GM's Future IPO: Whom Can Investors Trust?

Not only does General Motors' CEO, Edward E. Whitacre Jr., want to take GM public ASAP, he is asking the federal government to sell its $50 billion (!) stake at the same time. That's all well and good, but I have two concerns: (1) whether the SEC will, or can possibly be, an effective gatekeeper of a GM IPO; and (2) whether the contemplated timing (before the end of 2010) would be in the best interests of investors.

Concern #1: We Have Seen the Issuer, and It Is U. S.

A cornerstone of financial reporting regulation in the U.S. is the requirement that an offering of securities to the public must be preceded by a registration statement. This is the means by which required disclosures become public, while at the same time providing the SEC with all the time it needs (usually around 30 days) to review the disclosures for compliance with its rules.

Other jurisdictions claim to have similar protections for its investors, but nothing matches the thoroughness of the SEC's review of prospective IPOs. It is not uncommon for an IPO registration statement to generate dozens of comments, each one of which the issuer must address to the SEC's satisfaction before it will permit the offering to go forward.

The IPO review process isn't perfect, and the SEC in no way guarantees that they caught every "deficiency" in a document they reviewed. Yet, the SEC's reputation as the most active and effective securities regulator in the world is derived in large part from how seriously they take this most basic aspect of their work. But, the imminent IPO registration statement filing by GM could put that reputation to the test—not so much because of the record size of the transaction, but because the issuer and the regulator are one and the same.

Please forgive me for stating the obvious: the federal government holds a 61% of the outstanding shares of GM; GM's disclosures are expected to affect the offering price; and, the government has a direct and significant interest in the offering price. There is just no getting around the fact that the issuer is the government, and that selfsame government will be reviewing what is effectively the sales brochure for the offering for truth in advertising.

I would venture to say that the circumstances of the GM pose a singular challenge to the SEC, and they could be receiving the registration statement in just a few months.  To start the conversation on it can most appropriately defray itsconflict of interests, I humbly submit these ideas for the SEC's consideration:

Make the review process fully transparent.

Comments on registration statements and issuer responses are not normally made public until long after the offering has taken place. As a general matter, some could argue that confidential treatment of "deficiency letters" unnecessarily coddles issuers; but setting that cavil aside, nothing prevents the SEC from making an exception to its own policies. For example, the SEC could keep its initial comment letter confidential until GM provides its written responses. Concurrent with GM's response, both letters could be posted to the SEC's website.

Outsource the registration statement review to an independent third party.

There must be dozens of former SEC staffers in private practice who are qualified and willing to review GM's registration statement. The SEC could appoint, after a transparent selection process, a few individuals from among their alumni to serve on an independent committee whose sole responsibilities would be to review GM's registration statement, and ultimately to draft the comment letter. After appointing the committee, the SEC should recuse itself from the decision to allow the registration statement to become effective.

Review the reviewer

The SEC could hire one accountant and one attorney to oversee and report on the SEC's review of GM. Recusal, as described above, would be preferable, but an additional layer of review from an independent source is more acceptable than business as usual.

Of course, the SEC could choose to nothing special whatsoever -- i.e., proceed as if GM were like every other issuer. But, that would be a denial of reality, something which the SEC has recently become too prone to do (see Bernie Madoff, International Financial Reporting Standards, Bear Stearns, Pequod Capital and too many more). It would be acting as if a conflict between investor protection and the financial interest of the government doesn't even exist—yet that's what I am afraid will happen in the absent calls from investor groups and (gasp) politicians to undertake a singular review process that would be beyond reproach. When the government plays the issuer in the largest IPO in history, the safeguards investors are entitled to require even more reliability than deepwater blowout preventers.

Issue #2: If Timing Is Everything, Then Somebody May Be Getting Fleeced

GM seems to be poised to base its registration statement on its earnings from the third quarter of its current fiscal year. It is not uncommon for a company to time its public offering to follow on the heels of a couple of good fiscal quarters.  Under even normal circumstances, investors would have two concerns with that kind of timing: (1) whether anything like that gangbuster last six months or so can be sustained over the long term, and (2), whether the reported profits of an audited "stub" period will hold up to the scrutiny of the independent auditors.

I know that it has been the government's policy to let the management of GM run things, but after GM gets its money, Mr. Whitacre plans to take the next stagecoach out of Dodge (I noticed the pun only on the third reading). In the case of a restatement or other material error in the registration statement, Whitacre won't be around to take full responsibility for misleading investors, and the new gang in charge will be pointing fingers right and left.

For these reasons, the government needs to dictate the timing of the offering. First and foremost, it must assure that the latest balance sheet and income statement included in the registration statement will be audited (Note: interim period financial statements in the registration statement don't have to be audited under SEC rules).

Second, the CEO who signs that registration statement has to be on the hot seat for at least a year after the IPO. And, third, despite Whitacre's express wishes, the federal government needs to keep its own shares for another year after the IPO takes place. If investors are going to lose money because the IPO was mispriced, the government shouldn't be adding its shares to the public float until GM's share price is determined through a sufficient period of secondary market trading.

I can already hear in my head what the response of GM's management and IPO promoters will be: "Look, we're the ones that brought GM back from the brink. You can trust us."

Right.

Comments

[KPO'M]

The obvious concern is whether this IPO is being done now for political reasons. If all goes as planned, shares can be trading a few days before the election, providing campaign fodder for a party that is likely looking at significant losses in November.

The government (i.e. the lead shareholder) is out there right now trying to portray GM as an example of successful intervention. Normally, in an IPO, there is a "quiet period." While technically, GM management is abiding by the "quiet period," it's hard to argue that the government doesn't have a conflict of interest. Potentially, the SEC could also let another regulator perform a "secondary" review, though for obvious reasons the Canadian regulator would be out of the question. The UK's FSA is a possibility.