[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
REDUCING BARRIERS TO CAPITAL FORMATION
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON CAPITAL MARKETS AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRTEENTH CONGRESS
FIRST SESSION
__________
JUNE 12, 2013
__________
Printed for the use of the Committee on Financial Services
Serial No. 113-29
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HOUSE COMMITTEE ON FINANCIAL SERVICES
JEB HENSARLING, Texas, Chairman
GARY G. MILLER, California, Vice MAXINE WATERS, California, Ranking
Chairman Member
SPENCER BACHUS, Alabama, Chairman CAROLYN B. MALONEY, New York
Emeritus NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York
JOHN CAMPBELL, California STEPHEN F. LYNCH, Massachusetts
MICHELE BACHMANN, Minnesota DAVID SCOTT, Georgia
KEVIN McCARTHY, California AL GREEN, Texas
STEVAN PEARCE, New Mexico EMANUEL CLEAVER, Missouri
BILL POSEY, Florida GWEN MOORE, Wisconsin
MICHAEL G. FITZPATRICK, KEITH ELLISON, Minnesota
Pennsylvania ED PERLMUTTER, Colorado
LYNN A. WESTMORELAND, Georgia JAMES A. HIMES, Connecticut
BLAINE LUETKEMEYER, Missouri GARY C. PETERS, Michigan
BILL HUIZENGA, Michigan JOHN C. CARNEY, Jr., Delaware
SEAN P. DUFFY, Wisconsin TERRI A. SEWELL, Alabama
ROBERT HURT, Virginia BILL FOSTER, Illinois
MICHAEL G. GRIMM, New York DANIEL T. KILDEE, Michigan
STEVE STIVERS, Ohio PATRICK MURPHY, Florida
STEPHEN LEE FINCHER, Tennessee JOHN K. DELANEY, Maryland
MARLIN A. STUTZMAN, Indiana KYRSTEN SINEMA, Arizona
MICK MULVANEY, South Carolina JOYCE BEATTY, Ohio
RANDY HULTGREN, Illinois DENNY HECK, Washington
DENNIS A. ROSS, Florida
ROBERT PITTENGER, North Carolina
ANN WAGNER, Missouri
ANDY BARR, Kentucky
TOM COTTON, Arkansas
KEITH J. ROTHFUS, Pennsylvania
Shannon McGahn, Staff Director
James H. Clinger, Chief Counsel
Subcommittee on Capital Markets and Government Sponsored Enterprises
SCOTT GARRETT, New Jersey, Chairman
ROBERT HURT, Virginia, Vice CAROLYN B. MALONEY, New York,
Chairman Ranking Member
SPENCER BACHUS, Alabama BRAD SHERMAN, California
PETER T. KING, New York RUBEN HINOJOSA, Texas
EDWARD R. ROYCE, California STEPHEN F. LYNCH, Massachusetts
FRANK D. LUCAS, Oklahoma GWEN MOORE, Wisconsin
RANDY NEUGEBAUER, Texas ED PERLMUTTER, Colorado
MICHELE BACHMANN, Minnesota DAVID SCOTT, Georgia
KEVIN McCARTHY, California JAMES A. HIMES, Connecticut
LYNN A. WESTMORELAND, Georgia GARY C. PETERS, Michigan
BILL HUIZENGA, Michigan KEITH ELLISON, Minnesota
MICHAEL G. GRIMM, New York MELVIN L. WATT, North Carolina
STEVE STIVERS, Ohio BILL FOSTER, Illinois
STEPHEN LEE FINCHER, Tennessee JOHN C. CARNEY, Jr., Delaware
MICK MULVANEY, South Carolina TERRI A. SEWELL, Alabama
RANDY HULTGREN, Illinois DANIEL T. KILDEE, Michigan
DENNIS A. ROSS, Florida
ANN WAGNER, Missouri
C O N T E N T S
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Page
Hearing held on:
June 12, 2013................................................ 1
Appendix:
June 12, 2013................................................ 35
WITNESSES
Wednesday, June 12, 2013
Coulson, R. Cromwell, President and Chief Executive Officer, OTC
Markets Group.................................................. 4
Ferraro, Joseph, General Counsel, Prospect Capital Corporation... 6
Hansen, Shane B., Partner, Warner Norcross & Judd LLP............ 8
Langevoort, Donald C., Thomas Aquinas Reynolds Professor of Law,
Georgetown University Law Center............................... 11
Weild, David, Senior Advisor, Grant Thornton LLP................. 10
APPENDIX
Prepared statements:
Huizenga, Hon. Bill.......................................... 36
Coulson, R. Cromwell......................................... 37
Ferraro, Joseph.............................................. 67
Hansen, Shane B.............................................. 75
Langevoort, Donald C......................................... 93
Weild, David................................................. 97
REDUCING BARRIERS TO
CAPITAL FORMATION
----------
Wednesday, June 12, 2013
U.S. House of Representatives,
Subcommittee on Capital Markets and
Government Sponsored Enterprises,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 1:10 p.m., in
room 2128, Rayburn House Office Building, Hon. Scott Garrett
[chairman of the subcommittee] presiding.
Members present: Representatives Garrett, Hurt, Huizenga,
Grimm, Stivers, Fincher, Mulvaney, Hultgren, Ross; Maloney,
Sherman, Himes, and Carney.
Ex officio present: Representative Hensarling.
Also present: Representative Duffy.
Chairman Garrett. This hearing of the Subcommittee on
Capital Markets and Government Sponsored Enterprises will come
to order. The hearing is entitled, ``Reducing Barriers to
Capital Formation.''
I welcome the esteemed panelists for your testimony. But
before we do that, I will recognize myself for 5 minutes.
Today, we are here to discuss the important topic of
reducing barriers to capital formation for America's small
businesses. Startup companies and small businesses are
literally the backbone of our economy, generating literally
millions of jobs in the United States every year. Yet, these
companies often find it difficult to raise the capital they
need to successfully launch and grow their businesses.
So last spring, Congress passed the bipartisan Jumpstart
Our Business Startups Act, the JOBS Act, for short, to enhance
capital formation and reduce regulatory burdens for American
startups and small businesses. And although it is far too early
to judge the ultimate success of the JOBS Act, early
indications are that the law is working.
First, since April 2012, around 600 companies have elected
Emerging Growth Company (EGC) status under the Act, with about
a third of these companies listed or pending a listing on
NASDAQ or the New York Stock Exchange market. IPOs got a strong
start in 2013.
Second, more than 90 percent of EGCs that publicly filed
their first registration statements since 2012 elected to use
at least one accommodation under the JOBS Act, with certain IPO
on-ramp accommodations being particularly popular.
Third, according to an April 2012, Small Business Access to
Capital Survey, one in five respondents indicated that they are
more likely to seek outside investors as a result of the JOBS
Act.
And, fourth, with the short-term interest rates near zero,
the JOBS Act has benefited investors, providing more options to
put their money to work. Many companies have gone public under
the JOBS Act to outperform peer companies that did not.
But notwithstanding these positive trends, the full
potential of the JOBS Act remains largely unrealized today, as
the SEC continues, unfortunately, to delay mandatory rulemaking
to implement many of the law's most important and beneficial
provisions. Of course, this delay really comes as no surprise
to those of us who have followed the SEC's priorities in the
past. Indeed, year after year, the SEC seems to place promoting
capital formation, which is a key component of the agency's
mission, near the bottom of its agenda.
For example, last year the SEC tabled the JOBS Act
rulemaking to prioritize issues and rules under the Dodd-Frank
Act for companies to disclose their use of conflict minerals as
well as rules requiring the disclosure of payment of government
entities by companies engaged in resource extraction. While
these rules may have commendable goals, they fall outside of
the SEC's core expertise, and they appear to do very little, if
anything, to protect investors, make the U.S. markets more fair
and efficient, and promote capital formation. At worst, they do
the opposite.
While the SEC has for years received valuable
recommendations on how to promote access to capital for small
businesses from its own Government-Business Forum on Small
Business Capital Formation, and its Advisory Committee, the
agency so far has acted on only a small number of these
recommendations.
So with all this in mind, I was pleased to hear Chairman
White reaffirm to this committee last month that she is
committed to prioritizing the completion of mandatory JOBS Act
rulemaking as soon as possible, and I hope that her commitment
carries over to other efforts to facilitate small business
capital formation.
Today, America's startups and small businesses continue to
encounter difficulties accessing U.S. capital markets to
finance their business, and the cost of these companies going
and staying public remains very high.
On top of this, over the past 5 years the Obama
Administration has unleashed a record amount of burdensome red
tape that has disproportionately increased the cost of doing
business for smaller companies compared to their larger peers.
As a result, many small businesses have been forced to do what?
Cut back on hiring and employee benefits at a time when our
economy and those employees can least support it.
And so as our country continues to go down a path of slow
economic growth and persistently high unemployment, it is more
important than ever that we continue to reduce burdensome
government regulations on small businesses and enhance our
ability to obtain capital at a reasonable cost.
So I look forward to hearing from our panel this afternoon
on ways that Congress and the regulators, as well as market
participants, can continue to build on the JOBS Act, including,
among other things, efforts to modernize the regulatory regime
governing business development companies, to increase liquidity
in the shares of publicly traded small and mid-cap companies,
and to promote more research analyst coverage for small cap
companies.
With that, I yield back my time, and I recognize the
gentleman from California for 5 minutes.
Mr. Sherman. Mr. Chairman, thanks for holding these
hearings.
For most of what the average American would call a small
business, getting expansion capital means getting a loan. And
that is the purview, chiefly, of another subcommittee, but I
should address it for a minute.
First, we should commend the Fed for keeping interest rates
low at this critical time in our economy. Because if you are
trying to get enough money to open a second restaurant, you are
trying to get a loan, and if you are able to get the loan, it
will be a lower interest rate than it would be otherwise, and
your customers now think that their home is worth more than
their mortgage, and they are actually able to come to that
restaurant. Whereas, a few years ago, my constituents wouldn't
go to a restaurant unless there were golden arches in front of
it.
Second, we ought to pass the bill to allow credit unions to
make small business loans, and we ought to be pushing the
regulators of commercial banks to not turn up their noses at
small business loans.
We had, in this room, Jamie Dimon come in and say he had to
send tens of billions of dollars to London where, as you will
remember, it was eaten by a whale, because he couldn't find
businesses here in the United States to lend it to. One of the
very few things just about all sides of all aisles agree on
here is that we all know of 100 small businesses which need
capital. I am talking about the really small businesses that
aren't even thinking of going public.
As to those thinking of who are going public, a key thing
is whatever we can do to minimize legal and accounting fees and
the other costs of going public, one of those things would be
not to require audit rotation beyond the standards already
found in the accounting profession because that can, in some
cases, double the audit fee, which is a significant portion of
the cost of being a small publicly traded company.
