[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]


 
                  LEGISLATIVE PROPOSALS TO FACILITATE 
                    SMALL BUSINESS CAPITAL FORMATION 
                            AND JOB CREATION 

=======================================================================

                                HEARING

                               BEFORE THE

                  SUBCOMMITTEE ON CAPITAL MARKETS AND

                    GOVERNMENT SPONSORED ENTERPRISES

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               __________

                           SEPTEMBER 21, 2011

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 112-63

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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                   SPENCER BACHUS, Alabama, Chairman

JEB HENSARLING, Texas, Vice          BARNEY FRANK, Massachusetts, 
    Chairman                             Ranking Member
PETER T. KING, New York              MAXINE WATERS, California
EDWARD R. ROYCE, California          CAROLYN B. MALONEY, New York
FRANK D. LUCAS, Oklahoma             LUIS V. GUTIERREZ, Illinois
RON PAUL, Texas                      NYDIA M. VELAZQUEZ, New York
DONALD A. MANZULLO, Illinois         MELVIN L. WATT, North Carolina
WALTER B. JONES, North Carolina      GARY L. ACKERMAN, New York
JUDY BIGGERT, Illinois               BRAD SHERMAN, California
GARY G. MILLER, California           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            JOE BACA, California
MICHELE BACHMANN, Minnesota          STEPHEN F. LYNCH, Massachusetts
THADDEUS G. McCOTTER, Michigan       BRAD MILLER, North Carolina
KEVIN McCARTHY, California           DAVID SCOTT, Georgia
STEVAN PEARCE, New Mexico            AL GREEN, Texas
BILL POSEY, Florida                  EMANUEL CLEAVER, Missouri
MICHAEL G. FITZPATRICK,              GWEN MOORE, Wisconsin
    Pennsylvania                     KEITH ELLISON, Minnesota
LYNN A. WESTMORELAND, Georgia        ED PERLMUTTER, Colorado
BLAINE LUETKEMEYER, Missouri         JOE DONNELLY, Indiana
BILL HUIZENGA, Michigan              ANDRE CARSON, Indiana
SEAN P. DUFFY, Wisconsin             JAMES A. HIMES, Connecticut
NAN A. S. HAYWORTH, New York         GARY C. PETERS, Michigan
JAMES B. RENACCI, Ohio               JOHN C. CARNEY, Jr., Delaware
ROBERT HURT, Virginia
ROBERT J. DOLD, Illinois
DAVID SCHWEIKERT, Arizona
MICHAEL G. GRIMM, New York
FRANCISCO ``QUICO'' CANSECO, Texas
STEVE STIVERS, Ohio
STEPHEN LEE FINCHER, Tennessee

                   Larry C. Lavender, Chief of Staff
  Subcommittee on Capital Markets and Government Sponsored Enterprises

                  SCOTT GARRETT, New Jersey, Chairman

DAVID SCHWEIKERT, Arizona, Vice      MAXINE WATERS, California, Ranking 
    Chairman                             Member
PETER T. KING, New York              GARY L. ACKERMAN, New York
EDWARD R. ROYCE, California          BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma             RUBEN HINOJOSA, Texas
DONALD A. MANZULLO, Illinois         STEPHEN F. LYNCH, Massachusetts
JUDY BIGGERT, Illinois               BRAD MILLER, North Carolina
JEB HENSARLING, Texas                CAROLYN B. MALONEY, New York
RANDY NEUGEBAUER, Texas              GWEN MOORE, Wisconsin
JOHN CAMPBELL, California            ED PERLMUTTER, Colorado
THADDEUS G. McCOTTER, Michigan       JOE DONNELLY, Indiana
KEVIN McCARTHY, California           ANDRE CARSON, Indiana
STEVAN PEARCE, New Mexico            JAMES A. HIMES, Connecticut
BILL POSEY, Florida                  GARY C. PETERS, Michigan
MICHAEL G. FITZPATRICK,              AL GREEN, Texas
    Pennsylvania                     KEITH ELLISON, Minnesota
NAN A. S. HAYWORTH, New York
ROBERT HURT, Virginia
MICHAEL G. GRIMM, New York
STEVE STIVERS, Ohio
ROBERT J. DOLD, Illinois



































                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    September 21, 2011...........................................     1
Appendix:
    September 21, 2011...........................................    53

                               WITNESSES
                     Wednesday, September 21, 2011

Abshure, Heath, Arkansas Securities Commissioner, on behalf of 
  the North American Securities Administrators Association, Inc. 
  (NASAA)........................................................    29
Cross, Meredith B., Director, Division of Corporation Finance, 
  U.S. Securities and Exchange Commission, accompanied by Lona 
  Nallengara, Deputy Director....................................    10
Mauriello, Dana, Co-Founder and President, ProFounder............    31
Molinari, Vincent R., Co-Founder and Chief Executive Officer, 
  GATE Technologies, LLC.........................................    33
Silbert, Barry E., Founder and Chief Executive Officer, 
  SecondMarket...................................................    35
Waddill, William D., Senior Vice President and Chief Financial 
  Officer, OncoMed Pharmaceuticals, Inc., on behalf of the 
  Biotechnology Industry Organization (BIO)......................    36
Williams, Matthew H., Chairman and President, Gothenburg State 
  Bank, on behalf of the American Bankers Association (ABA)......    38

                                APPENDIX

Prepared statements:
    Abshure, Heath...............................................    54
    Cross, Meredith B............................................    66
    Mauriello, Dana..............................................    85
    Molinari, Vincent R..........................................   100
    Silbert, Barry E.............................................   110
    Waddill, William D...........................................   127
    Williams, Matthew H..........................................   133

              Additional Material Submitted for the Record

Garrett, Hon. Scott:
    Written statement of Burroughs & Chapin Company, Inc.........   140
    Written statement of the Credit Union National Association 
      (CUNA).....................................................   143
    Written statement of the Independent Community Bankers of 
      America (ICBA).............................................   147
    Written statement of the U.S. Chamber of Commerce............   149
Frank, Hon. Barney:
    Written statement of the CFA Institute, the Center for Audit 
      Quality, and the Council of Institutional Investors........   151


                  LEGISLATIVE PROPOSALS TO FACILITATE
                    SMALL BUSINESS CAPITAL FORMATION
                            AND JOB CREATION

