[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]
ENCOURAGING SMALL BUSINESS
GROWTH AND ACCESS TO CAPITAL
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
OVERSIGHT AND INVESTIGATIONS
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTH CONGRESS
SECOND SESSION
__________
SEPTEMBER 23, 2004
__________
Printed for the use of the Committee on Financial Services
Serial No. 108-113
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98-155 WASHINGTON : 2004
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HOUSE COMMITTEE ON FINANCIAL SERVICES
MICHAEL G. OXLEY, Ohio, Chairman
JAMES A. LEACH, Iowa BARNEY FRANK, Massachusetts
RICHARD H. BAKER, Louisiana PAUL E. KANJORSKI, Pennsylvania
SPENCER BACHUS, Alabama MAXINE WATERS, California
MICHAEL N. CASTLE, Delaware CAROLYN B. MALONEY, New York
PETER T. KING, New York LUIS V. GUTIERREZ, Illinois
EDWARD R. ROYCE, California NYDIA M. VELAZQUEZ, New York
FRANK D. LUCAS, Oklahoma MELVIN L. WATT, North Carolina
ROBERT W. NEY, Ohio GARY L. ACKERMAN, New York
SUE W. KELLY, New York, Vice Chair DARLENE HOOLEY, Oregon
RON PAUL, Texas JULIA CARSON, Indiana
PAUL E. GILLMOR, Ohio BRAD SHERMAN, California
JIM RYUN, Kansas GREGORY W. MEEKS, New York
STEVEN C. LaTOURETTE, Ohio BARBARA LEE, California
DONALD A. MANZULLO, Illinois JAY INSLEE, Washington
WALTER B. JONES, Jr., North DENNIS MOORE, Kansas
Carolina MICHAEL E. CAPUANO, Massachusetts
DOUG OSE, California HAROLD E. FORD, Jr., Tennessee
JUDY BIGGERT, Illinois RUBEN HINOJOSA, Texas
MARK GREEN, Wisconsin KEN LUCAS, Kentucky
PATRICK J. TOOMEY, Pennsylvania JOSEPH CROWLEY, New York
CHRISTOPHER SHAYS, Connecticut WM. LACY CLAY, Missouri
JOHN B. SHADEGG, Arizona STEVE ISRAEL, New York
VITO FOSSELLA, New York MIKE ROSS, Arkansas
GARY G. MILLER, California CAROLYN McCARTHY, New York
MELISSA A. HART, Pennsylvania JOE BACA, California
SHELLEY MOORE CAPITO, West Virginia JIM MATHESON, Utah
PATRICK J. TIBERI, Ohio STEPHEN F. LYNCH, Massachusetts
MARK R. KENNEDY, Minnesota BRAD MILLER, North Carolina
TOM FEENEY, Florida RAHM EMANUEL, Illinois
JEB HENSARLING, Texas DAVID SCOTT, Georgia
SCOTT GARRETT, New Jersey ARTUR DAVIS, Alabama
TIM MURPHY, Pennsylvania CHRIS BELL, Texas
GINNY BROWN-WAITE, Florida
J. GRESHAM BARRETT, South Carolina BERNARD SANDERS, Vermont
KATHERINE HARRIS, Florida
RICK RENZI, Arizona
Robert U. Foster, III, Staff Director
Subcommittee on Oversight and Investigations
SUE W. KELLY, New York, Chair
RON PAUL, Texas, Vice Chairman LUIS V. GUTIERREZ, Illinois
STEVEN C. LaTOURETTE, Ohio JAY INSLEE, Washington
MARK GREEN, Wisconsin DENNIS MOORE, Kansas
JOHN B. SHADEGG, Arizona JOSEPH CROWLEY, New York
VITO FOSSELLA, New York CAROLYN B. MALONEY, New York
JEB HENSARLING, Texas JIM MATHESON, Utah
SCOTT GARRETT, New Jersey STEPHEN F. LYNCH, Massachusetts
TIM MURPHY, Pennsylvania ARTUR DAVIS, Alabama
GINNY BROWN-WAITE, Florida CHRIS BELL, Texas
J. GRESHAM BARRETT, South Carolina
C O N T E N T S
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Page
Hearing held on:
September 23, 2004........................................... 1
Appendix:
September 23, 2004........................................... 29
WITNESSES
Thursday, September 23, 2004
Beller, Alan L., Director, Division of Corporation Finance,
Securities and Exchange Commission............................. 3
Connolly, James A. III, President, IBA Capital Funding, on behalf
of the CEO Council............................................. 17
Schneider, Thomas, President and Chief Executive Officer,
Pathfinder Bank on behalf of America's Community Bankers....... 22
Speight, Frank, Chairman and Chief Executive Officer, American
Capital Partners, Ltd., Co-Chairman, National Small Public
Company Leadership Council..................................... 20
Sweeney, Joan M., Managing Director and Chief Operating Officer,
Allied Capital................................................. 15
APPENDIX
Prepared statements:
Kelly, Hon. Sue W............................................ 30
Beller, Alan L............................................... 32
Connolly, James A. III....................................... 47
Schneider, Thomas............................................ 50
Speight, Frank............................................... 55
Sweeney, Joan M.............................................. 58
ENCOURAGING SMALL BUSINESS
GROWTH AND ACCESS TO CAPITAL
----------
Thursday, September 23, 2004
U.S. House of Representatives,
Subcommittee on Oversight and Investigations,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to call, at 11:23 a.m., in
Room 2128, Rayburn House Office Building, Hon. Sue Kelly
[chairman of the subcommittee] presiding.
Present: Representatives Kelly, Paul, Inslee, Moore,
Maloney, Crowley and Davis.
Chairman Kelly. [Presiding.] This hearing of the
Subcommittee on Oversight and Investigations will come to
order.
This morning, the Subcommittee on Oversight and
Investigations convenes to continue its review of efforts to
encourage small business growth and access to capital. Small
business drives our economy and creates jobs for millions of
Americans. In fact, small businesses currently generate nearly
three-quarters of the net new jobs per year and employ
approximately one-half of the private-sector workforce.
Capital is the lifeblood of small businesses and the
efficient access to capital is a crucial ingredient to a
strong, growing economy. We must ensure that our small
businesses have access to capital and that the current
regulatory scheme encourages future growth and development.
Available data shows that small businesses are recovering
from the downturn in the economy begun in 2001 in no small part
due to the easing of their access to capital. Banks began
relaxing lending standards in late 2003 for the first time
since 1998. In turn, demand for small business loans has
recently increased.
In terms of our equities markets, over 100 companies have
undertaken initial public offerings so far this year, making it
the best year for new offerings since 2000. Despite these
promising numbers, there are still significant regulatory
hurdles discouraging small business capital formation.
Last Congress, the Subcommittee on Oversight and
Investigations held a hearing entitled ``The SEC's Role in
Capital Formation: Help or Hindrance?'' In this hearing, the
subcommittee heard from a number of witnesses who contended
that the SEC has simply not kept pace with the needs of small
businesses despite their best effort. Since that time, Congress
has passed and the President has signed important legislation
known as Sarbanes-Oxley to improve auditing standards,
disclosure rules and corporate governance.
While investors in small companies expect and deserve the
same protections as those in larger companies, this law places
a renewed focus on the need to review the current regulatory
framework to ensure that small businesses are able to develop
and access capital. There must be concentrated effort to
modernize our federal securities regulatory framework to ensure
that we are protecting investors, but allowing small businesses
to grow.
Today, we will review the steps that our government is
taking to address the specific needs of small businesses. In
1996, under the National Securities Markets Improvement Act,
Congress was very clear that the SEC ensure competition,
efficiency and capital formation in its rulemaking.
This law also granted the SEC general exemptive authority
to ease regulatory burdens and to meet the needs of all
businesses, large and small, trying to access the capital
markets. Regrettably, the commission has not been as proactive
in exercising this authority to support the needs of small
businesses.
It is time to embrace the advantages that new technology
and the Internet have brought to our society and could bring to
our government agencies. While the SEC has tried to simplify
registration and other regulations for small businesses, these
tasks remain extremely daunting for the average small business
owner.
There is a tremendous amount of cost and effort that a
public company must incur to access the capital markets and
comply with federal securities laws. In their pursuit to
protect investors, the SEC must also make it a priority to
strive for more efficient regulations. The current regulatory
regime must keep pace with the market and the needs of small
businesses. Otherwise, investor protections are also going to
be undermined.
The commission's inaction has motivated me to draft with my
colleague from New York, Representative Nydia Velazquez, the
Increased Capital Access for Growing Business Act, H.R. 3170.
This legislation removes certain obsolete investment
limitations on business development companies which were
created in 1980 by Congress to encourage investment in small
developing and financially troubled businesses.
By simply modernizing securities laws, this legislation
would allow BDCs to provide significant resources to small
businesses as originally intended by Congress. Since the
commission's position on the legislation has been frustratingly
unclear, I urge the SEC to take this opportunity to express
their support for this legislation that would have a tremendous
impact on the ability of small businesses to access capital.