Finally, as to the SEC prioritization of regulations, I
think we ought to give the regulators a break here. They cannot
look at one statute and say, ``That is a good one, I will do
that one first,'' and look at another statute and say, ``That
is a bad one.''
It is possible the Chair believes that minimizing legal and
accounting fees for businesses going public is more important
than saving lives in Eastern Africa, where they are beset with
conflict mineral issues. Others would reach the other
conclusion. And the regulators simply have to follow the laws
we pass. I don't think the SEC should refuse to enact
regulations to implement laws just because the chairman voted
for them and I voted against them or vice versa.
With that, I yield back.
Chairman Garrett. The gentleman from Virginia is recognized
for 2 minutes.
Mr. Hurt. Thank you, Mr. Chairman.
Thank you for holding today's hearing on Reducing Barriers
to Capital Formation. One of the most important functions of
this committee is to promote initiatives to increase access to
capital for our small businesses and startups. Last Congress,
this subcommittee led the way in the enactment of the JOBS Act.
Among other things, the JOBS Act allowed emerging companies to
tap capital in the public markets without enduring some of the
most burdensome regulations which inhibit their ability to
grow.
Despite the SEC's ability to fully implement the JOBS Act
in a timely fashion, we are already seeing the positive impact
of the law, as 83 percent of IPOs after the JOBS Act's passage
were emerging growth companies. We, however, can still do more
to remove costly and unnecessary regulatory impediments that
are restricting companies from accessing capital in the public
and private markets.
I have heard from innovative biotech companies in my
district, Virginia's Fifth District, that the overall
regulatory burden which disproportionately impacts small or
public companies is the primary motivator in their decision to
stay private. We must look at solutions to eliminate and
streamline regulations to create an environment that is more
efficient and conducive for long-term economic growth.
I appreciate this committee's continued focus on ensuring
that our small businesses and startups have the ability to
access the necessary capital in order to innovate, expand, and
create the jobs that our local communities need, that my
Virginia's Fifth District needs. I look forward to the
testimony of our distinguished witnesses, and I thank them for
their appearance today.
Thank you, Mr. Chairman. I yield back the balance of my
time.
Chairman Garrett. The gentleman yields back.
In looking around, I think that is the end of opening
statements, which is great, because it means we can talk to the
experts now and hear your opinions.
Without objection your full written statements will be made
a part of the record. You will be recognized for 5 minutes for
a summary. The lights in front of you, of course, advise you as
to 5 minutes, 1 minute, and your time is up.
With that, I will begin on the left here.
Mr. Coulson, you are recognized for 5 minutes.
STATEMENT OF R. CROMWELL COULSON, PRESIDENT AND CHIEF EXECUTIVE
OFFICER, OTC MARKETS GROUP
Mr. Coulson. Thank you, Chairman Garrett, Ranking Member
Maloney, and members of the subcommittee. My name is Cromwell
Coulson, and I am CEO of OTC Markets Group. I appreciate the
opportunity to testify.
As an operator of public marketplaces for smaller
companies, and being a smaller publicly traded company
ourselves, in our own right, I hope I can provide the committee
with greater insights into barriers to capital formation that
should be removed.
We are all here because we recognize the value of public
trading to small growing companies and the U.S. economy. The
visibility, valuation, liquidity, capital, and trust that
public trading provides can create some of the most successful
and sustainable companies in the capitalist system.
We have provided 15 concrete suggestions in our written
testimony that together will make our public markets more open,
more transparent, and more connected for smaller public
companies, while reducing the complexity and cost.
Our marketplaces, like all public markets, are better
informed and more efficient when there is transparency of
trading activity and availability of company information. We
work with broker-dealers in the trading process, and we have
completely changed what was once an opaque marketplace. Now,
the broker-dealers trading out of our markets are the same
electronic broker-dealers trading NASDAQ and New York Stock
Exchange Securities.
But we also work with a wide range of companies. We need to
engage them to provide better information for investors. And we
have designed a system of tiered marketplaces to separate the
highest quality companies from the lowest, and also to clearly
warn investors when there is less information.
The JOBS Act, particularly through ending the ban on
general solicitation and new, more inclusive capital raising,
takes great strides towards achieving the type of transparency
our markets need to thrive. We can do more, though, to reduce
barriers to capital formation by thoughtfully enhancing our
public secondary markets.
Capital has greater value if it is liquid and transferable.
A carefully crafted tick size pilot program applicable to
quotes and orders but not trades could provide a much-needed
improvement to small company liquidity and value. Equity
markets in the United States are the most regulated of all our
financial markets. Our antifraud provisions already give
regulators a broad sword when they see wrongdoing. But
regulators should think like investors. Give investors the
information they need to make intelligent decisions, but let
them make choices.
Our limited resources should be used to protect investors
by driving transparency and smartly targeting the biggest
problems, not just creating the longest regulatory filings or
the largest number of enforcement cases. We urgently need more
transparency of the people behind SEC reporting companies that
are being widely promoted on the Internet. These advertisements
of penny stocks, without any information about the people
promoting them, makes a mockery of our regulatory system.
Our promotion disclosure regulations were written for an
era when promotion was done through the mail. It needs to be
updated, because we have interesting biotech companies, smaller
manufacturing companies, and community banks that are traded on
our markets which are drowned out by these other companies.
We want equality of regulation. There should be margin
eligibility for all higher quality public companies, not just
exchange-traded companies. This will help the community banks,
giving them greater access to capital. We also want consistent
disclosure of institutional holdings and insider trading in
non-exchange-listed securities.
With market structure, we should be careful not to be
governed by fear. Markets, like all U.S. industries, need
diverse choice and healthy competition to promote growth and
innovation. Some use the term ``fragmentation'' to paint a
picture of a broken marketplace in need of repair.
``Fragmentation'' may sound dark and dangerous, but it is just
a spin doctor's word used by those losing market share to more
dynamic competitors.
When NASDAQ was a market for small companies, it was not a
centralized stock exchange, but an automated quotation system
with fragmented trading connected by transparency. Promoting
competition efficiency is what drives a successful small
company marketplace. It would be a step in the wrong direction
to create monopoly stock exchanges or any attempt to create a
trade-out rule or regulation that would mandate centralized
trading on stock exchanges.
Thank you, again, for inviting me to testify. While the
issues I discuss may seem diverse, each is a vital component to
reducing barriers to capital formation by creating better
informed and more efficient financial marketplaces. I look
forward to discussing these and other ideas with you.
[The prepared statement of Mr. Coulson can be found on page
37 of the appendix.]
Chairman Garrett. Likewise. Thank you.
Next, Mr. Ferraro is recognized for 5 minutes.
STATEMENT OF JOSEPH FERRARO, GENERAL COUNSEL, PROSPECT CAPITAL
CORPORATION
Mr. Ferraro. Chairman Garrett, Ranking Member Maloney, and
members of the subcommittee, thank you for the opportunity to
testify today.
My name is Joseph Ferraro, and I am general counsel to
Prospect Capital, a leading provider of capital to job-creating
small and medium-sized companies in the United States. Prospect
is a publicly traded business development company, or BDC. Our
company completed its initial public offering in July 2004, and
since then we have invested more than $5.5 billion in over 175
small and medium-sized companies to expand their businesses,
hire workers, construct factories, and achieve other important
objectives.
Our capital has helped create thousands of American jobs
over the years, and our capital is much needed in this critical
period of high unemployment and economic uncertainty.
In 1980, Congress enacted amendments to the Investment
Company Act of 1940, authorizing BDCs to facilitate financing
of small and medium-sized businesses. Financing these companies
requires significant and time-consuming due diligence
activities and rigorous credit analysis that has become
uneconomical for traditional banks, and involves transaction
sizes too small for many other capital providers. Put simply, a
BDC is a lender to, and an investor in, small and medium-sized
businesses that might not otherwise receive financing.
Today, our industry is composed of about 40 publicly traded
BDCs, collectively managing $39.1 billion in assets. Our
industry believes that modest changes to our securities laws
can greatly enhance the ability of BDCs to serve the capital
needs of small and medium-sized companies without undermining
investor protections. These changes have been recommended by
bills introduced by Representatives Mulvaney, Velazquez, and
Grimm.
First, a BDC must invest at least 70 percent of its assets
in so-called eligible assets, namely public micro-cap and
private companies. But current law excludes financial services
companies from qualifying as eligible portfolio companies.
Thus, no more than 30 percent of a BDC's assets can be invested
in financial services companies.
This outdated limitation makes no sense. Financial services
is a sector that encompasses a wide array of companies,
including community banks, leasing companies, factoring firms,
and automobile financing companies. These companies have a
capital magnifying effect that results in more capital flowing
into small and medium-sized businesses. How? Because such
companies themselves frequently serve the needs of other
smaller companies.
Further, BDC investments in small to medium-sized American
financial services businesses are consistent with the principal
purpose for which Congress created BDCs--to provide capital and
assistance to small, developing businesses that are seeking to
expand and create American jobs. The law should not
artificially limit a BDC's ability to provide capital to such
companies.
Second, current law limits a BDC's investment in investment
advisors. Although the SEC routinely provides administrative
relief from this prohibition though exemptive relief orders,
the process is very time-consuming and expensive. The pending
bills would repeal this prohibition, in essence codifying
existing practice and ending the needless spending of
shareholder resources to seek administrative relief.
Third, BDCs, like other companies that regularly raise
capital through security issuances, rely on pre-filed shelf
registrations--filings that allow a company to be pre-
positioned to issue additional securities. Because shelf
registrations contain financial information that becomes
outdated, companies are allowed to incorporate by reference in
their shelf registrations subsequent financial reports.
However, BDCs are not allowed to take advantage of this
commonsense approach and instead must annually update shelf
registrations each time new quarterly information is reported.
This should be changed.
Fourth, in 2005 the SEC modernized the issuance process
especially for frequent securities issuers, reducing costs and
making the process more efficient. However, BDCs were excluded
from these commonsense reforms. Our industry is a frequent
issuer of securities. For example, Prospect has raised some
$2.5 billion since our IPO in 2004 through more than 26 public
offerings. There is no public policy justification for BDCs
being left behind when the SEC modernized these rules.
Fifth, the pending bills offer other reforms that can
assist BDCs in raising and deploying capital. For example,
these bills allow some easing of the leverage limits imposed by
current law on BDCs to allow more flexibility on how a BDC
constructs its own balance sheet.
In conclusion, business development companies are an
important source of capital for small and medium-sized
companies. With some commonsense reforms, it is possible to
increase the capacity of BDCs to support job-creating American
businesses without in any way undermining the strong investor
protections or costing taxpayers a dime. We applaud the efforts
of Representatives Mulvaney, Grimm, and Velazquez, and urge the
committee to act favorably on BDC reform legislation.