                              ----------                              


                     Wednesday, September 21, 2011

             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 10:06 a.m., in 
room 2128, Rayburn House Office Building, Hon. Scott Garrett 
[chairman of the subcommittee] presiding.
    Members present: Representatives Garrett, Schweikert, 
Royce, Manzullo, Biggert, McCarthy of California, Pearce, 
Posey, Fitzpatrick, Hayworth, Hurt, Stivers, Dold; Waters, 
Sherman, Maloney, Perlmutter, Donnelly, Himes, Peters, and 
Ellison.
    Ex officio present: Representative Frank.
    Also present: Representatives Fincher and McHenry.
    Chairman Garrett. Good morning. This hearing of the 
Subcommittee on Capital Markets and Government Sponsored 
Enterprises is called to order.
    And before I proceed, I seek unanimous consent that non-
subcommittee members, Mr. Fincher and Mr. McHenry, will be 
allowed to take part today and also give opening statements as 
well. Without objection, it is so ordered.
    We would also like to welcome the newest member of the 
subcommittee, the gentleman from California, Mr. McCarthy.
    Mr. McCarthy of California. Thank you, Mr. Chairman.
    Chairman Garrett. And with that, we will begin with opening 
statements. I yield myself 3 minutes.
    Before that, I would like to welcome our witnesses. I do 
look forward to your testimony in a little while, after we have 
run through all this, on a number of proposals that will 
encourage capital formation and job creation all across the 
country.
    A couple of weeks ago, as part of the job plan that he 
outlined at his speech over at the Joint Session of Congress, 
the President included some ideas that, in the case of 
Congressman Schweikert's bill, we have passed out of this 
committee already, and in some other cases are similar to 
proposals that we will be considering today.
    So I am pleased that we have a bipartisan momentum, it 
would seem, behind efforts to tap into the potential for 
American entrepreneurs to build companies and to create jobs.
    Many of the existing rules and regulations in the area of 
capital formation were, as always, well-intentioned at the time 
they were first established, but have sometimes been in place 
now for years and years, actually decades, and are due for a 
review.
    And so while the President did not end up including any 
capital formation proposals in his legislative language that he 
sent up to the Hill, we have five specific bills that we will 
be considering at today's hearing that we think can help jump-
start the economy.
    Let's do a quick run-down of them.
    H.R. 2167, the Private Company Flexibility and Growth Act, 
introduced by my Mr. Schweikert, would raise the threshold for 
mandatory registration with the SEC from 500 to 1,000, if it 
was signed into law, and would be the first time the 
shareholder threshold has been adjusted since way back in 1964.
    We will also consider a similar proposal today from 
Congressman Himes that pertains to smaller banks; he just took 
it down a little bit different road.
    Also, Congressman Patrick McHenry has a proposal under 
consideration today. His bill is called the Entrepreneur Access 
to Capital Act. What would it do? It would enhance the 
President's proposals on encouraging so-called crowdfunding, an 
innovative phenomenon that can tap into social networking 
tools, where many investors are able to basically pool smaller 
investments together, get them all together, without having to 
grapple with the regulations of the SEC and all the costs that 
go along with that.
    Also, the gentleman from California who was just 
introduced, Mr. McCarthy, has a bill. That is the Access to 
Capital for Job Creators Act and will also be on the docket, so 
to speak, today.
    As a former small business owner himself, he is an expert 
in this area and is no stranger to the challenges that they 
face. So his legislation provide more flexibility in soliciting 
accredited investors for private offering.
    And finally, I will wrap it up here; the newest member of 
the full Financial Services Committee, Mr. Fincher, has a draft 
proposal for consideration today that I am really interested 
in.
    During the consideration of Dodd-Frank, I worked closely on 
a bipartisan basis with my late colleague from New Jersey, John 
Adler. That was a proposal which was ultimately included in the 
final bill to permanently exempt smaller companies from having 
to comply with the burdens of SOX 404(b).
    Mr. Fincher's proposal would raise the market 
capitalization threshold for companies fully exempt from 404(b) 
compliance from the $75 million that we had, to $500 million, 
and provide further flexibility in 404(b) compliance for 
companies from $500 million to the $1 billion range.
    So all of these proposals are common-sense ideas, I think, 
to remove unnecessary regulations, which is what the 
Administration wants to do, from the shoulders of small 
businesses while unleashing American entrepreneurs to do what 
they do best: create jobs and help the economy grow.
    As I mentioned earlier, it is my hope and belief that most, 
if not all of these bills really should, at the end of the day, 
get bipartisan support.
    I appreciate the committee's attention. With that, the 
gentleman from Massachusetts is recognized for 5 minutes.
    Mr. Frank. Thank you, Mr. Chairman. I agree that we should 
be moving in a direction of reducing unnecessary regulation, 
particularly on smaller entities. And we have already worked on 
things.
    I believe we have an agreement between the parties, for 
instance, on Mr. Schweikert's bill on Regulation A, which I 
assume will be coming to the Floor soon. We support that. On 
our side, Mr. Himes has a bill that I believe is widely 
supported. And there are others that we will be working on.
    I agree with much of what we have today. I have two points. 
One, I am less enamored of further reducing the reach of 
Sarbanes-Oxley. I think Sarbanes-Oxley is not a generalized 
statute dealing with audits. I think that has a particular 
importance. The Congress did vote in the bill last year. And I 
didn't vote for the amendment, but it is now a law. We have 
raised them up to $75 million.
    I believe, and many in the corporate community have said 
that Sarbanes-Oxley--obviously, by its name, it is clearly a 
bipartisan measure--enhanced capital formation, because one of 
the things we have had from time to time is a lack of 
confidence on the part of investors.
    Sarbanes-Oxley is a great confidence builder. There were 
predictions that it was going to have a very negative effect on 
capital formation in America back when it was passed. And I 
don't believe that has been the case. I think it has been 
somewhat positive.
    The other area that I want to say--we can, on some of these 
bills, there is room for debate about the level: $1 million is 
too low in the crowdfunding, but $5 million may be too high. 
Maybe there are some intermediate things you can do, but I 
generally agree with the thought of increasing it. But where we 
may have a sharper difference is on the question of the 
preemption of State laws.
    That was an issue with regard to the Reg A bill. And I was 
glad that we are able to work that out. We have a study coming. 
But I do believe that State securities administrators have been 
helpful.
    And I would put it in this context. We have had a 
disagreement among ourselves about what level of funding the 
SEC should get, while even the most optimistic projections 
recognized that the SEC will not have enough money to do 
everything it theoretically is charged with doing. The Boston 
Consulting Group study talked about prioritizing.
    I think it would be a great mistake to reject the voluntary 
help that States are prepared to give us in enforcement, 
especially since in my experience--I come from a State which 
has an excellent securities administrator. In our case, he is 
the Secretary of the Commonwealth. He is an elected official. 
And his most important duty is to be the security 
administrator, I believe. And he has been very constructive.
    What you get, I think, is a level of enforcement and 
investor protection that you may not get elsewhere. The SEC has 
the mandate of maintaining a good market. The SEC has broader 
responsibilities.
    It has been my experience in general that at the State 
level, individual concerns, whether they be consumer concerns 
or investor concerns, get attention that is sometimes lost down 
here where we are doing mega policy.
    And I think that the macro gets a lot of attention here. 
The micro doesn't always get as much attention for 
understandable reasons. Everything is a competition for 
resources and attention.
    I think the States have been doing a good job of this. Yes, 
you need to recognize the need for national markets. But 
particularly where we talk about investor protection, where we 
are talking about anti-fraud protection, I am against the trend 
of preempting State laws that we have seen from time-to-time.
    And again, this is a bipartisan issue. The North American 
Securities Administrators Association (NASAA) works together in 
a pretty bipartisan way, and I think they make a very useful 
contribution.
    So I am in favor of reducing some of the SEC registration 
requirements on the smaller entities. That, in itself, helps 
the SEC focus better on the broader systemic issues. I don't 
extend that to Sarbanes-Oxley, which has a very specific 
purpose.
    But I also believe that my own confidence in our ability to 
do this at the Federal level is strengthened by knowing that 
the States are there to do the anti-fraud and investor 
protection. And I would hope that would be the mix we could 
get, that we would reduce the paperwork at the Federal level, 
but not diminish the ability of the States to serve that 
protective function.
    And I thank you, Mr. Chairman, for the time.
    Chairman Garrett. I thank the gentleman.
    The gentleman from Arizona.
    Mr. Schweikert. Thank you, Mr. Chairman.
    During the August break, we spent a lot of time visiting 
companies that were attempting to grow, trying to find ways to 
capitalize. We would hear two stories: one, a fear of certain 
regulations that may or may not be coming, but may be in 
promulgation; and two, access to capital. It is one of the 
reasons I am actually somewhat overjoyed with the progress we 
are making here.
    This happens to be one of those moments where we are 
actually understanding that this will help create jobs. And 
guess what? We are actually, on many of these, working through 
some of the partisan divide.
    To the ranking member and his staff, on a couple of our 
pieces of legislation, they have been very forthright in their 
concerns. And we really appreciate their working with our 
staff, because this really is one of those occasions where we 
are going to hopefully be disciplined, move bills through the 
process that do good things, and actually help in the 
definition of what is access to capital.
    In the old days, we used to think it was walking into our 
neighborhood bank. In today's world, it is something much more 
complicated, when you think of Mr. McHenry's cloud sourcing of 
raising money, and some of the other definitions here.
    I am hoping this becomes some of the future of how we help 
capitalize these small and medium-sized businesses.
    Thank you, Mr. Chairman.
    Chairman Garrett. And I thank the gentleman.
    The gentlelady from New York for 2 minutes.
    Mrs. Maloney. Thank you, Mr. Chairman, for convening this 
hearing.
    And welcome to all of the witnesses. I am so pleased to see 
that there are so many here today from the private sector to 
tell us what we need to do to help them grow and expand the 
economy.
    We are looking at several legislative proposals to enable 
smaller businesses to better grow, create jobs, and boost our 
economy. And certainly, that is the top of the list of 
President Obama's address to Congress and I would say both 
sides of the aisle, creating jobs.
    So I am pleased that we are going to study these bills 
today. They will all try to provide some relief to fledging 
businesses. And I look forward to working with my colleagues to 
advance them.
    During Dodd-Frank, I worked with my colleagues from New 
Jersey, Representatives Adler and Garrett, to extend the 
implementation period of Section 404(b) of Sarbanes-Oxley for 
smaller public companies.
    In Dodd-Frank, companies under $75 million were exempted 
from 404(b). And I would like to note that 60 percent of all 
public companies have market capitalization of under $75 
million. So I believe that we have the appropriate balance 
there.
    I am interested in supporting Mr. Himes' bill, and not only 
Mr. Schweikert's Reg A, but H.R. 2167 seems to be a good 
approach to allowing small businesses to grow and go public on 
their own. Too often, they have to sell in order to raise 
liquidity. That doesn't help jobs. That doesn't help growth. 
That doesn't help the overall economy.
    I feel that this is the number one issue in our country 
now, job creation. And I look forward to learning more about 
these proposals and supporting some of them.
    Thank you, Mr. Chairman.
    Chairman Garrett. And I thank the gentlelady.
    Mrs. Biggert is recognized for 1 minute.
    Mrs. Biggert. Thank you, Mr. Chairman. And good morning and 
thank you all for being here today.
    I think we can all agree that access to capital is an 
absolute necessity for job creation. According to a recent 
Small Business Administration survey, 71 percent of small 
businesses said they could increase their revenues by 25 
percent or more if they had access to additional capital. These 
additional revenues would allow companies to expand and hire 
additional employees.
    Unfortunately, the current regulatory environment remains a 
roadblock to businesses by strangling access to capital. 
Recently imposed regulations have led directly to banks 
tightening their lending standards and the reduction of credit, 
so badly needed.
    In addition to streamlining these burdensome new 
regulations and providing the certainty banks need to resume 
lending, it is imperative that we, on this committee, enact 
sound policies that will allow businesses to grow using 
additional sources of financing.
    We must explore all options to facilitate capital 
formation, reduce the onerous effects of Sarbanes-Oxley on 
small businesses, and reduce the regulatory obstacles to 
overcrowding.
    I yield back.
    Chairman Garrett. And the gentlelady yields back.
    Mr. Himes for 3 minutes.
    Mr. Himes. Thank you, Mr. Chairman.
    Let me begin by thanking the witnesses. The participation 
of the SEC is going to be really critical in what I think is a 
really technical and fiddly endeavor that we are embarking on 
here.
    The United States has the most efficient and liquid capital 
markets in the world, seizures like we have seen in the last 
couple of years notwithstanding. But I do think we can do 
better. I will never participate in the blanket anti-regulatory 
crusade that unfortunately we see from the other side of the 
aisle.
    I think getting the balance of regulation, particularly in 
financial services, is critical. But I am very open to the 
possibility, having reviewed, for example, initial public 
offering data over the last couple of years, that there are 
some rigidities there that are probably not just explained by 
additional volatility and risk in the market.
    I think we can do better. I am open to the possibility that 
Sarbanes-Oxley is not perfect, and that the securities laws 
that were initially established in 1933 and 1934 could evolve 
and adapt to be more germane to today's markets.
    And of course, that the litigation environment that rises 
up around these laws could, in fact, have a counterproductive 
and dampening effect on companies' access to capital, which is 
so critical right now to job creation.
    I am also intrigued by the governance questions that are 
involved here. I believe that even though the private equity 
industry comes in for a drubbing in this room, that private 
equity investors, inasmuch as they put people on the boards of 
directors of the companies that they own, provide a level of 
accountability and shareholder advocacy on those boards that 
you don't often see.
    But, of course, your mission and our most important task 
must be to make sure that we don't open the door to retail 
investors, to the widows and orphans getting hurt by fraud or 
misstatement. That has to be our first objective.
    Not surprisingly, I am a believer in my own bill, H.R. 
1965. The financial institutions that would be allowed 
registration exemptions are in an extraordinarily regulated 
environment. I take some comfort in that; they are much more 
regulated than most other commercial entities. I am a co-
sponsor of Congressman Schweikert's bill because I think it is 
a nice evolution of the 1933 and 1934 Acts.
    I have profound concerns though about crowdfunding and, in 
particular, the general solicitation exemption therein. I can 
imagine a scenario where the Internet is used to get people all 
over the country to send $5,000 to a snake oil salesman.
    I don't know the answer, but all of these things are at 
risk. It is fiddly and it is complicated. And I hope that you 
will help us understand what the trade-offs are, so that we 
come out of this in a bipartisan fashion, having improved the 
capital markets and created liquidity while protecting 
investors.
    Thank you, and I yield back the balance of my time.
    Mr. Frank. Mr. Chairman, if you will yield for a second, 
let me just point out, the chairman was not being lax in 
ignoring the clock. We had extra time, and I had him give it to 
Mr. Himes. So the chairman was accommodating us.
    I don't want other Members to complain that they didn't get 
the extra minute. That came out of our time.
    Chairman Garrett. Thank you.
    The gentleman from California is recognized for 2 minutes.
    Mr. McCarthy of California. Thank you, Chairman Garrett. I 
appreciate you convening this hearing to examine legislative 
proposals to facilitate small business capital formation and 
job creation.
    Small businesses are the engine of the American economy. 
They represent 99.7 percent of all employer firms and employ 
more than half of all private sector employees.
    It doesn't take close examination to these statistics to 
come to the conclusion that the solution to our national high 
unemployment must include a plan to allow for robust small 
business growth.
    In order to flourish, entrepreneurs and small business 
owners need fewer regulatory restrictions and greater access to 
capital to start and grow companies and get more people 
working.
    Unfortunately, onerous Federal regulations dampen both 
innovation and access to capital because of the restrictions 
and compliance burden they place on these enterprises. That is 
why I have introduced H.R. 2940, the Access to Capital for Job 
Creators Act.
    It removes the solicitation prohibition contained in Rule 
506 of Regulation D of the Securities Act to give small 
businesses another way to access private capital by allowing 
them to widely seek funds from the entire pool of wealthy SEC-
accredited investors without requiring them to go through the 
full SEC registration process.
    I believe that the legislative proposals the committee is 
exploring today are vital steps forward in promoting job 
creation and economic growth. By unshackling entrepreneurs and 
small businesses from excess Federal regulations, our economy 
job creation engine will once again put us back on the path to 
prosperity.
    And I yield back.
    Chairman Garrett. Thank you.
    The gentleman, Mr. Ellison, is recognized for a minute.
    Mr. Ellison. Thank you, Mr. Chairman.
    The House is soon going to consider a continuing resolution 
to fund the government after the fiscal year ends next week. 
And I remain concerned about the funding levels for the SEC in 
the upcoming fiscal year. The current House proposal for SEC 
funding is about $222 million less than the President's 
request. This budget shortfall will make it harder, not easier, 
for the SEC to do its job and to implement important reforms in 
Dodd-Frank.
    Underfunding today will cause delays and undermine the work 
on overcoming derivatives markets and also limit the number of 
enforcement investigations the SEC can pursue.
    So while I urge my colleagues to support full funding, I 
look forward to hearing what the SEC witness has to say today.
    Thank you very much.
    Chairman Garrett. And I want to yield at this point 30 
seconds to--
    Mr. Frank. Thank you, Mr. Chairman. I just got a copy of a 
letter signed by the Center for Audit Quality, the CFA 
Institute, and the Council of Institutional Investors, opposing 
the bill to raise the limits further on who is covered by 
Sarbanes-Oxley. Let me just read it briefly, and I ask to be 
able to put it in the record.
    Chairman Garrett. Without objection, it is so ordered.
    Mr. Frank. ``The Center for Audit Quality, the Council of 
Institutional Investors, and the CFA Institute are writing to 
urge you to resist efforts to further weaken SOX by exempting 
even more public companies from compliance with Section 404(b) 
of the Act, which requires an independent audit of a company's 
assessment of its internal controls as a component of its 
financial statement audit.
    ``Indeed, effective internal controls have become more 
central to the financial statement audit, a fact that has 
contributed to an increase in overall audit quality in the 
years since the passage of the Sarbanes-Oxley Act.''
    And it says, ``We believe that all investors should receive 
equal protections.'' They quote surveys from investors talking 
about the benefits in Sarbanes-Oxley. As I said, it is signed 
by the CFA Institute, the Center for Audit Quality, and also 
the Council of Institutional Investors, Mr. Mahoney. And I ask 
that it would be put into the record, as you have already given 
me permission.
    Thank you.
    Chairman Garrett. I thank the gentleman.
    The gentlelady from New York is recognized for 1 minute.
    Dr. Hayworth. Thank you, Mr. Chairman, and I appreciate our 
colleagues' comments regarding the necessity to, in essence, 
assess the cost-benefit ratio of regulations. Are we truly 
doing good things for investors and assuring their safety, 
while also not impeding the formation of capital or access to 
capital. And it does feel over the years that we have aired on 
the side of impeding access.
    In particular, I am concerned about small businesses' 
ability to raise capital. So I was encouraged by SEC Chairman 
Mary Schapiro, who last week said that she would work with us 
regarding issues such as decimalization, the global research 
settlement, and the general lack of market makers for small 
capital stocks.
    So I hope that we can work together to ensure that 
liquidity and price discovery can be facilitated in ways that 
can truly again grow jobs and facilitate enterprise. And I look 
forward to your comments.
    Welcome back, Ms. Cross, to the committee. And I am sure we 
can work together to make good things happen for our small 
businesses.
    Thank you, Mr. Chairman. I yield back.
    Chairman Garrett. The gentlelady yields back.
    Mr. Dold is recognized for 1 minute.
    Mr. Dold. Thank you, Mr. Chairman. I want to thank you for 
holding the hearing on this important topic.
    President Obama and congressional Republicans and Democrats 
all agree that one of the largest obstacles to job growth and 
economic recovery is capital formation. And I would argue that 
is specially true for small business capital formation.
    As a small business owner myself, I personally understand 
the challenges of business expansion, hiring, meeting a payroll 
and a budget, and managing cash flow. And capital formation is 
a crucial component in achieving these important small business 
objectives. But the reality is that small businesses right now 
all across our country are struggling for capital.
    Some capital formation problems are caused by factors the 
Federal Government can't directly or immediately affect. But 
there are other factors that the government can directly and 
immediately affect, starting with scrutinizing our existing 
regulations to determine which ones no longer make sense in our 
current economic situation and in our current practical 
marketplace realities.
    So I look forward to hearing from our witnesses about 
correcting regulations that are creating an unduly restrictive 
capital formation environment, while also maintaining necessary 
investor protections.
    With that, Mr. Chairman, I yield back.
    Chairman Garrett. And the gentleman yields back.
    Mr. McHenry for 1 minute.
    Mr. McHenry. Thank you, Mr. Chairman.
    As we know, most startups have a difficult time accessing 
the capital they need. Most small businesses began using a 
credit card or a home equity line of credit. In fact, my father 
started his own business on a credit card. We are grateful for 
that.
    But in these tough times, these challenges are twofold. 
First, fewer people have access to credit lines or home equity 
sufficient to start a small business. And second, a small 
businesses is highly burdened with a credit card, financing it 
with a credit card with a high rate of interest. Thus, most 
business ideas never make it past the dinner table.
    The Entrepreneur Access to Credit Act simply heeds the 
President's call to cut the red tape for startups and allow 
everyday investors to connect with entrepreneurs. In today's 
fast-paced world of information and innovation, all Americans, 
rather than just high- net-worth individuals, should be able to 
invest in the next Google, Groupon, or even their local coffee 
shop.
    Furthermore, State law will be preserved under this bill, 
dealing with anti-fraud laws at the State level.
    With that, thank you so much, Mr. Chairman, for holding 
this hearing.
    Chairman Garrett. And the gentleman yields back.
    Mr. Fincher is recognized for, I believe, the final 2 
minutes.
    Mr. Fincher. Thank you, Mr. Chairman, for the time and 
opportunity to join the subcommittee hearing today.
    As you know, I have submitted the discussion draft to 
expand Sarbanes-Oxley 404(b) exemptions for small and mid-sized 
companies with a market capitalization of less than $500 
million.
    Supporters of increasing the $75 million cap believe that 
duplicative audit requirements hinder many companies from going 
public. Going public provides opportunities for companies to 
raise desperately needed capital in order to expand, reinvest, 
and create jobs.
    Opponents argue that changing the auditing requirements 
would lead to corporate fraud and shift us back to the days of 
Enron and WorldCom.
    Let me be clear; I am not talking about doing away with the 
corporate audits or internal controls, just auditing of the 
internal controls of companies that could use their scarce 
resources to expand their business.
    By raising market capitalization, it helps companies create 
jobs, but also preserves the goal of Sarbanes-Oxley, which 
ensures that large and complex companies, which brought us 
Sarbanes-Oxley in the first place, continue to be subject to 
these additional audits.
    I look forward to the testimony today.
    And thank you for your time, Mr. Chairman.
    Chairman Garrett. And I thank the gentleman as well.
    Now then, to the panel. We welcome Ms. Cross to the panel. 
She is the Director of Division of Corporation Finance at the 
SEC. You will be recognized for 5 minutes. Obviously, your full 
written testimony will be made a part of the record.
    Ms. Cross?

     STATEMENT OF MEREDITH B. CROSS, DIRECTOR, DIVISION OF 
 CORPORATION FINANCE, U.S. SECURITIES AND EXCHANGE COMMISSION, 
        ACCOMPANIED BY LONA NALLENGARA, DEPUTY DIRECTOR

