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IPO rules after Facebook focus of hearing Tuesday

WASHINGTON (MarketWatch) -- In the wake of the controversial initial public offering from Facebook Inc. last month, participants at a congressional hearing Tuesday are expected to raise questions about the regulatory rules and whether there are ways to make IPOs more accessible to retail investors.

The House Oversight and Government Reform committee has scheduled a hearing Tuesday to examine the JOBS Act, which seeks to make it easier for small companies to raise money, including through IPOs.

Yet lawmakers at the hearing are also expected to discuss a related subject that the panel's chairman, Rep. Darrell Issa, has focused on recently -- Facebook's tainted IPO. The California Republican sent a letter to Securities and Exchange Commission Chairwoman Mary Schapiro last week, saying the social-networking company's problematic offering shows that the IPO process suffers "substantial flaws."

Investors have raised concerns that Facebook (FB) didn't publicly disclose enough information about its business before its controversial debut on the Nasdaq Stock Market (NDAQ) May 18. Specifically, retail investors and small institutional buyers were alarmed that revised analysts' estimates were provided privately to big favored institutional investors, after Facebook decided to offer more detail about its business in an amended SEC filing on May 9, just nine days before its IPO.

Some lawmakers and participants at the hearing are expected to ask whether the failures in the Facebook IPO argues for expanding an SEC rule adopted in 2000, known as Regulation Fair Disclosure, or Reg FD, which mandates that all publicly traded companies must disclose material information to all investors at the same time.

Columbia Law School Prof. John Coffee, who is scheduled to testify before the committee, told MarketWatch that he plans to argue that the Facebook IPO indicates to him that there is a Reg FD "loophole the size of the Arc de Triomphe" relating to the so-called road shows -- where executives for companies looking to go public meet prospective investors and analysts in various cities to pitch the stock and also take questions about the offering.

Coffee said that these road shows typically are places where management make oral forecasts and estimates that are not available to retail investors. "If you want to say that selective disclosure is bad, require that the real road show is available to the public," he added. "This will provide retail investors with more useful information, with the counterargument being that a little bit less information will be provided."

As a result of securities-offering reform rules implemented by the SEC in 2005, most companies involved in IPOs post a version of their road show online for retail investors to view.

However, the rules did not mandate that the publicly available electronic road show include any question-and-answer sessions between institutional investors and management. Nor did it require companies to give retail investors an opportunity to ask questions electronically to management via online sessions, something small investors have been seeking.

Linda Killian, principal at Renaissance Capital, a Greenwich, Conn.-based institutional investor, said companies are nervous about making road-show Q&A exchanges available to retail investors because it could open up the company to litigation. She added that many retail investors wouldn't take advantage of better access.

"Companies get ripped apart when they are overly specific and the future results are different from what they said," Killian commented. "Management would be more careful and hesitant in what they say if they knew everything they said was going to be made publicly available."

Coffee agreed that corporate lawyers "don't want the sexier predictions reaching the public market for fear of litigation," but stressed that companies need to be required to make more useful information from the road show available to retail investors.

University of Colorado at Boulder finance Prof. Sanjai Bhagat said he would like to have the SEC require companies in their pre-IPO filings to make very clear -- in the first few pages -- how many shares the CEO and venture capitalists plan on buying or selling, and how many shares they will have afterward. He said that information is the most important data to retail investors about whether executives have confidence in the firm's performance, but it is usually buried in the SEC filings.

"If the CEO has very strong beliefs in the company's prospects, then why do they want to sell shares?" Bhagat asked. "They can say they have liquidity needs, but it usually shows whether they have faith in the company."

Nevertheless, Killian argued that the SEC is hesitant about providing too much Q&A-type interactions, because they are worried about underwriters promoting "pump and dump" IPO schemes with false and misleading statements. "While [SEC rules] protect investors from a crummy company with a shady underwriter that claims to have discovered the next cure for cancer, it also ensnares a Facebook IPO with what looks like bad disclosure."

Lawmakers are also expected to debate whether regulators should encourage "Dutch auction" IPOs, an approach employed by Google Inc. (GOOG) where retail investors can participate in setting the initial price of the deal. Companies and their underwriting banks typically like to set prices for the IPO to encourage participation from long-term institutional investors.

However, retail buyers and smaller institutions may prefer an auction process to get access at a better price. "Institutional investors don't want to pay top price for an IPO and see retail investors drive down the stock price," Killian said.