[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
LEGISLATION TO FURTHER REDUCE
IMPEDIMENTS 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
__________
OCTOBER 23, 2013
__________
Printed for the use of the Committee on Financial Services
Serial No. 113-46
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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:
October 23, 2013............................................. 1
Appendix:
October 23, 2013............................................. 41
WITNESSES
Wednesday, October 23, 2013
Abshure, A. Heath, Arkansas Securities Commissioner, on behalf of
the North American Securities Administrators Association....... 8
Arougheti, Michael J., Chief Executive Officer, Ares Capital
Corporation.................................................... 10
Ertel, J. Michael, Managing Director, Legacy M&A Advisors, LLC... 11
Frank, Alexander C., Chief Financial Officer, Fifth Street
Management LLC................................................. 13
Quaadman, Tom, Vice President, Center for Capital Markets
Competitiveness, U.S. Chamber of Commerce...................... 16
Weild, David, Founder, Chairman, and Chief Executive Officer,
IssuWorks...................................................... 18
Wunderlich, Gary K., Jr., Chief Executive Officer, Wunderlich
Securities, on behalf of the Securities Industry and Financial
Markets Association (SIFMA).................................... 14
APPENDIX
Prepared statements:
Abshure, A. Heath............................................ 42
Arougheti, Michael J......................................... 58
Ertel, J. Michael............................................ 64
Frank, Alexander C........................................... 104
Quaadman, Tom................................................ 108
Weild, David................................................. 154
Wunderlich, Gary K., Jr...................................... 174
Additional Material Submitted for the Record
Garrett, Hon. Scott:
Letter to Representatives Garrett and Maloney from the
Financial Services Roundtable.............................. 180
Written statement of Joseph Ferraro, General Counsel,
Prospect Capital Corporation............................... 181
Letter to Representative Elizabeth Esty from Michael F.
Foley, former President and CEO, Reflexite Technology
Corporation................................................ 183
Letter to Representatives Garrett and Maloney from the Small
Business Investor Alliance................................. 185
Letter to SEC Chair Mary Jo White from various companies..... 187
Maloney, Hon. Carolyn:
Letter to Representatives Garrett and Maloney from SEC Chair
Mary Jo White.............................................. 191
Sherman, Hon. Brad:
Letter to Representatives Garrett and Maloney from the
National Association of Federal Credit Unions.............. 196
LEGISLATION TO FURTHER REDUCE
IMPEDIMENTS TO CAPITAL FORMATION
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Wednesday, October 23, 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 2:28 p.m., in
room 2128, Rayburn House Office Building, Hon. Scott Garrett
[chairman of the subcommittee] presiding.
Members present: Representatives Garrett, Hurt, Royce,
Huizenga, Grimm, Stivers, Mulvaney, Hultgren, Ross; Maloney,
Sherman, Moore, Scott, Himes, Peters, Watt, Foster, Carney,
Sewell, and Kildee.
Ex officio present: Representative Hensarling.
Also present: Representative Duffy.
Chairman Garrett. Good afternoon. The Subcommittee on
Capital Markets and Government Sponsored Enterprises is hereby
called to order. And I welcome the panel and their indulgence
as we just concluded votes for the morning until the next
series of votes. Before we go to the panel, we will have
opening statements, and I will begin by yielding myself 3
minutes.
Today's hearing, as you all know, is on legislation to
further reduce impediments to capital formation for who? For
America's small businesses. In a moment, I am going to
recognize my colleagues for opening statements to introduce
their legislative proposals. But first, I would like to briefly
highlight a mixed bag, if you will, of recent developments in
the area of small business capital formation.
First, data continues to flow in on the early impact of the
JOBS Act and the results are very encouraging. Thanks in large
part to the law's self-executing IPO on-ramp provisions, this
is helping to shape up to be one of the best years for IPOs
since 2007, and with more than 150 of them through the first
three quarters and counting, it is a good track record. And so
for our tech savvy crowd, I guess you could simply say with a
hash tag the JOBS Act is working.
Now, in addition, while the SEC's statutory mission to
promote capital formation has largely been ignored over the
past 4 years, it does seem that the Commission is finally
getting around to its responsibilities under the JOBS Act. Back
in July, the SEC issued rules lifting the ban on general
solicitation and advertising in connection with certain private
security offerings to credit investors and that was mandated by
Title II of the JOBS Act. So this rule change was expected to
be a milestone on the road to improving small business capital
formation through the private securities market.
Unfortunately, in Washington these days things are never as
simple as they should be. Instead of following Congress'
straightforward and narrow mandate to lift the ban on general
solicitation and advertising for certain private security
offerings, the SEC also saw fit, over the objections of two
Commissioners, to issue an additional, unrelated proposal to
change the disclosure and filing requirements for these very
same offerings.
This proposal, which was not called for by the JOBS Act, is
apparently intended to protect the already more sophisticated
investors who may participate in these offerings. However, it
is likely to impose additional new and significant costs and
burdens on small businesses who are trying to seek to raise
capital through private security offerings and thereby reduce
the attractiveness of these offerings and thereby undermine the
very purpose of the JOBS Act in the first place.
So although Chair White wants the SEC to move expeditiously
towards the adoption of this proposal, I would urge her and her
colleagues on the Commission to seriously rethink whether it is
the best option available to balance the SEC's important duties
both to protect investors and to promote small business capital
formation. Indeed, it seems that the SEC too often forgets that
an important part of protecting investors is ensuring that they
have access to a variety of investment options. And so with
respect to the remainder of the JOBS Act, earlier today the SEC
voted in favor of issuing proposed rules to implement Title
III, the crowdfunding provisions. And, frankly, I have not had
a chance to review the crowdfunding proposals. I hope that this
time the SEC has stayed true to the terms of the statute. I
also hope that a proposal from the SEC on regulation A will
follow before the end of the year.
Now, on top of the JOBS Act, more can and should be done to
help small businesses raise much-needed capital to grow and
create jobs during this period of record-breaking government
red tape, tepid economic growth, and persistently high
unemployment.
And so, finally, to that goal, I would like to recognize
the great work of Representatives Maloney, Grimm, Velazquez,
and Mulvaney on their bills addressing the regulations of
business development companies (BDCs). Also, we have
Representative Huizenga on his bill addressing the regulation
of mergers and acquisition brokers. Additionally, we have over
here Vice Chairman Hurt on his proposal to create a voluntary
filing exemption for small companies, and you have
Representative Duffy's bill on his proposal to create the tick-
size pilot program, and finally Representative Fincher on his
proposals to improve Title I of the JOBS Act.
And with that, I will look to some of those Members later
on for their opening statements, but at this point I would like
to turn to the ranking member of the subcommittee, the
gentlelady from New York, for 4 minutes.
Mrs. Maloney. Thank you, Chairman Garrett, for holding this
important hearing. And I want to particularly welcome Mr.
Weild, Mr. Arougheti, and Mr. Frank, who are all from the
district that I am privileged to represent. This legislative
hearing is the product of two informative hearings that this
subcommittee held earlier this year, and I hope that this
hearing will move our process forward.
The United States has the deepest, most liquid, and most
effective capital markets in the world. The United States stock
market is 13 times larger than the British and 14 times larger
than Germany's. Simply put, the United States is where
businesses come to raise money from investors. The sheer size
of our stock market is attractive for investors because they
know they will be able to sell their investment quickly if they
need to.
But, unfortunately, small businesses still have trouble
raising funds in these markets. Between 1991 and 2007, the
number of small companies that went public in our securities
markets declined by 92 percent. Providing incentives for
greater investment in our country's businesses and our
entrepreneurs will allow these companies to innovate, hire new
workers, launch new products, and ultimately grow our economy.
However, we also need to keep in mind that one of the main
reasons the U.S. markets are the envy of the world is the
transparency and trust that come from public disclosure. I have
always said that our markets operate more on trust and
confidence than on capital.
That is why it is so important that we get the right
balance between increased incentives for capital formation and
healthy public disclosure that benefits all investors. We also
need to make sure that any reforms we consider passing don't
harm the tremendous improvements our markets have made in the
past 3 decades.
As Chairman Garrett has noted, one of the big takeaways
from the roundtable on market structure that he hosted earlier
this year in New York was that today's retail investors have
better access to the markets and at lower costs than ever
before.
It is important not to lose sight of these benefits. And
given what we went through with the financial crisis, it is
also important that we put safety and soundness concerns first.
As SEC Chair White has said, if there is a way to increase
incentives for capital formation in a way that also protects
the safety and soundness of the system, then we should work
together towards that goal.
The bills that we are considering today represent a good
faith and sometimes bipartisan effort to improve our markets
and grow our economy. I look forward to a very informative
discussion of these bills from our distinguished panel. Thank
you for being here.
Chairman Garrett. Thank you.
Mr. Hurt is recognized for 2 minutes.
Mr. Hurt. Thank you, Mr. Chairman. Mr. Chairman, I want to
thank you for holding today's hearing on reducing barriers to
capital formation. I am glad that this subcommittee is moving
forward with additional proposals to increase access to capital
for our small businesses and our startups.
Our hearings over the summer have shown that while the JOBS
Act has been successful, more still needs to be done to ensure
that we remove or refine costly regulations, especially those
disproportionately affecting small or public companies and
those who are considering accessing capital in the public
markets. While a single regulation's effect may appear
insignificant, the combined costs of our regulatory climate
produce exponential consequence. For that reason, I appreciate
the subcommittee taking a holistic approach to examining our
capital markets' regulatory structure and its impact on
innovative companies.
One such requirement is related to the use of Extensible
Business Reporting Language (XBRL), which was mandated by the
SEC in 2009 and designed to lower the cost of capital for
smaller companies and provide more efficient access to
information for investors. While the SEC's rule is well-
intended, this requirement has become another example of a
regulation where the costs outweigh potential benefits. Smaller
companies expend tens of thousands of dollars or more complying
with the regulation, yet there is evidence that less than 10
percentage of the investors actually use XBRL, further
diminishing its potential benefits. That is why I am interested
in legislation to provide relief from the disproportionate
burdens of XBRL.
The legislation under discussion would provide an exemption
for emerging companies from complying with this regulation. It
is important to note that nothing in the draft would preclude
companies from utilizing XBRL for their regulatory filings with
the SEC if they so choose. Rather, it allows these companies to
assess whether the costs incurred with compliance are
outweighed by any potential benefits from utilizing this
technology.
I believe the draft offers a practical step forward with
XBRL requirements in line with the intent of the JOBS Act,
ensuring that our regulatory structure is not
disproportionately burdening smaller companies and
disincentivizing innovative startups from accessing our public
markets.
I look forward to the testimony of our distinguished
witnesses and thank them for their appearance before the
subcommittee today. Mr. Chairman, I thank you, and I yield back
the balance of my time.
Chairman Garrett. The gentleman yields back.
The gentleman from California is recognized for 2 minutes.
Mr. Sherman. Thank you, Mr. Chairman.
We always have to balance on the one hand transparency and
investor protection, which brings capital into our markets,
with minimizing the costs of those companies trying to raise
money. We should keep in mind that it is only for less than 2
centuries of human history that people invest with strangers,
and they can do that only because we have a good and
transparent accounting and financial reporting system that is
reliable.
We can provide more capital to the smallest businesses
doing something that is outside the scope of today's hearings,
and that is allowing credit unions to make business loans. We
bailed out banks that still aren't making the small business
loans that they ought to be making, some of the giant banks.
Here we have credit unions who just want the U.S. Government to
get out of the way and let them make business loans, and we
should be acting on that bill.
Finally, I want to recognize Mr. Quaadman of the Chamber
for his work in preventing a grave threat to all business
financings involving borrowing from a $100,000 bank loan to a
multibillion-dollar bond indenture, and that is the proposal of
the Financial Accounting Standards Boards to ``capitalize
leases.'' This would add over $2 trillion to the liabilities
listed on the balance sheets of unsuspecting businesses.
Financial Accounting Standards Board exposure drafts are rarely
on the front page of any newspaper, and so these businesses
don't know what is about to possibly hit them. But most
businesses that borrow have loan covenants, which means that if
they added to their liabilities, even if they added an equal
amount to their assets, and even if that addition wasn't a
change in business but just a change in accounting principles,
they would be in violation of their loan covenants and the
money would be due immediately. That poses a risk to the
financing of businesses that I hope this committee will look at
separately.
I yield back.
Chairman Garrett. The gentleman yields back.
The gentleman from New York, Mr. Grimm, is recognized for
1\1/2\ minutes.
