[Senate Hearing 112-444]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 112-444

 
                  SPURRING JOB GROWTH THROUGH CAPITAL
              FORMATION WHILE PROTECTING INVESTORS-PART I

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

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                                   ON

             EXAMINING JOB GROWTH THROUGH CAPITAL FORMATION

                               __________

                            DECEMBER 1, 2011

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York         MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii              JIM DeMINT, South Carolina
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin                 PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia             MARK KIRK, Illinois
JEFF MERKLEY, Oregon                 JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado          ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina

                     Dwight Fettig, Staff Director

              William D. Duhnke, Republican Staff Director

                       Charles Yi, Chief Counsel

    Dean Shahinian, Senior Counsel and Chief Security Policy Advisor

                     Laura Swanson, Policy Director

                 Levon Bagramian, Legislative Assistant

                 Andrew Olmem, Republican Chief Counsel

                Hester Peirce, Republican Senior Counsel

                       Dawn Ratliff, Chief Clerk

                     Riker Vermilye, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)
?

                            C O N T E N T S

                              ----------                              

                       THURSDAY, DECEMBER 1, 2011

                                                                   Page

Opening statement of Chairman Johnson............................     1
    Prepared statement...........................................    42

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     2
    Senator Reed.................................................     4

                               WITNESSES

Senator Kay Bailey Hutchison of Texas............................     5
    Prepared statement...........................................    42
Senator Mark L. Pryor of Arkansas................................     6
    Prepared statement...........................................    48
Senator Scott P. Brown of Massachusetts..........................     6
Meredith Cross, Director, Division of Corporation Finance, 
  Securities and Exchange Commission.............................     9
    Prepared statement...........................................    48
Jack E. Herstein, President, North American Securities 
  Administrators Association, Inc................................    11
    Prepared statement...........................................    55
John C. Coffee, Jr., Adolf A. Berle Professor of Law, Columbia 
  University Law School..........................................    13
    Prepared statement...........................................    61
Christopher T. Gheysens, Executive Vice President and Chief 
  Financial and Administrative Officer, Wawa, Inc................    16
    Prepared statement...........................................    66
Scott Cutler, Executive Vice President and Co-Head, U.S. Listings 
  and Cash Execution, NYSE Euronext..............................    17
    Prepared statement...........................................    68
Edward S. Knight, General Counsel and Executive Vice President, 
  Nasdaq OMX Group...............................................    19
    Prepared statement...........................................    72

              Additional Material Supplied for the Record

Statement submitted by Senator Carl Levin........................    79
Letters submitted by Senator John Thune..........................    85
Letter submitted by R. Cromwell Coulson, President and CEO, OTC 
  Market Groups, Inc.............................................    93
Statement submitted on behalf of the American Bankers Association   105
Letter submitted by Chairman Johnson from William F. Galvin, 
  Secretary of the Commonwealth, Commonwealth of Massachusetts...   108
Letter submitted by Barry E. Silbert, Founder and CEO, 
  SecondMarket, Inc..............................................   111
Statement submitted by the Biotechnology Industry Organization...   113
Statement submitted by the Computing Technology Industry 
  Association....................................................   116
Statement submitted by Barbara Roper, Director of Investor 
  Protection, Consumer Federation of America.....................   119

                                 (iii)


    SPURRING JOB GROWTH THROUGH CAPITAL FORMATION WHILE PROTECTING 
                            INVESTORS-PART I

                              ----------                              


                       THURSDAY, DECEMBER 1, 2011

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:05 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Tim Johnson, Chairman of the 
Committee, presiding.

           OPENING STATEMENT OF CHAIRMAN TIM JOHNSON

    Chairman Johnson. Good morning. I would like to call this 
hearing to order.
    Our Nation is facing an unemployment crisis. Nearly 14 
million Americans are unable to find a job, and over 5 million 
have been unemployed for 6 months or longer. Here in Congress, 
putting our fellow Americans back to work should be, and must 
be, our top priority.
    The American people are frustrated, and rightfully so, by a 
political system that is bogged down in partisan battles. 
However, our focus today is an issue where I believe there is 
real potential for bipartisan cooperation and for results.
    We are here to discuss how to help startups and businesses 
get access to the capital they need to grow and to create new 
jobs, while protecting investors.
    Today the Committee is pleased to hear testimony from three 
of our fellow Senators as well as expert witnesses who will 
talk about challenges that businesses and entrepreneurs can 
face when attempting to raise money by selling stock.
    The Committee will also hear about proposals and ideas that 
seek to improve existing securities laws. The witnesses will 
discuss the SEC's requirements for a person or company to sell 
securities to the public.
    They will also provide insights on proposals to expand the 
scope of Regulation A offerings, to permit general solicitation 
of investors in Regulation D offerings, and to allow 
individuals to solicit and sell small amounts of stock over the 
Internet through crowdfunding.
    They will address the size of a private offering and the 
amount of money that a crowdfunder should be able to risk 
without full regulatory protection. They will discuss the types 
of markets where these securities should trade. They will also 
describe the existing investors' safeguards, such as 
disclosures about the business and financials, and how current 
proposals would affect those safeguards.
    In addition, witnesses will review the requirements for 
banks and other companies with 500 or more shareholders of 
record to register with the SEC, which requires important 
information to be provided regularly to shareholders, and 
discuss whether the transparency is important to investors and 
appropriate for different types and sizes of companies.
    And additional ideas may be raised in the Committee's 
discussions. A recommendation that came up in a recent hearing, 
and which I have a strong interest in exploring, involves 
amending Regulation D to add American Indian tribes to the list 
of accredited investors.
    I want to thank Senator Shelby and his staff for their 
cooperation in developing this hearing. I think we agree that 
firms that are in a position to grow will seek to raise more 
capital if the process of selling stock is made easier and less 
costly. If they succeed, this can lead to more jobs and 
economic prosperity. At the same time, investors must be 
willing to buy the stock that businesses offer, and they are 
more likely to do so when they have enough reliable information 
and know that they are not at risk of being scammed.
    I look forward to the testimony of the witnesses and to 
working with my colleagues on both sides of the aisle to 
develop bipartisan legislative solutions that promote job 
growth and business expansion while protecting investors.
    With that, I will turn to Senator Shelby for his opening 
statement.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Mr. Chairman. Thank you for 
calling this hearing.
    Today the Committee will consider ways to increase job 
growth by improving access to capital for small businesses. 
Over the past 3 years, the number of new businesses launched 
each year has fallen by 23 percent. This sharp decline should 
be viewed as a warning signal about our economic future. Small 
businesses, as we all know, are the lifeblood of the U.S. 
economy. If entrepreneurs are not creating new small businesses 
today, there will not be new large industries tomorrow.
    It is, therefore, critical to the long-term health of our 
economy that entrepreneurs have the tools they need to create 
and to innovate. Unfortunately, the laws and regulations pushed 
by the administration over the past 3 years have created a 
regulatory climate hostile to business creation. The 
administration has viewed businesses not as valuable 
contributors to our economy, but as a means for implementing 
social policy.
    In the 2,000 pages of Dodd-Frank, there is not a single 
item that would make it easier to start a business. Instead of 
focusing on how to create jobs, the administration has imposed 
one costly mandate after another. These mandates are not only 
costly, but they bog down small businesses with unnecessary 
regulations. In some cases, these regulations are fatal to 
fragile startups. In other cases, they discourage the flow of 
capital investment needed to even start a new business.
    It should, therefore, be no surprise that our unemployment 
rate has stagnated at 9 percent and business creation has 
plummeted over the past 3 years. If we want to return to an 
economy that creates jobs, there needs to be a change in 
policy. Fortunately, there seems to be one area where there is 
a bipartisan consensus for change: making it easier for 
entrepreneurs to obtain funding. This could be done in two 
ways:
    First, the securities laws and regulations could be amended 
to make it easier for private companies to raise capital. For 
example, companies could be permitted to raise money from a 
greater number of investors without having to incur the 
substantial reporting costs of registering with the SEC. And 
since nearly all businesses are private companies, these types 
of reforms could help reduce one of the primary obstacles all 
entrepreneurs face.
    The second way we can increase the availability of funding 
is to make it easier for companies to access the public 
markets. Presently, small businesses that want to go public 
have to overcome a one-size-fits-all regulatory approach that 
requires them to bear disproportionate costs.
    According to a recent report by the IPO Task Force, a group 
of professionals representing emerging growth companies, and I 
quote: ``The cumulative effect of a sequence of regulatory 
actions, while mostly aimed at protecting investors from 
behaviors and risks posed by the largest public companies, have 
driven up costs for emerging growth companies looking to go 
public.''
    The IPO Task Force estimates that the average cost for a 
company to go public is $2.5 million, and the annual cost to 
stay public is $1.5 million. These costs make the public 
markets unaffordable for thousands of small companies. 
Regulation can deprive funding for companies at exactly the 
moment they want to expand and to create new jobs.
    And while our securities laws have helped to preserve our 
capital markets as the largest and the deepest in the world, 
they need to strike the right balance between protecting 
investors and ensuring that companies can raise funds. I think 
it is becoming apparent that we do not have the right balance. 
The laws need to consider the real-world costs of complying 
with regulations, especially those borne by small businesses.
    Accordingly, I am encouraged that several bills have 
already been introduced with bipartisan support that would 
address some of the unique problems faced by small businesses. 
It is my hope that the Committee will take a serious look at 
these bills and other proposals to modernize our securities 
laws.
    Over the past few weeks, there has been a lot of talk about 
the need to do more to create jobs. I believe that these bills 
give the Committee an opportunity to take action. I stand ready 
to work with the Chairman on these promising bills.
    Thank you, Mr. Chairman.
    Chairman Johnson. Thank you, Senator Shelby.
    Are there any other members who wish to make a brief 
opening statement? Senator Reed.

                 STATEMENT OF SENATOR JACK REED

    Senator Reed. Thank you very much, Mr. Chairman. I want to 
commend you and the Ranking Member for holding this hearing. It 
is a very important topic. We all want to make sure that 
cutting-edge American businesses have the capital to fund new 
products and, very importantly, provide jobs.
    At the same time, we need to ensure that investors have 
accurate information to make sound investment choices. Eroding 
investor protections can have a deleterious effect on investor 
confidence and actually, and ironically, reduce investment in 
our capital markets. And I know that our colleagues who are 
proposing this legislation are attempting to balance the ease 
of access to the markets along with protections of investors, 
and I appreciate that very much.
    In 1913, Louis Brandeis wrote about the importance of 
disclosure in securities offerings, that ``To be effective,'' 
in his words, ``knowledge of the facts must be actually brought 
home to the investor, and this can best be done by requiring 
the facts to be stated in good, large type in every notice, 
circular, letter, and advertisement inviting the investor to 
purchase. Compliance with this requirement should also be 
obligatory, and not something which the investor could waive.'' 
I think that is pretty sound advice even today.
    In 1933, Congress adopted the framework. It was not adopted 
in the last several years, but in 1933, Congress adopted the 
framework. The Securities Act had a simple goal: for insurers 
to tell the truth about their offerings. In fact, the small-
insurer exemption from registration was limited to an 
aggregation of about $100,000, which would be $3 million 
today--in fact, much smaller than it is actually today.
    There are various legislative proposals before us that seek 
to improve the flow of capital between companies and investors. 
We must carefully consider how the American economy has changed 
and how both the needs of issuers and investors have changed. 
Is the process too complex? Do certain longstanding regulatory 
requirements remain relevant? Or has the economy passed them 
by? Do the proposed changes increase the risk of fraud? And 
these are the serious questions that the sponsors have posed in 
their legislation.
    I am interested, obviously, in learning more about the 
current status of capital-raising efforts, how they can be 
improved, and I look forward to the testimony of all our 
witnesses, and I want to again commend my colleagues for their 
efforts.
    Thank you, Mr. Chairman.
    Chairman Johnson. Thank you all.
    I would like to remind my colleagues that the record will 
be open for the next 7 days for opening statements and any 
other materials you would like to submit.
    Before we hear from our witnesses, three of our colleagues 
in the Senate are here to provide their thoughts and views on 
today's topic. Today we will hear from our former colleague on 
the Committee, Senator Kay Bailey Hutchison of Texas, as well 
as Senators Mark Pryor of Arkansas and Scott Brown of 
Massachusetts. Thanks to all three of you for taking the time 
to be here.
    Senator Hutchison, welcome back to the Committee. Please 
begin.

STATEMENT OF KAY BAILEY HUTCHISON, U.S. SENATOR FROM THE STATE 
                            OF TEXAS

    Senator Hutchison. Well, thank you so much, Mr. Chairman. I 
want to say right off the bat that I actually wanted to stay on 
the Committee, but too many Republicans wanted to be on it, and 
I did not get a chance to do that. I really enjoyed it. I 
thought it was interesting, and I miss being on it. So I thank 
you, Mr. Chairman, Senator Shelby, Senator Toomey. I do so hope 
that we will be able to get an approval from the Committee for 
us to go forward on the bill that I am cosponsoring with 
Senator Pryor.
    Senate bill 556 is a common-sense bill with strong 
bipartisan support that will enable growth in our Nation's 
economy while strengthening our community banking system. Our 
bill would foster capital formation in the community banking 
industry and would allow community banks to bolster their 
balance sheets to meet the more stringent capital standards 
imposed by the Dodd-Frank Act.
    Senate bill 556 would update the threshold before a bank 
must register its securities with the SEC. Under current law, 
any company with $10 million in assets and 500 shareholders is 
required to register its securities with the SEC. The 
additional capital that would be gotten from our bill would 
free community banks to lend to creditworthy small businesses 
who in turn can go out and do what we need them to do: invest 
in new operations, projects, create jobs, and give our Nation's 
economy the lift we know it needs.
    The asset size threshold, which is $10 million now, has 
twice been increased since 1964. The 500-shareholder threshold 
has never been changed. For banks that exceed the 500-
shareholder threshold, the high cost of complying with SEC 
reporting requirements consumes capital resources that could 
otherwise be used for lending. Community banks tell me they 
could each save an average of $250,000 in costs to satisfy 
regulatory requirements if the shareholder threshold is raised 
to 2,000.
    Spread across the entire country, our bill would save 
community banks more than $80 million, which, when deployed as 
capital, could allow these banks to lend up to $800 million to 
America's small businesses.
    Community banks and small businesses are the backbone of 
our economy. With just 11 percent of the banking assets in 
America, community banks make up 40 percent of all loans to 
small businesses.
    I welcome today's hearing and hope that we will be able to 
move this bill expeditiously. The House recently passed a 
companion bill by a vote of 420-2. I am confident that the 
Senate would pass it by about the same margins.
    I want to ask your consent to put two letters that are in 
support of our bill from the American Bankers Association along 
with its members, the State associations, and the Independent 
Community Bankers of America.
    Chairman Johnson. Without objection.
    Senator Hutchison. Thank you, Mr. Chairman.
    Chairman Johnson. Thank you, Senator Hutchison.
    Senator Pryor, please proceed.

  STATEMENT OF MARK L. PRYOR, U.S. SENATOR FROM THE STATE OF 
                            ARKANSAS

    Senator Pryor. Thank you, Mr. Chairman, and I thank all the 
Committee for inviting me here today to discuss S. 556, a bill 
to amend the securities laws to establish a higher shareholder 
threshold for registration of banks as public companies. I want 
to thank Senator Hutchison for her leadership and for her 
important efforts on this bill. This is a good bipartisan bill, 
and we hope that we can move this relatively quickly through 
the Senate, if possible.
    Currently, the Securities and Exchange Commission requires 
a company with $10 million in assets and 500 shareholders to 
register its securities with the SEC and comply with the SEC's 
registration and reporting requirements. Since 1964, the 
original $1 million asset standard has been increased tenfold 
while the 500 shareholders of record requirement has never been 
updated.
    I want to emphasize that our bill only changes the 
shareholder threshold for banks and not for other businesses. 
Banks are unique businesses in the sense that they are already 
highly regulated and have to maintain large dollar assets tied 
to their loans. Consequently, shareholder size is the only 
meaningful standard for whether a bank should be registered as 
a public company.
    I have spoken with many community banks in Arkansas who are 
struggling to raise capital or expand their investor base. 
These community banks are increasingly subject to higher 
capital requirements due to Dodd-Frank, Basel III rules, and 
banking regulator stress tests. Increasing their capital 
reserves will enable these banks to continue to serve and 
benefit their communities. Increasing the shareholder limit 
would create an opportunity for community banks to bring in 
much needed new capital and increase lending. One dollar's 
worth of capital supports up to $10 in loans. As banks approach 
the current shareholder threshold, they have to decide whether 
to go public or to limit their access to capital. The result is 
that these banks are forced to make fewer loans in order to 
maintain their capital-to-asset ratio.
    Today a community bank with a small investor base is 
significantly different from what it was 40 years ago. While 
the shareholder threshold of 500 at one time may have been an 
accurate reflection of a public market, it is no longer so 
today. It is time Congress updated the standards for banks.
    Thank you again for this opportunity and letting me present 
the bill, and, again, I want to tell Senator Hutchison how much 
I appreciate her help on this effort, and
    I look forward to working with this Committee on its 
passage.
    Thank you.
    Chairman Johnson. Thank you, Senator Pryor.
    Senator Brown, please proceed.

  STATEMENT OF SCOTT P. BROWN, U.S. SENATOR FROM THE STATE OF 
                         MASSACHUSETTS

    Senator Brown. Thank you, Mr. Chairman, for calling this 
hearing. As you know, you and Ranking Member Shelby are 
embarking on a discussion of critical importance to our 
Nation's economy. It is a discussion with need to have as to 
how we get Americans back to work, and it starts really with 
capital formation.
    It is funny. As I go around the Commonwealth of 
Massachusetts and visit businesses, I had the opportunity to go 
to the Cambridge Innovation Center, which has hundreds of 
businesses, startup businesses, under one roof. And the biggest 
challenge that they had and have are the lack of regulatory 
intact certainty, but more importantly, the lack of the ability 
to actually get capital. And that is one of the biggest 
challenges, whether you are creating the seed money for a 
coffee shop, a florist needs capital to buy a truck, tech 
entrepreneurs with great ideas need capital to file patent 
applications, investments power payrolls across our Nation in 
every sector, as we know. It is the grease that keeps the gears 
in the American economy turning.
    But lately, as was just referenced in the proposal that my 
two colleagues made, capital has been scarce for American 
entrepreneurs. We all know it. And, predictably, our economy 
has ground to a near halt in certain respects. Every economist 
would tell you that many entrepreneurs are looking to the 
banks, but they know that there is really no money to be had 
for a lot of these startup businesses, and that, as you know, 
Mr. Chairman and Ranking Member and members of the Committee, 
needs to change if we are going to get our economy moving 
again. So with that change, we need to change some of the rules 
and regulations that are prohibiting those types of 
opportunities.
    Now, the bill that I am proposing is a bill that was 
similarly passed--and get ready for these numbers--405 Members 
of the House--when is the last time you heard that? Last week 
they did it with the 3-percent withholding, which I sponsored 
in the Hire a Hero Veterans. Well, this is another opportunity 
where they saw a need and worked together in a clearly 
bipartisan manner to create opportunities for small businesses.
    Now, the difference between that bill and my bill, because 
there were some concerns about the threshold in terms of the 
money that was allowed to be invested in some of the consumer 
protection--really the rules and regulations that would 
basically protect people's dollars. I think, quite frankly, my 
bill is better. It lowers the threshold to $1,000. It offers 
more consumer protections. So I am bringing this bill forward. 
It is called ``crowdfunding,'' and that is what happens when 
many investors make small investments, up to $1,000, in a 
project or a company. And someone with a business idea--and we 
all know, gosh, Twitter and Google and Facebook and a lot of 
those opportunities, those smaller--they started with an idea, 
and someone with a business idea gets a chance to convince 
members, his friends, other folks in the social network to join 
in, and the public at large, asking, hey, let us take a risk 
together, let us do it together and make that investment. And 
in return, the investor gets a share of the project or the 
company.
    You know, it is an innovative way, a way to look outside 
the box and kind of get up with the times to open up the 
capital markets to the new businesses and existing small 
businesses. It has the potential to be a powerful new venture 
capital model for, as I said, instances like Facebook and 
Twitter age opportunities, and its potential to, quite frankly, 
create jobs is enormous. But believe it or not, it is currently 
illegal in the United States because of obsolete regulations, 
some dating back to the 1930s.
    Imagine that the next Steve Jobs is being held back by 
rules written during the age of the typewriter. I do not even 
know if people use them anymore. I think I have one tucked 
under the desk back home.
    But, Mr. Chairman, many of these rules were put in place 
for a good reason back then, an absolutely good reason, but the 
nature of the business has changed, as we all know, and we 
should be willing to make thoughtful and careful changes as 
well because, you know, if not now, when. When are we going to 
give the tools and resources to our innovative job creators?
    Massachusetts is an innovative State. We have a different 
type of business model back home, and this would just take the 
gloves off and let the small business movers and shakers really 
go and do some good work. So I have introduced S. 1792, the 
Democratizing Access to Capital Act, which would exempt small 
investments, $1,000 per investment, with a total size of stock 
offerings capped at $1 million from prohibitive and basically 
onerous Federal regulations, which is really one of the biggest 
prohibitors for businesses to actually move forward and take 
these steps. And because we all know that you need a 
trustworthy market system before people will invest, my bill 
provides strong investor protections, as I referenced earlier. 
And I know that other efforts have been made to set up 
different caps, some lower, some higher. And I believe my bill 
is a good place to start in giving a fair shake to all market 
participants.
    I would suggest that you move my bill along with the other 
bills forward. Let us put them together. I am happy to work 
with your offices and your staffs to come up with a plan that 
we can pass in a bipartisan, bicameral manner that the 
President will sign, because that is the only way we are going 
to get things done here.
    But I am not the only one, as I said, who is moving 
forward. Even the Administration, entrepreneur groups, the 
Chamber of Commerce, hundreds of Democrats and Republicans in 
the House, as I referenced, and many of our colleagues in this 
distinguished body have made suggestions to legalize 
crowdfunding.
    So the opportunity for a new avenue of capital investment 
in small business is exciting. It is really kind of new and 
creative. It is a different way to look at investing, and we 
should take advantage of this multi- billion-dollar market 
opportunity to create jobs and get the economic engine going, 
get our economy moving again and let the small job creators be 
the ones that kind of help us out of the mess that we're in, 
and to achieve this promise for entrepreneurs, there must be 
sufficient confidence in the investors that they are going to 
get a fair shake, that they are not going to be held back by 
the burdensome regulation, the onerous reporting requirements. 
And that is why I have gone further than the House legislation 
in incorporating investor protections that are necessary to 
build the market while eliminating outdated and, quite frankly, 
costly regulations. And it limits the risk, as I said, $1,000 
per person, and if you actually take it up, for some people 
that is a year's cost of entertainment for some. Do you think 
maybe if they had a choice between spending that money on 
entertainment and actually taking a chance on the next great 
business opportunity with a potential for a good return that 
they would not want to take advantage of that opportunity? I 
know I would, and many of our other friends back home would 
like to do that.
    It also includes investor rights and protections and 
enhanced oversight. It also includes a role for States in 
providing oversight. I have spoken to the Secretary of State 
back home.
    I do want to acknowledge Senator Hutchison's and Senator 
Toomey's respective bills. They are thinking outside the box, 
again, in bringing new opportunities to our body here so we can 
try to get us back on track. And they are also seeking to 
eliminate the onerous SEC reporting regs for small business, 
including community banks, as was just referenced. I support 
their efforts as well, because it allows small businesses and 
community banks to focus their attention where it should be: in 
customer lending, in job creating, and giving the tools and 
resources to the men and women of my State and this great 
country the opportunity to do it better and be better and 
provide for their families and create jobs.
    So I hope we can hear today about all the ways that capital 
formation can be fostered. Enough of the excuses. Enough of the 
control that everyone is trying to get over these things. We 
need to do it better. We have an opportunity to do just that, 
and I commend you and the Ranking Member for holding this 
hearing, and my colleagues for participating as well.
    Thank you.
    Chairman Johnson. Thank you, Senators. You may be excused.
    As we wait for our witnesses to take their seats, I would 
like to briefly introduce the witnesses that are here with us 
today.
    Ms. Meredith Cross is the Director of the Division of 
Corporation Finance at the Securities and Exchange Commission.
    Mr. Jack Herstein is the president of the North American 
Securities Administrators Association.
    Professor John C. Coffee is the Adolf A. Berle Professor of 
Law at Columbia University Law School. He has testified many 
times before this Committee during the past decade.
    Mr. Chris Gheysens is executive vice president and chief 
financial officer of Wawa, Incorporated.
    Mr. Scott Cutler is executive vice president and cohead of 
U.S. Listings and Cash Execution at NYSE Euronext.
    And, finally, I would like to welcome Mr. Edward S. Knight, 
the executive vice president and general counsel at Nasdaq OMX 
Group.
    Ms. Cross, please proceed.

STATEMENT OF MEREDITH CROSS, DIRECTOR, DIVISION OF CORPORATION 
          FINANCE, SECURITIES AND EXCHANGE COMMISSION

    Ms. Cross. Chairman Johnson, Ranking Member Shelby, and 
Members of the Committee, my name is Meredith Cross and I am 
the Director of the Division of Corporation Finance at the 
Securities and Exchange Commission. I am pleased to testify 
today on behalf of the Commission on the topic of capital 
formation.
    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. 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.
    Chairman Schapiro has instructed the staff to take a fresh 
look at some of our offering rules to 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 ongoing and 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, 
restrictions on communications in public offerings, and 
regulatory questions posed by new capital raising strategies.
    Additionally, 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 companies, will provide the Commission 
advice and recommendations about regulations that affect 
privately held and publicly traded small and emerging 
businesses. The Advisory Committee held its first meeting at 
the end of October and we look forward to receiving their 
recommendations.
    My written testimony provides a more extensive update on 
our capital formation regulatory review, but I will briefly 
discuss a few of our efforts in this area.
    The staff is currently reviewing the 12(g) triggers for 
public reporting by nonlisted companies and the characteristics 
of companies that should be subject to public reporting 
obligations. Under the existing rules, the Section 12(g) 
trigger is generally 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, commissioned 
by Congress and conducted by the Commission. Some have called 
for changes to the Section 12(g) thresholds 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 the current thresholds should be 
updated in light of changes in companies, shareholders, and 
markets.
    Chairman Schapiro also 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 an unnecessary impediment to capital raising 
since only qualified purchasers are allowed to invest. Others 
support the restriction 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 preparing a 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 are also 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, 
including most recently in 2005, when the Commission 
significantly liberalized the rules for the largest public 
companies. 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 me to appear before you today. I 
would be happy to answer any questions you may have.
    Chairman Johnson. Thank you, Ms. Cross.
    Mr. Herstein, please proceed.