I would be pleased to answer any questions you may have.
[The prepared statement of Mr. Ferraro can be found on page
67 of the appendix.]
Chairman Garrett. I thank you.
Next, from Warner Norcross, Mr. Hansen, you are recognized
for 5 minutes. Good afternoon.
STATEMENT OF SHANE B. HANSEN, PARTNER, WARNER NORCROSS & JUDD
LLP
Mr. Hansen. Thank you, Chairman Garrett, Ranking Member
Maloney, and members of the Capital Markets Subcommittee. Thank
you for this opportunity to explain how and why today's one-
size-fits-all system of securities broker-dealer regulation
adversely impacts and unnecessarily increases the costs
incurred by business owners for professional and business
brokerage services to sell, buy, or grow their small and
medium-sized businesses in privately negotiated transactions.
My comments today are primarily focused on H.R. 2274, the
Small Business Mergers, Acquisition, Sales, and Brokerage
Simplification Act of 2013, a bipartisan bill introduced by
Congressman Huizenga, with Congressmen Higgins and Posey.
The public policy considerations supporting this
legislation go back to 2005, with the publication by the
American Bar Association of a report and recommendations of the
Private Placement Broker-Dealer Task Force which is available
on the SEC's Web site. A similar recommendation was made by the
final report of the SEC Advisory Committee on Smaller Public
Companies in 2006, which is also available on the SEC's Web
site.
Appropriately scaling Federal regulation of merger and
acquisition brokers has been among the top recommendations in
the 2006, 2007, 2008, 2009, 2010, and 2011 SEC Government-
Business Forums on Small Business Capital Formation. Indeed, in
January 2012, then-SEC Chairman Mary Schapiro acknowledged
these concerns in a response to a bipartisan congressional
letter and a Senate committee's question for the record, both
attached to my written statement. Despite this, in more than 6
years the SEC has not made this small business issue a
rulemaking priority and is unlikely to do so in the absence of
a congressional directive.
Let me describe for you the business context of this issue.
Each of you has in your districts likely hundreds, perhaps
thousands, of small and medium-sized business owners who sooner
or later will want to prepare for and sell their business. They
will want professional business brokerage services to help
them. Similarly, back in your districts you likely have
hundreds, perhaps thousands, of entrepreneurs committed to
owning their own businesses, or larger companies wanting to
grow their businesses through acquisitions. These potential
buyers want professional assistance finding and screening
potential sellers. These buyers and sellers are represented by
counsel and often assisted by accountants. They rely upon
written representations, warranties, covenants, and remedies in
their negotiated contracts for their protection.
Capital formation, business growth, jobs creation, and
preservation by small and medium-sized businesses are all
facilitated with business brokerage services. For example, the
acquisition of one business by another enables the combined
business to expand and to accumulate investor capital in more
diversified, often financially stronger business enterprises.
Small business sellers and buyers simply cannot afford to hire
a registered investment banking firm, whose fees typically
start at $500,000. And there are no registered investment
bankers in most small communities.
So today, Federal securities laws and rules regulate Main
Street M&A brokers the same way as they regulate Wall Street
investment banks handling public company transactions.
Compliance costs are necessarily passed on to the business
buyers and sellers in order for the M&A broker to stay in
business, and small firms only handle a few transactions each
year but must maintain ongoing regulatory compliance at all
times.
H.R. 2274 would direct the SEC to create a simplified
system of M&A broker registration through a public notice
filing, and would require delivery to clients of disclosures
about M&A brokers similar to those requirements applicable
today to investment advisors. The bill would direct the SEC to
review and tailor applicable rules to fit this smaller business
context.
In conclusion, regulatory reengineering is urgently needed,
even as recognized by the SEC. The perception of public
protection through today's broker-dealer regulation is illusory
because in fact thousands of small, unregistered M&A firms do
business across the country. The rules are simply not clear in
how they apply to them and do not fit. Today's one-size-fits-
all broker-dealer regulation is simply too costly for small and
medium-sized businesses to afford, so they either go without
professional advice or hire cheaper unregistered firms. This
congressional directive to adopt a regulatory solution will
ultimately free up the SEC's resources to better protect our
public markets and passive investors.
I urge you to support H.R. 2274, and I look forward to your
questions.
[The prepared statement of Mr. Hansen can be found on page
75 of the appendix.]
Chairman Garrett. Thank you.
At this point, I will yield to Mr. Huizenga.
Mr. Huizenga. Thank you, Mr. Chairman.
I appreciate that. I came in from the House Floor--where we
were moving along our package of derivatives bills--just as Mr.
Shane Hansen was starting. Important things are happening here
in the Financial Services Committee.
But I want to thank Shane for bringing this issue to my
attention a while ago, now, and it was a great meeting and a
great opportunity for us to begin to work together. I think, as
he has aptly pointed out, the proposal that is before us is
going to significantly reduce the regulatory compliance costs,
which currently exceed $150,000 initially and $75,000 annually.
The SEC has not taken this recommendation in the past. And I
think it is time that we do this legislatively.
As we know, approximately $10 trillion of privately owned
Main Street, mom-and-pop type businesses will be sold or closed
as Baby Boomers age. That is a tremendous amount of transfer of
wealth that is going to be happening. I think how we handle
that is very important for our future generations. I appreciate
everything that this committee is doing to help ease that.
So thank you, Mr. Chairman.
With that, I yield back.
Chairman Garrett. Thank you. I appreciate that.
Mr. Weild, you are now recognized for 5 minutes. Thank you
for being with us this afternoon.
STATEMENT OF DAVID WEILD, SENIOR ADVISOR, GRANT THORNTON LLP
Mr. Weild. Thank you. Chairman Garrett, Ranking Member
Maloney, and members of the subcommittee, thank you for
inviting me to speak today about an issue of great importance
to America, how to reduce barriers to capital formation,
particularly for small companies, which are the growth engine
of the U.S. economy.
My name is David Weild. I oversee Capital Markets at Grant
Thornton, LLP, one of the six global audit, tax, and advisory
organizations. I was formally vice chairman of the NASDAQ stock
market, with responsibility for all of the listed companies. I
also ran the equity new issues business of a major investment
bank for many years.
U.S. capital markets, once the envy of the rest of the
world, have undergone a profound transformation in less than a
generation, leaving small business investors and the U.S.
economy much worse off. I will quickly share several shocking
statistics confirmed by a study that I recently coauthored for
the Organization for Economic Cooperation and Development
(OECD). U.S. markets have lost nearly half of all listed
companies from their peak in 1997. The United States has
suffered 15 years of consecutive lost listings from the U.S.
stock markets. The U.S. small IPO market has suffered a
catastrophic failure, falling from first place in small IPOs to
12th among the 26 largest IPO markets. On a GDP-weighted basis,
we are now 24th, ahead of only Mexico and Brazil.
The U.S. IPO market should be producing 5 to 10 times the
number of IPOs it has produced over the past 13 years. We
estimate 10 million additional U.S. jobs would have been
created during this timeframe. Notably, in our work for the
OECD comparing the top 26 IPO markets, low-cost electronic
markets with inadequate tick sizes are harming IPO markets in
other areas of the world as well.
After-market support is the biggest single obstacle to
resurgence in the U.S. IPO market for small companies. The
collapse in tick sizes from 25 cents to 1 cent, a result of
regulatory and structural changes since 1997, is gutting the
infrastructure of smaller broker-dealers, research analysts,
and capital support that is essential to take small companies
public and support them in the aftermarket once they are
public.
Ultimately, while lower tick sizes have benefited short-
term, high-turnover traders through lower transaction costs,
long-term fundamental investors in small cap stocks have lost
liquidity and investment opportunities and are thus much worse
off today. The U.S. stock markets are now essentially governed
by a one-size-fits-all framework, with 1 cent tick sizes for
every stock, regardless of share price, market capitalization,
or liquidity. Only big brands and large companies can sustain
adequate visibility with investors in today's market. Small cap
stocks need broker-dealers to support their liquidity, sales,
and equity research in order to sustain active markets.
U.S. capital markets have lost their way, but as my written
testimony elaborates, we can take proactive and immediate steps
to overcome the structural challenges faced by the U.S. stock
markets and promote capital formation for small companies.
First, we applaud passage of H.R. 701 by an overwhelming
vote of 416-6, and we encourage swift Senate adoption of this
bipartisan bill that requires the SEC to finalize Regulation A-
plus rulemaking by October 31, 2013. Reg A-plus will provide a
less complex registration process, a higher offering limit of
$50 million, and increase investor protections. This is an
important catalyst by which small companies can now go public,
grow, and contribute to job creation. However, we urge Congress
to also consider the need for Blue Sky exemptions, or we fear
this Regulation A-plus will not be utilized.
Second, we strongly urge an immediate SEC pilot program of
at least 5 years in length to let emerging growth companies and
small cap companies trade with higher tick size increments.
Higher tick size increments will increase liquidity and capital
formation for small companies by increasing the incentives
required to fuel investments in equity distribution sales and
aftermarket support. As markets realign, share performance and
returns on investment will improve, all while laying the
foundation for increased IPOs, economic growth, and job
creation.
Third, we encourage the creation of a new parallel stock
market exempt from Regulation NMS for public companies under $2
billion in value. Adequate aftermarket support is a continuing
challenge for small companies. This new market would give
issuers a choice in markets, proper balance between
intermediaries, issuers, and their investors, and usher in a
return to the business of underwriting and supporting small cap
companies.
Thank you for the opportunity to present information on
such an essential topic. I am pleased to answer any questions.
Thank you.
[The prepared statement of Mr. Weild can be found on page
97 of the appendix.]
Chairman Garrett. Thank you very much.
Finally, from Georgetown University Law Center, Professor
Langevoort, you are recognized for 5 minutes.
STATEMENT OF DONALD C. LANGEVOORT, THOMAS AQUINAS REYNOLDS
PROFESSOR OF LAW, GEORGETOWN UNIVERSITY LAW CENTER
Mr. Langevoort. Chairman Garrett, Ranking Member Maloney, I
am pleased to testify today on the vitally important topic of
capital formation and investor protection. With the JOBS Act
more than a year old, we still await rulemaking by the SEC on
many of its key provisions.
However, the JOBS Act does not exhaust the possibilities
for innovations in capital raising and secondary trading that
can make our financial markets more robust and opportunities
for honest entrepreneurship more compelling.
The SEC's Advisory Committee on Small and Emerging
Companies has made a number of recommendations for additional
changes that, if appropriately crafted, could be a positive
step forward, including a more sensible disclosure regime for
small and emerging issuers, those companies with a smaller
footprint in our markets, our economy, and our society.
While I do not agree with all of their suggested
exemptions, there is much room for adjustment. As the Advisory
Committee also recommends, we can also do more to facilitate
the evolution of fair and efficient secondary trading markets
for both nonpublic companies and smaller public companies,
recognizing, however, that if that evolution turns sharply in
the direction of larger and more robust accredited investor-
only markets, the adverse implication for our public markets
could be profound.