Mr. Grimm. Thank you, Mr. Chairman.
And thank you, Mr. Mulvaney.
Chairman Garrett. We appreciated the help from the
gentleman for paying attention.
Mr. Grimm. Thank you for calling the hearing. I appreciate
it because it is extremely important that we discuss several
legislative proposals that would increase capital formation and
further economic growth and job creation. I am very proud to
have introduced one of the bills under consideration today,
H.R. 1800, the Small Business Credit Availability Act.
This commonsense legislation would increase the ability of
business development companies, otherwise known as BDCs, to
lend to small and midsized firms, the key drivers of new job
growth in our economy. H.R. 1800 would allow BDCs to modestly
increase their leverage, accurately reflect how their preferred
stock is considered for regulatory purposes, and harmonize
their securities issuance procedures with those of other
registered firms.
At a time when our economy is still struggling to create
jobs and erase the damage done during the great recession, we
must strive to do all that we can to ensure the flow of much-
needed capital to Main Street businesses and make sure they are
not interrupted. In the wake of the financial crisis, BDCs
filled an important void in the economy by continuing to
provide much-needed capital to small firms. It is crucial that
we ensure that they are able to continue in this vital role.
So I look forward to hearing from all the witnesses today.
I would like their thoughts on BDCs and the other important
legislation that is before us. And I yield back.
Chairman Garrett. The gentleman yields back.
And Ms. Moore is recognized for 2 minutes.
Ms. Moore. Thank you, Mr. Chairman. It sure is good to be
back at work. I think that this is an auspiciously timed
hearing after the whole shutdown debt ceiling episode, a step
in the wrong direction, to be trying to now look at legislation
that might promote positive, sustainable, and widespread
economic growth.
I think there are very varying degrees of merit to the many
ideas that are coming before this committee today, but I do
think that this is an opportunity for the authors, the sponsors
of these drafts to help us come to some kind of consensus.
I have not committed myself to any of these ideas, but I do
think that proposals that my colleague from Wisconsin,
Representative Duffy, on tick size, is of interest to me. The
credit union business lending bill is of some interest to me.
And I strongly encourage the sponsors to work with the SEC and
State regulators on those proposals that impact the so-called
accredited investors definition as a part of implementing the
JOBS Act.
After some of the more high profile cases, like Bernie
Madoff, I think this is a really, really critical undertaking
by the SEC, and the committee needs to work in sync and be
mindful of that process.
I thank you so much, Mr. Chairman and committee members,
and I look forward to hearing from our witnesses.
Chairman Garrett. Thank you. The gentlelady yields back.
Mr. Huizenga for 1 minute, please.
Mr. Huizenga. Thank you, Mr. Chairman, and Ranking Member
Maloney.
Since 2006, the Securities and Exchange Commission has
highlighted the merger and acquisition broker proposal as one
of its top recommendations to help small businesses. However, 7
years later--count them, 7 years later--the SEC has not acted
on this recommendation. I have been working with a constituent,
Shane Hansen, who has been very involved in this, who had
testified earlier, and that is why I, along with
Representatives Brian Higgins and Bill Posey, introduced H.R.
2274, the Small Business Mergers, Acquisitions, Sales, and
Brokerage Simplification Act.
This bipartisan legislation would create a simplified SEC
registration system for brokers performing services in
connection with the transfer of ownership of smaller, privately
held companies. It has been estimated that approximately $10
trillion, that is trillion with a ``T,'' of privately owned
Main Street mom-and-pop type businesses will be sold or closed
as baby boomers retire. We don't want them closed, we want them
sold so that they can continue. We must streamline and simplify
the regulatory structure so small and midsized businesses are
able to safely, efficiently, and effectively sell their
companies while preserving and protecting jobs at these
companies.
Thank you, Mr. Chairman. I appreciate the time.
Chairman Garrett. The gentleman yields back.
The gentleman from Georgia for 2 minutes.
Mr. Scott. Thank you, Mr. Chairman.
I think it is very important for us to understand why the
BDCs were put together in the first place. Back in 1980,
Congress created the BDCs as a specialized type of closed-end
investment company whose primary goal is to invest in and
provide managerial assistance to small and growing and
financially troubled domestic businesses. Today, there are 68
active BDCs with the total assets of $53.7 billion, and the
BDCs are required to invest 70 percent--70 percent--of their
funds in what are called eligible portfolio companies. These
are private companies or publicly held companies with a public
float of less than $250 million, and an eligible portfolio
company does not include mutual funds, hedge funds, or other
private funds. But the BDCs do have a broader discretion
regarding the remaining 30 percent of funds, so they are quite
flexible.
Another feature of the BDCs is that they are also required
to provide significant managerial assistance to eligible
portfolio companies, which can include providing guidance on
management, business operation of the company, and exercising
or controlling influence over the company. And because they are
publicly traded, BDCs provide a unique opportunity for retail
investors to invest in private companies.
But I do have one concern here, and I hope that the
committee, as we go forward on these three bills with our
assessment of the BDCs and questions of how we can reduce
barriers of capital formation through legislative means, that
we must be mindful of how such adjustments that we might make
might inadvertently divert capital away from the small growing
businesses that the BDCs were originally created to help. As
always, the hallmark of this committee is the delicate balance
that we seek.
Thank you, Mr. Chairman.
Chairman Garrett. And I thank the gentleman. The gentleman
yields back.
Mr. Mulvaney is recognized for 1 minute.
Mr. Mulvaney. Thank you.
As the chairman noted, the purpose of today's hearing is to
investigate the possibilities of reducing impediments to
capital formation. And along those lines I am appreciative of
the opportunity to include in the discussion today H.R. 1973,
the Business Development Company Modernization Act, a fairly
simple bill. For some reason back in 1980, the last time we
changed this, we limited BDCs and their ability to invest in
financial services companies. They can only invest 30 percent
of their capital in those businesses.
I imagine that might have made sense in 1980. I have no
idea why it would make sense today. These are companies that we
excel at as Americans, excel at in their ability to employ
people, to grow businesses, and I am interested in trying to
see us get rid of what is admittedly an arbitrary cap. So I
appreciate several members of the panel today who have said
favorable things about H.R. 1973. I look forward to continuing
that discussion today because I think it is a great opportunity
for us to do exactly what we have talked about, which is
improving capital formation.
With that, I thank the chairman for the opportunity.
Chairman Garrett. And I thank the gentleman for his
legislation and for yielding back.
And the last word on this will be Mr. Duffy for 1\1/2\
minutes.
Mr. Duffy. Thank you, Mr. Chairman, and I appreciate the
panel taking time out of their day to provide testimony to the
committee. I have been working on legislation with the
gentleman from Delaware, Mr. Carney, that would establish a
pilot program that would allow emerging growth companies to
trade at 5 and 10 cent increments. Why? We all know that
America's number one job creators, our small businesses, still
need help. Congress put aside partisan differences last year
and passed the JOBS Act, which removed a number of barriers to
raising capital to start a business. It is only logical that
the next step is to help improve the liquidity of emerging
growth companies once public.
This is the main purpose of our proposal. It is no secret
that the number of U.S.-listed IPOs raising less than $50
million has declined since the 1990s. Then, there were
typically more than 100 such IPOs. Last year, there were less
than 10.
Further, when the SEC implemented decimalization, larger
companies saw an influx of investors, while our smaller
companies saw their liquidity decrease. I believe that this
issue can be partially remedied through reforms to our tick
sizes for our small cap companies.
I look forward to all of your comments on how we could
create better liquidity with increasing our tick sizes. And
with that, Mr. Chairman, I yield back.
Chairman Garrett. And the gentleman yields back, which
concludes, I believe, the opening statements.
And now we can get to the matter at hand. So before you all
begin, let me just remind you that your full written testimony
will be made a part of the record, and you will now be
recognized for 5 minutes. For those of you who have not been
here before the committee before, you have a warning light that
is in front of you: it is green when you start; yellow when it
gets down to the last minute; and red when your time is up.
I also will probably ask each and every one of you to make
sure that you bring the microphone closer to you than it is for
just about everyone right now, since the microphone is very
sensitive to that.
So with that being said, I now recognize Mr. Abshure, the
Arkansas Securities Commissioner, testifying on behalf of the
North American Securities Administrators Association. Thank
you, and welcome to the panel.
STATEMENT OF A. HEATH ABSHURE, ARKANSAS SECURITIES
COMMISSIONER, ON BEHALF OF THE NORTH AMERICAN SECURITIES
ADMINISTRATORS ASSOCIATION
Mr. Abshure. Good afternoon, Chairman Garrett, Ranking
Member Maloney, and members of the subcommittee. I am Heath
Abshure, Arkansas Securities Commissioner. Until earlier this
month, I was also the president of the North American
Securities Administrators Association, or NASAA, the
association of State and provincial securities regulators.
Prior to serving NASAA as president, I served as the
chairman of both NASAA's Special Committee on Small Business
Capital Formation and NASAA's Corporation Finance Section. In
addition, since 2011, I have served as an observer member of
the SEC's Advisory Committee on Small and Emerging Companies,
which has recently considered a number of the same questions
that will be examined at the hearing today.
I personally have a deep interest in small business finance
and capital formation, and I am honored to testify for a second
time before this subcommittee about these issues. In 2011, I
testified before this subcommittee and expressed concern about
many of the policies in the JOBS Act, including legislation
directing the SEC to lift the ban on general solicitation in
private securities offerings and to legalize equity
crowdfunding. I remain deeply concerned that some of the
policies enacted under the JOBS Act, including in particular
the lifting of the ban on general solicitation in Reg D, Rule
506 offerings, will be detrimental to investors and ultimately
to the companies that rely on this method of capital formation.
The SEC is currently considering a number of proposed
amendments to the general solicitation rule adopted in July
pursuant to Section 201 of the JOBS Act. State securities
administrators strongly support many of the proposed
amendments, and we consider it particularly essential that the
Commission move swiftly to adopt the requirement that Form D be
filed prior to the use of general solicitation.
Today, the subcommittee is considering a number of new
bills related to capital formation. NASAA's view regarding this
new collection of bills is mixed. NASAA supports a number of
these proposals, especially the proposed Small Business
Mergers, Acquisitions, Sales, and Brokerage Simplification Act
sponsored by Congressman Huizenga. NASAA also understands the
need for some delay or regulatory forbearance for small
businesses that may be struggling to meet the SEC's requirement
that certain filings be made using Extensible Business
Reporting Language.
At the same time, NASAA has concerns with other legislation
pending before the committee today. Most notably, NASAA is
troubled by the proposal to further expand what are basically
new, untested regulatory carve-outs for emerging growth
companies. NASAA is additionally dismayed by proposals to
increase leverage limits with respect to the investment
activities of business development companies and strongly
opposed to allowing BDCs to invest in financial services
companies, including investment advisers. In our view, such
policies would invite problems such as conflicts of interest,
dilution of common shareholders, and investment risk due to
lack of transparency. These policies would turn BDCs into
speculative hedge funds for unsophisticated, nonaccredited
investors.
In addition, NASAA cannot help but observe that competition
from financial services firms will not benefit traditional BDC
portfolio companies, meaning small operating companies that
produce goods or provide services. If Congress were to enact
such changes, the result would be that small businesses which
create jobs in the real economy would be forced into
competition with financial firms for BDC capital. This would
frustrate the subcommittee's goal of spurring job growth. BDCs
were initially created for the purpose of providing capital to
domestic small and medium-sized businesses that participate in
the real economy and not jobs in the financial services
industry.
Finally, there are some bills before the subcommittee,
including notably Congressman Duffy's bill dealing with tick
sizes, on which NASAA does not have a strong stakeholder
interest. In discussing these bills, I will offer my own
personal observations based on my experience as a securities
regulator, as well as the many discussions I have had with
other regulators, academics, and industry participants as part
of my work on the Advisory Committee.
Thank you again, Chairman Garrett and Ranking Member
Maloney, for the opportunity to appear before the subcommittee
today. I would now be pleased to answer any questions you may
have.
[The prepared statement of Commissioner Abshure can be
found on page 42 of the appendix.]
Chairman Garrett. And the gentleman yields back. Thank you.
Mr. Arougheti is now recognized for 5 minutes. And welcome
to the panel.
STATEMENT OF MICHAEL J. AROUGHETI, CHIEF EXECUTIVE OFFICER,
ARES CAPITAL CORPORATION
Mr. Arougheti. Chairman Garrett, Ranking Member Maloney,
and members of the subcommittee, thank you for the opportunity
to testify today. I am Michael Arougheti, the CEO of Ares
Capital Corporation, a BDC that has invested more than $14
billion in more than 450 small and medium-sized companies,
creating tens of thousands of American jobs.
