A Case Study in the Unintended Consequences of Financial Market Regulation: The Death of the Small Cap U.S. IPO?


The first 100 days of the Obama administration
are widely expected to usher in a new era of U.S. capital markets regulation designed to restore the
public’s trust in the decimated institutions that provide much of the liquidity
infrastructure for the global capitalist system.
  It is imperative that improved financial oversight be
achieved swiftly through the enactment of effective regulation so that the
markets can re-equilibrate and resume their normal function.
  Without these necessary changes, global
economic growth will continue to falter.

At the same time, we must recognize that
regulations enacted in haste can have severe, negative unintended
  The current moribund
state of the American IPO market is a real-time case study in such unintended
regulatory consequences.
  Of equal
import is the fact that the IPO drought is structural, not cyclical, and this
has far reaching implications for the future of innovation in America.

On November 19th, Grant Thornton
released a white paper, “Why Are IPO’s in the ICU?” written by David Weild,
former Vice Chairman of the NASDAQ, and Edward Kim, former head of NASDAQ
product development, both now principals at Capital Markets Advisory Partners.

To download the white paper click Download Why are IPOs in the ICU_11_19 :  

The paper was presented to the NYSE and
National Venture Capital Association’s Blue Ribbon Regional Task Force, which
has been convened to make specific recommendations to the Obama administration
in January regarding changes that must occur if America is to restore the small cap IPO
as a compelling and differentiated positive feature of our capital markets.

The paper is concise and makes a cogent case as to how we got here.  If you want to understand why the IPO
market has died and why the middle market for public emerging growth companies
has effectively ceased functioning, you must read this paper.

 I agree with the paper’s overall thesis and with
a number of its important assertions, including:

* While conventional wisdom may
say the U.S. IPO market is going through a cyclical downturn, exacerbated by
the recent credit crisis, many are beginning to share a view of a new and much
darker reality: The market for underwritten IPOs, given its current structure,
is closed to most (80 percent) of the companies that need it.

* The lack of an IPO market has
caused venture capitalists to avoid financing some of the more
far-reaching and risky ideas that have no obvious Fortune 500 buyer.
Gone are the days when most venture
capitalists would so willingly pioneer new industries and technologies (e.g.,
semiconductors, computers and biotechnology) that have no obvious outlet other
than the IPO market.

* Regulators may have unwittingly
done a real disservice to mom and pop investors by enabling traders to hijack
the markets for speculation. This phenomenon can be seen by the large Wall
Street firms who have witnessed their top 10 (by revenue) institutional
investors — which only a decade ago were “long-
mutual funds such as Fidelity and Alliance — be displaced by hyper-trading
long-short hedge funds.

* The U.S. will lose its
competitive advantage in developing, incubating and applying new technologies.
Technologists are already returning to foreign jurisdictions like China and
India where government has devised an increasing array of economic and capital markets
incentives to compete

The lack of IPO’s in the U.S. has broad, negative
implications for continued risk taking by U.S. venture capitalists. If we have
no public market liquidity for emerging growth companies, there will be no next
generation of American technology giants. The demise of the technology IPO has also
contributed to the structural breakdown in the broader cycle of research and
development that underlies the American innovation crisis heralded by Silicon
Valley thought leaders such as Judy Estrin.


If you have constructive recommendations for reforms that
you believe should be enacted to support a renewed IPO market, please contact me
at pascal@levp.com, and I will forward
your suggestions to the NVCA.

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