Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

PIPE deals as regulatory arbitrage

Sjostrom has an excellent paper on SSRN about how
PIPE (Private Investment in Public Equity) deals can be regarded as a
form of regulatory arbitrage. Sjostrom’s argument is that the
hedge fund that invests in a PIPE deal is performing the same economic
function as an underwriter without being subject to either the
NASD’s cap on maximum underwriting fees or the due diligence
liability that the SEC imposes on underwriters. The paper also argues
against the harsh posture that the SEC has adopted against PIPE deals.

I agree with much of this analysis but this line of thinking raises
a few other broader issues that Sjostrom does not touch upon:

  • Why should the regulation of primary market offerings be so
    dramatically different from that of secondary market trades? In the
    US, people often joke that this is largely because the Securities Act
    was enacted in 1933 while the Exchange Act was enacted only in
    1934. This is a silly reason in the US and even sillier in the rest of
    the world.
  • Is the regulatory regime for underwriters anti competitive and has
    it contributed to the emergence of a cosy oligopoly?
  • Is it sensible to bundle due diligence liability and underwriting market
    risk as inseparably as the current regulatory regime seeks to do in
    the US?
  • Why should regulators not embrace simple auctions as the best way
    to conduct follow on public offerings?

In an earlier
blog entry
, I argued that “Regulators however continue to
act as if anything unfamiliar is worse than the status quo even when
it is potentially better.” The SEC’s response to PIPE
deals seems to fit this description. PIPE deals which are not of the
death spiral variety appear to me to be a very legitimate financing


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