Rethinking IPO Bureaucracy

As the hunt for wasteful and counterproductive regulatory programs ramps up in Washington, the SEC’s IPO review process makes for a promising target. In a new paper, I show how this IPO ‘comment letter’ bureaucracy has outlived its original justification and call for fundamental reform.

Before going public in the US, a company must file a registration statement with the SEC making extensive disclosures. The main purpose is to inform prospective investors and others looking to evaluate the investment, but those market actors don’t get to see the filing until it’s been subjected to close scrutiny by SEC staff.  

A team of accountants, lawyers, and analysts in the SEC’s Division of Corporation Finance will examine the registration statement and send the company a ‘comment letter’ raising (on average) 40-60 distinct issues. The company sends a letter back to the agency responding to each issue along with an amended registration statement. This back-and-forth continues four-to-six times (on average) until the staff is satisfied.

No such bureaucratic review process was contemplated in the Securities Act of 1933. The agency invented it at the dawn of the regime. Back in the early to mid-20th century, individuated government screening was needed to compensate for institutional shortfalls and vulnerabilities elsewhere in the securities ecosystem.

But those shortfalls subsequently disappeared, leaving behind an obsolete regulatory program that imposes heavy costs and yields uncertain benefits. For instance, early IPO firms had vanishingly little access to private expertise on compliance with the brand new securities regulation system (which reasonably necessitated direct engagement with agency staff to teach firms what was required), but today’s IPO firms have an abundance of such expertise at their disposal, including through their expert professional advisers and the extensive library of IPO precedents, regulations, and guidance now available. Similarly, early IPO firms faced virtually no threat of ex post enforcement for violations (which reasonably justified the SEC’s efforts to prevent violations on the front end), but today’s IPO firms face a robust ex post deterrent threat, with about 10-20% of IPO firms facing a securities class action in a recent period. And early IPO investors were human beings who could not ‘fend for themselves’ (which reasonably justified the SEC’s interventions on their behalf), but today’s IPO investors are sophisticated institutions who are well equipped to do so.

As these institutional weaknesses were rectified over the decades, the SEC’s bureaucratic review process not only failed to recede, it actually grew ever more elaborate, ballooning to 4-5 months (on average)—a potentially deal-breaking delay for IPO firms seeking optimal market conditions. IPO filers now frequently drop out of the process without completing their offerings, turning to alternative capital raising strategies like private placements and M&A. Drawing on newly obtained FOIA data on confidential IPO filings, I estimate that around 40% of initial IPO filers fail to complete a transaction.

These and other costs might be worth it if SEC review materially enriched the information environment around IPOs. But empirical studies have failed to find convincing evidence that SEC review provides any such benefit. Some have found that SEC comments fail to mitigate IPO underpricing or securities class actions, which suggest the opposite.

In the last decade, a bipartisan consensus has converged around increasing the power, centrality, and costs of the bureaucratic comment letter process (and the well-paid professionals who guide firms through it) by enabling and expanding the confidential IPO filing process. Legal academics, for their part, have overlooked the comment letter process in debates over mandatory disclosure and the ‘disappearing’ IPO.

A new direction in IPO reform is needed. Hundreds of SEC staffers are standing on the ‘IPO On-Ramp,’ blocking, slowing, and directing traffic. After 90 years, it might be time for them to get off the ramp and let cars drive.

The author’s complete article is available here.

Alex Platt is an Associate Professor at the University of Kansas School of Law. A version of this post was previously published on the CLS Blue Sky Blog here.