    Ms. Cross. Chairman Garrett, Ranking Member Waters, and 
members of the subcommittee, my name is Meredith Cross, and I 
am the Director of the Division of Corporation Finance at the 
Securities and Exchange Commission. Joining me today is Lona 
Nallengara, Deputy Director of the Division.
    We are pleased to testify on behalf of the Commission on 
the topic of capital formation and, in particular, the 
Commission's small business capital formation initiatives and 
the broader capital formation regulatory review that the staff 
is undertaking.
    Our written testimony also discusses the internal controls 
audit requirement. I note that a number of the members of the 
subcommittee have introduced bills addressing many of these 
topics, and we look forward to discussing those with you today 
and in the future.
    The SEC's mission is to protect investors, maintain fair, 
orderly and efficient markets, and facilitate capital 
formation. Companies of all sizes need cost-effective access to 
capital to grow and develop. And the Commission recognizes that 
any unnecessary regulations may impede their ability to do 
that.
    At the same time, the Commission must seek to ensure that 
investors have the information and protections necessary to 
give them the confidence they need to invest in our markets. 
Investor confidence in the fairness and honesty of our markets 
is critical to the formation of capital.
    A few months ago, Chairman Schapiro instructed the staff to 
take a fresh look at some of our offering rules, develop ideas 
for the Commission to consider that may reduce the regulatory 
burdens on small business capital formation in a manner 
consistent with investor protection.
    The staff's review is focusing on a number of areas, 
including the number of shareholders and other triggers for 
public reporting, the restriction on general solicitation in 
private offerings, and restrictions on communications in public 
offerings.
    We are committed to carefully considering these areas and 
developing thoughtful recommendations for the Commission 
consistent with the goals of facilitating capital formation and 
protecting investors.
    In this regard, we look forward to receiving the input of 
the Commission's recently formed Advisory Committee on Small 
and Emerging Companies, which includes representatives from a 
range of small and emerging companies and investors in those 
types of companies with real-world experience under our rules.
    Our written testimony provides a more extensive update on 
our review, but I will briefly discuss a few of our efforts in 
this area.
    Chairman Schapiro has asked the staff to review the Section 
12(g) triggers for public reporting by non-listed companies and 
the characteristics of companies that should be subject to 
public reporting obligations.
    Under our current rules, the Section 12(g) trigger 
generally is 500 shareholders of record and $10 million in 
assets. Section 12(g) was adopted in 1964 following a rigorous 
special study of the securities markets in the early 1960s, 
commissioned by Congress and conducted by the Commission. Some 
have called for changes to the Section 12(g) threshold in light 
of the significant changes in the securities markets since the 
enactment of Section 12(g).
    To facilitate the Commission's review of the issues related 
to the thresholds for public reporting, and those for leaving 
the reporting system, the staff is undertaking a robust study 
like the one conducted when Section 12(g) was enacted. The 
study should help the Commission determine whether and how now 
the current thresholds should be updated in light of changes in 
companies, shareholders, and markets.
    Chairman Schapiro also has asked the staff to review the 
restrictions our rules impose on communications in private 
offerings, in particular the restrictions on general 
solicitation. Some have cited the restriction on general 
solicitation as a significant impediment to capital raising.
    At the same time, others support the restriction on general 
solicitation on the grounds that it helps prevent securities 
fraud by, for example, making it more difficult for fraudsters 
to find potential victims or unscrupulous issuers to condition 
the market.
    In analyzing whether to recommend changes in this area, the 
staff is considering next steps, including a possible concept 
release for the Commission to seek the public's input on the 
advisability and the costs and benefits of retaining or 
relaxing the restrictions on general solicitation.
    We also are assessing our rules and the regulatory burdens 
they impose with respect to communications in public offerings. 
Over the years, the Commission has taken steps to facilitate 
continued communication around public offerings.
    In 2005, the Commission significantly liberalized the rules 
governing communications by the largest companies during public 
offerings. The staff is reviewing these rules and our 
experience with them to see whether any of the liberalizations 
should be adapted for smaller public companies.
    Finally, as a part of our overall capital formation 
regulatory review, the staff is considering regulatory 
questions posed by new capital raising strategies such as 
crowdfunding, and the scope of our existing rules for small 
business capital raising such as the Regulation A exemption.
    Thank you for inviting us to appear before you today. We 
will be happy to answer any questions you may have.
    [The prepared statement of Ms. Cross and Mr. Nallengara can 
be found on page 66 of the appendix.]
    Chairman Garrett. And again thanks, Ms. Cross, for being 
here today. Thank you for your testimony. I assume we will have 
a whole slew of questions along the lines of legislation.
    Let us just begin where you sort of started out, with 
regard to the SEC setting up this advisory committee on small 
and emerging companies. Quickly, how do you define a small 
company?
    Ms. Cross. Companies with a market capital of $250 million.
    Chairman Garrett. Okay. So we set up or you have set up a 
new committee, an advisory committee on this. Now, this 
advisory committee, as I look at things, is in addition to your 
Office of Small Business. Would that be overlapping in some 
responsibilities what the Office of Small Business would do, 
briefly?
    Ms. Cross. The Office of Small Business, of course, is 
staffed with lawyers within the SEC. So we get the real-world 
experience from the advisory committee in helping us figure out 
what we should do.
    Chairman Garrett. Right.
    Ms. Cross. So they will work together. The Small Business 
Office will support the advisory committee in its work.
    Chairman Garrett. Okay. But then on top of this, you also 
have the annual forum, which I guess is statutorily required.
    Ms. Cross. That is correct.
    Chairman Garrett. And for how long have you been having 
those annual forums?
    Ms. Cross. I believe over 15 years.
    Chairman Garrett. Yes. Maybe like 2 or 3 decades.
    Ms. Cross. It did quite well, yes.
    Chairman Garrett. So those meet annually. The last one 
was--it would have been in 2010. Can you tell us how many 
recommendations came out of that forum? And how many 
recommendations that came out of that forum did the SEC 
actually take and issue rule changes from?
    Ms. Cross. I don't know the exact number of 
recommendations. They do issue a large number of 
recommendation.
    Chairman Garrett. Okay.
    Ms. Cross. I can't say that any of them have been 
specifically enacted.
    There were a number of them in, I think the forum before 
the last one, that were part of the small business initiatives. 
That would have been in 2007. The small business initiatives 
included a number of forum recommendations.
    We are currently going through the forum recommendations as 
a part of our current initiatives. So we hope to be able to 
move on some of them in this effort we are under now.
    Chairman Garrett. So how many over the last couple of years 
have actually gone through not just the process, but actually 
ended up in the final rulemaking?
    Ms. Cross. We have not done any of them--
    Chairman Garrett. Okay.
    Ms. Cross. --on the most recent forum.
    Chairman Garrett. All right. So with the new advisory 
committee, can you tell us briefly what the process is? Is 
there a deadline, since we are already getting almost all the 
way through 2011, looking back to 2010, and we haven't seen 
that done?
    Is there going to be a deadline with regard to the new 
advisory committee, as far as when they come up with their 
rules or when they come up with their recommendations, and 
when, if any of those recommendations will actually be 
submitted, they will go through the rule process?
    Ms. Cross. I appreciate your question. I think what we are 
doing right now is developing the list of the priority 
questions we would like them to help us analyze.
    So instead of sending them off to think about ideas and 
come back with a report, we are hoping to get pretty real-time 
feedback from them on the different ideas that are currently 
being discussed and how helpful they would be and what changes 
would be needed to implement those specific ideas.
    So I would say this will be real-time, hopefully, help from 
them on looking at these ideas.
    Chairman Garrett. What does that mean, real-time?
    Ms. Cross. We are currently discussing with the chairs of 
the committee the questions we would like them to take up 
first. So hopefully, they will be able to get us feedback on 
the ideas in the next few months.
    Chairman Garrett. Obviously, you know where I am coming 
from on this.
    Ms. Cross. I understand.
    Chairman Garrett. You can have all these committees in the 
world, and we have committee meetings all the time. And people 
always ask, when does actual legislation get through and 
eventually get signed into law? It is the same thing here.
    We are going to be concerned that we are going to take up 
time and energy and staff time with the SEC. I think it is 
appropriate that they look at this. But if we are here a year 
from now and we are saying dialogue and they are saying, ``We 
are still looking at it,'' you can see our concern.
    Another area on this, as far as setting up the committee, 
is with Sarbanes-Oxley, SOX. I understand--the President comes 
out with a White Paper that says we need to make some of these 
reforms, reduce regulation, what have you. And so now as part 
of this effort, a new committee was formed at SEC to take a 
look at SOX.
    I guess I am taken aback a little bit with regard to that, 
that this committee is taking a look at recommendations with 
regard to SOX. This is not a new issue as far as that is 
concerned.
    You are puzzled.
    Ms. Cross. Oh, I am puzzled. I apologize. I am not aware of 
a committee that has been formed at the SEC to look at SOX. So 
I guess that is unclear to me.
    I think the small business advisory committee that was just 
formed, that has not been on the list of, so far, priority 
items for them--
    Chairman Garrett. Okay.
    Ms. Cross. --because the SOX level is set by Congress.
    Chairman Garrett. Right.
    Ms. Cross. And so we have not--Congress changed the SOX 
level in Dodd-Frank.
    Chairman Garrett. Okay.
    Ms. Cross. And so we implemented a rule to implement what 
Congress--
    Chairman Garrett. What Congress expected you to do.
    Ms. Cross. Congress directed us to do a study of Section 
404 for companies between $75 million and $250 million, which 
the staff completed and posted on the--
    Chairman Garrett. I understand.
    Ms. Cross. And right now, GAO is doing a follow-up study as 
directed by Dodd-Frank. Maybe all of those different studies 
are what you are referring to.
    Chairman Garrett. We will get back to you.
    Thank you, Ms. Cross.
    The gentlelady from New York is recognized.
    Mrs. Maloney. On the Schweikert and the Himes bills, unlike 
the Schweikert bill, the Himes bill only applies to banks and 
bank holding companies. How many banks would be eligible to de-
register under this proposal? And how many banks would be 
affected by this change?
    Do you have any sense? And should the shareholder of record 
definition be revised to only include individual investors?
    Ms. Cross. Thank you for your question.
    On the number of community banks that would be exempted as 
a result of the provision, I don't have that data. We are in 
the process of gathering data through our 12(g) study. I think 
it would be a significant percentage of the small community 
banks.
    On who should count as shareholders of record, we think 
that is a very important question and one that we need to get 
updated data on. We would like to know the make-up of 
shareholders of the public companies of different sizes and 
also private companies. So we are in the process of looking at 
that now.
    Mrs. Maloney. Can the SEC raise the shareholder threshold 
on its own, the way it has raised the asset limits from $1 
million to $10 million?
    Ms. Cross. I have been advised by our Office of General 
Counsel that we do have authority under the 1934 Act as 
currently in effect to raise the level.
    In addition, the question of how do you count holders would 
have significant impacts on the level, because we can define 
holders of record. And so if we say you either do or don't look 
through various intermediaries, for example, or we say you 
don't count certain holders, that would have the practical 
impacts of changing it.
    Mrs. Maloney. If you can raise it, is there any reason why 
you have not?
    Ms. Cross. We just began the studies of this. We started in 
the late spring. As I mentioned in my opening remarks, when the 
levels were put in there with a robust study directed by 
Congress, the SEC has to go through the rigorous rulemaking 
process in order to make changes like that.
    If Congress makes the change, it will be in place, of 
course. If we need to do it, we need to do it through the 
process that would be expected, with public comment and the 
like.
    Mrs. Maloney. Are you planning to put it out for public 
comment?
    Ms. Cross. Following completion of the study, when we know 
what would be reasonable to recommend, then I would expect that 
the Commission would want to come forward with something to 
provide the thresholds. But, obviously, I can't commit the 
Commission. I am just the staff.
    Mrs. Maloney. And does any evidence suggest that $10 
million is the appropriate asset threshold at which to require 
SEC registration?
    Ms. Cross. I think that is a very fair question and part of 
what we would be looking at. For example, for banks, $10 
million is obviously not a meaningful measure, since a bank's 
assets include its loans.
    For other companies, it may be more reasonable, although it 
may need to go up. It has been in place since 1992. And it may 
also be reasonable to look at revenues. It may be reasonable to 
look at any number of other measures and see what are the kinds 
of companies that should be subject to public reporting.
    Are they only employee-held? There could be any number of 
things that are very important to this analysis, many of which 
Congress is currently considering in your legislation.
    Mrs. Maloney. And could you go over what benefits investors 
experience when a company is registered with the SEC?
    Ms. Cross. There is very important benefits. The way the 
securities laws are structured, investors are able to invest in 
companies of their choosing based on full and fair disclosure 
about those companies.
    The SEC doesn't decide who can be a public company and what 
investors can invest in. Instead, they leave it up to the 
investors' good judgment, based on having a full and fair 
disclosure document, with the financial statements and the 
management information and the risks that the companies face.
    So those are things that come through our public reporting 
system and are valuable to investors in making investment 
decisions.
    Mrs. Maloney. My time is running out, but is it appropriate 
to exclude accredited investors and employees from shareholder 
numbers?
    Ms. Cross. I would like to first address the employee 
question. The one thing I would want to have Congress 
considering when looking at the employee question is, if 
somebody is an employee at a company and they have invested 
heavily in the company and they lose their job and the company 
goes under, that would be pretty devastating.
    So you would want to make sure that if you go that route, 
there is other information available to the employee, so that 
they can keep an eye on whether their employer is, in fact, 
doing well.
    I am not saying that information necessarily has to be 
disclosed publicly. But at least the employee, it would be 
better for them to have information about their company's 
financial condition if they have both their job and their 
investments in the company.
    Mrs. Maloney. And should a shareholder include broker-
dealers holding on behalf of shareholders or only individual 
investors?
    Ms. Cross. That is an important question we are currently 
considering. Right now, you do only count at the broker-dealer 
level instead of the beneficial owners.
    For some companies, that could mean they have tens of 
thousands of investors but only count as 100. We are 
particularly concerned about that in the OTC markets, where 
there is no public reporting, and there is trading with really 
no information. That is one of the areas that we would like to 
get a handle on.
    Comparing that to a company that is a pre-IPO company, 
where everybody is a record-holder and it is really only 499, 
that is a pretty big distinction that we want to get a good 
look at. That seems like not a good place to be. And that is 
one of the things that the staff would like to address.
    Mrs. Maloney. My time has expired. Thank you.
    Ms. Cross. Thank you.
    Chairman Garrett. And I thank the gentlelady.
    The gentleman from Arizona is recognized.
    Mr. Schweikert. Thank you, Mr. Chairman.
    Sorry, Ms. Cross. First, I know my staff owes some of your 
staff a thank you for exchanging information, okay. Yes. You 
always point at the lawyer, right?
    Ms. Cross. Yes.
    Mr. Schweikert. You have the committees and you have been 
taking input on saying, what are we doing, particularly in that 
$250 million and under point? What can we do to expand access 
to capital?
    You see some of the bills that are before you today. Any 
other ideas that both would come to either regulatory or you 
need statutory change that come to the forefront of thought? 
And it is sort of an open-ended question.
    Ms. Cross. It is an open-ended question. I think it is a 
good question that we are currently considering. I would say 
the one area, which wouldn't really be something you likely 
would legislate in, but I think could make a big difference is 
with our current rules for public offerings, we have a large 
number of very small reporting companies that do need access to 
capital.
    They are complying with the rules. They are providing 
information. The reforms we adopted in 2005 that really free up 
their communications and the offering techniques for the 
largest companies have worked quite well. And so one of the 
things the staff would really be interested in doing is 
exploring, and we are currently exploring whether we can make 
some of those available to small companies.
    If the benefit of being a reporting company is that you 
have quicker access to capital, that is very important. And so 
we would very much like to see if there are things we can do in 
the registered market to help companies have more cost-
effective access to capital.
    With regard to the bills that are pending, the Commission 
hasn't taken a position on the bills, and so I have to defer on 
that. But there are a number of very important ideas in these 
bills that I think, depending if they are implemented in a way 
that carefully balances the cost and benefits and keeps 
investor confidence up, they also could provide real benefits.
    Mr. Schweikert. Now, Ms. Cross, I want to solicit if you 
have any of those ideas that we can grab, I can take credit for 
them and start running through the process, you just let me 
know.
    Ms. Cross. Absolutely, absolutely.
    Mr. Schweikert. It is sort of a side question, particularly 
as we are trying to get a little more creative here. We are 
also looking at much smaller organizations.
    From your standpoint as a regulator, using the Internet, 
using some of the technologies and access to information we 
have today that, let's face it, when a lot of these rules were 
promulgated did not exist. How much is that playing into the 
thought, the design of future regulations? And how much should 
that be playing into what we are designing here today?
    Ms. Cross. The Internet presents tremendous opportunities 
to be able to reach investors who could provide access to 
capital for companies. It also presents tremendous 
opportunities for fraudsters to open up, steal your money, and 
disappear.
    So the key here is it is critically important to all we are 
doing right now in looking at this regulatory area, because we 
want to make sure that we take advantage of what is good and 
come up with safeguards so that we don't erode investor 
confidence for the dangers.
    I think in the area of private offerings, for example, we 
have heard from many that it is very frustrating that they 
can't use an open Web site in order to find accredited 
investors for their private offerings. That is the restriction 
on general solicitation that has been discussed.
    That obviously is very much impacted by the Internet and 
other ways to find investors.
    Mr. Schweikert. Ms. Cross, and I love that term 
``fraudsters,'' even in the crowdfunding bill, there are many 
of us who believe sunlight, information is in many ways one of 
the greatest regulators because of the speed and flow of 
information.
    How do we use that if I am going to go put my $500 into 
this investment through something like Mr. McHenry's 
legislation, but also a robust ability to say, ``Oh, I am going 
to just also do a quick search and get information that is 
posted about that company.'' And it is a slightly different 
thought process than how we have regulated in the past.
    It is like I had this concern that as we are designing 
this, we are also designing something that creates a velocity 
of information and sort of egalitarian information, as well as 
a regulatory environment.
    Ms. Cross. I think that with regard to how to structure any 
particular exemption, the ability to access information will be 
important. And coming up with an oversight system will be 
important, on a cost-effective basis though. So I think that is 
something we would be weighing with regard to any of these 
exemptions.
    Mr. Schweikert. Thank you, Mr. Chairman. I yield back.
    Chairman Garrett. The gentleman yields back.
    The gentleman from Colorado is recognized.
    Mr. Perlmutter. Thank you, Mr. Chairman, and thanks for 
this hearing today.
    Ms. Cross, we thank you for your testimony.
    There are several ideas that I believe deserve merit. Mr. 
Schweikert has a bill that involves increasing the number of 
potential purchasers in Reg A. Mr. Himes has a bill that I 
think deserves a lot of review and merit.
    But I think we all have to step back for a second. My 
questions are going to be more directed to the next panel. But 
I think, as you said, confidence is what is key here in capital 
formation. We have the chicken and the egg: demand; capital; 
and credit--those three things.
    And which comes first, capital or demand, or credit and 
demand? But we have to watch out in terms of capital formation 
that we don't cause people who want to purchase stock or extend 
some kind of financing to businesses that they lose confidence.
    In the Denver Post, it seems like they must be looking at 
the chairman's agenda, because they always have a story right 
on target. The headline is, ``Hard Times Make for Soft 
Targets.'' And so as we go through this, I think we have to 
really maintain our attention towards not getting defrauded.
    As we push towards capital formation and the ability to 
raise capital, we still have to have safeguards in place and 
not drop all of the precautions that exist.
    And one of those that I am concerned about is the change in 
the 404 limitations, going from $75 million, I think it is, to 
$500 million. Can you comment on that please?
    Ms. Cross. Certainly. I agree, first off, that our mission 
includes investor protection and facilitating capital 
formation. And if investors aren't confident in the honesty of 
our markets, then they won't invest, and so you haven't 
facilitated capital formation.
    So whatever it is that happens here, whether from Congress 
or through the Commission, it will be important that safeguards 
be included, so we don't end up changing the markets to where 
people are afraid to go.
    On 404, I would start by, of course, the opening point 
there is that 404(b) was enacted by Congress after the 
accounting scandals in Enron and WorldCom and other companies. 
And it did a lot to restore investor confidence and improve the 
quality of financial reporting. There certainly were serious 
concerns about the cost-effective implementation. And many 
steps have been taken along the way to try to enhance that.
    Congress exempted 60 percent of the companies in Dodd-
Frank. The move to go from $75 million to $500 million would 
exempt a total of approximately 80 percent. It is a pretty 
significant number. The Commission hasn't taken a position on 
the bill.
    The staff did a study following Dodd-Frank, as directed by 
the Act, of whether there is--the staff was recommending an 
exemption between $75 million and $250 million. And based on 
looking at all the factors, the staff's recommendation was not 
to do that.
    I think this is something that Congress should decide. It 
is not in the Commission's area to make this decision. If 
Congress were to decide to exempt additional companies, you 
would need to be carefully weighing the costs and the benefits 
and whether it should only apply to the very largest companies 
or the companies in this range.
    One other point I would make, very quickly, is that as you 
go up in size on the companies, in order to decide how to do 
the audit, the auditors have to test internal controls to 
decide how much testing to do, because if they can rely on the 
internal control, they do less testing. So the cost as you get 
to bigger companies of eliminating 404(b) becomes less 
significant, because they are going to have to do that anyway.
    Mr. Perlmutter. Thank you. And I guess, just in preparation 
for the next panel, I have a bill with Mr. Coffman from the 
Small Business Committee on what we call CAMS, Capital Access 
for Main Street.
    It is on the credit side of all these, so it really isn't 
an SEC issue. It is more of a banking issue, which we are able 
to pass to make sure that community banks had appropriate 
capital so that they could continue to lend and make credit 
available to their small business customers. I hope we take 
that up either in the Banking Committee or here at some point.
    With that, I yield back.
    Chairman Garrett. The gentleman yields back.
    The gentlelady from New York?
    Dr. Hayworth. Thank you, Mr. Chairman.
    Ms. Cross, I am interested in Section 404(b) and the costs 
of compliance. When they were originally estimated, it was felt 
that the annual cost for a publicly traded company might be, on 
average, $91,000. But 5 years after implementation, an SEC 
study found that the average cost of compliance was closer to 
$2.37 million per company, which is obviously considerably 
more.
    Now, it certainly can be hard to predict the cost of 
compliance before. We know the realities on the ground. But 
when we think again about how we can rationally lift burdens 
and yet also protect investors, you had to provide those secure 
markets.
    Under these circumstances, given that we want to release 