   STATEMENT OF JACK E. HERSTEIN, PRESIDENT, NORTH AMERICAN 
          SECURITIES ADMINISTRATORS ASSOCIATION, INC.

    Mr. Herstein. Good morning, Chairman Johnson, Ranking 
Member Shelby, and Members of the Committee. I am Jack 
Herstein, Assistant Director of the Nebraska Department of 
Banking and Finance, Bureau of Securities, and President of the 
North American Securities Administrators Association. NASAA 
represents State securities regulators.
    Our members have protected Main Street investors and 
facilitated access to capital by small businesses for the past 
100 years. My colleagues and I are acutely aware of the present 
economic environment and its effects on job growth. Because we 
realize that small businesses are vital to job growth and 
improving the Nation's economy, State securities regulators 
have no interest in throwing up needless roadblocks for small 
businesses. Instead, we are interested in creating ways to spur 
economic development and job creation.
    Small business investment has the potential to be a very 
positive economic force and a major driver of wealth and jobs 
when done in the right way. But when done incorrectly and 
without appropriate oversight, these investments have the 
potential to become costly failures. The challenge for Congress 
today is to balance the legitimate interest of investors with 
the legitimate goals of entrepreneurs.
    Three principles have guided NASAA's thinking on the 
proposals pending before this Committee regarding the 
regulation of small business investment. First, Congress should 
not preempt State securities laws. Preempting State authority 
is a very serious step and should never be done without a 
thorough examination of all available alternatives. While 
decreasing Federal regulation over small business capital 
formation may be appropriate, several proposals under 
consideration by Congress would needlessly preempt State law. 
Instead, Congress should give States greater flexibility to 
create innovative regulations that allow small businesses to 
use modern methods of attracting investors and provide 
appropriate disclosures.
    Second, while the desire to facilitate access to capital 
for new and small businesses is warranted, Congress must be 
aware to do so in a careful and deliberate manner. If investors 
lack faith that small business offerings are being regulated to 
their satisfaction, they will be unlikely to invest their 
capital in these companies. This would undermine the very 
markets these bills seek to promote.
    Third, Main Street investors should not be treated as the 
easiest source of funds for the most speculative business 
ventures. If a company cannot get financing from a bank, an SBA 
loan, a venture capital fund, or even friends and family, it is 
probably because the funding sources have determined that the 
investment is extremely risky. The law should not provide less 
protections to small, unsophisticated investors who can least 
afford to lose their money.
    My written testimony offers detailed observations and 
suggestions regarding the capital formation bills pending 
before the Committee. I also direct the Committee's attention 
to a letter sent by my colleague, Massachusetts Secretary of 
the Commonwealth William Galvin, outlining our joint concerns 
about the serious consequences of S. 1831, which removes the 
ban on general solicitation and offerings under SEC Rule 506.
    I would like to focus the remainder of my time on the 
proposal that has received the lion's share of public 
attention, the establishment of a registration exemption for 
crowdfunded securities as proposed by H.R. 2930 and S. 1791.
    Crowdfunding began as the way for the public to donate 
small amounts of money, often through social networking Web 
sites, to help creative people finance their project or causes. 
Think of it as passing the hat through the Internet. But 
investing is a totally different matter.
    Just last month, the House of Representatives approved H.R. 
2930 in a remarkable 7 weeks after its introduction on 
September 14. This bill would create a massive hole in the 
investor protection safety net. NASAA believes S. 1791, with 
its lowered dollar thresholds, is closer to what was originally 
meant by crowdfunding.
    Balancing the needs of small businesses and investors 
requires a degree of regulatory flexibility and creativity. 
Crowdfunding presents us with one of those challenges, but the 
States are committed to accommodating the needs of small 
businesses by adopting an innovative exemption to permit 
crowdfunding. Instead of preempting States, as both bills would 
do, Congress should allow the States to take a leading role in 
implementing an appropriate regulatory framework for 
crowdfunding. The best approach would be for Congress to direct 
the SEC to work with the States to fashion the Federal 
exemption in tandem with the State model rule.
    If regulatory authority is preserved for the States, NASAA 
will continue to pursue the development of its model exemption 
for crowdfunding, which I discuss in detail in my written 
testimony. The model's most notable feature is that it would 
allow a one-stop filing in the State of the issuer's principal 
place of business. This streamlined approach can be achieved 
without preempting State securities regulators and is 
consistent with the goals of both Congress and the Obama 
administration to help small businesses access the capital they 
need in order to promote economic recovery and job growth.
    Given the small size of the offering, the small size of the 
issuer, and the relatively small investment amounts, States 
have the most direct interest in these offerings. States also 
are in the best position to communicate with issuers and 
investors to ensure that this exemption is an effective means 
of small business capital formation. States are most familiar 
with local economic factors that affect small businesses and 
States have the strongest interest in protecting investors in 
these types of offerings.
    In closing, NASAA firmly believes that the States should be 
the primary regulator of small businesses and capital 
formation, including crowdfunding offerings. I would 
particularly appeal to those of you with roots in State 
government who may be skeptical of Federal efforts to preempt 
State law. Your background gives you a unique perspective on 
the dynamic and dependable role States play in serving your 
constituents, both investors and small businesses alike.
    Thank you.
    Chairman Johnson. Thank you, Mr. Herstein.
    Professor Coffee, please proceed.

 STATEMENT OF JOHN C. COFFEE, JR., ADOLF A. BERLE PROFESSOR OF 
              LAW, COLUMBIA UNIVERSITY LAW SCHOOL

    Mr. Coffee. Chairman Johnson, Ranking Member Shelby, other 
Members of the Committee, thank you for inviting me.
    I share the goals of the sponsors of this legislation. I am 
not saying no. I am saying instead that the means chosen in 
several of these cases are unnecessarily overbroad and we can 
target the new exemptions a little bit more surgically so they 
apply to smaller issues and not lots of other companies who are 
very large but would like to ``go dark'' or would like to do 
other things that should give us considerable concern.
    Now, two of the bills before the Committee, S. 1544 dealing 
with what is called the Reg A exemption, and S. 1831, dealing 
with general solicitations of accredited investors, in my 
judgment, make quite serious and reasonable attempts to improve 
the access of small issuers to capital markets without 
sacrificing investor protections. I have a number of comments 
on these, but basically, I support the idea. I just have tweaks 
on the language that are in my testimony.
    The next bill, S. 1791, or the crowdfunding bill, is, I am 
sure, well intentioned, and we are all Internet friendly and we 
all like the idea of tweeting for investors. Nonetheless, in 
its current form, this bill could well be called the ``Boiler 
Room Legalization Act of 2011,'' because it would, I think, 
occasion a reemergence of boilershops across the country. 
Nonetheless--again, I am not saying no. I am saying, with some 
relatively modest adjustments, I believe that the potential for 
fraud and abuse could be substantially curbed without 
preventing the use of the Internet, and I will get back to that 
in a minute.
    Finally, S. 1824, which would raise the threshold at which 
a company must become a reporting company and make continuous 
public disclosure, this bill gives me the greatest concern 
because it could, in its broadest form, represent a major 
retreat from the principles of full disclosure and transparency 
which have long characterized our capital markets. But again, I 
am saying not that 500 is a limit that is sacred, but we have 
got to update. We are using a concept called ``shareholders of 
record'' here which has become obsolete and archaic. I think 
there are better tests that could be used, whatever way you 
want to calibrate the point at which you have to enter the 
continuous disclosure system. And there are some simple steps 
that some are proposing that I think could be adopted tomorrow.
    For example, one of the problems out there is that we count 
shareholder employees toward the 500 shareholder limit, and if 
these shareholders are receiving stock underneath employee 
benefit plans, which are exempt from registration, I think it 
follows quite consistently that those same employee 
shareholders should not be counted toward whatever limit we 
have, whether it is 500, 700, or some other test that I will 
propose.
    My problem is, again, that shareholders of record are 
subject to manipulation. You can reduce them. It is actually 
possible today to take a company that might have 3,000-4,000 
shareholders and reduce those beneficial shareholders holding 
stock in street name to maybe only 1,000 or less shareholders 
of record. And once you create an incentive for gaming like 
that, we will see people pick up on those incentives.
    Now, let me just talk briefly about some of the bills 
before you. S. 1544, the Reg A exemption, I think it is a very 
significant idea that could have some impact, but again, on the 
topic of preemption of State law, I would suggest it is a 
problem if you have to comply with 50 different States. But if 
NASAA could come up with a uniform exemption, I do not think 
there is a serious grounds for preempting one uniform exemption 
because these kind of offerings are below the SEC's natural 
radar screen. You have to rely on the States to enforce fraud 
at the smaller level.
    S. 1831, the general solicitation, I think that is the 
least controversial proposal before you, but the language does 
not quite work and I make some suggestions.
    Now, with respect to crowdfunding, let me just explain what 
the problem is. There are two exemptions here. There is the 
issuer exemption from registration and there is a special 
broker-dealer exemption for the crowdfunding intermediary. It 
is the second one that concerns me. Let me sketch what I think 
will happen under this bill.
    A character vaguely resembling Danny DeVito, who may have 
been barred for life from the securities industry, now enters 
the field as an unlicensed salesman. He sets up shop in a 
barroom, flips open his laptop on the bar or the Starbucks 
counter, and begins showing glossy PowerPoint slides to 
customers of allegedly high-growth companies. Maybe these 
companies are real or maybe they are fictitious. While I 
recognize he can only sell 1,000 to a customer, he can sell 
each customer 10 different companies and get to 10,000 that 
way. So he can really deplete people's assets by selling 
multiple companies.
    Now, maybe he is paid by the crowdfunding intermediary, or 
maybe he is simply pocketing the proceedings on his own because 
these are fictitious companies. But there is the problem here 
that this unlicensed salesman with no self-regulatory body 
supervising him can do almost anything.
    How to curb this problem? My basic proposal is this. Keep 
the broker-dealer exemption for the crowdfunding intermediary 
narrow so that the intermediary must remain passive and cannot 
solicit sales. The issuer can solicit, but the issuer should 
have to use registered broker-dealers who are subject to the 
oversight of FINRA and the industry. That is my basic proposal, 
and let us use the Internet. But when you get to how you make 
the actual solicitations, whether it is oral or by email, 
there, I think it should be actual broker-dealers who are 
licensed and subject to control and not these unlicensed 
salesmen who will sneak under this.
    Finally, in the last 10 seconds, when we look at what we 
should do about defining when you become a reporting company, I 
think we should junk the idea of shareholders of record, which 
can be gamed, and turn instead to the concept of public float. 
Public float looks at the market value of the securities held 
by public shareholders, not employees, not affiliates, but that 
is the test that tells us the need for disclosure. And I think 
if you used a test like $500 million of public float, that 
would give you a much better test that could not be 
manipulated. Where you draw that line is up to the Congress, of 
course, but I think you should use a line that is more adjusted 
to market realities.
    Thank you.
    Chairman Johnson. Thank you, Professor Coffee.
    Would Senator Toomey care to share some comments about Mr. 
Gheysens.
    Senator Toomey. Thank you very much, Chairman Johnson, and 
thanks for giving me the opportunity to introduce Mr. 
Christopher Gheysens, the Executive Vice President, Chief 
Financial and Administrative Officer for Wawa, Inc., which 
operates convenience stores and gas stations in the Mid-
Atlantic region and can trace its history back over 200 years. 
Wawa is headquartered in Wawa, Pennsylvania, in the greater 
Philadelphia area, and employs 16,000 people throughout 
Pennsylvania, New Jersey, Delaware, Maryland, and Virginia.
    Mr. Gheysens has worked at Wawa for over 14 years and 
became CFO in January of 2006. As CFO, Mr. Gheysens is 
responsible for leading all aspects of Wawa's financial, legal, 
and human resource functions. In addition, Wawa has recently 
announced that he will become President of Wawa, Inc., on 
January 1, 2012, and President and CEO on January 1, 2013.
    Mr. Gheysens graduated from Villanova University in 1993 
with a Bachelor of Science in accountancy. He earned his 
Master's of Business Administration from Saint Joseph's 
University and is a CPA in New Jersey.
    I am delighted that Mr. Gheysens could be with us today and 
I welcome his testimony before our Committee.
    Chairman Johnson. Mr. Gheysens, please proceed.

STATEMENT OF CHRISTOPHER T. GHEYSENS, EXECUTIVE VICE PRESIDENT 
   AND CHIEF FINANCIAL AND ADMINISTRATIVE OFFICER, WAWA, INC.

    Mr. Gheysens. Thank you, Senator Toomey, for that 
introduction. Good morning, Chairman Johnson, Ranking Member 
Shelby, and other distinguished Members of this Committee. 
Thank you for allowing me here today to testify on what I 
believe are really two of the most pressing issues, along with 
others here, job creation and capital formation. My name is 
Chris Gheysens. I am currently the Executive Vice President and 
Chief Financial Officer of Wawa, Incorporated. I am happy to be 
here today to testify on behalf of the company.
    Wawa is encouraged by the strong bipartisan support that 
all the legislation relative to job creation and capital 
formation has. Specifically, however, I am here to talk about 
S. 1824, the Private Company Flexibility and Growth Act. That 
has the most significance to Wawa and many private companies. I 
would like to thank Senator Toomey and Senator Carper, as well 
as Senators Warner, Kirk, Johanns, and Senator Scott Brown for 
cosponsoring and introducing such important legislation.
    Let me share my thoughts and insights as to why this is 
significant for Wawa and other private companies. First, our 
company was founded over 100 years ago in the Philadelphia 
region in the Delaware Valley. We were incorporated in the 
State of New Jersey in 1865 and we are headquartered in Wawa, 
Pennsylvania. Today, our modern day business of convenience 
store and retailing began in 1964 with our first store opening 
in the State of Pennsylvania. That was the same year the 500 
shareholder limit went into place. Since then, Wawa and many 
other private businesses have expanded, have grown, and have 
dramatically changed.
    Today, we have over 16,000 associates and almost 600 stores 
across five States, the States of Pennsylvania, New Jersey, 
Virginia, Delaware, and Maryland. However, in that same 47-year 
period, the 500 shareholder rule has not kept pace with the 
growth in our business and many other private businesses as 
well as the economy and the securities markets. Without change, 
Wawa and others will be limited in their growth and being able 
to create jobs going forward.
    Our success at Wawa over the long term is really founded in 
two principles which are an important part of my testimony, 
being privately held and sharing ownership with our associates. 
First, on being privately held, it affords us a long-term point 
of view. For example, we plan and think in terms of decades, 
not quarters. Additionally, being private allows us and many 
other private companies to invest more significantly in our 
associates. Another example, in the recent economic downturn, 
Wawa created more jobs, hired more associates. In addition, we 
increased--significantly increased--our retirement plan 
contributions to a level that is the highest of several hundred 
companies that we benchmarked against.
    The second guiding principle of sharing ownership with our 
associates has given our associates a significant stake in our 
company. Today, Wawa associates own approximately one-third of 
Wawa's company through an ESOP and through a broad stock-based 
compensation plan for managers. This equity compensation has 
been an important part of what has enabled us to attract and 
retain associates and will continue to be an important part in 
the future as our business grows.
    The combination of being privately held, the combination of 
our privately held and associate ownership, gives us a unique 
competitive advantage. We have a workforce that is a highly 
engaged set of associate owners. Our corporate culture is based 
on this, our corporate DNA, and these things are not negotiable 
for us.
    In the near future, without a change and an increase in the 
500 shareholder rule, Wawa would be forced to redirect capital, 
in our case, tens of millions of dollars, away from building 
new stores and creating new jobs just so we can reduce and 
restrict the number of shareholders we have to remain private 
under these outdated rules. Many of those shareholders that 
would be eliminated would be shareholders that are associates 
today and working for Wawa. That goes against one of the core 
principles that has made us successful.
    So in conclusion, we believe it is necessary to take action 
now on the Private Company Flexibility and Growth Act so that 
Wawa and other private companies can continue to focus on job 
creation and spurring economic growth.
    Thank you for the time to testify today and I look forward 
to any questions you may have.
    Chairman Johnson. Thank you, Mr. Gheysens.
    Mr. Cutler, please proceed.

STATEMENT OF SCOTT CUTLER, EXECUTIVE VICE PRESIDENT AND CO-HEAD 
       OF U.S. LISTINGS AND CASH EXECUTION, NYSE EURONEXT

    Mr. Cutler. Chairman Johnson, Ranking Member Shelby, 
Members of the Committee, my name is Scott Cutler, Executive 
Vice President of NYSE Euronext, the world's leading exchange 
group and the number one capital raising venue in the world. I 
appreciate your invitation to testify today.
    The bills pending before this Committee are focused on 
opening up the private markets to broader pools of investors. 
As important as it is to encourage capital formation in those 
private markets, it is even more critical to look at the 
capital our public markets provide young, growing companies and 
examine the ways to make it easier and more cost effective to 
access our public markets. Young, innovative companies are the 
engines of job creation and access to capital through initial 
public offerings is key to allowing these innovative companies 
to grow and hire new employees.
    When looking at ways to stimulate job creation through 
capital formation, we need to look at both private and public 
markets. However, it is also important to understand the 
differences between the well regulated and transparent public 
markets and the private markets that provide investors with 
much less protection, reduced or no issuer disclosure, and low 
levels of liquidity. The private markets have an appropriate 
role in addressing capital and liquidity needs for certain 
issuers and shareholders and we support methods of private 
capital formation that facilitate growth. However, issues of 
transparency, disclosure, and liquidity in these markets must 
be addressed as these markets expand to an ever-increasing 
larger set of investors.
    Investments in private companies are highly risky and 
historically have been limited to investors that can 
understand, evaluate, and financially bear the risks. Any 
proposal to greatly expand the role of private markets must 
require a high level of investor sophistication and a 
relationship with the issuer or its placement agent such that 
the investor is known and can understand the risks or a 
sufficient and uniform amount of disclosure such that less 
sophisticated investors understand what they are investing in.
    As for the specific legislative proposals, first related to 
crowdfunding, allowing entrepreneurs to raise capital through 
crowdfunding is an important step to encourage new business and 
growth. However, investor protections are needed. Any 
crowdfunding exemption should, therefore, include low limits on 
total offering size and on the amount that any individual can 
invest and require the issuers disclose sufficient information 
to assure that investors understand what they are purchasing.
    As it relates to Regulation D, the restriction on general 
solicitation has been a core feature of the private placement 
exemption and is an important safeguard to avoid fraud against 
investors. It is the key limitation which protects the general 
public from being drawn into highly risky and unsuitable 
private investments.
    On Regulation A, the NYSE applauds the House for passing 
the Small Company Capital Formation Act of 2011 and commends 
Senators Tester and Toomey for their leadership on this. This 
bill would help small companies access significantly more 
capital through Regulation A offerings without the expense of 
full regulation under the Securities Act. At the same time, 
investors are protected as Regulation A securities are offered 
with significant disclosure regarding each issuer.
    We also support the Private Company Flexibility and Growth 
Act as passed by the House, which would increase from 500 to 
1,000 the level of beneficial shareholders which would force 
public information disclosure. Importantly, this would also 
exclude employees from that count.
    Finally, NYSE supports the recommendations laid out by a 
Private Sector IPO Task Force recently released. Young 
companies are the true job creators and IPOs have had a 
significant impact on job creation. Ninety-two percent of job 
growth occurs after a company's IPO and most of that within the 
first 5 years of an IPO. However, unfortunately, over the past 
decade, the number of companies going public has significantly 
decreased due to burdensome regulatory hurdles. The Private 
Sector Task Force recommendations would significantly reduce 
the obstacles that prevent IPOs, yet maintain important 
investor protection. They suggest creating a 5-year on ramp for 
emerging growth companies, which would include any company 
pursuing an IPO. Importantly, this would not affect any company 
that is already public. For this small number of emerging 
growth companies, certain disclosure and other public company 
regulatory requirements would be phased in, thus lowering the 
costs associated with the IPO and initial burdens of complying 
with certain public company requirements. This would give 
emerging growth companies the chance to go public, expand and 
hire before incurring this expense.
    In closing, I applaud your focus on capital formation and 
encourage you to consider reforms for both public as well as 
the private markets as both are critical to this process, and I 
appreciate the opportunity to testify before the Committee this 
day and am happy to answer any questions you may have.
    Chairman Johnson. Thank you, Mr. Cutler.
    Mr. Knight, please proceed.

