Lockups When a company does an initial public offering to sell its stock to public investors for the first time, it will hire some banks to act as underwriters for the IPO. It will pay them a fee, often as much as 7% of the IPO proceeds. The underwriters will help the company write its prospectus and market the deal to investors, and they'll advise it on the right price for the IPO. As repeat players in the IPO business, they will also have lots of general advice on the process for the company. One thing that they will tell the company is that it needs to have a lockup: For six months after the IPO, the company has to promise not to sell any more stock, and all of its pre-IPO insiders—its founders and executives and venture-capitalist investors—have to promise not to sell any either. The point of the lockup is to protect investors in the IPO. It limits the supply of the stock, increasing the likelihood that investors who buy stock in the IPO will make money. Founders and venture capitalists, on the other hand, might not want to be locked up. They might say, look, if it turns out that people want to buy this stock, we want to be able to sell. A lot can change in six months, and we want the flexibility to manage our money however we want. We'd rather not sign the lockup. What do the underwriters say in that situation? There is a standard answer. The standard answer is: You need the lockup because investors demand it. If you don't sign the lockup then investors will not buy stock in the IPO, or they will only buy stock at a lower price. The lockup is standard in every IPO, and it's material to investors, and if you don't have it they will pass on the deal. We are just looking out for your interests, and it is essential for you to include the lockup. I am not convinced this answer is always true. My impression is that investors will tolerate a lot, and for a hot IPO in a strong market they're not going to insist on a lockup. One piece of evidence for this is that investors pretty regularly pile into IPOs despite complaining about even more material structural problems like non-voting stock. But my best evidence is that several big U.S. companies have recently gone public via direct listings without any lockups, and investors have cheerfully bought those companies' shares. It turns out that, empirically, investors do not in fact insist on lockups. But the underwriters could give a different answer. They could say: Look, we don't really work for you. You hired us, and you are paying us, and we're trying to deliver a good result for you. But that's not our whole job. We represent the market. We put our stamp of approval on this deal. If our names go on the cover of your prospectus, then we are vouching for you, we are telling investors that you are a good company and that your IPO is a good deal. And we think that doing an IPO without a lockup is a bad deal for investors, even if they don't care. Because they might care later on: If you sell stock now without a lockup, and they buy it without complaint, and a month later you dump a bunch of stock and drive down the price, they will complain to us. We will be on the hook. I find this answer very convincing. (Disclosure: I am a former capital markets banker, and have in my time given both of these answers to companies who pushed back on terms.) The underwriters are the representatives of the market, not just in the mechanical sense that they aggregate the expressed desires of investors, but also in the more paternalistic sense that they understand what investors should want and try to give it to them. They are responsible for making sure that securities offerings comply not just with law but with market custom, that investors get terms that are reasonable and customary and expected, that they will not be surprised later on. That is the point of underwriting. The point of underwriting is that the underwriters are repeat players, and they develop a reputation in the market for bringing good deals that treat investors fairly, and then they rent out this reputation to each new issuer. An issuer who says "we are the client, we're paying you, we don't want a lockup, so get rid of the lockup" is missing the point. The value that the underwriter is providing to the issuer is its reputation, and that reputation depends on it sometimes refusing to do what issuers want. In the dumb obvious sense this means refusing to underwrite deals that are frauds. But in harder cases it means refusing to put non-standard terms deep in the IPO document because investors might later feel aggrieved by those terms. The underwriters aren't just making sure the document is accurate; they are also, in a sense, reading it so the investors don't have to. If page 103 of the prospectus lets the issuer do something weird and horrible, and later the issuer does that horrible thing, and investors call the underwriters to complain, and the underwriters say "well it was disclosed in the prospectus," that is a good legal defense, but it is not a good commercial defense. The investors will still be mad. But this is a tough answer. It's a tough answer in part because it is not easily and universally true; the underwriters partly play a gatekeeping role and partly play a neutral middleman role, particularly though not exclusively on price. These days nobody really thinks that the underwriters of an IPO are vouching for the price; they are trying to get a price that balances supply and demand, not one that "correctly" values the company in their own subjective judgment. Several big banks seemed perfectly happy to underwrite WeWork's IPO despite all sorts of (fully disclosed but not at all standard) governance weirdness, and at an aggressive