every dollar we can for job creation for further investment and 
rather than tied up in red tape so to speak, would it be 
reasonable to propose that public companies that have no 
material defaults on your assessment of internal controls be 
allowed to go to an every other year schedule for attestations, 
as opposed to every year?
    Ms. Cross. That is an interesting idea. I think that the 
staff study looked at that question and there were concerns 
that may not actually save very much money, because in order to 
know that you are going to be okay in the following year, you 
would have to keep doing the work. And then the auditors are 
still going to be auditing the financial statements and having 
to decide how much they can rely on management's internal 
controls.
    And so I am not sure that it would release a lot of 
savings, but it is certainly something that could be 
considered.
    Dr. Hayworth. And more broadly, I guess, the question would 
be then, if every other year may not be a sufficient benefit, 
could we broaden the schedule for those who have great bona 
fide? Is there some way we could identify companies that are 
reliable doing these things?. Or can we better identify proxies 
for malpractice so to speak?
    Ms. Cross. Those are interesting questions. I also would 
like to comment on the cost. You are right that the costs were 
much higher than were anticipated. And I think that major 
efforts were undertaken, once it was realized that the costs 
were so high, to recalibrate through AS5 and through other work 
that market participants engage in.
    And the costs, I understand, have come way down. But I also 
recognize that regulatory compliance costs are certainly a 
concern.
    Dr. Hayworth. Obviously, it is one of our themes. But, I 
appreciate the thought that goes into that kind of issue as we 
go forward.
    And I want to echo Chairman Garrett's thoughts on the 
Government Business Forum on Small Business Capital Formation. 
I think our small businesses eagerly await whatever forms of 
relief you could provide. And certainly, our office stands 
ready to help with bringing those forward in the form of 
legislation.
    Thank you very much.
    Ms. Cross. Thank you.
    Dr. Hayworth. I yield back, Mr. Chairman.
    Chairman Garrett. The gentlelady yields back.
    Mr. Himes is recognized.
    Mr. Himes. Thank you, Mr. Chairman.
    Ms. Cross, I have questions in two categories. The first is 
something you touched on in your written testimony, which is 
the issues raised by the definition the SEC uses around holder 
of record, and the fact that all of these thresholds are 
triggered by holder of record consideration. This has an impact 
on my bill and I think raises some questions.
    I guess my question is, since I think the spirit of the law 
was not around holder of record or street name, but around 
beneficial holders and shareholders as individuals, over the 
course of thinking about this, has the SEC been provided with 
or do there exist good arguments in principle for why there 
should be a holder of record, as opposed to a beneficial holder 
definition?
    Or are there arguments around mechanics that this would be 
outrageously prohibitive cost-wise for the industry to abide? 
And should that definition flip?
    Ms. Cross. The question of whether you should look through 
to the actual investors, I think is quite important. At the 
time when Section 12(g) was put in, most of the holders were 
holders of record. DTC and the street name ownership structure 
have developed since then.
    I think that it makes a lot of sense to look through. And 
we are looking at that question in our study. I recognize that 
with regard to the community banks, they are usually holders of 
record. The people who are the investors are the holders of 
record. So the 500-holder cap hit them much harder than it does 
other companies who are held in street name.
    I think however this is calibrated, it needs to take 
account of the different way companies are held. I am not sure 
that I--I don't have the answers today, but I am particularly 
sympathetic to the fact that with the community banks, they are 
held one-to-one, similar to the pre-IPO companies who were held 
one-to-one, for the most part.
    Mr. Himes. So yes, thank you. Thank you. I guess it feels 
to me like a historical artifact. And I guess my question, and 
to sort of pause it one more time is, is there a policy 
argument for why we use a holder of record designation as 
opposed to beneficial holder?
    Ms. Cross. I think that probably, if there is a policy 
argument today, it would be workability. I think that the 
question of how do you know how many holders you have, it is 
not hard to go to DTC and get the participant listing, which 
gives you a number. So if you are a public company and you need 
to know how many holders you have, you can do that through the 
DTC participant listing.
    For non-public companies who are not held through DTC, it 
is harder certainly to see why it would be problematic.
    Mr. Himes. Okay. Thank you.
    My second category of questions, in my opening statement, I 
said I had some concerns about the whole crowdfunding 
mechanism. I understand you may have a recusal issue on this, 
so perhaps this is for Mr. Nallengara.
    Can whichever one of you is appropriate walk us through--in 
my understanding, your testimony indicates that Rule 504 
provided a similar exemption, although I guess the threshold 
was $1 million rather than $5 million as proposed by the 
current legislation, that in 1999 there was a revision made to 
Rule 504 associated with investor protection.
    Can you, for the benefit of the committees, walk us through 
the considerations that led to that revision and what the 
implications are for the current legislation in the 1 minute 
and 30 seconds we have remaining.
    Mr. Nallengara. Yes, Congressman.
    The Rule 504 consideration that resulted in the amendment 
related to trading in the securities--the old 504 allowed for 
general solicitation. It allowed for a broad sale of those 
securities. And because of that, there was, in some areas, 
fraud perpetuated in the secondary market.
    As a result of that, 504 was narrowed to effectively remove 
in part some of the advantages that were provided in the 
original rule. And one of those was removing the general 
solicitation.
    Mr. Himes. So the fraud that led to that revision was 
really in secondary market trading, as opposed to fraud in 
initial issuance?
    Mr. Nallengara. Primarily, it was secondary market trading. 
The pump and dump schemes were perpetuated using the 504 rules.
    Mr. Himes. Thank you. I yield back the balance of my time.
    Chairman Garrett. Thank you. The gentleman yields back.
    Mr. Dold is recognized.
    Mr. Dold. Thank you, Mr. Chairman. I certainly appreciate 
the time you have allotted.
    Ms. Cross, I just wanted to follow up. We talked a little 
bit before about costs. Obviously, small businesses' costs are 
a significant burden out there. We know that sometimes they are 
necessary.
    When we look at Section 404(b), it was stated originally 
that the rule would impose an annual cost of about $91,000 for 
businesses and yet--for publicly traded companies.
    But the study, 5 years later, found an average 
implementation cost for 404(b) to be somewhere in the vicinity 
of--correct me if I am wrong--about $2.87 million per company 
annually. Obviously, that misses the mark in terms of what 
people are asked to do from a publicly traded company in terms 
of just compliance.
    So I guess my first question would be, how can this 
committee be assured that we don't have those types of 
significant errors going forward, especially when we are 
looking at the number of rules and regulations that are going 
to be coming out of Dodd-Frank and the enormous regulatory 
compliance costs that will be imposed?
    Ms. Cross. Thank you for your question.
    First off, I guess I would say that with regard to the 
implementation of 404(b), we recognize that the costs were 
significantly higher than expected. And the rules and the 
implementation--the implementation rules were then changed to 
bring the cost down. But that doesn't make people feel better 
that it was very expensive at the beginning. I recognize that.
    On the current--
    Mr. Dold. Can you give me an idea just of what the costs 
are now?
    Ms. Cross. They are in our study that is on our Web site. I 
can get back to you with that.
    Mr. Dold. Can you ballpark it for us? Just give me some 
sort of an idea, because $91,000 and $2.87 million, there is a 
pretty wide gap. And if it came down 50 percent, I mean--
    Ms. Cross. I believe the numbers are different at different 
company sizes. So I would be afraid to give you an answer that 
is not accurate. I think they are much lower at smaller 
companies, but there is a wide range.
    On the question of the cost-benefit analysis at the cost of 
the implementation of the Dodd-Frank rules that we are 
currently implementing, that is something about which we are 
very sensitive. And we have in pre-rulemaking email boxes on 
our Web site where we are soliciting comment on prospective 
ways to implement the rules that we need to implement, we are 
getting comments through the rulemaking process, through the 
comments, so we then--through the comment request, so that we 
can then more accurately, hopefully, predict what it will cost.
    We are seeking comment on those specific points. And if 
nothing else, when we implementing something that we have been 
directed to implement, we at least want to get good guidance 
from the public about how much that is going to cost, so that 
we can reflect that correctly in our analysis.
    Mr. Dold. Okay. Turning just for a second to Sarbanes-
Oxley; does the SEC have any evidence that would point to 
Sarbanes-Oxley placing a disproportionate cost burden on 
smaller businesses?
    Ms. Cross. With the exemption of the $75 million and below 
level, there is no cost for relief for those companies, since 
they have been exempted by Congress from that.
    For the next group, I think that we find that it is more 
expensive in comparison to your size at the smaller levels. As 
you go up, the costs calibrate better. But I would need get 
back to you with an answer for the record on all the different 
levels.
    Mr. Dold. The $75 million threshold, do you think that is 
sufficient right now? Or do you think that there is room to 
raise that?
    Ms. Cross. The Commission hasn't taken a position on the 
bills on that point. The staff study that was mandated by Dodd-
Frank looked at the group from $75 million to $250 million and 
concluded that the staff didn't recommend an exemption at that 
level for a whole host of reasons, one of which included that 
companies move in and out of that category regularly. And so it 
would be difficult for even a particular company to know 
whether they were in or out in any given year.
    But as you get larger with companies, the cost savings 
become less clear, because you have to test the internal 
controls in order to do the audit anyway.
    Mr. Dold. Sure.
    Ms. Cross. So there is some level in between, which I guess 
is what Congress is looking at now.
    Mr. Dold. Just my final, in the last 20 seconds, when we 
look at trying to leverage the Internet and the ability to try 
to get information out to people, and the protections that are 
out there, do you think that there is a way for us to be able 
to raise capital, to be able to safeguard without having the 
concern, which I recognize is very real, that people can try to 
raise resources on the Internet and then disappear?
    But there are also a lot of secured transactions that have 
gone and we use the Internet each and every day. Is there a way 
for us to be able to leverage the Internet to try to get 
information out there and allow people to invest, allow small 
businesses to be able to reach out to people and go through a 
more secure process? Is that something that you are 
entertaining?
    Ms. Cross. Absolutely, that is something that we are 
looking at. We recognize the power of the outreach that you can 
have through the Internet. I think that possibilities include 
having intermediaries that are subject to oversight, so that 
you know that somebody is checking to see is there really a 
company there, and perhaps some sort of notice filings, things 
that might address the concerns that have been raised.
    Mr. Dold. Great. Thank you. I yield back, Mr. Chairman.
    Chairman Garrett. The gentleman yields back.
    The gentleman is recognized for 5 minutes, Mr. Donnelly?
    Oh, then the gentleman from New Mexico, Mr. Pearce?
    Microphone. Mr. Pearce, microphone.
    Mr. Pearce. Excuse me.
    Chairman Garrett. There you go.
    Mr. Pearce. The transmission slipped out of gear. Thanks.
    I know you are testifying about the capital formation. But 
looking at investments, protecting investors, how do you 
differentiate between bad business plans and fraudsters?
    Ms. Cross. We don't make that distinction on the staff. 
What we want is for investors to have access to the information 
so that they can decide if they like a particular business 
plan. So we try to do this through disclosure.
    If some offering includes somebody with a fraud pass, for 
example, then perhaps disclosure would also be appropriate to 
get investors unnoticed, if they are dealing with people who 
may have a bad past.
    Mr. Pearce. Do you have any kind of a Web site to where 
people can come? Do you post the people that, say, repeatedly 
get into the fraud business? Do you have some open source? Or 
do they have to come and ask what about this scheme that I am 
seeing? What about this investment proposal that I am seeing? 
Do they have to ask or you provide it just--
    Ms. Cross. We don't provide investment advice at the SEC 
about any particular--
    Mr. Pearce. I am not asking for advice. You have people who 
conduct fraudulent operations and they repeat. Is that correct?
    Ms. Cross. I believe FINRA has a Web site where you can go 
look for information on violations by broker-dealers. With 
regard to information about whether any particular offering is 
fraudulent, if people--
    Mr. Pearce. I am not asking about a particular operation. 
When you have people who have established precedent, and they 
do fraudulent things, do you advertise for them that they are 
sometimes fraudulent operators, that maybe this thing they are 
doing isn't good? I am just asking, is it possible for 
investors?
    One of your missions is to protect investors. And so I am 
asking, do you actually do things to protect investors before 
they get into it? Or do you only try to put out the fire after 
it is going?
    Ms. Cross. We try to prevent the fire through our review 
program, where we ask companies about their offerings and their 
business plans, and if we find a problem, we refer them to our 
enforcement division if we think there might be fraud. So our 
goal is to prevent fraud at the front end.
    Mr. Pearce. Yes. You were talking about the fraudsters 
versus investment opportunities. As you look in your daily 
work, looking at the combined amount of work that you do, how 
much is fraud and how much are probably pretty legitimate 
opportunities?
    Ms. Cross. Oh, I would say that, by far, my perception is 
that the markets are not dominated by fraud, by any stretch, 
that most companies are not fraudulent, are well-intentioned 
and provide good disclosure, and that our markets are perceived 
as fair and honest.
    Mr. Pearce. Does that mean less than one-half percent or 
less than one-tenth or one percent? Or do you have any 
quantitative data on that about basically how many--if people 
are looking on the Internet, they can assume that one-tenth or 
one percent is fraudulent. You don't quantify it or you do?
    Ms. Cross. I don't have statistics like that. I do know 
that we have an Internet fraud task force that searches the 
Internet to look for fraudulent offerings. And I think those 
actually find a pretty significant amount of them. But there 
are plenty of other, obviously, non-fraudulent investment 
opportunities.
    But it is an area that does present the ability to come in, 
steal money, and disappear. So it is always a cost-benefit 
analysis. You don't want to regulate to the absolute, zero 
fraud risk, but you also want to be in the place where you can 
protect investors at a reasonable level.
    Mr. Pearce. As you evaluate the capital formation in the 
last 5 years, is capital formation increasing, decreasing? What 
is happening in the big picture?
    Ms. Cross. My understanding is that the IPO markets have 
been coming back, which is a positive sign, although the 
markets themselves are rocky, so that is hard to calibrate.
    For the smaller companies, I think it has been challenging. 
I think the financial crisis cut off a lot of capital. And so 
it has taken time for the capital markets to come back. But we 
have seen signs of increasing offering activity, at least in my 
division.
    Mr. Pearce. Okay. Thank you, Mr. Chairman.
    Chairman Garrett. And I thank the gentleman.
    And Mr. Stivers is recognized.
    Mr. Stivers. Thank you, Mr. Chairman.
    Ms. Cross, thank you for being here. Your Regulation 12(g), 
which was passed in 1964, I guess issued in 1964, originally 
held small companies, including community banks, to a $1 
million asset threshold and 500 shareholders. I wanted to just 
give you a story and help me as we go through it.
    In 1964, my father was 29 years old. He bought shares in 
the community bank. Unfortunately, my father passed away in 
2004 at the age of 69 years old. He had three children. And I 
am one of them.
    So can you tell me basically what happened to the holders 
of record probably, since we all got equal shares? They went up 
by three.
    In a generation, if people, let us say, on average, have 2 
kids, and a bank starts out at 280 shareholders, after a 
generation, assuming that they issue no stock, what is going to 
happen to the number of shareholders of record?
    Ms. Cross. I guess, you have to know how many children are, 
but--
    Mr. Stivers. I said, on average, they have two children 
so--
    Ms. Cross. So it will double. Right.
    Mr. Stivers. They will go over what number? 500?
    Ms. Cross. Correct.
    Mr. Stivers. And so in that 40 years, you increase your 
asset threshold by 10 times and you increase the number of 
shareholders by how many, in rule?
    Ms. Cross. It has stayed the same.
    Mr. Stivers. Zero, that is right. And so, I guess I want to 
urge you--I appreciate the bills on this with Mr. Schweikert, 
Mr. Himes, and others. But it doesn't take a bill. This is a 
rule.
    You have increased the asset number over 40 years. You 
could today, and I wish you would go back and do this, increase 
the number of shareholders today, because community banks are 
getting especially hammered by this.
    I talked to a community banker this weekend. And he told me 
that they did a reverse three to one split just to try to 
prevent having--or to deregister. And when you deregister, 
actually you don't go to 499. You have to go to 300.
    That is the other thing I would tell you. If there is a 
line, there is a line. And the deregistration number should be 
the same as the registration number, in my opinion. So if you 
go below 499, you can deregister. And so I would ask you to 
look at that as well. These are things that don't take our 
action.
    And, since the United States Senate has passed five 
substantive bills this year, and these bills are great, but 
they are probably not going to happen. So you have the ability 
to relieve regulatory burden on banks, and I am asking you to 
do it.
    Ms. Cross. I appreciate your--
    Mr. Stivers. I guess that is not a question, but I will 
take your response.
    Ms. Cross. I know. Thank you. I appreciate the concern. And 
it is something that we understand needs attention right away.
    Mr. Stivers. Great. And I think maybe I finished the story. 
So when he did his reverse three to one split, deregistered, 
went below 300 shareholders, he was earning about a million 
dollars a year and he saved $200,000. That is 20 percent. That 
is meaningful.
    And so I would ask you to--I don't really have a lot of 
other questions. I guess the only other question I have, 
because you did get into a conversation about a street name, 
but if you don't issue securities in 30 years, like a lot of 
these community banks have shareholders, and they haven't been 
actively issuing securities, they don't really have a market 
maker.
    So these stocks aren't in DTC. They are in manual form. And 
they have the shareholder's name on it. And it 
disproportionately affects those folks. So--
    Ms. Cross. I appreciate that, yes.
    Mr. Stivers. I would be happy to yield the rest of my time 
to Mr. McHenry. But again, before I yield my time, I would urge 
you to go back and get to work. We need your help. These 
community banks that are struggling need your help.
    Ms. Cross. Thank you.
    Mr. Stivers. Thank you.
    Mr. McHenry. Thank you, all. Thanks for your testimony 
today. I thank my colleague for yielding.
    Ms. Cross, I certainly understand your recusal and I 
respect that. Thank you for taking that action.
    So, Mr. Nallengara, thank you for being here. You mentioned 
under the old Rule 504 that the change was on general 
solicitation--remove that change. You said the fraud occurred 
in the secondary market trading. Is that correct?
    Mr. Nallengara. Yes, primarily.
    Mr. McHenry. Primarily. How many prosecutions came as a 
result of that fraud?
    Mr. Nallengara. I don't have that information. I think we 
can--
    Mr. McHenry. If you would come back to us with that, submit 
that in writing, that would be helpful for us to understand. 
And if the real concern is the secondary market, not the direct 
issuance, was there much fraud in the direct issuance?
    Mr. Nallengara. Again, I would need to gather that 
information.
    Mr. McHenry. Okay. Thank you. I yield back.
    Chairman Garrett. And I thank the gentleman for yielding 
back.
    The gentleman was not using his time during that time, but 
does the gentleman have any other questions?
    Mr. McHenry. I yield back.
    Chairman Garrett. You yield back? I understand.
    But now it is time for your time. Did you have additional 
questions?
    Mr. McHenry. [Off mike.].
    Chairman Garrett. Very good. We will see during the 5 
minutes whether it is very good or not.
    Mr. McHenry. Thank you. Thank you, Mr. Chairman. Thank you 
for your generosity.
    Chairman Garrett. We are raising the bar as it is--but we 
know we will always--
    Mr. McHenry. That is a short choke. I will take that, Mr. 
Chairman. So--
    Chairman Garrett. No, no, no.
    Mr. McHenry. --with that, I appreciate--
    Chairman Garrett. We don't all see things through those 
glasses.
    [laughter]
    Mr. McHenry. And you have just used up 15 seconds. Thank 
you and thank you for your testimony.
    Mr. Nallengara, very simple questions. Obviously, we are 
concerned about fraud. Mr. Himes has some very solid questions 
about fraud. But, was it general solicitation that really 
allowed the perpetration of fraud?
    Mr. Nallengara. In part, it was also the fact that the 
securities were not restricted securities. So upon issuance, 
those securities were freely tradable.
    A consideration would be whether in any capital-raising 
strategy that would be designed to assist small business, you 
would consider whether the securities issue, if you place 
transfer restrictions on them, that could prevent some fraud in 
the after-market trading.
    Mr. McHenry. Okay. So perhaps by a limitation of 
information and a limitation of capital that can flow into 
these transactions, that allowed for a greater avenue of fraud, 
because there is less information and less capital flow.
    Mr. Nallengara. Sorry, Mr. Chairman, I am not sure I--
    Mr. McHenry. Okay. What I mean is with less information 
available on a security, as a purchaser, it gives you less 
avenue to understand what you are actually purchasing. Is that 
correct?
    Mr. Nallengara. Yes.
    Mr. McHenry. Okay. So, this is sort of the sticky wicket on 
the subject matter, because many of my colleagues, they will 
make it sound like the fact that you are making these decisions 
over the Internet and capital is flowing over the Internet--it 
makes it sound like the Internet is the great perpetrator of 
fraud.
    And I said this to Ms. Cross in our hearing last week, that 
it sounds like the SEC's mentality is that eBay couldn't exist 
because there would be this fraud perpetrated on a mass basis. 
But, I would dissuade you from that type of thinking.
    So the real question here is, how do we allow average 
investors to help access capital for startups. Is that 
possible?
    Mr. Nallengara. Mr. Chairman, I think it is possible. And 
part of the discussion is looking at how to harness the 
technology and the power of social media to provide an 
opportunity for small businesses to seek capital from a broader 
scope of investors and a geographically dispersed group of 
investors.
    Mr. McHenry. Okay. So what if you had--obviously, broker-
dealers are important in this process in securities trades. 
What if you had a small broker-dealer exemption, small issuance 
for broker-dealer? In essence, for smaller issuances, you have 
a lower regulatory hurdle. Is that something the SEC is looking 
at in order to spur crowdfunding.
    Mr. Nallengara. The Commission hasn't taken a position on--
    Mr. McHenry. No, at the staff level, has that been 
discussed?
    Mr. Nallengara. At the staff level, we have considered a 
variety of different investor protection possibilities in 
crafting an exemption for crowdfunding.
    One of those would be providing some oversight of the 
intermediaries at the broker-dealer, for lack of a better term, 
the individuals or the Web site that is facilitating the 
transaction between the small business and the investor, yes.
    Mr. McHenry. Okay. So, in essence, regulate that 
marketplace where this would be done.
    Mr. Nallengara. Correct.
    Mr. McHenry. Correct. Okay. Now, and I understand the 
difficulty here that you are sort of answering these questions 
that I have had a great conversation with Ms. Cross about in 
the discussions you all have had.
    But, in essence, you regulate that marketplace and you have 
basically the rules of the road, so you can have these 
transactions, rather than regulate all the issuers, basically 
the small businesses.
    Maybe they were trying to raise a half a million dollars or 
$100,000. Do you regulate that playing field? Is that sort of 
the mentality of the SEC on how this could work?
    Mr. Nallengara. I wouldn't characterize that as being the 
mentality of the SEC. I think that is one of the considerations 
that we are looking at when we analyze crowdfunding. When we 
look at the benefits that could be derived from small business 
capital formation and we try to calibrate that with providing 
the appropriate level of investor protections, we see one of 
the ways to do that would be through looking at intermediaries 
and providing some oversight over their activities.
    Mr. McHenry. Thank you.
    Chairman Garrett. I thank the gentleman. And I thank this 
panel. I thank the gentleman. I believe we all agree by 
unanimous consent the gentleman has met the bar and exceeded 
it. He raised up to that threshold. So I appreciate the 
gentleman's questions.
    And again to this panel, I very much thank you very much 
for this panel. And you are dismissed.
    Will the second panel please come forward?
    You all can be seated, yes. Get comfortable. You are going 
to be here for hours and hours--
    Oh, I am told that when I say things like that, you believe 
me. So, no, you are not going to be here for hours and hours.
    I thank the second panel for being with us today. And as 
indicated before, as you all know, your complete written 
statements will be made a part of the record. You will be 
recognized for 5 minutes.
    And we will begin with Mr. Abshure.