Congress created BDCs in 1980 to encourage capital flows to
small and medium-sized business at a time much like today when
these businesses had limited options for securing credit.
Uniquely, the BDC model allows ordinary investors to
participate in this process, effectively Main Street funding
Main Street.
I have been asked today to testify on behalf of the BDC
industry to express my support for the three pieces of proposed
legislation, and I think it is important to note that the BDC
industry is not seeking any government or taxpayer support or
subsidy.
Many of the challenges faced by BDCs arise out of their
peculiar place in the regulatory framework. BDCs are more akin
to operating companies and commercial finance companies than
mutual funds. We are a proverbial square peg in a round hole.
Three bills have been introduced into the House regarding
BDCs. H.R. 1973, introduced by Congressman Mulvaney, offers
welcome flexibility for BDC investment in financial
institutions and finance companies. For example, a BDC
investing in a growing leasing company might have to curtail
useful lending to small business because of a limit that in
context feels quite arbitrary.
H.R. 31 and H.R. 1800 contain 4 nearly identical provisions
which we believe illustrate the significant bipartisan support
for these initiatives. First, both bills propose an increase in
the BDC asset coverage test from 200 percent to 150 percent. We
don't believe that this introduces more risk. Rather, it should
broaden the universe of potential borrowers and allow BDCs to
invest in lower yielding, lower risk loans that don't currently
fit in our economic model. In fact, the current asset coverage
test may ironically be forcing BDCs to invest in riskier,
higher yielding securities in order to meet the dividend
requirements of its shareholders.
We also believe that this change will grant borrowers
greater financing alternatives at a reduced cost and will
benefit shareholders with more conservative diversified
portfolios. This proposed change would apply to BDCs the same
leverage ratio as small business investment companies, but
unlike SBICs, without putting any government capital at risk.
In fact, I also believe that this is extremely modest relative
to typical bank leverage, which can exceed 10 times or greater.
Under the current asset coverage test, most BDCs currently
operate at leverage significantly less than allowed. A prudent
manager would likely continue this practice if the asset
coverage were to change.
Second, both bills would allow BDCs to treat preferred
stock as equity rather than as debt. Had BDCs been able to
raise capital during the post-2008 period by issuing preferred
shares as equity, many more loans could have been made and many
more jobs created.
Third, both bills direct the SEC to make specific technical
amendments to certain securities offering rules that make
raising capital cumbersome and inefficient. These rule changes
aren't controversial and would merely place BDCs on equal
footing with non-BDC entities.
And fourth, both bills would restore BDCs' ability to own
registered investment advisers, a right that was inadvertently
structured away.
Importantly, the first two provisions of these bills would
become effective immediately upon passage. The other provisions
will require action by the SEC.
So in closing, we are encouraged by the bipartisan focus on
this important initiative, and we look forward to working with
Representative Grimm, Representative Velazquez, and
Representative Mulvaney, as well as Chairman Garrett,
Representative Maloney, and the rest of the committee in moving
this important initiative forward. Thank you.
[The prepared statement of Mr. Arougheti can be found on
page 58 of the appendix.]
Chairman Garrett. And I thank you.
Mr. Ertel is recognized for 5 minutes. And welcome.
STATEMENT OF J. MICHAEL ERTEL, MANAGING DIRECTOR, LEGACY M&A
ADVISORS, LLC
Mr. Ertel. Chairman Garrett, Ranking Member Maloney, and
members of the Capital Markets Subcommittee, thank you for this
opportunity to explain how today's one-size-fits-all system of
regulating securities broker-dealers adversely impacts owners
of privately held companies who seek professional advice and
business brokerage services to sell, buy, or grow their small
and midsized businesses through privately negotiated
transactions.
Public policy considerations supporting H.R. 2274 go back
to at least 2005 and have been well-documented in the oral and
written testimony submitted by Shane Hansen, securities law
partner with Warner Norcross & Judd, who testified before this
committee on June 12th.
My testimony is based on my experience as co-chair of the
Campaign for Clarity, a profession-wide effort to bring clarity
to the regulation of M&A advisers and business brokers, which
has been led by the Alliance of Mergers & Acquisitions Advisors
and supported by at least 17 other regional, national, and
international associations of M&A advisers, business brokers,
and related professionals. My testimony is also based on my
experience in providing business brokerage and M&A advisory
services to sellers and buyers of privately held businesses
since 2000 and being a small business owner myself.
Since July 2011, I have been a registered representative
with an SEC and State-registered broker-dealer and FINRA
member, but I am not speaking for or representing that firm in
my remarks today. I became a registered rep because in 7 years
of persistent appeals by the Campaign for Clarity, the SEC has
yet to address this critical small business issue through
rulemaking.
For most business owners, the sale of their business is one
of the largest personal financial transactions of their lives,
but something they may do only once. While they may be experts
at managing and growing their own business, they have little or
no experience in preparing their company for sale and getting
it sold and closed. While their attorneys and accountants will
provide valuable advice, astute business owners recognize they
may need an experienced professional to quarterback the entire
multidisciplinary business sale process from start to finish.
Most business sales start with the buyer preferring to
acquire business assets and the seller preferring to receive
all cash at closing. Such a transaction would be exempt from
Federal and State securities regulation. But for a variety of
legitimate business and personal reasons, the structure of the
transaction may morph to one that involves the purchase, sale
of the company's stock or may include an earnout or a seller's
note, any of which could arguably convert this business sale to
a securities transaction. The final deal structure is generally
not known until very late in the business sale process, which
can run for months or even years.
In facilitating the sale of an ongoing business, M&A
advisers and business brokers are not in the business of
selling securities, nor do they raise capital, nor do they hold
anyone's funds or securities, nor do they invest funds for the
account of others. Nonetheless, the current one-size-fits-all
regulatory scheme requires business brokers and M&A advisers to
hold the same FINRA classifications and comply with the same
Federal and FINRA regulations as Wall Street investment bankers
and retail securities brokers.
The cost to organize and operate a FINRA member broker-
dealer for the first 12 months has been estimated at $150,000
to $250,000. For most business brokers and M&A advisers, this
is prohibitive. Since many business brokerage firms and M&A
advisory firms do very few transactions per year, occasionally
none in some years, and since not all transactions are subject
to securities regulation, the cumulative cost attributable to
an occasional securities transaction can be very, very
substantial. Ultimately, these costs must be passed on to the
business buyers and sellers.
In summary, professional and cost-effective business
brokerage services facilitate capital formation and promote
economic growth, job preservation and creation by small and
midsized businesses. 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 disclosure to clients about the
M&A broker similar to those required of investment advisers
today. The bill would direct the SEC to review and tailor
applicable rules to fit this business context. This directive
from Congress to the SEC will ultimately free up 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. Ertel can be found on page
64 of the appendix.]
Chairman Garrett. Thank you.
Next, Mr. Frank. Welcome. You are recognized for 5 minutes.
STATEMENT OF ALEXANDER C. FRANK, CHIEF FINANCIAL OFFICER, FIFTH
STREET MANAGEMENT LLC
Mr. Frank. Thank you. Good afternoon, Chairman Garrett,
Ranking Member Maloney, and members of the subcommittee, and
thank you for the opportunity to speak today. My name is Alex
Frank. I am the CFO and a partner in Fifth Street Management,
with over $3 billion in assets under management and the SEC-
registered investment adviser of two publicly traded business
development companies. Our team has a 15-year track record
financing small and midsized companies, primarily in connection
with investments by private equity sponsors.
BDCs like Fifth Street play an essential role in the new
world of middle market lending. As traditional banks have
pulled away from lending to small and midsized private
businesses, alternative lenders like BDCs have filled the void,
emerging as the primary conduit between banks and smaller
companies that are noninvestment grade credits. Consider that 9
years ago, there were just four publicly traded BDCs. Today,
there are roughly 10 times as many, and we estimate that within
the next few years, BDC assets will exceed $100 billion.
Despite the growing importance of BDCs in helping finance
small and midsized companies in our economy today, the BDC
industry is still operating with legacy regulations that cost
the industry significant amounts of time and money each year.
Since BDCs are pass-through vehicles, that cost is borne not
just by BDC shareholders, but by small businesses we serve.
Several aspects of H.R. 1800 and H.R. 31 could go a long
way towards modernizing the BDC regulatory framework. Shell
filing, incorporation by reference, and treating preferred
equity as regulatory capital will bring parity to the industry
vis-a-vis counterparts like REITs and MLPs. We also support
allowing BDCs to own registered investment advisers as a
shareholder-friendly step that would offer investors
incremental fee-based revenue.
As you can see, I join you today as a proponent of the
proposed rule changes in virtually their entirety. However, as
the CFO of a conservatively managed investment grade BDC, and
having spent 22 years working at Morgan Stanley, including
serving as the firm's global treasurer, I cannot endorse the
move to a 2:1 leverage ratio.
Today, the Securities and Exchange Commission does a highly
effective job enforcing this leverage ratio. I believe the 1:1
ratio and strict SEC oversight contributes to a reputation for
safety that is appreciated by both BDC investors and nationally
recognized rating agencies alike. Permitting 2:1 leverage might
compel investors to reevaluate the BDC model, and retail
investors may not appreciate the higher level of risk they are
taking. And as rating agencies adjust their models, downgrades
could follow. Even those BDCs who adopt a more conservative
approach could be penalized and a noninvestment grade credit
rating would increase a BDC's cost of capital.
I would like to conclude my testimony with a discussion of
effective leverage, which takes into account on a look-through
basis leverage of the underlying assets in which a BDC invests.
In other words, it is important to recognize that BDCs often
provide expansion capital to their portfolio companies, which
are often heavily leveraged themselves.
Effective leverage is an important concept because it shows
the true risk in a BDC's balance sheet. Wells Fargo Securities
estimates the BDC peer group average at 3.5 times equity. But
the most highly leveraged BDCs have effective leverage ratio
estimates over 5.5 times. If the bills are enacted in their
current form, BDCs with already high levels of effective
leverage could essentially double their effective leverage up
to 11 times.
Not all BDCs are alike, and I am also not convinced that
1:1 leverage is precisely the right level. During this period
of high growth and increasing small business reliance on BDCs,
completely removing the safety rails should be reconsidered.
Having reduced the amount of risk in the financial system by
requiring banks to hold more capital to support the risks
associated with lending to noninvestment grade companies, only
to shift that risk to entities like BDCs already operating with
less risk, could significantly undermine the long-term vision
the bill set out to achieve.
Thank you, Chairman Garrett, Ranking Member Maloney, and
members of the committee for allowing me to present my views on
this critically important topic.
[The prepared statement of Mr. Frank can be found on page
104 of the appendix.]
Chairman Garrett. And I thank you for your testimony.
Mr. Wunderlich is now recognized, and welcome, for 5
minutes.
STATEMENT OF GARY K. WUNDERLICH, JR., CHIEF EXECUTIVE OFFICER,
WUNDERLICH SECURITIES, ON BEHALF OF THE SECURITIES INDUSTRY AND
FINANCIAL MARKETS ASSOCIATION (SIFMA)
Mr. Wunderlich. Chairman Garrett, Ranking Member Maloney,
and members of the subcommittee, thank you for the opportunity
to appear before you today to discuss various legislative
proposals to promote capital formation and job creation. My
name is Gary Wunderlich, and I am CEO of Wunderlich Securities.
I am testifying today on behalf of the Securities Industry and
Financial Markets Association.
Wunderlich Securities is an independent investment firm and
full service broker-dealer headquartered in Memphis, Tennessee,
with 28 offices in 16 States employing over 450 people. We
provide a full range of financial services to retail and
institutional clients, including investment banking,
institutional sales, trading, and research.
So on behalf of SIFMA and its member firms, I am here to
express our appreciation for this committee's dedication to a
review of the environment for capital formation.
America's success depends on a vibrant financial system
that provides access to capital and credit at a reasonable
price, and regional firms, such as the one I founded 17 years
ago, play an integral role in our financial services system,
particularly to assist smaller issuers.
Turning to the legislative proposals before us today, I
would like to begin by discussing our views of one area of
capital formation that has been frequently debated over the
past few years: The impact of decimalization on liquidity of
small cap and midcap issuers. Many have suggested that the move
to decimalization has contributed to lower levels of liquidity
in those stocks and that along with other factors has impeded
capital formation for those companies. This question has been
posed in a variety of forums of late, including Chairman
Garrett's recent roundtable, as well as the SEC roundtable on
decimalization.