valuation; the IPO ultimately didn't happen because investors read the prospectus and said "no way." (Jamie "Dimon said he never believed WeWork was worth $47 billion," even though his bank was hoping to sell it at that valuation.) A normal issuer could quite reasonably say "wait you'd let WeWork do all that stuff and you won't let me do an IPO without a lockup?" But it's also a tough answer because the issuer, after all, is paying the underwriters. There is no written rulebook saying what terms the underwriters have to insist on; the lockup isn't required by law. And all of this stuff is very obviously a conflict of interest. When the underwriters insist on terms that are good for investors but restrictive for the issuer, like lockups,[1] then it looks like they are putting their own interests ahead of their clients'. "Wall Street banks are helping Wall Street investors at the expense of their Main Street clients," the issuers might say, "because the banks and the investors are repeat players, and the banks care more about getting future trading business from the investors than they do about protecting their IPO clients."[2] And that will be kind of true! And it is kind of the point! If you're an issuer, you are hiring underwriters exactly for their conflicts of interest, for the trust that they have built up with investors. But when the banks tell you "you can't do that because we don't want to upset investors," you will find it very unfair. It will seem like an evil cartel designed to perpetuate its own power and extract value for itself. Also separately your stock will probably go up 10 or 20% on the first trading day after the IPO, and everyone who bought stock in the IPO will have underpaid you for it, and you will say "man, just another case of Wall Street banks favoring Wall Street investors over their actual clients." Again, true, again, the point. Anyway issuers and founders and venture capitalists find all of this annoying enough that direct listings are having a real vogue, and the New York Stock Exchange sought permission from the Securities and Exchange Commission to let companies raise money in direct listings and basically disintermediate the IPO process entirely. And last week the SEC said no, for reasons that are still unclear. (The NYSE has filed a revised proposal.) We talked about this on Tuesday, and I speculated that the SEC might have been concerned about getting rid of the underwriters' gatekeeping function. Direct listings in the U.S. so far have kind of had underwriters, but not exactly, and there is no guarantee that future direct listings will have even that. And the SEC might reasonably think that the underwriters play an important role in protecting investors. At the Information, Kevin Dugan has more on the SEC's decision: Some investors and other observers say doing away with protections afforded by IPOs, particularly lockup provisions, could hurt small investors in the public market. Lockups prohibit early investors and employees from selling for three to six months after an IPO. They prevent situations where company executives or early investors hype a stock offering and then quickly dump their shares. ... Another issue was the elimination in direct listings of lockup agreements, which prevent early shareholders from selling for six months in a traditional IPO. While federal law doesn't require lockups, banks use them to carry out their responsibility to protect investors from market manipulation. Underwriters argue that lockups favor the interests of shareholders by showing officers' confidence in the company, which could then justify a higher share price, said John C. Coffee, director of Columbia Law School's Center on Corporate Governance and a former member of the NYSE's legal advisory board. "Typically, these lockups have been meant to protect investors coming in," Kathleen Smith, principal at IPO research and investment firm Renaissance Capital, told The Information. "Without a lockup, you have the chance for a lot of information being promised and finding out the company doesn't deliver. But in the meantime, the selling has already happened by insiders." In a sense these are weird concerns. "We want companies to do IPOs instead of direct listings because IPOs require lockups" is a strange thing for the SEC to conclude, because IPOs don't require lockups. It's just a custom, a thing that underwriters usually ask for but that isn't in the law anywhere. But I think that the SEC would be basically correct to think that having underwriters as representatives of the market does tend to protect investors. That's exactly why companies want to do direct listings! The thing that bothers direct-listing proponents is that, in an IPO, the underwriters sometimes aren't working wholeheartedly on behalf of issuers; they are sometimes working in the interests of investors instead. If you are an issuer who will only ever do one IPO, you want that IPO to maximize your own interests; if you are an underwriter who will do dozens, you want each one to make investors happy. Getting rid of the underwriters might be good for the issuers, though I suspect it mostly wouldn't be; I suspect that the reputation-rental function of the underwriters actually adds value for issuers. But if the underwriters are partly in the business of representing investors, then getting rid of them would be bad for investors, and that might be what the SEC is worried about. Mr. Stone Okay my most important rule around here, more important than the Laws of Insider Trading, is: Never participate in a corporate parody video of any kind, for any reason. That is my best life advice for you, and really it is almost legal advice; ask the opioid salesman