 STATEMENT OF HEATH ABSHURE, ARKANSAS SECURITIES COMMISSIONER, 
   ON BEHALF OF THE NORTH AMERICAN SECURITIES ADMINISTRATORS 
                   ASSOCIATION, INC. (NASAA)

    Mr. Abshure. Good morning, Chairman Garrett, Ranking Member 
Waters, and members of the subcommittee. I am Heath Abshure, 
Arkansas Securities Commissioner and chairman of the 
Corporation Finance Section of the North American Securities 
Administrators Association, or NASAA.
    NASAA is the association of State and provincial securities 
regulators. I have a keen interest in issues regarding capital 
formation. And I was pleased to accept an appointment on 
September 13th as an observer member of the SEC's Advisory 
Committee on Small and Emerging Companies.
    State securities regulators are acutely aware of the 
difficult economic environment and its effect on job growth. In 
Arkansas, I see the recession's impact on small businesses 
every day.
    I can assure the subcommittee that no State securities 
regulator wants to inhibit America's economic recovery by 
regulation that is overly burdensome or restrictive. We do have 
serious concerns about recent proposals put forth in Congress 
that proposed to spur job growth by rolling back investor 
protections or preempting State investor protection laws.
    Unfortunately, this is precisely the approach that is taken 
by some of the bills that are the focus of the hearing today.
    Increasing small businesses' access to investment capital 
has the potential to be a very positive economic force and a 
major driver of wealth and jobs. At the same time, if done 
irresponsibly or hastily, such policy changes have the 
potential to become costly failures that undermine market 
disciplines and place Main Street investors at great risk.
    This last point is crucial because investors must be 
confident that they are protected in order to be confident 
enough to invest capital in the markets that Congress seeks to 
grow. The stakes are high in this area because while many don't 
recognize or acknowledge it, small businesses investments are 
extremely speculative.
    Proponents of the legislation under consideration today 
tout the high rates return sometimes associated with small 
business investment. However, in a majority of cases, these 
high returns are not realized. Unfortunately, roughly 50 
percent of small businesses fail within the first 5 years
    The risks associated with small business investment arise 
from a host of factors. In my experience, these risks include 
the fact that small business investments are almost entirely 
illiquid and often rely for success on unproven technologies, 
business models, market assumptions, and other unknowable 
factors.
    The important point is that this is a risky area, and not 
an area where Congress can expect that investor protections can 
be withdrawn without average investors getting hurt.
    Efforts to foster capital growth for small business must 
consider and address the particular dangers investors will 
encounter. I am very concerned that some of the proposals being 
contemplated include substantial preemptions of State 
authority.
    State authority to continue to review and police 
investments must be preserved. Any capital formation proposal 
should consider carefully the loss of investor protections that 
a partial or complete preemption of State regulation would 
cause.
    As we saw with the passage of the National Securities 
Markets Improvement Act in 1996, State securities regulators 
have been handcuffed from reviewing certain offerings prior to 
sale. Since then, a regulatory black hole has emerged to expose 
investors to high-risk investments offered by companies with 
little or no financial stability or regulatory scrutiny.
    In the 15 years since NSMIA became law, it has become 
painfully clear that preemption of State review of offerings is 
a failed experiment. We must not let history repeat itself by 
creating more regulatory black holes and exposing investors to 
unacceptable levels of risk and fraud.
    Let me now comment on the legislation before the 
subcommittee.
    The Entrepreneur Access to Capital Act, H.R. 2930, seeks to 
create a new exemption from registration for security offering, 
commonly known as crowdfunding. Crowdfunding may sound like a 
good idea and enjoy a measure of bipartisan support. But on 
careful inspection, it is apparent that the crowdfunding 
exemption contemplated by H.R. 2930 is replete with problems.
    Section 4 of H.R. 2930 specifically preempts State law for 
the new crowdfunding exemption. We strongly oppose this 
provision. States have been vigilant in protecting retail 
investors from the risk associated with these securities. State 
authority to continue to review and police these investments 
must be preserved.
    Further, if crowdfunding centers around community 
investment, the oversight must be vested with the regulator 
with the most direct interest in protecting that community, and 
that is the States.
    Additionally, under the current proposal, there will be no 
verification that the issuing companies actually exist. With no 
notice, there is no ability for a State to be certain that the 
issuer is really a business entity or even really has an 
address.
    Further, there is no disqualification provision so that bad 
actors can't use it. This is going to result in an enforcement 
nightmare.
    The Access to Capital for Job Creators Act, H.R. 2940, will 
allow general solicitation in Rule 506 offerings. I have 
already noted the States' experience with 506 offerings after 
NSMIA preempted State regulation.
    As the subcommittee is aware, Rule 506 is a safe harbor 
under Section 4(2) of the Securities Act of 1933. These 
securities were meant to be private offerings. With its 
expansion, we are getting further and further away from the 
ideas of a private offering under Section 4(2). There is 
nothing private left.
    An issuer can advertise to an unlimited number of people, 
raise an unlimited amount of money, and sell to an unlimited 
number of accredited investors without filing a single 
disclosure document. And there is no presale review of any 
document by any regulator.
    This is clearly a nonregistered public offering, which is 
not allowed under the exemption of 4(2).
    Further, I see it firsthand. Privately placed securities, 
including Rule 506 offerings, are the biggest enforcement issue 
in Arkansas and throughout the country. They did it--sir?
    Chairman Garrett. You are 1 minute over actually. But--
    Mr. Abshure. I will get to my conclusion, I will wrap it 
up.
    Chairman Garrett. I have been enjoying hearing your points, 
but if you can wrap it up, yes.
    Mr. Abshure. They have been identified by State regulators 
as the top 10 investor trap in three of the last 5 years. Given 
the potential amount of fraud investor losses, NASAA has 
significant concerns about H.R. 2940 and believes there is a 
more reasonable way of doing this, as I have discussed 
extensively in my written testimony.
    In conclusion, State regulators understand the complex 
challenges faced by small business issuers. We also understand 
that a reasonable balance of the issuers' interests and the 
investors' interest is in the best interest of both groups. The 
States are ready to play an active role in balancing those two 
interests.
    Thank you, and I will be happy to answer any questions.
    [The prepared statement of Mr. Abshure can be found on page 
54 of the appendix.]
    Chairman Garrett. Thank you.
    Ms. Mauriello?