SIFMA and its members have also been engaged in an active
dialogue about the impact of decimalization on small and midcap
issuers, and we generally believe that a pilot program which
widens quote increments for small and midcap issuers would
increase trading liquidity in those securities.
SIFMA supports a carefully structured pilot designed with
very clear metrics for determining success to increase
liquidity in the small and midcap market and create a more
fertile environment for small and emerging growth companies to
access the public markets. We know that these companies can be
an engine for economic growth, and Congressman Duffy is to be
commended for considering new ways to incentivize interest in
small cap issuers seeking growth.
While SIFMA is supportive of a pilot that explores how a
wider tick size could benefit small cap issuers, we do oppose
any pilot program that would restrict trading within the spread
as the current discussion draft contemplates. Any restriction
against trading inside the quoting increment would be an
unprecedented alteration of market practice and would prevent
broker-dealers from providing price improvement to retail
investors and deter the commitment of capital for market-making
activities.
With respect to market price, trading within the quoted
spread has always been permitted. Before Reg NMS and before the
establishment of the stock exchanges themselves, market
participants have always been able to meet in the middle on a
negotiation over price. Perhaps more importantly, a trading
restriction would have a negative impact on Main Street savers
and retail investors. A consensus of most every market
structure discussion in recent months is that it has never been
better to be a retail investor, as the options for routing
trades have increased, and as a result trading costs have
substantially decreased.
Just a few years ago, the SEC considered and rejected a
trading restriction when it adopted the current penny-wide
quoting increment, concluding that such price improvement
benefits retail investors and is in the public interest. The
SEC's conclusion that it is in the public interest to allow
trading within the spread is as relevant in 2013 as it was in
2005.
Moving on, I would note that SIFMA supports efforts to
modernize regulation of business development companies as
contemplated in the three bills we are discussing here today to
better enable BDCs to fulfill their mission. The BDC structure
was created to promote public vehicles as a means to bring
capital to small and medium-sized businesses, and by regulation
70 percent of BDCs' investments must be in private and small
cap companies.
BDCs offer a critical source of capital to eligible
companies not met in today's environment by traditional
lenders. In fact, Wunderlich Securities has supported the
efforts of some 17 BDCs this year alone resulting in more than
1.3 billion in capital formation.
Further, Congressman Fincher's discussion draft, which
would modify existing regulation of EGCs, is also laudable, and
SIFMA supports each of the four provisions in the discussion
draft. These modifications remove some technical inefficiencies
to the JOBS Act on-ramp so as to reduce uncertainty in
regulatory treatment and allow EGCs more flexibility to launch
their offerings in a timely manner.
In conclusion, SIFMA welcomes your continued interest in
supporting capital formation through appropriate regulatory
relief. Many in government often try to distinguish Main Street
from Wall Street, but the capital allocation function provided
by my firm and thousands of others across this country supports
the creation and expansion of tens of thousands of small
businesses which are truly the backbone of our economy and the
best hope we have for robust job creation moving forward.
Thank you for the opportunity to testify before you today,
and I look forward to your questions.
[The prepared statement of Mr. Wunderlich can be found on
page 174 of the appendix.]
Chairman Garrett. Thank you for your testimony.
From the U.S. Chamber, Mr. Quaadman, welcome.
STATEMENT OF TOM QUAADMAN, VICE PRESIDENT, CENTER FOR CAPITAL
MARKETS COMPETITIVENESS, U.S. CHAMBER OF COMMERCE
Mr. Quaadman. Thank you, Chairman Garrett, Ranking Member
Maloney, and members of the subcommittee for the opportunity to
testify before you today. I would also like to take this time
to thank the subcommittee for its continued leadership in
ensuring that the United States has the deepest and most
efficient capital markets. And I think today's release of the
crowdfunding rules by the SEC, albeit a lot later than I think
a lot of us would have liked, is a testament to the leadership
of this subcommittee.
A free enterprise system needs diverse capital markets.
Capital is the fuel that drives our economic engine and
different businesses have different financing needs. Filling
those needs is a dynamic marketplace in response to an ever-
changing economic, legal, and regulatory landscape. The 2008
financial crisis has had obvious impacts upon Main Street
businesses.
To take one example out of Dodd-Frank, there is going to be
a comment period that closes next week on credit risk
retention, that if the rule is not properly implemented,
collateralized loan obligations, which finance businesses to
the tune of $300 billion, could no longer be an attractive form
of capital formation. Basel III is having direct impacts on
business lending by small and midsized banks, and Basel III
also specifically disincentivizes the extension of commercial
lines of credit by banks.
The bipartisan legislation that is being presented here
today by the committee, which the Chamber supports, is keeping
pace with those dynamic markets and is not lagging behind it.
Business development corporations are filling a void and
are a growing source of financing for small and midsized
businesses. As businesses are looking to be acquired rather
than go public, the extension of reporting requirements and
easing of reporting requirements for merger and acquisition
brokers is key. The tick-size pilot program is an experiment to
increase liquidity and look at regulatory innovations through
factual evidence. The XBRL exemption, as well as security laws
changes for emerging growth companies, are building upon the
IPO on-ramp created by the JOBS Act.
However, we do have suggested improvements to these bills.
With business development corporations, as has been stated
before, they are close-ended funds that are open to retail
investors and not just accredited investors, and they have
higher yields, as well as higher risks. We believe that the
SEC, in developing implementing regulations, should be directed
to reexamine disclosures so that investors know what they are
investing in.
With XBRL, we believe that the rule 406T grace period
should be extended for 2 years for large issuers and 5 years
for smaller issuers. We also believe that there should be a
requirement for an annual SEC report to Congress on the SEC's
progress on XBRL, the cost to businesses for XBRL
implementation, the use of XBRL by investors, and that there
should also be a report by the SEC to periodically report to
Congress on the retrospective review of obsolete and
unnecessary disclosures.
To give one example that I have in my testimony, one
Federal agency, working under the auspices of President Obama's
regulatory reform executive order, took 120 outdated
regulations off the books on May 17th, and that was the Federal
Communications Commission, some of those regulations dating
back to the 1930s. With tick size, we believe that there should
be a safe harbor from litigation so that as directors and
management decide on a tick size, it is recognized that they
are operating within their fiduciary duty for the best
interests of the corporation and that they should not be
subject to unnecessary litigation.
With emerging growth companies, we believe that Rule 701
should be modernized so that the dollar limit on private
offerings may conform to the JOBS Act section 12(g) changes. So
while the JOBS Act changed the number of investors that could
be subject to private offerings, the $5 million limit that was
put in place by the SEC in 1988 no longer is indicative of the
market forces, so if you even just change that for inflation,
that number today would be $10 billion.
There is a cost of inaction if these bills are not passed.
If these bills are not passed, we will see continued economic
underperformance, sluggish job growth, and business caution. If
these bills are passed, combined with the implementation of the
JOBS Act, we can break that cycle and stoke the smoldering
engines of growth.
Thank you, Mr. Chairman. I am happy to take any questions
you have.
[The prepared statement of Mr. Quaadman can be found on
page 108 of the appendix.]
Chairman Garrett. And I thank you, Mr. Quaadman.
And finally, Mr. Weild is recognized for 5 minutes. And
welcome to the committee as well.
STATEMENT OF DAVID WEILD, FOUNDER, CHAIRMAN, AND CHIEF
EXECUTIVE OFFICER, ISSUWORKS
Mr. Weild. Thank you, Mr. Chairman. Chairman Garrett,
Ranking Member Maloney, and members of the subcommittee, thank
you for inviting me to speak today on legislation to further
reduce impediments to capital formation. My name is David
Weild. I am chairman and CEO of IssuWorks Holdings, which was
recently founded to develop technologies to improve capital
formation in the public markets. I was formerly vice chairman
of the NASDAQ stock market with responsibility for all of its
listed companies, and I ran the equity new issues business at
Prudential Securities back when Prudential Securities was one
of the 10 largest underwriters in the United States.
Improving access to equity capital in the United States is
simply one of the most important needs for our economy. It
fuels job growth and innovation, which in turn enables free
markets to solve problems from poverty to unemployment to
finding cures for cancer, global warming, and many of the other
challenges that this generation and every other generation will
face.
I would like to start by thanking you for the terrific
bipartisan work that culminated with the signing into law of
the JOBS Act on April 5th of 2012, but while the JOBS Act
created the so-called on-ramps to facilitate companies getting
public, it did nothing to improve the after-market for these
companies and their investors. So one might legitimately ask,
have we created the on-ramp to nowhere?
We are generally supportive of all of the bills in this
group and our specific comments are contained in our written
testimony. We have included other recommendations on capital
formation and job growth in our written testimony and we hope
that this committee will take it under advisement. However, I
would like to focus on Mr. Duffy's bill because it speaks to
after-market support, and without after-market support for
small cap equities, the U.S. economy will languish.
Our listed stock markets are in the midst of a protracted
collapse, and I call your attention to data which is contained
in our statement that was recently compiled by the CFA
Institute's Jason Voss. The United States today has fewer
publicly listed companies than at any point since all the way
back to 1975. In fact, we have fewer than 4,900 publicly listed
companies. We have lost half of them from the markets. And we
should have, if we hadn't done anything to market structure in
the 1990s, closer to 13,000 publicly listed companies.
We published a study for the Organization of Economic
Cooperation and Development in July, and in it we found that
the United States has the lowest after-market incentives of any
of the 26 largest IPO markets in the world. Very simply, we are
starving our markets. Consumer activists who promote low-cost
trading in stocks are promoting fool's gold. There is no free
lunch. In fact, low-cost trading in illiquid stocks harms
consumers by depriving them of higher disposable incomes while
wreaking havoc on the lowest socioeconomic classes of our
society. It also seems obvious that the great growth companies
of tomorrow, those very companies that will find the cure to
Alzheimer's and global warming and advance the technologies for
sourcing renewable energy, need a United States IPO market that
is as vibrant as it used to be when companies like Intel,
Microsoft, and Amgen went public. We are doing 135 IPOs since
the end of the dot-com bubble. We were doing over 500 a year
before the dot-com bubble, and on a GDP-weighted basis we
should be doing closer to 900 IPOs a year today.
So we not only support this bill, we hope that this bill
will, in addition to 5 and 10 cent tick-size increments within
nano-cap stocks defined as stocks under $100 million in market
value, consider a 20 cent tick option. The bill should require
that trading be done only at a minimum tick-size increment, not
within the tick size.
And I am going to take issue actually with the SIFMA
testimony in this regard because much of that is a view that is
proffered by dark pool interests with the larger firms. You
have to be very careful not to gut the tick-size incentives and
takeaway by allowing people to trade within the economic
incentive and to actually take away the inventive for smaller
firms to provide value, which is research, capital, commitment,
and sales support to these stocks. There should also be no
payment for water flow allowed that would make a mockery of the
intent of this structure.
Higher after-market incentives through higher tick sizes
will lead to more liquidity, which will bring more
institutional investment, which will raise stock prices in
smaller stocks, and lead to more IPOs and more job creation
that will grow the U.S. economy. Today, there are already fewer
than 3,700 operating companies in the Wilshire 5000 index.
So with this in mind, we urge Congress to come together and
get behind this bill and give Americans an on-ramp to
prosperity. Thank you, Mr. Chairman.
[The prepared statement of Mr. Weild can be found on page
154 of the appendix.]
Chairman Garrett. And thank you for your testimony.
I welcome everyone, and thank you all for your testimony.
At this point, we will turn to questions, and I will recognize
myself for 5 minutes. I will just start with Mr. Abshure.
Do you see any benefits, either in jobs or benefits to the
economy, for financial services investment companies, financial
institutions?
Mr. Abshure. I guess I am--
Chairman Garrett. I say that, because your opening comments
were opposed to the legislation that is before us today that
would expand for the asset classes the type of assets that they
may invest in?
Mr. Abshure. The type of asset classes that BDCs could
invest in.
Chairman Garrett. Yes.
Mr. Abshure. Do I see a benefit of BDCs investing in
financial services companies?
Chairman Garrett. Do financial services companies not
provide the economy with growth to the economy? Do they not
provide the economy with new jobs and the like?
Mr. Abshure. They invest in companies that do that. But if
you already have--
Chairman Garrett. But they don't provide them jobs and what
have you in amongst themselves?