Regulatory reform efforts should continue, but it is
essential that this be done with due regard for investment
protection. No amount of regulatory reform can eliminate the
uncomfortable truth that small business capital formation is
difficult because small business is very risky and the cost of
capital high.
While inefficient regulation raises the cost of capital,
good regulation lowers it. Investor trust is closely tied to
capital formation and economic growth. Although that trust has
proven resilient over time, it is not something that can be
taken for granted. If it hits some tipping point and recedes
because there is too much perceived risk of opportunism and
abuse, capital formation will be damaged by poorly crafted
innovations, not enhanced.
For all the honest entrepreneurs who deserve a better shot
at marketplace funding, there are opportunists who not only
threaten the financial well-being of targeted, sometimes
vulnerable investors but take funds away from legitimate
enterprise, pollute the reputation of our markets generally,
and create no jobs except for perhaps in boiler room
operations. No innovations in capital raising will work unless
the help investors tell the difference between good promoters
and bad, as well as between good business plans and dubious
business plans. Otherwise, this is just gambling, from which
smart investors know to stay away.
I would commend to you the SEC's Investor Advisory
Committee as another bipartisan voice worth listening to as its
members reach consensus. Although there are many imperatives in
crafting good rules to promote entrepreneurship and capital
formation, two are paramount. One is that we recognize the role
of retirement savings as an at-risk target, the threat to which
neither aging Americans nor our economy generally can afford.
The other imperative is the need for greater transparency in
so-called private markets so that there can be better oversight
and surveillance in the otherwise dark spaces where investments
are aggressively promoted and sold.
I commend members of the subcommittee for their attention
to these important challenges.
Thank you.
[The prepared statement of Professor Langevoort can be
found on page 93 of the appendix.]
Chairman Garrett. Thank you.
Again, I thank the panel for their testimony. At this time,
we will go to questioning, and I will recognize myself for 5
minutes.
Let's begin with one area, and that is the area of research
analysts. I will throw it out to maybe Mr. Weild and Mr.
Coulson, I guess.
First of all, would you agree on the basic premise that
when it comes to research analysts--I think you will agree,
there is less availability of research analysts for small
businesses than there are for large businesses.
Mr. Weild. Absolutely.
Mr. Coulson. Yes.
Chairman Garrett. If that is the case, it makes it harder
for smaller cap companies to grow and be able to sell and get
into the equity markets and sell their shares.
Mr. Weild. Yes.
Mr. Coulson. Absolutely.
Chairman Garrett. I will set the premise here, and maybe I
will give you the answer. Do you think this came about due to
the SEC's 2003 global research analyst settlement agreement?
Mr. Weild. I believe that it was already in process, dating
back to the Order-Handling Rules and Reg-ATS and the collapse
of the economic incentives to support small cap companies and
have a way to pay for that research.
Chairman Garrett. Give me a date, then.
Mr. Weild. That was 1997 and 1998. But I think it was
obfuscated by the bubble. The dot.com bubble was in full form
at that point in time. When you fast-forward to decimalization
in 2001, people were already starting to shed research
analysts, research compensation.
Chairman Garrett. Mr. Coulson?
Mr. Coulson. From what I hear from investment bankers, they
are very nervous about having banking related to the research
process. And it creates a dynamic, even for big companies,
because we have some of the largest ADRs in our marketplace,
globally, and they say the large banks, because equity trading
is funding research now, restrict which institutions they send
it to. So tier two and tier three institutions don't even see
some research from big banks because you have to send it to the
ones who pay for the trading. And if it is driven by investment
banking, paid for or equally funded with proper oversight and
controls, it is used more broadly to support the knowledge of
the firm in that space. I think on Wall Street, we have always
had conflicts. We have ways of dealing with conflicts, rather
than just ban an activity and cut off the funding for it.
Chairman Garrett. I am getting slightly different things
here.
Mr. Weild. They are both accurate. Excuse me. When we study
actually--about 80 percent of commissions are generated by the
top 100 institutional investors in the market, which are skewed
very large cap and high turnovers. So, consequently, that small
cap research product really doesn't have a home because it
tends to be consumed by smaller and smaller institutions that
don't have the liquidity constraints of the big firms. That is
all a product of this hyper-efficient, low-cost penny tick size
market, which means there is really no way to make money as an
investment bank from supporting specialists in investment in
small cap companies.
Mr. Coulson. The smaller investment banks do not have the
trading business today. It has gone to the more electronic,
larger transaction firms. So the business relationship they
have with smaller companies is based on investment banking.
Chairman Garrett. So, even if we solve the conflict issue
somehow or other--you used words like ``proper regulation'' or
something like that--that the settlement agreement tried to
address or did address, are both of you saying that in and of
itself--I hear your points on the tick size and what have you.
Is that not enough to try to address this problem?
Mr. Coulson. No.
Chairman Garrett. Okay.
Mr. Coulson. I think it is a great start, but I also think
we need to solve the liquidity issue for smaller companies by--
the tick study is one approach.
Chairman Garrett. So maybe the question should be this,
then: Is this conflict issue in addressing the settlement issue
an essential part of it? In other words, we have to address the
tick size, and there are a couple of other things we are going
to pull out of this panel, although all my time is focused on
this one issue. This, though, has to be addressed as part of
that process, is that correct?
Mr. Weild. It is an important part of that process, yes.
Mr. Coulson. It is one of the key things that needs to be
done.
Mr. Weild. Chairman Garrett, I believe that the key part is
liquidity. It is not necessarily even research. It is capital
commitment to small cap stocks to facilitate liquidity and
having a mechanism whereby brokers can actually earn a return
on facilitating institutional liquidity. Because institutions
have increasingly cut allocations to small cap stocks because
of the loss of liquidity. And that is not necessarily related
to the research problem. It is related to market making.
Chairman Garrett. I get that. I will close on this: That is
why we had the panel up in New York to try to begin the overall
discussion on market structure reform similar to what this
panel has talked about there. So, that goes to the larger
issue.
Thank you for your testimony.
The gentleman from Connecticut is recognized for 5 minutes.
Mr. Himes. Thank you, Mr. Chairman, and thank you to all
the witnesses for coming in front of this robust committee
today to talk about this topic, which clearly has drawn the
interest, at least on my side of the aisle.
I, for one, have been following the IPO market pretty
closely prior to the creation of the JOBS Act. And I think it
is a really important topic of conversation.
Of course, over the last couple of years, people have made
every argument conceivable for why the IPO market over the
years has declined. Some people say it is Sarbanes-Oxley. Some
people say it is NMS. Other people say it is order handling
rules. Other people point to the economy.
There is actually some pretty dramatic data coming out
about the U.S. IPO market in the year 2012. IPOs--this is by
dollar volume--in the Asia-Pacific were down 40 percent. In
Europe, they were down 64 percent. In the United States, they
were up by 17 percent, such that the United States IPO volume
represented just less than half--43 percent--of global IPO
issuance. That would suggest perhaps that the story we hear
from the other side of the aisle that overwhelming U.S.
regulation is going to crush our markets is perhaps not
entirely factual. But it is also intriguing. What drove that?
Was this in fact a difference of regulation relative to Europe
and Asia Pacific? Was this in fact different order handling
rules? Can somebody explain to me the incredible sort of
volatility in issuance volumes and the out-performance of the
United States IPO market?
Mr. Weild. Yes, sir. We interact with international
companies because we have 1,500 ADRs on our marketplace. So we
see the largest and the smallest. In Europe, the economy is
what is driving that dynamic right now. The financial markets
there are very depressed. We talked to the IROs of the largest
companies. That said, the dynamic when I meet an interesting
small public company, it is most likely listed in Toronto or
London or on the Australian stock exchange because they have
created processes which are a lot more friendly. And that is
what I keep hearing from companies--from smaller companies
especially--and we will see U.S. companies. We had a company
that is in the payment business that went public on the Aim to
Raise Capital, came back to our marketplace to re-enter the
U.S. markets, and then they upgraded to NASDAQ at the turn of
the year. Small companies find it friendlier to go overseas
from the United States. And international companies--
Mr. Himes. Let me stop you there, because I have limited
time, and I have two other categories of questions. One is, as
public policymakers, how do we know when we have that balance
right? I used to do IPOs many, many years ago, and I know they
are darn expensive things to do. Gross spread is still 7.5
percent. By the way, I would like to talk about that. For 20
years, I have been paying attention, and gross spread for an
IPO is 7.5 percent. I am sort of fascinated by that
consistency. But it is an expensive thing to do. That doesn't
include lawyers' fees. Pretty soon, you are getting up to 10
percent of your volume of issuance.
How do we know that our system is set up such that the
companies that go public via IPO, set aside these are risky
companies we are talking about and what that implies for retail
investors, how do we know when we have struck the right optimal
balance? Do we just look at Canada and Europe and say, we are
doing less $50 million IPOs than they are? How do we know?
Mr. Weild. Congressman Himes, those markets--I am going to
recommend to you the paper that we wrote for the OECD. I think
it is entitled, ``Making Stock Markets Work for Economic
Growth.'' But we looked at, say, 26 IPO markets. The ones that
Cromwell ticked off all have higher tick sizes to the
percentage of share price for smaller capitalization stocks.
There are aftermarket incentives. And the multiple regression
that we ran actually explains, based on economic incentives,
about 70 percent of IPO production globally.
Mr. Himes. Can I stop you there? Because I am going to run
out of time. That was my third category of questions. Maybe I
will have a chance to come back for some others.
Can you, in the 45 seconds remaining, give us a sense for
why increasing the tick size would in fact promote more smaller
IPOs? This is not a regulatory thing. This would essentially be
moving money from one group of third parties to the other. Can
you sort of explain that and why that would be helpful?
Mr. Coulson. Market-structured penny tick size creates a
market structure that competes almost exclusively on cost of
trading. And in microcap markets, you need value creation,
which is sales, promotion, marketing of stories, telling of the
stories. You need to capital to facilitate institutional-size
liquidity. Those are primary ingredients. You need research.
That is value creation. There is no economic model to support
value creation. So, as a consequence, we go to the lowest
common denominator and compete on price alone. That is
catastrophic for stocks that trade episodically: big buyer, no
seller. It works fine for large cap stocks. So this is the
reason we take this model and we apply it to everything, and it
disenfranchises the entire small company ecosystem.
Mr. Himes. Thank you. I note my time is up. Maybe I will
get a chance to ask more questions later. But I appreciate the
answer. Thank you.
And thank you, Mr. Chairman.
Mr. Coulson. Just one quick point is, because talking about
the structure of what, hopefully, tick size would incentivize
is more displayed liquidity by intermediaries. If you have a
small company stock that trades 30 times a day--that is once
every 1,000 seconds--you need intermediaries.