    STATEMENT OF DANA MAURIELLO, CO-FOUNDER AND PRESIDENT, 
                           PROFOUNDER

    Ms. Mauriello. Good morning. My name is Dana Mauriello, and 
I am a co-founder and president of ProFounder, which is an 
online platform for raising investment capital from your 
community. We do this through--first, I apologize for 
forgetting to thank you so much, Chairman Garrett, for having 
me here, and members of the subcommittee.
    We do this fundraising through Regulation D 504, securities 
exemption for private offerings within communities. And we take 
no salesman stake in those deals. I am here to comment 
specifically on H.R. 2930, as that is my area of expertise and 
experience.
    We started ProFounder because we saw a very interesting 
case study unfolding around us. We saw our classmates wanting 
to raise capital from fellow classmates, the people who knew 
them best. And we saw them not being able to do so because our 
classmates were ``unaccredited investors,'' a term that we 
weren't even familiar with before the lawyer made us aware that 
this capital could not be freely traded in these communities.
    That really confused us, how you could have entrepreneurs 
doing great things, communities that want to support them, and 
yet, for some reason, those two parties could not connect. So 
we embarked on an effort to find a solution via ProFounder for 
communities to be able to support each other in a very 
efficient, simple, inexpensive way.
    This seems like second nature to be coming from small 
family businesses, none of which would have gotten off the 
ground without supportive aunts, uncles, family members, and 
friends, doing exactly the same thing that our classmates were 
trying to do.
    Since then, we have helped--since starting ProFounder, we 
have helped a number of entrepreneurs. I will highlight one, 
Bronson Chang. He has a shaved ice stand in Honolulu, which he 
was able to start with $54,000 that he raised through 
ProFounder with the help of 19 investors. Those 19 investors 
included his college roommate, his best customers, his aunts 
and uncles, etc.
    Through this venture, he has created six jobs. He employed 
a construction company for 3 months to open his new shop. We 
are so proud of him and other stories.
    We have so much more potential through the help of H.R. 
2930 to help other entrepreneurs like Bronson.
    I am very pleased with what Mr. McHenry has put forward. 
And I would like to suggest two more pillars be added to this 
for discussion. One is how the platforms that facilitate 
crowdfunding can be able to succeed. As great as the bill is, 
the platforms also need to be able to help make this happen for 
it to be taken advantage of.
    And second and very importantly, investor protection. I 
certainly echo that concern.
    So first, on the topic of how these platforms can succeed 
and facilitate, one is national preemption. The current regime 
of State regulation makes it extremely difficult to scale the 
model of crowdfunding, how this can happen. The majority of our 
deals that we have done have had investors from about three 
States.
    Negotiating the laws between those three States to allow 
for these issues to happen in an efficient, scalable way is 
extremely challenging. For example, if I have one investor from 
the State of Colorado, under 504, I can only have 10 investors 
from the State of Colorado. Rules like that made it extremely 
difficult to scale.
    If I want to have my aunt in New York invest in my company, 
I need to pre-file and get approval from the State of New York 
in writing, which will take a few weeks, if not months, to get 
before my aunt can invest in my company. These are some 
examples of why I think scalability through national exemption 
is important.
    Second, broker-dealer licensing. I was told by a broker-
dealer yesterday that it takes them $25,000 minimum to do the 
due diligence necessary for them to facilitate deals. The 
average deals that we do are $30,000. It is a completely cost-
prohibitive process to abide by current broker-dealer processes 
for these rules. I am in support of mini broker-dealers or 
other ways to make this flexible for smaller offerings.
    Now, to highlight investor protection. Certainly, I think 
this is important. I think one of the ways that it can be done, 
among many, is through qualifying purchasers. The way that 
general solicitation can be effective is as a way to spread the 
word to your community in a free way about what is happening. 
But then there is no reason that the people who actually can 
invest after learning about the opportunity don't need to be 
qualified, qualified through sophistication.
    A definition is needed for what sophistication truly means, 
to allow people to make those investments. Through knowing the 
issuer, or through being local, being physically co-located 
next to the coffee shop makes you very qualified to evaluate 
opportunities, to gather information, to learn about the issuer 
and be able to invest.
    Next, I have been inspired by what FINRA has done with 
self-regulation. I think that we have a lot, as a crowdfunding 
industry, to learn and can replicate and add on to what FINRA 
has created as a self-regulatory body.
    For example, one thing that I think that this self-
regulatory body would put in place is no endorsements on behalf 
of non-broker-dealers. So to go back to the pump and dump 
schemes, which were mentioned before, the problem with 504 when 
it happened in the late 1990s, in addition to secondary 
markets, the real problem was also broker-dealers were making 
cold calls and hard selling to purchasers who didn't have 
adequate information. So that is where regulation can happen.
    If I am an open marketplace that is not endorsing deals, 
not pushing deals, not doing what happened into the late 1990s, 
then that regulation should not apply to me. If I do want to do 
that endorsement, sure, there is a different level of 
regulation that can be necessary.
    Thank you so much for the time. And I look forward to your 
questions.
    [The prepared statement of Ms. Mauriello can be found on 
page 85 of the appendix.]
    Chairman Garrett. Thank you very much.
    Mr. Molinari, you are recognized for 5 minutes.

    STATEMENT OF VINCENT R. MOLINARI, CO-FOUNDER AND CHIEF 
           EXECUTIVE OFFICER, GATE TECHNOLOGIES, LLC

    Mr. Molinari. Chairman Garrett, Ranking Member Waters, and 
members of the Subcommittee on Capital Markets and Government 
Sponsored Enterprises, my name is Vincent Molinari. I am the 
chief executive officer and co-founder of GATE Technologies, 
LLC.
    I commend the chairman, the ranking member, and the members 
of the subcommittee for holding this hearing on the proposals 
that facilitate small business capital formation and job 
creation.
    I also want to acknowledge Chairman Bachus and Ranking 
Member Frank and thank them for bringing these issues before 
the public today. I offer my opinions today as a businessman, 
an entrepreneur, and a chief executive of a firm committed to 
the creation of new jobs through innovation and capital 
formation.
    GATE is a global financial services and technology company, 
which I co-founded in 2009. We provide technology solutions and 
develop platforms that facilitate the trading of illiquid 
securities and promote transparency. Currently, GATE operates 
in the United States though its wholly owned broker-dealer 
subsidiary, which is registered with the SEC and FINRA as an 
alternative trading system. GATE also operates a subsidiary, 
which focuses on impact investing.
    We facilitate transactions in the following asset classes: 
unregistered securities of private companies; restricted 
securities of publicly traded companies; and warrants. GATE is 
also working with other firms to facilitate the trading of 
State and Federal tax credits, asset-backed securities, and 
limited partnerships.
    We believing in creating value through trading in 
structured, regulated venues, where buyers and sellers meet for 
price discovery and to transact, settle, and transfer 
securities.
    Our business is fully regulated, archivable, and auditable. 
While the core of our business model is creating value for 
private companies and market participants, GATE itself is also 
an innovative, privately held, emerging company.
    GATE appreciates the role of the SEC in protecting the 
public and preserving market integrity. We believe the trading 
of unregistered securities is accomplished most effectively 
through a broker-dealer, an ATS, or an exchange registered with 
the SEC, because such transactions provide the books and 
records and the audit trail that can be used for surveillance 
processes.
    While the SEC has the authority to amend Regulation D and 
Regulation A, we support the legislation design to amend both 
of these regulations.
    The capital formation process is currently broken. And the 
proposed reform of Regulation D would be a welcome improvement. 
The proposed changes would promote economic expansion and job 
creation.
    I commend Representative Schweikert on the bill's 
introduction, which would increase the total asset threshold 
for registration to $10 million and raise the shareholder of 
record limitation from 500 to 1,000 holders.
    Increasing the SEC's Regulation A exemption from $5 million 
to $50 million will improve the ability of small companies to 
access desperately needed capital.
    By reducing the regulatory burden and the expenses 
associated with capital from the investing public, Congress can 
boost the flow of capital to small businesses and fuel 
America's most vigorous job-creation machine.
    I commend Representative Schweikert, as well as the 
Financial Services Committee for considering and passing this 
legislation in June. I look forward to the House Floor action 
on the legislation, and I also commend the authors of the 
Senate companion, Senators Tester and Toomey.
    Crowdfunding: GATE is encouraged by the Entrepreneur Access 
to Capital Act sponsored by Congressman McHenry and President 
Obama's support for crowdfunding initiatives.
    Any efforts that promote capital formation at the 
microfinance level have an immediate positive effect on capital 
formation and job creation. GATE is prepared to facilitate such 
efforts through our GATE Impact Platform and is confident that 
other firms will also rise to the call in assisting in this 
effort.
    I am encouraged by the recent progress that has been made. 
I commend President Obama and Speaker Boehner for their 
leadership on this issue.
    I congratulate the authors and co-sponsors of the pending 
legislation, as well as the leadership of the relevant 
committees on both sides, as we are moving forward with 
continued discussions, hearings, and some mark-ups.
    When companies have adequate capital, they can invest, 
expand, and hire. These small and private companies offer the 
economy tremendous growth potential and job creation. And they 
deserve to be supported with Federal policies that make capital 
more available and foster their success.
    They have the ability to become the engine of economic 
recovery, which is so sorely needed in the United States today.
    On behalf of GATE Technologies, thank you for the 
opportunity to present these views in support of reforming the 
capital formation process.
    [The prepared statement of Mr. Molinari can be found on 
page 100 of the appendix.]
    Chairman Garrett. And I thank you.
    And the founder of SecondMarket, Mr. Silbert, you are 
recognized.

  STATEMENT OF BARRY E. SILBERT, FOUNDER AND CHIEF EXECUTIVE 
                     OFFICER, SECONDMARKET

    Mr. Silbert. Thank you.
    Good morning, Chairman Garrett, Ranking Member Waters, and 
members of the subcommittee. My name is Barry Silbert, and I am 
the founder and CEO of SecondMarket. I am grateful for the 
opportunity to testify this morning regarding these very 
important topics.
    I founded SecondMarket in 2004 to create a transparent, 
centralized and independent market for alternative investments, 
including stock in private companies. We have grown rapidly and 
now employ nearly 150 employees in New York and California. And 
we completed several billions of dollars in transactions. We 
are a FINRA-registered broker-dealer and an SEC-registered 
alternative trading system.
    Up until a decade ago, fast-growing startups followed a 
similar capital formation path. They raised angel capital, a 
few rounds of venture capital, and went public in about 5 
years. For several decades, these small-cap companies could 
thrive in the public markets with research coverage, brokers, 
and market makers driving investor interest in these companies.
    The public market allowed companies like Starbucks, Intel, 
Genentech, and Dell to grow from small-cap companies into 
economic powerhouses. However, the capital formation process 
has evolved over the past decade, and the public markets are no 
longer receptive to small companies. It now takes companies 
twice as long, nearly 10 years, to grow large enough to reach 
the public market.
    A number of factors have contributed to the systemic 
problems in the public stock market. These include a shift from 
stockbrokers to online trading, the inability for market makers 
to profit from supporting small-cap stocks, lack of research 
coverage on smaller companies, and finally, Sarbanes-Oxley, 
which made it cost prohibitive to be a small public company.
    One other important systemic change is the emergence of 
computer-driven high-frequency trading. Although it brings 
liquidities to public markets, these traders ignore small-cap 
companies and have contributed to the casino-like trading 
atmosphere in the markets.
    Disturbingly, it is estimated that over 60 percent of 
public stock market trading volume is being done by computer 
algorithms, which has caused the average time that a share of 
public stock is held to decline from 5 years in 1970 to less 
than 3 months today.
    The small-cap market is a vital part of the capital 
formation process, and the failure of U.S. capital markets to 
support these companies limits our ability to create jobs, 
innovate, and grow. In fact, in 2010, a Kauffman Foundation 
study noted that without startups, there would be no net job 
growth in the U.S. economy. It is essentially that the 
regulatory framework recognizes this reality and enables these 
startups to flourish.
    Thus, I believe there are two regulatory hurdles in 
particular that must be re-examined. The first is the so-called 
500-shareholder rule. As you know, pay structure at startup 
companies generally involves giving employees below-market 
salaries, coupled with stock options. These options enable 
employees to realize the financial upside, while enabling the 
startup to higher top talent even if they don't have the cash 
to pay market salaries.
    As a result, this cap has created a disincentive for 
private companies to hire new employees, raise capital from a 
broad group of investors, or acquire other businesses for 
stock, as the companies are fearful of taking on too many 
shareholders and, thus, triggering a public filing requirement.
    That is why I strongly urge Congress to pass H.R. 2167, the 
Private Company Flexibility and Growth Act, which increases the 
shareholder threshold from 500 to 1,000, while also exempting 
employee owners and accredited investors from the count.
    The second rule that must be re-examined is the prohibition 
against general solicitation, which requires that issuers have 
a pre-existing relationship with the investor prior to making 
an offering available. Given that only accredited investors are 
eligible to purchase private company stock, we should strive to 
maximize the full investors that are aware of an offering. In 
short, let everyone see, but only let accredited investors 
invest.
    Thus, I urge the passage of H.R. 2940, the Access to 
Capital for Job Creators Act, which eliminates the ban against 
general solicitation, provided that the ultimate purchaser 
qualifies as an accredited investor.
    Although I do not have the expertise to provide detailed 
feedback on the other bills under consideration, I fully 
support the contemplated policy changes to create an exemption 
for crowdfunding, to allow private community banks to have 
2,000 shareholders, and to ease the compliance requirements of 
Sarbanes-Oxley.
    Additionally, I support the legislation put forth by 
Representative Schweikert and endorsed by the President to 
increase the cap on many offerings under Reg A from $5 million 
to $50 million.
    In summary, it is absolutely critical that we address our 
data and regulatory framework around capital formation. Without 
these rule changes, we will significantly limit access to 
capital for our young, small companies, thereby restricting job 
growth, stifling innovation, and weakening the United States 
globally.
    Thank you again for the opportunity to participate this 
morning.
    [The prepared statement of Mr. Silbert can be found on page 
110 of the appendix.]
    Chairman Garrett. Thank you.
    Mr. Waddill, senior vice president and chief financial 
officer of--is it OncoMed?
    Mr. Waddill. Yes.

  STATEMENT OF WILLIAM D. WADDILL, SENIOR VICE PRESIDENT AND 
  CHIEF FINANCIAL OFFICER, ONCOMED PHARMACEUTICALS, INC., ON 
    BEHALF OF THE BIOTECHNOLOGY INDUSTRY ORGANIZATION (BIO)

    Mr. Waddill. Good morning, Mr. Chairman, and members of the 
subcommittee. Thank you for giving me the time to speak today.
    My name is William Waddill. I am senior vice president and 
chief financial officer of OncoMed Pharmaceuticals, and co-
chair of the Finance and Tax Committee at the Biotechnology 
Industry Organization. I want to thank you for the opportunity 
to speak with you today about the unique hurdles that 
innovative biotechnology companies face.
    Biotechnology has incredible potential to unlock the 
secrets to cure a devastating disease and help people live 
longer, healthier, and more productive lives. But the barriers 
that small biotech companies encounter on a daily basis raise 
some important questions.
    Would we rather see the next generation of breakthrough 
cures discovered by researchers in New Jersey or New Delhi? Do 
we want the jobs associated with these groundbreaking science 
to go to workers in San Francisco or Shanghai?
    If we want more scientific breakthroughs that allow us to 
enjoy a high quality of life, indeed, breakthroughs that save 
the lives of our loved ones, then shouldn't we put in place 
policies that encourage innovation?
    While the biotechnology industry faces significant 
challenges, we nonetheless have the ability to deliver the next 
generation of cures and treatments to the bedsides of patients 
who desperately need them, while, at the same time, creating a 
healthier American economy.
    The leash that holds our industry back from helping more 
people, in a large part, is the exorbitant costs of development 
of treatments that must be undertaken by a growing company. 
Today, Congress has the opportunity to help speed lifesaving 
cures and treatments to patients by removing burdens to 
innovation in our industry.
    As you know, the Sarbanes-Oxley Act was passed in 2002 with 
the intent of protecting investors from corporate fraud. While 
we can all agree that investors benefit from the greater 
transparency, some of the regulations found in SOX, namely 
Section 404(b), are unnecessarily burdensome on small 
companies, and often involve onerous compliance with little to 
no benefit to investors or the general public.
    In fact, the biotech companies facing their first few years 
as a public company are forced to divert funds from scientific 
research and development to the stringent Section 404(b) 
auditing requirements. The opportunity cost of this compliance 
can prove damaging, resulting in limited resources being driven 
away from a company's research for cures and treatments.
    The compliance costs of Sarbanes-Oxley are fixed and 
ongoing, and have a severe impact on the long-term investing of 
microcap and small cap companies at the forefront of developing 
new treatments for severe diseases.
    These small companies are the most affected by SOX at a 
time when they often have little or no product revenue to 
devote to compliance costs and must, as a result, shift funds 
from core research functions. This can lead to research 
programs being shelved or slowed as compliance takes 
precedence.
    Further, the true value of a biotech company is found in 
scientific milestones and clinical trial advancements towards 
FDA approvals, rather than financial disclosures of losses 
incurred during protracted development terms. Investors often 
make decisions based on these development milestones rather 
than the financial statements mandated by Section 404(b).
    Thus, the financial statements required do not provide much 
insight for potential investors, meaning that the high costs of 
compliance far outweigh its benefits.
    The Dodd-Frank Act set a permanent exemption from Section 
404(b) for companies with a public float below $75 million. 
However, the SEC Small Business Advisory Board recommended in 
2006 that the permanent exemption be extended to companies with 
public floats less than $700 million.
    The Advisory Board also realized that public float alone 
does not fully portray the complexity and risk associated with 
a reporting company, and suggested a revenue test to paint a 
more fuller picture. Revenue should be a critical consideration 
when determining the appropriateness of Section 404(b) 
compliance, along with public float.
    Public companies with a public float below $700 million and 
with product revenue below $100 million should be permanently 
exempt from Section 404(b), allowing them to focus their 
resources on critical research and development rather than 
burdensome regulations.
    The U.S. biotechnology industry remains committed to 
developing a healthier American economy, creating high-quality 
jobs in every State, and improving the lives of all Americans.
    In my written testimony, I have detailed a number of 
additional provisions which could bolster capital formation to 
make these advances possible. There are many pitfalls and 
obstacles endemic to biotechnology, including scientific 
uncertainties and the high costs of conducting research.
    However, the challenge added by Sarbanes-Oxley continues to 
stand in our way without providing a real benefit to the 
investors the law purports to protect.
    Congress has the opportunity to support and inspire 
biotechnology breakthroughs by unburdening startup companies 
and allowing innovation and entrepreneurs to continue working 
towards delivering the next generation of medical breakthroughs 
and, one day, the cures to patients who need them.
    Thank you.
    [The prepared statement of Mr. Waddill can be found on page 
127 of the appendix.]
    Chairman Garrett. Thank you, Mr. Waddill.
    Mr. Williams, chairman and president of--is it Gothenburg 
State Bank?
    Mr. Williams. Yes.
    Chairman Garrett. On behalf of the American Bankers 
Association.