 STATEMENT OF EDWARD S. KNIGHT, GENERAL COUNSEL AND EXECUTIVE 
                VICE PRESIDENT, NASDAQ OMX GROUP

    Mr. Knight. Thank you, Mr. Chairman, and thank you for the 
opportunity to testify today before this distinguished 
Committee. Ranking Member Shelby, it is a pleasure to be back 
here.
    I have to tell you, this subject is a subject that is a 
very passionate topic at Nasdaq right now, and this hearing 
comes at a very critical moment in our economic history. We 
have a jobs crisis in this country, and we need to do something 
about it. We do not have a lot of money to spend to deal with 
this crisis, and we think one way to get dramatic action in 
this area is through showing some attention to the public 
equity markets.
    The legislation you have before you today is very 
important. It deals with the private markets. The private 
markets work hand in glove with the public equity markets. We 
want them to be strong. We want them to have the most modern 
regulation and up-to-date regulation. And we think there is a 
lot of merit to the legislation you are considering.
    But as we make it easier for companies to choose the 
private company route and avoid public capital markets, either 
by staying private or by going overseas to list, we should also 
deal with structural issues that make the U.S. public markets 
less attractive than they could be.
    We know it is not your intention, but we think if the 
Committee acted only on these bills, it could be interpreted as 
a sign of retreat from the public markets. We strongly urge the 
Committee to expand the scope of this action and look at 
reforms of the public markets.
    Now, some might ask, If you can access the capital you need 
from the private markets, what is the concern? I will give you 
three reasons.
    One, jobs. A healthy public equity market enables companies 
to raise capital more efficiently, funding more rapid growth 
and more jobs. Companies create 90 percent of their new jobs 
after they go public. Companies create 90 percent of their new 
jobs after they go public.
    Second, efficient pricing. A public company trading on a 
public market provides the most efficient pricing and funding 
of entrepreneurial activity. It is well recognized that 
companies that do not trade on transparent exchanges or 
exchange-like venues are valued at a discount.
    Third, public access. A public listing allows access to 
ownership by the most diverse universe of investors. At Nasdaq, 
we believe that equity ownership and participation as 
shareholders in entrepreneurial-led growth should be widely 
available to the public. We may be biased, but we believe an 
initial public offering is the best policy outcome in terms of 
jobs.
    But I want to be careful here. I do not want to look like I 
am talking our own book, so let us look at the facts.
    From 1995 to 2010, listings on U.S. exchanges shrank from 
8,000 to 5,000 companies, while listings on non-U.S. exchanges 
around the world grew from 23,000 to 40,000.
    The U.S. averaged 398 IPOs per year in the 1990s while in 
the last 10 years it has only been 117. Today IPOs are much 
larger in size because of, as we are told over and over again, 
the increased regulatory costs associated with the public 
company model. I am not suggesting that the health of the U.S. 
economy is directly tied to the number of IPOs on Nasdaq or the 
number of listings on U.S. exchanges. But I do know--and my 
testimony spells it out in more detail--when IPO capital 
formation is restricted, entrepreneurs are incented more often 
to create products that complement the existing products of 
large companies rather than creating transformational products.
    Moreover, entrepreneurs may be tempted to sell their ideas 
too cheaply in the private markets. In the broadest terms, we 
believe resources are inefficiently allocated when public 
capital formation is unnecessarily constrained.
    How do we improve these markets? Two areas: the regulation 
of the markets themselves and the regulation of the companies.
    We embrace some recent studies. I point to the President's 
Council on Jobs and Competitiveness and the IPO Task Force 
which Scott mentioned earlier. There are four ideas that come 
out of that. Our goal should be to restore the ecosystem that 
used to exist to support these companies. When I talked to my 
colleagues on what is the difference today than in the 1990s, 
they say that ecosystem no longer exists. How do we get that 
ecosystem started again?
    One issue that comes up over and over again, and to a 
person, when I ask people why do people say they do not want to 
list publicly, why do they list outside of the United States, 
the issue that comes up over and over and over again is 404. 
404 needs to be reformed in Sarbanes-Oxley. PCAOB retains broad 
powers in this area. They can act to police the accounting 
industry without imposing this burden on public companies. The 
President's Council recommended a $1 billion--and opt-out for 
companies from 404 that are valued $1 billion or below. We 
endorse that.
    Second, we believe we need to adopt the ramp-on idea that, 
again, Scott mentioned that is in the IPO Task Force 
recommendations that were delivered to Treasury that I believe 
is embraced in Senator Toomey and Senator Schumer's bill in 
dealing with regulation in this area and scale up regulation 
for smaller companies. This scaling of disclosure and 
administratively burdensome regulations we think will help 
jump-start this area.
    Third, a venture capital market. We think we need special 
rules for a venture capital market in the United States. 
Vancouver has 2,100 companies on their venture market. We run a 
venture market in Sweden that is very successful. But we need 
the SEC's help to create some trading rules in that area.
    And, fourth, the SEC has had before it for over a year--2 
years, in fact--a market structure reform set of 
recommendations embodied in a concept release. We think we are 
overdue to act upon that and revise the market structure in the 
public markets to reduce fragmentation and darkness.
    Let me close by saying Nasdaq is not opposed to regulation. 
We are one of the most heavily regulated businesses in the 
world. This year we will make 400 rule filings with the SEC 
just to keep our business going. We believe in this regulation. 
It has served the public well. But if you study the public 
company model and the empirical evidence from the last 10 
years, you will clearly find that in some areas we have gone 
too far and in other areas we have been neglectful. This is not 
a partisan issue. There is no need to assign blame. We all want 
more and better jobs in the United States. The public equity 
markets have been the best source of jobs in this economy and 
in this country, and attention should be paid to those markets.
    Thank you.
    Chairman Johnson. Thank you, Mr. Knight.
    I would like to thank all of our witnesses for their 
testimony. As we begin questions, I will ask the clerk to put 5 
minutes on the clock for each member.
    Ms. Cross, Mr. Gheysens, Professor Coffee, and Mr. Knight, 
the securities laws require a company to register when it has 
500 shareholders of record. Professor Coffee has testified that 
record ownership is easily manipulated and companies could come 
to have 5,000 or more beneficial shareholders and begin stock 
market capitalization without becoming subject to the increased 
transparency required by registration.
    Ms. Cross, Mr. Gheysens, Professor Coffee, and Mr. Knight, 
what are the advantages and disadvantages of the current way of 
counting shareholders of record? Ms. Cross.
    Ms. Cross. Thank you. I would say that companies would say 
that the certainty of using shareholders of record makes it 
easier to count. Beneficial holders requires that you look 
through broker-dealers to find the number, and if you are a 
public company with your securities trading, that can take some 
time and would lead to some uncertainty. You can control your 
number of holders when it is the record holders because you can 
have restrictions on transfer. But you cannot control it if 
they are trading through, for example, DTC.
    These questions, though, are important in deciding whether 
or not the 12(g) test is correct. The statute refers to holders 
of record. The Commission has currently tasked the staff with 
studying whether we should change that by rule to look through 
to beneficial holders. If we do that, I would say that the 
number would almost certainly need adjusting because if you do 
look through to beneficial holders, the number gets much 
larger.
    Chairman Johnson. Mr. Gheysens.
    Mr. Gheysens. I agree that the current advantages of--it is 
a long-time rule, and the current advantages, especially at 
Wawa, are it is simple and easy to understand to count 
shareholders of record. At Wawa we do have beneficial ownership 
in a family trust and also in an ESOP, an Employee Stock 
Ownership Program. The family trust has been in existence since 
1922, before these rules we are discussing today even were 
formed originally. And our ESOP certainly is a valid cause in 
trying to provide for associate ownership and long-term 
retirement planning, which we give to our associates.
    So disadvantages of looking through in my understanding is 
there are rules today that the SEC could enforce if beneficial 
ownership is causing reason to avoid or evade public reporting, 
which is something Wawa and many companies that we work with 
would not do.
    Chairman Johnson. Professor Coffee.
    Mr. Coffee. We are talking about updating obsolete law, and 
I am in favor of updating obsolete law. The concept of record 
ownership, which was quite normal back in 1964, has become 
obsolete because most shareholders hold stock beneficially. I 
would suggest either that you could have the SEC redefine 
record ownership. If they find that Merrill Lynch is holding 
shares as one record own for 50 or 500 or 5,000 different 
shareholders, there should be some adjustment made. We should 
not ignore that. We do not have to be blind.
    I do recognize that you cannot easily count beneficial 
shareholders, which is why I was suggesting something that is 
used in other contexts, which is the public float. You look at 
the value of shares, which is easily computed--you look at the 
market price--and you say the shares held by the nonaffiliates 
and the nonemployees. This would also solve the problem of Wawa 
because we would not count employee shareholders against this 
limit. We would say that if there is a certain level of public 
ownership and it is above a value, let us say $500 million, 
then that company really should make disclosure to the market 
and investors. We do that under what is called Form S-3, where 
we use a $75 million public float test, so it is used in some 
contexts. Something like this could be used in this context.
    Chairman Johnson. Mr. Knight.
    Mr. Knight. We support the legislation as proposed. We 
feel, as Professor Coffee has indicated, that it is time 
overdue for reform. It is widely supported in the investment 
community and among members of the securities bar. I think, 
though, Professor Coffee raises some important technical issues 
that should be addressed here.
    Chairman Johnson. A recent column in the Detroit Free Press 
said crowdfunding could be a part of the picture to generate 
jobs, but that picture could get very ugly quickly if 
reasonable protections are not part of the mix.
    For all the panelists, what safeguards do you recommend for 
crowdfunding to be successful for businesses and investors 
alike? Ms. Cross.
    Ms. Cross. Thank you. First of all, as our written 
testimony notes, I do not participate in crowdfunding matters 
because of my prior work for a peer-to-peer lender, but our 
written testimony jointly with my Deputy, Lona Nallengara, 
includes a description of factors that should be considered in 
the crowdfunding arena. The list that I would note for your 
benefit would be: a limit on the aggregate amount of funds that 
can be raised, both by a company and invested by an individual; 
requiring basic information to be provided to potential 
investors, for example, about the business, the planned use of 
funds raised, principals, agents, and finders; requiring 
crowdfunding transactions to be placed through an intermediary 
that is subject to some sort of oversight; restrictions on 
participation by individuals or firms that have been convicted 
or sanctioned for prior securities fraud; requiring issuers to 
file a notice with the Commission so the Commission knows what 
is going on in this area; and restricting transfer of 
securities sold in crowdfunding so that you do not end up with 
the pump-and-dump schemes that were so problematic in the late 
1990s.
    Chairman Johnson. Mr. Herstein.
    Mr. Herstein. Thank you, Senator. I would echo Ms. Cross' 
comments except I would add that the preemption that is 
currently in both bills be lifted. That way they would also 
have to do a filing with the States, and the States could then 
basically make sure that the States' investors are given proper 
disclosure, and the States could also be aware of what is 
happening within their borders.
    I agree that crowdfunding could create jobs, would help the 
economy, but, again, you are basically talking about 
unsophisticated investors probably buying most of the 
securities regarding crowdfundings, and there needs to be some 
protections there.
    Chairman Johnson. Professor Coffee.
    Mr. Coffee. I would say that we should move in the 
direction of allowing the issuer to use the Internet. The 
issuer should be able to post its PowerPoint slides on a Web 
site, including a crowdfunding intermediary's Web site. But at 
that point, I am very nervous about the intermediary being able 
to directly solicit investors without being a licensed broker-
dealer. The unlicensed salesman directly marketing securities 
to unsophisticated customers defines what the old boiler room 
was. We want people who directly sell securities to customers 
to be broker-dealers because that gives them the oversight of 
both SEC rules, some professional training and examination, and 
the FINRA disciplinary process. Once we drop that net, we are 
playing tennis with the net down on a very new playing field 
that I think is quite dangerous.
    So go forward with the Internet, but try to keep the 
crowdfunding intermediary passive so it displays this but does 
not directly solicit investors. The issuer could solicit 
investors through registered broker-dealers. That I think is 
the safe way to go, and it does allow you to use the Internet.
    Chairman Johnson. Mr. Gheysens.
    Mr. Gheysens. Thank you, Senator. Crowdfunding is really 
not pertinent or relative to Wawa, but certainly from a 
position of capital formation, while also protecting investors, 
it certainly makes sense given there is a balance in that 
approach.
    Chairman Johnson. Mr. Cutler.
    Mr. Cutler. We would agree that the opportunity for 
additional access to capital is important, and crowdfunding can 
provide that necessary capital. I think we also have to 
understand, however, that these investors are not as 
sophisticated as a typical venture investor. When a company is 
offering securities to sophisticated investors, these investors 
typically demand certain information rights; they demand 
certain investor protections, corporate governance provisions. 
And the types of investors here that we are talking about would 
not be subject to those types of investor protections.
    And so we support, for example, the bill introduced by 
Senator Brown which puts a maximum offering size as well as a 
limit on the individual investor amount and, importantly, adds 
additional investor protection or disclosure matters so that 
investors know what they are investing in and are protected in 
the types of investments they are making.
    Chairman Johnson. And, last, Mr. Knight.
    Mr. Knight. I will be frank with you, Mr. Chairman. The 
experts and practitioners and law professors and others that I 
have consulted on this--and we are just getting up to speed on 
this idea--recommend caution in this area for just the reasons 
that Scott mentioned and that Professor Coffee mentioned 
because of the nature of the investors. I think it would be 
also important to hear from organizations like FINRA about 
their views in this area.
    Chairman Johnson. Senator Shelby.
    Senator Shelby. Thank you, Mr. Chairman.
    Mr. Knight, in your testimony you recommended several 
significant regulatory reforms, including reforming Sarbanes-
Oxley, rejecting ``expansive and expensive new regulations on 
public companies,'' and allowing public companies to trade only 
on the market on which they are listed. If enacted, how would 
these reforms impact the number of listings on U.S. exchanges? 
And how could such reforms improve the attractiveness of U.S. 
capital markets as compared to our foreign competitors?
    Mr. Knight. Thank you, Senator. In several ways, but I want 
to emphasize, one, this is not just about Nasdaq. It is not 
just about the New York Stock Exchange and how many listings we 
get or how many fees we collect in this area. But we happen to 
be on the front lines----
    Senator Shelby. But it is about our competitiveness.
    Mr. Knight. It is, and we happen to be on the front lines 
selling to investors, to entrepreneurs, to companies overseas 
the merits of the U.S. markets. We do it every day. We are 
proud to do it. We have a license from the U.S. Government to 
do it. We are heavily regulated because of that, and we 
understand why that happens. But we hear over and over again 
and we see from the empirical evidence that people do not view 
our markets very attractively, that they choose--even U.S. 
companies are choosing to list overseas. And we look behind 
that at where the resistance is, and often it is what I would 
call a lack of scaling in regulation, that we pass laws with 
good intentions, we had a company in mind that is typically 
much larger, and the smaller companies are just not in the 
position to spend that sort of money.
    Now, I hear the accounting industry, for instance, say it 
does not cost a few million dollars to comply with 404, it may 
be only a few hundred thousand dollars. And I am not just 
trying to get on Scott's--in his face, but Viacom switched from 
the New York Stock Exchange to Nasdaq a few weeks ago and 
issued a press release that said it was because of the savings 
associated with the listing with Nasdaq. That is $400,000 for a 
$14 billion company. Now, if $400,000 makes that much 
difference for a $14 billion company, how about a $5 million or 
a $10 million company or an Israeli technology company that can 
go to London, it can go to many other markets to access the 
global capital markets? They will not come here with that.
    And when you look at what 404 has accomplished, I think it 
is hard to point to a lot of achievements in that area. It 
makes sense for a lot of big companies. There is a lot of good 
that comes from it from big companies. But even with that, we 
have had problems with MF Global. It did not seem to affect 
much the financial firms that ran into crisis in 2008. So I 
just think it is time to look at it soberly, just like we 
looked at our antitrust laws and many other economic statutes 
and amended them over time.
    Senator Shelby. Mr. Knight, you also point out in your 
testimony that the Public Company Accounting Oversight Board is 
a source of additional regulatory burdens on public companies. 
I recently introduced a bill that would require the financial 
regulators, including regulatory bodies such as the PCAOB, to 
conduct economic analysis, cost/benefit analysis. Would such a 
requirement help to improve the regulatory requirements without 
compromising investor protection that we all care about?
    Mr. Knight. I think now is the time to look at things like 
that. I think it is consistent with the scaling proposals 
which, in essence, are saying that the benefits of the 
regulation to small companies are outweighed by the costs 
associated, that the benefits are limited. And I think that 
sort of thinking is needed now as we struggle to restore the 
jobs to our economy.
    Senator Shelby. Ms. Cross, the shareholder threshold study, 
specifically what questions do you hope to answer in this study 
at the SEC? And how soon could you provide this Committee with 
the results of the study? And, obviously, what--and when will 
the SEC use the results of this study, if they use them? Where 
are you on that study?
    Ms. Cross. We are deep into the data-gathering stage of the 
study. We are also preparing a request for public comment to 
get input from those where it is difficult to get the 
information. You might imagine that as we try to get 
information from private companies about themselves, private 
companies are private, so it is a little bit difficult to get 
that information.
    We are asking a full range of questions. We think it is 
important to understand what are the characteristics of 
companies that are getting forced to start reporting before 
they may think it is appropriate to do so. We want to know, for 
example, how many are having to become reporting companies 
because their employee numbers go high or, for example, do 
companies have to start reporting in certain industries sooner 
than others, things like that.
    On the timing, we are working on the study now. We expect 
to complete it during 2012 and get the results to the 
Commission so they can act.
    Senator Shelby. Will you get the results to the Committee?
    Ms. Cross. I am happy to report out, yes.
    Senator Shelby. OK. Ms. Cross, the utility of Regulation A, 
you are very familiar with this. As you noted in your 
testimony, last year only three Regulation A filings were 
qualified by the SEC. So far this year not a single Regulation 
A filing has been cleared. Aside from the change to the 
threshold amount, are there any changes that could be made to 
make Regulation A more appealing to companies?
    Ms. Cross. That is a very good question. We are not sure 
why Regulation A is not appealing to companies. Things like the 
fact that the filings are not made on EDGAR may be relevant. 
The companies that do Regulation A offerings tend to be pretty 
unsophisticated. For example, one of the filings recently was 
handwritten. We think that it is an area that has not taken off 
because people are not very familiar with it. I think that 
perhaps modernizing the disclosure scheme would make a 
difference. The size is probably relevant as well.
    Senator Shelby. I have one last question. If I can, I will 
direct it to Mr. Cutler and Mr. Knight. Can either of you for 
the record here provide any data about the regulatory costs 
that a company faces in connection with this initial public 
offering and in the years immediately following the IPO? And 
could either of you provide any data for the record here with 
respect to the cost savings--you mentioned this earlier--that a 
company would experience as a result of regulatory reforms that 
have been recommended here? Mr. Cutler, do you want to go 
first?
    Mr. Cutler. Sure. If you look at the recent recommendations 
from the IPO Task Force, importantly they cite the costs of 
numerous regulations, one of them being Section 404 compliance 
which, for most companies going public, averages somewhere 
between $1.5 to $2 million for the initial year going public, 
which is often cited as the key hurdle for many companies going 
public. That number is only larger, the larger the enterprise. 
Additional costs around compliance with public disclosure 
requirements add to that cost, but that tends to be the most 
significant concentration of the costs of going public.
    Senator Shelby. Mr. Knight.
    Mr. Knight. I would like to come back to you with some 
detailed information on that, but Scott's statistics and, as I 
noted, the IPO Task Force also has statistics in its report 
that it delivered to the Treasury Department on October 20th, 
and I think that would be important for the record, too.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Tester.
    Senator Tester. Yes, thank you, Mr. Chairman. I appreciate 
you holding this important hearing to examine the proposals 
before the Committee and their potential to create jobs and 
spur economic growth and spur innovation. I appreciate the 
panelists all being here and appreciate your testimony.
    The critical component of achieving the goals that I talked 
about is ensuring that small businesses have access to capital, 
that they need to grow and create jobs. In July, I held a 
hearing to examine the challenges and opportunities that are 
facing innovative small businesses, many of which present the 
greatest opportunity for job creation in this country.
    A key take-away from that hearing was the need to ensure 
that capital markets remained within the reach of those 
startups at various stages in their development, particularly 
in the stages before they may be ready to go public.
    A key recommendation offered at that hearing came from a 
chap by the name of Robert Bargatze from LigoCyte 
Pharmaceuticals, headquartered in Bozeman, Montana. It was that 
we ought to take a closer look at updating Regulation A to 
better enable small businesses to raise capital through public 
offerings.
    For LigoCyte, access to capital to fund their clinical 
trials for a new norovirus vaccine will be the determining 
factor in their ability to not only create jobs but to gain FDA 
approval for a critically important vaccine with the potential 
to prevent hospitalization and save significant health care 
costs.
    In working with Senator Toomey, we were able to draft the 
Small Company Capital Formation Act, S. 1544, to update 
Regulation A by increasing the total amount of capital that can 
be raised through these public offerings to $50 million while 
providing new investor protections. Currently, businesses can 
only raise $5 million under Regulation A, a limit that has not 
been updated in nearly 20 years, and one that many view as too 
low to be a valuable tool in raising capital.
    The bill maintains the most attractive elements of 
Regulation A, including the ability for issuers to test the 
waters before registering with the SEC but adds new safeguards. 
These include a requirement that issuers file audited financial 
statements with the SEC. It permits the SEC to establish 
additional disclosure requirements and requires issuers to 
electronically file offering statements with the Commission. 
Additionally, the bill subjects those offering or selling 
securities under this exemption to liability under 12(a)(2) and 
includes disqualification provisions to prevent bad actors from 
making these offerings in a way that is consistent with Dodd-
Frank.
    It is a balanced bill. It has garnered strong bipartisan 
support. Both President Obama and Senator McConnell support the 
bill. It recently passed the House by 420-1.
    The bill is not a silver bullet that will fix all the ills 
that prevent small businesses from accessing capital, but it 
certainly is a common-sense measure that will provide an 
important avenue for high-growth, innovative companies to raise 
critical early stage capital that they need.
    Ms. Cross, first of all, I want to say thank you to you and 
your staff at the SEC for the technical assistance and 
suggestions that you made on ways to improve our legislation. I 
think you have helped make it--I do not think--I know you have 
helped make it a better bill.
    I am hoping that you might be able to clarify a few points 
for us. As I understand it, the Securities Act of 1933 provided 
the SEC with exemptive authority for offerings made under 
Regulation A and that the SEC has that authority to adjust this 
exemption as it sees fit. Can you explain that authority?
    Ms. Cross. Yes, and thank you for your kind remarks.
    Section 3(b) of the 1933 act has an exemption for offerings 
of up to $5 million, and Regulation A was adopted under that 
authority.
    In 1996, long after Regulation A was adopted, Congress 
amended the 1933 Act to add general exemptive authority in 
Section 28. The SEC could use the Section 28 general exemptive 
authority to increase the cap in these offerings above the $5 
million currently allowed under Section 3(b), so that authority 
already exists.
    Senator Tester. OK. And under this authority, I would guess 
that the SEC would have to make some sort of justification to 
make the adjustments for that exemption. Is that correct?
    Ms. Cross. Yes, that is correct. Section 28 requires that 
the Commission, in adopting any rules or regulations to provide 
exemptions under the 1933 Act, find that the exemption is 
necessary or appropriate, in the public interest, and 
consistent with the protection of investors.
    Senator Tester. OK. Some have suggested that increasing the 
exemption through this legislation and requiring the SEC to 
report periodically on the need to adjust the limitation would 
somehow provide the SEC with an unlimited or open-ended 
authority to increase the limitation under Regulation A. Could 
you respond to that?
    Ms. Cross. Certainly. As I noted, the Commission already 
has the authority to increase the cap for these offerings and 
could do that under Section 28, subject to the overall 
determination that such an exemption would be necessary or 
appropriate, in the public interest, and consistent with the 
protection of investors. The legislation would amend Section 
3(b) to require the Commission to review the offering amount 
limitation every 2 years and increase it if it determines it to 
be ``appropriate''--is the word in the section. In deciding 
whether it is appropriate, I would expect that the Commission 
would consider the factors it considers in using Section 28 
exemptive authority; that is, is it in the public interest and 
consistent with the protection of investors?
    Senator Tester. And does the SEC have the authority to 
decrease that limit if they feel it is appropriate?
    Ms. Cross. The current--right. Currently under----
    Senator Tester. Not just increase but also decrease.
    Ms. Cross. Yes.
    Senator Tester. OK, good. Real quick--I am over time--some 
have suggested that this limitation should be capped. Could you 
respond to that?
    Ms. Cross. Again, I think because the Commission can adopt 
exemptions in general that do not have caps, capping this 
particular one I think would add confusion, frankly, to the way 
the 1933 Act works since, if the Commission found another 
exemption to be appropriate, it could adopt a different 
exemption with a different cap, and so capping this particular 
one I think could create some pretty serious confusion.
    Senator Tester. And as a regulator, it would restrict your 
ability to meet the needs of the marketplace, I would assume.
    Ms. Cross. I think it could. I also would note that while 
the Commission has not taken a position on this particular 
bill, there are a lot of investor protections built into it. 
And so when you consider the SEC filing, the 12(a)(2), all of 
that combined, I think that the Commission would presumably be 
able to act in a manner consistent with investor protection.
    Senator Tester. Thank you, Meredith.
    Thank you, Mr. Chairman, for your latitude.
    Chairman Johnson. Senator Toomey.
    Senator Toomey. Thank you very much, Mr. Chairman, and let 
me just add my thanks to you for having this hearing and 
pursuing this. As a former entrepreneur and with experience in 
finance in both large and small institutions, I have long been 
convinced that the formation of capital and access to capital 
is perhaps the single biggest driver of economic growth and 
opportunity. So I think what we are doing here is very, very 
important.
    I have got three bills that address this in various ways, 
and they have been mentioned already. I want to thank Senator 
Tester for the great work that he has done on the Regulation A 
bill, which I am really quite optimistic about, given the very 
broad bipartisan support for that bill. Later today I will be 
unveiling with Senator Schumer a bill that he and I have that 
will facilitate IPOs, which I think is very constructive, and I 
think will also have broad bipartisan support.
    But I would like to start my questions on the third bill, 
which is one that Senator Carper and I have introduced, which 
is the Private Company Flexibility and Growth Act. We have had 
some discussion about this, and I would like to start with Mr. 
Gheysens, if I could, with a couple of questions.
    First, in your testimony I think you briefly alluded to a 
relationship between this bill and Wawa's ability to grow and 
create jobs, and I was wondering if you could just make that 
really clear to the Committee, the connection between passage 
of this bill and Wawa's ability to grow, to expand, and to 
create new jobs.
    Mr. Gheysens. Absolutely. Thank you, Senator Toomey. Wawa's 
ability to grow since its inception in 1964 has not been 
hindered because the regulations at that point in time allowed 
us enough flexibility. However, today we have grown to a point 
where, going forward, because being privately held is so 
critical to being successful over the long term and being able 
to share and focus more of our ownership with our employees, 
therefore going forward the desire to remain private and the 
number of shareholders we have, we would be forced to redirect 
capital away from new stores, new growth, and job creation, 
dollar for dollar right into reorganizing and restructuring our 
balance sheet and our capital ownership so that we could 
eliminate and reduce or restrict the number of shareholders we 
have to remain in compliance with this outdated law.
    Senator Toomey. So it is fair to say then that passage of 
this bill and having it signed into law would directly result 
in a more rapid expansion and greater job growth at Wawa?
    Mr. Gheysens. Yes, Senator, exactly. These are the same 
dollars that we are going to deploy and will deploy with more 
flexibility to building new stores in the five States we are in 
as well as a new market versus putting them to work to just 
stay in compliance.
    Senator Toomey. Right. Does it make any difference to you 
guys whether the ceiling on the number of permissible 
shareholders is lifted by regulation, presumably by the SEC, or 
through legislation of Congress?
    Mr. Gheysens. It does not. Either Congress or by rule of 
the SEC, the process to us, we are indifferent. The importance 
for us really is the timeline. We are at an inflection point. 
Several private companies that we are aware of are at an 
inflection point, and really it is the timeline that is most 
important for us in order for us to be able to dedicate that 
capital to growth instead of reserving it for these other 
activities.
    Senator Toomey. And since this is going to accelerate your 
ability to create jobs, I would think the timeline matters to 
the people who have to get hired as a result, which brings me 
to my next question.
    Ms. Cross, it is my understanding that the SEC has been 
considering this at various levels and in various ways for some 
period of time. Do you have any sense for a timeframe that you 
could give us by which the SEC would reach a decision about 
raising the shareholder limit?
    Ms. Cross. I would be happy to. As I noted in my testimony, 
when the limit was originally put in, it followed a robust 
study to understand the costs and the benefits and the economic 
consequences of a change in the rule. So we are doing that now. 
That takes time, I am afraid. So I expect that we would get the 
work done on the study during 2012, and then the Commission, if 
they decide they want to change the rule, would need to put out 
a rule proposal. So it is at least, I would have to say, you 
know, more than a year away.
    Senator Toomey. OK. I just have to say that is 
disappointing. I know this has been a subject of consideration 
and on the agenda of the SEC's Government Business Forum on 
Small Business Capital Formation for several years. So if there 
is any way that that could move more quickly, that would be 
very helpful.
    Ms. Cross. Well, I appreciate that, and to the extent that 
we are able to get information such as that provided by Mr. 
Gheysens about the private company marketplace, that would 
really help. That is one of the things we are seeking right 
now. I think that is exactly the kind of information that we 
need.
    Senator Toomey. I think Senator Shelby was engaged in a 
discussion about the cost of being a public company, if I 
remember correctly, and might have asked a question. I happen 
to have in front of me the number from the IPO Task Force 
suggesting that the average cost to go public is $2.5 million 
and the annual cost to stay public on average is $1.5 million. 
I think this is for smaller new companies. I am just wondering: 
Does that sound like I have got my figures right, Ms. Cross? 
Does that sound right to you?
    Ms. Cross. I do not have data on the cost of IPOs. We are 
studying the IPO Task Force report now as well, and they are 
the kind of group from which we can get that data. So I would 
have to assume they are correct. I think the amounts vary, of 
course, according to the size of the company.
    Senator Toomey. Right, right. The last question I have is 
for Mr. Knight. In your testimony you mentioned that the 
PCAOB's recent proposal to require public companies to rotate 
auditors, it is an example of a regulation that is not clearly 
necessary, but it certainly is costly. I share your concern, 
and I am wondering if you could explain exactly why this is a 
very costly regulation for companies.
    Mr. Knight. Well, there is a ramp-up cost involved with 
when you hire a new firm in this area, and so you spend that 
money, and then you are going to have to bring in and rotate 
another auditing firm and go through that same process again.
    When I take a step back and look at this, what it seems to 
me is an area where the PCAOB could focus more on is using 
their existing powers to oversee the accounting industry and 
not necessarily using them to, if you will, put more burdens on 
public companies. They have broad, broad powers to regulate 
every aspect of accounting firms in this country, and that 
authority should be used more. We all want the highest 
financial standards, accounting standards possible. Nasdaq 
would not exist today without the accuracy and the reliability 
of financial disclosures. The accounting industry has a lot of 
challenges in front of it, including unlimited liability and 
other issues. But the direction of regulation is--it seems to 
me too many times we turn to, well, let us add another 
requirement on public companies to deal with what I think is 
ultimately an issue of the accounting industry itself.
    Senator Toomey. Thank you very much.
    Chairman Johnson. Senator Merkley.
    Senator Merkley. Thank you very much, Mr. Chair, and thank 
you all for your testimony. I want to note that both Senator 
Bennet and I share a real interest in the crowdfunding issue, 
and I am going to direct my questions in that direction. It 
seems like such a promising possibility but one also fraught 
with considerable danger.
    Ms. Cross, you mentioned on your list that one of the 
things we should be concerned about or think about is a limit 
on aggregate amount for investors. But how does one implement 
such a cap?
    Ms. Cross. Well, you can certainly consider it in terms of 
in the particular transaction, such as, you know, whether they 
can invest $1,000 or $100, or pick a number, and then I think 
perhaps a harder question is across crowdfunding investments. I 
think that you could require--if you chose a number, if you 
want an individual not exposed to more than, say, $10,000 worth 
of crowdfunding in any given year, you could have a requirement 
be that there is a cap on the amount, and that would be part of 
the inquiry that the seller would have to make and the investor 
would have to represent that they do not have more than, say, 
$10,000.
    I think it would be very difficult to otherwise police it, 
for example, but at least an investor would have to 
affirmatively not tell the truth in order to be able to invest.
    Senator Merkley. Yes. So you were not proposing or thinking 
that there would need to be some kind of central reporting by 
Social Security number or something to implement such an 
aggregate cap?
    Ms. Cross. I imagine that would be awfully perceived as 
burdensome, but, again, the Commission has not taken a position 
on this legislation.
    Senator Merkley. Yes. You also mentioned not allowing the 
transfer in order to avoid pump-and-dump, a huge, huge 
challenge. Were you thinking in terms of this type of annual 
restrictions or 1-year restriction? Or are you thinking of 
something much, much longer?
    Ms. Cross. Under the general securities laws now, if 
something is a restricted security, for example, sold in a 
private offering, sold in other kinds of exempt offerings like 
701 employee offerings, Regulation S offshore offerings, for a 
nonreporting company they are restricted for 1 year, and that 
is long enough, I would imagine, my own personal view, to keep 
the security from being something that is promptly used in a 
pump-and-dump scheme where, if the security can be traded right 
away, it is just handed over to a broker-dealer who uses a 
boiler room technique to bring the stock price up and dump it 
into the marketplace.
    So the 1 year I do not think has been problematic in the 
other exempt offerings, and that would, I imagine, be 
appropriate.
    Senator Merkley. Thank you. I want to turn to another area, 
which is the preemption of State blue sky laws, and the ``blue 
sky'' term goes back to, I believe, in Kansas, the sense that 
people were selling just blue sky and very little of substance 
behind the representations. Indeed, this is why we have had 
State blue sky laws.
    One of the advantages, of course, of preemption is you 
create this consistent playing field across the country. 
However, we did see some enormous damage in the mortgage area 
when States were taken off the beat, if you will, from being 
able to regulate transactions within their boundaries.
    Is there a strategy that would make sense in terms of 
providing a consistent strategy across the States but also 
giving States an opt-out should they be concerned that the 
standards have become too relaxed, the regulations have become 
too relaxed, and so on and so forth? Is there some compromise 
that would be important to kind of make sure we do not create a 
national regime and preempt States in a fashion that puts 
people at risk? Professor Coffee, is that something you might 
want to address?
    Mr. Coffee. I will certainly address it. I think Mr. 
Herstein would like to, also. I think you do need a compromise 
here, because I understand that a small issuer finds it 
burdensome to have to file with blue sky commissioners in 20 or 
30 States, because the Internet is worldwide, and if you are 
going to follow up with an intermediary that is going to be 
making offers also by emails, that is going to be a national 
distribution.
    Therefore, I think the answer is to have some sort of 
uniform limited exemption that the NASAA would agree upon. They 
have done that in the area of private placements with their 
uniform limited private placement exemption. I think they could 
do something similar here.
    So I would urge you not to preempt any form of uniform 
limited exemption which could provide for a one-stop filing 
that you could file electronically and you would know that you 
were in compliance. There is very little burden there. And, 
ultimately--and I want to say this, you can endorse this or 
disagree, but I think that the blue sky commissioners would be 
the primary line of regulatory defense. If there is fraud, it 
is more likely to be found by the blue sky commissioner because 
these transactions, particularly under crowdfunding, will be so 
small to be largely below the SEC's radar screen. The SEC is, 
frankly, an overworked and underfunded agency. They have to 
prioritize. And I think these smaller offerings of a half 
million or so are more likely to be monitored and, if 
necessary, enforced by blue sky commissioners. So I do not want 
to have them fully preempted.
    Senator Merkley. Mr. Chair, do I have time to continue this 
for a moment?
    Chairman Johnson. Yes.
    Senator Merkley. Thank you. Go ahead.
    Mr. Herstein. Thank you, Senator, and thank you, Professor 
Coffee. The States definitely look at preemption as a concern 
for them. They are small investors, small issuers, and they are 
in the States. In my written testimony that I gave, the States 
are currently working on a model rule which I think Professor 
Coffee described as basically a one-stop filing in the State 
that is the principal place of business for the crowdfunding 
issue. It would have basically limited filing requirements. 
Most of the items would be probably on their Web page. And the 
States are working on it, and the States can do this if the 
preemption cause is listed. And you talked about the mortgage 
problems. I will go back to 1996 when NSMIA was adopted. The 
States were taken out of reviewing Regulation D offerings or 
506 offerings. Since that time, that has been the States' 
number one investigation problems. We have had more cases per 
year on investigating Regulation D frauds than any other fraud 
that comes along.
    So preemption is on the mind of States. Once you take 
preemption away from the States, it is very difficult to get it 
back. We have been trying since 1996 to get Regulation D back, 
and we have not been successful. So definitely with the small 
issuers that deal with the States, we do not want to lose that 
preemption.
    Senator Merkley. I have one more issue if we have time, but 
I will defer to my colleague.
    Chairman Johnson. Take up the issue.
    Senator Merkley. Thank you.
    Mr. Cutler, I wanted to get a sense of one issue I have 
heard raised under raising the Regulation A limit, and that is, 
whether or not by going to a $50 million limit you have a path 
that could be created in which companies could get onto the New 
York Stock Exchange but never experience, if you will, the more 
detailed disclosure requirements that all companies on the New 
York Stock Exchange currently abide by. Have you explored that 
issue?
    Mr. Cutler. I think you have to remember that, should a 
company utilize the Regulation A offering, first of all, they 
would still be subject to the shareholder limitation 
requirements that already exist, and so they would have to be a 
regular reporting company under 12(g) to the extent that would 
be triggered. And the disclosure requirements that are 
currently in existence under Regulation A, while less than what 
is required under full registration, still require review and 
approval by the SEC in a document that is filed with the SEC, a 
much greater level of disclosure that is required certainly in 
any other private placement scenario. And so the amount of 
disclosure there is significantly greater than what you see in 
other areas.
    Senator Merkley. In other words, the pathway is possible, 
but not one you are concerned about.
    Mr. Cutler. Well, again, I think in order for a company to 
obtain, I believe, exemption from all the State blue sky, you 
would still have to list on a national exchange and also 
qualify the quantitative listing requirements on either NYSE or 
Nasdaq to be able to qualify to list on that exchange and 
comply with all of the governance requirements, were you to 
choose to list and trade on an exchange utilizing that 
offering.
    Senator Merkley. Thank you.
    Thank you, Mr. Chair.
    Chairman Johnson. Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman, and I appreciate 
this hearing, and I am sorry that I could not get here earlier 
since I was at the Senate Foreign Relations Committee where we 
were having a very spirited debate with the Administration on 
Iran sanctions, which we think is critical, a ticking time bomb 
that is on its way, and a vote that will take place later on 
the floor. But I am glad to have been able to get here because 
I think it is critical that small businesses have more access 
to capital and to create jobs and grow our economy. And I have 
been pursuing that in many different ways, and I am certainly 
open-minded to the different ways we can do that and glad we 
are exploring that today.
    I am thrilled to welcome Mr. Gheysens to the Committee. As 
a fellow New Jerseyan, we appreciate you being here and sharing 
some insights.
    I want to ask you, we have a series of different bills in 
the Senate to raise the fairly old 500-shareholder threshold 
for companies so that they can raise money for more 
shareholders before SEC registration kicks in. One of those 
bills applies just to banks, while another one applies to all 
companies.
    My question to you would be: Why is the threshold important 
to companies other than banks like Wawa? And if, in fact, we 
did that, what would be your projection of the possibilities of 
how many more jobs Wawa would be able to create in New Jersey 
if that threshold was raised?
    Mr. Gheysens. Thank you, Senator Menendez. So in terms of 
why this is important to private companies and not banks, if 
you will, a company like Wawa and other private companies have 
come up, have grown over the time when they have had 
flexibility under the laws, the 500-shareholder limit that has 
been in place since 1964. However, many have hit an inflection 
point where remaining private is still critical to their 
success, like Wawa, but going forward will be limited in their 
ability to grow because remaining private means dollar for 
dollar we would have to take capital dollars for new store 
growth and job creation away to be able to restrict and reduce 
the number of shareholders we have just to remain private under 
that outdated rule.
    So, in particular, Wawa would have a one-time probably $40 
million in our analysis reverse stock split that would be 
dollar for dollar away from new store growth.
    Now, specifically in New Jersey, it would be tough for me 
to say where exactly those jobs would come from. New Jersey, as 
you know, today has 235 Wawa's, 7,200 associates that work just 
in the State of New Jersey, and has a significant amount of our 
growth planned going forward, as well our new market in 
Florida. So those two markets would be most significantly 
impacted. I would project several hundred jobs at Wawa in a 
one-time event would be lost--or not gained, if you will, 
through creation, and also other jobs around that we support 
through our vendor network and construction network.
    Now, that just talks to a one-time event. If the rule is 
not updated over the long term, we will continue to have to 
reserve a significant amount of capital just to stay private, 
and I do not have those specific numbers. I can get back to 
you.
    Senator Menendez. Let me ask the other members of the 
panel, if we were to raise the threshold, how do we ensure that 
additional investors would be protected from fraud? Anybody 
have any ideas on that? Ms. Cross.
    Ms. Cross. I could weigh in on one point. I think one of 
the suggestions that is being discussed is to exclude employees 
from the count of shareholders in the up to 500, and I think 
that--I have some concern that if you exclude employees and do 
not otherwise provide them information, that if things went 
poorly at their company, they could both lose their job and 
their savings.
    I think that if you look at Mr. Gheysens' written 
testimony, his company provides information to their employees, 
financial information about the company, quarterly and 
annually, and one possibility is to condition an exemption for 
excluding employees on requiring a company to provide 
information to the employees that would not have to be filed 
publicly, but at least so that the employees have a sense for 
how things are going at their employer, I think is one 
important thing to consider.
    Senator Menendez. Now, the House has addressed changing the 
500-shareholder threshold for community banks and nonbanks in 
separate bills, and they have two different thresholds: one is 
2,000 for banks, another one is 1,000 shareholders for 
nonbanks.
    Does it matter to the SEC? Is there a greater ability to 
pursue, for example, under the single threshold that Toomey-
Carper has for banks and nonbanks as well? Does it make a 
difference to you from a regulator's perspective?
    Ms. Cross. The Commission staff is currently doing their 
study of the Section 12(g) thresholds and how different 
companies would be impacted. I think that as it relates to 
banks, the analysis that has been put forward by proponents of 
having a separate test for them is that they have the call 
report information, which provides information to bank holders 
in a way that other unregulated companies do not. So that is 
certainly something that is relevant to the discussion, but the 
questions about, for example, whether companies are traded in a 
fashion that should require the public disclosure is probably a 
similar question both for banks and other companies. So I think 
that there is--we do not have a conclusion at this point on 
whether it should make a difference what kind of company it is, 
but there certainly are some arguments that could be made.
    Senator Menendez. Finally, if I may, Mr. Chairman, I know 
you were just here just less than a month ago on an unrelated 
topic. How are we doing on 953(b) of getting that provision 
pursued?
    Ms. Cross. We are drafting the release as we speak and 
working hard to get it done just as soon as we can.
    Senator Menendez. All right. Thank you very much.
    Chairman Johnson. Senator Schumer.
    Senator Schumer. Thank you, Mr. Chairman. I thank all the 
witnesses. Sorry I was late as well.
    There is a lot of focus on job creation, justifiably, get 
businesses growing again, so I am glad to see, Mr. Chairman, 
the Banking Committee is focusing on ways we can help.
    We all know that our capital markets have really been a 
vital part of American job growth. American companies rely more 
on the capital markets than competitors in Europe or Asia, and 
as prior testimony has pointed out, the data shows that 
historically over 90 percent of job creation occurs post-IPO. 
But we all know the number of IPOs in the U.S. has been 
declining for some time, especially for small- and medium-sized 
businesses. So this morning I am introducing, along with 
colleagues on this Committee--Senators Toomey and Warner as 
well as Crapo, and I want to thank them for their help and 
support. We have introduced a bill that would accelerate that 
job creation by creating an on-ramp for small- and medium-sized 
businesses to go public and phasing in certain obligations over 
time as the companies grow.
    The proposals in our bill were based on work done by the 
IPO Task Force. That is a group with a broad cross-section of 
representation--venture capitalists, entrepreneurs, lawyers, 
bankers, academics.
    So my first question is for Mr. Cutler. In your testimony 
you refer to the on-ramp concept in our bill. You also discuss 
several other proposals floating around Congress that have been 
the subject of debate this morning. In your view, if Congress 
were to adopt one of the proposals to stimulate job creation, 
which of these proposals would do the most to encourage job 
creation?
    Mr. Cutler. Thank you, Senator Schumer, and I applaud your 
leadership on this issue and applaud the efforts to actually 
create legislation that addresses the biggest problem that has 
the potential to have the greatest impact on job creation, 
which is really addressing the problem of the hurdles of our 
public markets. I think it is important to note that this is, 
what has been proposed, not a rollback of regulation, and it is 
only impacting those companies that need it most at the time of 
capital formation in the public markets.
    I give you the example of a company like LinkedIn that went 
public earlier this year. It has doubled its workforce in the 
last year after going public this year. Rack Space, a 
technology company that went public a few years ago, a 55-
percent increase in growth.
    And so we really think this has the greatest potential 
impact because you are also addressing the largest pool of 
liquidity that is available to these companies of anywhere in 
the world.
    Senator Schumer. So you would choose our bill. And as you 
mentioned, do you think the bill--well, that is what he said. 
He just did not say it explicitly.
    [Laughter.]
    Senator Schumer. Would you choose our bill as the one that 
would do the most?
    Mr. Cutler. Of course, yes.
    [Laughter.]
    Mr. Cutler. It is a fantastic piece of legislation.
    Senator Schumer. Thank you. Now, let us try a second 
question and see if you can get to the point quicker. In your 
view, does our bill strike a good balance between easing the 
burdens on small-company IPOs and protecting investors?
    Mr. Cutler. Yes. I think if you look----
    Senator Schumer. Thank you.
    [Laughter.]
    Senator Schumer. I am only hurrying along because we have 
limited time. This is to Mr. Knight. In your testimony you 
allude to a phased-in approach for certain obligations similar 
to the approach we take in our bill. Do you support the 
proposals of the IPO Task Force and our bill and think they 
will help increase IPOs by growing companies and helping spur 
creation?
    Mr. Knight. Yes, sir. Absolutely.
    Senator Schumer. Good. Thank you.
    Next, Ms. Cross, I understand you are familiar with the IPO 
Task Force proposals, in particular the concept of creating an 
IPO on-ramp for small- and medium-sized families. Would you 
support any of these proposals or at least agree to work with 
my colleagues and me on the Committee to develop an on-ramp 
that will help companies access public markets while protecting 
investors?
    Ms. Cross. Well, first of all, of course I would agree to 
work with you and your colleagues. I have met with the IPO Task 
Force leaders, and they have some very thoughtful 
recommendations. There are some that I am particularly 
personally interested in, the ones--the on-ramp, the disclosure 
requirements.
    I do want to note that some of the ideas do raise some 
important policy questions relating to the treatment of 
research reports and the research analyst rules which I think 
the Commission would be particularly interested in making sure 
do not tip the balance the wrong way on investor protection. 
But, yes, we would be, of course, happy to work with you.
    Senator Schumer. OK. Thank you.
    Mr. Herstein, do you support the concept of an IPO on-ramp?
    Mr. Herstein. In most cases, those----
    Senator Schumer. I think you have to turn on your 
microphone.
    Mr. Herstein. Sorry, Senator. In a majority of those cases, 
those type of offerings would be exempt or preempted from the 
State filing requirements. But being a part of the SEC's Small 
Business Advisory Committee several years ago, one of our 
recommendations was to help small businesses basically on your 
on-ramp proposal.
    Senator Schumer. Thank you.
    And the last question is for Ms. Cross on a different 
subject, if I might, Mr. Chairman. It is about the Chinese 
audit firms and what the SEC is doing to ensure investors are 
protected, even though the PCAOB has not been able to examine 
Chinese audit companies. As you know, last week I wrote that 
organization to request they take disciplinary action to 
deregister Chinese audit firms that refuse to cooperate. This 
is a pattern we see with China everywhere. They just want 
different rules, and we sort of shrug our shoulders and say OK, 
and enough is enough.
    In this one, the PCAOB operates under the oversight of the 
SEC, so I want to know what steps you have taken to get the 
PCAOB to do its job and inspect the China-based auditors or 
take enforcement action. How long are we going to let this 
stalemate with China go on?
    Ms. Cross. I appreciate the question. I think we also view 
this with some urgency and are working closely with the PCAOB 
to solve this problem. I cannot give you a date. I do not want 
to--our chief accountant's office is the one that is working 
the most closely with the PCAOB on this issue, but we also view 
it with some urgency. And the suggestion that I understood that 
you had raised about perhaps requiring disclosure so investors 
are at least aware of the lack of inspection I think is an 
interesting idea that we are certainly discussing internally 
right now.
    Senator Schumer. OK. Thank you, Mr. Chairman. Thank you, 
Senator Reed, for----
    Chairman Johnson. Senator Reed.
    Senator Reed. Well, thank you very much, Mr. Chairman, and 
let me apologize for my comings and goings, but we have a 
national defense bill on the floor and we have an 
appropriations bill that I am the chairman of the subcommittee.
    Let me just go back to a question, I think, that was raised 
by several of my colleagues, and Professor Coffee, when we talk 
about raising the number of individual holders of stock to 
qualify for an exemption for securities laws, I interpreted or 
assumed from your answer we also have to look back at the 
notion of beneficial ownership, that if we do not fix both, we 
could have this situation where we raise it to X level, but, in 
fact, the number of people who actually hold the shares could 
be huge. So is that something that has to be done, in your 
view, sort of in parallel or together, otherwise, we just do 
not fix the problem?
    Mr. Coffee. I think you are summarizing the intent of my 
testimony. You just said it clearer. You can game, you can 
manipulate this, not only in terms of when you become a 
reporting company, but several of these bills allow companies, 
particularly banks, to deregulate, or ``go dark'' in the 
vocabulary, if they can get their number of shareholders of 
record below 1,200. If you let them escape the system, even 
though they are now making the disclosure, by getting the 
number below 1,200, they can pressure their shareholders to 
switch from record ownership to street name ownership, 
beneficial ownership in order to escape SEC oversight, and 
frankly, I will tell you, if they ``go dark,'' bad things 
happen in the dark. Conflicts of interest do not get disclosed. 
Foreign Corrupt Practices Act gets escaped because you are no 
longer subject to it. I think you have got to solve this 
problem more or less simultaneously.
    I am not against raising the level. Maybe it should be 
adjusted. But I think it has got to be a meaningful level that 
gives priority and protection to small issuers and does not 
allow large institutions to escape out the back door.
    Senator Reed. I would like for Ms. Cross to respond, also, 
but before I do that, one of the arguments with respect to 
banking holding companies is they are subject to significant 
financial regulation. But your response seems to suggest that 
that would not deal with a lot of the issues--Foreign Corrupt 
Practices Act, et cetera--and the fact that a lot of financial 
reporting is deliberately close held because they do not want 
to disclose proprietary information or many other reasons. So--
--
    Mr. Coffee. You have again summarized me better than I did. 
Bank regulation is looking at the solvency of the bank. SEC 
regulation is looking at things like conflict of interest and 
the minority investors problems.
    Senator Reed. Thank you.
    Ms. Cross, your comments in terms of the relationship 
between the number of owners and the notion of beneficial 
ownership and record ownership. It has to be done in tandem. 
And also any comments in terms of financial institutions in 
particular.
    Ms. Cross. Thank you. So the number of holders question and 
whether you should adjust both the number of record holders and 
require a look through to how many beneficial holders--that is 
is something that we think is a very important part of this 
conversation. If Congress adopts the legislation that is before 
it, that does not preclude the SEC from still going ahead and 
looking--and trying to decide how should we count, and in fact, 
one could look at the numbers that are in the bills and then 
decide, once you figure out how that translates in terms of 
beneficial owners, that it requires further adjustment because 
a change from 500 to 1,000 when it turns out that 1,000 is 
really 50,000 would result in a different policy call. So those 
are all things that the staff is helping the Commission 
consider.
    Senator Reed. Just a comment, given recent observations, is 
that there are some who have criticized Dodd-Frank for many 
different reasons, but so much discretion given to the SEC and 
then seeing some of the rules being voided by court appeals, by 
courts, by economic analysis, et cetera, that might argue if we 
are going to fix this, we should probably fix it in legislation 
rather than rely upon sort of the inherent rulemaking or the 
implicit rulemaking of SEC. That is just a comment.
    If I can, again, Mr. Chairman, change the subject slightly, 
because Mr. Gheysens, you not only are a very articulate 
advocate for the company's position with respect to this 
legislation, but you run a business that is Main Street in 
every little community. I drive, particularly around here, I 
drive by them all the time. And we are currently engaged in a 
debate about an extension of unemployment benefits, et cetera. 
Do you have any sort of notion about the effects on the demand 
in a convenience store gas station operation like you if we do 
not do this? Are you anticipating a shock to your sales?
    Mr. Gheysens. Senator, let me make sure I understand the 
question.
    Senator Reed. Yes.
    Mr. Gheysens. So if unemployment benefits are not extended, 
what would be the impact----
    Senator Reed. Right.
    Mr. Gheysens. I would only be speculating, but certainly 
the American consumer, as we have seen in our sales, is 
pinched. They are trading off and making decisions each and 
every day to make ends meet. Some of our business is 
discretionary. Some of our business, frankly, is not, in terms 
of gas. So I do not have a particular belief, but I would tell 
you, over what we have seen in the last several months, it 
would suggest that that could have a negative effect on our 
sales.
    Senator Reed. Thank you very much. That is a very fair and 
very thoughtful answer.
    If I may take one more question, Mr. Chairman----
    Chairman Johnson. Yes.
    Senator Reed. Let me go back to Professor Coffee. You also 
in your testimony, you talked about the increased use of 
Regulation D for private offerings. In fact, there was a 
suggestion that $320 billion was raised in the first quarter of 
2011 alone and that it could put us on a trajectory for $1.2 
trillion through--these are private offerings, which are, in 
some respects, a surrogate or a replacement for the IPO 
offerings, and these offerings were about a million dollars. So 
it seems to me that the markets are responding, at least in 
Regulation D, to the needs of small companies that are looking 
to get started. Can you comment?
    Mr. Coffee. I think the SEC's Chief Economist has estimated 
that between 2009 and maybe the middle of 2011, there were 
37,000 Regulation D offerings and the median size was $1 
million. That means that many issuers are choosing the private 
market route. I do not think that the SEC or Congress should 
tell the private issuer which way to go, private versus public. 
Make your own choice. You should make sure that both avenues 
are available and are both consistent with reasonable investor 
protection and issuers will choose what is best for them. So I 
think we have to recognize that Reg D is likely to be the main 
highway for lots of companies raising capital.
    Senator Reed. Can I ask one final question, and that is--
you might not have the statistics, but one of the persistent 
criticisms of the regulatory structure is it is expensive, 
particularly when it comes to initial public offerings. Is 
there any sort of notion of what the compliance costs are in a 
public offering vis-a-vis the investment banking costs, I mean, 
the promotion costs, the advertising costs? If the actual 
compliance costs are relatively small, then the monetary 
deterrence of sort of public offering is not about regulatory, 
it is about other factors.
    Mr. Coffee. I know a number of studies of what the costs 
are both in going public and in remaining public in the first 
couple of years. If you look at the costs of remaining public 
after the IPO, the largest single cost is D&O insurance because 
you do not dare go public without insuring your board. That can 
be nearly a million dollars there.
    Then you have costs for enhanced auditing. This is not 404. 
This is basically auditors charge more if you are a public 
company because they are afraid of getting sued. So that is 
significant.
    There are costs for listing fees and there are some other 
costs, but I would have to say that the costs of 34 Act, of 
Securities and Exchange Act filing, would only be fourth or 
fifth on this list. That does not mean that we do not want to 
reduce those costs, but it is not one of the top three costs 
compared to things like D&O insurance or higher auditing costs.
    Senator Reed. But these costs, to be fair, are all related 
to the public status of the company?
    Mr. Coffee. Yes. And, first of all, when you do a public 
offering, you pay underwriters. Underwriters normally charge 
6\1/2\ to 7 percent of the total offering price. It is a lot 
cheaper in private placements.
    Senator Reed. Thank you all very much. Thank you, Mr. 
Chairman. You are very kind.
    Chairman Johnson. I would like to thank all of our 
witnesses for being here with us today. The testimony we have 
heard today will help the Committee in its important work of 
determining how best to help businesses sell stock to get 
needed capital while protecting investors. I am committed to 
help spur job growth as we help to take legislative action as 
quickly as possible and bipartisan solutions.
    This hearing is adjourned.
    [Whereupon, at 12:18 p.m., the hearing was adjourned.]
    [Prepared statements and additional material supplied for 
the record follow:]

