Problems in US regulation of public offerings

Two events this week have highlighted the persistent problems in US regulation of public offerings: first was the unacceptable effect that the quiet period regulation had on the Blackstone IPO and the other was the decision by the SEC to further tighten short selling activities during a public offering.

While the Blackstone IPO was in progress, a bill was introduced in the US Congress to increase the tax rates applicable to listed private equity firms. Since this proposal came with a five year breather, the market would have benefited from an analysis by the company explaining the tax incidence in the light of anticipated profit realization during the next five years. Unfortunately, as the Lex column in the Financial Times pointed out (“Blackstone’s tax bill”, June 18, 2007), the quiet period regulation prevented Blackstone from commenting on the situation at all. This is a totally unacceptable outcome. Clearly, the regulations that were framed long ago in a much slower paced era need to change to keep up with the times.

Sometimes, however, when regulations are changed, they are changed for the worse. The SEC’s proposal to tighten short selling restrictions during public offerings of securities is an example of this kind. The SEC states:

When a trader expects to receive shares in an offering, there is an incentive to sell short prior to pricing an offering and then cover that short position with shares bought at the reduced offering price. By doing so, the trader can cover the short sale with minimal risk, and generally lock in a guaranteed profit – to the detriment of the issuer and the other shareholders.

The amendments change the way the rule works to prevent this from happening. They replace the rule's current limitation on covering the short sales in the offering with a prohibition on purchasing in the offering after a short sale in the securities. This change was triggered by persistent non-compliance with the rule and a string of strategies to conceal the prohibited covering. Under the amended rule, if a person sells short during the restricted period prior to pricing, that person is prohibited from purchasing the offered security. Thus, the amended rule changes the prohibited activity from covering to purchasing the offered security.

Accurate price discovery is as important (if not more important) during a public offering as at other times and short selling is a critical element of good price discovery. In the absence of this process, there is a risk that companies and their underwriters would be able to manipulate the market and overprice their issues. In this light, the rule proposed by the SEC is a step in the wrong direction.

Posted at 3:16 pm IST on Fri, 22 Jun 2007         permanent link

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