The legislation was first introduced last Congress, passed
the House unanimously and now awaits Senate consideration.
After working with the SEC on the legislation for several
years, it is time for the commission to give a public
endorsement of the bill and help small businesses by moving the
process along in the Senate.
I thank all the witnesses for their appearance before the
committee to address these important issues. It is my hope that
we together will make progress that will enable small
businesses to devote their energies to their customers, and not
outdated and inefficient requirements that no longer reflect
the realities of our new economy.
[The prepared statement of Hon. Sue W. Kelly can be found
on page 30 in the appendix.]
Without objection, all members's opening statements will be
made part of the record.
I would like to turn now to Mr. Moore. Mr. Moore, do you
have an opening statement?
Mr. Moore. Madam Chairman, I do not have an opening
statement. I do appreciate the witnesses here today and am
anxious to hear their testimony.
Chairman Kelly. Thank you.
Mr. Paul?
Mr. Paul. I do not have an opening statement.
Chairman Kelly. Mr. Paul has no opening statement.
Mr. Inslee?
Mr. Inslee. Briefly, perhaps everyone is aware of this, but
I think probably every member of Congress when they return on
the weekends talks to small business members about the cost of
compliance of Sarbanes-Oxley. It is particularly acute,
obviously, for small business people. I just think over the
next year or two or more, I hope this committee will be engaged
in a continuing effort to see if there are ways to accomplish
our purposes and reduce that obligation of small business
owners.
I just throw out the idea almost that we ought to even have
tiger teams looking for any possible things we can do to reduce
the cost of compliance as this process goes along. I just hope
we look at it as an ongoing process, because it is a very, very
important thing and we all hear it in 435 districts. So I look
forward to any ideas. Even though a rule has been adopted, I do
not think it is the beginning of the end. It is the end of the
beginning.
Thank you.
Chairman Kelly. Thank you very much.
We turn now to our first panel.
Testifying on our first panel is Mr. Alan Beller, the
Director of the Division of Corporation Finance and Senior
Counselor at the U.S. Securities and Exchange Commission. Mr.
Beller joined the SEC in January of 2002. Prior to joining the
SEC, Mr. Beller practiced law concentrating on a variety of
domestic and international corporate securities and derivatives
issues.
Without objection, sir, your written statement will be made
a part of the record. You will be recognized now for a 5-minute
summary of your testimony.
If you have not testified before in front of this committee
or any other committee here on the Hill, there are black boxes
at either end of the table. They will be lit first with a green
light, which means you have 5 minutes. The yellow light means
please summarize. The red light means 5 minutes is over.
We now turn to your testimony, and we welcome you. Thank
you.
STATEMENT OF ALAN L. BELLER, DIRECTOR, DIVISION OF CORPORATION
FINANCE, SECURITIES AND EXCHANGE COMMISSION
Mr. Beller. Thank you, Chairwoman Kelly, members of the
subcommittee. I am pleased to appear before the subcommittee
today on behalf of the Securities and Exchange Commission.
The stated mission of the Securities and Exchange
Commission is to protect investors, maintain fair, orderly and
efficient markets, and facilitate capital formation. The
commission has long strived to balance its mission to
facilitate capital formation with its mission to protect
investors.
For example, while we can carefully consider how our
regulatory scheme impacts small businesses, we also believe
that investors in small companies deserve a proper level of
disclosures and equivalent protections to those of investors in
larger companies.
In most cases, we believe the two goals complement each
other. The public is more likely to invest in our capital
markets if they believe that their investments are being
protected. The strength and vigor of our markets, including our
markets for small business issuers, notwithstanding the
difficulties that you have mentioned and that we are aware of,
are we believe unmatched and are ample proof of this very
important fact.
Our mission to facilitate capital formation requires us to
consider carefully how our rules and regulations impact small
businesses. In order to ensure that we do this, the SEC has
taken a number of steps to focus on small businesses.
Primary among these is the Office of Small Business Policy
in the Division of Corporation Finance. The office directs the
division's small business rulemaking initiatives and
interpretations and comments on SEC rule proposals affecting
small companies generally. It also answers questions received
from small businesses by telephone or at its e-mail address,
and works with outside groups concerned with small businesses.
The head of the Office of Small Business Policy also serves
as the commission's Special Ombudsman for Small Business. The
SEC created this position in 1996 to represent the concerns of
smaller companies within the entire SEC. The ombudsman also
answers general questions from small businesses.
The disclosure operations section of the Division of
Corporation Finance, whose primary role is to review registrant
filings, is central to the mission of the Division. Disclosure
operations is divided into 11 groups, 10 of which are organized
by industry type.
The 11th group is the Office of Emerging Growth Companies,
which reviews substantially all of the initial filings of small
business issuers. We feel that the small business expertise
that is developed within this office is as important to small
businesses and investors as the industry expertise that exists
in our other groups.
In addition to these offices, which serve as resources for
small business, the commission has a special page targeted to
small businesses on its Web site. This special page includes
material created to help small businesses understand how to
raise capital and comply with the federal securities laws, as
well as links to other information of interest to small
companies.
We also coordinate with other government regulators to
discuss issues related to small business. In April of this
year, we held our annual conference with state securities
regulators at which we discussed methods of achieving greater
uniformity and effectiveness in securities regulation. The SEC
staff also works closely with the Office of Advocacy at the
U.S. Small Business Administration on regulatory matters
affecting small entities.
I want to talk a moment about the Government-Business Forum
on Small Business Capital Formation. Since 1982, under the
mandate of the Small Business Investment Incentive Act of 1980,
the SEC has sponsored this forum. It is an annual meeting that
provides the only government-sponsored national forum for small
businesses to let government officials from different parts of
the federal government know how their laws, rules and
regulations impact smaller companies. This year's forum was
held just this past Monday at our headquarters here in
Washington.
The focus of this year's forum was, first, developments in
auditing and their impact on smaller public companies; and
second, the current challenge to smaller public companies
related to disclosure and SEC filings and corporate governance.
I want to pause. If you are familiar with some of the
requirements of Sarbanes-Oxley, as I know you are, I think you
will understand that these two focal points of the forum were,
I think, direct results of the concerns of small business and
smaller companies that have been referenced with the expense
and difficulties of complying with Sarbanes-Oxley for smaller
companies. That definitely was a focus of this year's forum.
The recommendations that came out of the forum, I think the
primary recommendations, we are still reviewing them. We just
had since Monday to sort out what the primary recommendations
were. Quite clearly, the most important recommendation is to
deal with the impact of the internal control assessment and
audit requirement of Sarbanes-Oxley on small business.
Other important recommendations involved our exemptions in
rules that accommodate capital formation by small businesses,
and the status of nonregistered intermediaries, sometimes
called ``finders,'' in the capital formation process.
The finder recommendation was also an important
recommendation of last year's forum and our Division of Market
Regulation is currently quite actively involved in looking at
questions related to how the registration requirement for
broker-dealers impacts the processes of paid intermediaries
such as finders, who help small businesses raise money.
The Division has been in discussions with many small
business representatives, including a group formed under the
auspices of the American Bar Association. It is addressing the
important question of what sorts of requirements and what
aspects of the registration process are or are not appropriate
for application to those sorts of intermediaries. Obviously,
the task for us there is to balance the need to facilitate
capital formation with the very important mandate to protect
investors. That is what the division intends to do.
In terms of our regulation of small businesses more
generally, a number of our rules and exemptions are
specifically tailored to provide accommodations for small
businesses that seek to raise capital in the U.S. Some of the
accommodations come in the form of general exemptions to our
registration requirements that apply only to small businesses.
Others are general exemptions that in fact by their nature have
greater or special applicability to small businesses.
These rules and regulations are detailed in my written
testimony, but briefly, Regulation A provides an exemption from
registration for nonreporting issuers issuing up to $5 million
in any 12-month period. Regulation D is an exemption that has
several prongs to it. Most importantly for small business Rule
504 exempts offerings of up to $1 million in a 12-month period
and allows for the issuance of freely tradable securities if
the companies make offerings in accordance with State laws.
Rule 506 permits sales without limitation to accredited
investors and to a limited number of nonaccredited investors
who are sophisticated. Finally, Rule 701 exempts from
registration sales of securities of private companies to their
employees. That has been a very important element in allowing
small businesses and other private companies to retain their
employees and compensate them appropriately before they go
public.
We have received suggestions, including from the forum, to
increase the amount of capital that can be raised under these
exemptions and to loosen the conditions. We are always willing
to, and frankly are always in the process of, considering those
recommendations and balancing them against the overall context
of our investor protection mandate.
In addition to the exemptions, we have a regulatory regime
for public companies that is designed specifically for small
businesses. They have a special set of disclosure rules that
are simpler and easier to comply with than the rules for larger
companies. They have a special set of registration forms that
is also easier to comply with.