               PREPARED STATEMENT OF CHAIRMAN TIM JOHNSON

    Our Nation is facing an unemployment crisis. Nearly 14 million 
Americans are unable to find a job, and over 5 million have been 
unemployed for 6 months or longer. Here in Congress, putting our fellow 
Americans back to work should be, and must be, our top priority.
    The American people are frustrated, and rightfully so, by a 
political system that is bogged down in partisan battles. However, our 
focus today is an issue where I believe there is real potential for 
bipartisan cooperation, and for results.
    We are here to discuss how to help startups and businesses get 
access to the capital they need to grow and to create new jobs, while 
protecting investors.
    Today, the Committee is pleased to hear testimony from three of our 
fellow senators as well as expert witnesses who will talk about 
challenges that businesses and entrepreneurs can face when attempting 
to raise money by selling stock.
    The Committee will also hear about proposals and ideas that seek to 
improve existing securities laws. The witnesses will discuss the SEC's 
requirements for a person or company to sell securities to the public.
    They will also provide insight on proposals to expand the scope of 
Regulation A offerings, to permit general solicitation of investors in 
Regulation D offerings, and to allow individuals to solicit and sell 
small amounts of stock over the Internet through crowdfunding.
    They will address the size of a private offering and the amount of 
money that a crowdfunder should be able to risk without full regulatory 
protection. They will discuss the types of markets where these 
securities should trade. They will also describe the existing 
investors' safeguards, such as disclosures about the business and 
financials, and how current proposals would affect those safeguards.
    In addition, witnesses will review the requirements for banks and 
other companies with 500 or more shareholders ``of record'' to register 
with the SEC, which requires important information to be provided 
regularly to shareholders, and discuss whether the transparency is 
important to investors and appropriate for different types and sizes of 
companies.
    And additional ideas may be raised in the Committee's discussions. 
A recommendation that came up in a recent hearing, and which I have a 
strong interest in exploring, involves amending Regulation D to add 
American Indian tribes to the list of accredited investors.
    I want to thank Senator Shelby and his staff for their cooperation 
in developing this hearing. I think we agree that firms that are in a 
position to grow will seek to raise more capital if the process of 
selling stock is made easier and less costly. If they succeed, this can 
lead to more jobs and economic prosperity. At the same time, investors 
must be willing to buy the stock that businesses offer, and they are 
more likely to do so when they have enough reliable information and 
know that they are not at risk of being scammed.
    I look forward to the testimony of the witnesses and to working 
with my colleagues on both sides of the aisle to develop bipartisan 
legislative solutions that promote job growth and business expansion 
while protecting investors.
                                 ______
                                 
           PREPARED STATEMENT OF SENATOR KAY BAILEY HUTCHISON

    Good morning, Chairman Johnson and Ranking Member Shelby, and thank 
you for holding today's important hearing on proposals to support job 
creation through capital formation.
    After serving on the Banking Committee during the last Congress, it 
is a pleasure to be back, even if on the other side of the dais, to 
speak in support of S. 556.
    S. 556 is a common-sense bill with strong bipartisan support that 
will enable growth in our Nation's economy, while strengthening our 
community banking system.
    I sponsored this legislation last year and again this year with my 
friend from Arkansas, Senator Pryor.
    Our bill would foster capital formation in the community banking 
industry, and would allow community banks to bolster their balance 
sheets to meet the more stringent capital standards imposed by the 
Dodd-Frank Act.
    This additional capital would free community banks to lend to 
creditworthy small businesses, who in turn can go out and do what we 
need them to do: invest in new operations and projects, create jobs, 
and give our Nation's economy a badly needed lift.
    It is estimated that this measure could free banks to lend up to 
$800 million to American small businesses.
    S. 556 would to update the threshold before a bank must register 
its securities with the Securities and Exchange Commission (SEC).
    Under current law, any company with $10 million in assets and 500 
shareholders is required to register its securities with the SEC.The 
$10 million asset size threshold has twice been increased since being 
enacted in 1964.
    The 500-shareholder threshold, however, has never been changed.
    For banks that exceed the 500 shareholder threshold, the high cost 
of complying with SEC reporting requirements consumes capital resources 
that could otherwise be used for lending.
    Modernizing the shareholder threshold would allow banks to raise 
the additional capital they need to shore up reserves, and increase 
lending to worthy small businesses and families.
    Community banks tell me that they could each save about $250,000 in 
costs to satisfy regulatory requirements if the shareholder threshold 
is raised to 2,000. Spread across the entire country, our bill would 
save community banks more than $80 million, which, when deployed as 
capital, could allow these banks to lend up to $800 million to American 
small businesses.
    Community banks and small businesses form the backbone of our 
economy.
    With just 11 percent of the banking industry's assets, community 
banks make nearly 40 percent of all loans to small businesses.
    I welcome today's hearing on S. 556 and other bills to spur job 
creation through capital formation.
    The bill that I am offering with Senator Pryor has strong 
bipartisan support. The House recently passed a companion bill by a 
vote 420 to 2. I am confident that the Senate would pass it in 
similarly overwhelming fashion if we put it to a vote.