Mr. Abshure. Not in the way that BDCs were designed. You
have a carve-out specifically for BDCs that was designed for
small companies, startup companies, and financially distressed
companies. And then you have that mechanism for unaccredited
investors to invest in those companies. Financial services are
something different. And my point is, if you allow BDCs to
invest in financial services companies that are, in turn, going
to be a conduit for that capital to go somewhere else, you have
just inserted a second step that provides no benefit but more
cost. If BDCs can invest in what a financial services company
can invest in, why do they need to be there?
Chairman Garrett. Okay. I see your point. You are
suggesting that we are not getting any benefits from those
financial institutions in and amongst themselves. I would
disagree with that.
Turning to the questions that Mr. Weild was talking about,
you seem fairly passionate about the issue of the--I guess on
the Duffy language and the trade-out rule. In your testimony,
you said trading should be done only at the ``outer bounds of
minimum tick size increments, not within the tick increment.''
And you go on to say this may be controversial.
First, why do you say that may be controversial?
Mr. Weild. We don't trade stocks, so we don't have a horse
in this race. I can step back and I think be objective.
There are lots of interests right now that provide so-
called price improvement to investors, a tenth of a penny,
something that is relatively trivial. Large cap markets can
perform very well because there are lots of buyers to offset
sellers. There is a network effect. It is what academics will
call symmetrical order book markets. But in small cap markets,
which are asymmetrical--big buyer, no seller; big seller, no
buyer--somebody has to provide value capital, and they have to
provide salesmen to find the other side of the order. So you
need an economic incentive to do that, and the minute they
start trading within the tick size, the market devolves and it
starts competing exclusively on price, so the whole thing
starts to fall apart again.
So I don't think it will work, Chairman Garrett, in my
view, and I think that if you give people a real nickel, and
everybody trades, say at 10 by 1005, then what it will do is it
will cause the firms to think about how to provide value to
attract order flow, to create order flow, and it will start to
bring capital into these micro-cap markets, lift them, which
will then make them more attractive to move market IPOs into.
Chairman Garrett. So if we do something along the lines of
setting--I will open this to you and other members, Mr.
Wunderlich, if you wanted to join in--if we do something along
the lines of setting of a pilot program, are there ways to do
it such that you could set up measurement matrices to actually
measure what you are talking about, and also measure liquidity
in the marketplace on this?
Mr. Weild. Sure. You could set up different baskets of
stocks where you actually test where you have pull sanctity to
the tick size, where you allow maybe even, it has been said
trade at one price point within the tick size so that, for
instance, if it was a nickel tick, you can trade at 2.5 cents,
but that is it. And then, sort of the status quo. And you could
test three buckets.
You have to be careful though because Wall Street sometimes
can be very crafty and they can ``paint the tape,'' to use an
old term.
Chairman Garrett. What do you mean?
Mr. Weild. Meaning that you can have some interest that if
you have a basket of 100 stocks, that if they want to
demonstrate that there is more volume in one particular size,
they may actually push volume through one pile, which could be
very careful to control.
Chairman Garrett. Yes, okay.
Mr. Wunderlich, do you want to join in on that?
Mr. Wunderlich. Our position, SIFMA's position is that
there is value in the off-exchange pools and there is price
improvement that we think is very demonstrable. Any restriction
or prohibition on trading, on free market trading, we think
would be a deterrent and distort actual market valuation and
efficiency.
I can speak on behalf of Wunderlich Securities. In my firm,
we are market makers. Our market-making activities have come
way down from when decimalization was put in place. And a part
of it is, so it is not, ``Wall Street trying to make more
money,'' it is managing risk. And so if I know now I have to
trade at a nickel, or a dime, or even 20 cents, I am less
likely to commit as much capital to market-making activities as
I would if I knew that I could negotiate a price as a buyer and
seller.
Mr. Weild is right in that it can be a somewhat inefficient
market, certainly without market makers. There are large buyers
at some times and a few sellers, and there are large sellers
and sometimes a few buyers. And market-making activities which
we would undertake are to facilitate those orders. We could
potentially take one side of that trade in order to facilitate
an order from a customer who had a position, whether buying or
selling. But we are less likely to do that if we are being
prohibited or restricted on how we can liquidate that position.
Chairman Garrett. How you do the trade--yes? I can keep on
going on this, but my time is up. And before I yield to the
gentlelady from New York, I would just like to recognize the
former chairman of the Financial Services Committee, who is not
only looking at me in the face now, but is also looking over my
shoulder as well, and welcome Chairman Oxley.
It is good to be with you again.
And of course I should point out that he is one of the
reasons why I am even on this committee here in the position I
am in today, so thank you for that as well, Mr. Chairman.
At that, I will yield to the gentlelady from New York.
Mrs. Maloney. I likewise would like to recognize the
gentleman who is literally on the wall, usually in the
chairman's seat. It is very good to see you again, Chairman
Oxley. It is wonderful to see you.
I would like to start with Mr. Frank. You testified that
basically, allowing BDCs to double their leverage would magnify
the risk to shareholders, which are often retail investors.
Mary Jo White, the Chair of the SEC, shares your concern in a
letter that arrived today, and I would like to ask unanimous
consent to make that letter a part of the record.
Chairman Garrett. Without objection, and it should be
indicated that this is a letter with which I am familiar. This
is a letter from Ms. White in her individual capacity and not
from the SEC.
Mrs. Maloney. Right.
Chairman Garrett. Without objection, it is so ordered.
Mrs. Maloney. Thank you.
And I would like to know, do any other panelists agree with
Mr. Frank's position on this issue? Does anybody else agree
with him? No one else does? Does anyone disagree with him, and
would they like to give their position? Mr. Arougheti?
Mr. Arougheti. I would be happy to, for a counterpoint.
First of all, representing the BDC industry today, to my
knowledge, I think Fifth Street is the only member of this
growing industry who has come out in opposition of an increase
in leverage or a change in the asset coverage ratio. I have
difficulty reconciling that with the fact that they also signed
a letter of support for the proposed legislation with a host of
other industry participants that came from the SBIA to the SEC
a couple of weeks ago.
In order to really understand this, I think it is important
to just maybe take a step back and understand how the assets
that BDCs invest in are already getting leveraged in the market
and how the market participants are thinking about the
increased risk.
First, I think it is also worth clarifying that about 40
percent of investors in BDC stocks today are sophisticated
institutions and not retail, and it may be a misconception that
retail investors are driving growth in the BDC space.
If you look at BDC balance sheets today, BDCs, depending on
who you are, pursue different business models. Some BDCs invest
in riskier mezzanine loans, which on their face are not
leverageable due to their higher risk, and to use Mr. Frank's
language, have a higher effective leverage and therefore will
not command leverage at the portfolio level. Other BDCs, such
as ourselves, pursue a less risky strategy focusing on senior
secured loans, which by definition carry less risk and
therefore can command greater leverage. So the idea of leverage
of loan collateral is something that is well-documented and
already in practice in the BDC space in the financial services
industry generally.
To put a finer point on that, leverage in the BDC industry
today is about 50 percent provided by banks. To use Ares as an
example, we have about $2 billion of leverage that we get from
the banking community, from notable lenders such as JPMorgan,
Merrill Lynch, and Bank of America, et cetera, and we have 50
percent of our leverage that comes from the institutional debt
markets.
If you drill down into how the underlying documents work
for these loan agreements, you will see that there are actually
borrowing bases that are already in place where the bank
lending community has assigned different risk to different
asset classes that BDCs invest in, and based on that perception
of risk have a willingness today, as does the institutional
market, to either increase leverage on lower-risk assets or
decrease leverage on higher-risk assets.
So I think the mechanisms are already in place. The
overarching constraint is the regulatory restriction on
leverage. So I don't believe that leverage in and of itself
means increased risk. I think the markets have reached a level
of complexity and sophistication today to handle the
differentiation between low-risk assets and high-risk assets. I
think to not allow a change in the asset coverage ratio flies
in the face of the policy mandate that BDCs were created for
today, which is to make sure that we can get capital to small
companies and grow jobs.
Mrs. Maloney. Mr. Abshure?
Mr. Abshure. I just wanted to make sure, apparently I
didn't nod my head sufficiently vehemently enough. State
securities regulators share the concerns voiced by both Mr.
Frank and Chair White in her letter. However, I don't feel that
I could put those concerns anywhere near as eloquently as Mr.
Frank and Chair White did.
Mrs. Maloney. Mr. Quaadman?
Mr. Quaadman. Ms. Maloney, I think one is the change in
leverage from 1:1 to 2:1 is actually a modest change in
leverage. If you look at a well-capitalized bank, obviously
there are different companies, but a well-capitalized bank has
a leverage ratio of 7 or 8 to 1. So one is, that change
actually will allow BDCs to provide more liquidity. The SEC
also has a number of different tools at its disposal to see if
the BDC is acting properly, is being an appropriate, active
participant. And that is also one of the reasons why we ask for
more disclosures for investor protection.
Mrs. Maloney. Mr. Chairman, my time has expired, but may I
ask for a few seconds for Mr. Weild to respond? His hand was in
the air.
Mr. Weild. Thank you. We actually commented on this in our
written testimony, and we just said that a higher leverage
ratio my boost yields to investors and result in an increase in
share price values. And we had actually called for some
scenario analysis, some stress test analysis. Because these are
already fairly highly leveraged businesses. It is the mezzanine
debt finance market, debt plus warrants, and to understand in
an inverted yield curve environment to where, in a deep
recessionary environment how these portfolios are going to
perform, I think would be only prudent. We are not averse to
going to 1.5:1, but we would just like more information on how
the portfolios would perform.
Mrs. Maloney. My time has expired. Thank you.
Chairman Garrett. All right. And I would just ask you to
maybe provide us some measurement tools on how you would do
that, how we would gather that information.
But with that, I will yield now to Mr. Hurt for 5 minutes.
Mr. Hurt. Thank you, Mr. Chairman.
I want to thank each of you for your testimony here today
and for the work of our colleagues in trying to improve access
to our capital markets.
My questions relate, as I said in my opening statement, to
the XBRL. And I want to say how much I appreciate the useful
comments made by the Chamber as it relates to this issue.
With that in mind, Mr. Quaadman, I was wondering if you
could talk a little bit about what the benefits are of XBRL in
the big picture? You point out in your testimony that perhaps a
2-year delay in the compliance might be a good idea. I am
wondering, what are the benefits and how would a delay be
consistent with those benefits?
Mr. Quaadman. Sure. There would be a number of different
benefits with a delay. One is that XBRL is still a work in
progress, and the whole theory behind XBRL is that you are
going to move away from a paper-based system to a digital-based
system, and then investors can pick and choose what information
they want to analyze a company with.
The problem is the SEC has, quite frankly, had a number of
different problems with getting this off the ground. Some of
the exemptions that we are talking about actually allow
companies that are in XBRL to furnish instead of file reports
under XBRL, and that is important because if it is furnished
there is no liability; if they are filed, there are.
So the reason why we are asking for a delay is, one, is to
get the SEC's house in order, to get the system up and running
as best as they can. The other issue, and this is the reason
why we asked for reports, is it is also important for Congress
and the SEC to know how exactly are investors using XBRL, are
they using it or not, and currently they really aren't.
Mr. Hurt. Right, and why is that?
Mr. Quaadman. Because they think there are a number of
different sources that are out there that investors can use to
access information if they like. It is available in a number of
different sources and formats. Theoretically, if you can get
them all in under XBRL at the SEC, it will make it easier. It
will be one-stop shopping. That just hasn't existed. So it is
sort of the savvy investor who knows where to find the
information can get it now; others can't.
Mr. Hurt. Okay. And you mentioned this, I think there is a
study that shows that less than 10 percent of investors use the
system at all.
Mr. Quaadman. That is correct.
Mr. Hurt. And I think it must go without saying that there
is already an obligation. To the extent that SEC should promote
transparency, I think we would all agree that is one of the
cornerstones of our capital markets and the SEC's fundamental
mission.
But with that said, these issuers have that responsibility
going forward. It is not like they can, without XBRL, somehow
have some added incentive or added ability to hide information.
Is that a fair statement?
Mr. Quaadman. That is correct. And the challenge that has
existed, and there has been a frustration in the issuer
community on this, the SEC has had a concept release out now
for over 3 years on how to overhaul proxy plumbing systems. And
this actually goes back to XBRL as well, because all of the
systems in terms of how you report these issues, the
disclosures, the corporate governance issues, they are all
rooted in a 1930s technology, and the SEC has sort of just
allowed this to languish. So XBRL to some degree is a little
bit of a symptom, but there is a disease out there, and we need
to overhaul these systems into the 21st Century.