An issue that small businesses now consistently face with
us involves the Sarbanes-Oxley Act of 2002 and our rules
implementing that act. In doing that implementation, we tried
very hard to be sensitive to the concerns of small business
issuers.
We made a number of accommodations for them that are
detailed in my written testimony. I am happy to discuss them
further.
Despite these accommodations, we have heard, as has already
been suggested by a member of the subcommittee, that some
smaller public companies are burdened by the new rules.
I think we agree that the rulemaking process that we have
now completed is not the end, but the end of the beginning. We
intend to consider over the coming months what, if any,
appropriate steps we can take to recalibrate the way the
regulatory system affects small businesses.
The staff is actively in listening mode. I think the
commission is actively in listening mode. I think we are going
to seek advice wherever we can get it. We will try to come up
with the best solutions that we can.
I think everyone recognizes that in doing that
recalibration, it is important to keep front and center the
principle enshrined in Sarbanes-Oxley that improved corporate
governance, improved financial reporting, improved auditor
performance are important for all companies regardless of size.
The last thing I would like to touch on a little bit is use
of technology. I know it was raised in the last hearing, the
importance of the SEC coming to grips with changes and
improvements in technology.
I think since 2001, the commission has in fact to a greater
degree than ever before embraced new technology, embraced the
use of the Internet. All-Internet offerings are something that
we have now, at least in one case, blessed and in others would
consider. The whole Internet auction process is now something
that we have not only accepted, but frankly facilitated in
initial public offerings. The use of company Web sites for
posting of information is something that we encourage,
consistent with companies continuing to comply with their
reporting requirements with us.
We do continue to have concerns about the use of the
Internet for private offerings where access to the offering
material is not restricted to the appropriate target class of
investors. That is a concern that we continue to balance
against the important advantages that the Internet and
technology offers.
We are in the course of a fairly significant overall reform
project of our Securities Act offering processes. One element
of that project, when it comes out as a recommendation to the
commission and if the commission approves, would be a proposal
that would involve updating the communications process to
permit use of the Internet and other new technologies in ways
that are currently not permitted by the statutory restrictions.
We are cognizant of the need to be responsive to technological
developments.
Chairman Kelly. Mr. Beller, if you could sum up.
Mr. Beller. I think that is the last point I wanted to
address from my written testimony.
All I would say again is I thank you for the opportunity to
be here today.
The SEC has long considered small businesses to be an
important part of our regulatory responsibilities. We have
looked and we are continuing to look for ways to accommodate
small businesses in the fulfilling of our dual mission of
facilitating capital formation and protecting investors.
I would conclude by saying I would be pleased to answer any
questions that Chairwoman Kelly or any other members of the
subcommittee might have.
[The prepared statement of Alan L. Beller can be found on
page 32 in the appendix.]
Chairman Kelly. Thank you very much.
I am interested in the definition of small companies. There
are a number of different definitions used. Standard & Poor's
uses, for instance, a small cap index as a $300 million to $1
billion company. Some people find it difficult to consider that
that is a small company.
But the question is, if you have a company that is $300
million to $1 billion, how complicated, how difficult is it for
them to access capital? I am wondering if the SEC should
reexamine size standards for some of these small businesses.
Mr. Beller. For purposes of our regulations directly
related to small businesses, the defined term involves assets
or revenues of $25 million, that is assets or revenues. So that
is not anywhere near the $250 million level.
So, for example, our Regulation S-B, for special disclosure
rules, our special forms tie to that number. I am sorry, it is
market cap and revenues, not assets and revenues.
I think the other important cut-off we have in our
regulatory regime is that companies with market cap of $75
million or more are eligible to use shelf registration for
primary offerings. Companies of $75 million are similarly
defined as accelerated filers in our new rules that have
shortened the period in which companies have to file their
quarterly and annual reports.
Chairman Kelly. Mr. Beller, my question really was, do you
think you should reexamine the size standards for these small
businesses, the ones that you use?
Mr. Beller. What I think we have to focus on is two things,
for example, whether the $25 million is the right level or
whether it should be $50 million, for example; whether the $75
million for some purposes is maybe even too small; and also
whether there should be different levels for different
purposes.
I am thinking particularly of the internal control
requirement in Sarbanes-Oxley, where I think we are hearing,
and I would not be surprised if the members are hearing, that
$250 million is a definition for small business. Companies with
$250 million of market cap find the internal control
requirement to be a burdensome requirement in its current form.
So yes, we should think about changing them, but I think
also we should think about whether there ought to be maybe
different levels for different purposes.
Chairman Kelly. I am glad to hear you say that.
Also I am glad that in your testimony, you finally
acknowledge the need to modernize some of our security laws
relating to the BDCs. Representative Velazquez and I have been
working on this legislation now for two Congresses. It has
passed the House unanimously.
In spite of all this support and no opposition, we continue
to ask the SEC for feedback. Don't you think our legislation
would help many of these small businesses access capital?
Mr. Beller. We certainly agree with the premise of the
legislation that the changes in the margin rules in 1999 had an
unacceptable impact on the operation of the definition for
eligible portfolio companies. We have been in communication
with your staff on an ongoing basis on the legislation and the
rulemaking that you mentioned that is being considered within
the staff at this point.
The commission has not taken a position on the legislation.
I know that it has passed the House. I know that it would deal
with the eligible portfolio company issue.
I am more than pleased to take back the request to the
staff of the Division of Investment Management. The BDCs do not
come under the jurisdiction of the Division of Corporation
Finance. I am happy to take that request back to the Division
of Investment Management and back to the commission itself and
get you an answer, but I cannot answer that question today.
Chairman Kelly. I wish you would come back to us with an
answer for that question.
One of the problems that I see with small business issues
at the SEC is they cut across a lot of different internal
divisions of the SEC. I am wondering if it would not be better
at the SEC, if it would be better for the people in the
businesses and the SEC itself, if you had some sort of a small
business policy office that was a part of the Division of
Corporation Finance, but separate from, so that they could be
within the umbrella, but separate so there is one way for those
of us in Congress and the businesses themselves to get some
clarity and specific direction. I think it would speed up a
number of issues.
As I said, Ms. Velazquez and I have been working on this
for 4 years and we do not have a response from the SEC. We
would really appreciate getting one.
I also would hope that you would come back to us with your
thoughts about the idea of having a specific separate small
business policy office. I think that would be very helpful for
some of these businesses and for the SEC.
I am out of time. I am going to turn now to Mr. Davis.
Mr. Davis. Thank you.
Mr. Beller, I probably will not use my full 5 minutes, but
I wanted to go back to the area of your testimony that relates
to Sarbanes-Oxley. I was reviewing the part of your written
testimony that deals with some of the allowances that have been
made for small businesses who may be struggling, or who will
eventually struggle with the compliance aspects of Sarbanes-
Oxley.
Let me ask you a broader philosophical question. What is
your position or the SEC's position on whether Sarbanes-Oxley
ought to apply to certain small businesses at all?
Can you talk about whether there is any strong public
interest or any strong public policy rationale that dictates
that Sarbanes-Oxley even apply to a lot of these smaller
companies?
Mr. Beller. Sure. I would answer that in two different
ways.
One, as a regulatory agency, we take our direction from
Congress, of course. The Sarbanes-Oxley Act of 2002 does not
itself make any distinction between larger companies and
smaller companies. I think we take that direction very
seriously. So the direction from Congress is in a sense the
benefits in that statute are to be directed at all of our
reporting companies.
The second answer I would give you is that consistent with
that direction, I think the commission's philosophical view,
and certainly mine, is that the benefits of Sarbanes-Oxley to
improved financial reporting, to improved disclosure, to
improved performance by auditors, to improved corporate
governance, and to improved performance of people, gatekeepers
like lawyers and accountants and underwriters and analysts, all
of those improvements are important to companies of all sizes.
So the statute correctly directs us, if you will, as a
philosophical matter, to apply its principles across the board.
Mr. Davis. Let me ask a different follow-up. Let's say that
in the 109th Congress for whatever reason we were to take a
look at Sarbanes-Oxley and we were of a mindset to make some
changes in it, recognizing that we make the policies and
theoretically you do not.
Give me some guidance if Congress were to be interested in
carving out exceptions for small businesses or if Congress were
to be interested in creating a different set of standards. Give
me some guidance of how we ought to be thinking about that
process.
Mr. Beller. I think the honest answer to that is that we
have certainly heard enough regarding the impact of the burden
of the requirements to assess and audit internal control over
financial reporting, that certainly the Chief Accountant of the
Commission, Don Nicolaisen, and I have both indicated publicly
that we would like the private-sector individuals, principally
an organization called the Committee of Sponsoring
Organizations, or COSO, we would encourage COSO to think about
whether they should develop an alternative framework that would
apply to smaller companies. I actually think that that would be
the most appropriate way to address that burden, and I think
before we were to do something, before the PCAOB were to do
something and before Congress were to do something, I would
like to see what COSO is prepared to do.