              PREPARED STATEMENT OF SENATOR MARK L. PRYOR

    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee: Thank you for inviting me here today to discuss S. 556, a 
bill to amend the securities laws to establish a higher shareholder 
threshold for registration of banks as public companies. I also want to 
thank Senator Hutchison for her leadership on this important bipartisan 
bill.
    Currently, the Securities Exchange Act requires a company with $10 
million in assets and 500 shareholders to register its securities with 
the SEC and comply with the SEC's registration and reporting 
requirements. Since 1964, the original $1 million asset standard has 
been increased tenfold while the 500 shareholders of record requirement 
has never been updated.
    I want to emphasize that our bill only changes the shareholder 
threshold for banks and not for other businesses. Banks are unique 
businesses because they are already highly regulated and have to 
maintain large dollar assets tied to their loans. Consequently, 
shareholder size is the only meaningful standard for whether a bank 
should be registered as a public company.
    I have spoken with many community banks in Arkansas who are 
struggling to raise capital or expand their investor base. These 
community banks are increasingly subject to higher capital requirements 
due to the Dodd-Frank Act, Basel III rules, and banking regulator 
stress tests. Increasing their capital reserves will enable these banks 
to continue to serve and benefit their communities.
    Increasing the shareholder limit would create an opportunity for 
community banks to bring in much needed new capital and increase 
lending. One dollar worth of capital supports up to $10 in loans. As 
banks approach the current shareholder threshold, they have to decide 
whether to go public or limit their access to capital. The result is 
that these banks are forced to make fewer loans in order to maintain 
their capital-to-assets ratio.
    Today, a community bank with a small investor base is significantly 
different from what it was 40 years ago. While the shareholder 
threshold of 500 at one time may have been an accurate reflection of a 
public market, it no longer is today. It is time Congress updated this 
standard for banks. Thank you again for the opportunity to present this 
bill and I look forward to working with the Committee on its passage.
                                 ______
                                 
                  PREPARED STATEMENT OF MEREDITH CROSS
  Director, Division of Corporation Finance, Securities and Exchange 
                               Commission
                            December 1, 2011

    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee: My name is Meredith Cross, and I am the Director of the 
Division of Corporation Finance at the Securities and Exchange 
Commission. I am joined in this testimony by Lona Nallengara, Deputy 
Director of the Division of Corporation Finance. We are pleased to 
testify today on behalf of the Commission on the topic of capital 
formation. \1\
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     \1\ Ms. Cross's participation in this testimony does not include 
matters related to crowdfunding. Prior to joining the Commission staff 
in June 2009, Ms. Cross served as counsel to a company in connection 
with its registration under the Securities Act of 1933 of notes offered 
and sold through its ``peer-to-peer'' lending platform. Although Ms. 
Cross has no financial or other interest in her former client or her 
prior employer, in light of the small number of participants in that 
market, in order to avoid any appearance concerns, she does not 
participate in matters involving peer-to-peer lending. Further, since 
there are some similarities between peer-to-peer lending and some 
crowdfunding concepts, even though Ms. Cross has been advised by SEC 
Ethics Counsel that there is no conflict of interest, Ms. Cross has 
determined that in order to avoid any appearance concerns, she will no 
longer participate in crowdfunding matters. For purposes of this 
written testimony, Mr. Nallengara is addressing crowdfunding matters.
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    The mission of the Securities and Exchange Commission is to protect 
investors, maintain fair, orderly and efficient markets, and facilitate 
capital formation. A critical goal of the SEC is to facilitate 
companies' access to capital while at the same time protecting 
investors. Companies of all sizes need cost-effective access to capital 
to grow and develop, and the Commission recognizes that any unnecessary 
or superfluous 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, and the 
protections provided by the securities laws are critical to large and 
small company investors alike.
    Over the years the SEC has taken significant steps, consistent with 
its investor protection mandate, to facilitate capital-raising by 
companies of all sizes and to reduce burdens on companies making 
offerings, be it through introducing or increasing eligibility for 
shelf registration or implementing small business reforms. Going 
forward, the Commission will continue to consider and, if appropriate, 
implement changes to its existing rules to reduce regulatory burdens 
while maintaining important investor protections provided under the 
securities laws.
    Chairman Schapiro has instructed the staff to take a fresh look at 
some of our offering rules to 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 ongoing and 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.

    Additional areas of review concern the regulatory questions posed 
by new capital raising strategies, such as crowdfunding, and the scope 
of our existing rules that provide for capital raising, such as 
Regulation A.
    Additionally, the Commission's recently formed Advisory Committee 
on Small and Emerging Companies will provide the Commission and the 
staff with advice and recommendations about regulations that affect 
privately held and publicly traded small and emerging businesses. \2\ 
The members of the Advisory Committee include representatives from a 
range of small and emerging companies, and investors in those types of 
companies, with real world experience under our rules. The Advisory 
Committee held its first meeting on October 31, 2011, where it 
considered a number of issues related to capital formation for small 
and emerging companies, including the triggers for registration and 
public reporting and suspension of reporting obligations, possible 
scaling of regulations for newly public companies, crowdfunding, 
possible modifications to Regulation A, and the restrictions on general 
solicitation. \3\ We understand that the Advisory Committee intends to 
provide preliminary recommendations to the Commission on many of these 
topics in the coming weeks, and we are looking forward to receiving 
these recommendations.
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     \2\ See, SEC Announces Formation of Advisory Committee on Small 
and Emerging Companies (Sept. 13, 2011), http://www.sec.gov/news/press/
2011/2011-182.htm.
     \3\ See, SEC Advisory Committee on Small and Emerging Companies To 
Hold First Meeting on Oct. 31 (Oct. 13, 2011), http://www.sec.gov/news/
press/2011/2011-207.htm; SEC Announces Agenda for First Meeting of 
Advisory Committee on Small and Emerging Companies (Oct. 25, 2011), 
http://www.sec.gov/news/press/2011/2011-222.htm.
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    My testimony today will focus on small business capital formation 
initiatives and the broader capital formation regulatory review we are 
undertaking at Chairman Schapiro's request.
Update on Review of Certain Offering Regulations
    I would first like to provide an update on the staff's review of 
our regulations relating to the triggers for public reporting, the 
restrictions on general solicitation, and communications in connection 
with public offerings.

Triggers for Public Reporting
    Chairman Schapiro has asked the staff to review the triggers for 
public reporting and the characteristics of companies that should be 
subject to public reporting obligations. In addition, bills have been 
proposed in both the House and the Senate relating to the Section 12(g) 
thresholds for reporting.
    Section 12(g) of the Exchange Act, which sets forth certain 
registration requirements for securities, 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. \4\ The study 
included a survey of over 2,000 issuers that sought data from these 
issuers on, among other things, asset levels, their securities 
offerings, shares outstanding, stockholders of record, and the number 
of shares held by large shareholders. The data derived from the study 
was critical in developing metrics upon which to base the triggers for 
public reporting given the nature of the companies and the shareholders 
that would be impacted.
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     \4\ Report of Special Study of Securities Markets of the 
Securities and Exchange Commission, H.R. Doc. No. 88-95, pt. 3 (1963). 
According to the Committee Report summarizing the results of the study: 
``There is no convincing reason why the comprehensive scheme of 
disclosure that affords effective protection to investors in the 
exchange markets should not also apply in the over-the-counter market. 
. . . [B]ecause the over-the-counter market includes not only 
securities of widely known and seasoned companies but also those of 
relatively unknown and insubstantial ones, the need of investors for 
accurate information is at least as great, if not greater than in the 
exchange markets.'' [S. Rep. No. 88-379, at 9 (1963)]
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    Section 12(g) requires a company to register its securities with 
the Commission, within 120 days after the last day of its fiscal year, 
if, at the end of the fiscal year, the securities are ``held of 
record'' by 500 or more persons and the company has ``total assets'' 
exceeding $10 million. \5\ Shortly after Congress adopted Section 
12(g), the Commission adopted rules defining the terms ``held of 
record'' and ``total assets.'' \6\ The definition of ``held of record'' 
counts as holders of record only persons identified as owners on 
records of security holders maintained by the company, or on its 
behalf, in accordance with accepted practice. As such, this definition 
simplified the process of determining the applicability of Section 
12(g). \7\
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     \5\ See, Exchange Act 12(g)(1); Exchange Act Rule 12g-1. When 
Section 12(g) was enacted, the asset threshold was set at $1 million. 
The asset threshold was most recently increased by rule to $10 million 
in 1996. Release No. 34-37157, Relief from Reporting by Small Issuers 
(May 1, 1996), http://www.sec.gov/rules/final/34-37157.txt.
     \6\ See, Release No. 34-7492, Adoption of Rules 12g5-1 and 12g5-2 
Under the Securities Exchange Act of 1934 (January 5, 1965).
     \7\ See, id. 
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    Of course, securities markets have changed significantly since the 
enactment of Section 12(g) and the Commission's adoption of the 
definition of ``held of record.'' Today, the vast majority of 
securities of publicly traded companies are held in nominee or ``street 
name'' rather than directly by the owner. This means that the brokers 
that purchase securities on behalf of investors typically are listed as 
the holders of record. One broker may own a large position in a company 
on behalf of thousands of beneficial owners, but because the shares are 
all held in street name, those shares count as being owned by one 
``holder of record.'' This change in the way securities are held means 
that for most publicly traded companies, much of their individual 
shareholder base is not counted under the current definition of ``held 
of record.'' Conversely, the shareholders of most private companies, 
who generally hold their shares directly, are counted as ``holders of 
record'' under the definition. This has required private companies that 
have more than $10 million in total assets and that cross the 500 
record holder threshold--where the number of record holders is actually 
representative of the number of shareholders--to register and commence 
reporting. At the same time, it has allowed a number of public 
companies, many of whom likely have substantially more than 500 
beneficial owners, to stop reporting, or ``go dark,'' because there are 
fewer than 500 ``holders of record'' due to the fact that the public 
companies' shares are held in street name. In light of these issues, 
some have called for changes to the definition and threshold adopted 
pursuant to Section 12(g).
    The Commission has exercised its exemptive authority in the past to 
adjust the application of Section 12(g). \8\ For example, in 2007, the 
Commission adopted Rule 12h-1(f) under the Exchange Act, which provides 
an exemption from the held of record threshold for compensatory stock 
options. This exemptive rule allows private companies to provide 
compensatory stock options to employees, officers, directors, 
consultants and advisors without triggering the need to register those 
options under the Exchange Act. \9\ A variety of proponents have 
advanced a wide range of proposals relating to possible amendments to 
Section 12(g) reporting standards. Some of these proposals seek to 
limit the class of issuers required to report pursuant to the Exchange 
Act, for example, by raising the shareholder threshold, \10\ by 
excluding employees, or by excluding accredited investors, qualified 
institutional buyers (QIBs) or other sophisticated investors from the 
calculation. \11\ Conversely, the Commission has received a rulemaking 
petition requesting that the Commission revise the "held of record" 
definition to look through record holders to the underlying beneficial 
owners of securities that would prevent issuers from ceasing to report 
in certain circumstances. \12\
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     \8\ Exchange Act Section 12(h) provides the Commission broad 
authority to exempt issuers from the registration requirements of 
Section 12(g) so long as the Commission finds that the action is not 
inconsistent with the public interest or protection of investors. The 
Commission has previously relied on Section 12(h) to raise the total 
assets threshold. Additionally, Congress has provided the Commission 
broad exemptive authority in Section 36 of the Exchange Act. The 
Commission has previously established exemptions from the Section 12(g) 
requirement and Section 12(g) provides the Commission with authority to 
define the terms ``held of record'' and ``total assets.'' See, Exchange 
Act Rule 12g3-2 and Exchange Act 12(g)(5).
     \9\ Release No. 34-56887, Exemption of Compensatory Employee Stock 
Options from Registration Under Section 12(g) of the Securities 
Exchange Act of 1934 (December 3, 2007), http://www.sec.gov/rules/
final/2007/34-56887.pdf. The staff of the Division of Corporation 
Finance also issued a no-action letter saying that it would not 
recommend an enforcement action to a company that issued restricted 
stock units due to the similarities between them and stock options. 
See, Twitter, Inc. (September 13, 2011); Zynga Inc. (June 17, 2011); 
Facebook, Inc. (October 14, 2008).
     \10\ In a November 12, 2008, letter, the American Bankers 
Association made the argument that the 500-shareholder threshold should 
be increased to reduce the regulatory hardship suffered by small 
community banks. See, Comment Letter from American Bankers Association 
to SEC (November 12, 2008), http://www.sec.gov/rules/petitions/4-483/
4483-21.pdf.
     \11\ See, 2009 Annual SEC Government-Business Forum on Small 
Business Capital Formation Final Report (May 2010), http://www.sec.gov/
info/smallbus/gbfor28.pdf.
     \12\ On February 24, 2009, the Commission received a rulemaking 
petition urging the Commission to count beneficial owners instead of 
record holders to prevent companies with large numbers of holders from 
exiting the reporting system. See, Petition from Lawrence Goldstein to 
SEC (February 24, 2009), http://www.sec.gov/rules/petitions/2009/petn4-
483-add.pdf. This followed an earlier, similar petition. See, Petition 
for Commission Action to Require Exchange Act Registration of Over-the-
Counter Equity Securities (July 3, 2003), http://www.sec.gov/rules/
petitions/petn4-483.htm.
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    As stated, the securities markets have gone through profound 
changes since Congress added Section 12(g) to the Exchange Act. 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 is seeking to determine 
whether the current thresholds and standards effectively implement the 
Exchange Act registration and reporting requirements and what it means 
to be a ``public'' company such that an issuer should be required to 
register its securities and file with the Commission. The staff has 
begun a detailed analysis of public company information--including 
numbers of record and beneficial owners, total assets, and public 
float--to assess the characteristics of public companies. The study 
also will seek to obtain and consider private company information to 
assess current reporting thresholds. In connection with the study the 
staff expects to seek comment and data from companies, investors, 
financial market participants, academics, regulators and others on a 
number of the issues related to the current triggers for public 
reporting. To the extent that the staff develops recommendations or 
proposals regarding changes to the reporting thresholds for the 
Commission's consideration, the consequences of any such proposed 
change will be subject to careful assessment as to the impact on 
investor protection and capital formation and the other costs and 
benefits of any proposed change.

Restriction on General Solicitation
    Chairman Schapiro also asked the staff to review the restrictions 
our rules impose on communications in private offerings, in particular 
the restrictions on general solicitation. In addition, legislation has 
been introduced which would require the Commission to revise its rules 
to permit general solicitation in offerings under Rule 506 of 
Regulation D.
    One of the most commonly used exemptions from the registration 
requirements of the Securities Act is Section 4(2), which exempts 
transactions by an issuer ``not involving any public offering.'' 
Currently, an issuer seeking to rely on Section 4(2) is generally 
subject to a restriction on the use of general solicitation or 
advertising to attract investors for its offering. \13\ The restriction 
was designed to protect those who would benefit from the safeguards of 
registration from being solicited in connection with a private 
offering.
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     \13\ See, Rule 502(c) of Regulation D and Release No. 4552, Non-
Public Offering Exemption, (November 6, 1962).
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    The Commission and staff have acted to provide increased certainty 
in connection with private offerings by adopting safe harbor rules, 
such as Rule 506, and providing guidance with respect to the scope of 
Section 4(2) and the restriction on general solicitation and 
advertising. Recognizing the increased use of the Internet and other 
modern communication technologies in private offerings, the staff has 
issued no-action letters providing issuers with flexibility to use 
modern communication technologies without the staff recommending 
enforcement action regarding the general solicitation restriction. \14\
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     \14\ See, e.g., IPONET (July 26, 1996) (general solicitation is 
not present when previously unknown investors are invited to complete a 
Web-based generic questionnaire and are provided access to private 
offerings via a password-protected Web site only if a broker-dealer 
makes a determination that the investor is accredited under Regulation 
D); Lamp Technologies, Inc. (May 29, 1998) (posting of information on a 
password-protected Web site about offerings by private investment 
pools, when access to the Web site is restricted to accredited 
investors, would not involve general solicitation or general 
advertising under Regulation D).
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    Notwithstanding these efforts, the restriction on general 
solicitation is cited by some as a significant impediment to capital 
raising. \15\ We understand that some believe that the restriction may 
be unnecessary because offerees who might be located through a general 
solicitation but who do not purchase the security, either because they 
do not qualify under the terms of the exemption or because they choose 
not to purchase, would not be harmed by the solicitation. \16\ In 
addition, some have questioned the continued practical viability of the 
restriction in its current form given the presence of the Internet and 
widespread use of electronic communications. 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. \17\
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     \15\ See, e.g., Final Report of the Advisory Committee on Smaller 
Public Companies to the U.S. Securities and Exchange Commission (April 
23, 2006), http://www.sec.gov/info/smallbus/acspc/acspc-
finalreport.pdf; Joseph McLaughlin, ``How the SEC Stifles Investment--
and Speech'', the Wall Street Journal (February 3, 2011). Concerns 
about the scope of the Commission's rules on general solicitation and 
advertising have been raised by the participants in the annual SEC 
Government-Business Forum on Small Business Capital Formation. See, 
2010 Annual SEC Government-Business Forum on Small Business Capital 
Formation Final Report (June 2011), http://www.sec.gov/info/smallbus/
gbfor29.pdf.
     \16\ See, Pinter v. Dahl, 486 U.S. 622, 644 (1988) (``The purchase 
requirement clearly confines 12 liability to those situations in which 
a sale has taken place. Thus, a prospective buyer has no recourse 
against a person who touts unregistered securities to him if he does 
not purchase the securities.'').
     \17\ See, e.g., J. William Hicks, Exempted Transactions Under the 
Securities Act of 1933 7:160 (2d ed. 2002); Comment Letter from 
Investment Companies Institute to SEC (October 9, 2007), http://
www.sec.gov/comments/s7-18-07/s71807-37.pdf (warning that unlimited 
general solicitation would ``make it difficult for investors to 
distinguish between advertisements for legitimate offerings and 
advertisements for fraudulent schemes'').
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    We believe it is important to consider both of these views about 
the need for the restriction on general solicitation in private 
offerings when considering possible revisions to our rules. In 
analyzing whether to recommend changes to the restriction, the staff is 
preparing a concept release for the Commission's consideration, through 
which it would seek the public's input on the advisability and the 
costs and benefits of retaining or relaxing the restrictions on general 
solicitation. The Commission could seek views from all interested 
parties on a number of issues related to the restriction on general 
solicitation, including specific protections that could be considered 
if the restriction is relaxed and the types of investors who would be 
most vulnerable if it is relaxed. Of course, in considering whether to 
recommend that the Commission make changes to the rules restricting 
general solicitation, we will remain cognizant of our investor 
protection mandate.

Communications in Public Offerings
    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 
communications around public offerings. For example, as early as 1970, 
the Commission adopted safe-harbor exemptions to make it clear that 
continued analyst research coverage does not constitute an unlawful 
offer. \18\ In 2005, the Commission significantly reformed the 
registration and offering process by adopting a comprehensive set of 
rules and amendments to facilitate capital raising and relax 
restrictions on communications by issuers during the registered 
offering process. \19\ These changes significantly liberalized the 
rules governing communications by the largest issuers during public 
offerings, thereby allowing more information to reach investors. The 
staff is reviewing the rules relating to communications in public 
offerings to consider whether any of the liberalizations adopted in 
2005 should be adapted for smaller public companies, including whether 
more companies should be able to use free writing prospectuses before a 
substantially complete prospectus is filed. As a result of this review, 
the staff may recommend proposed changes to the offering rules, or 
recommend that the Commission seek additional input through the 
issuance of a concept release.
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     \18\ See, Release No. 33-5101, Adoption of Rules Relating to 
Publication of Information and Delivery of Prospectus by Broker-Dealers 
Prior to or After the Filing of a Registration Statement Under the 
Securities Act of 1933 (November 19, 1970).
     \19\ See, Release No. 33-8591, Securities Offering Reform (July 
19, 2005), http://www.sec.gov/rules/final/33-8591.pdf.
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    As part of its review, the staff also is considering regulatory 
questions posed by new capital raising strategies, such as 
crowdfunding, and the scope of our existing rules that provide for 
capital raising, such as Regulation A.
Crowdfunding--A New Capital Raising Strategy
    A new method of capital raising that is gaining increasing interest 
is crowdfunding. Generally, the term ``crowdfunding'' is used to 
describe a form of capital raising whereby groups of people pool money, 
typically comprised of very small individual contributions, to support 
an effort by others to accomplish a specific goal. This funding 
strategy was initially developed to fund such things as films, books, 
music recordings, and charitable endeavors. At that time, the 
individuals providing the funding were more akin to contributors than 
``investors'' and were either simply donating funds or were offered a 
``perk,'' such as a copy of the related book. As these capital raising 
strategies did not provide an opportunity for profit participation, 
initial crowdfunding efforts did not raise issues under the Federal 
securities laws.
    Interest in crowdfunding as a capital raising strategy that could 
offer investors an ownership interest in a developing business is 
growing. Bills have been introduced that would provide an exemption 
from Securities Act registration for securities sold in crowdfunding 
transactions that meet specified requirements. Proponents of 
crowdfunding are advocating for exemptions from the Securities Act 
registration requirements for this type of capital raising activity in 
an effort to assist early stage companies and small businesses. For 
example, the Commission received a rulemaking petition requesting that 
the Commission create an exemption from the Securities Act registration 
requirements for offerings with a $100,000 maximum offering amount that 
would permit individuals to invest up to a maximum of $100. \20\
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     \20\ Petition from Sustainable Economies Law Center to SEC (July 
1, 2010), http://www.sec.gov/rules/petitions/2010/petn4-605.pdf. To 
date, the petition has received almost 150 comment letters, all in 
favor of the creation of such an exemption, with some offering 
different thresholds for offering size and/or individual investment 
limits. The comment letters are available at http://www.sec.gov/
comments/4-605/4-605.shtml.
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    The staff has been discussing crowdfunding, among other capital 
raising strategies, with business owners, representatives of small 
business industry organizations, and State regulators. For example, 
crowdfunding was discussed at the first meeting of the Advisory 
Committee on Small and Emerging Companies on October 31, 2011, and at 
the Commission's most recent annual Forum on Small Business Capital 
Formation on November 17, 2011. In January, the staff met with a group 
from the Small Business & Entrepreneurship Council advocating an 
exemption from registration requirements for crowdfunding offerings 
meeting specific requirements. In addition, in March the staff 
discussed crowdfunding with representatives from the North American 
Securities Administrators Association, the organization of State 
securities regulators.
    Current technology allows small business owners to easily access a 
large number of possible investors across the country and throughout 
the world as a source of funding to help grow and develop their 
businesses or ideas. This source of capital and the ease with which an 
individual can communicate with and access investors electronically 
presents an opportunity for smaller companies in need of funds.
    At the same time, of course, an exemption from registration and the 
investor protections provided thereby also would present an enticing 
opportunity for the unscrupulous to engage in fraudulent activities 
that could undermine investor confidence. \21\ As a result, in 
considering whether to provide an exemption from the Securities Act 
registration requirements for capital raising strategies like 
crowdfunding, the Commission needs to be mindful of its 
responsibilities both to facilitate capital formation and protect 
investors.
---------------------------------------------------------------------------
     \21\ Note that the antifraud provisions of the Federal securities 
laws continue to apply to any offering or sale of securities, even if 
an exemption from registration applies. In Fiscal Year 2010, offering 
frauds--cases where promoters, issuers or others defraud investors in 
the offer of securities--comprised 22 percent of the Commission's 
cases.
---------------------------------------------------------------------------
    The Commission's rules previously included an exemption, Rule 504, 
which allowed a public offering to investors (including nonaccredited 
investors) for securities offerings of up to $1 million, with no 
prescribed disclosures and no limitations on resales of the securities 
sold. \22\ These offerings were subject only to State blue sky 
regulation and the antifraud and other civil liability provisions of 
the Federal securities laws. In 1999, that exemption was significantly 
revised due in part to investor protection concerns about fraud in the 
market in connection with offerings conducted pursuant to this 
exemption. \23\ In assessing any possible exemption for crowdfunding, 
it would be important to consider this experience and build in investor 
protections to address the issues created under the prior exemption.
---------------------------------------------------------------------------
     \22\ See, Release No. 33-6949, Small Business Initiatives (July 
30, 1992), http://www.sec.gov/rules/final/6949.txt.
     \23\ See, Release No. 33-7644, Revision of Rule 504 of Regulation 
D, the ``Seed Capital'' Exemption (February 25, 1999), http://
www.sec.gov/rules/final/33-7644.txt (referencing ``disturbing 
developments'' in, among other things, initial Rule 504 issuances).
---------------------------------------------------------------------------
    Some of the questions to consider with regard to crowdfunding 
include:

    what limitations should be placed on the aggregate amount 
        of funds that can be raised by a company and invested by an 
        individual;

    what information--for example, about the business, the 
        planned use of funds raised, and the principals, agents, and 
        finders involved with the business--should be required to be 
        available to investors;

    how and to what extent should Web sites that facilitate 
        crowdfunding investing be subject to regulatory oversight;

    what restrictions should there be on participation by 
        individuals or firms that have been convicted or sanctioned in 
        connection with prior securities fraud;

    should a Commission filing or notice be required so that 
        activities in these offerings could be observed; and

    should securities purchased be freely tradable?

