the package of financial reforms endorsed this week by the House Financial Services Committee.

Among other measures, the Committee backed a restriction on the marketing of public companies – namely, SPACs – to retail investors.  Per the proposed legislation, no investment adviser or broker-dealer would be permitted to recommend, or even facilitate a trade in, a SPAC investment by an unaccredited investor unless either the “promote” is less than 5%, or the SPAC “makes such disclosures to the Commission as the Commission, by rule, may determine to be necessary or appropriate in the public interest or for the protection of investors.”

Now, this is kind of a weird requirement – what disclosures is the SEC supposed to mandate? Isn’t it already, like, mandating disclosures of everything it thinks is necessary or appropriate?  So, I don’t think this proposal – or, I suspect, a lot of the other proposals endorsed by the Committee – will actually become law.  That said, it’s interesting to me that the proposal functions not by placing new restrictions on SPACs before they can go public – it doesn’t say, no SPAC can go public with a promote greater than 5%, or even mandate additional disclosure requirements in the S-1 – but instead, it distinguishes among public companies.  Those that meet the requirements can be freely recommended and traded; those that do not will still be publicly traded, but, as a practical matter, will only be available to accredited investors.

This is not the first time such a move has been proposed; in 2019, the SEC wanted, in practical effect, to have retail investors take the equivalent of a financial literacy test before their brokers/investment advisers could sell them leveraged ETFs, though that proposal never went anywhere.

Over the years, Congress and the SEC have gradually expanded private companies’ ability to market and sell their securities to ever broader groups of investors; and now there also seem to be these impulses to simultaneously restrict the trading in public companies based on the same measures of sophistication that typically are used in private markets.  It's almost ridiculous to call companies “private” today, when you can go to a website that offers shares in pre-IPO companies, and depending on what type of investor you are, you’ll be given different investment opportunities.  And for the hot start-ups unavailable on those sites, well, in addition to the other secondary trading platforms out there for private company shares, Morgan Stanley is creating a new one that promises to be “friendlier” to corporate CEOs (what could possibly go wrong?).

In many ways, the system is gradually becoming what Stephen Choi recommended once upon a time, namely not so much treating companies as public or private, but instead treating investors as more or less qualified to transact. 

That, of course, is a radical rethinking of the current system, which tends to assume that it’s not simply a set of required disclosures, but a robust regulated market that protects investors; by segmenting opportunities, that market is fractured and cannot fulfill its function.  And, well, as is currently on display in a California courtroom, it does raise the question of how well we believe regulators can distinguish between sophistication and naivete among investors.

https://lawprofessors.typepad.com/business_law/2021/11/public-but-limited.html

Ann Lipton | Permalink

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