Full disclosure vs. Paternalism - Unqualified Opinions #22

and why crypto markets should consider the two cases


  • KWu offers up an insightful explainer on public offerings, and the difference between IPOs in disclosure-driven and paternalistic regulatory regimes. It’s illustrative of both the risks of closed-mindedness in the token market, and the tremendous opportunity ahead - if only we can give market-based solutions a try.

IPO listings: disclosure-based versus paternal choices - Unqualified Opinions #22

In my previous Messari feature, I wrote about U.S. securities laws and the ways a company can raise capital in public and private markets under current U.S. regulation.

The TLDR of the previous post: Since the financial crisis, IPO activity is flat, while private offerings have doubled. This is largely due to the immense paperwork / compliance burden and cost to IPO. So more companies are delaying or entirely circumventing an IPO as a fundraising mechanism. Instead, more money is being funneled into projects via private offerings.

But what is an IPO?

The IPO process in the U.S.

In the U.S. public markets, a company can apply for listing on an exchange, like the NYSE or Nasdaq, so long as they meet certain minimum requirements and provide accurate, relevant information about their companies for shareholders. Generally (and I’m massively over-simplifying this), the first step in an IPO is to elect an investment bank and legal team to work with. After that, the nightmarish process of “filing”, aka “get all of your shit together” begins.

That result of the months (and sometimes years) of work that goes into this first step is a filing called an S-1 registration statement.

The S-1 shows the public it has good internal financial controls (the financial statements are accurate and reviewed by auditors), have honestly assessed their risk factors, and disclosed things like insider holdings, legal issues, etc.

The SEC requires the information provided be be accurate, but it does not guarantee it. The SEC makes a strong point on this. The onus in on the offerer to be thorough.

To the extent the SEC has the resources, the agency’s office of Compliance Inspections and Examinations (OCIE) can audit or examine filings and documents. Through a combination of examinations, lawsuits, whistleblowers, and the like, companies have a strong incentive to file accurate information, since the penalties are serious for presenting misleading or inaccurate information, including executive jail time.

[TBI Note: This was Sarbanes-Oxley in a nutshell. Make sure officers are criminally culpable for their companies material misstatements, and it will dissuade bad actions.]

In the U.S., if a company wanted to go public, the SEC will require complete and audited financial statements, and work with companies to ensure its disclosures meets public market standards by providing them comments. If the facts and numbers check out (according to the auditors, lawyers, etc.), the company can proceed with its IPO.

Going public in the U.S. is very much a disclosure-based process— the SEC does not have a heavy hand in deciding what types of companies to list.

IPOs in mainland China.

The path for a public offering in mainland China is drastically different.

Any initial public offering in China requires the approval of the Listing Committee of the China Securities Regulatory Commission (CSRC), something that requires more than mere disclosures accuracy.

For example, Chinese securities regulators insist that companies turn three consecutive years of profits before the company is allowed to do an IPO. The CSRC also considers other factors in the decision making process: sector type, ownership structure, etc. China operates under a socialist market economy, which ultimately means (very roughly!!) that—though market forces exist—it is ultimately the state that plans and runs the economy, as opposed to the West’s private-sector interests.

The CSRC often slows down or entirely freezes new IPO listings during periods of market weakness in an effort to boost demand in existing public shares. IPOs were halted for 15 months between 2012 and 2014 in an effort to boost the market. And again in 2015, China imposed a 4 month freeze on new listings. This means a backlog of companies gets built up, and a company's plans to go public could be delayed for years. The CSRC essentially picks and chooses the types of companies that gets listed on Chinese exchanges— and this is why some have described the Chinese IPO listing process as being more “paternalistic” as compared to the disclosure-based U.S. way.

The result?

Companies *will* leave & go elsewhere to IPO…

Despite the complexity and paperwork burden of U.S. securities laws, many Chinese companies try to access the public markets via the U.S. instead of waiting to meet the CSRC’s standards. Some of China’s biggest tech companies are listed outside of China.

Alibaba (which raised $25 billion!!) went public on the New York Stock Exchange.

Baidu went public on the NASDAQ.

Tencent went public on the Hong Kong stock exchange.

A report from earlier this year showed China currently has 164 unicorns companies (start-ups worth more than US$1 billion) a combined $628.4 billion of equity value waiting to get unlocked via IPOs.

With the staggering growth of China’s internet and technology companies that are nearing IPO stage, there have been predictions the CSRC would begin to loosen its grip on new stock market listing controls—or risk losing more China-based companies on its own domestic exchanges.  

While other countries (like the U.S.) have the lead today with respect to the straightforwardness of going public, and have a well established process that is both time efficient and more reliable, the CSRC is taking baby steps to catch up.

The CSRC set up a “fast-track” vetting process for IPO prospects, with its own chairman personally urging companies to list either in Shanghai or Shenzhen, which is where the two major exchanges in China are located.

Regulators looking at Crypto: take notes!  

So paternalistic or disclosures-driven? Which direction should we go with token sales and the emerging crypto economy.

In the world’s largest and more liquid markets, there is evidence that allowing companies to fundraise freely can bring advantages to innovative companies and the nation-states in which they go public. Companies are free to move (and have moved) to jurisdictions with friendlier laws and regulations in order to flourish.

