JOBS Act Fallout: More Fraud, Fewer IPOs
I'm on vacation, very far from home, so apologies for the short post. I'll be back online next week, and we have a fun story coming out in Rolling Stone the week after that.
In the meantime, I wanted first of all to thank everyone who participated in the Thunderclap Twitter experiment. I'm away, and haven't heard the full report yet, but I understand it was a rousing success. I'll find out more when I come home, but until then, thank you all again for taking the time to sign up.
One story I did want to pass on while I was gone is a very interesting Wall Street Journal piece entitled, "Meet the JOBS Act's Jobs-Free Companies." A few months ago, I wrote a few articles about the JOBS Act, which a number of friends of mine from congress and from the regulatory community insisted would pave the way for a return to the IPO fraud boom of the late nineties, if not for a return to the penny-stock fraud age.
Well, eight weeks after the passage of the law, we're finding some unexpected results. Among the more controversial provisions of the JOBS Act, remember, was a sort of blanket regulatory exemption for so-called "Emerging Growth Companies," which were loosely defined as public companies with less than $1 billion in annual revenues. Among other things, the new law allows such companies to avoid independent accounting requirements for the first five years of their existence.
According to the WSJ, what's happening now is that the JOBS Act is being used to facilitate what are known as "reverse mergers." Because it's traditionally been difficult for new companies to meet the regulatory requirements for going public, what's often happened is that young companies look for dormant or dead corporations that are already registered. They then merge with those "empty shell" companies, use their corporate structures, and thusly avoid the IPO process altogether. This process is called a "reverse merger."
Oftentimes those empty shell companies – also called "blank check" firms or "special purpose acquisition companies" – are dead for a reason. Otherwise honest new companies that merge with those firms often find themselves in bed with unexpected, and unexpectedly shady, partners. In other cases, the problem goes the other way: the government has had issues in recent years, for instance, with Chinese startups that use American empty shell firms to establish businesses here.
So why does this matter? Well, the JOBS Act was ostensibly designed to make it easier to launch actual IPOs, and theoretically should have made the darker, more problem-ridden reverse merger process less appealing. But what we're finding now is that companies are using the JOBS Act to designate those "blank check" firms as "emerging growth companies." From the WSJ piece:
The Act... also allows [emerging-growth companies] to make fewer financial disclosures, use a new, confidential SEC review process for IPOs and lets their bankers communicate more freely with potential investors. The confidential reviews are designed to let companies sort out any differences with the SEC behind closed doors.
Many of the hundreds of companies that have claimed to be emerging-growth companies under the new law are small biotech, technology, retail and energy companies. But 17 explicitly described themselves as blank-check companies or trusts.
About 30 companies have submitted IPO filings to the SEC confidentially under the law, according to the agency's staff. And at least two of those submissions are for blank check companies, an advisor to those companies said.
These little reverse-merger enterprises are exactly the sorts of companies where small investors should want to have as much transparency as possible, so they know whom they're jumping in bed with. Instead, we're going to use this new tool to allow already-troubled companies to hide their warts in behind-closed-doors sessions with the SEC. So that's awesome.
Coupled with the news that IPOs are expected to be way down this summer, the early returns on the JOBS Act don't look so hot. But it's early yet.
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