Closing the US securities markets

Larry Ribstein —  8 April 2011

The WSJ reports that the SEC is considering raising the 500-shareholder limit on the number of holders of a class of securities a company can have before having to register that security with the Commission under Section 12(g) of the 1934 Act. The SEC reportedly is also considering relaxing the “general solicitation” restriction on private offerings.

At first blush this seems like a pro-market liberalization.  The story notes that “the agency has a responsibility to encourage companies to raise capital as well as to protect investors.”

But look again.  The SEC move clearly results from market arbitrage moves by hot firms like Facebook, Twitter and Zynga to open an end-run around the 500 shareholder rule.  I noted last January that Facebook got around the limit by selling all the stock to one person, a special purpose vehicle, which only wealthy investors can trade privately under an exemption to the 1933 Act.  (And maybe only non-US rich people.  Shortly after the story reported above, I noted that Goldman had moved its Facebook market exclusively offshore.) The SEC was also worried about insider trading in this new private market.

In other words, the market created this exemption, not the SEC.  Faced with inexorable market demand and arbitrage the SEC is considering making the escape route official. This resembles the “check the box” tax rule a decade ago which opened the door for LLCs after numerous unincorporated vehicles had challenged the government’s ability to put a lid on exempting unincorporated firms from the partnership tax. 

The SEC’s other option was reducing the various regulatory taxes on IPOs and public companies under the 1933 Act, SOX and Dodd-Frank which created the pressure on the 500 share limit.   In my earlier post I noted that VC partner Ben Horowitz had told the WSJ that

the incentive for going public has lowered and the penalty for going public has increased. . . [T]he regulatory environment and the rise of hedge funds has made it “dangerous” for start-ups go to public without a large cushion of cash. In general, we recommend that our companies be very careful about going public.

By expanding the private market for new firms, the SEC would release some of the political and market pressure building against over-regulation of going public.  Rather than liberalizing regulation, it would help protect existing regulation. 

The costs of this choice are significant.  Consider that in 2004, Google went public when it ran up against the 500 shareholder requirement.  Now, instead of IPOs, we have a market reserved for rich people. As I said last January:

[T]he increased costs of being public have helped exclude ordinary people from the ability to own the stars of the future.  Back in the 1980s, you could just call your broker and get rich off of the Microsoft IPO.  Now you have to be a wealthy Goldman client to do it.  Of course you also got to get poor off of a company that turned out to be a dog.  Now both options are reserved for wealthy people in the name of increasingly onerous disclosure regulation and federal governance requirements such as board structure, proxy access, and whistleblowing rules.

Each of these rules was thought to have some benefit at the time they were enacted.  Nobody really considered how private markets would react (e.g., by establishing alternatives to public markets) or the long-run effects of substituting quasi-private for public markets.  So rules designed to make the markets safe for ordinary investors have ended by excluding them.

Maybe it’s time to start considering whether we got what we wanted

The emerging market for rich people is especially ironic in view of the SEC’s increased push against insider trading. While the SEC is going all out in its Quixotic task to “level the playing field,” it is emptying that playing field of the people for whom it’s supposedly unlevel.

This move from public to private has broad ramifications.  The US traditionally has the broadest and deepest public securities markets in the world.  Indeed, the securities laws were enacted in the 30s to encourage participation by ordinary investors, and the securities laws have been interpreted consistent with that goal.  The problem is that Congress and the SEC have taken this goal too far, overburdening the US markets with regulation.  Coupling the shrinkage of the public market with an expanded option for rich people hastens this evolution away from strong US capital markets. 

At the same time, the US faces increased global competition.  As I discussed last week, evidence on IPOs suggests that public markets elsewhere in the world are catching up with the US.

The privatization of US markets could have important indirect effects.  Broad public participation helps democratize capitalism.  A move in the opposite direction could deepen Americans’ suspicion of capitalism as the playground of the wealthy.  Also, the securities markets are the primary source of data about large companies.  Closing these markets reduces transparency for everybody and not just investors.

The better move is to reverse the regulation that prompted this trend toward closing the public markets. The SEC is opting instead for short-term political expediency.

Larry Ribstein


Professor of Law, University of Illinois College of Law

5 responses to Closing the US securities markets


    Several Key Trends intersect in this development:

    US law no longer dominates the (Non-US) world capital markets which have enough money (US Dollars)to dominate the US capital markets.

    The Fed and SEC have been ecliped or nearly do by US and world capital markets evidenced by certain recent events: 2008 Sub-prime buildup and meltdown and US investment banking collapse; 1990’s Dot.Com tech-led market surge and margin loans as a monmey supply. The Fed did manage to kill that one, and the market and Enron with an about-turn on interest rates. So, the next wave was non-fed-banking “lending” via securitized CDO’s. Eclipsed.

    Wealth Pools ever seek the inside track – witness an historic rise in financial and ploitial aritocracy (intrenched, multi-generaltional wealth and political power) even as the last monarchies are swept away. When will the new monarchies rise? Now, not in titles but in the club.

    Democratization of behavior and information (Google, Twitter, Facebook) enable the youth waves of liberty of the mind (following on the post-war-baby-boomers’ US-British led culture shock dynamism). Seen as “schooling” behaviour, this enables a vast (initially benign) exploitation and ownership of this media (again: Google, Twitter, Facebook)which are certainly monarchical empires, moving to hegemony of the rich and powerful as the “privatization” invites the private wealth concentrations into the deal – the new-rich creators join the club and are supported by the club.

    Private equity started the trend, and now it’s increasingly clear that raising all the money one needs for a really good comapany can be wired through the club without an IPO.

    Miss-placed over regulation and inept enforcement. I blame the SEC and the Justice Department for thier thrashing of Martha Stewart and Waxman, which did more harm to the system than good – as minor public market faux pas yields real jail time. Who wouldn’t stay out of that game at all costs?

    Excessive protectionism weans the players from spreading the wealth around – Democratic public markets move to oligarchical private capital. Spreading the wealth around is a thankless act, fraught with penaly. Is the IPO dead? May as well be if none of the regular folk can get in on Facebook and Twitter. I missed Cisco, Compaq and Dell in the ’80’s. Poor me, hopes of another ride fade.

    Back to the conspiracy theory of history, as the bankers rig everything for the club.

    It’s interesting that this all rises out of the sub-prime meltdown which was primarily a realization the bankers couldn’t trust each other, both in the deal content and stucture, and when things got tight (except Paulson did his bit for the club).

    Now the big deals are underground, closed to ordinary investors, and the big players will lose big from time to time. But, who could stay out of Facebook or Twitter after Egypt?

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