Beyond internal control, what I said earlier holds. We are
at the end of the beginning. We have completed the rulemaking
process. We have now very actively entered listening mode, both
at the commission level and the staff level. I think we are not
bashful at all about our eagerness to get outside help in that
listening mode.
Mr. Davis. Let me try to slip in one question while I have
a little bit of time left on the clock.
Can you comment on an issue that, as you know, has been
very controversial in this chamber and is now before the other
body, relating to expensing of stock options?
Of course, as you know, the House passed a particular bill
and the Senate right now is reviewing it. It is unlikely we
will get a final product before we adjourn.
Can you comment for a moment on whether it makes any sense
to carve out exceptions to the expensing rules for smaller
businesses?
Mr. Beller. I think my answer to that would be the same as
the commission's answer has been with respect to that issue
generally. Our chairman is certainly very clearly on record as
to this.
We believe that the right place for these questions to be
dealt with is the FASB. We think the FASB has an open and
appropriate due process. The question of whether there should
be different treatment for smaller companies and whether there
should be different treatment for private companies has
certainly been presented to the FASB. That is where I would
look to get the answer to that question.
What I think we are committed to do once the FASB has acted
is to provide appropriate implementation guidance so that the
rule that the FASB comes out with is a rule that is
appropriately implemented by the companies large and small that
it would apply to. I think that is where we are.
Mr. Davis. I think my time has expired, if the Chair would
give me an additional 30 seconds.
One of the controversies as you know has been the degree to
which we should be deferential toward FASB. We have had a
fairly strong discussion over that.
So if you can answer just theoretically, if Congress were
to decide to put some kind of restraints on FASB's
decisionmaking process, as the House has already done, what
should we be looking at if we were to try to do some kind of a
carve-out for smaller companies to make them less subject to
the full expensing requirements?
Should we be looking at the small companies in the same way
we look at the large companies when it comes to the expensing
issues?
Mr. Beller. Again, I think my answer has to be that we
would encourage leaving this to the FASB and not the
legislative process. I am not sure I can give any more guidance
than that.
Mr. Davis. Okay. I will take the witness's answer as I do
not think I am going to get another one, Madam Chairwoman.
Chairman Kelly. Thank you, Mr. Davis.
Mr. Paul?
Mr. Paul. Thank you, Madam Chairman.
Your mission has been described as protecting investors,
ensuring orderly markets and promoting capital formation. I am
going to ask the question, then I am going to develop a little
bit.
Has it ever crossed your mind that this is an impossible
mission and something that is unachievable?
The reason I ask this is that I think the wrong things get
blamed for our problems. In the 1930s, we had a bad period of
time. We had a crash in the stock market and we introduced this
notion that all we needed were regulations and everything would
be okay. And yet when they investigated the crash and the loss
of funds in the late 1920s and early 1930s, they found out
there was essentially no fraud. There was a financial bubble
and there was a collapse. Yet during the 1930s, we kept
introducing more and more regulations and kept the markets out
of balance for a long period of time and things got worse.
Therefore, there was no proof that regulations in the 1930s
were helpful; maybe exactly the opposite was true.
Today we have problems. We had the collapse of the Nasdaq
bubble, 80 percent, probably trillions of dollars lost. We had
Enrons. And yet we did have the SEC and others sort of poking
around there hoping to prevent this, and it did not do any
good.
Our conclusion now is we need even more regulations, so the
Congress responded. You are right. You do not create these
problems. You do what we tell you, so we passed Sarbanes-Oxley
and now you are making this effort.
I still maintain maybe the impossibility of solving our
problems through regulation because we are not directing our
attention to the problem. To me, the problem is the bubble. You
do not create the bubble. As a matter of fact, nobody can
prevent the correction once the bubble is created. Right now,
we have had a partial collapse of the bubble, but we probably
have a long way to go.
So far we as legislators always have to do something, and
we are doing something, and you are responding and you are
doing your best. But you are involved in trying to cause
capital formation while what we are doing is causing costs of
capital formation to go up.
I do not think we have the right definition of ``capital
formation'' because in a free market economy capital comes from
savings. It does not come out of the thin air. I think what we
talk about when we talk about capital formation, and when you
talk about it, I think you are alluding more to allocation of
credit, how to send some credit over into small business in
places where we think it is necessary.
I think that is completely different than capital
formation. Capital formation means productivity and savings,
yet our savings rate is real low, so we are not doing a heck of
a lot to create real capital. Of course, we do create credit
out of thin air.
I just am concerned that we are on the wrong track, and
that all your good efforts will not pay off very well because
we have not asked the question: How have we created the bubble
and the collapse and the mal-investment and all the debt in the
system?
And some people lose money, and we have very disorderly
markets. When you think about it, they are very disorderly.
Just one day this week, the dollar lost 1 percent. This affects
everybody's investments, exporters and importers, and prices,
and the whole works.
So once again, the question is: Has it ever occurred to you
in the slightest manner that maybe the regulatory process is on
the wrong track and it cannot solve the problems that we face?
Mr. Beller. I guess I would say that I agree with you that
the SEC is not, without trying to address whether there is a
regulator or which regulator it is, the SEC is not the
regulator to address issues of bubbles and collapsing of
bubbles and productivity and savings rates and the other things
that you very properly allude to as the critical underpinnings
of a capital market.
I think when we talk about capital formation, what I think
we think our mission is, is to eliminate obstacles in the way
that markets operate, including regulatory obstacles, that is,
thinking about our own rules, that keep the capital formation
process that you are talking about from operating in a free
market, competitive way. I think that is a mission that we can
appropriately address.
I think there is evidence that it is a mission that can be
consistent with our investor protection mission if we do it
right. I think that the fact that the global markets, which
have lots of models available to them other than ours, the
global markets have more often than not followed the U.S. lead
in terms of both the way we regulate markets to encourage
capital formation and the way we regulate companies to
facilitate their being able to raise capital and to foster
investor protection.
I think that trend following the U.S. lead in the global
markets is actually also true of Sarbanes-Oxley. If you look at
what is happening in Europe, certainly, and what is happening
in some parts of Asia even, you will find best practices and
legislation and EU directives, all of which to some degree
mimic what Congress did in Sarbanes-Oxley and what we did in
implementing it.
So I think if you narrow what capital formation means to
the narrower concept that I think we use, and not savings and
productivity and the like that are really not part of our
function, I think the mission is a possible one. The mission
can be swamped by forces outside our control. That is, bubbles
can come and go and our regulatory function does not really
address them in any way.
Mr. Paul. May I have 30 seconds for one quick one?
Chairman Kelly. So ordered.
Mr. Paul. If there is an argument made that these
regulations are too great a burden for the small company,
wouldn't this be the perfect argument to show that if it is a
burden to small companies, it is also a burden to the large
company and it would make the case that all the regulations are
not beneficial.
Mr. Beller. It would, and I think we do think about that. I
think if you take internal control as an example, though, I
think you can fairly reach a conclusion that differentiates
larger companies from smaller companies.
The internal control mechanism at larger companies depends
on processes, depends on checks and balances, depends on
documentation. And properly so, because there is no one
consciousness that knows all the things that are going well or
going badly across the board.
A smaller company, you will find, and certainly when we get
down to the $25 million level, you will find that it is the
rule, rather than the exception, that the CEO knows everything
that is going on, or the CFO knows everything that is going on
in the financial area.
The right kinds of control mechanisms and the right kinds
of assessments really could be different in that environment.
So when we talk about right-sizing the framework for thinking
about internal control, it is those kinds of issues. I think
you can get to saying small businesses ought to have different
treatment or ought to be recalibrated.
There are other instances where, as you say, you can fairly
argue that what is burdensome for the small companies is
proportionately burdensome for the large companies and why are
we doing it at all. We do think about that.
Chairman Kelly. Thank you, Mr. Paul.
Mr. Beller, there is clearly some overlap between the work
of the SEC and the work of the Small Business Administration
for small private businesses and small public companies.
Especially there is an overlap when small businesses reach the
point where they want to go public.
I am interested in the fact that the SBA I know has written
to the SEC for comment on proposals that could have an impact
on small businesses. I want to know what the SEC is doing to be
proactive for the small businesses? How are you working, what
are you doing to try to work more closely with the SBA to make
that juncture a little easier for people to navigate?
Mr. Beller. I think we have good relations and good
communications with the Small Business Administration,
certainly with the Office of Advocacy. The head of our Office
of Small Business Policy is in I would say ongoing
communication with them about their concerns and our concerns.
Chairman Kelly. But you do not have a small business
advocate at the commission, nor does the commission have one
person designated to be a small business liaison. That might
help, don't you think?
Mr. Beller. I took your earlier point about whether it
should be someone within the Division of Corporation Finance or
whether there should be a separate office. I think we feel we
do have someone who acts as a liaison between the agency and
small business for all issues. That is the head of the Office
of Small Business Policy.
