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03:05 PM
Ivy Schmerken
Ivy Schmerken
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Private Markets Threaten Exhanges

If companies continue to choose to raise money via private placements rather than via IPOs and electronic venues fuel a secondary market, what will the future hold for the exchanges?

The Blackstone Group's IPO on the NYSE in June attracted a mega-media frenzy, proving that institutional investors are hungry for new IPOs in the hot private equity sector. But the euphoria associated with Blackstone's successful IPO may be short-lived.

Because of onerous U.S. regulations, such as Sarbanes-Oxley, and concerns over disclosing confidential information and living up to quarterly earnings expectations, some private equity firms and hedge funds could become less enamored with raising capital via the public markets. In addition, in June, democrats in Congress introduced several bills to raise taxes on private partnerships, including private equity firms and hedge funds, that go public.

Among the increases, Congress is seeking to tax the "carried interest" or performance fees that partnerships, including private equity firms, earn at the corporate income tax rate of 35 percent -- they currently are taxed at the capital gains rate of 15 percent. If the bills go into effect, it doesn't look like those potential issuers will be rushing to do IPOs.

As a result, companies increasingly are raising capital in the private markets as an alternative to exchanges, prompting the Wall Street innovators that invented dark pools and other crossing mechanisms for publicly traded shares to turn their talents to the private markets. Goldman Sachs already launched GSTrUE -- Goldman Sachs Tradable Unregistered Equity -- an electronic platform for issuers of private equity that want to control their offerings. And The Nasdaq Stock Market is revamping its Portal Market, a registration system for 144A securities, and expects to launch a real-time trade negotiation capability for the resale of 144A securities this summer. (see Nasdaq, Goldman Sachs Creating Electronic Trading Platforms for Private Equity).

Both private placement platforms are for the eyes of the elite institutional investors and hedge funds that do their own due diligence. "We're not positioning this as an alternative to the public market," says a Goldman spokesman. "We're positioning this as an enhancement to an existing market." Goldman's first issuer was an alternative asset manager, Oaktree Capital Management.

But is issuing all this paper in the private markets -- away from the public exchanges -- a positive model for equity issuance and secondary market trading?

In his blog, "Information Arbitrage," Monitor110 CEO Roger Ehrenberg,(who previously ran DB Advisors, Deutsche Bank's hedge fund complex) praises Goldman Sachs for being "smart and visionary" for inventing this type of execution venue. But, he warns, "This opportunity exists because of the badly broken regulatory regime in the U.S."

Ehrenberg notes that this model is good for companies like Oaktree and other alternative asset managers (such as Fortress, the first hedge fund IPO, and Blackstone) that want to keep their operations confidential and stay out of the public eye. But he cautions that it will have a dampening effect on new listings for U.S. exchanges. Ehrenberg urges SEC Chairman Cox and his friends in Congress to "get on the ball -- and quick -- if they hope to stem the bleeding of new issuances flying off of U.S. shores and onto foreign and alternative exchanges like GSTrUE."

On the other hand, private equity platforms could be a way to bring those shares back to the exchanges. According to Nasdaq EVP John Jacobs, a lot of the 144A securities come with registration rights, and most of them register anyway. "It's nice to develop an institutional marketplace on the way to going public," he says. Jacobs contends that there are three types of companies -- those that will raise capital on Portal and stay private because they don't want to answer to a universe of retail shareholders, those that will go public after first building an institutional following or shareholder base in the private market, and finally, companies like Microsoft and Google that will go public right away.

Whether issuers tap the private or public markets for raising capital, clearly they will have more choices as to where their shares can be traded.

Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio
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