I am sure the Department of Labor did not intend to benefit private equity sponsors when it announced it’s new “stockbrokers are fiduciaries” program. The fall out may already be starting, I was surprised to learn that JP Morgan will not allow its brokers to solicit trades in “non-investment grade” issuers. I really was shocked by this policy and its ramifications for the whole swath of the capital markets that deal with non-investment grade issuers. Does this mean brokerage firms have decided that they cannot meet the fiduciary standard if they are soliciting trades in smaller, more risky companies? Does this policy apply to debt and equity securities? Does it apply to initial public offerings which by the nature of the offering are mostly smaller, riskier issuers? Will brokers set trading limits based on float to meet a fiduciary standard? Does hasty rule making challenge the U.S. Stock and Bond markets by equating the fiduciary standard with the investment rating of the securities? Maybe I have been asleep and these policies have always been in effect and have nothing to do with new fiduciary standards? Maybe Thomas Perez has leaked the playbook to big brokerage so they can get ahead of his rulemaking which is just now going into effect?
All I know is that the capital markets have not been receptive to initial public offerings for a long time. The Chairman of one of our portfolio companies sent me this recent snapshot of the IPO scene:
Krispy Kreme and Keurig follow a growing number of companies going private to shield themselves from public company regulations and shareholder groups’ competing goals, in an effort to focus on the health of the enterprise. Data from Weild & Co. show that the number of public companies trading on the exchanges has decreased by 35 percent over the past 20 years, the New York Times reported last year. Due to global economic volatility and poor initial public offering (IPO) performance, more companies are also forgoing an IPO in favor of being bought by competitors or interested investment firms. The dollar volume of IPOs decreased 63 percent from 2014 to 2015 as the volume of mergers and acquisitions has increased by 46 percent.
Source: NACD Weekend Reader
American Business and Capitalism Are powered By Self Interest
In my experience in the brokerage business the old adage, “stocks are sold, not bought”, is almost universally true. Self-interest propels the brokerage industry to generate investment ideas for its retail customers because commissions are usually a reward. However, the retail customer benefits from institutional quality research from firms like Goldman Sachs and JP Morgan even if the stock broker is serving them up with a commission. If you dictate a fiduciary standard that only allows brokerage idea generation to focus on the largest companies, we may all find that the NASDAQ and AMEX have shrinking liquidity and relevance. It is not inconceivable that many discount brokers who thrive from retail customers will go out of business. If most below investment grade issuers are too risky for retail, what will it mean for employment and sustainability in the small end of the brokerage industry? I also wonder what it will mean for the NASDAQ and the AMEX.
You Can Crowdfund But You Can’t Solicit?
It is ironic that crowdfunding rules for early stage, pre-revenue business ideas have virtually no boundaries anymore while established companies trading on vibrant exchanges are experiencing the wrath of wanton rule makers. I guess it is ok for a retail investor to lose all his money on crowdfundings for a startup but a stock broker cannot solicit a trade in below investment grade issuers. So Tesla ( NADAQ:TSLA) with a S&P rating of B- might be off limits for broker solicitation, but Elio Motors (3 wheeler with promised 84mpg but no products and no production) can solicit non-accredited investors and raise $25.0+ million in a series of crowdfunding’s. Tesla has a $27 billion market cap! This seems a little absurd but the laws of unintended consequences produce goofy results, especially when they are concocted by rule makers who do not believe in American exceptionalism and likely do not know the US capital markets are the envy of the world.
Big Brokerage Is Now Big Banks
One reason you may not have heard a hue and cry from the big brokers is self-interest. The “too big to fail group” are all banks now and they will get all the business they want, directly or indirectly, when the little guys fail. Instead of having to compete with low commissions, you will now get a 1% wrap fee with Goldman, JP Morgan or Wells Fargo.
This is a great boom for private equity because small issuers may not have an alternative liquidity path through the capital markets. Right now the M&A market works much like a mini NASDAQ with thousands of investment bankers acting as market makers soliciting capital from institutionally funded private equity and mezzanine capital firms to provide complete liquidity in change of control transactions for private companies. If it does not want to give up control, a private company can always consider going public as an alternative. Given the proctologic experience imposed by Dodd Frank and Sarbanes Oxley that choice right now is skewed toward the M&A markets. The fiduciary standard might be the last nail. The Department of Labor may have succeeded in permanently stifling capital formation at the small end of the capital markets for big employers while the SEC is encouraging it for companies that don’t even have employees.
This is the kind of nonsense you find when the people in charge are more concerned about votes than voters.
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