We have a world where, yes, we have displayed prices. And
the average community bank in my marketplace has a spread of 19
cents, trades at $17. But it is kind of like stores in Cuba.
The prices are low, but you can't buy anything. How do we fill
the shelves up with liquidity again? How do we reignite
liquidity, so an inventor says, ``Hey, I can buy something in
here.'' Instead of, ``If I buy something, the price yo-yos up.
When I am filled, it goes back down.''
And the tick study is a good start. But I can't explain it
to you in 15 seconds because I need to sit down with you and
your staff and go through the market structures and go through
some of the things we have seen. We used to have increments in
our market. We saw more displayed liquidity by intermediaries.
I think it is a great experiment.
Chairman Garrett. Thank you.
Mr. Fincher is recognized for 5 minutes.
Mr. Fincher. Thank you, Mr. Chairman.
I thank the panel for being with us today. Something we
have been focused on in my short time of being here in the
second term is jobs, jobs, jobs--trying to get more people into
the workplace to get our economy moving. Mr. Carney and I, last
year or I guess the year before, sponsored the JOBS Act. And
this was something that has been very good.
I have a couple of questions, but I am going to read a
statement first: ``Since April 2012, shares of U.S. companies
that have gone public under the JOBS Act are generally
outperforming those that did not; a 28.9 percent average stock
price appreciation from offered price for JOBS Act companies
compared to 13.1 percent for non-JOBS Act companies. From April
2012, to January 2013, U.S. companies that have gone public
under the JOBS Act have outperformed the Russell 2000 Growth
Index, which is up 11 percent over that period.''
Just a couple of questions, and I will end with a simple
one: Why have small company IPOs, under the $250 million market
cap, declined since 2004? And the second question, aside from
the SEC's failure to fully implement the JOBS Act, what do you
believe are the largest factors explaining why many companies
are still sitting on the sidelines and not going public? If you
could answer the second one first?
Mr. Coulson, I will start with you.
Mr. Coulson. So on why are companies sitting on the
sidelines? Because they are scared of the cost and complexity.
It is not just when you go in today. They think it gets raised
every time you are a public company and some big company does
something wrong from corporate governance, you need to hire
more consultants.
There is a dynamic. Big companies are owned by index funds.
We have to have a different corporate governance system for
them. Small companies, we should design our markets to fit
intelligent investors, so there is information availability,
because investors aren't forced to own them. They get to buy
and sell them. And how do we get that efficient information
out, but not creating this compliance?
One of our recommendations is that we wait on XBRL for
smaller public companies because we are hearing from SEC
reporting companies it is going to $35,000 to a vendor every
year and take up their finance committee time. So, those are
things we can do reduce the complexity. And XBRL is a great
idea. Everybody thought it was smart. But we have created this
cost on smaller companies.
Number two, why are we seeing fewer IPO's and smaller
companies? One, we have a very successful private capital-
raising marketplace. And the JOBS Act, when the SEC votes--and
I have heard they are going to vote rather soon on removing
general solicitation--we are going to really change this wall
between private capital raising and public capital raising. We
are changing the check-at-point-of-sale rather than blocking
out all this transparency about capital-raising activity in the
markets. And this is going to make going public be more of a
continuum. Companies suddenly aren't dark everything because
they are scared of breaking their capital raising because they
put their annual report on their Web site, and that we start
seeing more disclosure and companies start trading. That is how
it used to be, but our markets got broken up.
The second piece, which I am not sure we can fix that
easily, is some of the numbers from when the IPOs were higher,
were smaller, riskier IPOs on NASDAQ; the Stratton Oakmont, the
boiler room movie guys. Those were NASDAQ securities, which
most people don't remember. But those raised the numbers. What
happened was, the firms got overloaded with regulation on sales
practices. So they said, ``We don't really want to sell to
individual investors anymore. We just want to sell privately to
accrediteds who are more sophisticated.'' And that dynamic is
even if you do a private placement, those securities, if you
make them tradeable after they have come to rest, after they
have been seasoned for a year, that capital becomes more
valuable and thus companies will have a lower cost of capital
if you make a security tradable. Because securities are based.
They are property.
Mr. Fincher. One final question, Mr. Hansen, for you and
anybody else who wants to respond in 40 seconds, in your
opinion, what regulation or law has inhibited capital formation
for businesses the most? What one?
Mr. Hansen. I would say, in the context of raising capital,
it would be limitations on the ability to generally solicit
investments, but which needs to be carefully constructed to
protect investors. On the M&A side, I would tell you that
formation of capital comes from mergers and acquisitions of
businesses, and the broker-dealer regulation inhibits that by
forcing very small firms into a very expensive system of
regulation.
Mr. Fincher. Thank you very much.
I yield back, Mr. Chairman.
Chairman Garrett. I now recognize Mr. Ross.
Mr. Ross. Thank you, Mr. Chairman.
I appreciate that.
Back when the Advisory Committee on Small and Emerging
Companies did their recommendations, on January 6, 2012, they
recommended the Commission take immediate action to relax or
modify the restrictions on general solicitation, as you
referred to, Mr. Coulson. We passed the JOBS Act and required
it to be done by July 4th. Unfortunately, the SEC missed that
deadline. Unfortunately, this becomes endemic, not only with
the SEC but with any agency under the jurisdiction of Dodd-
Frank, that we are having these deadlines just lapse.
I guess my question is, to what extent has this impacted
not only capital markets but also just some sense of certainty
in business planning for the business environment out there,
when the JOBS Act, under the Regulation D of general
solicitation restrictions being removed, not being done?
Mr. Coulson?
Mr. Coulson. I was speaking to a CEO who has a publicly
traded company. They are not SEC-reporting, but they have $100
million in revenues and they own restaurants. And he was
reaching out to me, saying, ``I have been raising capital
privately from friends and family. We have been growing the
business. But we have an opportunity to expand. When is the
JOBS Act going to take place? When is Reg A-plus going to come?
Because I want to use that.''
I keep hearing about it. That is the story I keep hearing,
that this is going to change capital raising for small
companies.
Mr. Ross. So, they are sitting on the sidelines. In other
words, investment capital is waiting.
Mr. Coulson. They are constrained.
Mr. Ross. Let me ask you this, then. Do you feel that there
is sufficient capacity of investment capital out there to meet
what hopefully is a pent-up demand for those who are
entrepreneurs or businesses that want to put it to use?
Mr. Coulson. It is going to change and open up capital
raising because now the rules of privacy for private capital
raises, you can only talk to pre-existing relationships. You
can't have any publicity around it. So much capital is stuck,
sitting there. There will be some dumb ideas financed because
of the transparency.
Mr. Ross. But isn't that what the market does?
Mr. Coulson. And it will be so much better if we, not only
investors, but the press and the public see what is going on in
capital markets. If we stop having this one tier of markets,
where things take place publicly, and then you have everything
else taking place in private. Unless you are Dr. Evil, you
would really like to finance your company publicly.
Mr. Ross. I am going to poll each one of you on this,
because I only have 2 minutes left. Mr. Sherman from California
referred to this. Put it down on my level. When I go back home
and I see mom-and-pop investors, and see my developers that are
looking for investment capital in order to expand their
business or to start their development, and they go to the
banks and because of their restrictions, there is nothing in
the equity markets. So, they go to a credit union.
What is your opinion, if I would just poll you, we have
this issue of whether we should raise the commercial lending
capacity for credit unions. How do I tell my people back home,
``Just wait, the JOBS Act will pass? We will have more
investment capital out there for you. You don't need to go to a
credit union.'' But in the meantime, they are waiting. So what
is your opinion on expanding the commercial credit limit for
credit unions?
Mr. Coulson. It is another great access to capital. But
debt is different than equity. And they should all be there and
companies should decide. Equity has a lot of advantages because
it is perpetual. You don't go bankrupt issuing equity.
Mr. Ross. But entrepreneurs have to act. They don't have
the luxury of waiting for equity financing. And they need the
liquidity so they will go to debt financing.
Mr. Coulson. The JOBS Act was filled with great ideas for
all levels of creating equity. But it just hasn't happened. We
are all waiting.
Mr. Ross. Mr. Ferraro, anything to add?
Mr. Ferraro. Congressman, I look at that issue in the
context of my own company because business development
companies are in the business of providing that debt. We do
both debt and equity. But really, being a lender is the bread
and butter. We are here today promoting legislation that is all
about increasing opportunity, increasing the category of
investments in financial services companies that we can freely
invest in. Some of the legislation concerns leverage limits, a
lot of registration parity and reform. So getting to your
question, essentially, those kinds of reforms that we are in
favor of, that is the other avenue. I hope you tell them to
visit a BDC.
Mr. Ross. Message delivered. I believe my time has expired,
so I will yield back.
Chairman Garrett. Mr. Stivers is recognized for 5 minutes.
Mr. Stivers. Thank you, Mr. Chairman.
My first question is for Mr. Coulson. You listed 15
recommendations in your testimony. Do you know, are there
proposals out there for--I know for several of them, there are,
but there were a bunch that I wrote question marks next to. Are
there folks working on many of these ideas or any of these
ideas that you know of? I know a couple of folks who are
working on some of these ideas.
Mr. Coulson. They are working on some of the proposals. The
SEC has a draft rule filing--I haven't seen it, so I don't know
if it is good or bad--to better regulate SEC transfer agents.
We proposed that the SEC have better disclosure around
promotion on the Internet, which hurts all capital raisers. We
did it 7 years ago. There were 200 comments in favor of it, but
there has been nothing but silence.
So these are areas where getting them to act--and I am a
plumber of electronic markets. My goal is to connect broker-
dealers so they trade things efficiently. My goal is to connect
companies to putting information on the Internet so it is
freely available and the market can make informed choices. But
I can't if these pieces of plumbing from broad ranges of the
JOBS Act to small things such as marginability for a community
bank shares--we have 600 community banks. When one of them
leaves NASDAQ, there is no change in that company. Why
shouldn't that security be marginable? It is an asset in our
economy.
Mr. Stivers. That makes a lot of sense. I did appreciate in
your testimony where you talked about benefits of publicly
traded markets, visibility liquidity, valuation capital and
trust. And the fact that now we are basically encouraging, by
how complicated we are making things, capital to go other
directions. And I think that is the gist of this hearing.
Mr. Weild, I wanted to talk about your proposal for the
change in the tick size. I believe Mr. Duffy may be working on
something like that. I don't want to preempt him. But it seems
like that would help a lot of small companies.