    Although the business venture may have a well-formulated plan and a 
committed entrepreneur, potential investors may have little information 
about the plan, its execution, or the entrepreneur behind the business. 
Investments in small businesses can be open to opportunism created by 
this information asymmetry. Although sophisticated investors with 
sufficient bargaining power may be able to negotiate protections for 
themselves in privately negotiated transactions, that opportunity is 
unlikely to be available in the crowdfunding context. Due to the nature 
of crowdfunding ventures, crowdfunding investors may have limited 
investment experience, limited information upon which to make 
investment decisions, and almost no ability to negotiate for 
protections. While the small amount of any crowdfunding investment may 
limit the extent of an individual's potential losses from any single 
investment, such losses may nevertheless be significant to the affected 
individual. These issues are among those that would need to be 
considered as a part of the cost-benefit analysis that the Commission 
would consider in connection with any future proposal.

Potential Increase in Offering Amount Permitted Under Regulation A
    Regulation A under the Securities Act provides an exemption from 
registration for transactions by nonreporting companies of up to $5 
million per year. The exemption requires an offering document to be 
filed with the SEC, which is subject to SEC staff review. The exemption 
sets forth information requirements that are simpler than those 
required in registered offerings, including allowing companies to 
provide the disclosure in a question and answer format, and allows 
companies to ``test the waters'' for interest in their offerings before 
they incur the full expense of preparing the Regulation A offering 
document. Unlike the private placement exemption, the Regulation A 
exemption permits a public offering that is not limited to particular 
types of investors, and the securities purchased are not transfer-
restricted under the Securities Act. Unlike registered offerings, 
companies that complete Regulation A offerings do not automatically 
become subject to ongoing reporting under the Exchange Act. Instead, 
reporting would be required only if the company has a class of 
securities listed on a national securities exchange or the company 
reaches the thresholds under Section 12(g) that require registration 
under the Exchange Act. Offerings conducted in reliance on Regulation A 
are not preempted from State registration under Section 18 of the 
Securities Act, and, thus, are subject to compliance with State 
securities laws in the States in which the company offers or sells the 
securities.
    Regulation A is not widely used. For example, in the fiscal year 
ended September 30, 2010, there were 25 initial Regulation A filings 
with the Commission and only three Regulation A offerings were 
qualified. Some have indicated that the $5 million annual cap reduces 
the utility of the Regulation A exemption and have advocated for an 
increase. The Regulation A offering limit was last raised in 1992, when 
it was increased from $1.5 million to $5 million. \24\ Others have 
noted the lack of State preemption, requiring issuers and 
intermediaries to qualify offerings under Regulation A in each State 
under applicable blue sky laws. Bills have been introduced in both the 
Senate and the House that would require the Commission to create a new 
exemption, which would be similar to Regulation A, but with certain 
additional conditions and a higher offering limit.
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     \24\ Regulation A was promulgated pursuant to Section 3(b) of the 
Securities Act, which allows the Commission to adopt rules exempting 
certain offerings, up to $5 million, if the Commission finds that 
``enforcement of this title with respect to such securities is not 
necessary in the public interest and for the protection of investors by 
reason of the small amount involved or the limited character of the 
public offering . . . .''
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    The ongoing review of the impact of our regulations on small 
business capital formation will include consideration of whether the 
Regulation A ceiling should be raised, including whether raising the 
ceiling would promote increased reliance on the exemption in a manner 
consistent with investor protection, and whether there are other 
impediments to use of the exemption that could be addressed by the 
Commission.

Conclusion
    In considering possible revisions to the Commission's rules, it is 
critically important that the staff gather data and seek input from a 
wide variety of sources, including small businesses, investor groups, 
and other members of the public. The data and input the staff receives 
should aid in the development of thoughtful recommendations for the 
Commission consistent with the goals of facilitating capital formation 
and protecting investors.
    Thank you again for inviting me to appear before you today. I would 
be happy to answer any questions you may have.
                                 ______
                                 
                 PREPARED STATEMENT OF JACK E. HERSTEIN
 President, North American Securities Administrators Association, Inc.
                            December 1, 2011

Introduction
    Good morning Chairman Johnson, Ranking Member Shelby, and Members 
of the Committee, I'm Jack Herstein, Assistant Director of the Nebraska 
Department of Banking and Finance, Bureau of Securities and President 
of the North American Securities Administrators Association, Inc. 
(NASAA). NASAA is the association of State and provincial securities 
regulators.
    State securities regulators have protected Main Street investors 
for the past 100 years, longer than any other securities regulator. 
State securities regulators continue to focus on protecting retail 
investors more so than any other regulator. Our primary goal and 
mission is to act for the protection of investors, especially those who 
lack the expertise, experience, and resources to protect their own 
interests.
    The securities administrators in your home States are responsible 
for enforcing State securities laws by pursuing cases of suspected 
investment fraud, conducting investigations of unlawful conduct, 
licensing firms and investment professionals, registering certain 
securities offerings, examining broker-dealers and investment advisers, 
and providing investor education programs and materials to your 
constituents.
    Ten of my colleagues are appointed by State Secretaries of State; 
five are under the jurisdiction of their States' Attorneys General. 
Some are appointed by their Governors and Cabinet officials. Some, like 
me, are employed by State government departments or State agencies. 
Others work for independent commissions or boards.
    States are the undisputed leaders in criminal prosecutions of 
securities violators. In 2010 alone, State securities regulators 
conducted more than 7,000 investigations, leading to nearly 3,500 
enforcement actions, including more than 1,100 criminal actions. 
Moreover, in 2010, more than 3,200 licenses of brokers and investment 
advisers were withdrawn, denied, revoked, suspended, or conditioned due 
to State action.

Investor Protection and Job Creation
    State securities regulators are acutely aware of the present 
economic environment and its effects on job growth.
    In Nebraska, I see and also hear about the recession's lingering 
impact on small business on a daily basis and these effects can be 
devastating. Neither I nor any other State securities regulator seeks 
to inhibit economic growth through regulation that is overly burdensome 
or restrictive. To the contrary, Nebraska and other States are 
committed to fostering responsible job growth through capital formation 
because we believe small businesses are indispensable to a strong 
economy.
    At the same time, as a securities regulator, I have for 34 years 
observed the profound and negative consequences of securities fraud and 
undisclosed investment risks on individuals and families, and on 
healthy and functional markets.
    In much the same way small business investment has the potential to 
be a very positive economic force and a major driver of wealth and jobs 
when done in the right way, such investment also has the potential to 
become a costly failure that undermines market health and discipline, 
and places middle income investors at an extreme risk if done without 
appropriate oversight. The key is balancing the legitimate interests of 
investors with the legitimate goals of entrepreneurs, and pursuing 
policies that are fair to both.
    The success of small business is, in many respects, America's 
success, and one of the things we will need to do to get America moving 
forward again is to encourage small business growth and 
entrepreneurship. In the midst of a prolonged period of high 
unemployment and slow economic growth, this appeal grows even stronger. 
Many of us have seen businesses disappear since the financial crisis, 
not due to the inability to compete, or due to shortcomings in their 
business plan or the goods and services they produce, but due to their 
inability to get loans from banks.
    The challenge for Congress today is to find policies that achieve 
the right balance between the objectives of promoting investment in 
valid business opportunities and protecting investors. Finding the 
right balance may be difficult, but the States stand ready to work with 
Congress and the SEC to ensure that this balance is achieved.
Principles for the Regulation of Small Business Investment
    Before I discuss specific proposals pending before the Committee, I 
want to outline the several overarching principles that inform NASAA's 
thinking in this important area.
    First, Congress should refrain from preempting State law. 
Preempting State authority is a very serious step and not something 
that should be undertaken lightly or without careful deliberation, 
including a thorough examination of all available alternatives.
    Securities regulation is a complementary regime of both State and 
Federal law. Several of the proposals under consideration by Congress 
would needlessly and capriciously preempt State law. The exact opposite 
is better public policy. A decrease of Federal regulation in this area 
may be appropriate, but the States should continue to have the 
authority and flexibility to provide appropriate oversight because 
small business capital formation is a matter of grave concern at the 
State level. State securities regulators have no interest in throwing 
up needless roadblocks for small businesses. In fact, we are interested 
in creative ways to spur economic development and job creation.
    Second, while Congress' desire to facilitate access to capital for 
new and small businesses is warranted, it must be sure do so in a 
careful and deliberate fashion.
    Expanded access to capital markets is beneficial only insofar as 
investors remain confident that they are protected, transparency in the 
marketplace is preserved, and their investments are legitimate. Such 
assurances promote investor confidence, which is the key to the growth 
that Congress wants to encourage. If investors have no faith that small 
business offerings are being regulated to their satisfaction, they will 
be unlikely to invest their capital in these companies, and our efforts 
to facilitate growth through providing additional avenues of capital 
formation by small business will be in vain.
    Third, Main Street investors should not be treated as the easiest 
source of funds for the most speculative business ventures. The law 
should not provide lesser protections to the investors who can least 
afford to lose their money.
    Some of the proposed legislation before the Committee would give 
unproven companies direct access to small, unsophisticated investors 
without being required to provide the normal types of financial and 
risk disclosures. If a company cannot get financing from a bank, an SBA 
loan, a venture capital fund, or even friends and family, it is 
probably because there is a significant risk that the investment is 
extremely risky. The critical questions are: Have these sources stopped 
funding small businesses? If so, why?
    The answers to these questions should dictate the universe of 
proposals Congress should entertain.
    If the answer is that funding is not available because banks are 
not lending as they should, or because traditional sources of small 
business capital are unavailable even to well-qualified, established, 
or very promising small business endeavors, then this has the potential 
to stifle small business growth and hurt the economy. Therefore, 
Congress might consider certain steps to minimize or remediate this 
needless loss of productivity.
    On the other hand, if the answer is that traditional sources of 
small business capital have reviewed the particular small business 
applicant and determined that the risk is too great, then we should not 
allow that applicant to seek investment from unsophisticated, ``mom and 
pop'' investors without appropriate investor protections. The typical 
retail investor, unlike the traditional small business financier, does 
not have the ability to conduct a reasonable investigation of a start-
up or development-stage entity.

NASAA Comments on Specific Legislation Pending Before the Senate
    In addition to the general priorities I articulated a moment ago, 
NASAA offers the following observations and suggestions regarding 
several bills that are now pending before the Senate and the Committee 
on Banking, Housing, and Urban Affairs.

I. Establishment of a Registration Exemption for ``Crowdfunding'' 
        Securities (H.R. 2930, S. 1791)
    Several bills recently introduced in the House and Senate would 
create a registration exemption for securities offerings made by 
``crowdfunding.'' Because there are important distinctions between each 
of these bills, I believe it is appropriate for NASAA to comment on 
them individually.
The Entrepreneur Access to Capital Act ( H.R. 2930)
    On November 3rd, 2011 the House of Representatives voted to pass 
H.R. 2930, the Entrepreneur Access to Capital Act, in a remarkable 
seven weeks after its introduction on September 14. The bill would 
create a new exemption from SEC registration for an offering amount up 
to $2 million ($1 million if the company does not have audited 
financial statements), with a maximum of $10,000 per investor (or 10 
percent of the investor's annual income). The bill would treat these 
offerings as ``covered securities'' thereby preempting State authority 
to register the securities.
    If this legislation is enacted in its current form, it will 
prohibit States from enforcing laws designed to minimize the risks to 
investors. By expressly preempting State law for the new crowdfunding 
exemption created under the legislation, it leaves a massive hole in 
the investor protection safety net. One of the fundamental tenets of 
securities law is that an investor is protected when the seller of 
securities is required to disclose sufficient information so that an 
investor can make an informed decision. Post-sale antifraud remedies 
provide little comfort to an investor who has lost a significant sum of 
money that is unrecoverable. This is a fundamental concern that States 
have had with H.R. 2930 since its introduction.
    NASAA recognizes the need for small businesses to access capital in 
innovative ways that reflect modern realities, but we believe the 
exemption that would be established by H.R. 2930 is far too broad. The 
thresholds for individual investment and aggregate offerings set by 
H.R. 2930 are far higher than those sought by most advocates of 
crowdfunding and, as a result, small investors are exposed to the 
danger of considerable losses in these highly risky investments. A 2009 
survey by the Employee Benefits Research Institute indicated that 53 
percent of American households had less than $25,000 in total savings 
and investments, \1\ so a $10,000 loss would be crippling to these 
households.
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     \1\ According to the Employee Benefits Research Institute's 2009 
Retirement Confidence Survey, 53 percent of workers in the U.S. have 
less than $25,000 in total savings and investments. http://
www.ebri.org/files/FS-03_RCS-09_Saving.FINAL.pdf
---------------------------------------------------------------------------
The Democratizing Access to Capital Act (Senator Scott Brown-S. 1791)
    The Democratizing Access to Capital Act differs from H.R. 2930 in 
several important respects. First, under S. 1791, individual 
investments in crowdfunding are limited to $1,000 per person, per year, 
with an aggregate offering cap of $1 million. In addition, S. 1791 
provides that in order to raise money through crowdfunding under a 
Federal exemption, the entity raising the money must be incorporated 
under, and subject to, State law, and a ``crowdfunding intermediary'' 
must be used.
    S. 1791 represents a considerable improvement from H.R. 2930. 
Indeed, S. 1791 is in many respects similar to the framework for a 
model State-level exemption for crowdfunding that is described below.
State Model Rule With Corresponding Federal Exemption
    NASAA firmly believes that the States should be the primary 
regulator of small business capital formation, including crowdfunding 
offerings. Based on the small size of the offering, the small size of 
the issuer, and the relatively small investment amounts, it is clear 
that the States have a more direct interest in these offerings. The 
States are in a better position to communicate with both the issuer and 
the investor to ensure that this exemption is an effective means of 
small business capital formation. The States will be most familiar with 
the local economic factors that affect small business and have a strong 
interest in protecting the particular investors in these types of 
offerings. Further, requiring the SEC to regulate these small, 
localized securities offerings is not an effective use of the agency's 
limited resources.
    In short, the oversight of these offerings should be done by State 
regulators.
    If regulatory authority is preserved for the States, NASAA will 
pursue the development of a model exemption for crowdfunding that uses 
many of the components of S. 1791. We have completed an initial draft 
of a model exemption that includes the following elements:

    An aggregate offering amount to $500,000 over a 12-month 
        period.

    Individual investments are limited to $1,000 per year, per 
        offering.

    It uses a one-stop filing in the State of the issuer's 
        principal place of business. The issuer must provide the home 
        State with contact information and other basic information 
        about the company, and the home State will share the 
        information with other States upon request.

    The issuer has the choice whether to use an intermediary or 
        not.

    To inform investors, the issuer must make basic disclosures 
        on its Web site, including its business plan and proposed use 
        of proceeds. Boilerplate language will be developed to provide 
        investors with important information about the general 
        investment risks of crowdfunding.

    The issuer will be required to escrow investor proceeds 
        until it reaches at least 60 percent of the target investment 
        amount.

    Individuals and companies that have criminal records or 
        have violated securities laws will be precluded from using the 
        exemption.

    State securities regulators fully understand the need for small 
businesses to raise capital and create jobs, and we are willing to 
accommodate small issuers by creating this very innovative type of 
exemption. But we also recognize that small business offerings are 
usually high risk, and there is the potential for significant fraud in 
this market. To maintain an appropriate balance between investor 
protection and legitimate capital formation, we believe it is crucial 
that the States keep their authority over these offerings. The States 
are the regulator positioned to provide a modicum of investor 
protection by ensuring that the company exists, that its principals are 
not bad actors, and that basic disclosures are made to our investors.

II. Removal of the Prohibition on General Solicitation in Regulation D 
        Offerings (H.R. 2940, S. 1831)
    On November 3rd, 2011, the House of Representatives voted to pass 
H.R. 2940, the Access to Capital for Job Creators Act. This 
legislation, along with identical companion legislation introduced in 
the Senate by Senator John Thune (S. 1831), would eliminate the ban on 
``general solicitation'' in nonpublic offerings.
    Current law requires that securities offerings to the general 
public be registered with the SEC. Regulation D was built upon the 
premise that certain offerings should be given special treatment 
because they are nonpublic, or ``private.'' This means that the 
investment is marketed only to people with whom the company has a 
preexisting relationship. Given their knowledge of the company and its 
operations, these investors are in a better position than the general 
public to gauge the risks of the investment. They, therefore, have less 
need for the protections that flow from the securities registration 
process. This concept of giving preferential treatment to private 
offerings is embedded throughout State and Federal securities law, and 
a reversal of this fundamental condition of Rule 506 would have far-
reaching repercussions.
    The removal of the ``general solicitation'' prohibition 
contemplated by H.R. 2940 and S. 1831 would represent a radical change 
that would dismantle important rules that govern the offering process 
for securities. However, because many States already allow issuers to 
use general advertisements to attract accredited investors, NASAA does 
not oppose outright the underlying goal of H.R. 2940.

H.R. 2940 as modified by the ``Garrett Amendment''
    NASAA believes it is critical to call the Committee's attention to 
an amendment to H.R. 2940 that was added to the bill during its 
consideration by the House Financial Services Subcommittee on Capital 
Markets. Unfortunately, in the course of its consideration by the 
House, an amendment sponsored by Representative Scott Garrett resulted, 
in the introduction of deeply problematic changes to H.R. 2940.
    As introduced, H.R. 2940 would have repealed only the ban on 
general solicitation of accredited investors in offerings made under 
Rule 506. The Garrett Amendment expanded application of the bill to 
Section 4(2) of the Securities Act. Thus, in its current form, H.R. 
2940 would amend Section 4(2) to provide an exemption for transactions 
``not involving any public offering, whether or not such transaction 
involve general solicitation or general advertising.'' Permitting the 
public solicitation of investors in an offering that, under law, is 
deemed a ``nonpublic'' offering is inconsistent. Therefore, NASAA 
respectfully suggests that a better approach would be to adopt an 
entirely new exemption under Federal law to permit general solicitation 
of accredited investors.

The MAIE as an alternative to H.R. 2940
    One alternative to H.R. 2940 would be to make Federal use of the 
Model Accredited Investor Exemption (MAIE), which already provides a 
way under State law for issuers to find accredited investors through a 
more public offering by allowing an issuer to use a general 
advertisement to ``test the waters'' for a proposed offering. \2\ There 
is no limit on the number of investors under the MAIE, and there is no 
limit on the amount an issuer may raise in an offering under the MAIE. 
Although only accredited investors may purchase securities offered 
through the MAIE, dissemination of the general announcement to 
nonaccredited investors will not disqualify the issuer from claiming 
the exemption.
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     \2\ The MAIE was adopted by NASAA in 1997 and has been adopted by 
the majority of States, but its utility is very limited because a 
corresponding Federal exemption has never been adopted by Congress or 
the SEC.
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    A Federal equivalent of the MAIE, with modifications to reflect 
modern modes of communication, would accomplish the goal of broadening 
issuers' access to accredited investors. NASAA believes this approach 
is far better than the approach of H.R. 2940, which undermines the 
``nonpublic'' foundation of Section 4(2) and Regulation D.
    If the Committee prefers to move forward with H.R. 2940, however, 
it should at a minimum remove the Garrett Amendment or section 2(a) of 
the bill. It is one thing to allow general solicitation of accredited 
investors within the confines of an offering otherwise conducted in 
accordance with Rule 506, but it's quite another to allow a general 
solicitation for all offerings made in reliance on Section 4(2).

III. Increase of the Limit on Regulation A Offerings From $5 Million to 
        $50 Million (H.R. 1070, S. 1544)
    On November 2, 2011, the House of Representatives voted to pass 
H.R. 1070, the Small Company Capital Formation Act. Identical companion 
legislation (S. 1544) has been sponsored in the Senate by Senator John 
Tester of Montana.
    Under current law, offerings conducted in accordance with 
Regulation A are subject to the registration requirements of State law. 
Given the risky nature of these offerings, NASAA believes State 
oversight is critically important for investor protection. However, we 
also recognize the cost and difficulty of the typical registration 
process, and the particular burden it places upon small companies, so 
we adopted a streamlined process for an issuer to use in an offering 
under Regulation A. We developed a ``Small Company Offering 
Registration'' form that uses a fill-in-the-blank and question-and-
answer format to guide a small issuer through the preparation of an 
adequate disclosure document.
    NASAA had significant concerns regarding the original version of 
H.R. 1070 because it stripped away investor protection by preempting 
State review of Regulation A offerings that are sold through broker-
dealers. However, Representative Schweikert agreed to remove the 
preemptive provisions of his bill prior to its passage by the House, 
and the counterpart bill sponsored by Senator Tester in the Senate 
never included such provisions.
    NASAA harbors some concerns regarding the dollar amount of 
potential offerings under H.R. 1070. Nonetheless, we believe that the 
States' ability to review these offerings, along with the SEC's proper 
exercise of discretion in creating reasonable reporting requirements 
for issuers, will prove to achieve a proper balance of the issuers' 
needs with investor protection. Accordingly, NASAA does not oppose H.R. 
1070 or S. 1544.

IV. Raise the Number of Shareholders of Record for Registration With 
        the SEC (H.R. 2167)
    Section 12(g) of the Exchange Act requires issuers to register 
equity securities with the SEC if those securities are held by 500 or 
more record holders and the company has total assets of more than $10 
million. After a company registers with the SEC under Section 12(g), it 
must comply with all of the Exchange Act's reporting requirements. \3\
---------------------------------------------------------------------------
     \3\ The reporting requirements include filing annual reports on 
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, 
and proxy statements on Schedule 14A.
---------------------------------------------------------------------------
    On October 24, 2011, the House Financial Services Committee voted 
to favorably report the Private Company Flexibility and Growth Act 
(H.R. 2167), which would raise the threshold for mandatory registration 
under the Securities Exchange Act of 1934 (the ``Exchange Act'') from 
500 shareholders to 1,000 shareholders for all companies. This bill 
would also exclude accredited investors and securities held by 
shareholders who received such securities under employee compensation 
plans from the 1,000 shareholder threshold.
    The States are primarily interested in the issues related to the 
regulation of small, nonpublic companies. We give considerable 
deference to the SEC in the regulation of public companies and 
secondary trading. However, we do have concerns about drastic changes 
in the thresholds for reporting companies or the information they must 
disclose. Investors and the markets depend upon access to information 
that public companies are currently required to disclose, and drastic 
changes could be disruptive and harmful.
    The question of an appropriate registration threshold should not 
just consider the cost to the issuer, but also the cost to investors 
and the impact on the integrity of the U.S. markets. Giving smaller 
companies the ability to disclose less information may be 
counterproductive because it could diminish investor confidence in the 
markets or drive investors to the larger companies that are required to 
be more transparent.
    The primary reason for requiring a company to be ``public'' is to 
facilitate secondary trading of the company's securities by providing 
easily accessible information to potential purchasers. The principal 
concern for States is the facilitation of this secondary trading market 
with adequate and accurate information. It may be possible to achieve 
this without full-blown Exchange Act registration and periodic 
reporting, but the States are wary of changes that may lead to the 
creation of less informed markets. Because the Exchange Act 
registration and periodic reporting requirements are designed to 
protect and inform purchasers in the secondary trading market, a 
company's obligation to become an Exchange Act filer should be based 
upon the need for liquidity in such a market. Determining this need 
requires an assessment of the potential activity in the secondary 
trading market. This activity is best measured by the count of 
beneficial holders, not record holders, and would include all 
accredited investors, employees, and crowdfunding investors, because 
they will be active in the secondary trading market.
    No matter what threshold number is chosen before a company becomes 
``public,'' it makes little sense to exclude any investor from the 
count of beneficial holders. Those that purchased from the issuer were 
protected by the requirements of the Securities Act. The Exchange Act, 
and Section 12(g), serves a different purpose--providing a trustworthy, 
truthful marketplace so that shareholders have liquidity and that 
secondary buyers have adequate information upon which to make their 
purchase decision. Accordingly, it makes no difference that the seller 
in this market is an accredited investor or an employee. Both the 
seller and the purchaser benefit from the robust marketplace 
facilitated by the Exchange Act registration.
    In short, the registration threshold should be based upon the need 
to provide for a legitimate secondary trading market. Regardless of 
where the threshold is set, everyone who is a potential seller in the 
market should be counted. This would include all beneficial owners, not 
just holders of record.

