The troubled IPO market can be fixed

November 7, 2009

Grant Thornton’s Capital Markets Group has released a new report titled “Market Structure is Causing the IPO Crisis”, which examines the demise of initial public offerings in the United States and offers remedies to resurrect the IPO market. The paper is a follow up to Grant Thornton’s original study, “Why are IPOs in the ICU?” which was published in November 2008. A link to a free copy of the new white paper is available at the end of this article.

The updated study continues to focus on how technological, regulatory and legislative changes have combined to chisel away at the U.S. IPO market. Although conventional wisdom holds that the U.S. IPO market has been going through a cyclical downturn exacerbated by the recent credit crisis, the paper points out that in reality, the market for underwritten IPOs, given its current structure, is closed to 80% of the companies that need it.

The report was co-authored by David Weild, Senior Advisor at Grant Thornton, founder of Capital Markets Advisory Partners and former NASDAQ vice-chairman, and Grant Thornton Senior Advisor Edward Kim.

The report provides fresh market data and incorporates additional insight gleaned from discussions with a wide range of key market participants, including former senior staffers at the SEC and senior executives at “bulge bracket” and “major bracket” investment banks.

“Despite the recent uptick in IPO activity, over the last several years, initial public offerings in U.S. have nearly disappeared,” noted Mr. Weild. “Our findings since publication of the original white paper have served to reinforce our thesis that the loss of the IPO market in the United States is due largely to changes in market structure. By killing the IPO goose that laid the golden egg of U.S. economic growth, the combination of technology, legislation and regulation undermined investment in small cap stocks, drove speculation and killed the best IPO market on earth.”

“The fact that the handful of recent IPOs have garnered so much attention is testament to how dire the situation has been and how complacent we have become,” said Mr. Kim. “A vibrant IPO market, in which companies of all sizes can raise capital efficiently and be supported in the public equity markets, is critical for the macroeconomy. It will not magically return without thoughtful, decisive action.”

The white paper proposes a solution to this crisis – an issuer and investor opt-in capital market that would make use of full SEC oversight and disclosure, and could be run as a separate segment of NYSE or NASDAQ, or as a new market entrant. It would offer:

(1) Opt-in/Freedom of Choice – Issuers would have the freedom to choose whether to list in the alternative marketplace or in the traditional marketplace.

(2) Public – Unlike the 144A market, this market would be open to all investors.

(3) Regulated – The market would be subject to the same SEC corporate disclosure, oversight and enforcement as existing markets.

(4) Quote driven – The market would be a telephone market supported by market makers or specialists, much like the markets of a decade ago.

(5) Minimum quote increments (spreads) at 10 cents and 20 cents and minimum commissions – 10-cent increments for stocks under $5.00 per share, and 20 cents for stocks $5.00 per share and greater, as opposed to today’s penny spread market. These measures would bring sales support back to stocks and provide economics to support equity research independent of investment banking.

(6) Broker intermediated – Investors could not execute direct electronic trades in this market; buying stock would require a call or electronic indication to a brokerage firm, thereby discouraging day-traders from this market.

(7) Research requirement – Firms making markets in these securities would be required to provide equity research coverage that meets minimum standards.

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