Mr. Hurt. The Chair of the SEC has talked about disclosure
overload. We think about the benefits and what we hope that
XBRL will bring, or what the SEC hopes it will bring to the
table, but there are real costs to this for issuers and
potential issuers. That is what we have heard certainly through
our work on this as we have talked to folks about this issue.
Would you agree with that?
Mr. Quaadman. Yes. The disclosure overload harms both
investors and issuers. So if you look at disclosures today,
they are well over 100 pages and probably at least double what
they were 15 years ago. And if you looked at disclosures in the
1950s, you could have had a concise report that was 6 pages
long. So the problem is, it is more difficult for companies to
communicate with their investors. The investors just have
information dumped on them and it is difficult for them to sort
through what they think is actually material or not.
And that actually gets to the core of the issue, is that
the SEC--and this is what Chair White was also referencing in
her speech--has moved away from what is material to investors.
And the more we have moved away from that, the more inefficient
the capital markets become. So we need to reorient the reports
in a readable format, we need to make the information in there
more material, and therefore there can be actual real
communications between companies and their investors.
Mr. Hurt. Excellent. Thank you for your answers. My time
has expired.
Chairman Garrett. The gentleman's time has expired.
The gentleman from California is recognized for 5 minutes.
Mr. Sherman. Thank you, Mr. Chairman, and thanks for this
series of hearings because it is very important that we get
capital, particularly to small business.
Without objection, I would like to enter into the record a
letter from NAFCU, the National Association of Federal Credit
Unions, dealing with the role that they can play in financing
small businesses if we were to make a few changes in the laws
regulating credit unions.
Chairman Garrett. Without objection, it is so ordered.
Mr. Sherman. Previously entered into the record is a letter
from the Chair of the SEC, and I would like to highlight on
page 4 of that letter a statement that two of the bills, one of
which would amend Section 60 and permit BDCs to purchase
securities issued by registered investment advisers, and
another one that would direct the Commission to revise certain
rules under the Securities Act of 1933 to put BDCs on parity
with other issuers that are required to file certain reports
with the SEC under the 1934 Act. The chairman says that in her
view these provisions do not raise significant investor
protection concerns, so we should congratulate the authors of
those two bills.
Mr. Frank, there are two possible changes dealing with BDCs
that would increase the upside and downside risk to those who
invest in the common shares of the BDC. One would open the door
to more issuance of preferred stock. The other would allow
greater leverage. And I can see how you wouldn't want to harm
the brand name of BDCs among retail investors. They are looking
for a moderate level of risk and here is an opportunity to have
more risk, both upside and downside.
Should we create a new designation, the high-leverage BDC,
that would be allowed to get the benefit of those preferred
share issuances and the higher leverage, and in that way just
let investors know that you can invest in a regular, old-
fashioned BDC or you can invest in the Ferrari that might
crash? Would that solve the problem allowing some BDCs to go
Ferrari style and some to be, what should I say, a Volvo with
lots of air bags?
Mr. Frank. No, I don't think it would. But first, I would
just like to say that I think that allowing BDCs to include in
their capital structure some level of preferred equity, which
had the appropriate characteristics around capital permanence,
is not something that we would think is necessarily imprudent
and probably there is a place in the capital structure for
that.
Mr. Sherman. But you would object to the idea of having
high-leveraged BDCs identified as such, allowed to have
different coverage ratios than regular BDCs? You would object
to that?
Mr. Frank. I would, yes. I think that would introduce a
level of complexity in the industry that would--it is already a
fairly complex structure for investors, particularly retail
investors to understand, and I also think that--
Mr. Sherman. I have to reclaim my time because I have other
questions on other issues. We are dealing with so many issues
here.
Mr. Quaadman, XBRL software, why does it cost $20,000 per
filing for even a small company to use that software?
Mr. Quaadman. I don't know the reason for why it costs that
much. But--
Mr. Sherman. Excel is free.
Mr. Quaadman. I think you just made the point right there.
Mr. Sherman. Could the solution to this be to not exempt
smaller companies from using it, but to make sure that the
charge for using it is closer to $1,000 a filing rather than
$20,000 a filing?
Mr. Quaadman. I would hope that with the length of time
that can be done to get this right, we would have costs that
are much more realistic. We need to go to some digital-based
form of reporting, but we need to do it right and the SEC needs
the time to get it right.
Mr. Sherman. So we might have a circumstance where we would
delay a requirement due to the difficulty of government getting
the computer technology right. That is interesting. Thank you.
Mr. Quaadman. Sure.
Mr. Sherman. I yield back.
Chairman Garrett. Yes, there we go. That is right.
Mr. Huizenga for 5 minutes.
Mr. Huizenga. Thank you, Mr. Chairman. I appreciate that.
And I would like to kind of open it up on a couple of
different fronts to a few of you. Under our existing system,
there is a one-size-fits-all approach with SEC registration for
the brokers, and I am curious why you believe the SEC should be
more tailored in its registration system for M&A brokers. I
know Mr. Abshure and Mr. Ertel and a few others had talked
specifically about our bill here.
But, Mr. Ertel, do you want to start off, maybe, and Mr.
Abshure?
Mr. Ertel. Having been through the process of getting the
FINRA certifications to be a registered rep, they really bear
little resemblance to the work that I do in helping a business
owner get his business ready to sell, take it to market
confidentially, sort through the various offers, and work with
the various advisers to get that deal closed. So it poses an
inordinately burdensome level of regulation on a transaction
for which historically there have been very few bad actors,
there have been very few cases where anybody has been injured.
Mr. Huizenga. And we have had testimony before this
committee--Shane Hansen, whom I mentioned in my opening
statement, Alliance of Merger and Acquisition Associates, I
believe that you are advisers, you are familiar with him, he
had said setup and compliance-related costs often exceed
$150,000. I think you had said $150,000 to $250,000 in your
testimony, correct? And then ongoing compliance often exceeding
$75,000 per year. Talk a little bit about that impact for a
smaller M&A person.
Mr. Ertel. A lot of business brokerage firms and M&A
advisory firms are very small shops--many sole practitioners,
many firms of just two or three practitioners. So if you take
that cost and spread it over the few transactions that they do
a year, it is a very significant burden per transaction.
Mr. Huizenga. Mr. Abshure?
Mr. Abshure. Yes, I think if you go back and look at the
historic definition of a broker under the securities laws,
which is--and see that buy securities for its own account and
for the--on the account of others, and you look at the existing
system of regulation, both at the SEC and State level and also
FINRA, you will learn that the system of regulation and the
requirements is not really designed for the business in which
an M&A broker engages. And I believe in your opening remarks
you point--or perhaps Mr. Ertel pointed that out--that
oftentimes an M&A deal, how it is structured is determined by
the tax treatment. The M&A broker goes in, looks at the
financial statements of the entity to be sold, helps clean that
up, and makes some management advice. And then you get ready to
do the deal, you look at the tax treatment, and decide whether
it is an asset deal or a stock deal. If it is an asset deal, he
is not a broker. If it is a stock deal, he is a broker. So it
doesn't really make sense.
Mr. Huizenga. Even though that is the exact same transition
and transaction, basically?
Mr. Abshure. True M&A brokers are business advisers that
specialize in the business of advising a company that is
looking to change management, is putting itself on the market.
And as long as they stay within that narrow frame, I think that
the States are fine with creating alternative registration and
compliance systems for those.
The problem is that it is a very thin line between changing
ownership and just selling a large block in connection with a
capital-raising transaction. So we would have concerns that the
distinctions are clearly drawn.
Mr. Huizenga. All right. I have around a minute-and-a-half
here. Under my bill, H.R. 2274, M&A is exempt from FINRA, while
subject to some of these SEC rules relevant to the limited
nature of what M&A broker activities are. But should FINRA
regulate M&A brokers? Anybody care to comment on that?
Mr. Abshure. No.
Mr. Huizenga. Excellent. Okay.
Mr. Ertel. I would agree.
Mr. Huizenga. I am curious why, if you want to elaborate.
Mr. Abshure. It goes back to why you are talking about
exempting or changing the structure of M&A brokers. The entire
FINRA system, regulatory system, is set up to govern brokers
that are in the business of buying securities either for their
own accounts or for the accounts of their client. That is not
what these guys do. So there is no reason--and plus the numbers
are so much smaller than what we are going to see from a
regular broker-dealer standpoint--there is no reason, it would
be extremely inefficient to set up a third level of regulation
for business brokers considering the very narrow nature of
their business.
Mr. Huizenga. This is government we are talking about, so
there is not always a concern about efficiency. But there is
from this member, and I know from many members of this
committee. And ultimately, I will part on this, who ultimately
bears the cost of the fees associated with registration and
compliance associated for the M&A brokers? I think we probably
all know the answer, but if anybody cares to jump in?
Mr. Ertel. It ultimately passes through to the buyer and
seller of the business. I have made the statement that if the
deal was all cash and you marked the bills that were brought to
closing, the buyer brings all the money and the broker takes
home some of it. So a lot of it falls to the buyer. Some of it
falls to the seller.
Mr. Huizenga. Right, thank you. My time has expired. I
appreciate that. I just wish Mr. Hensarling was here, our
Chairman Hensarling was here to hear again how important that
this bill is. But I am glad he was here for opening statements.
So, thank you.
Chairman Garrett. Okay. The gentleman from Georgia is
recognized for 5 minutes.
Mr. Scott. Thank you, Mr. Chairman. This is certainly a
fascinating hearing.
I have two lines of questions. First of all, it seems to me
we are sort of turning the BDCs on their head here, and so I
think it is important that the first question I want to ask is
that by permitting the BDCs to invest all of these funds in
financial firms instead of the nonfinancial small businesses,
would not that divert capital from the small, growing
businesses that the BDCs were originally created to help? Am I
off base there? Do you all have any concerns that might be
happening?
Mr. Abshure. The State securities regulators share your
concern.
Mr. Scott. And I am also concerned about the fact of the
other thing. Right now, it is prohibited in the hedge funds.
And would BDCs and their allowing them to invest entirely in
private funds, including hedge funds, would not that allow the
BDCs to circumvent the general prohibition on selling interest
in private funds to retail investors?
Mr. Abshure. If you will recall, in my opening remarks I
said that in the State securities regulators' opinion, the
changes in the BDC laws that are being proposed would
effectively allow hedge funds for unaccredited investors.
Mr. Scott. Okay, thank you. And would not this turning this
on its head eliminate all of the provisions intended to protect
preferred stock investors? Holders of preferred stock could
find that dividends not paid during lower earnings periods are
never paid, even if the BDC subsequently prospers. Is that not
a true statement? Shouldn't we be concerned about that, that
these investor protections would be lost here?
Mr. Arougheti. If I may, I think we may be talking about
apples and oranges. And there was testimony introduced into the
record by Prospect Capital around some of these issues. I think
it is important to differentiate between finance companies and
financial services companies. My understanding of the dialogue
is in regard to traditional commercial finance structures such
as equipment leasing companies, commercial finance companies,
and franchise finance companies, all of whom occupy a very
important role in the capital formation for small companies.
Under current regulations, BDCs are actually prohibited
from investing in those types of businesses, and it is those
types of businesses that are part of the formula for getting
capital to small business. When we are talking about structures
like private equity funds and hedge funds, to Mr. Abshure's
point, I do think that could be worthy of further reflection
and discussion insofar as those are fund structures, not
operating companies. And I think it is important to make a very
clear distinction between those two types of structures.
Mr. Scott. Okay. Now, let's go to the tick sizes. There is
a tick size that is being advocated of 5 cents or 10 cents.
There are even some who want the continuation of the 1 cent or
the penny. So there is not a unified position in the community
on what size this split should be, which there should be. So my
point is, given that there are some who want 5, there are some
who want 10, there are some who want a penny, and some even
want less than that, my question is would it be appropriate to
enshrine the tick sizes in the statute with this split and
difference in your community?
Mr. Weild. May I take a shot at that, Congressman? Any
increase in tick sizes for small micro-cap stocks is going to
be a step in the right direction. I think then it is a question
of how we actually implement it. And I share this view with
Professor James Angel from the University of Georgetown, who
was a proponent of the issuer choice tick size model, because
we think that what will happen is, by discussing what the
appropriate tick size is with the securities firms, the
investment banks, the value providers, and the institutional
investors, that the companies will figure out an appropriate
tick for the share price. A 5 cents tick size in a $10 share
price is twice the value of a 5 cent tick size in a $20 share
price.