   STATEMENT OF MATTHEW H. WILLIAMS, CHAIRMAN AND PRESIDENT, 
   GOTHENBURG STATE BANK, ON BEHALF OF THE AMERICAN BANKERS 
                       ASSOCIATION (ABA)

    Mr. Williams. Mr. Chairman and subcommittee members, my 
name is Matt Williams, and I am president and chairman of the 
board of the Gothenburg State Bank in Gothenburg, Nebraska. I 
am pleased to be here today to represent the ABA. And I also 
appreciate the chairman's remarks when he started this 
committee meeting today talking about building companies and 
creating jobs. That is what banking is about in our country.
    The topic of this hearing today is an important one for a 
great many community banks whose shareholders include 
generations of families and local community members.
    Many of these community banks have faced a rule that has 
remained in place for over 40 years without being updated. That 
rule, under the Securities Exchange Act of 1934, causes small, 
local banks to be subject to the same costly reporting 
requirements as large public firms.
    The Exchange Act has two tests to determine whether a 
company must register its securities with the SEC. The first 
test is the $10 million asset test. The loans that we, as 
banks, make are considered assets, so this measure is actually 
meaningless. There are more than 7,500 banks in our country, 
but only 31 of those banks are less than $10 million in total 
assets.
    The second test is the limit of 500 shareholders of record. 
This is the only test that really matters for banks. While the 
asset threshold has been increased tenfold since the tests were 
introduced in 1964, the shareholder test has stayed the same. 
It is time to update this threshold.
    In my role as vice-chairman of the American Bankers 
Association, I have the opportunity to speak with bankers all 
across the country. One banker recently explained to me how a 
small institution found itself in a situation where it was 
going to have to register with the SEC.
    This bank had, for many years, offered shares to community 
members. These shareholders distributed stock to children, to 
grandchildren, multiplying the number of shares outstanding.
    When this bank reaches its 501st shareholder, it is either 
going to have to reduce the number of shareholders or become 
subject to the full range of regulatory requirements that apply 
to the largest of public companies. This makes no sense and 
absorbs precious resources that could better be put to use by 
small banks making loans.
    Not surprisingly, when the economy is weak, new sources of 
capital are scarce. This is made more serious by bank 
regulators piling on new requests for even greater levels of 
capital.
    Existing shareholders may not be willing or able to invest 
additional capital in small banks. Banks that are nearing the 
500-shareholder threshold cannot access new capital from 
additional investors without registering as a public company 
and incurring those significant costs.
    To boost their capital-to-asset ratio to satisfy regulatory 
demands, these banks are forced to shrink by making fewer loans 
in order to raise their capital past that ratio. Clearly, it 
would be better to turn to additional investors to provide new 
capital that would support additional community lending.
    We are grateful, Vice Chairman Schweikert, to you and to 
Representatives Himes and Womack for introducing legislative 
solutions. These bills would increase the shareholder threshold 
for registration to as many as 2,000 shareholders, a level the 
ABA supports for banks, and allow the SEC to provide much 
needed regulatory relief for community banks.
    ABA also recommends raising the threshold for 
deregistration. Raising the 700-shareholder cap would eliminate 
costly reporting requirements that are unnecessary for small 
banks that are already highly regulated and have significant 
reporting requirements. It would increase access to capital and 
free up resources that could be better used making loans.
    The urgency to address this situation increases everyday. 
Over the last several years, banks have faced increased 
regulatory costs and will face hundreds of new regulations with 
the Dodd-Frank Act.
    These pressures are slowly but surely strangling the 
traditional community banks, and handicapping their ability to 
meet the credit needs of their communities. Increasing the 
shareholder limit would open up an avenue to bring capital to 
community banks.
    The ABA stands ready to work with this subcommittee to move 
this important legislation forward. I look forward to answering 
your questions.
    [The prepared statement of Mr. Williams can be found on 
page 133 of the appendix.]
    Chairman Garrett. Thank you, Mr. Williams.
    All right. Let us do the first question with my good from 
Frog Jump, Mr. Fincher.
    Mr. Fincher. Thank you, Mr. Chairman.
    Thank you, guys for your testimony. It was great.
    Just to Mr. Waddill, a question for you, the limit of 
404(b). On average, how many research and development jobs--
because that is what we are focused on now is opening up the 
flow of capital to the private sector, which would make it 
easier for us to recover from this recession and downturn that 
we have been in for a while.
    But how many jobs are not realized due to the dollar cost 
of 404(b) compliance for a small company with a market cap of, 
say, $150 million?
    Mr. Waddill. Right. So if I may be allowed to jump on the 
theme of math that has been presented recently, for every 
million dollars that I have to pay to an auditing firm, I am 
going to be prohibited, just because of allocation of funds, to 
hire 10 to 15 employees.
    So if you look at some of the averages that were in the SEC 
report that can be multiplied twofold or threefold, depending 
upon my compliance cost and having to spend money there versus 
hiring people.
    Mr. Fincher. Thank you. I yield back, Mr. Chairman.
    Chairman Garrett. You are making my life far too simple.
    Mr. Fincher. Thank you.
    Chairman Garrett. The gentlewoman from New York is 
recognized.
    Mrs. Maloney. I thank all of the panelists for what you are 
doing to help our economy, out there employing people and going 
to work on it, and looking at ways that we can grow our capital 
and liquidity in the markets.
    I want to welcome one of my constituents, Barry Silbert, 
who is the founder and CEO of SecondMarket. And he was also 
honored by the World Economic Forum as a technology pioneer and 
was recognized by Fast Company as one of the 10 most innovative 
companies in finance.
    So congratulations to you. I single you out only because 
you have a company in the district that I am honored to 
represent. But I believe all of you have done innovative, 
exciting efforts to grow our economy.
    And we are right on message. The President's most recent 
speech focused on ways to bring more liquidity to our capital 
markets and to help finance.
    We have two good bills before us, H.R. 2167 and H.R. 1965, 
which would really modernize the 1934 Act. And I would like to 
start with Mr. Silbert, since you are my constituent, and ask 
you a few questions about H.R. 2167. It excludes accredited 
investors and employees from shareholder count that would 
trigger the registration under Section 12(g). Do you agree with 
that or oppose that?
    And it requires the SEC to revise the term held of record 
to reflect the changes in shareholder numbers to provide safe 
harbors that can be used by a company to determine who is an 
accredited investor or receive shares through an employee 
compensation plan.
    If you could comment on those two aspects of 2167? And also 
tell me, are you supporting 2167 and 1965? And what would it 
mean from a business point of view for these two measures to 
really update the 1934 Act?
    Mr. Silbert. First, thank you for the kind words, 
Congresswoman. Thank you for your support of the New York 
entrepreneur community. It means a lot to us job creators.
    With respect to the exemptions from the counts, I think it 
is important to recognize that the increase from 500 to 1,000, 
the exemption of employee owners and accredited investors, they 
deal with three different types of, call it share holders.
    So the reason why the accredited investors--it is important 
for them to be exempted out is this is going to be a way for 
these small companies to actually access capital, by making 
opportunity available to a broader group of investors.
    If you are limited to 500 slots as it currently exists for 
all shareholders, companies that are growing fast and hiring a 
lot of employees don't have the ability to broadly make 
available investment opportunities to the accredited investor 
universe.
    With respect to the employees, this to me is--it ultimately 
affects a company's ability to hire and compensate their 
employees. What is interesting is options in their form don't 
count towards the count. But once they invest and exercise, 
they do count towards the count. So we think that both of those 
are two important exemptions.
    With respect to the held of record, I don't believe that 
the bill addresses the definition of record holders. But if it 
does, I would have to get back to you with an answer on that.
    Mrs. Maloney. Maybe they shouldn't have that definition.
    Mr. Silbert. I think that is more relevant on companies 
going from public to dark, which I think is kind of covered 
under the Community Bank bill, which--I apologize. H.R. 1965 is 
which bill?
    Voice. Himes.
    Mrs. Maloney. That is the Himes bill that amends the 
securities laws to establish certain thresholds for shareholder 
registration and for other purposes.
    Mr. Silbert. So I fully support that bill as well, because 
I think a lot of the same issues that you and Mr. Williams 
talked about in his testimony--it applies to whether you are a 
community bank or whether you are a fast-growing pre-IPO 
company, I think it is important to make those changes as well.
    Mrs. Maloney. Okay. Thank you. And Mr. Williams, who is 
representing the banking industry, under the Schweikert bill, 
this bill only--I am talking about the Himes bill--only applies 
to banks and bank holding companies. I would like to ask you 
how many banks would be affected by this change? And are you 
supporting the Himes bill, H.R. 1965?
    Mr. Williams. We are certainly supporting the Himes bill. 
We think it is a good policy and a good change. The number of 
banks that are affected is subject to debate. But basically, we 
feel that there are at least 500 banks in our country that 
would benefit immediately.
    I have the opportunity to travel around the country and 
visit with banks. And it just happened to me last night, here 
in Washington, meeting with a group of bankers from Florida and 
California. And a banker from Tallahassee caught me after the 
meeting and said, ``I started a new bank 4 years ago, and I am 
not very large. I am up to about $120 million, but we are 
growing quickly and capital is really important to us. But we 
are already up to 400 shareholders.''
    The cost of registration he estimates to be $190,000 
annually. That means in the ten to one ratio of capital to 
loans, that will decrease this bank's ability to make loans by 
nearly $2 million per year, which according to Bill here, would 
turn into 25 to 30 jobs each year with those small businesses 
that could obtain those loans. We are clearly supporting that 
legislation.
    Mrs. Maloney. I am supporting both of these bills. I would 
like your opinion on this one aspect. Should the shareholder of 
record definition be revised to only include individual 
investors? And if the definition was revised in this way, what 
would be the appropriate number of shareholders of record?
    Mr. Williams. We believe we have worked under the current 
shareholder of record description for a number of years and 
that is a comfortable level to work with. But actually, in the 
banking industry, there is very little distinction, I believe, 
between the shareholder of record and the other definition.
    We believe, based on our analysis, that a move from 
somewhere between 2,000 and 3,000 shareholders would keep us in 
line with what would be deemed adequate with the banking 
industry.
    Mrs. Maloney. Thank you. My time has expired.
    Thank you, Mr. Chairman.
    Chairman Garrett. Thank you, Mrs. Maloney.
    Mr. McHenry?
    Mr. McHenry. Thank you, Mr. Chairman.
    Ms. Mauriello, I appreciate your testimony and the efforts 
you are making to help entrepreneurs get access to capital.
    In your experience, under SEC's Reg D Rule 504, you found 
that there is, in fact, a limited ability to do crowdfunding 
within this exemption. And that is how you found your place, as 
I understand it, and your ability to do your business.
    What experience do you have? You mentioned this in your 
testimony, but if you can expand on it. What experience do you 
have with the limitations that complex SEC rules and then, 
furthermore, the State regulations, the impact they would have 
on crowdfunding?
    Ms. Mauriello. Absolutely. So, on an SEC perspective, the 
complications come from lack of definition. For example, under 
Reg D 504, I can reach out to people with whom I have a 
substantial pre-existing relationship.
    That is incredibly difficult to define and to be made 
understood by someone who is saying, do my Facebook friends 
count? Does this type of person count? And we can provide as 
much transparency and information as exists to say people who 
have adequate information about your financial situation, etc. 
But those definitions are so vague that they are very difficult 
to comply with.
    The same goes for sophisticated investors, ``for being able 
to make their own decisions on investment.'' That is not 
sufficient to be able to allow sophisticated investors to be 
able to invest in a way that the counsel of the entrepreneur 
truly has confidence and being able to use this, and in a way 
that platforms can truly scale it, because we feel confident 
that we can stay in compliance.
    On the State level, my biggest concern is that the greatest 
bill in the world could be put forward, but if the States can 
then say, actually, we don't like this and you can only have 10 
investors in our State, despite what the bill at the national 
level says, which is what is happening with 504.
    For instance, they call the case of--at the Federal level 
for 504, you can have 500 investors. Connecticut says you can 
only have 10 nationally. That really negates a lot of the good 
work that had been done on the Federal level.
    And I think some of the intention behind the State 
regulation can stay by still having notice filings with the 
State. You can still have even the filing fees. You can still 
have the fraud protection measures, as you mentioned, while 
making it scalable.
    Mr. McHenry. Mr. Abshure, can you respond to that concern 
about these complex regulations and these limitations through 
the focus that you are representing here today?
    Mr. Abshure. Exactly. I think that I understand that 
industry's concern to effectively have one-stop shopping, go to 
one regulator. And I think that in this case, the one stop is 
the States.
    And the States have, in the past, shown their ability to 
recognize the needs of small business and to facilitate capital 
raising transaction through model accredited--
    Mr. McHenry. Okay. Actually, I am trying to get you to 
respond to Ms. Mauriello's specific concern. When you say only 
she used 10 investors in the State of Connecticut, do you have 
the similar limitation in the State of Arkansas?
    Mr. Abshure. In terms of the number of investors under a 
504 offering? If 504 is--no, we wouldn't have that in 
implementation.
    Mr. McHenry. Okay. But then the folks that you are 
representing here today, is there a way to still have that 
filing? It would be less won risk and less expensive.
    Mr. Abshure. Absolutely.
    Mr. McHenry. So, you could go and raise $100,000 from 1,000 
investors across the country.
    Mr. Abshure. There is apparently an assumption that the 
States can't come together and come up with a better mousetrap 
in this scenario and the fact that--
    Mr. McHenry. They haven't?
    Mr. Abshure. We can.
    Mr. McHenry. Yes, and we are still waiting, so this is 
really the concern I want you to answer.
    Mr. Abshure. Yes.
    Mr. McHenry. Can you alleviate Ms. Mauriello's concerns and 
her experience in trying to raise capital across State lines?
    Mr. Abshure. I think it is up to the States to develop a 
program where we can say, this is the avenue, this is the 
route. I understand we don't disagree with the goal at all. We 
have issues with the root that crowdfunding wants to use to get 
to the goal. And we think that we can come up with a better 
route to get there.
    Mr. McHenry. Okay. So, do you currently have oversight 
over--in the 1933 Act, they are considered to cover securities 
because of the interstate qualities of these securities.
    Mr. Abshure. Yes.
    Mr. McHenry. Now, if we had a similar security, right, 
which is what we are talking about with crowdfunding, why would 
that not fall under that 1933 Act exemption?
    Mr. Abshure. The coverage securities under the 1933 Act 
included those securities that are traded on the nationally 
recognized exchanges. When you get to the private placement, 
the coverage securities are those that are issued pursuant to 
rules adapted under section 4(2). It is limited to 506.
    Mr. McHenry. Okay.
    Mr. Abshure. 505 securities aren't covered. 504 securities 
aren't covered.
    Mr. McHenry. Mr. Molinari, how do you alleviate that 
concern? Could these crowdfunded securities, in essence, be 
done on a national platform that could get them under this 1933 
Act in the very point that Mr. Abshure is saying, that the 
exemption is because they are on a trading platform at the 
national level?
    Mr. Molinari. Absolutely, Congressman. I think when you 
look at this on a macro level, it is not just about the 
crowdfunding side of the equation. I think we are at a new era 
today. If we look at technology, platforms meeting broker-
dealer applications or ATS', as the utility in the middle of 
the transaction, it becomes the barrier of entry when you start 
to look at accredited investors, State registrations, Federal 
regulation.
    The flow of information, whether that is solicitation ban 
or other, gives us the parameter to have tracking, archiving, a 
level of transparency, and record-keeping that is readily 
available to the regulators. And you are creating new market 
infrastructure, starting to create new investment practices 
that we haven't seen before. So the short answer is yes, 
absolutely, we can.
    Mr. McHenry. So, to Ms. Mauriello's concern about the cost 
of being a broker-dealer, is there a way that what you are 
discussing and, Ms. Mauriello, what you have discussed, in 
terms of having this platform for the exchange of these 
securities, but to do so for a smaller offering than Ms. 
Mauriello is currently working through? Let us say half a 
million dollars, a hundred thousand dollars?
    Is there a way for what she is proposing--what Ms. 
Mauriello is talking about to fit in with the elements that you 
are discussing, with the national platform?
    Mr. Molinari. Again, yes, 100 percent. I think when we look 
at the initiatives and start to think about the broker-deal a 
little bit differently, and focus a bit on the ATS, the 
Alternative Trading System aspects, the next level up from the 
broker-dealer. If you make that in an electronic software 
application, tremendous efficiencies in cost, tremendous 
efficiencies in disclosure and transparency. It is one of the 
very reasons why we start to GATE Impact.
    Looking at the impact initiatives, some of the microfinance 
issues that are now evolving from lending practices that were 
more grant-oriented and kind of just the do good side of the 
equation, to create that into an investment practice. And we 
would love, frankly, to leverage our infrastructure, our 
