A U.S. House of Representatives committee chairman has sent a letter to the Securities and Exchange Commission, asking what went wrong with Facebook's recent IPO and suggesting that it's time to overhaul the landmark Securities Act of 1933.
"As we consider means to improve capital formation, we must revisit the Securities Act of 1933," Rep. Darrell Issa (R-Calif.) wrote on behalf of the House Committee on Oversight and Government Reform in a letter obtained by The Wall Street Journal. "The investment banks were given almost 80 years to enjoy this flawed law, fraught with conflicts of interest and incentives to misprice shares. Among other things, I ask that you take advantage of the vast improvements in communications technology to protect investors while unleashing capital formation to strengthen our economy."
The Securities Act of 1933 has provided the framework by which all IPOs are handled. One of Issa's chief issues is a provision that allows lead underwriters and an issuer to "exercise substantial discretion" in establishing the IPO price, potentially leading to a scenario where shares are priced too high for the market to bear.
Facebook's IPO has shed light on some of the potential flaws impacting the IPO process. Soon after the company's shares went public for $38 last month, they shot up. For the rest of the day, however, underwriters kept the stock at or just above its opening price for fear of allowing it to sink lower. As of this writing, the company's shares are trading at $31.60, causing some to believe that Facebook and its underwriters priced the stock too high at its start.
Facebook's offering was also hit hard by reports that investment banks told only select investors information that was not made available to the public. Morgan Stanley and other underwriters on the offering say that such communication is well within their legal right. However, Issa -- and many individual investors who were burned by the IPO -- think things should change.
"The negative views provided by the analysts succeeded in reducing the institutions' valuation of Facebook," Issa wrote, adding that analyst information given to select investors gave them an unfair advantage over individual investors. "As of Friday, May 18, the first day Facebook shares traded, 25 percent of trading volume was attributed to short sales. The informational disadvantage to the less-informed public proved harmful."
The Wall Street Journal last month published a wide-ranging report on the behind-the-scenes events that marked the Facebook IPO. According to the publication, citing a host of sources, on the eve of Facebook's IPO, a Capital Research manager who had received extra information on the social network's finances said that the $38 IPO price was "ridiculous." Still, the companies went through with it.
Issa asked in his letter to SEC Chairwoman Mary Schapiro if she would support a change to the current law and ban so-called "book building," which allows investment banks to determine IPO prices. Instead, Issa would like to see the SEC force companies to follow Google's lead when it went public in 2004 and hold a "Dutch auction." Under that system, anyone can bid for shares at any price they want. Based on the supply and demand in that auction, the IPO price is set. A Dutch auction system is widely viewed as one of the more fair options for establishing an IPO price.
"Google had a successful IPO that benefited from broad participation," Issa wrote. However, few companies have followed in their footsteps. I would like to better understand any barriers that prevent firms from issuing IPOs via Dutch Auctions."
Issa has requested Schapiro's office answer his committee's questions and concerns by July 3. It's not immediately clear what the committee might do with the information once it's obtained.
Correction at 7:13 a.m. PT: Darrell Issa's party affiliation has been corrected.