So it is not going to be a one-size-fits-all. Where we came
out was let the market decide, let individuals get into a
discussion, and that we would start to see liquidity bands and
we would start to see individual ticks sort of gravitate to
certain underlying liquidity bands as a result of market input.
Mr. Scott. One quick point and I am through, Mr. Chairman.
But is everybody in agreement that a penny and a subpenny tick
size is central to the decline of the U.S. IPO market over
recent years?
Mr. Quaadman. Mr. Scott, if I could just take a stab at
that. Number one, decimalization actually lowered costs for
investors and actually provided for price discovery. What we
are having now is a debate about whether or not, if you are
going to have a pilot program on tick size changes, is that
going to help drive liquidity to smaller issuers? So I think we
need to differentiate different parts of the market from the
other.
The other point to your first question is, I think it is
important to leave it in the hands of the companies to decide,
if there is a pilot program, decide what is best for the
company, but then it is really going to be incumbent on the SEC
to really research it in terms of, is it providing that
liquidity to those companies, is it allowing people to look at
smaller companies in a closer way than they are now, but also
what is it doing in terms of cost to investors? So is it
helping retail investors go to invest in smaller companies?
What does it mean for mutual funds? Is it going to increase
cost or lower cost for mutual funds? Is it going to have them
become a bigger investor in smaller companies?
So I think the SEC, if there is a pilot program, needs to
look at this holistically to see if this program is going to
work, and then we should all come back and decide what the next
step should be.
Mr. Scott. Thank you, Mr. Chairman, for that extra time. It
was very helpful. Thank you.
Chairman Garrett. Mr. Grimm?
Mr. Grimm. Thank you, Mr. Chairman.
Mr. Arougheti, we are hearing a lot of different opinions
on the role of BDCs and the impact that it could have. So I
wanted to hone in on a few things regarding the kind of BDCs
that you specialize in, like yours. What is their current
ability, the kind of firms that BDCs like yours finance, the
ones that you are providing capital to, what is their current
ability to access capital to grow either via a bank or the
other capital markets?
Mr. Arougheti. Thank you, Mr. Grimm. Maybe just to take a
quick step back to understand the ecosystem that we operate in
and to really understand the critical role that BDCs play, if
you think about the traditional financing alternatives
available to a small and growing company, there are community
banks and local banks that can meet the needs of small
businesses as they grow, with government subsidy or without
government subsidy. However, they are limited in the
flexibility of their product. Oftentimes, they are limited in
their risk tolerance. Many times, they are limited in the size
of capital commitment that they can give to a growing company.
So the BDC industry really begins to become relevant at the
point in which the needs of a small and growing business
outgrow the traditional small company alternatives, and we grow
with that business all the way up to the point at which they
can access the debt or equity capital markets. That goes hand
in hand with the policy mandate that we provide strategic and
managerial assistance to these companies. So one of the ways I
have always thought about BDCs, and it is inherent in the
growth in the industry, is we effectively grow with these
companies as they graduate through the capital markets
ecosystem.
When you look at the type of companies that we lend to, we
will lend to venture companies that are investing pre-revenue
and pre-cash flow in new technology and innovation, all the way
up to more mature companies. But the borrowers that find their
way to the BDC space find their way to us for a reason, because
their needs are being unmet by traditional alternatives.
Mr. Grimm. And right now, just approximately last year,
say, how many in loans did you provide capital for?
Mr. Arougheti. Ares is the largest industry participant,
and we committed about $4 billion in new capital into the
middle market.
Mr. Grimm. And if this bill were to pass and the leverage
ratio was increased, which I think is a very modest increase,
from $1 to $2, how much do you think you would be able to
increase your capability of loaning money to these small and
midsized firms?
Mr. Arougheti. Significantly, and it goes back to my prior
commentary. I think the increase in leverage will actually
encourage BDCs to seek out lower-risk borrowers in a part of
the ecosystem that they currently can't serve. When you look at
the BDC structure as a pass-through entity, the yield
requirement on BDC dividends for the more conservative players
like us is 8 percent, and some of the ``riskier players'' the
market is already differentiating with yields in excess of 11
or 12 percent. My expectation is that with a modest increase in
leverage you would see the ability of BDCs to further meet the
needs and serve the needs of their existing customer base.
I would also highlight, if I may, if you look at the SBIC
debenture program, which has been very successful and is a very
good indicator of the underlying performance of these types of
loans, to put that in perspective, in Fiscal Year 2012, the
SBIC debenture program extended about $3.1 billion in loans,
and I would highlight that the SBIC debenture program currently
allows for leverage of 2:1, consistent with the proposed
legislation, as opposed to the 1:1 under the existing BDC
regulation.
Mr. Grimm. I apologize. I really want to get this in with 1
minute left, so please be as concise as you can because I think
this is important. What level of losses would a BDC like yours
need to experience to wipe out its equity at these ratios, the
proposed ratios?
Mr. Arougheti. Commissioner White had in her letter a
description of increased risk, saying that the loss rate would
have to go from 50 percent to 33.3 percent to harm BDC
shareholders. I think it is worth pointing out that the BDC
industry over the last 10 years has experienced actual realized
loss rates of about 60 basis points and some of the more
conservative structures like Ares have actually had positive
realizations, i.e., no net losses. So as we come off of the
experience of the great recession and see how these middle
market companies and this middle market collateral have
performed, I struggle to craft a scenario where we--
Mr. Grimm. Did any BDCs fail in the 2008 crises because of
too much leverage?
Mr. Arougheti. There have been no BDCs that have failed or
gone bankrupt.
Mr. Grimm. Thank you. I yield back.
Chairman Garrett. The gentleman yields back.
Mr. Foster is now recognized.
Mr. Foster. Thank you, Mr. Chairman.
In Mr. Abshure's testimony he notes that one of his
concerns with the BDC bills is the proposal that would allow
them to invest in investment adviser firms. And his concern was
that it might create a potential conflict of interest for the
investment advisers to recommend to their clients that they
invest in the BDC or their portfolio companies. And I was
wondering if any of the other witnesses have a comment on this
potential conflict-of-interest concern?
Mr. Quaadman. I would just add, I think that is one of the
issues that the SEC can look at. I think that is what Mr.
Sherman was sort of driving at, is that if you go forward with
this legislation, you allow them to become bigger liquidity
providers in the market and you provide for more investor
protections, if you know that there are different types of
strategies that are involved, the SEC has the tools, through
stress tests and others, to see if they are acting
appropriately and the like. So I think there are ways to
monitor that and then to come back and see if more needs to be
done.
Mr. Foster. Is anyone willing to venture a guess as to what
fraction of BDC holdings might be expected to flow into
investment advisers if the restrictions are lifted? Is this
going to be a little pimple on the whole industry or does this
have the potential to be a dominant component? Any feeling at
all? All right.
If I can move to tick size, would it be a good idea if the
tick-size experiments were conducted both with and without bans
on trading between the ticks? Is that an interesting element of
the pilot proposals? Because there is sort of a different
opinion as to how big an effect that would be and whether it
would effectively vitiate the tick-size proposals.
Mr. Weild. I think that was a recommendation we made way
back at the February 5th roundtable on decimalization, and if
you really want to create a pilot you can segregate different
groups of stocks and you can extract interesting comparable
information.
Mr. Wunderlich's comment, I agree and I don't agree with
the comment about market makers, risk taking. There are 53
different trading venues in the United States now so markets
are structurally very different from the days when we had over-
the-counter market makers, when we did control risk by
essentially being able to put stock out within the bid and the
ask side of the market. So it is not clear that is actually
going to be the way that market makers control risk today given
that a dark pool might siphon off just mounds and mounds of
liquidity as investors are searching out lowest possible price
as opposed to value provision.
I just honestly think we have to get started and try some
stuff and we have to keep doing it and keep trying it because
the problems are so extreme and the impact on the economy is so
extreme that the upside for the American people is
extraordinary. And so we may not get it right the first shot,
but doesn't mean that we don't take a second or third shot at
getting it right.
Mr. Foster. Is it anticipated that the tick-size changes
would result primarily in changes in the amount of technical
trading or research-based trading or sales commission-based
trading? And which is the kind of trading and liquidity that
you are trying to encourage here?
Mr. Weild. Real liquidity is when there is no order and
somebody goes out and creates an order to offset a buyer or
offset a seller. And that usually takes human beings to do.
Machines don't do that. And there has to be an economic model
to incent somebody to get on the phone. Right now there is no
economic model to do that.
Mr. Foster. But that could be based on a statistical
analysis of previous price points, which I would consider to be
technical trading, or based on actually a study of the
fundamentals of the company. And I am just trying to figure out
which one you are trying to incent mainly, or which will you
end up incenting mainly with the tick-size changes.
Mr. Weild. We would be incenting real brokers, human
beings, talking to institutional investors or retail investors
about stocks and creating visibility in those names, in those
stocks, which is activity for the most part which is going out
of the market today.
We would also hope to be incenting capital commitment to
facilitate the positioning of a block of stock before they find
a buyer that is real liquidity on the other side for that block
of stock. So we would expect that if these pilots were
structured appropriately that one of the metrics you would look
at is block liquidity. If block liquidity starts to go up 5,000
shares--right now things are put through the electronic
mixmaster and you are looking at 100-share, 150-share trades ad
nauseam, and if you start seeing the numbers creep up in terms
of size of the trade, I think that is a sign that this system
is having its intended effect.
Mr. Foster. Right. Thank you. My time is up. I yield back.
Chairman Garrett. Thank you. The gentleman yields back.
Mr. Duffy is recognized for 5 minutes.
Mr. Duffy. Thank you, Mr. Chairman. And again, I appreciate
all of the conversation around tick sizes and maybe the
benefits or drawbacks that you guys all have provided your
opinions on.
First, I want to thank Mr. Quaadman for bringing up the
issue of a safe harbor. I think that is a good point. If we are
going to have a successful tick-size pilot program, we want to
make sure there is no liability. And I think that is a
conversation we want to pursue. But I appreciate you bringing
that point up.
And I want to be clear, we don't have any interest, I am
not trying to engage in the larger argument between our dark
pools and exchanges, and I think we have entered into a space
that has some people excited. We truly are trying to create
more liquidity for small cap companies. That is the true intent
here. And I know that people are looking down the road and it
might take some signaling of our proposal that we are trying to
have a greater impact on a market structure, and that is not
the intent.
But maybe to Mr. Wunderlich, if we allow just a quote at,
aren't we really undermining the purpose of a tick-size bill?
We don't get the full impact of this experiment, this pilot
program?
Mr. Wunderlich. Yes and no, in that it does seem sort of
counterintuitive, right, that you are going to quote it in
nickels and dimes and then you are going to trade it maybe in
between. So maybe it does seem a little counterintuitive. But
the issue, it is sort of, I guess, I would go back to a point
in history when we tried to do it in 8ths and 16ths. We always
traded between the bid and the ask. It has been done
historically. And I think liquidity in our experience was a lot
better before decimalization in small and midcap stocks; not
necessarily the case in larger cap stocks.
The other issue is, from where I sit from a market-making
standpoint we do think that it is taking more risk if you are
committing to basically having to trade in larger increments.
And the other side it is just sort of market valuation and
efficiency. Markets, liquid markets are very efficient over
time as far as where things should or shouldn't be priced. And
I don't want to say it is manipulation or price fixing, but in
a sense you kind of are, if you are mandating you have to be at
this dime or this nickel or 20 cents.
That being said, I will reiterate, we are for the pilot,
again, but we think we ought to be able to trade between the
bid and the ask.
Mr. Duffy. And we are creating a financial incentive here,
aren't we? That is the purpose.
Mr. Wunderlich. I'm sorry, I didn't hear you.
Mr. Duffy. We are trying to create a financial incentive
here.
Mr. Wunderlich. That is correct.
Mr. Duffy. And that incentive may be diminished if we allow
more price improvement, trading between the ticks. Yes?
Mr. Wunderlich. No, sir. I think I would go the other way.
The incentive is for whom? Right? Is it for the investor or is
it for the brokerage firm, is it for the issuer? There are
several constituents involved. And one is for us to have an
incentive to even traffic in these stocks. And if we view that
to an outsized business risk where we are mandated to have to
take a price, then we are less likely to commit capital to
something like that than if we were able to trade freely
between the bid and the offer. Did that answer your question?
Mr. Duffy. Kind of. Maybe we can talk about it a little
more later.
Mr. Weild, do you agree with that? Do you think we diminish
the pilot program, our tick-size pilot program if we allow
trading between the ticks?