That trend will only accelerate with a frontier asset class like crypto.

The business-friendly Cayman Islands is home to more than 100,000 companies, nearly twice as many companies as people. Why? Fees for company registration add more than $125 million annually to Cayman’s government revenue. The bulk of that income comes from exempt companies offshore companies that are registered there.

In the crypto space, we’ve already started to see this. Countries like Malta are working to ensure fintech innovation is allowed to flourish within their borders. Whether it’s through a reconstruction of legal frameworks, the creation of better regulatory “sandboxes”, or the loosening of 80 year old regulation, large economies like China and the U.S. will need to offer better wiggle room if domestic crypto development is to continue to thrive.

We think there are ways to think about constructing token sales that are done legally and ethically, and protect retail and institutional investors alike.

But we should push for minimal disclosure standards before paternalism.

- Katherine

P.S. Bonus history lesson: China reopened its stock markets in 1990 (the Shanghai Stock Exchange) after being closed off after the Chinese Civil war in 1949. A couple years ago, Reuters put together an historical overview of the state’s intervention in the stock market for those of you who are interested. 🤓

P.P.S. Smash those share and subscribe buttons, and spread the love. Tweet at me or Messari for feedback, comments, or (more?) questions.

News & Analyses

Messari Compression Algorithm

Content and thoughts from around the web as summarized by the Messari team.

🏛 [Analysis] A primer on fractional reserve banking – Erik Torenberg

Fractional reserve lending is lending more money out than you have in your bank’s reserves. Full reserve banking is - ta da! - only lending out what you have. Saifedean believes fractional reserve banking in bitcoin will be tried but won't succeed. Bitcoin is too decentralized its ledger is public, so markets will discount and “correct” fractional reserve bitcoin banks. With no Fed or FDIC to bail out fractional reserve banks, it will be hard for any bitcoin bank to get away with any type of maturity mismatch in the capital markets for any period of time. (Messari | Source)

👾 [Analysis] “Coin control” is a must learn if you care about your privacy in bitcoin – nopara73

No matter how much you use mixers, if you don't learn to use coin control you can be de-anonymized. Coin control prevents addresses from joining together. Bitcoin mixers may mix transactions, and anonymize certain addresses, but those transactions can still be de-anonymized by doing forensics on the amount outputs or by tracing participants when they start joining their inputs. Coin control prevents wallets from automatically joining addresses, which allows mixed transactions to remain anonymous. Wasabi Wallet, for instance, uses coin control and a donation mechanism to confuse blockchain analysis tools and to maintain anonymity. (Messari | Source)

Quick Bits (Don't read that, I read it for you)

Choke Points (Exchange News)

  • ⛔ The official IDEX account tweeted on Tuesday that “IDEX will begin blocking new orders from users with New York State IP addresses on Thursday, October 25th (6pm UTC). Cancels and withdrawals will remain active.” No explanation or reasoning was given. IDEX is a smart contract based exchange for trading ethereum tokens. (Messari | Source)

Startup Signals (ICOs, Cryptos, and Startups)

  • 🔓 Square is open-sourcing the documentation and code for Subzero, its enterprise offline Bitcoin wallet that protects Square’s bitcoin holdings. (Messari | Source)

  • 🤝 Hadley Stern, the blockchain R&D lead at Fidelity Investments for the past three years, was named COO of blockchain startup Bloq, the Jeff-Garzik founded company which provides blockchain solutions to enterprises. The departure comes days after Fidelity launched a digital asset trading and storage platform. (Messari | Source)

  • 📱The new HTC Exodus 1 blockchain-enabled phone must be purchased with bitcoin or ethereum. The Exodus 1 contains its own cryptocurrency wallet called Zion, allowing the phone to function as a hardware cryptocurrency wallet. (Messari | Source)

The Powers That Be (Legal/Reg/Policy)

  • 💸 Users of the long-troubled crypto exchange WEX have begun filing police reports after more than three months of being unable to withdraw major cryptocurrencies or fiat. As many as 35 such reports have been filed thus far online through the website of the Russian Interior Ministry. (Messari | Source)

  • 🚀 A new stablecoin tied to the Australian dollar is launching on the Stellar blockchain, payments processor company Novatti Group announced on Tuesday. The Novatti AUD Utility Token will be issued on Nov. 19. (Messari | Source)

Did I miss something?

Send me the link, your twitter handle and your best imitation compression algorithm write up. If I like it, I’ll include your bit next issue (with attribution).

Community Updates

Podcast Recap

🎧 ICYMI, we also host & produce our own podcasts on Spotify, iTunes, and Google Play. In our latest episode, Katherine interviewed Blockchain Capital’s Spencer Bogart (disclosure: he’s a Messari investor) in SF. They chat about fund tokenization, benchmarks for crypto fund performance, and his transition from equity research to venture investing - something that might be interesting to our analyst community.

Some other great episodes are #9 (Tony Sheng on his writing proecess), #6 (Jake Chervinsky’s primer on federal & State crypto regulators), #4 (Nic Carter on data integrity in crypto), and #8 (Conversations on the ground at CryptoSprings).

Find our podcast series on Apple here, Google Play here, and Spotify here.

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