Mr. Weild. It will help not just public companies,
companies going public, but it will help the private markets as
well because this is the equity food chain or the supply chain,
if you will. And by having a hole blown out of the IPO market,
we don't have capital then coming back into the private markets
and then reinforcing itself. All of these rules which allow us
to get out and promote or, if you will, market stocks, what
they will do is they will help with the reallocation of assets
from larger capitalization companies into smaller
capitalization companies, which is where the job formation
lives. And innovation lives. So it is a very healthy thing in
the aggregate if you look at it in macro terms.
Mr. Stivers. I used to work for a securities firm, and one
of the things I did was IPOs. I worked there for 5 years. The
IPO market is very cyclical. And when somebody comes out and
has a successful offering, either two or three lookalikes come
out after it. I also know in the conversation with Mr. Himes
earlier, he was trying to get at that issue. That seems to me
to be part of the issue as well. But clearly, you need a few
successful offerings for other people to then come behind them.
And I think that is part of the problem with some of the
smaller companies right now, too, because somebody has to be
first. And nobody--a lot of people don't want to be first in
the marketplace.
Mr. Weild. And IPO markets are always cyclical. They still
are. They always were. But the new cycles, the new highs--
Mr. Stivers. Are not as high.
Mr. Weild. --are lower than the old lows. That should tell
you something. Banks are losing money in the aftermarket for
small companies, so they don't support the companies. The deals
break issue price at higher rates because they are not getting
supported, which shuts the IPO window. And somebody had asked
the question before, why do these sub-$250 million market value
companies not go public? And they are rational. It is because
the success rates of IPOs have gone lower and lower, even for
larger capitalization companies that been cut in half over the
last 15 years, because of the lack of support.
Mr. Stivers. So your proposal for a secondary market system
for some of those smaller companies that serve as alternative
exchange, would that be similar to kind of what the pink sheets
have been? Or tell me how you--
Mr. Weild. No. I think actually increasingly everything has
been subject to the same sort of trading regulation. And what
we were really encouraging was a governance structure that put
investment banks, institutional investors, and issuers, they
gave them all a seat at the table and actually focused
exclusively on the needs of small cap markets and small cap
investors, small cap issuers, just so that you created that
core discipline, which I think is generally lacking, because if
you go to the SEC and you listen to a lot of the debate, it is
totally overwhelmed by large cap data, S&P 500 data. And that I
think is really leading us astray.
Mr. Stivers. It overwhelms the small companies for sure.
Mr. Weild. Absolutely.
Mr. Coulson. And just a point, we bought and killed the
pink sheets with technology and transparency. So that old
opaque phone-base is--and we have changed that. So it is not a
pink sheets type market. Our marketplace looks a lot more like
NASDAQ.
Mr. Stivers. I understand it is a lot more transparent, and
it is realtime.
Mr. Coulson. Like NASDAQ, when it was a marketplace for
small companies.
Mr. Stivers. I am out of time.
Thank you, Mr. Chairman, for your indulgence.
Chairman Garrett. The gentleman is welcome. And the
gentleman yields back.
The gentleman from California.
Mr. Sherman. I think, Mr. Weild, it was you talking about
the greater tick sizes. A company could decide to make sure
that its shares were worth $5 rather than $50, just by issuing
10 times as many. Would that in effect give them a higher tick,
because the 1 cent would be on a $5 rather than a $50 per share
basis?
Mr. Weild. It is an excellent point. And the answer is it
would, except that in the United States, because the practice
of Wall Street is to prohibit solicitation on stocks under $5 a
share and keeping those stocks on margin, every issuer wants to
keep their stock above $5 a share. So, unlike other foreign
markets where people will actually trade their stocks or split
them down to 50 cents or $1 so that 1 penny on a dollar share
price would be 1 percent incentive, in the United States, that
option is effectively eliminated by the practice of the market
from issuers. So, it doesn't work in the United States.
Mr. Sherman. So you could do it at $10 a share, but you
have to keep your shares at well above $5, because they could
always go down. You could do a stock split to go from 50 down
to about 10 as long as you are confident--
Mr. Weild. Right. And that has why a 10 cent tick size on a
$10 share price would be the equivalent of what we see in
foreign markets that makes them work with a dollar share price
with a penny tick size. That is why having higher tick sizes is
the easiest way to fix this problem in the United States.
Mr. Coulson. So if you are the CEO of a community bank, are
you going to say, ``Oh, I need a higher tick size, so I am
going to have my stock be at $3, and then my depositors will
think I am economically distressed?'' We should have proper
tick sizes based--
Mr. Sherman. I realize there is some belief that if the
share is selling for $50 per share, the company is stronger
than if it is selling for $8 or $5 per share. That is just
psychological. There is no basis for it. But we all can't have
shares with the value of Berkshire Hathaway.
Is there anyone here on the panel who thinks that the
greater tick size would be harmful to investors? At first
blush, it would seem to, since it is in effect, more cost. Jack
wants to sell the shares. Bob wants to buy them. And the
transactions cost is greater.
Yes?
Mr. Coulson. If you are looking at cost based on where was
the inside quote at the time of trade, it would look like it is
more cost, because the way markets work now is intermediaries
use what is called a tail trading strategy. They move the price
the bid offer up and down as investors come in and out. So if
you thicken it up a little bit--and we don't agree with having
tick sizes as widely spread as they are today. We just think
you should organize them. If a community bank has a 19 cent
spread today at $17, the debate is whether it is a nickel or
dime increment, not a 25 cent increment. I have seen when we
had increments--we used to have increments of below a dollar of
half a penny--we saw much more proprietary liquidity stack up.
And, that was a good thing for investors.
Mr. Sherman. So, it is counterintuitive. But you think
investors do better with a 5 or 10 cent tick rather than a 1
cent tick--minimally, or incrementally?
Mr. Coulson. It is based on price and velocity. We really
shouldn't care if it is a $1 stock or a $100 stock, just to
have increments that organize. They don't sell Picassos at
Sotheby's in penny increments--
Mr. Sherman. Let me try to get in one more question,
because we are all focused here on publicly traded companies,
which most businesses aren't and don't even aspire to be.
Mr. Ferraro, you are investing in companies that are
smaller. What is missing, in my area at least, are loans that
yield 6 to 12 percent. In other words, if you are creditworthy
enough to get yourself a 5 percent loan, I have four bankers
out there in the hallway who will make a loan to you right now.
But if you are not quite that creditworthy, nobody will make
you the loan. What is the typical rate of interest that you
charge when you are not getting an equity kicker?
Mr. Ferraro. Typical rates of interest--our rates can range
anywhere from 8 to 12 to 14 percent. It really all depends on
the opportunity at hand, the health of the company involved.
Mr. Sherman. Do you insist on full collateralization?
Mr. Ferraro. I'm sorry?
Mr. Sherman. Do you have to have as much collateral as you
borrow? Or do you borrow against A, it is a good company or
here is the hard asset?
Mr. Ferraro. All different levels. Collateralized loans.
Whatever is appropriate in the situation.
Mr. Sherman. If you set up an office in the San Fernando
Valley, make sure it is in the west or southern portion of that
valley. I yield back.
Mr. Ferraro. That is what we like to do.
Chairman Garrett. Mr. Huizenga is now recognized.
Mr. Huizenga. Thank you, Mr. Chairman.
Mr. Hansen, I do appreciate you for staying on message
about H.R. 2274, when my colleague Mr. Fincher had asked what
your one thing is. And I do want to get to that. I want to ask
everybody. But if you could, really quickly, this has been a
recommendation from the SEC working group and forum for a
number of years. I think 2006 was the first time it came up.
Why has the SEC not taken this recommendation? Why do we find
ourselves at a point now where we need to use a legislative
tool?
Mr. Hansen. I think that is a great question. I think the
answer is essentially that the SEC has a long to-do list that
is directed by Congress. And so, it is focused on those types
of priorities, which to some extent reflect national crises
with which they have had to deal. In the area of M&A brokers,
small businesses, medium-sized businesses, this is not an area
where there have historically been issues. There haven't been
frauds. The parties rely upon their lawyers. They negotiate
transactions. And they are not relying upon Federal securities
laws for those protections.
So I think it is not perceived as an urgent issue, except
it is because there are estimated to be $10 trillion of
privately held companies in the process of being sold as Baby
Boomers retire. And as a result of that, these sellers and
buyers each need professional advice. It is an urgent issue.
So, I think it does necessitate Congress stepping in to say,
``We need to simplify this.''
Mr. Huizenga. All right. Thank you. Here is what I would
like to do in the remaining 3 minutes. I would like to quickly
hear from each one of you. What do we need to do next? We have
one piece of legislation that we are talking about. I think,
Mr. Ferraro, you have talked about a couple of other pieces.
And I know, Professor Langevoort--it takes a Dutch guy to
know a Dutch name--you had said in your testimony that the JOBS
Act, we need to have some more patience, we don't want to rush
this, is kind of how I am interpreting what was there. But I am
curious, what can we do next, to have a next step so that we
can continue some momentum here? And I would like to have
everybody try to give us a quick--
Mr. Langevoort. Sure. I think you have heard actually from
a number of people. We need to transition to a much more open
and efficient market for small companies, which is going to
take a large number of steps, much longer than we have today;
that we are going to have to rearticulate what disclosure
demands be put on smaller and medium-sized companies. I think
if we can get competing platforms for smaller companies, get it
fair and open so that investors are attracted to it, it is
probably the next best step. I think we have to see what the
JOBS Act will bring when the SEC acts. I think that will be
soon. But I think that new market is our next--
Mr. Huizenga. There are a lot of us hoping they will act
soon on that.
Mr. Weild?
Mr. Weild. It is essential to get tick sizes up, and it is
essential to get the JOBS Act implemented and to worry about
what can go right and come back and fix it around the edges if
you have to course-correct. But the paralysis is just killing
people. We have 20 percent of kids in the United States living
below the poverty line. And if you read Professor--I am trying
to think of his name--Moretti's book, ``The New Geography of
Jobs,'' there are five service sector jobs created for every
technology job. There is a multiplier effect at stake here. So,
we have to get moving.
Mr. Hansen. I would add that while you were looking at
issuer-related questions on capital formation, you should not
overlook the fact that the service providers, the broker-
dealers, the M&A brokers, the private placement type brokers or
finders who are raising capital or need to raise capital, would
want to be compensated for raising capital. They don't enjoy
any type of exemption that the issuers do. An issuer may have
an exempted registration, but it is still a security. It still
takes a registered broker-dealer, if they are going to get
paid, to raise the capital or to sell the business. So I think
that what you need to look at is the fact that the service
providers in this marketplace, private as well as public, also
have concerns that need to be addressed.
Mr. Ferraro. Congressman, I think you need to bring BDCs
from 1980 into 2013. And the suite of legislation that is
currently on the table does that. Predominantly, we are
removing arbitrary barriers to investment in certain kinds of
investment areas to financial services. It is a much different
universe today than it was back then. On top of that, I would
also highlight from our legislative agenda the offering reform.