V. Raising the Threshold of Record Holders That Triggers Registration 
        for Banks and Bank Holding Companies (H.R. 1965, S. 556)
    On November 2, 2011, the House of Representatives voted to pass 
H.R. 1965, which would amend Section 12(g) of the Exchange Act by 
raising the threshold that triggers registration from 500 to 2,000 
record holders for banks or bank holding companies. The bill would also 
modify the threshold for deregistration under Sections 12(g) and 15(d) 
of the Exchange Act for a bank or a bank holding company from 300 to 
1,200 shareholders. The bill is a companion to a Senate bill (S. 556) 
by Senator Kay Bailey Hutchison (R-TX) and Senator Mark Pryor (D-AR).
    NASAA understands H.R. 1965 to be a bill designed to remedy a 
unique and specific problem that is today confronting certain community 
banks.
    Specifically, as a result of the increasing costs of public company 
registration, many community banks have determined that deregistration 
is in the best interests of their shareholders. But in order to 
deregister, community banks must have fewer than 300 shareholders. As a 
result, community banks must often buy back shares to deregister, which 
reduces the access of small banks to capital and deprives small 
communities of an opportunity to invest in local companies.
    Given the narrow scope of the bill and its application only to 
banks and bank holding companies, NASAA has not taken any position on 
H.R. 1965 or its Senate companion.

Conclusion
    As regulators, States are guided by the principle that every 
investor deserves protection and an even break and has the right to not 
be cheated or lied to. As we saw with the passage of NSMIA in 1996, 
State securities regulators have been handcuffed from reviewing certain 
offerings before they were sold to members of the public. 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 the National Securities Markets Improvement 
Act of 1996 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 outright fraud.
    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' interests is in the best interest 
of both groups. It protects the investors, and it facilitates the 
market for the issuers' securities. If the investors do not trust the 
small business issuer market, they will not invest.
    The States are ready to play an active role in balancing these two 
interests. We believe that reasonable registration or exemption 
provisions can be adopted that benefit only those issuers for which 
they are designed, disqualify ``bad boys,'' and provide for reasonable 
investor qualifications and protections. Further, we remain adamant 
that these provisions must preserve the ability of States to protect 
the interests of investors.
    Thank you again, Mr. Chairman, for the opportunity to testify 
before the Committee today. I will be pleased to answer any questions 
you may have.
                                 ______
                                 
               PREPARED STATEMENT OF JOHN C. COFFEE, JR.
    Adolf A. Berle Professor of Law, Columbia University Law School
                            December 1, 2011

    Chairman Johnson, Ranking Member Shelby, and fellow Members of the 
Committee, I am happy to be here today and appreciate the balanced 
approach that the title for these hearings reflects. We want at the 
same time to spur job growth and minimize any sacrifice of investor 
protection. I support the intent of the bills now pending before the 
Senate to facilitate smaller offerings at low cost (particularly S. 
1544 and S. 1831). Still, without some changes (which are essentially 
modest), one of these bills (S. 1791) could well be titled ``The Boiler 
Room Legalization Act of 2011.'' Of even greater concern to me is the 
overbreadth inherent in S. 1824, which pushes up the threshold at which 
an issuer must become a ``reporting company'' and make periodic 
disclosures to the market to 2,000 shareholders of record. I can 
understand the case for increasing the threshold under Section 12(g), 
but the problem with the approach taken is that record ownership is 
easily manipulated and companies could come to have 5,000 or more 
beneficial shareholders (and billions in stock market capitalization) 
without becoming subject to the increased transparency of the 
Securities and Exchange Act of 1934. There is no need for such an open-
ended exemption (largely benefiting larger firms) or for such a 
dramatic retreat from the principle of transparency that has long 
governed our securities markets in order to spur job creation at 
smaller firms.

I. Introduction
    In a nutshell, let me define the contours of the dilemma. There is 
considerable reason to believe that smaller businesses 
disproportionately create jobs. But smaller businesses have been 
increasingly shut out from access to the public equity markets. 
Although smaller IPOs (usually defined as IPOs of under $50 million) 
once accounted for as much as 80 percent of all IPOs, that pattern 
changed abruptly in the late 1990s. Since then, smaller IPOs (again 
defined as those seeking to raise less than $50 million) have 
constituted less than 20 percent of the number of all IPOs. \1\ This 
pattern is unlikely to change. Much as some wish we could turn the 
clock back to the mid-1990s, the smaller IPO has largely disappeared 
for a variety of reasons, including:
---------------------------------------------------------------------------
     \1\ See, Statement of David Weild before the House Financial 
Services Committee, Subcommittee on Capital Markets and Government 
Sponsored Enterprises, on March 18, 2011. See, also, Grant Thornton, 
``Stock Markets, Capital Formation and Job Creation Under Attack'' 
(2011).

  1.  There are high fixed costs to an IPO. The greater the size of an 
        offering, the less these fixed costs--for lawyers, accountants, 
        offering expenses, etc.--represent as a percentage of the total 
        offering. Hence, small IPOs are an economically inefficient way 
---------------------------------------------------------------------------
        to raise capital;

  2.  Institutional investors are the primary buyers of IPOs, but 
        institutional investors want secondary market liquidity, and 
        they can rarely obtain such liquidity unless the market 
        capitalization of the IPO issuer is equal to $500 million or 
        more;

  3.  The market infrastructure that supported smaller IPOs, including 
        multiple securities analysts following and supporting the 
        stock, is largely gone, and smaller IPOs may not be followed by 
        any analyst; and

  4.  The retail public still remembers the Internet bubble of 2000 and 
        the Enron/WorldCom scandals of 2001-2002. Once investor 
        confidence is lost (because of conflicted analysts, offering 
        hyperbole, and dubious financial statements), it is not easily 
        recovered.

    A final reason why smaller IPOs have declined is that smaller 
issuers have found it easier, quicker, and less costly to raise capital 
in the private markets than in the public markets. Smaller issuers 
prefer to avoid the higher liability and greater SEC oversight that is 
associated with public offerings. Accelerating this shift from public 
to private markets was the gradual relaxation of SEC Rule 144's holding 
period for ``restricted securities'' issued in private placements. In 
early 1997, the SEC amended Rule 144 so that the purchaser of 
``restricted securities'' could resell them into the public market 
after an only one year holding period (as opposed to the prior two year 
holding period rule), and almost immediately thereafter smaller public 
offerings fell off dramatically, crashing from over 75 percent of the 
number of all IPOs in 1996 to less than 20 percent in 1998.
    This shift toward the private market has continued and accelerated. 
In 2010, SEC Commissioner Elisse Walter estimated last month that over 
$900 billion in securities were sold pursuant to Regulation D (which is 
the primary SEC rule exempting private placements from registration 
under the Securities Act of 1933). Similarly, the SEC's Chief Economist 
has recently estimated that, since the beginning of 2009, there have 
been some 37,000 Regulation D offerings reported to the SEC \2\ (and in 
all likelihood this underestimates the use of Regulation D because many 
such offerings are not reported to the SEC). The median size of these 
offerings was approximately $1 million. Thus, the implication seems 
clear: smaller issuers have displayed a marked preference for private 
offerings, and this preference is likely to persist.
---------------------------------------------------------------------------
     \2\ See, Craig Lewis, ``Unregistered Offerings and the Regulation 
D Exemption'' (2011) (Powerpoint slides).
---------------------------------------------------------------------------
II. The Pending Bills
    This introduction sets the stage for my comments on the bills 
before this Committee. Basically, I believe that S. 1544 and S. 1831 
are useful efforts to facilitate exempt offerings. Although I have some 
skepticism about whether they will significantly increase or expedite 
the raising of capital, they do not sacrifice investor protection. In 
contrast, S. 1791 is an innovative effort to facilitate the raising of 
small amounts of capital from retail investors. Although we all want to 
be Internet-friendly, S. 1791, in its present form, seems likely to 
invite a significant amount of fraud that could, over the longer run, 
stigmatize those attempting to market smaller offerings. Still, with 
some adjustments that would not raise the costs of such an offering 
procedure, I believe that the potential for fraud and ``boiler room'' 
marketing could be substantially curtailed. Finally, S. 1824 seeks to 
delay the point at which smaller companies must become ``reporting'' 
companies under the Securities Exchange Act. This is understandable, 
but the approach it takes is overbroad and it could permit some very 
large companies (i) to avoid the transparency and periodic disclosure 
mandated by the Securities Exchange Act, or (ii) to ``go dark'' (that 
is, cease to become reporting companies), even though they had already 
become reporting companies and had a significant market 
capitalizations, shareholder populations, and trading volumes. This is 
unnecessary, but again a small revision could reduce this potential, 
while still enabling smaller companies to avoid these costs.
    A. S. 1544 (The Small Company Capital Formation Act of 2011). This 
legislation raises the ceiling on the exemption for small issues under 
Section 3(b) of the Securities Act of 1933 from $5 billion to $50 
million. This provision strikes me as balanced and well-crafted because 
at the same time as it raises the ceiling under Section 3(b), it adds 
additional investor protections, including (1) a clearly specified 
litigation remedy (Section 12(a)(2)); and (2) audited financial 
statements. As before, an offering statement would be filed with the 
Commission, and periodic disclosure would be required to the extent 
that the Commission directs.
    In sum, investors receive (1) SEC oversight; (2) a detailed 
disclosure document; (3) continuing periodic disclosure; and (4) a 
negligence-based litigation remedy that roughly approximates the remedy 
that they would receive in a registered public offering.
    Two aspects of S. 1544 do give me some concern. First, Section 2(b) 
of S. 1544 would deem securities sold in certain offerings under 
Section 3(b) to be ``covered securities'' and hence exempt from 
registration with State ``Blue Sky'' commissioners (at least if the 
securities are sold to a ``qualified purchaser'' as defined by the 
SEC). It is unclear how the Commission will use this authority (and the 
Commission could preclude offerings to unsophisticated investors as the 
price of escaping Blue Sky regulation). Although I recognize that 
smaller offerings tend to fly under the SEC's radar screen and to be 
principally monitored by the Blue Sky commissioners, S. 1544 does 
permit these Blue Sky commissioners to retain their antifraud authority 
under Section 18(c) of the Securities Act. Thus, it is only their 
authority to require registration of the offering that is preempted. 
This presents a close question.
    In evaluating whether it is desirable to preempt State registration 
of offerings under Section 3(b), this Committee may want to consider 
the very limited incentive that today exists to use this Section 3(b) 
exemption. I have been advised by SEC staffers that in 2010 only seven 
offerings went effective under Regulation A (which is based on Section 
3(b)). Most issuers saw Section 3(b) as unattractive (in comparison to 
a private placement under Regulation D) both because of Section 3(b)'s 
low ceiling (i.e., $5 million) and the need to file an offering 
document that is reviewed by the SEC. Raising the ceiling to $50 
million does not necessarily imply that this provision, as revised, 
will be more attractive than Rule 506 under Regulation D (which has no 
ceiling on the amount that may be offered and does not require SEC 
approval of the offering document). I suspect that Regulation D will 
remain far more popular than Regulation A, even with the revised 
ceiling on Regulation A. In this light, preempting State registration 
of Regulation A offerings may represent an additional, but small, step 
towards increasing the attractiveness of a Regulation A offering. 
Unlike Regulation D, Regulation A offerings may today be marketed to 
retail investors (and without any limit on their number), and a general 
solicitation of investors is possible. Thus, its use could increase, 
but frankly I am skeptical that there will be any dramatic rise in its 
use.
    A second concern relates to the authority given the SEC by Section 
2(a)(5) of S. 1544, which authorizes the Commission to increase the 
ceiling on the Section 3(b) exemption and instructs the Commission to 
review this matter every two years. This authority is open-ended, and 
conceivably a future Commission could increase the Section 3(b) ceiling 
from $50 million to $500 million. I suggest it would be advisable to 
limit this authority to some form of inflation indexing.
    B. S. 1831 (the ``Access to Capital for Job Creators Act''). I 
believe this to be the least controversial of the bills now pending 
before this Committee. Its intent is to simplify the private placement 
process and allow issuers to contact a broader range of investors by 
eliminating the existing ban on general solicitation (at least in cases 
when only accredited investors are solicited). See, SEC Rule 502(c) 
(prohibiting a general solicitation or general advertising under Rules 
505 and 506 of Regulation D). This idea is hardly radical, as the SEC 
in past years has discussed the possibility of deleting the general 
solicitation prohibition. The rationale for this change would be the 
same that governs in the NBA: ``No Harm, No Foul.'' Accredited 
investors are deemed to be sophisticated, and thus a general 
solicitation of them harms no one--in theory.
    Of course, this theory may be overbroad in that many accredited 
investors are unsophisticated and even naive. The standard for an 
accredited investor is only $1 million in net worth or a $200,000 
income for the most recent 2 years (see, SEC Rule 501(a)(5) and (6)). 
Thus, much of the American middle class is reached by this term. 
Nonetheless, this proposed revision will simplify private placements 
and allow smaller issuers to reach more investors at low cost. In that 
sense, its benefits may exceed its costs.
    But there is a serious problem with the drafting of S. 1831, at 
least if the intent is simply to allow a general solicitation of 
accredited investors. Section 2(a) of S. 1831 would revise Section 4(a) 
of the Securities Act of 1933 to read as follows:

        (a) transactions by an issuer not involving any public 
        offering, whether or not such transactions involve general 
        solicitation or general advertising.

    Section 2(b) then instructs the SEC to revise its rules to permit a 
general solicitation in connection with a Rule 506 ``provided that all 
purchasers of the securities are accredited investors.''
    The problem here is that Section 2(a) covers with a blanket what 
Section 2(b) wants the SEC to cover only with a napkin. The plain 
meaning of the language of Section 4(2), as revised by Section 2(a) of 
S. 1831, is to permit a general solicitation in all private placements, 
including those not restricted to accredited investors. Both the 
Supreme Court and the D.C. Circuit Court of Appeals have shown, time 
and time again, that they will focus on the plain meaning of the 
statutory language and ignore legislative history.
    Thus, I would suggest that, if Section 4(2) is to be revised at all 
(and a statutory revision of it is not really necessary, given Section 
2(b)), it should be amended to read:

        (a) transactions by an issuer not involving any public 
        offering, including transactions involving a general 
        solicitation or general advertising to the extent such 
        solicitation or advertising is permitted by rules or 
        regulations adopted by the Commission.

    The Commission could still be instructed by Section 2(b) as to how 
to exercise its discretion in this regard. Alternatively, no change 
need be made at all in Section 4(2) of the Securities Act, as Section 
2(b) alone should be sufficient.
    C. S. 1791 (Democratizing Access to Capital Act of 2011). This bill 
has an innovative premise: namely, to allow issuers to solicit retail 
investors through the Internet without providing any meaningful 
disclosure document and without prior SEC oversight, so long as the 
amount that may be sold to each investor is small. Under S. 1791, no 
individual investor could invest more than $1,000 in such an offering. 
\3\ Presumably, such offerings would remain subject to Rule 10b-5 
(because no antifraud exemption is provided).
---------------------------------------------------------------------------
     \3\ The House bill, however, provides a $10,000 ceiling on 
individual investor purchases.
---------------------------------------------------------------------------
    Because the maximum aggregate amount that may be raised in any 12-
month period is $1 million, this exemption is likely to be used 
primarily by early stage issuers that do not yet have an operating 
history or, possibly, even financial statements. Such issuers are in 
effect flying on a ``wing and a prayer,'' selling hope more than 
substance. Precisely because of this profile, however, such offerings 
are uniquely subject to fraud, and some issuers will simply be phantom 
companies without any assets, business model, or real world existence.
    To enable these early stage issuers to seek small investors, S. 
1791 confers both an exemption from offering registration under Section 
5 of the Securities Act and an exemption from broker registration under 
the Securities Exchange Act. Of these two exemptions, the latter should 
be of greater concern, because it offers unparalleled opportunities for 
the traditional boiler room operation to reemerge.
    To understand this point, let's focus on how fraudsters could most 
easily exploit this exemption from broker-dealer registration. 
Unlicensed salesmen (some of whom might have been banned for life from 
the securities industry) could set up shop and solicit potential 
investors by phone, email, or face-to-face contacts. They could create 
very short profiles of phantom companies, display them on a Web site, 
invite customers to view them, and then seek ``hard sell'' follow-up 
meetings. Even though a single customer could not invest more than 
$1,000 in any single company, such a customer could be induced by 
salesmen to invest in five or six different companies. The salesmen's 
motivation could be either to pocket the entire proceeds received from 
the investors (telling them, if later questioned, that the business 
failed) or to deduct an inflated sales commission from the investor's 
payment for shares.
    How is the prospect for such fraud best limited without also 
precluding a ``crowdfunding'' solicitation? I suggest the best strategy 
is two pronged: (1) keep the Web site (or ``crowdfunding intermediary'' 
in S. 1871's terminology) largely passive; that is, do not permit to 
engage in any active solicitation beyond display of the issuer's 
offering materials on its Web site; and (2) require those who engage in 
active solicitation of investors (by any means other than a passive Web 
site) to register as broker-dealers. Thus, the ``broker and dealer 
exemption'' in Section 7 of S. 1791 should be limited so that it 
applies to a Web site that does not itself allow its employees to 
solicit sales or that does not pay outside agents to do so. The issuer 
could, of course, pay agents to solicit, but they would have to be 
registered brokers. This approach allows a ``crowdfunding 
intermediary'' to serve as a conduit for the issuer's offering 
materials without registration as a broker, but it confines this 
unregistered intermediary to a passive role. Active selling would be 
limited to registered brokers (who are subject to the oversight of 
FINRA and SEC rules regarding brokers).
    Failure to adopt this approach (or some similar variant) would 
likely mean that every barroom in America could become a securities 
market, as some unregistered salesman, vaguely resembling Danny DeVito, 
could set up shop to market securities under the ``crowdfunding 
exemption.'' Under the current version of S. 1791, such a person could 
open his laptop on the bar, show slides of a half dozen companies to 
the bar's patrons, and solicit sales. This will create few jobs (except 
for dubious unregistered salesmen) and much fraud.
    If this Committee decided that it wanted to restrict active 
securities solicitations by a ``crowdfunding intermediary,'' the 
simplest way to do so would be to expand the proposed language in 
Section 7 of S. 1791, which language would amend Section 3(a)(4) of the 
Securities Exchange Act of 1934. Proposed Section 3(a)(4)(G)(ii)VII 
could be revised to read:

        (VII) does not (a) offer investment advice or recommendations, 
        (b) solicit purchases, sales, or offers to buy the securities 
        offered or displayed on its Web site or portal, or (c) 
        compensate employees, agents, or other third parties for such 
        solicitation or based on the sale of securities displayed or 
        referenced on its Web site or portal.

    This language is intended to permit an exempt intermediary to 
display the issuer's offering materials but not otherwise to solicit 
sales, leaving that task for registered brokers.
    One last comment about the proposed ``crowdfunding exemption'': the 
existing language in S. 1791 does not address the SEC's integration 
doctrine. An issuer who utilizes proposed Section 4(6) to make a $1 
million offering might cause the issuer to sacrifice its ability to 
make an exempt offering under some other exemption for a period 
beginning 6 months before the start of, and extending until 6 months 
after the end of, the crowdfunding offering. See SEC Rule 502(a) 
(defining the general contours of the integration doctrine and 
employing a 6 month safe harbor before and after the offering). See 
also Securities Act Release No. 33-4552 (November 6, 1962). To prevent 
this, a section might be added to S. 1791 instructing the Commission to 
adopt rules to ensure that use of the ``crowdfunding exemption'' in 
Section 4(6) will not cause the issuer to forfeit other exemptions.
    D. S. 1824 (the ``Private Company Flexibility and Growth Act''). 
This bill is intended to delay the point at which a company must become 
a ``reporting'' company under Section 12(g) of the Securities Exchange 
Act (and thus required to make periodic disclosures to the market on at 
least a quarterly basis). Specifically, it would raise the limit from 
500 shareholders of record (on the last day of the issuer's fiscal 
year) to 2,000 such record holders (as of the same moment). The offered 
rationale for this change is, at least in part, that many private 
companies have been delayed in their ability to consummate an IPO, and 
this delay has forced their employees holding stock options to either 
exercise (and become shareholders of record) or let the options expire. 
As a result, some private companies (most notably Facebook) are 
approaching the 500 shareholder limit before their likely IPO date.
    There are several obvious solutions to this problem. First, one 
could simply exempt securities held by employees from this computation, 
and Section 3 of S. 1824 does this. Second, shareholders in these 
companies could hold shares beneficially (and not of record) by using a 
broker or bank as an intermediary. Such ``street name'' ownership is 
today the prevalent mode of ownership in public companies.
    The problem with expanding the threshold for reporting status under 
Section 12(g) of the Securities Exchange Act is that record ownership 
is outdated--in effect, a relic of a bygone era. Using a 2,000 
shareholder of record ceiling would enable some companies to remain 
``dark'' (i.e., not to enter the SEC's continuous disclosure system), 
even if they had total assets in the billions of dollars and possibly 
10,000 beneficial shareholders. In short, companies could exploit this 
provision by insisting that shareholders hold their stock only in 
``street name'' (or by repurchasing the shares of those unwilling to do 
so).
    In addition, proposed Section 5 of S. 1824 would permit a bank or 
bank holding company that was already a ``reporting'' company to 
deregister under Section 12(g)(4) of the Securities Exchange Act (and 
thus ``go dark'' in the parlance) if it could cause the number of its 
shareholders to fall below 1,200 shareholders of record. Again, this 
could be manipulated by inducing shareholders to hold in street name.
    The Federal securities laws have insisted upon transparency on the 
part of a company with a substantial number of shareholders since 1964. 
In 1964, ``shareholders of record'' was a meaningful concept; today it 
no longer is. The proposed language is a threat to that principle of 
transparency. Put simply, ``going dark'' invites bad things: 
undisclosed self-dealing, conflicts of interest, etc. Some companies 
might also wish to go dark to avoid the Foreign Corrupt Practices Act 
(some of whose provisions apply only to reporting companies).
    I do not suggest that the 500 shareholder threshold is immutable 
and cannot be revised. The real problem is that the ``shareholder of 
record'' concept is archaic and can be gamed. A superior test would 
look to the size of the company's ``public float'' (i.e., the value of 
the securities held by nonaffiliates) in order to determine whether the 
company should enter the SEC's continuous disclosure system. This 
public float test has been used by the SEC in determining eligibility 
for Form S-3 and is easily calculated. Although it is impractical to 
compute the number of a company's beneficial holders, it is very simple 
to compute its ``public float.'' Under such a test, it would make no 
difference whether shares were held beneficially or of record. But the 
value of stock held by affiliates and controlling persons would not be 
counted, thus permitting family controlled companies to remain private.
    Of course, a compromise is possible here: a shareholder of record 
test could be used, subject to a proviso that a company with a 
specified market capitalization held by nonaffiliated shareholders 
would still have to become a reporting company. Thus, the relevant 
lines in Section 12(g)(1) of the Securities Exchange Act might require 
an issuer to register under it when:

        the issuer has total assets exceeding $10,000,000 and a class 
        of equity securities (other than an exempted security) held of 
        record by 2,000 persons; provided however, that, without regard 
        to the number of its shareholders of record, an issuer with a 
        class of equity having a market value on the last day of its 
        fiscal year (excluding for this purpose the value of such 
        shares held by affiliates of the company) in excess of $[500 
        million] shall be required to register under this section 
        within 120 days after the end of such fiscal year.

    This approach simply says that at some point a company which has 
successfully kept its shares in beneficial ownership through the use of 
brokers or other intermediaries will still have to register and become 
a ``reporting'' company. My use of a $500 million threshold is simply 
for purposes of illustration (as, I believe, few could quarrel with a 
threshold that high).
                                 ______
                                 
             PREPARED STATEMENT OF CHRISTOPHER T. GHEYSENS
    Executive Vice President and Chief Financial and Administrative 
                          Officer, Wawa, Inc.
                            December 1, 2011

I. Introduction
    Chairman Johnson, Ranking Member Shelby, and distinguished Members 
of the Committee, thank you for holding this hearing on what I believe 
are two of the most pressing issues our Nation faces, job creation and 
capital formation. My name is Christopher (Chris) T. Gheysens. I am 
currently Executive Vice President and Chief Financial and 
Administrative Officer, for Wawa, Inc. (Wawa). I have been selected to 
become Wawa's next President and Chief Executive Officer effective in 
the next year. I am here today to testify on behalf of Wawa.
    As Chief Financial and Administrative Officer for Wawa, my primary 
responsibilities include leading all aspects of the Financial, Legal 
and Human Resource functions. I became CFO in January 2006 and have 
worked at Wawa for over 14 years, previously holding positions of 
Director of Planning & Analysis and Retail Accounting Manager.
    Prior to joining Wawa, I worked in the audit practice at Deloitte 
LLP in Philadelphia. During my 4 years with Deloitte, I focused 
primarily on the retail industry, serving clients such as Reading China 
and Glass, The Wall Music, The Pep Boys, and Wawa.
    I graduated from Villanova University with a Bachelor of Science 
degree in Accountancy in 1993. I obtained a Master's of Business 
Administration from Saint Joseph's University and am a Certified Public 
Accountant in New Jersey.
    I have been an active member of the Board of Directors and Finance 
Committee for the Southeastern Pennsylvania Chapter of the American Red 
Cross since June 2009.
    While I understand the Committee will examine several bills related 
to job creation and capital formation, and I support the purpose behind 
these bills, I am here to speak specifically to Wawa's support for S. 
1824, the Private Company Flexibility and Growth Act, introduced by 
Senators Toomey and Carper. This legislation is cosponsored by Senators 
Warner, Kirk, and Johanns, who are also Members of this Committee, as 
well as Senator Scott Brown.
    I would like to thank Senator Toomey and all of the Members of the 
Committee who have cosponsored S. 1824. Wawa is encouraged by the 
strong bipartisan support of this legislation that will benefit all 
Americans in this time when job creation and economic stimulus are most 
critical.