You correctly observed that that office is within the
division and I think fairly ask, is that the best place for it
to be. But there is such a person, and that person certainly
believes that part of his function is to be the liaison.
We will certainly take your question back and consider it.
I would say that one of the reasons that person is in the
division--and in a sense it could be in any of three divisions:
there are four divisions in the SEC--and functions that get
spun off outside those divisions, they think more multi-
divisionally, but they risk becoming orphans. That is, I think,
the issue we have to address in thinking about the right place
for that office.
But we do have an office. The man who heads that office
firmly believes, and I as the division director firmly believe,
that he is the liaison between the commission as a whole and
small business. We talk to the other divisions about that
liaison function.
Chairman Kelly. Is that apparent to the small businesses
who need that person?
Mr. Beller. I think we try to make that point extremely
clear. I think, for example, the small business forum, the
forum that was just held last Monday, is organized by that
office. It is held by that office, organized by that office,
but the subjects that are raised include the finders issue from
market reg; include BDC issues and investment management.
The small businesses who participate in that forum, I think
it is crystal clear to them that the head of that office is the
liaison for all purposes within the agency, yes.
Chairman Kelly. Since you brought up the small business
forum, there was in the report, I think it was this last
report, that there was a recommendation that the commission
create a position to act as a small business liaison, and that
one commissioner serve as an advocate.
I think that that is something that we would be very
interested in seeing happen. I would hope that you will
consider that. You seem to indicate that you will.
We thank you very much. The Chair notes that the U.S. Small
Business Administration will submit a statement in writing due
to their inability to be appear before this subcommittee today.
We thank you very much for appearing here, Mr. Beller.
The Chair also notes that some members probably will have
some additional questions for this panel which they may wish to
submit in writing. So without objection, the hearing record
will remain open for 30 days for members to submit written
questions to these witnesses and to place their response in the
record.
We thank you very much, Mr. Beller. We appreciate your
sharing time with us today. Thank you.
Mr. Beller. Thank you for the opportunity to appear before
you. Thanks very much.
Chairman Kelly. Thank you.
As Mr. Beller leaves, I would like to bring up our second
panel. We have several private-sector witnesses to discuss the
current state of small business development and access to
capital.
Our first witness is Ms. Joan M. Sweeney, the chief
operating officer and chief compliance officer of Allied
Capital in Washington, D.C. Ms. Sweeney has worked with Allied
Capital since 1993 and oversees the company's daily operations.
Prior to joining Allied Capital, Ms. Sweeney was employed by
Ernst and Young, as well as Coopers and Lybrand and the SEC
Division of Enforcement.
We welcome you, Ms. Sweeney.
Also appearing on our second panel is Mr. Frank Speight,
chairman and chief executive officer of American Capital
Partners in West Palm Beach, Florida. Mr. Speight is
representing the National Small Public Company Leadership
Council, a Washington, D.C.-based group seeking to educate the
White House, Congress and federal agencies about the economic
contribution of small publicly held companies.
In addition, we also hear from Mr. Thomas Schneider, the
President and chief executive officer of Pathfinder Bank in
Oswego, New York. Mr. Schneider will be representing America's
Community Bankers, an advocacy group of community banks whose
members have assets which aggregate more than $1 trillion and
pursue progressive entrepreneurial and service-oriented
strategies in financial services to benefit their customers and
communities.
Our final witness of the day is Mr. James Connolly III, the
President of the IBA Capital Funding in Perrineville, New
Jersey. Mr. Connolly is representing the CEO Council, a group
which advocates on behalf of CEOs of small public companies.
Mr. Connolly is also the director of the new business
development of InvestTrend, a fee-for-service financial
analysis organization.
Without objection, your written statements will be made
part of the record. You will each be recognized for 5 minutes.
We will begin with you, Ms. Sweeney. We welcome you here.
STATEMENT OF JOAN M. SWEENEY, CHIEF OPERATING OFFICER AND CHIEF
COMPLIANCE OFFICER, ALLIED CAPITAL
Ms. Sweeney. Thank you, Madam Chairwoman and members of the
subcommittee. I am Joan Sweeney, the chief operating officer of
Allied Capital Corporation. We invest in the American
entrepreneurial economy as the nation's largest business
development company or BDC.
Thank you for the opportunity to discuss the essential role
that BDCs play in providing growth capital and expertise to
smaller businesses.
I also want to thank you, Madam Chairwoman and
Congresswoman Velazquez, for your efforts in passing H.R. 3170,
the Increased Capital Access for Growing Business Act. If
enacted, this important piece of legislation will increase the
number of American companies that could access capital from
BDCs.
Allied Capital has been investing in growing businesses for
46 years, and over that time we have provided financing to
thousands of companies. Our assets today are over $3 billion
and we have investments in 116 portfolio companies, which
generate aggregate annual revenues of approximately $11 billion
and employ more than 105,000 people.
We provide both mezzanine debt and equity capital. We
believe that smaller companies need additional financing
sources. The U.S. financial services industry has been
contracting as a result of consolidation. This trend has
reduced the amount of debt capital available to smaller
companies. In addition, the cost of being a public company in a
post-Sarbanes-Oxley world is higher than ever. Going public has
become less attractive, and more companies are seeking private
financing options.
Small public companies, however, cannot turn to a BDC as a
private financing source because under current law they are not
eligible. This is unfortunate because BDCs, as regulated
entities, provide transparency as to their investing activities
and are a natural match for smaller companies.
Deprived of this option, many small public companies,
desperate for capital, have instead sought private financing
from private equity and hedge funds, which provide private
investment in public equities, or PIPE financing.
These unregulated funds have little transparency as to
their activities, and may not have the best interests of the
small company in mind. Some have even structured ``death
spiral'' PIPEs where the fund intends to profit from the fall
of the small firm's stock price.
Congress saw the need for alternative financing sources for
small companies in 1980 when it created BDCs. In defining the
types of businesses eligible for BDC financing, Congress
defined an ``eligible portfolio company'' as a company that did
not have a class of marginable securities under the rules of
the Federal Reserve.
According to the legislative history, Congress intended the
pool of eligible portfolio companies to be very broad, and it
was estimated that 8,000 of the 12,000 publicly traded
companies at the time would be eligible.
However, in 1999 the Federal Reserve greatly expanded the
definition of marginable securities. Today, any security listed
on the Nasdaq stock market is considered marginable, which is a
substantial shift from what was marginable in 1980.
The Federal Reserve's changing view of marginability
collided with congressional intent for BDCs and drastically
reduced the universe of companies eligible for BDC financing.
Small public companies needing cash for growth are no longer
eligible, and recently questions have been raised about the
eligibility of private companies with outstanding debt
securities, since debt securities are also now marginable.
BDCs may invest limited capital in companies that are not
eligible, but we do not think there should be any limit when it
comes to providing growth capital for smaller companies.
One investment that Allied Capital made is in a small
public company called Blue Rhino, which you may recognize as
the supplier of the propane gas cylinder for your outdoor
grill. This company came to us in 2001 for $15 million in
financing. Their stock was trading at only $3.70 per share, and
their market capitalization was less than $100 million. They
were not suitable for a secondary public offering.
Our financing enabled the company to grow its sales
substantially in 2001 and 2002. The company increased in value,
its shareholders benefited, and Allied Capital's shareholders
benefited with a capital gain.
BDCs work well. BDCs can play a much more meaningful role
in providing capital to entrepreneurial companies if the
definition of ``eligible portfolio'' company is updated.
We encourage the subcommittee to review the rulemaking
activity of the SEC to ensure that the definition is
appropriately amended both to restore Congress's original
vision and to provide consistency with the provisions of H.R.
3170.
Thank you for the opportunity to testify today.
[The prepared statement of Joan M. Sweeney can be found on
page 58 in the appendix.]
Chairman Kelly. Thank you very much.
We move next to Mr. Connolly.
STATEMENT OF JAMES A. CONNOLLY III, PRESIDENT, IBA CAPITAL
FUNDING, REPRESENTING THE CEO COUNCIL
Mr. Connolly. Thank you. Good morning, Chairwoman Kelly and
members of the subcommittee.
Chairman Kelly. It is a busy day.
Mr. Connolly. I am certainly aware, and I thank you for
taking the time. I do not know that I will be as compelling to
listen to as Mr. Allawi, but I will try. I have congratulated
Ms. Sweeney for truly cooking with gas, as Blue Rhino is
certainly a great stock and a valuable addition to the
marketplace.
To begin again, good morning, Chairwoman Kelly and members
of the subcommittee. First, allow me to thank you for the
opportunity to appear before you to present a somewhat
different perspective than has been heard here today on small
business capitalization as experienced by the over 7,000
publicly traded companies currently listed on either the Over-
The-Counter Bulletin Board or the Pink Sheets.
We are gratified that our efforts to communicate with the
Congress and relevant federal agencies, under your leadership
as advocates for small business, results in my appearance here
today.