who faces years in prison after he played a rapping bottle of opioids in a corporate video. But even if you are not committing felonies in these videos, you will inevitably be committing crimes against good taste. They are so rarely funny! So often embarrassing! It is extremely unlikely that the inside jokes you dream up in a conference room will resonate even with your coworkers, but the real problem is that when the video comes out on the internet, all the stuff that you thought was hilarious will just be gibberish, and everyone will just see you, like, rapping in your business casual clothes. It is terrible, do not do it, there are no exceptions. Ugh fine though I will concede that this year's Blackstone Group Inc. holiday video is pretty good? Like I laughed a few times, and not only in an awkward horrified way ("We were on such a great trajectory with our C-corp conversion," says a guy, possibly as part of a joke) but also in a genuine though nerdy way. At about 4:30 there is a joke about footnotes that I fully enjoyed! The central joke of the video is that Blackstone President Jon Gray decides that the firm needs a mascot, and everyone rolls their eyes, and there are auditions for the mascot ("Mr. Stone"), and then a mystery person shows up in the costume and dances and dunks a toy basketball and wins the role, and then there are a bunch of scenes of him being an awesome and high-energy and universally beloved mascot, and all these Blackstone employees are like "but whooooooo could this amazing perfect genius be," and it is immediately completely obvious to anyone who has skimmed the acknowledgments of Steve Schwarzman's book that the video is going to end with Schwarzman, Blackstone's founder and CEO, revealing that he was Mr. Stone all along and then plugging his book. So it ends on a bit of a clunker. But on the whole the thing … works? I'm sorry, I can't really believe it either. Still my advice stands. Is conceptual art a security? No, but here is a law review article by Brian Frye that argues the answer is yes: A certificate of ownership of a work of conceptual art is quite obviously and literally a security. The purchaser of a work of conceptual art invests money in a concept, with the expectation of profiting based on the efforts of the artist. It is trivially the case that the sale of a work of conceptual art is the illegal sale of an unregistered security. The buyer of a certificate in a work of conceptual art is literally investing in a common enterprise controlled by the artist, in the hope of selling their interest in that enterprise at a profit in the future. I don't think that any of that is true. (The purchaser might invest money primarily for an aesthetic experience, not for profit; the value of the artwork does not depend on the future efforts of the artist, and might in fact be enhanced by the artist's early death, but instead depends on social acceptance of the art as art; there is no "common enterprise" because no future efforts are required, etc.) Still! There is a basic element of truth to it, which is that: - people buy lots of different intangible things hoping that they will increase in price;
- some of them are securities and some of them aren't; and
- even experienced lawyers can be unsure which is which.
In particular lots of cryptocurrency tokens are arguably securities and arguably not. In fact some meaningful number of cryptocurrency tokens are also conceptual art, and if you are buying them it is not clear whether you are speculating on a currency, or speculating on a security, or speculating on art, or just paying for an aesthetic experience. Also it is a pleasing artifact of financial capitalism to think, like, "art is a subset of securities law." Why not! "Everything is securities fraud," I often say, but I mean "everything" in a narrow sense, something like "all bad behavior by a public company is also securities fraud." But what if everything is securities fraud? What if all of human culture is just an "investment in a common enterprise with the expectation of profits from the efforts of others," which is almost the famous Howey definition of a "security" in U.S. law? What if every time we interact, hoping to get something out of it, hoping to make our lives better through our shared humanity, we are participating in an unregistered offering of securities? Seems reasonable really. Things happen Saudi Aramco Set to Pay Banks Only $64 Million for Record IPO. Fed plans to double repo market intervention to avoid cash crunch. FTC Weighs Seeking Injunction Against Facebook Over How Its Apps Interact. Goldman Sachs CEO David Solomon and his management team are ditching their stuffy offices and moving to an open floor plan closer to the people so they can feel the buzz of New York headquarters. Battle over Volcker's rule outlives its creator. Elliott Says PG&E-Backed Restructuring Plan Ignores State Mandates. Robinhood has fractional shares now. (Earlier.) "It took Del Frisco 2,723 words to explain what Ebitda means, the most of any borrower included in the study." "'Obviously nobody invests in a hedge fund...based on an article in a no-name online blog,' Mr. Gottlieb said in a statement, though he added it has 'improved my reception on Tinder.'" If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! [1] But especially like covenants in *debt* underwriting, where all of this is more fraught. [2] With lockups specifically, the fact that the underwriters can waive the lockup also gives them some economic leverage over the company: If the company asks them to waive the lockup so it can sell more stock, they will demand to underwrite that offering too. |
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