Twitter's 'secret' IPO puts investors in the dark, for now

Twitter's use of a confidential initial public offering filing has reignited a debate about a 2012 US law that critics say denies investors time to digest a company's financial information and erodes the widely-held value of market transparency.

The social media giant can use the more secretive process thanks to the Jumpstart Our Business Startups (JOBS) Act, which loosened a number of federal securities regulations in hopes of boosting capital raising, and thereby increasing job growth. It included a provision known as the IPO on-ramp that allowed "emerging growth companies" to keep draft filings with the Securities and Exchange Commission under wraps while negotiations over the disclosures occur.

Companies that don't meet the emerging growth criteria must release their IPO filings, usually with hundreds of pages of detail about their financial condition, risk factors and ownership and management structure, months before they sell their shares.

This gives investors, financial analysts and journalists a lot longer to analyze the company's prospects. In the case of Twitter and other emerging growth companies, they can delay the release until 21 days before a roadshow to investors, which usually precedes the share sale by only a few days or weeks.

They can also can disclose less information about pay for executives and directors, and gauge interest by sophisticated investors prior to filing IPO documents with the SEC.

The law helps true startups test the regulatory process for an IPO without worrying about bad publicity if they decide to later withdraw their paperwork. It also allows companies to keep information from their rivals for longer. Some critics say it's absurd to lump a household name like Twitter in this category, even if it fits the technical definition of less than $1 billion in annual revenue.

Its market value once listed is expected to be more than $10 billion. There is also an irony in Twitter, which freely spreads around vast amounts information in the blink of an eye, keeping its own details out of view. It announced its IPO plans in a bare-bones tweet late on Thursday. J. Edward Ketz, an accounting professor at Pennsylvania State University, said the idea of having a confidential filing process is "dead wrong". "It goes against everything the SEC is about," he said.

"The whole purpose of having the SEC in the first place is to get corporations to provide full and complete information about what they're doing." Advocates of the JOBS Act say those arguments don't hold water. They contend that keeping private the initial discussions with regulators spares companies the heartburn of putting out financials and then being prevented from elaborating on them due to "quiet period" rules.

Those rules prevent company executives from making public statements related to information in the filing. They note that 21 days before the roadshow provides plenty of time for public debate. Ketz said Twitter is not doing anything illegal or wrong, but said the decision is not encouraging for shareholders. "If management at Twitter were more investor friendly, it seems they wouldn't invoke the option that they have."

Others disagree, including Kate Mitchell, who chaired the IPO Task Force, a private-sector group whose work advised the Treasury Department and lawmakers, including Senator Charles Schumer, a New York Democrat who helped draft the IPO on-ramp provision of the JOBS Act. She said that while the idea of a confidential IPO process "sounds nefarious," it allows for the company and the SEC to have a generous discussion about proper disclosures and accounting methods.

And it prevents companies from being put in the awkward position of putting out some business information to some potential investors and Wall Street analysts and then not being able to publicly discuss it. She pointed to the recent IPOs of Facebook and Groupon. Groupon in 2011 was plagued by questions about its reliance on what some considered to be unusual accounting practices. Facebook faced serious doubts last year after its IPO filing described its lack of mobile advertising as a risk factor.

"All this hype was building around these offerings, and there was limited and static communications," said Mitchell, who is also a co-founder and partner at Scale Venture Partners. She also said potential investors get to look at all the SEC's red-line edits on the draft registration statements before the company goes public.

Act was a rare bipartisan bill that sailed through Congress last year, even though Washington was generally gridlocked over budget and other domestic issues. The idea of fostering young companies at a time of sluggish economic growth had strong appeal, and those critics concerned about the erosion of investor protections were only able to make modest changes to the legislation. Besides allowing emerging growth companies to quietly navigate the IPO process, the bill also opened the door for hedge funds to advertise private securities deals and allowed for crowdfunding, a capital-raising strategy that lets investors take small stakes in private start-ups over the Internet.

Overall, roughly 250 companies have used the confidential IPO process as of June 2013, according to the SEC, who will not name the firms. Among the known companies are some that are far cries from start-ups. English soccer powerhouse Manchester United last year used a confidential IPO to launch its offering in the United States after abandoning earlier attempts in Hong Kong, Singapore and the UK.

The architects of the Sarbanes-Oxley corporate accountability law in late July mocked the notion that the soccer club is an emerging growth company that is going to help create jobs in the United States. "They've been emerging for 120 years," said former U.S. Representative Michael Oxley, drawing laughter from a conference crowd last year.

Schumer, in a statement to Reuters, said the confidential filing provision has been one of the most successful parts of the JOBS Act. He said investors still have all the information they need to analyze well in advance of the IPO. "If Twitter meets the definition of an emerging growth company, they're free to avail themselves of the relief provided under the bill," Schumer said.

Even early on, some questioned whether the definition of "emerging growth company" was too broad. Mary Schapiro, who headed the U.S. Securities and Exchange Commission when the legislation was being debated, had tried to lower the $1 billion threshold but was not successful.

In a March 2012 letter to Senate Banking Committee Chairman Tim Johnson and then-ranking Republican Richard Shelby, Schapiro said she recognized the importance of reducing IPO obstacles for small businesses, but was not sure the JOBS Act had found the best way.

"A lower annual revenue threshold would pose less risk to investors and would more appropriately focus benefits provided by the new provisions on those smaller businesses that are the engine for growth for our economy," she said. Barbara Roper, the director of investor protection for the Consumer Federation of America, said Twitter's use of the confidential filing process undercuts the idea behind the JOBS Act. "It exposes the absurdity of the basic premise that this was about small company capital formation," she said.