My name is James Andrew Connolly III. I am a native New
Yorker and am here as a founding member of the CEO Council, a
Maryland-chartered 501(c)(6) organization of small public
company executives, with both a growing network of local
chapters and an expanding membership base throughout the
country.
Our stated purpose is to enhance the public markets for
investors and couple this with affordable financing options for
smaller public companies. We are seeking to achieve these goals
with both a member-driven advocacy effort, along with
supplementing the information available to the markets as to
the opportunities open for investment in these engines of
economic growth, job creation and innovation.
Our market space of 7,000 companies includes hundreds of
millions of dollars in market capitalization, tens of thousands
of employees, and likely hundreds of thousands of stockholders.
We are the dirty little secret of the securities markets, much
maligned, overregulated, and often referred to as ``penny
stocks'' in the same sentence as ``scam.''
I can state with certainty that the perception of fraud is
not the same as fraud, and the substantial majority of these
companies are operated in an ethical and businesslike manner.
They are responsive to their customers, good employers and
contributors to their communities along the way. They operate
in all 50 States and probably in most congressional districts.
They range from startups to well-seasoned enterprises who all
share the competitive challenges of a global marketplace, a
recovering economy and the burden of often-unaffordable
compliance costs.
It is frequently the case when apportioning resources that
a microcap CEO is compelled to choose between expanded
reporting costs and new hiring, payroll and benefits or audits
and expanded legal advice. Public transparency costs, whether
as traditional investor relations or fully compliant research
dissemination, director indemnification or liability coverage,
without which many of these companies cannot attract qualified
outside directors, compete for scarce corporate resources and
are therefore often lacking.
Heretofore, our microcap colleagues have had to compete
without being able to collectively represent their interests as
significant contributors to the economic well being of the
United States, not to mention often very good investments
without running the gauntlet of regulatory indifference at
best, and outright hostility to our continued existence at
worst.
This has not occurred in a vacuum. There clearly have been
instances of abuse. We hear of them in the press when advised
to avoid penny stock investments, and unfortunately with
regular and necessary enforcement actions that become highly
publicized.
Taken cumulatively, these facts explain both the virtual
impossibility of obtaining either startup or expansion capital
on terms that are rational, as well as diminished liquidity in
secondary trading.
Undoubtedly, the modern era of instant execution, online
trading and affordable transaction costs, combined with the
relative lack of substantive reliable data on many microcap
securities, has led to an overall lack of transparency and
created multiple opportunities for both fraud and market
manipulation.
The CEO Council was formed with these challenges in mind
and has worked deliberatively over the past 3 years to effect
what we hope are progressive changes.
We took an early and active role in opposing the BBX as
envisioned by Nasdaq. They, like all profit-motivated
organizations, hoped to escape the costs of regulating the
Over-The-Counter Bulletin Board without provision for the
thousands of companies who either would not, could not, or
chose not to list, thereby relegating them to Pink Sheet
status, which demonstrably would lead to a major loss of both
market capitalization and reduced investor liquidity.
The council has maintained an active presence at the
annual, most recently on Monday concluded SEC Government-
Business Forum on Small Business Capital Formation held every
year since Congress mandated it in 1980.
We have contributed to its agenda and suggested several of
the hundreds of recommendations that small business owners,
regulators and industry practitioners have suggested for
implementation. Sadly, far too few have been adopted or
implemented. As a matter of fact, Madam Chairwoman, virtually
every year one of those recommendations is to re-adopt the
recommendations from the year before.
It often seems that the various, admittedly dysfunctional
divisions of the SEC are in conflict with each other when
responding to our concerns. The perception of enforcement
appears to be guilty until examined innocent. Corporate finance
clearly has a Fortune 1000 focus, and it is left to the small
business ombudsman, Mr. LaPorte, to represent our interests
within the bureaucracy, often to no avail.
I have included with my written testimony for the
subcommittee's review the recommendations from 2002 and 2003.
If I may, just as an aside, I would like to point out that
recommendation number 24 last year was mine. It called upon the
SEC to work diligently to expand financial literacy within the
investor community so that investors are much more confident
and aware of the realities of investing.
The NASD has had some significant negative effects on our
marketplace as well. In their determination to disallow broker-
dealers to receive any compensation for filing form 15(c) 211,
despite substantial costs to fully due diligence a listing, the
200-plus market makers in Pink Sheet-listed companies shrank to
40 active submitters, creating less than a fully open and
competitive marketplace.
If the attorneys and accountants have no problem being paid
for rendering professional services and are fully registered,
licensed professional market makers who, through their due
diligence prior to a filing, are the first line of defense
against fraud, any less deserving?
Time does not permit me to cite many other obstacles
microcap companies encounter in a full discussion here today,
but with your indulgence I will cite three other significant
proposals that the CEO Council would recommend.
Firstly, I am aware that there is interest at both the
American Stock Exchange in New York and the Pacific Coast
Exchange in San Francisco in the development of a specialist-
based new venture or microcap exchange. This should be fully
explored at both the SEC and the NASD, neither of which appear
to be overly interested in those proposals from the indications
I have received, as its potential for small company access to
capital is very promising.
Secondly, we would like to propose a new regulatory regime
for small business issuers. This might include consultative
roles for organized participation by all elements of the
capital markets with investor advocates, institutional
investors, regulators, issuers and other interested parties
operating in a framework to create what some have called the
``enterprise exchange.'' There are opposing views on whether a
specialist or a dealer market is a better solution, but we
believe this is worth exploring.
Finally, we believe that regulation 15(c) 211 should be
improved and streamlined, such that nonreporting issuers should
provide financial information to the marketplace, and that
regulation 15(c) 211 should be right-sized to fit this goal.
Additionally, despite multiple efforts, some with very
substantial congressional support, I might add, the information
on this form which every publicly traded company in the Pink
Sheets or Bulletin Board needs to file to effect trading, and
therefore is available in the repository of the NASD, and I
believe in most cases at the SEC, could form the basis of
informed investor interest and is maintained by the NASD, where
individuals have been refused by them to have these documents
fully disseminated to the public as filed. There are data
vendors who would gladly supply this information, several free
of charge, as transparency, we all agree, is a paramount goal.
Investor protection and small business capitalization need
not be mutually exclusive and hopefully this dialogue today
will add to the efforts expended by many of us who are deeply
concerned that without both regulatory changes and a more fully
informed investor base through increases in financial literacy,
coupled with enhanced disclosures, the microcap marketplace can
once again thrive and be a hotbed of innovation and growth for
our economy.
Thank you for hearing our concerns today, as well as your
willingness to address them. I know the members of the CEO
Council are pleased to be a resource. We hope you will call on
us in your future efforts to keep our markets the most
efficient and transparent in the world.
With your permission, we would like to add to the record in
the allotted record period time. Thank you again.
[The prepared statement of James A. Connolly III can be
found on page 47 in the appendix.]
Chairman Kelly. So moved.
Thank you very much.
Mr. Speight, we welcome you here today.
STATEMENT OF FRANK SPEIGHT, CHAIRMAN AND CHIEF EXECUTIVE
OFFICER, AMERICAN CAPITAL PARTNERS, LTD., REPRESENTING THE
NATIONAL SMALL PUBLIC COMPANY LEADERSHIP COUNCIL
Mr. Speight. Good morning, Madam Chairwoman and members of
the subcommittee. I want to thank you for the opportunity to
appear before you today to testify on the issue of small
business access to capital.
My name is Frank Speight. I am the founder, chairman and
CEO of American Capital Partners, Limited, a registered
business development company which is based in West Palm Beach,
Florida. I also serve as co-chairman of the National Small
Public Company Leadership Council, a Washington, D.C.-based
group that seeks to educate and inform the White House,
Congress, and federal agencies about the crucial issues
impacting the nation's small publicly traded companies and the
economic contributions that those companies are making.
Let me first congratulate Chairwoman Sue Kelly on the House
passage of the bill called Increased Capital Access for Growing
Businesses Act, H.R. 3170, that would modernize outdated
securities laws to ensure that small businesses have better
access to capital through business development companies, or
BDCs.
We have enjoyed working with Congresswoman Kelly on behalf
of the Leadership Council. It is exciting to see the first
fruits of her efforts to broaden access to capital for BDCs,
which are publicly traded investment companies that invest in
both public and private companies and generate necessary
injections of capital for all businesses.
I am here today in support of her efforts and to urge that
access to capital be broadened to encompass all small and
developing companies. Small business is the engine of the
economy.
The ability of small business to raise funds and have
access to loans or the necessary capital markets is essential.
When small businesses do not have the capital they need, they
are unable to make the investments they require to grow their
business. This, in turn, hampers growth in the overall economy.
We must do all we can to create a greater access to capital
markets for all small business.
An important step in providing greater access to the
capital markets for small public companies can be taken by
reinstating a modified and updated version of SEC Rule 504,
which was among the reforms created by the Reagan
Administration.
