SECURITIES REGULATION AND THE ALTERNATIVE INVESTMENT MARKET
by Joseph Gerakos, Associate Professor, Booth School of Business, University of Chicago.
As the U.S. increased centralized securities regulation through legislation such as the Sarbanes-Oxley Act, the London Stock Exchange’s Alternative Investment Market (AIM) implemented an approach that provides regulatory flexibility and relies heavily on the private sector to provide oversight of firms. Explicit listing, regulatory and disclosure requirements on the AIM are limited relative to other major markets. Moreover, the rules that do exist provide flexibility and are open to interpretation. The AIM entrusts primary oversight to private entities (Nominated Advisors or Nomads) who are chosen by the firms to serve the roles of gatekeepers, regulators and advisers.
In the U.S., the AIM drew attention because of its success in attracting new listings relative to the NYSE and NASDAQ. For example, in 2006 firms raised more capital through initial public offerings on the AIM than on the NASDAQ ($16.3 billion versus $12.8 billion). Moreover, some U.S. firms chose direct AIM listings, thereby bypassing the U.S. capital markets. Not surprisingly, the AIM’s regulatory structure and success generates heated discussion about the optimal level of regulation, the role of public versus private oversight, and the effect of regulation on competition among capital markets.
The AIM’s regulatory structure can be cost effective for listing firms in several ways. First, in terms of direct costs, the Nomad can relax disclosure, auditing and governance standards. Second, indirect costs can be lowered because public disclosure of proprietary information can be limited. In theory, public disclosure can be replaced by private disclosure to the Nomads who publicly attest to firm quality.
The AIM’s lack of a formal regulatory structure means that the effectiveness of oversight hinges on the role of the Nomad. The Nomad relationship is complicated by the fact that the Nomad is hired and paid by the listing firm. Furthermore, the requirements for admission as a Nomad are quite light. Hence, it is unclear how much oversight is provided in practice. As noted by Taylor (2009), “in Aim’s 14-year existence, only four companies quoted on the market have been publicly censured, with just one fined. And only one nominated adviser to an Aim company has been fined and publicly censured.” Nevertheless, Nomads include major commercial banks (e.g., Citigroup, Credit Suisse, Deutsche Bank, and ING), major investment banks (e.g., Merrill Lynch, Morgan Stanley, and Goldman Sachs) and affiliates of major audit firms (e.g., PricewaterhouseCoopers, Deloitte and KPMG), so reputational concerns may, for at least some Nomads, provide incentives for greater oversight.
The effectiveness of the AIM’s regulatory structure is an empirical question. Given its lower levels of mandated regulation and disclosures, the AIM might attract unscrupulous managers of low-quality firms. On the other hand, given that the Nomad’s and the LSE’s reputations are potentially at stake, the AIM might attract high-quality small firms for whom the costs associated with standardized disclosure are prohibitive. Understanding the types of firms listing on the AIM and their performance post-listing is important, given that the AIM is designed to serve individual investors. Unlike Rule 144a or venture capital offerings in the U.S., which are limited to “sophisticated investors” and institutions, the AIM is designed to provide access to retail investors. Moreover, up until 2008, the U.K. tax code encouraged retail investment in the AIM by providing tax advantages with respect to capital gains relative to shares traded on other U.K. exchanges.
In Gerakos, Lang and Maffett (2011), my co-authors and I compare AIM firms to several benchmark samples to assess the performance of firms that self-select into an AIM listing. Our main comparison is with firms listing on traditionally regulated exchanges and quotation bureaus (the NASDAQ and OTC Bulletin Board [OTCBB] in the U.S. and the LSE Main Market in the U.K.). We include a range of comparison venues to ensure that results are not driven by particular types of firms or economic environments. We control for a range of factors including size, leverage, growth opportunities, industry and year.
Overall, our results suggest the AIM’s relaxed regulatory environment limits its ability to screen firms relative to traditionally regulated exchanges—AIM firms perform poorly on almost every dimension. AIM firm post-listing returns significantly underperform post-listing returns on other markets. Moreover, liquidity in AIM-traded shares tends to be low, and the information asymmetry component of the bid-ask spread tends to be large, suggesting investors perceive substantial information asymmetries for AIM firms. Furthermore, even controlling for other potential determinants of delisting, AIM firms are more likely to fail.
While AIM firms perform poorly on average, it might be the case that the market provides access to an unusually large pool of “high-flier” stocks. In particular, some commentators assert that the AIM provides small investors with the opportunity to gain access to high performance firms that might otherwise be available only to venture capitalists. We therefore assess whether the AIM has an unusually large number of firms that double in price over the two years following the IPO. Again, the results are disappointing. If anything, the AIM has fewer firms with extreme positive returns.
We next compare AIM firms to firms quoted on the “Pink Sheets.” Pink Sheets firms are not required to be SEC registrants, are limited in terms of permitted capital raising and share ownership, and are viewed as “among the riskiest investments” by the SEC. This analysis addresses the question of whether the AIM regulatory environment screens firms relative to what is largely an unregulated market. Again, results are disappointing. AIM firms are more like Pink Sheets firms than firms that trade on regulated exchanges and, if anything, underperform the typical Pink Sheets firm. Finally, we compare U.S. firms that pursued direct listings on AIM to similar U.S. firms that listed on either NASDAQ or the OTC Bulletin Board. Once again, the U.S. firms that listed directly on AIM underperform similar SEC regulated firms in terms of buy-and-hold returns, liquidity and survival.
The SEC has been put under pressure because of the number of firms apparently bypassing U.S. markets by listing on the AIM. A reasonable question is what has been the experience of such firms. While it is difficult to judge whether regulatory structures should be changed, firms attracted by the AIM’s regulatory structure tend to underperform relative to similar firms on more traditionally regulated exchanges and are characterized by significant informational asymmetries. Furthermore, the AIM provides a unique setting in which to examine the potential effects of private regulation in practice. Although private regulation might be optimal in some cases, our results suggest that it has had a limited screening role as applied in the case of the AIM.
1.Gerakos, J., Lang, M., Maffett, M., 2011. Listing Choices and Self-Regulation: The Experience of the AIM. Unpublished working paper, University of Chicago Booth School of Business..
2. Taylor, P., 2009. Astaire’s Public Punishment is a Warning to Others. The Telegraph, June 28.