Dick Costolo really needs to invest in some hoodies, what is this. Photographer: Tomohiro Ohsumi/Bloomberg.
Dick Costolo really needs to invest in some hoodies, what is this. Photographer: Tomohiro Ohsumi/Bloomberg.

People are very annoyed, or pretending to be, about the fact that the registration statement for Twitter's initial public offering was filed confidentially and will be reviewed by the SEC out of the public eye. The theory seems to be that more disclosure is always better: The more drafts of a registration statement you see, and the more time you have to look at it, the better your decision about whether to invest in the company. Here's Steven Davidoff:

Yet there might be value in having the regulator’s critique of a company’s I.P.O. occurring more or less simultaneously in the public eye. For example, both Zynga and Groupon received pushback from the agency over their accounting methods. This arguably allowed the investing public to better assess the financial results.
But for Zynga and Groupon, the experience probably wasn’t so great, because it led to sharp criticism of their filings and put their stock offerings on a back foot. In both cases, the S.E.C. process raised warning signs that turned out to be accurate about these companies.

So this theory is not really the theory of U.S. securities regulation. Consider Groupon, which ended up forbidden by the SEC from using certain measures in its prospectus that it had used in its initial registration statement. Specifically, Groupon had used a thing called "adjusted consolidated segment operating income" to make its income sound better than it, strictly speaking, was, and the SEC called shenanigans. No, Groupon, said the SEC, you cannot do that, that is misleading to investors.* Of course, Groupon also disclosed its normal GAAP financial measures; its ACSOI measure was just a bonus piece of additional information for investors. And the SEC said no.

That generally is what is happening in a confidential IPO filing. There is no risk at all, not even a little, that investors won't have ample time to review Twitter's registration statement when it gets through the SEC's process. The JOBS Act requires it to be public for at least 21 days before Twitter starts its roadshow, and IPO roadshows are really never shorter than a week or so. So you get a month to read the prospectus. That is enough, I promise you. It's not gonna be that interesting.

But what might happen is that the SEC will demand changes in Twitter's prospectus, to make it not misleading to investors, and under the JOBS Act those changes will not occur in public. Which, yes, is a loss to the public record. But: If it's misleading to investors, why is it good for investors to have it? I think your choices are:

  • It really is misleading to investors, so having it out there, endlessly repeated and discussed, in the preliminary registration statement, is Bad; or
  • It really isn't all that misleading, and its inclusion provides some sort of valuable information about the company, so taking it out is Bad.

Now of course that second choice might be right: Maybe the SEC shouldn't be the arbiter of what information, and what arithmetic manipulations of information, are too dangerous for investors to have. That's a reasonable theory I suppose, but if you believe it then you should want less SEC review, not more public SEC review.

If the first choice is right -- if the SEC is protecting investors from knowing information that can hurt them -- then why should investors also have the information? One good argument that they should is that the back-and-forth is itself informative; in particular, a company whose first-draft prospectus is full of misleading claims that are rejected by the SEC is a company that you might want to stay away from. This has a certain appeal though it shouldn't be overstated: Not every company whose public filings go overboard in presenting it in a flattering light is a fraud, particularly if it's a new-web-2.0-whatever company with no experience of public disclosure and no obviously applicable old-economy-1.0-beta-whatever way to measure its success.** And truthfully calculating and prominently displaying your non-GAAP earnings-before-everything is a relatively benign form of accounting aggressiveness: Just plain cooking the books is a close substitute, but much worse and less likely to be caught by the SEC.

Also, I mean: People probably talked more about Groupon's ACSOI than they would have if the SEC hadn't publicly forced Groupon to delete it from the prospectus. If the very mention of that number was misleading, then preventing widespread obsessive focus on that misleading number seems like a good idea. There'll be plenty of other things to obsessively focus on in the run-up to the Twitter IPO.

* Here's what they said:

We note your use of the non-GAAP measure Adjusted Consolidated Segment Operating Income, which excludes, among other items, online marketing expense. It appears that online marketing expense is a normal, recurring operating cash expenditure of the company. Your removal of this item from your results of operations creates a non-GAAP measure that is potentially misleading to readers. Please revise your non-GAAP measure accordingly. Refer to Rule 100(b) of Regulation G.
** Surely not net income hahahahaha.