TCS Daily

The SEC's War Against Growth

By John E. Tamny - October 26, 2004 12:00 AM

Perhaps not satisfied with the harm its reforms brought to the mutual fund industry, last week the SEC turned its attention to Initial Public Offerings. The proposed remedies for "IPO abuses" will almost certainly make IPOs less frequent, and make it far more difficult for tomorrow's innovators to earn capital market funding.

The major proposed reforms will rein in the practices of "tying" and "laddering." As with seemingly all government actions, not much thought was given to the potential unintended consequences, though the SEC does to its credit plan to solicit comments on the proposals for 60 days. Here's hoping the investment banks and businesses that someday hope to tap the capital markets aggressively state their cases.

"Tying" occurs when a salesman allocates shares of a "hot" IPO to an institution in return for the institution agreeing to buy shares in upcoming offerings that are less highly anticipated. and the now defunct are two examples of hot IPOs from the not so distant past. Investors who received shares in those offerings (both skyrocketed on the first day of trading; over six fold) were also expected to participate in less highly anticipated IPOs such as MetLife and Packaging Corp. of America.

Here's where regulators once again suffer from what Hayek termed "the fatal conceit." According to the Wall Street Journal, the proposed new rules say the practice by which institutions agree "to buy another, less desirable stock," will be outlawed. The problem is that no one, excepting regulators, is arrogant enough to presume with any certainty what newly public stocks are desirable for the long-term. MetLife and Packaging Corp. of America both qualified as "undesirable" IPOs during the Internet boom, but in the past year returned 12% and 20% respectively. Formerly "desirable" Priceline fell 32% during that time, while countless other formerly hot stocks have ceased to exist altogether.

"Laddering" is the practice by which shares of a hot IPO are allocated to investors in return for those same investors promising to buy more shares in the open market later. The New York Post's Paul Tharp painted this process in a sinister light, calling the purchase agreements "a conspiracy of greed among Wall Street underwriters and certain selected clients who agreed to play ball for a piece of the profits."

Tharp's assumption is truly remarkable considering the very common belief that investors participated in IPOs only to dump their shares once trading in the stock began. Indeed, that laddering was a common practice sort of debunks the myth that a privileged few were able to make outsized profits in a "rigged" (Eliot Spitzer) market. Those who got shares were expected to be much bigger owners once trading began. If they weren't, their allocations in future hot IPOs were significantly curtailed.

Looking to the future, rules against "laddering" mean that the big institutions that make IPOs possible will be less willing participants. After all, these are the most sophisticated investors in the world. Who of them will in their right mind want to participate in public offerings in which banks are not allowed to require participants to support the shares in the aftermarket? Rules against "tying" mean that only "hot" companies will have a chance to achieve funding; cold comfort considering the post 2000 performance of formerly attractive companies like Palm,, and CMGI.

Economic pundits continue to say that the stock market is unhinged from a growing economy. It says here once again that the stock market has priced in the future perfectly. Small companies are the job creators in the U.S. economy, and are also often the force behind economy-expanding innovations. The SEC has just proposed rules that will make it far more difficult for tomorrow's companies to achieve funding. While the stock markets can't possibly know what future Microsofts and Intels will get strangled in this pious investment environment, they can certainly price in the reality that some will.

The markets are proving once again that policy matters. The 2003 tax cuts aside, the U.S. economy has since the 2000 stock market crash been assaulted by overzealous regulators, a too-loose Fed, and the innovation-sapping Sarbanes-Oxley bill. The latest SEC proposals fit in nicely with these other anti-growth measures. That in mind, it's no surprise that stocks are swooning.

John Tamny is based in Washington, DC and can be reached at


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