For small businesses in particular, the paperwork and legal
costs are prohibitive oftentimes for raising money through the
capital markets. The Reagan Administration wisely knew that the
SEC Rule 504 made it easier for small firms to raise money from
the stock market by exempting them from many SEC regulations
and registrations if they raised $1 million in a calendar year.
To briefly review, the results of Reagan's SEC reforms were
immediate. Small businesses fueled the boom of the 1980s and
1990s. Small businesses quickly realized that they could raise
capital as never before, and the sector became the engine of
growth for the new economy.
For example, in 1984 two friends who owned a small ice-
cream shop in Vermont wanted to build a full-fledged
manufacturing plant to sell their product nationally. The
friends decided to bypass an underwriter or a broker and raised
$750,000 by selling directly to Vermont residents. A year after
raising this seed capital, Ben & Jerry's listed on the Nasdaq
and soon became one of the best-selling brands in the United
States.
According to a report in The New York Times in 1983, the
SEC's changes under the Reagan Administration had brought an
additional $500 million into the markets in less than 2 years.
Also, as Philip Koslow wrote in his book, The Securities
and Exchange Commission, published in 1990, ``The SEC's new
approach undoubtedly contributed to the expansion of the
markets and the growth of new capital. Wall Street, which had
seen some hard times since the 1970s slump, began to boom. New
buildings were going up throughout the financial district in
lower Manhattan, and firms were hiring thousands of new
workers. Suddenly, Wall Street was the place to be for
energetic and ambitious young people. All this activity clearly
bolstered the economy in the short run.''
During the early 1990s, the reforms of Rule 504 were
liberalized even further and once again small businesses fueled
an economic boom. According to the Small Business
Administration, more than one-half of all U.S. employees work
for companies with 500 employees or less. These firms produce
47 percent of all business receipts and nearly all the new job
growth. Firms with more than 500 employees actually had a net
decrease of jobs from 1992 to 1996. Some economists credit
small business for the dramatic growth in American productivity
that was responsible for the incredible prosperity of the
1990s.
But since that era, the SEC has found many excuses to roll
back the reform policy that the Reagan Administration put into
place. During its reign, Rule 504 successfully proved to build
prosperity by giving small companies more access to the capital
markets.
The SEC would argue, as I heard today, that Rule 504 still
exists on the books. But in reality, the SEC has taken the
teeth out of the measure and it is of little use, by relegating
the decisionmaking process to the States and taking it away
from the federal level.
Under the former 504 guidelines, accredited investors could
receive unrestricted securities for their investment, thus
allowing them the necessary liquidity to lessen their risk
exposure. It also allowed them the opportunity to more quickly
reinvest the proceeds from an investment into another small
public company and there expand the capital base.
There is a tremendous need to modernize outdated securities
laws to ensure that small businesses have better access to
capital.
My recommendation is a reinstatement of SEC Rule 504 to its
former parameters, but with several modifications. These
changes would be to increase the annual cap on the money small
businesses can raise to $2 million, from the former $1 million.
This would allow small microcap public companies the access to
the levels of capital they truly need in today's marketplace.
Also, require the SEC to develop some kind of mechanism to
streamline the process for filing. If a small public company is
current in its SEC filings, they should be allowed to file an
easy 504 notification filing, with supporting documentation
such as a legal opinion letter on EDGAR, similar to the current
same-day filing S-8 that is currently in place for compensating
consultants.
Madam Chairwoman and members of the subcommittee, small
businesses are the backbone of our economy. There is no
question about that. It is critical, absolutely critical, I
believe, for small businesses of all kinds to have more access
to capital in order to create jobs, buy products, invest in
this beautiful country of ours, and ensure a strong and growing
economy.
Thank you, Madam Chairwoman, for your time.
[The prepared statement of Frank Speight can be found on
page 55 in the appendix.]
Chairman Kelly. Thank you very much, Mr. Speight.
Mr. Schneider?
STATEMENT OF THOMAS SCHNEIDER, PRESIDENT AND CHIEF EXECUTIVE
OFFICER, PATHFINDER BANK, REPRESENTING AMERICA'S COMMUNITY
BANKERS
Mr. Schneider. Good afternoon, Chairwoman Kelly and members
of the subcommittee. Thank you for inviting me to testify. I am
Tom Schneider, President and CEO of Pathfinder Bank in Oswego,
New York. Pathfinder is a community bank traded on Nasdaq with
capital of $22 million. I am here representing America's
Community Bankers.
I am proud to report that the climate for small business in
my community is improving. Small businesses are the economic
engine in our country. They are our job creators and they are
vital customers for my bank. Small businesses are growing and
creating much-needed jobs, often because community banks across
our nation focus on helping local businesses with their capital
needs.
Oswego, New York, is located in the old manufacturing heart
of our nation. As the U.S. economy has shifted from a
manufacturing economy to one that is service-oriented, our
community has had to adapt. Pathfinder Bank has been proud to
provide capital to aid in that transition. My bank proudly
offers several types of financial products to meet the capital
needs of the small businesses in the Oswego area.
One of the greatest tools we have is also one of the best
private-public partnerships ever created by Congress, the
programs of the Small Business Administration. The SBA is an
excellent partner in carrying out the mission of providing
capital to small businesses. We use two primary programs, the
7(a) loan program and the 504 loan program. These guarantee
programs allow community banks the opportunity to provide
capital to small businesses that would not otherwise qualify
for credit.
We also offer something else. Community banks offer access
to the decision maker, and that decision maker knows the people
and the area. Because we know and understand the unique needs
of small businesses, community banks are often more flexible in
their decisionmaking. Often, making a loan decision will come
down to the character and integrity of the applicant. As a
community banker, I know the people of my community and I can
make that decision
We have a vivid example of this in the case of the
community hospital in Oswego. A few years ago, the hospital
needed capital to renovate and expand services it provides in
our community. It tried working with a large institutional
bank, but the hospital did not meet the bank's cookie-cutter
criteria and the hospital faced the prospect of being denied
the funds it needed. We at Pathfinder Bank knew the hospital
and the people running it. Working with another community bank,
we were able to serve the people of Oswego by helping secure
the financing for the hospital.
There is a second topic I would like to address today, the
effect of the Sarbanes-Oxley Act. It has had an impact on how
small, publicly traded banks such as Pathfinder do business.
Ultimately, the legislation will make our economy stronger by
increasing corporate accountability and providing greater
confidence for investors.
However, small banks are seeing large cost increases. A
recent survey of ACB members found that the biggest impact of
Sarbanes-Oxley appears to be higher compliance fees and costs.
Sarbanes-Oxley is important to reeling in the conduct of bad
corporate lawyers, executives and accountants.
However, we believe that some of its provisions are
unnecessary for the banking industry because we are already
tightly regulated and tightly supervised by federal regulators.
Parts of the law are particularly burdensome on the smaller
community banks.
That is why we suggest that the costs and fees associated
with complying with Sarbanes-Oxley may justify allowing smaller
organizations to be exempt from portions of the law.
In addition, ACB and its members support efforts to see if
there are requirements that can be streamlined or waived by the
Securities and Exchange Commission to promote greater access to
the capital markets for small businesses. While many of the
existing regulations may be necessary for larger and more
complex companies, they may be an unnecessary obstacle to small
businesses in seeking access to capital markets.
Because Pathfinder Bank is publicly traded, we have access
to capital and can therefore make more loans to small
businesses in our community. Before that, we were like any
other small business. We had to seek capital so we could
further expand our services and product lines, and more
importantly hire additional employees.
I am proud to bring to the subcommittee's attention an
effort to bring greater visibility and capital to community
banks. In partnership with Nasdaq, we created the America's
Community Bankers Nasdaq Index of over 500 community banks
traded on Nasdaq. This focuses attention on community banks as
a vital sector of the financial services industry and our
nation's economy.
In conclusion, Pathfinder Bank and ACB believe there is a
prosperous climate for Americans to start and to grow small
businesses. Community banks across our great country are
willing and able to meet the capital needs of small businesses.
Chairwoman Kelly and members of the subcommittee, thank you
again for allowing me the time to testify today. I am available
to answer any questions you may have.
[The prepared statement of Thomas Schneider can be found on
page 50 in the appendix.]
Chairman Kelly. Thank you very much, Mr. Schneider.
I would like to ask you, Ms. Sweeney, if BDCs are allowed
to invest in all private companies, Pink Sheet companies,
bulletin board companies, any company that is facing some sort
of a de-listing, would that increase the number of public
companies to which you can offer capital assistance?
Ms. Sweeney. Well, today, because of the way the Federal
Reserve change happened in 1999, we cannot invest in any
company that has a marginable security. So that under some very
narrow interpretations would mean even private companies, if
they already have an outstanding debt issuance to a private
issuer, because that is a marginable security.
So what was proposed in H.R. 3170, which is essentially
update the definition, allow BDCs to finance any company with a
market capitalization of $250 million or less, that opens up
the universe to all private companies and to small public
companies.