Items, simple items such as incorporation by reference, which
most every other public company in America can do, saving money
on attorneys, money on accountants, all costs that get passed
on either in the form of the percentage on the loans that we
are charging or less of a dividend that can be distributed to
our shareholders. There is no need for any of that. And it is
an area where I think having legislation is the most effective
and efficient means forward.
Mr. Huizenga. I know my time has expired, so it is up to
the chairman here.
Chairman Garrett. The gentleman yields back.
I now recognize the gentlelady from New York.
Mrs. Maloney. I thank the chairman for yielding, and I
apologize to my colleagues and the chairman; there were three
bills out of the Financial Services Committee that were on the
Floor being debated, and I wanted to be part of that debate.
Chairman Garrett. So, you wanted to be down there to
support those?
Mrs. Maloney. I was. I did support them. I want to welcome
all the panelists today, particularly Joe Ferraro, who is from
the great City of New York. And my colleague, Mr. Sherman, said
he wanted him to open up an office in California. I am very
pleased that Mr. Grimm and I have him in the great City of New
York.
Welcome, and thank you for being here.
Mr. Ferraro. Thank you.
Mrs. Maloney. Regarding the business development companies,
has the BDC community asked the SEC to modify any of its rules
to accommodate the concerns that you have expressed here today?
And if so, which ones?
Mr. Ferraro. It has. Colleagues at Ares and Apollo have
already talked to the SEC about some of their legislation. Our
legislation is relatively new, and we are planning to talk to
the SEC in the next couple of weeks about those pieces. And
there is a lot in there where--going back to comments I had
made previously, there is much that would benefit by
congressional action versus anything like the SEC rulemaking.
For example, the reforms that we are proposing to open up what
is called the 30 percent basket in the business and basically
make investments in financial services not captive to that
limitation is something that really needs congressional action
more than SEC action.
On the SEC action side, there have been in particular
offering reform ideas on the table. Incorporation by reference,
electronic road shows, just simple things from which many other
companies in the public space already benefit. And there is
something where the rulemaking hasn't happened, and if we are
at the table now to further reform BDCs both in those areas and
others that are mentioned in the written testimony, it just
makes sense and it is more efficient to get it all done now in
this process.
Mrs. Maloney. Some of the changes that you have mentioned
can be done by SEC action, correct?
Mr. Ferraro. They can. I point to the offering reform for
that. I think the SEC has always been very responsive to us. I
think what happens is the particular division of the SEC that
deals with business development companies also oversees
hundreds of mutual funds. And there are just constraints on
resources and time. So it just makes more sense to do it this
way.
Mrs. Maloney. And is it necessary--aside from the time
constraints on the SEC--for Congress to legislate these
changes?
Mr. Ferraro. I believe it is, yes.
Mrs. Maloney. So they cannot be done by the SEC? They have
to be done by Congress?
Mr. Ferraro. Many of them cannot be done by the SEC alone.
Mrs. Maloney. Would anybody else like to comment on some of
the really salient barriers to small business growth that you
feel are there?
Mr. Coulson. Just two quick points. The promotion proposal
of transparency of the people behind it; if we don't fix this,
the JOBS Act, the advertising general solicitation of
securities under the JOBS Act, these same people will be hiding
out and doing that. So transparency of who are the people
behind offerings is really one of the most important things for
investors, knowing who it is.
Second, it is not this committee but taxes for smaller
public companies, the easiest way to attract investors is to
pay a dividend on your shares. But small corporate companies
don't have the efficiency of the REIT structure. And if we did
that, it would be the silver bullet to bringing more profitable
public companies and ones where investors could track by income
rather than just future potential. And that is something to
talk to your colleagues about because that really would change
the dynamics for smaller public companies because they are
squeezed between the debt bias for interest with private equity
firms. And larger global companies having much lower tax rates.
My company pays a 39 percent tax rate.
We also pay more for our tax accountants like Grant
Thornton than we do for our auditor at Deloitte. We don't get a
great rate, and that is something that needs to be worked on,
because the New York Times says large, large S&P 500 companies
pay a 29 percent rate. And IT companies pay a 22 percent rate,
so we are at a capital disadvantage. And we are also at a
disadvantage of providing returns to our investors.
Mrs. Maloney. So why are you paying 39 percent when larger
companies are only paying 29 percent? Why is that happening?
Mr. Coulson. Sadly, we are in New York State. And I love
New York. It has a great community of people. We are also--
unlike the New York Stock Exchange, which developed software in
Ireland, we develop our software in our offices in New York
City, and our office is in Washington, D.C. So we are at a
disadvantage for capital. And that is a point. It is like the
REIT business has been hugely successful in bringing income-
producing companies public. So why aren't we taking that known
process to smaller public companies and having a process to
bring in, not only companies that are needing a lot of capital
for growth, but companies which are creating income, because it
flows through to the other side of the equation. If investors
own dividend-paying securities in their retirement, they beat
inflation. Debt eventually gets beat by inflation. So we should
be incentivizing equity. It makes our system more stable. It
makes our financial statements more true because you can tell
the income a company is paying. It makes our marketplaces more
efficient. And it opens the door for smaller companies being
public.
Mrs. Maloney. Thank you.
My time has expired.
Chairman Garrett. Thank you.
The other Representative from New York, Mr. Grimm.
Mr. Grimm. Thank you, Mr. Chairman. I appreciate it. Thanks
for holding this hearing.
I want to thank everyone on the panel today for your
testimony.
Welcome to the committee. We appreciate your input.
I would like to try to keep it a little bit cogent. We were
discussing BDCs, so, Mr. Ferraro, if I could go to you to
discuss a little bit more. I have legislation, H.R. 1800, the
Small Business Credit Availability Act--fancy terminology--to
somewhat modernize the way small development companies with
BDCs are regulated. I believe BDCs provide an important service
for providing financing to the small and medium-sized firms
that we just spoke about. And they often have difficulty
obtaining traditional bank financing. So I see the value in
that. And these are the exact kinds of firms that are
responsible for a lot of the new job creation.
So it is apropos, since we have discussed so much about the
unemployment rate. This bill would allow BDCs to borrow more
than they do now: $2 for every $1 of assets that they hold
versus the current one-to-one structure. In addition, it would
streamline the forms of procedures by the BDCs for securities
offerings. I think you are familiar with that. And bringing
them more in line with some of the publicly traded companies.
As the VP of a BDC, what kind of an impact do you think that
would have if implemented on job creation just as a whole?
Mr. Ferraro. I think it would have a tremendous impact.
Everything that you are talking about I think the entire suite
of BDC legislation essentially says to business investment
companies, go out, raise capital, pass that capital on to small
and medium-sized businesses. And when you do that, not only a
lot of times are you helping those businesses to grow when you
are talking about, in my estimation, financial services
businesses in particular, they then go on and help additional
businesses to grow. The typical company that comes to us is
looking for that level of investment that results in the
creation of a factory, a new expansion of a warehouse, a new
line of business. And because of that and the rigorous due
diligence process that we have, we kick the tires. We say,
okay, is this the kind of company that we believe can get
there, that we would put our shareholders' money behind and in
turn earn our shareholders a good return?
Mr. Grimm. On that exact point, could I just expand on
another question, since you brought it up, the companies that
your company finances, what is their ability in general to
access capital to grow their business via bank loans or capital
markets?
Mr. Ferraro. It is generally limited. I think as a lot of
my colleagues have mentioned, when you are talking about small
and medium-sized businesses, your traditional banks can be more
hesitant to lend, and the sad fact is, after what we have
experienced in the past few years, a lot of the banks just
aren't there and lined up to provide that kind of capital. So
we service a very critical and important area of financing for
these companies because they really can't get the money
elsewhere.
Mr. Grimm. I feel that a two-to-one leverage ratio is
conservative by any standard. But can you just tell us, how
does that compare with ratios used by other financial firms?
Mr. Ferraro. Oh, it is very, very low. When you talk about
a traditional bank, you might see a 12-to-1 leverage. I know
people at different times in this hearing have talked about
multiples way beyond that, that are just stunning. Anything we
are talking about in the reform is still highly, highly
conservative.
Mr. Grimm. And on that note, for those who think, wow it
seems like you are doubling. It seems like a lot of leverage,
in comparison, I would say it is not even close to what other
financial institutions have. It is extremely conservative. But
for those naysayers, what level of losses would a BDC need to
experience to wipe out its equity at these ratios?
Mr. Ferraro. At those ratios, I don't really have the
numbers with me.
Mr. Grimm. Just ballpark, though, just to give an idea.
Mr. Ferraro. I don't want to guesstimate, but at the same
time, it would have to be a substantial degradation of the book
to quite a significant level.
Mr. Grimm. As far as you know, have we ever seen losses
like that--
Mr. Ferraro. No.
Mr. Grimm. --experienced by BDCs, even during the height of
the financial crisis?
Mr. Ferraro. Not to that extent, no.
Mr. Grimm. Okay. I see my time is just about out. Thank you
very, very much. And thank you all on the panel.
I yield back.
Chairman Garrett. Thank you.
The gentleman yields back.
Mr. Carney, you are recognized for 5 minutes.
Mr. Carney. Thank you, Mr. Chairman. And thank you for
having this hearing today. I apologize for arriving late. I
realize I may have missed your opening statements and a lot of
the discussion and debate. Professor Langevoort, if I am
pronouncing your name correctly or at least close enough, I
have just a couple of questions. You mentioned at the beginning
of your testimony a reference to the JOBS Act, and that some of
the rules are still being completed. You also say in the first
paragraph that all good policymaking takes time and can't be
rushed if it is to be done well. So it may be a little bit
premature to ask this question.
But I was one of the sponsors of the IPO onramp part of the
JOBS Act. And I wonder if you could comment on what you have
seen on that aspect of the Act itself, and whether we have any
results there, recognizing that it may be too early to judge.
Mr. Langevoort. Yes. Obviously, that was self-executing, so
we saw the first effects right away. Ernst & Young just issued
a report on the first 12 months of onramp. So we have seen
data. Perhaps due to our economy, factors that have nothing to
do with the JOBS Act, you are not seeing a larger number of
IPOs than you saw previously. The growth is not necessarily in
emerging growth companies, even though 80-some odd percent of
all of the IPOs are emerging growth companies. So I am going to
play right into your hands. We will know a lot more.
Mr. Carney. It is too early to tell. Sir, are you familiar
with some of the discussion that led up to some of the
provisions in that Act? It is my understanding, again, as part
of the team that with my colleague, the prime sponsor, Mr.
Fincher from Tennessee, it started out of a conference that the
Treasury Department had of people in the high-tech, primarily
Silicon Valley world, Silicon Valley bank. From that, interest
was generated, and there was a working group that met several
times. And they came up with a list of ideas. What do you
think, are there other ideas that didn't become part of the IPO
Act that we might think about now? Or what do you think about
the ideas that became the provisions in that Act?