Mr. Weild. I think we do on the margin. Step back for a
second and look at the study that we did on the 26 foreign IPO
market, the 26 largest. And we have a convention in this
country where we don't allow--most brokerage firms don't allow
brokers to solicit stocks or put them on margin if they are
under $5 a share. So it arbitrarily keeps our stock prices
high. So the United States has zero stock, zero percent stocks
that have a 1 percent or higher tick size that are sub-500
million that are micro-cap or smaller, whereas the high IPO-
producing countries, which are countries like Singapore,
Australia, Canada, weighted for GDP, 70 percent or more of
their micro-cap stocks have 1 percent or higher tick sizes
because they split the stocks down to levels where a penny, at
50 cents, a penny can make 2 percent difference incentive.
I do believe that a nickel or a dime and having some
integrity to the tick size will ultimately cause the market to
compete on providing sales, capital, value support, and it
won't let the market compete on price, which is the problem in
micro-cap markets.
I totally agree with the point of view, I think Tom said
this earlier, large cap stocks that are innately liquid stocks
actually become more liquid with smaller tick sizes, but the
academic literature clearly shows that innately illiquid stocks
become less liquid with smaller tick sizes. So the reverse of
that, which is increase the tick and respect the tick size,
will bring liquidity to these stocks.
Mr. Duffy. And, Mr. Wunderlich, do you agree with that?
Mr. Wunderlich. Yes, I do.
Mr. Duffy. Thank you, I yield back.
Chairman Garrett. The gentleman yields back.
For the last word, Mr. Carney is recognized.
Mr. Carney. Thank you, Mr. Chairman, and thank you for
holding the hearing today. Thank you to all the witnesses. I
have been working with Mr. Duffy on this tick-size issue, so I
have been listening very carefully to the discussion over the
last three questioners.
And our objective is pretty simple, Mr. Duffy laid it out,
is to drive more liquidity, more activity to the smaller cap
companies. And do I interpret everybody to say that you are for
a pilot of some kind. Mr. Wunderlich? Mr. Quaadman? The last
three had the most discussion, right?
Mr. Wunderlich. Yes.
Mr. Carney. So the question is, how to get it right. I was
interested in the suggestion that Mr. Foster had about having
both maybe a quote at and trade at provision in the pilot. Does
that make sense? I will start with you, Mr. Wunderlich. You
have a problem with our current approach, so what about the
approach of having both?
Mr. Wunderlich. Clearly, and let me speak for myself and
maybe not SIFMA here--
Mr. Carney. Sure, sure.
Mr. Wunderlich. I will speak for SIFMA in this regard. One,
we need to have very clear metrics. And I think Mr. Weild said
earlier, we want to make sure that if you do something on it,
we want to compare apples to apples, and it needs to be very
clear.
Mr. Carney. And by the way, that is my last question, and
that would be the metrics in terms of the evaluation of this
pilot. So to the extent that you independently can provide us
with something in writing about what they ought to be, you have
mentioned some of those, that would be much appreciated.
Please.
Mr. Wunderlich. And now I have forgotten your question. I
apologize.
Mr. Carney. The question was, the pilot that included both
a quote at and a trade at, so that you have two different looks
at trading within the spread.
Mr. Wunderlich. And I will speak for myself and Wunderlich
Securities severally. I do believe that being able to trade
between the bid and the--between tick sizes would be better.
That being said, ultimately, I am for a pilot in some way,
shape, or form. And if it means having two pilots then I would
be personally, and I will speak for myself and Wunderlich
Securities here, I would be for that, versus not having a pilot
at all.
Mr. Carney. Okay.
Mr. Quaadman, do you have a view of that?
Mr. Quaadman. Let me take it in reverse order.
Mr. Carney. Sure.
Mr. Quaadman. We are supportive of a pilot program. We
think there needs to be exhaustive metrics on that.
Mr. Carney. And you have a view of what things ought to be?
Mr. Quaadman. Yes. We will work with both you and Mr. Duffy
on that.
As to your last point, I think there is some attraction to
that, and I want to think about that some more and get back to
both you and Mr. Duffy on that.
Mr. Carney. Okay, sure.
Mr. Weild, do you want to take both of those pieces?
Mr. Weild. We have done some work already on what we think
the metrics should be. There is also a committee that has been
advising Treasury, an ad hoc committee that includes some
institutional investors that has done some work. So let me pull
that together and I will just get it back to you on what we
think metrics should be.
Clearly, the things that require people investments, on a
short-term pilot people are not going to make long-term
investments in research and things like that, but when you look
at the trading characteristics, you will get a sense, I think
pretty quickly with the right metrics, whether or not it is
working. And so, I think this is eminently--
Mr. Carney. So we have a duration in the bill. Any comment
on the duration? A 5-year duration is too long, too short,
about right?
Mr. Weild. I think longer is better, and then if it proves
to be working, then just make it permanent. Because the problem
with a short-term pilot is people might game it. If it is a 1-
year pilot, which I think has been recommended in some circles,
like in the Citigroup article that came out in the Wall Street
Journal today, I think they recommended a year, I think that is
too short.
Mr. Carney. Mr. Quaadman, you look like--
Mr. Quaadman. I think a 5-year pilot is fine, but I would
recommend that the SEC come out with some interim report either
at 2 or 3 years so you get a snapshot early on.
Mr. Carney. Any comment on the definition of companies that
would be eligible either in terms of total cap size or other?
Right now the definition pretty much tracks the emerging growth
company definition in the JOBS Act, I believe. So is that too
limited, too expansive? Any comments on that?
Mr. Quaadman. No, I actually think that is the right way to
go, because that is a defined universe that Congress has
already picked out, and it makes sense to go with that universe
for this pilot program.
Mr. Carney. Okay. Are there other comments?
Mr. Wunderlich. I would agree.
Mr. Weild. We would agree. I would also in our testimony,
page 11, just call your attention to just show you, if you just
use this one metric, sub-$2 billion market value companies,
they only represent 6.6 percent of total market value. Said
another way, you could trade yourself silly in the large cap
markets, and that is the vast majority of market value, and
these small stocks are just fundamentally different. About 81.1
percent of all listed companies are sub-$2 billion in market
value, the institutional definition of small cap, and they
represent only 6.6 percent of aggregate market value. You are
comparing apples to oranges structurally. So, EGC definition is
fine, gets to the same, close to the same place.
Mr. Carney. I want to thank each of you for your help, and
your testimony today, and I thank my colleague from the other
side. I yield back.
Chairman Garrett. The gentleman yields back.
And we have been joined by Mr. Mulvaney for the last
questions.
Mr. Mulvaney. Mr. Chairman, I apologize to both you and the
panel for having to run back out and back in. It has just been
that kind of day.
Mr. Abshure, I was here for your testimony, but I was not
here for some of the follow-up questions. But as I understand
it, you have a difficulty with retail investors being exposed
to investments in hedge funds and private equity. Is that
correct, sir?
Mr. Abshure. Yes.
Mr. Mulvaney. Okay. And I guess in theory I can sympathize
with that a little bit, but don't pension funds face the same
issue? And aren't there other instruments out there already
that expose retail investors to investments in hedge funds and
private equity funds?
Mr. Abshure. I don't think so on the levels that you are
talking about here. You are talking about unaccredited,
unsophisticated investors having access.
Mr. Mulvaney. Unaccredited, unsophisticated investors. Does
that not describe most pensioners who work for CalPERS?
Mr. Abshure. Sure.
Mr. Mulvaney. Don't they invest in hedge funds and private
equity funds?
Mr. Abshure. No.
Mr. Mulvaney. They don't? Pensions funds don't invest in
hedge funds and private equity funds?
Mr. Abshure. No. Unaccredited investors can invest in
pension funds, but unaccredited investors cannot invest in
hedge funds.
Mr. Mulvaney. Okay. Don't the managers of both of those
types of entities, of pension funds--
Mr. Abshure. The difference is you have a manager.
Mr. Mulvaney. I'm sorry?
Mr. Abshure. The difference is you have a manager in a
pension fund as opposed to an unaccredited or an
unsophisticated investor deciding to invest in the BDC all on
his own, and then that BDC making decisions.
Mr. Mulvaney. I have never invested in a BDC. I have
invested in a closed-end mutual fund before and it was readily
apparent to me what the closed-end mutual fund had invested in.
Is that same information available to somebody who invests in a
BDC? If I want to know what they are investing in before I buy
a share of a BDC, do I get to know what they are investing the
money in?
Mr. Abshure. No.
Mr. Mulvaney. That is a secret.
Mr. Abshure. I don't think a registered BDC is going to
disclose all of its investment on the front end--
Mr. Mulvaney. Mr. Arougheti, help me out here. Do you tell
your investors what you invest in?
Mr. Arougheti. Just a minor correction. By regulation, BDCs
are required to have a detailed investment listing of every
single security and investment.
Mr. Mulvaney. Okay. That is not a minor clarification. That
is the exact opposite of what Mr. Abshure just said.
Mr. Arougheti. No, every quarter BDCs, by regulation, are
required to provide a detailed investment listing by security
that they hold on their balance sheet.
Mr. Mulvaney. Okay, Mr. Abshure, so is he wrong?
Mr. Abshure. No. You provide that every quarter after the
purchase has been made, correct?
Mr. Mulvaney. Go ahead. You can respond, Mr. Arougheti.
Mr. Arougheti. Correct. We have full transparency as to
what resides--
Mr. Abshure. So if I am a BDC owner on January 1st, I am
going to learn what you did with my money at the end of that
quarter.
Mr. Mulvaney. But you are also going to know on the day
that you purchased the stock where that money is invested,
correct?
Mr. Abshure. But in terms of what happens on day number 2
then, I will know at the end of the quarter.
Mr. Mulvaney. I didn't stay in the State government long
enough to participate in that State pension, but a lot of my
friends have. I have teachers in the South Carolina retirement
system. How are they treated any differently than your
hypothetical BDC investor? Do they know when they put money
away for their pension where that money is going on a daily
basis or do they get regular updates?
Mr. Abshure. No.
Mr. Mulvaney. They don't know, do they? There is no
difference here. I guess what I am trying to get at is, why
would we treat BDCs any different from pensions when it comes
to hedge funds and private equity funds?
Mr. Abshure. I think there are many differences between
BDCs and pension funds.
Mr. Mulvaney. And I am asking you for some of them.
Mr. Abshure. I think just the entire structure, the entire
goal behind the pension funds, the required payouts of the
pension funds, the way that pension funds are structured to
provide payments over time, the way that pension funds are
constantly monitored to make sure that they have assets to meet
the payout responsibilities.
Mr. Mulvaney. And there is another difference, which is a
lot of times, for example, if I am a teacher in South Carolina
I don't even get the choice to participate or not, I have to
participate. So there are actually certain areas where it is
actually worse to be in a pension.
Let me ask you this, because the SEC raised similar
questions. I think it was a lot more well-articulated than what
we have been through today. But, Mr. Arougheti, aren't there
ways to handle this? That is really the concern. If there is
legitimate concern that you don't want to end up with these
entities being pass-through entities to simply fund hedge
funds, aren't there ways to deal with that?
Mr. Arougheti. Yes, Mr. Mulvaney. I apologize, in prior
commentary I thought that it was worth making the distinction
between finance companies and funds. And as I said earlier, I
do believe that there are parts of the financial ecosystem--
leasing companies, franchise finance companies, et cetera--that
are a valuable provider of capital, that are very distinct in
the way that they operate and bring capital than the hedge
funds and private equity funds.
Mr. Mulvaney. So to the extent Mr. Abshure's questions are
legitimate, let's assume for the sake of discussion that they
are, we can fix that, can't we?
Mr. Abshure. Absolutely.
Mr. Mulvaney. Thank you.
I yield back the balance of my time.
Chairman Garrett. The gentleman yields back. And I think
that was the last word.
So at this point I want to, again, thank you all on the
panel. And I ask unanimous consent to put 3 letters into the
record from the Financial Services Roundtable, Reflexite, and
Prospect, and also from SBIA. They are letters with regard to
today's hearing, so they are put into the record. Without
objection, it is so ordered.
Now, I can say thank you all for coming and for your
testimony, which has been very illuminating and educational.
And if we had any questions that we threw out to you that we
didn't get back, we would appreciate you responding in writing
for the record.
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.
So with that, I again thank you all. And this committee is
hereby adjourned.
[Whereupon, at 4:30 p.m., the hearing was adjourned.]
A P P E N D I X
October 23, 2013
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