Because I think you made an interesting point in the
earlier panel, the definition of what is small, when it comes
to a public company today, needs to be reexamined.
The S&P small cap index picks up above $250 million. There
is this universe of companies below $250 million, Blue Rhino is
a classic example, that need capital. They cannot access; they
cannot do a secondary. There is no research on these companies.
There are no investment banks who think they are worth their
time for the fee that they will earn to raise the capital.
So we think that that definition, for very many purposes,
needs to be reexamined.
Mr. Connolly. Will you marry me?
[Laughter.]
Chairman Kelly. Mr. Connolly, do you want to comment on
that?
Mr. Connolly. Ms. Kelly, I must say, I have just asked Ms.
Sweeney if she would like to marry me.
[Laughter.]
Those are the most incredible points that have not I think
effectively been presented either to this committee, and
certainly to the larger media, the public perception as well,
is that we are bandits. Not for nothing, as they say I guess
back in the 'hood.
I am a third generation in my family in the marketplace. My
grandfather came back from World War I in 1915; went to work
for Brown Brothers, and became a specialist in the New York
Stock Exchange, probably mid-way when these guys were founded,
the SEC. I do not know if he was responsible for the necessity
of their creation.
My father was on the street for 30 years and when I was
born he was working for the President's family's firm, G.H.
Walker and Company. I have spent my professional career working
to assist small public companies, both as a licensed
professional regulated broker and also as an investor direct,
specifically, venture, however one wants to define it. In that
entire period of time, there are very, very few companies with
market caps of over $250 million that I have even met.
So the truth of the matter is that the BDC bills, the
support that you and Ms. Velazquez cumulatively have put behind
that effort, and by the way we have been knocking on their
doors for 3 years as an organization, the CEO Council.
So I would share your frustration, I suspect, in getting
responses.
But you can do something about it. So to that extent, this
hearing I think is a critical link in making both my community
of 7,000 companies in the marketplace be aware that Congress is
certainly concerned to the level of hearing, certainly
considering potential technical corrections, I guess, if you
were to the possibility of Sarbanes-Oxley looking at the issues
that day to day the ladies and gentlemen of our community have
to address.
Chairman Kelly. Thank you.
Does anybody else want to address that?
In that case, Mr. Speight, you started to talk about Rule
504. There is a problem evidently at the SEC in trying to
balance the interests of capital formation and investor
protection. It is a very tricky one, and it goes to what Ms.
Sweeney and Mr. Connolly were just talking about. The problem
is that investor protection sometimes seems to get in the way
of the capital formation part.
Have you any suggestions to the SEC? Obviously, this is
going to be printed testimony which we can pass on to the SEC.
I would be interested in any suggestions you might have.
Mr. Speight. I honestly believe that you can have your cake
and eat it too. I really do believe that you can reinstate
something similar to the 504 exemption, increase the limits to
it. All companies that would have access to it would have to be
fully reporting companies. That obviously tells the marketplace
the financials of the company, any changes that have been made
to the company. I think that the commission can keep in place
all the anti-fraud provisions in it.
I was in a meeting where a representative from the SEC
basically told us that their estimate was that out of the 504
offerings, about 1 to 1.5 percent were fraudulent. I think that
is an overreaction to basically take the teeth out of an
exemption that did so much for small companies because of 1 to
1.5 percent fraud. That is my opinion.
The predecessor company to American Capital Partners,
Dunhill Capital, did 24 504 offerings in 1998 alone. That is
$24 million that was pumped into small public companies and you
can multiply us by thousands of other funding sources.
I think it is a travesty that they took the teeth out of
something that allowed small companies to access $1 million a
year in capital in such an easy way, and they could reinstate
it and still keep the anti-fraud provisions in there, make the
company report, make the company even file an immediate
notification that they are doing a 504, and what the terms of
that 504 are.
Let the public know. Let it be transparent. Nobody has a
problem with that.
Chairman Kelly. One of the problems that the agencies in
government seem to have, though, is that many agencies really
do not have the funding right now to put in the information
technology systems so that, for instance, you are talking about
reporting.
One of the problems is that some of the rules that they
promulgated back in the early 1900s still apply, so that you
have to do certain things by written note and telephone because
it is mandated in the rule.
Some of the rules need to be changed, but also I am hopeful
that we can get the agencies to shift some of their funding
priorities so that they can put in the information technology
that is necessary so that we can perhaps open up the doors
more, especially to something like the 504. We will have to
wait and see.
I have one question here, if I can find it, for you, Mr.
Schneider. In your testimony, you spoke of the existing SEC
regulations that for the large complex companies, so they
probably or maybe an unnecessary obstacle for the small
business access to capital markets. You offered a couple of
examples.
I would be interested if you have any ideas of what
regulations you feel could be streamlined or eliminated beyond
what you started talking about. I think you are in a very
interesting position with regard to your bank being a small
company, in a sense.
I know for a fact that when we wrote the Sarbanes-Oxley
bill, there was no intent to try to curtail. There was only an
intent to try to make a transparent system so that investors
would feel comfortable, everyone could see what was going on in
the companies and we could then have a certain comfort level
with people investing in the market.
Obviously, there are some things there you would like to
see changed. You suggested a couple of them. I would be
interested in hearing any others.
Mr. Schneider. When it comes to the governance and the
independence of the organization, those were very easy things
for us to adapt to. I think we adopted a very comprehensive set
of governance guidelines. Our audit committee was already
functioning after years of examination by the New York State
Banking Department and the FDIC. It was already functioning in
a very independent and effective manner.
I think it is going to come about for us, and it is just
transitioning now, but on the certification and attestation of
internal control systems, which 305 does account for, and
accounts for at the $500 million level. We are a $300 million
bank. I think that that limit was put in there because the
resources at our organization, and I was happy to hear Mr.
Beller's comments regarding it because he seemed to be aware of
the fact that in a smaller organization the knowledge of the
internal control system is inherent in the CFO and the CEO
positions.
But going through the process of that documentation now of
that system is going to be very costly. That cost has already
begun for us. I would probably put that cost somewhere at about
$100,000 for us to get from here to there by December of 2005,
which is the set of financials that we are going to have to put
out that are going to have to be attested to by our external
auditors.
After that, there is going to be the accelerated filings of
10Qs and 10Ks quarterly in annual reports. I think that that is
going to be a difficult transition for smaller organizations,
too. I think it is going to put a strain on the whole system.
The external auditors that we utilize do not really get into
it. We have a fiscal calendar-year end of 12/31. They do not
get into us until February because they are working with their
larger clients in January.
So I am not certain how we are going to be able to meet
those accelerated 10K filing requirements if the access to, and
many companies are running fiscal years on calendar years. I am
not sure how you are going to get your access to your external
auditors in time to go through that whole certification-
attestation process, with everybody feeling comfortable that
the external auditors are opining to the financial statements.
It just seems like, and I think you talked about technology
and that solution perhaps lies there, but for us we are still
operating with a good transaction processing system. It is not
the greatest accounting system in the world, so it takes us a
while. And that ``while,'' frankly, is a better internal
control because we are spending more time in the compilation.
I am not so sure that you can achieve both quality and
speed simultaneously. I think that the quality is probably more
important to the stability of the place than speed is at this
juncture. Those would be the two areas that I would think are
going to be cost-burdensome.
Chairman Kelly. Both of those areas are very serious things
that we really do need to take a look at and work with.
I want to thank all of you for taking the time to come here
to speak to us. I want to just simply throw out one more
question to all four of you. Are there any messages that you
would like to leave this committee with that you have not had
the opportunity to speak about today?
Mr. Connolly. Fairly simply from my testimony, Madam
Chairwoman, the one item that I specifically alluded to
crafting this statement relative to rule 15(c) 211 and its
transparency.
That came as a shocking statement from the President of a
firm called Knobias.com or ``no bias'' as it may be referred
to, who is the repository as an information source for
professional market players and individuals of all data that is
available for small fees in the penny stock and bulletin board
arena.
The President of that firm, which is Mississippi-based,
indicated to me that for the last 5 years, with some
substantial congressional assistance, as you can imagine, it
found a stone wall at both the NASD and the SEC in terms of
getting that 15(c) 211 information, which is the basic
financial information submitted prior to a company trading
publicly, to be released on an FTP server at Knobias's expense
and at no cost to the American public, that material and
information transparent to the marketplace would be available.
To the extent that the committee finds that of interest
that those two organizations would preclude the public from
having a basic fundamentally transparent set of facts on which
to make an investment decision, I know that is of great concern
to us.
Chairman Kelly. Thank you.
Anyone else?
Then we thank you very much.
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 30 days for the members to submit written questions to
these witnesses and place their responses in the record.
I thank all of you for your time and your patience and your
very interesting comments here today.
This hearing is adjourned.
[Whereupon, at 1:01 p.m., the subcommittee was adjourned.]
A P P E N D I X
September 23, 2004
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