Mr. Langevoort. As I indicate in my testimony, I think with
more time--and this is not, by any means, pointing any
fingers--there could be a much more rational, comprehensive
articulation of what we should expect in terms of governance
and disclosure from emerging companies. I have a list of things
I would have added to the exemptions that aren't there. There
are a couple on the list.
Mr. Carney. Could we get that list? It is not in your
testimony. Could we get a list of those?
Mr. Langevoort. I would be happy to give you a list, but I
think they are fairly predictable.
Mr. Carney. You referenced the SEC's Advisory Committee on
Small and Emerging Companies and a number of recommendations. I
haven't seen that. I assume that we could get our hands on that
as well. Are they similar kinds of recommendations to what you
have on your list?
Mr. Langevoort. There are a number of recommendations. One
is to conform the disclosures for relatively smaller companies
to the list that was put in the JOBS Act for emerging growth
companies. So to some extent, it piggybacks on what you all
wrote. But there is also a call for a more comprehensive look
at what we ask for from smaller companies, and that goes beyond
the JOBS Act.
Mr. Carney. And one last question: Is there anything that
gives you pause? At the end of your testimony, you talk about
investor protections that give you pause in terms of--there is
a balance to be struck here, but for sure in terms of what is
required and reporting and the like as we move forward.
Mr. Langevoort. We are waiting for the rules on general
solicitation. I think it was 25 years ago that I first wrote
calling for the end on the ban on general solicitation. So, I
completely support the effort. It is, however, going to be new
territory. And there are going to be abuses. So we are going to
find out whether the SEC has the capacity, the resources,
whether FINRA has the capacity, the resources, to be watching
this space, because for all the good that is going to be done,
there are going to be people at risk.
Mr. Carney. Thank you very much. My time has expired. I
apologize that I don't have enough time for questions for the
rest of the panel, but thank you all for coming, and for your
ideas and advice.
Chairman Garrett. Mr. Mulvaney, you are recognized for 5
minutes.
Mr. Mulvaney. Thank you, Mr. Chairman.
Mr. Ferraro, I want to go back to some of your original
testimony and expand a little bit on that, and some of your
written testimony and talk about H.R. 1973, not the least of
which because it is my piece of legislation. But I know you and
I have talked about it. I have spoken with folks in your
industry about it. Very briefly, if we set the stage here, you
go back to the current rules, you go back a couple of decades,
and you are limited in your ability to invest in financial
services companies, small banks, community banks, those types
of things. My bill would seek to remove that restriction. Tell
me why that is important. Tell me what that means to the BDC
industry. Tell me what opportunities that creates. Tell me what
you could do in the future that you can't do now. If you have
examples of things that you have tried to do in the past, but
you can't do because of that rule. Help us understand the
practical realities of why those rules need to be changed.
Mr. Ferraro. Sure. It will be my pleasure. What has
happened over the past 33 years in the existence of BDCs is
that the area of potential investment in financial services
type businesses has itself expanded. When the BDC rules were
originally enacted, there was just an arbitrary line put that
said 30 percent of your assets can only be invested in certain
kinds of companies. Typically, they are foreign or they are
other types of investment companies, and we are not interested
in changing that. But there is one area where there is
limitation on financial services companies. I still can't find
the policy justifications or reasons behind it, even if you go
back to the legislative history. The practical reality for
businesses in the BDC space is that we have these kinds of
companies that come to us.
A good example is Nationwide Acceptance out of Chicago. It
is an auto lender. A wonderful company. It creates jobs. It
helps families get autos. They can take their kids to school.
They can go to work and so on. We would like to invest in more
companies like that. Depending upon our asset balance at a
particular time, if we had another attractive Nationwide come
to us, we may not be able to do that simply because that
investment may be slightly over 30 percent of our assets. And
so when I have that valuable company, when I have that
potential great investment before me, and I am being asked by
that company, why can't you provide capital to us, all I can
say is, well, there is a line set that tells me that I can't.
And beyond that, I don't have a great explanation as to why.
Mr. Mulvaney. Mr. Coulson, do you want to comment on that?
You look like you have a comment.
Mr. Coulson. No. It is the constant regulation away of
capital, which is frustrating, because I hear it from the
community banks that they are always constrained on going to
their best markets for capital, their best seekers and it is a
more personal frustration that--
Mr. Mulvaney. So the strong argument actually helps the
community-based financial institutions as well?
Mr. Coulson. Yes.
Mr. Mulvaney. Does anybody know, by the way, why the rule
was there? Does anybody have any insight? I think you are
right. It sounds like it is random. It sounds like it is just
an arbitrary number. Does anybody have any background on why
that is? In fact, it strikes me--and to get back to the bill--
Mr. Sherman was here a while ago and he wants you to come to
California into his district and start offering your services.
And knowing the little bit I know about his district, that
might be the best way to get there.
Mr. Ferraro. It absolutely would be, yes.
Mr. Mulvaney. Thank you. I will yield back the balance of
my time to the chairman. Thank you.
Chairman Garrett. Okay. On that note, we will now turn to
Mr. Duffy for maybe the last word.
Mr. Duffy. Thank you, Mr. Chairman.
Unemployment right now stands at 7.6 percent. This has been
one of the longest and toughest recoveries since the Great
Depression. We are having a jobs issue in America, and it is
affecting our families. Many of them want to get back to work.
They want to make a better living. They want to get more
dollars into their family coffers.
The greatest way to generate jobs in America is to make
sure that our small businesses and our startups are growing and
expanding and creating those jobs, the small businesses that
are the best generators. If our small businesses don't grow,
neither do our American jobs. Recently, our small cap companies
have had a difficult time accessing capital and, therefore,
growing their businesses. Capital issues for small cap
companies, I would argue, have coincided with decimalization.
If we want a vibrant job market and job growth, we need to have
a vibrant market for our small cap companies.
So, I want to ask the panel as a whole kind of a two-part
question. One, do you all agree with the SEC Chairman that one
tick size doesn't fit all? And do you agree that we should
implement a tick size pilot program to determine if wider
trading spreads would improve liquidity for small cap companies
and increase economic incentive for investors? We have held a
long conversation about this. But I would like everyone to
weigh in on what you think about those issues. Mr. Coulson?
Mr. Coulson. I completely agree. We need liquidity. We have
changed our marketplace into a series of orders instead of
intermediaries. And the idea that marketplaces should just be
these nice investors lining up and matching and never have a
liquidity provider is a mistake. We need broker-dealer
participation in the marketplace providing liquidity, and we
need to incentivize it, but we also need to make sure that the
tick sizes are not too wide. We can't artificially widen
spreads. That would be a step backwards. But if we organize the
marketplace, and we have increments that reflect the trading
velocity.
We have Fannie Mae and Freddie Mac trades on our
marketplace. Fannie Mae trades 78,000 times in one day. It
doesn't need tick sizes. That would be bad. But for companies
that trade 100 times a day, they need organization. They need
liquidity. And if we start seeing--because we also have a
little different viewpoint. With tick sizes, because it will
give a little more profitability to market makers, we should
have them show larger sizes. And that way, we get a multiplier
effect of more liquidity displayed. And if we do that, we are
guaranteed the tick sizes will succeed. FINRA lowered our
displayed sizes in our marketplace. And we saw liquidity go
away.
Mr. Duffy. I want to make sure I get to everyone. So, I
will go down the line.
Mr. Ferraro. Congressman, I will respectfully defer to my
colleagues. I don't believe the BDC community has established
an opinion on this one.
Mr. Duffy. Fair enough.
Mr. Hansen. I would generally defer to them, too, except to
observe the fact that small business issuers as well as small
investors rely upon there being available research about these
companies. And you would need have a way of funding that. I
think the unintended consequence, as described by the other
witnesses, has been--
Mr. Duffy. Do you believe that the tick size would address
that issue?
Mr. Hansen. It could. And on that, I will defer to the
other experts in the markets.
Mr. Duffy. Mr. Weild, I think I know where you stand on
this, but--
Mr. Weild. Clearly. But I will tell you that everybody
understands that at zero tick size, the entire stock market
implodes. So at a penny tick size, one size fits all is
idiotic. When we had quarter points for large cap stocks, it
charged investors too much money. Now we have 1 penny tick
sizes, one-size-fits-all. It is a disaster. It is catastrophic
for the small cap markets. So I couldn't agree more with the
Chairman of the SEC or with your views on getting higher tick
sizes into smaller capitalization companies to jump-start the
U.S. economy.
Mr. Duffy. Mr. Langevoort?
Mr. Langevoort. Yes. Interference with free market is to be
preferred, again. But we do need to incentivize this activity.
Finding the right balance is the key, and a pilot program is
the right way to do that.
Mr. Duffy. Thank you all for the answers. I want to go to
an issue that the gentleman from California brought up, Mr.
Sherman. He was talking about how the higher cost of these
transactions might affect our investors and traders. But isn't
it fair to say that if there is no liquidity, these trades
aren't happening, and therefore, there are no investors to be
heard? And illiquid stocks don't help investors. They don't
help the companies. They don't help the economy, and therefore,
if we can improve the liquidity, we are improving the market
for our investors' companies and the economy.
Mr. Coulson. Liquidity is a virtuous circle, and we now
have an incentive for--if you are a liquidity provider and
intermediary, you don't provide the liquidity on the bid offer.
You provide the liquidity at the tail end of an investor coming
into the market. So we would be changing the liquidity provider
model so there is more displayed liquidity on the bid offer.
And what you would see is, if you see a bid offer with
liquidity on both sizes, you are much more likely to take the
offer or hit the bid, because you see enough liquidity to do
what you want to do. And that creates the virtuous circle. And
also, if there is displayed liquidity in my marketplaces, other
broker-dealers, if there are 2,000 shared offered, other
broker-dealers will compete and sell 5,000 shares at that price
point. So we have competition with displayed liquidity, which
again multiplies the liquidity. So if we only have 100 shares
there, there is nothing to multiply.
Mr. Duffy. My time has expired. But just quickly, stay
tuned. We are going to draw up a bipartisan bill that will
provide us a pilot program to expand our tick sizes. And
hopefully, we will see the end result as an end positive. I
yield back the remainder of my time.
Chairman Garrett. On that bipartisan note, we bring this
hearing to an end. I want to thank all the witnesses once again
for not only your testimony today, but for your written
testimony as well, which has already been reviewed by our
staff.
The Chair notes that some Members may have additional
questions for this panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to these witnesses and to place their responses in the record.
Also, without objection, Members will have 5 legislative days
to submit extraneous materials to the Chair for inclusion in
the record.
With that, this hearing is adjourned.
[Whereupon, at 2:55 p.m., the hearing was adjourned.]
A P P E N D I X
June 12, 2013
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