broker-deal compliance, the ATS designations, with folks like 
ProFounder to create that new ecosystem, to be that utility in 
the middle that handles a lot of that compliance and 
regulation.
    Mr. McHenry. Mr. Silbert, could SecondMarket facilitate 
this as well? What are your thoughts on this?
    Mr. Silbert. Yes, I think the issue is--and it has been 
highlighted that as a registered broker-dealer, the costs to 
conduct diligence on an issuer or small offering is cost 
prohibitive.
    And so the idea of either running through an ATS or some 
type of new regulated entity, you have to be kind of--to find 
or describe, it makes perfect sense.
    Mr. McHenry. So, something scalable?
    Mr. Silbert. Right.
    Mr. McHenry. Okay. Thank you for your testimony. I am sorry 
I didn't get to the whole panel.
    But, certainly, I appreciate your testimony and your 
willingness to be here. My concern with the purpose of the ban 
on general solicitation--I, obviously, want to limit fraud and 
certain communications that would lead to fraud.
    But it seems like this ban from the SEC really is simply 
choking off capital right now. We want that capital to be able 
to flow. We want it to be done in an environment where we won't 
have fraud, so we can prevent fraud.
    But I do think the scrutiny of mass markets can help. And 
technology is certainly a wonderful way to make that possible.
    Thank you for your time and thank you for being here.
    Chairman Garrett. Thank you, Mr. McHenry.
    Mr. Sherman?
    Mr. Sherman. Thank you. At the end of the hearing, almost 
everything that could be said has already been said. So, I am 
going to mention some things that are just on the periphery of 
this hearing, on the theory that that will minimize the 
overlap.
    The first is that we haven't dealt with FASB number two. 
That is the provision of the Financial Accounting Standards 
Board that requires businesses to write off as an expense all 
the money they invest in research. So, if you build a research 
building, that doesn't hit your earnings. If you do any 
research in the building, that does.
    And certainly, small businesses are doing the high-tech 
work. It is bad accounting theory. It is just easier to carry 
out. But it is bad accounting theory to say money that is 
invested in 2011 to create research results that are going to 
be used in the future should be written off as an expense.
    And I think that a lot of smaller companies are reporting 
far less earnings per share as a direct result.
    The second comment I will make is that for most businesses 
in my district, access to capital means getting a bank loan. 
Now, that isn't the subject of this hearing, because that is 
another subcommittee's jurisdiction. But I look forward to 
doing everything possible in the full committee so that it is 
easier to get depository institutions to make loans not to--
this is important for all of business.
    We are talking here about companies going public and having 
hundreds of shareholders, going to the SEC and the dreams of 
the most ambitious small business people.
    A lot of gas station owners in my district, their idea of 
access to capital is getting a loan so that they can put in new 
tanks. And that is not necessarily the SEC's function.
    But I want to commend my colleagues on the Small Business 
Lending Enhancement Act, which would allow credit unions to 
make business loans to those in their field of membership.
    And while that may not help anybody become the new--it may 
indeed help somebody become the new Google. It will certainly 
help the small businesses that are not looking for 400 
shareholders and $40 million, but instead are looking for 
$40,000 to be able to make the investments they need to keep 
the business going.
    And then, finally, as to the Wall Street--as to the 
provision on 404(b), I may be disagreeing with some of our 
witnesses here. But I do want to put in the record that the 
Counsel of Institutional Investors, the Center for Audit 
Quality, and others have opposed other efforts in our committee 
to permanently exempt companies of over $75 million in 
capitalization from the 404(b) audit requirements.
    And it may be easier to do less auditing. It may be cheaper 
to do less auditing. But I have never met an investor who said, 
oh, gee, I wish I had less auditing.
    Chairman Garrett. Mr. Sherman? I do believe the ranking 
member put that letter in the record.
    Mr. Sherman. I thank you and I am glad that has already 
been done. And with that, I am going to spare the witnesses. 
They have been through enough and I yield back.
    Chairman Garrett. Thank you. But do you really think we 
have put them through enough?
    [laughter]
    Mr. Sherman. These people are nicer than most of our other 
witnesses.
    I promise you, I will not be nice some other day.
    Chairman Garrett. You are a very likeable group. But just 
for a couple of moments, sort of a quick prerogative because 
Mr. Abshure, you seem like a likeable soul and fairly creative.
    You heard the story from Mr. Williams of some of the issues 
that were happening with some of the smaller banks and their 
ability to--hitting up against that share ceiling.
    I know this is not necessarily within your regulatory 
specialty. But if you were to solve his problem in a way that 
would make you comfortable with your regulator hat on, what 
would you do?
    Mr. Abshure. Specifically, the problem with small banks 
with the shareholder aspect?
    Chairman Garrett. Yes. Just purely running up against the 
ceiling.
    Mr. Abshure. With regard to that question, that shareholder 
registration threshold, it strikes me as everyone involved 
understands the particular issues there. And I think that you 
have to balance. You have to determine when a company really 
becomes a public company.
    And it is a balancing between the number of shareholders, 
but also really the assets and, perhaps, market cap. And I 
think that--
    Chairman Garrett. So, you would consider looking at other 
types of triggers other than just?
    Mr. Abshure. Other than just the shareholder. Look, you can 
have a company that has two shareholders and a $2 billion 
market cap between those two.
    The company is a balance. The size of the company is a 
balance between the number of shareholders and also the 
financial size of the company.
    So, I think you have to balance those two.
    Chairman Garrett. Okay. That is a fair comment. Just an 
odd, one-off question for Mr. Silbert.
    Has there ever been--we will call it a secondary market, 
even though I think you now have that copy written--that has 
traded--when an employee, you spoke about--okay, we can only, 
right now, give so many shares out to employees, but you give 
them an option for the future. Has anyone ever traded those 
employees?
    Mr. Silbert. Typically, with all private cap securities, 
there are restrictions on transfer. And in particular options, 
even once they invest, they are not transferable.
    Chairman Garrett. In that case, when you also look at the 
model you are building--let us say we had a small business, and 
either my piece of legislation or some of the others that are 
out there, where an employee is given so much ownership, but we 
restrict them, saying, it has to be held for 36 months and 
those types of triggers. How do you respect those rules when 
you are also creating a secondary platform to move those 
shares?
    Mr. Silbert. I think what is unique about SecondMarket is 
we are not creating an over-the-counter golden board in the 
back alleys. We are creating a registered, regulated, 
transparent, centralized platform, where the companies 
themselves are the ones that are setting the rules around how 
those securities can be traded.
    So a company decides when they want to open up a liquidity 
window. The company gets to decide how many buyers and which 
buyers are allowed in to their market. The company gets to 
decide if there are restrictions on employee sales.
    So, from that perspective, the market will be customized to 
the companies' objectives, versus forcing the company to comply 
with the public market roles, which is not a one-size-fits-all.
    Chairman Garrett. And forgive me if I mispronounce your 
name, Ms., is it ``Mauriello?''
    Ms. Mauriello. Yes.
    Chairman Garrett. In some of the, we will call them 
placements, you have been involved in, how helpful has the 
Internet been? Do you have some of these small investors? Are 
they using the Internet to vet the company and the concepts?
    Ms. Mauriello. It is extremely challenging for them to use 
the Internet and take best advantage of the power that it has, 
because of the prohibition on general solicitation. But it has 
some value.
    For example, our issuers will create their business plan 
and create their term sheet and put those on a private 
fundraising Web site that they will then be able to e-mail the 
people who they have a substantial pre-existing relationship 
with, under 504, to be able to invest directly through.
    It is helpful to be able to view the information in a 
centralized place, to be able to share new information, etc. 
But what they all come back to us and say is, why can't I send 
out a link that they can send to their friends, also someone 
whom I have a relationship with, but I might not have thought 
of.
    So, the way the regulation is set in place is very 
difficult to explain to the common person, who has used normal 
Internet practices, and see that they have to use the Internet 
in a very different way and almost an illogical way than what 
they are used to.
    Chairman Garrett. As a one-off, have you ever seen some of 
these small investors create a social media of some fashion to 
either discuss the concept, the marketplace, as more of an 
investor instead of the actual person doing the offering?
    Ms. Mauriello. If the investors have discussed amongst 
themselves?
    Chairman Garrett. Yes? Or just even put it out saying, give 
me input.
    Ms. Mauriello. Exactly. They are all scared to, because 
they know they can't generally solicit. Their counsel has 
battered than over the head with this. We remind them of this 
all the time. So, they are scared. They want to stay as 
conservative as possible.
    What we encourage them to do is to talk about their idea 
and before you ask someone for money, you should ask their 
advice. You should make them aware of what you are doing with 
their business. So, we do encourage them to do that as a 
separate matter, just as good business practice.
    But within the offering, everyone is far too scared to 
touch that.
    Chairman Garrett. Thank you. We are entering into, in many 
ways, sort of a brave new world, where our access to 
information is so radically different today than it was even a 
decade or 15 years ago. And I keep hoping we are going to find 
that sweet spot where information is the ultimate regulator 
here.
    And in some ways, our desperate hunger for capital for the 
small job-creating growth industries might be also the same 
time where we also get to find out the future of the regulatory 
environment. Do we have--oh, I am sorry, Mr. Himes. I didn't 
even see you sneaking up on me.
    Mr. Himes. Thank you, Mr. Chairman. Let me thank the panel 
for your very, very helpful and useful testimony. I have a 
couple of questions. I want to come back to this crowdfunding 
issue.
    So, I have some questions for Ms. Mauriello. I want to say, 
though, there was a sort of spirited back-and-forth with Mr. 
McHenry. I am not trying to set this up as an antagonistic 
situation. I honestly don't know whether this is a good idea or 
not. I am trying to get at it.
    I think the core of my concerns with crowdfunding is that 
the underwriting process in the case of debt or the process by 
which an individual or an institution decides to make an equity 
investment is essentially a process of getting to know 
somebody.
    When you are going to lend to somebody, you don't just look 
at interest coverage and the ability to repay. You actually get 
to know the individual.
    Ms. Mauriello. Yes.
    Mr. Himes. To me, that is the core of the investment 
decision. What worries me is nothing specific about the 
Internet or eBay or anything else. But what worries me is that, 
by definition almost, crowdfunding takes away that getting-to-
know-you element.
    So, I have two questions for you, Ms. Mauriello. I would 
like you to respond to that more generally. But also in your 
testimony, you have talked about your days as a student at 
Stanford and you said you had great ideas and people wanted to 
fund them, but that it couldn't happen.
    Under Federal law, it is only companies with assets in 
excess of $10 million, and even then under Reg D, you can do 35 
or 34, not 35, non-accredited investor. So, what was actually 
keeping those Stanford students from investing in each others 
startups?
    Ms. Mauriello. Sure. On that particular question, it was 
fear on behalf of their counsel, because the regulation was 
unclear about the specifically sophisticated investor clause 
and what that meant.
    So, they ultimately wound up doing it through Regulation D 
506, after a number of months and about $20,000 in legal 
expenses to get there, because their lawyer said, yes, you can 
have 35 sophisticated investors. But there is no standard SEC 
issue tasked for what sophisticated investor means.
    There is a level of risk to take on saying that somebody is 
sophisticated. So they ultimately, out of 60 people who were 
interested, could take on 35 who would fit under 506. Would you 
like me to address the getting-to-know-you as well?
    Mr. Himes. That is actually really my concern. We hear 
story after story about people starting businesses with credit 
cards and second mortgages.
    This is the way it has always been done, angel investors. 
With credit cards and mortgages, there is recourse for you. 
That will focus the attention.
    Ms. Mauriello. Right.
    Mr. Himes. If it is friends and family and mothers-in-law, 
that will focus your attention. This seems to me to do away 
with that relationship, which is both about information and 
data, but also about just sizing up the individual and that 
individual's character. Is that not lost in this process?
    Ms. Mauriello. I don't think it has to be. I think it could 
be. It really depends the way the investor protection is 
written, right?
    So, there are two points. One is on disclosure. So, I think 
there is a certain level of disclosure which is necessary to 
make information available, that is also not too prohibitive. 
For example, the level of disclosure in 506, many small issuers 
were doing $20,000, etc., find that to be prohibitive.
    There is a balance there. But secondarily, I mentioned one 
suggestion for investor protection around qualifying the 
issuers. All the deals that we have done so far are through 
504, because the way it is written there is within communities. 
It is truly community investing.
    Ricky Puthiya has a coffee shop in Montana. His community, 
his neighbors, the people who know Ricky best, looked into this 
opportunity and decided to invest. I think that is the most 
common way that we are going to see crowdfunding happen.
    I am really excited and encouraged by the way the bill is 
being written and it is being talked about to create unlimited 
potential. At the end of the day, how I think the majority of 
people will use it is within communities to be able to invest.
    So, what I put forward as a suggestion for qualified 
investors is that if you know the person, if you are local to 
that person, or if you are a sophisticated investor and are 
deemed to be able to make good decisions based on the 
disclosures alone, you should be able to make that investment.
    That is how I would suggest addressing the getting-to-know-
you issue.
    Mr. Himes. Okay. Thank you. I appreciate that.
    One question for Mr. Molinari. I appreciate your testimony, 
Mr. Molinari. Something caught my eye, though. In your 
testimony, you said that Sarbanes-Oxley and the Dodd-Frank Wall 
Street Reform and Consumer Protection Act are limiting the 
ability of benefits to smaller private companies that are going 
public. I have heard the Sarbanes-Oxley they wanted before.
    But, of course, Dodd-Frank, which we spent a lot of time on 
in the last Congress, really applies largely to financial 
institutions and has broad exemptions for smaller financial 
institution.
    I wonder if you can walk me through the mechanism by which 
you think Dodd-Frank specifically inhibits the ability of 
nonfinancial companies to raise capital.
    Mr. Molinari. I think when you look at it, Congressman, it 
is the macro theme of looking at the IPO more. Looking at the 
macro theme that the small to mid-sized public offerings in our 
country have been dramatically reduced. And we can go over 
statistic after statistic.
    Mr. Himes. I know that. And look, we all know what happened 
in the market. I am curious about the specific mechanism by 
which the Dodd-Frank legislation--which of the rule writing 
not, of course, having been completed is inhibiting capital 
raising of nonfinancial companies?
    Mr. Molinari. You say nonfinancial as private companies.
    Mr. Himes. You say smaller private companies, yes.
    Mr. Molinari. I think it is the concerns of being public 
and going public relative to those costs associated across the 
spectrum of overreaching regulation, perhaps, where we have 
private companies that need to grow further, that are budding 
up against certain issues. And I know we are talking about more 
issues.
    Mr. Himes. But just to stop you, because I am running out 
of time. I do appreciate the answer. Sarbanes-Oxley imposed a 
substantial regulatory burden, as does the SEC, on public 
companies, but you think a lot of Dodd-Frank here.
    I am just wondering, does Dodd-Frank, in fact, impose 
regulatory burdens on nonfinancial companies, small company?
    Mr. Molinari. Not as much. As we point out, Dodd-Frank is 
more a macro regulation that is affecting the marketplace, not 
necessarily drilling down to the specifics in this instance.
    Mr. Himes. Okay. Thank you very much. Thank you, Mr. 
Chairman.
    Chairman Garrett. Thank you, Mr. Himes, though you live 
dangerously if you are raising money from the mother-in-law.
    [laughter]
    Chairman Garrett. Talk about recourse.
    [laughter]
    Chairman Garrett. Oh, yes. And that was the entertainment 
portion of our program.
    [laughter]
    Chairman Garrett. In that case, we are done. I just have to 
read a couple of statements here. And I know the committee 
wants to thank you very much.
    As I often say, particularly for a couple of you, it may be 
your first time to testify here, if you look out in the room 
and don't see a lot of faces staring back at you, understand 
that there are faces staring at you all over the building.
    It is something you get to used to, as you are on 
televisions everywhere. And a lot of folks don't realize how 
much they are being watched. That is what gets me in trouble 
when I try to be amusing up here.
    All right, statements for the record. We have: the U.S. 
Chamber of Commerce; the Independent Community Bankers of 
America; Burroughs & Chapin Company; and the Credit Union 
National Association have all submitted letters. And they will 
be placed in the record without objection. So ordered.
    The Chair notes that some Members may have additional 
questions for these witnesses which they may wish to submit in 
writing. Without objection, the hearing record will remain open 
for 30 days for Members to submit written questions to these 
witnesses and to place their responses in the record.
    And with that, our committee is finished. Thank you all.
    Mr. Molinari. Thank you.
    Ms. Mauriello. Thank you.
    [Whereupon, at 12:40 p.m., the hearing was adjourned.]
































                            A P P E N D I X



                           September 21, 2011

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