*UPDATE* On Friday, December 6, the SEC rejected the NYSE's proposal to expand direct listings by allowing them to raise new capital. A NYSE spokesman said that the company "will continue to work with the SEC on this initiative."
Instead of our planned final installment of the “Hijacking the IPO Market” series, we published the following in response to the NYSE's stealth filing with the SEC to expand direct listings to companies issuing new stock, the latest attempt to create a fake IPO alternative to traditional IPOs.
The NYSE has proposed an expansion of its direct listing offering that, if approved by the SEC, is nothing more than a giant bailout for technology unicorn insiders at the expense of public investors.
Direct listings, according to the NYSE’s website, allow large numbers of existing shareholders “to monetize their shares on day one.” In other words, direct listings are designed for technology unicorn insiders to dump large amounts of shares on the public in one orchestrated fell swoop. What falls by the wayside are transparency, fairness, and sufficient price discovery.
Current Rules on Direct Listings
Under the current NYSE rules, the shareholders of large private companies can do direct listings on the NYSE without the benefit or cost of underwriting the offering. The direct listing must be at least $250 million in size to ensure sufficient market liquidity.
Proposal to Expand Direct Listings
Following an invitation-only conclave for technology unicorn CEOs in San Francisco, the NYSE in late November proposed expanding direct listings to companies that want to raise funds. Under these proposed rules issuers could raise at least $250 million in a primary offering and existing shareholders could concurrently sell shares in a secondary offering. This proposal doubles down on all of the pernicious features of direct listings and adds new conflicts.
Why Direct Listings are Bad for Public Investors
It is important to point out the many defects in the proposal to expand direct listings, because whatever the SEC approves will surely be adopted by the Nasdaq. Here are the specific reasons why direct listings are opaque and biased towards large, institutional sellers.
No Lock-up. In a traditional IPO, insiders are contractually prevented from selling shares for 180 days or more. This is not true for direct listings. Lock-ups exist to force insiders to wait for one or two quarterly reporting periods before they can sell. Lock-ups discourage insiders from offering overly optimistic guidance and then failing to deliver.
- Lack of Transparency on Pricing. In the Spotify offering, the company had a NYSE “reference price” of $132 determined by an internal valuation. Private market trading in the company preceding the listing ranged from $49 to $132.50 from January to March 2018, providing potential investors with no reliable frame of reference.
- No Real Price Discovery. In a traditional IPO, the proposed offered has a price range, which is based on internal valuations, comparisons with publicly traded comparables and feedback that the bankers get from potential investors. In a NYSE direct listing the initial trading price is set by market makers based on order flow at the opening of trading. Yet, the track records of Slack, which is down more than 40% since its opening trade, and Spotify, which is down 13%, suggest that this process gives insiders the chance to sell at or near the high on the first day of trading.
- No Set Number of Shares. In a direct listing, selling shareholders (or the company) register a specified number of shares to be sold, but the number of shares that are actually sold could be more or less. In the Slack listing, for example, 118 million shares were registered, but another 164 million shares were eligible to be sold. In the Spotify listing on the NYSE, 55.7 million shares were registered, but another 106 million were eligible to be immediately traded.
- No Roadshow. In a traditional IPO, the company meets with investors in one-on-ones and group lunches and posts a publicly-available net road show. In a direct listing, the company has an “investor day,” which in practice has been a single web cast.
The bottom line is that direct listings are designed to be panacea for technology unicorn investors stuck with large, illiquid positions, but are just plain bad deals for new investors.
Questions the SEC Needs to Answer
Of all of the issues the SEC needs to resolve about expanding the scope of direct listings is whether the process is fair to public investors. The limited experience to date suggests otherwise.
In a secondary direct listing of insider shares, the prospectus is declared effective 10 days prior to the offering date. This allows the company to issue forward guidance and talk to shareholders because the company isn’t offering the shares. But if the company is selling shares, what will the rules on forward guidance be? The simultaneous direct listing of primary and secondary shares opens the door to unfair discrimination between public investors, insiders and issuers.
The lack of transparency on pricing, the number of shares to be offered and the lack of a lock-up appear to disadvantage new public investors. An investor who bought Slack and Spotify in the excitement of trading on the first day would be under water today.
These issues need to be carefully addressed by the SEC before more technology unicorns go forward with direct listings.
Let the SEC Know What You Think
The direct listing proposal was slipped in a day before Thanksgiving and has not gotten much attention. The SEC is accepting comments for 45 days from the publication of the proposed rules in the Federal Register.
Send an email to the SEC at firstname.lastname@example.org. Make sure you use File Number SR-NYSE-2019-67 in the subject line.
The NYSE filing describing the proposal can be found here:
Our recommendations to make the IPO market more efficient and transparent.
Part 1: How the IPO Market Is Being Hijacked
Part 2: How Government Regulations Nearly Killed the IPO Market
Part 3: How the JOBS Act Abuses Most Public Investors
Part 4: How the IPO Market went from Dot.com to Unicorn Bubble
Part 5: Why Direct Listings Are Fake IPOs
Part 6: The Direct Listing Bailout for Unicorn Investors
Part 7: How to Promote and Protect Healthy Capital Creation
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