II. Wawa Information and History
    Wawa is headquartered in Senator Toomey's home State of 
Pennsylvania, in an area that is 20 miles southwest of Philadelphia. 
Wawa is a privately held company that was founded over 200 years ago by 
the Wood family as an iron foundry in New Jersey. Toward the end of the 
19th century, owner George Wood took an interest in dairy farming and 
the family began operating a small dairy in Wawa, Pennsylvania. As home 
delivery of milk declined, Grahame Wood, George's grandson, opened the 
first Wawa Food Market in 1964 as an outlet for our dairy products, the 
same year that the 500 shareholder limit was put in place. This year 
marked our 47th year in the retail business. Throughout our history, we 
have maintained several deeply held beliefs, not the least of which are 
to remain a privately held company and to promote shared ownership with 
our associates. Private ownership allows us to take a long-term point 
of view and make long-term investments to ensure our business is 
sustainable. The founding family has always believed in sharing 
ownership with our associates. The belief in shared ownership is a part 
of Wawa's DNA and fosters an ownership mentality in our associates, 
creating a significant competitive advantage by having ``owners,'' not 
employees.
    We are considered one of the most successful privately held 
companies in America, having evolved into a regional convenience store 
chain with over 590 stores in Pennsylvania, New Jersey, Virginia, 
Delaware, and Maryland, three of which are the home States of Members 
of this esteemed Committee, Senators Toomey, Menendez, and Warner. Wawa 
employs approximately 18,000 associates. Wawa also recently broke 
ground for our first store in Florida, with plans to construct as many 
as 100 stores in Florida over the next 5 years, expending over $500 
million in Florida alone and creating approximately 3,000 new jobs at 
Wawa in the local economy.
    Through the years, Wawa has consistently invested in the 
communities in which we operate. Our stores represent long-term 
investments, and our growth has fueled the success of other businesses 
and organizations in the community. Wawa's connection with the 
community goes well beyond that of a typical business. Being a good 
neighbor and recognizing our responsibility to the communities in which 
we live and work is an equally important part of our business. Every 
year, we commit millions of dollars in contributions in financial 
grants from the Wawa Charities Fund, we conduct in-store fundraising 
campaigns that have a significant, positive impact on regional and 
local charities and we support numerous special events through product 
donations and volunteering.

III. The Private Company Flexibility and Growth Act
    I would like to commend this Committee for its consideration of the 
Private Company Flexibility and Growth Act. This legislation would 
amend the Securities Exchange Act of 1934 (the ``Act'') to increase a 
shareholder registration threshold that has not been updated since 
1964. While the United States has undergone vast changes since 1964, 
including Wawa's dramatic expansion from one store to nearly 600, this 
shareholder threshold has stayed the same. This proposed legislation 
will provide companies the flexibility to remain privately held, while 
continuing to grow and remain strong drivers of economic development 
and prosperity.
    Section 12(g) of the Act requires a company to register its 
securities with the U.S. Securities and Exchange Commission (the 
``SEC'') if it has more than 500 shareholders of record and assets 
exceeding $10 million. As Wawa has grown and its shareholder base has 
increased, we recognize that the 500 shareholder limit will cause our 
organization to face a significant issue in the not-so-distant future, 
in that we will be required to choose between becoming a public 
reporting company and initiating a costly, time consuming corporate 
restructuring. Our culture of shared and private ownership would guide 
us to choose the costly restructuring at the expense of future growth.
    The Toomey/Carper Private Company Flexibility and Growth Act would 
raise the existing 500 shareholder threshold to 2,000 shareholders 
before a company would be required to register under the Act. The bill 
would also exempt shares awarded to employees pursuant to compensation 
plans from this registration threshold. Wawa believes this legislation 
is worthy of your support because it would provide additional 
flexibilities to a variety of companies, some like Wawa that are well 
established, and others that are not. I am confident that the 
additional flexibility offered to privately held companies under the 
proposed legislation will allow such companies to use scarce resources 
on research and development, new store growth and job creation, rather 
than on regulatory compliance costs. In summation, by updating this 
almost five-decade old threshold, Congress will take needed steps to 
foster continued growth for private companies, like Wawa, allowing them 
to continue to add jobs, build new stores and be strong economic 
drivers.
    Wawa, like many other privately held companies, has made the 
strategic decision to remain private for competitive and cultural 
reasons. Based on Wawa's 200-plus years of experience, the company has 
seen that privately held companies can focus on long-term results, 
rather than being concerned solely with short-term results in order to 
meet Wall Street analysts and other third-party expectations. This 
long-term focus by privately held companies, in turn, can create 
prosperity throughout the economy through growth, innovation, and 
investment, and has a multiplier effect on suppliers, builders, 
contractors, and vendors that support their businesses.
    In the case of Wawa, we believe that we are creating value for our 
customers, more sustainable growth for our company and a more stable 
working environment for our associates. Specifically, it is our belief 
that privately held companies are able to create more generous benefit 
packages for their employees, since they do not have to be as concerned 
with short-term earnings. In fact, during the most recent recession and 
extended period of weak corporate and overall economic growth, Wawa has 
been able to maintain generous compensation and benefits, while 
avoiding layoffs because of our long-term view.
    In addition, privately held companies are more likely to have 
Employee Stock Ownership Plans (ESOPs), which enable employees to share 
in the growth of the company by having a personal financial stake in 
the business. This, in turn, creates a more engaged employee since they 
benefit directly from the company's success. Wawa also provides senior 
level management equity through stock-based compensation plans. These 
plans allow Wawa to attract and retain talented associates that help 
drive growth and, ultimately, create jobs. Our ability to utilize this 
form of compensation becomes limited as we approach the 500 shareholder 
limit. One manner in which to address the 500 shareholder limit is the 
implementation of a reverse stock split. Such a mechanism would take as 
much as $40 million of capital away from new store growth and likely 
eliminate as shareholders many of the associates these plans are 
designed to attract and retain.
    Public reporting companies in the U.S. are required to meet 
financial reporting requirements associated with SEC reporting. A 2007 
law firm study of public company compliance costs indicates that the 
average annual cost of compliance for companies with under $1 billion 
in annual revenue could approach $2.0 million or more. A privately held 
company has no such requirements, enabling it to invest the funds it 
would otherwise pay in the form of very expensive professional fees 
into capital assets and job creating activities. We recognize that 
raising the shareholder limit could add to the pool of the investing 
public who would not, by regulation, have access to certain basic 
financial disclosure.
    We value and understand the need to provide shareholders current 
financial information. This is consistent with our culture of sharing 
ownership and treating our associates as owners. At Wawa, we provide 
our shareholders and associates access to quarterly financial updates 
and detailed annual financial reports that keep them informed of our 
company's progress and health.

IV. Conclusion
    We have always believed that being privately held is better for our 
associates, our shareholders, and our company's long-term growth. Our 
culture of teamwork and our family atmosphere is a direct reflection of 
our private ownership and heritage. The short-term pressures and 
interference of a third party are not consistent with our values or the 
culture that has enabled us to flourish for more than 200 years. 
Without an increase in the shareholder limitation, Wawa would need to 
take a significant amount of capital away from activities that will 
drive job creation and economic growth for our communities.
    We hope to have the flexibility needed to be able to continue to 
grow, add jobs and be an economic driver in our communities for another 
200 years.
    Thank you again for the opportunity to testify today. I look 
forward to answering any questions that the Committee Members may have.
                                 ______
                                 
                   PREPARED STATEMENT OF SCOTT CUTLER
Executive Vice President and Co-Head, U.S. Listings and Cash Execution, 
                             NYSE Euronext
                            December 1, 2011

    Chairman Johnson, Ranking Member Shelby, Members of the Committee: 
My name is Scott Cutler, Executive Vice President of NYSE Euronext--the 
world's leading and most diverse exchange group with equities, futures 
and options markets throughout the United States and Europe. I 
appreciate the opportunity to testify today regarding ways to stimulate 
job growth and innovation through capital formation while protecting 
investors.
    Young, innovative, emerging growth companies are the engines of job 
creation, and access to capital through initial public offerings is key 
to allowing these innovative companies to grow and hire new employees. 
From 1980 to 2005, firms less than 5 years old accounted for all net 
job growth in the U.S. For those companies that ``go public,'' 92 
percent of job growth occurs after the company's IPO, and most of that 
within the first 5 years after the IPO. \1\ Clearly, an IPO provides 
these young and growing companies an opportunity to expand their 
business and hire more workers.
---------------------------------------------------------------------------
     \1\ Venture Impact Study 2010 by IHS Global Insight. http://
www.nvca.org/
index.php?option=com_content&view=article&id=255&Itemid=103.
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    Our public markets provide significant benefits for issuers, 
investors and our economy. Public companies obtain permanent access to 
capital, the ability to reach the deepest pool of both institutional 
and retail investors, and the power to use their stock as currency for 
future acquisitions. Founders, employees, and public shareholders 
obtain liquidity for their investments and the opportunity to transact 
in real-time, in a transparent and well-regulated market that provides 
extensive issuer disclosures while protecting both buyers and sellers. 
It is this symbiotic relationship between issuers and investors that 
make our markets function so well.
    However, over the past decade, the number of young companies going 
public has declined significantly, and the age of companies at the 
point of their IPO has increased. While in 1996, there were 761 
companies that underwent an IPO, an average of fewer than 157 companies 
went public per year between 2001 and 2008, and the number remains well 
below historical norms. At the same time, the average age of a company 
at the time of its IPO has increased from 5\1/2\ years during the 
period from 1997 to 2001, to 9 years from 2006 to 2011. \2\
---------------------------------------------------------------------------
     \2\ Rebuilding the IPO On-Ramp: Putting Emerging Companies and the 
Job Market Back on the Road to Growth, p. 6. http://www.nvca.org/
index.php?option=com_docman&task=doc_download&gid=805&Itemid=93.
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    Rather than pursue an IPO, early investors have shifted toward 
gaining liquidity for their investment by selling their young companies 
to larger enterprises. While in 1991, about 90 percent of venture 
investor exits occurred through an IPO and about 10 percent through a 
merger and acquisition (M&A) event, this trend has completely reversed 
in recent years: in 2010, about 80 percent of exits were through M&A 
compared to 20 percent through an IPO. \3\ This shift is critically 
important because an M&A event does not generally produce the same job 
rapid growth as an IPO, and often results in job losses over the short 
term as the acquirer eliminates redundant positions.
---------------------------------------------------------------------------
     \3\ Ibid at 7.
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    The movement away from IPOs has been driven in large part by 
burdensome regulatory hurdles. In particular, extensive regulatory 
reporting requirements in order to go public and remain a public 
company have increased the cost of going public. This is a significant 
barrier that every CEO we meet highlights as an obstacle to pursuing an 
IPO.
    At the same time, regulatory requirements have also limited the 
amount of research about these emerging companies available to 
investors, constraining investor interest. We believe that additional 
research enhances investors' understanding of emerging companies and 
facilitates the demand side of the equation.
    Removing these barriers to going public is critical to unlocking 
emerging growth companies' job creation potential.
    Several members of this Committee have taken the lead on a bill, 
the Reopening American Capital Markets to Emerging Growth Companies Act 
of 2011, which would significantly reduce the obstacles that prevent 
emerging growth companies from going public--and accessing the capital 
to hire more employees--while maintaining important investor 
protections. The bill would tackle both sides of the equation: 
addressing companies' reduced interest in an IPO due to the costs of 
going public, while facilitating the sharing of information with 
investors to stimulate awareness and demand.
    The bill would create a transitional category of companies pursuing 
an IPO called ``emerging growth companies.'' This category would 
generally include those companies pursuing an IPO that have less than 
$1 billion in annual revenue and less than $700 million in public float 
(common equity held by nonaffiliates) and would not affect any company 
that has already completed its IPO. For this small number of emerging 
growth companies, certain disclosure and other public company 
regulatory requirements would be reduced or phased-in, thus lowering 
the costs associated with an IPO and complying with public company 
requirements. The maximum phase-in period would be 5 years from the IPO 
date (with the phase-in being eliminated earlier if a company reached 
the $1 billion in revenue or $700 million in public float levels). In 
particular:

    Emerging growth companies would have scaled-back financial 
        information requirements and scaled-back requirements in their 
        ``Management's Discussion and Analysis'' and ``Executive 
        Compensation'' disclosures. Many of these scaled-back 
        requirements are already permitted for microcap companies with 
        less than $75 million of public float.

    One of the largest expenses associated with becoming a 
        public company is the cost of complying with the requirement to 
        obtain an auditor attestation of a company's internal controls 
        over financial reporting, under Section 404(b) of the Sarbanes-
        Oxley Act. The bill would phase-in this requirement, giving 
        emerging growth companies the chance to go public, expand and 
        hire before incurring this expense.

At the same time, emerging growth companies would be able to ``test the 
waters'' to gauge investor interest and provide more research 
information to prospective investors:

    Many emerging growth companies may consider an IPO, but are 
        unsure of whether there is sufficient investor interest. 
        Because current law makes it difficult for companies to test 
        the waters and gauge interest before actually undergoing the 
        expense of preparing an IPO registration statement, companies 
        may forgo an IPO altogether. The bill would allow these pre-IPO 
        companies to communicate with sophisticated investors about a 
        potential IPO, and consider the probability of an IPO's 
        success, before undergoing the expense of preparing a 
        registration statement.

    On the other side of the equation, restrictions on 
        investment banks providing research coverage on emerging growth 
        companies undergoing an IPO have limited investors' ability to 
        obtain information--and thus their ability to assess whether to 
        invest in an emerging growth company. The bill would improve 
        the availability and flow of research coverage by scaling back 
        regulatory restrictions that prevent such coverage.

    By phasing-in some of the more expensive regulatory requirements of 
being a public company, and scaling back restrictions on research 
coverage, the bill will allow more emerging growth companies to access 
the public capital markets, finance their growth and create more 
American jobs. Our system of securities regulation, including the 
robust disclosures required of large or seasoned public companies, 
would be maintained--while the largest obstacles preventing our most 
promising young companies from growing and hiring would be removed.
    While this bill would remove roadblocks from accessing the public 
markets for emerging growth companies, the extensive process of SEC 
registration may still be overly burdensome and expensive for some 
smaller companies and start-ups, who need a method of raising smaller 
amounts of capital through a less restrictive and less expensive 
process. I would therefore also like to comment on a number of other 
legislative proposals.
    I applaud the House for passing H.R. 1070, the Small Company 
Capital Formation Act of 2011, and commend Senators Tester and Toomey 
for their leadership on this issue in the Senate. I encourage the 
Committee to pass S. 1544 as well. This bill would expand the size of 
offerings eligible to use the scaled-back process for publicly offering 
securities under Regulation A for small public offerings, from $5 
million to $50 million. This would help small companies access public 
capital and grow their businesses without the more extensive 
undertaking and expense of full registration under the Securities Act. 
At the same time, investors are protected as Regulation A securities 
are traded in the light of the public markets and investors are 
provided with significant disclosure regarding each issuer.
    In contrast to the well-regulated and transparent public markets, 
private markets provide investors with much less protection, with 
reduced or no disclosure about the private issuers in which they 
invest, and low levels of liquidity. These private markets have an 
appropriate role in addressing capital and liquidity needs for certain 
issuers and shareholders, and we support methods of private capital 
formation that facilitate growth while, importantly, protecting 
investors. In particular, existing law appropriately balances the 
interest in fostering these transactions with investor protection 
concerns. For example, the Regulation D private placement safe harbor 
permits sales to accredited investors without the need to provide 
information, but prohibits general solicitation, limits the number of 
nonaccredited investors and requires that specified information be 
provided to nonaccredited investors. Because not all accredited 
investors are necessarily sophisticated, the prohibition on general 
solicitation ensures that investors who do not have any relationship 
with the issuer or its placement agent are not drawn in through public 
advertisements.
    While technological advancements have caused a proliferation of 
private platforms to match buyers and sellers of private stock, 
investor protection concerns such as the lack of transparency, 
disclosure and liquidity in these markets should be addressed as these 
markets expand to a larger set of investors. Investments in private 
companies are highly risky, with significantly greater risk than 
investing in the public markets, and historically have been limited to 
investors that can understand, evaluate, and financially bear these 
additional risks. I therefore have concerns about legislative proposals 
that could open up these markets in private companies to a larger set 
of investors without additional investor protection measures. Any 
proposal to greatly expand the role of private markets must require 
either: (1) a high level of investor sophistication and a relationship 
with the issuer or its placement agent such that the investor can 
consider and understand the risks of the company in which he or she 
invests, or (2) a sufficient and uniform amount of disclosure so less 
sophisticated investors understand what they are investing in.
    Two recent legislative proposals need to be considered against 
these threshold criteria. H.R. 2940, the Access to Capital for Job 
Creators Act, would remove the requirement under Section 4(2) of the 
Securities Act and Rule 506 of Regulation D that, in order to qualify 
for an exemption from registration as a private placement (a 
transaction ``not involving any public offering''), there be no general 
solicitation. The restriction on general solicitation has been a core 
feature of the private placement exemption since the first court 
interpretations of Section 4(2), and is an important safeguard to avoid 
fraud against investors. The restriction on general solicitation is the 
key limitation which protects the general public from being drawn into 
the private markets--a market that by its very nature has a high level 
of risk not suitable for most investors, and does not provide the real-
time liquidity of public markets. In fact, in connection with another 
exemption under Regulation D, Rule 504 (which permits certain offerings 
of $1 million or less in reliance on State ``blue sky'' laws), the SEC 
found that instances of fraud greatly increased when it relaxed the 
prohibition on general solicitation. As a result, the SEC found it 
needed to reinstate into Rule 504 elements of the prohibition on 
general solicitation to prevent the abuses which it can cause. \4\
---------------------------------------------------------------------------
     \4\ SEC Release No. 33-7644 (Feb. 25, 1999).
---------------------------------------------------------------------------
    Additionally, any proposed exemption from registration for 
``crowdfunding'' offerings also needs careful consideration. Allowing 
entrepreneurs to raise capital through crowdfunding is an important 
step to encourage new business and growth, however, important investor 
protections are needed. These types of investments are very risky, and 
because they may be offered through a general solicitation, less 
sophisticated investors may be drawn in. Any crowdfunding exemption 
should therefore include a low limit on total offering size, a low 
limit on the amount any individual can invest (such as $1,000), and 
require that issuers disclose sufficient information to ensure that 
investors understand what they are purchasing.
    The Committee also asked me to comment on pending legislative 
proposals to increase the number of shareholders a private company may 
have before being required to publicly disclose information. We support 
a measured increase from the current 500 shareholder level, but believe 
that public policy concerns regarding shareholder access to information 
should limit the size of the increase. In particular, we support H.R. 
2167, the Private Company Flexibility and Growth Act, which would 
increase the level to 1,000 shareholders while excluding from the count 
current or former employees that were issued shares as compensation.
    In closing, I applaud the Committee's focus on finding ways to 
encourage job creation through facilitating capital formation. The 
reforms contained in the Reopening American Capital Markets to Emerging 
Growth Companies Act of 2011 reflect a measured approach that would 
remove the major roadblocks preventing emerging growth companies from 
raising capital in the public, transparent markets, while avoiding the 
potential for fraud and investor abuse that may arise from opening up 
the illiquid and private markets to average investors.
    I appreciate the opportunity to testify before the Committee today 
and am happy to answer any questions you may have.
                                 ______
                                 
                 PREPARED STATEMENT OF EDWARD S. KNIGHT
     General Counsel and Executive Vice President, NASDAQ OMX Group
                            December 1, 2011

    Thank you Chairman Johnson and Ranking Member Shelby. On behalf of 
the NASDAQ OMX Group, I am pleased to testify on ``Spurring Job Growth 
Through Capital Formation While Protecting Investors.''
    Capital formation and job creation are in NASDAQ OMX's DNA. Forty 
years ago NASDAQ introduced the world to electronic markets, which are 
now the standard for markets worldwide. The creation of NASDAQ 
introduced sound regulation to the over-the-counter trading. Around 
NASDAQ grew an ecosystem of analysts, brokers, investors and 
entrepreneurs allowing growth companies to raise capital that was not 
previously available to them. Companies like Apple, Microsoft, Oracle, 
Google, and Intel, all of which are listed on the NASDAQ Stock Market, 
use the capital they raised to make the cutting edge products that are 
now integral to our daily lives. As they grew, these companies have 
created millions of jobs along the way. It is this heritage that is the 
foundation of my testimony today.
    Today, the NASDAQ OMX Group owns and operates the global 
infrastructure of public markets, markets for securities that are 
publicly traded and available to all investors. We own 24 markets, 3 
clearing houses, and 5 central securities depositories, spanning 6 
continents. Eighteen of our 24 markets trade equities. The other six 
trade options, derivatives, fixed income products, and commodities. 
Seventy exchanges in 50 countries trust our trading technology to run 
their markets, and markets in 26 countries rely on our surveillance 
technology to protect investors, together driving growth in emerging 
and developed economies. We are the largest single liquidity pool for 
U.S. publicly traded equities and provide the technology behind 1 in 10 
of the world's securities transactions.
    To summarize, we believe that regulation is absolutely necessary to 
support capital formation and protect investors in both the public and 
private markets. It is, however, particularly critical to the public 
markets. Significantly, the public markets are best at allocating 
capital and creating jobs. Therefore, it is absolutely imperative that 
we strike the right balance in regulating the public markets and avoid 
losing their benefits.
    Recently, Congress has moved forward in its consideration of 
several proposals that focus on the private company model. Each is 
briefly described below:

        H.R. 2940: eliminates the ban on solicitation of investors when 
        a company is offering securities under Regulation D.

        H.R. 2167: increases the number of shareholders from 500 to 
        1,000 before a company is required to register with the SEC.

        H.R. 1070: increases the offering threshold from $5 million to 
        $50 million before a company must register with the SEC.

        H.R. 2930: exempts certain crowdfunding investments from SEC 
        registration.

    The first three bills have been well considered and debated, and we 
have no objection to them. The last bill represents a new and exciting 
concept, which we look forward to learning more about and sharing views 
with other market regulators and participants before we reach a final 
opinion.
    While these bills will help the private capital formation markets, 
my comments today focus on the public markets. Private and public 
markets play complementary roles. It is ironic that in the debate about 
these bills about private company markets, supporters have cited 
challenges facing the public markets--the declining number of U.S. IPOs 
and the high cost of being a public company--to bolster the case for 
legislation relaxing the rules for raising private capital.
    While we support modernizing rules to embrace new circumstances and 
technologies, our struggling economy demands more substantive action 
that goes to the heart of the problem. In other words, as we make it 
easier for companies to avoid the U.S. public capital markets either by 
staying private or going overseas to list, we should also deal with 
structural issues that make our public markets less attractive today. 
In fact, I submit that Congress would signal a retreat from the public 
markets if it limits the scope of its action to the private markets.
    I'm here today to urge you to take steps to enable NASDAQ to 
continue our long term commitment to facilitating capital formation 
while protecting investors and contributing to economic and job growth. 
We ask for your help in reshaping the rules driving the public markets 
so that investors and entrepreneurs will continue to view the U.S. 
capital markets as the most efficient and best regulated markets in the 
world.
Why Do We Need Public Companies and Markets?
    In light of the movement to relieve more companies from the 
obligations of registration and going public, we think it is time for 
Congress and regulators to review why we need strong, vibrant public 
company markets. Some might ask, if companies can access the capital 
they require in the private markets, why should we be concerned? There 
are three critical reasons in our view to recommit to the public 
markets:

  1.  Efficient pricing and funding of entrepreneurial activity: The 
        value of an enterprise, how much capital it should receive, and 
        at what costs are best determined by a deep competitive market 
        like the public markets. A company that has a clear price set 
        in the open market will attract more investors and lenders to 
        help them fund growth. It is well recognized that companies 
        that do not trade on exchanges are valued at a discount. 
        Companies that do not trade in the public markets must 
        establish their value through ad hoc valuation and opaque 
        negotiation. A limited number of potential investors bid for 
        private companies. Financial experts, the IRS, the SEC, and 
        courts recognize that discounts for lack of marketability can 
        range from 30 percent and even higher. Clearly, a company 
        valued 30 percent or more below its true value will not be able 
        to invest, grow and create jobs as quickly.

  2.  Jobs: A healthy public equity market enables companies to raise 
        capital more efficiently, funding more rapid growth and more 
        jobs. Companies create 90 percent of their new jobs after they 
        go public. An IPO is the best public policy outcome in terms of 
        jobs for the broader economy. A company that has exchange-
        traded shares can better use its stock as a currency to grow 
        its business and incentivize employees. A successful IPO is a 
        very public signal to other entrepreneurs about the 
        availability of capital financing.

  3.  Wide availability of investment opportunity: A public listing 
        allows the most diverse universe of investor's access to 
        ownership. This democratization allows employees, individual 
        investors, pensions, mutual funds, corporations, and others to 
        put their capital to work and enjoy the rewards, and risks, of 
        equity ownership.

Condition of the U.S. Public Markets
    The United States used to be the market of choice for global IPOs. 
From 1995 to 2010, listings on U.S. exchanges shrank from 8,000 to 
5,000, while listings on non-U.S. exchanges grew from 23,000 to 40,000.



    Calls to increase exemptions from SEC registration indicate that 
excessive regulation is stifling innovation, capital formation, and 
growth. Prior to the Internet bubble, the U.S. averaged 398 IPOS per 
year in the early 1990s and there were never fewer than 114 IPOs per 
year, even during a recession. Following the regulatory changes of the 
last decade, there has been an average of only 117 U.S. IPOs per year. 
In 5 of the last 10 years, including 2011, there have been fewer IPOs 
than in the worst year of the 1990s. In addition to the overall decline 
in the number of public companies, the average IPO has increased in 
size as the cost of complying with increased regulation has deterred 
many smaller and younger companies from going public.
    I am not suggesting that the health of the U.S. economy is 
dependent on the number of companies listing on U.S. exchanges. It is, 
of course, much more complex than that. But, I would point to two 
recent academic studies which suggest that the reduction in the 
availability of IPO capital may have profound consequences for the U.S. 
economy as a whole. When IPO capital formation is restricted, 
entrepreneurs are incented to create products which complement existing 
products of large companies, rather than creating transformational 
products which change the way we live, work and think. Entrepreneurs 
are forced to sell their ideas too cheaply in the private markets. 
Essentially, the NASDAQ ecosystem of the past has been replaced in a 
``second best'' form by the private markets. In the broadest terms, 
resources are inefficiently allocated, growth is negatively impacted, 
and the economy falls short of its potential.
    As I indicated above, we operate in 50 countries around the world 
and provide regulatory services in twenty-six. Markets in Australia, 
Canada, Brazil, and Hong Kong offer levels of efficiency and regulatory 
integrity that are perceived as world class by investors and issuers. 
Longstanding rivals to the U.S. markets such as the United Kingdom have 
also taken significant steps to improve the efficiency and 
competitiveness of their markets. And that is good for the global 
economy. However, the U.S. is no longer the top jurisdiction for 
capital raised via IPOs, ranking second in 2011, and only three of the 
top 10 IPOs so far this year have been by U.S. firms. In 2010, IPO 
issuances from the Asia-Pacific region accounted for almost two-thirds 
of global capital raised. The story is the same for smaller companies 
too. Venture oriented markets in Australia, Canada and the U.K. have 
listed 155 companies each raising $50 million dollars or less, while 
only 44 such companies have listed in the U.S. during 2011.

What Is Hurting the U.S. Public Markets?
    Well-intentioned incremental public policy decisions have 
accumulated over time, that in their totality, serve as major 
barricades to getting more IPOs in the U.S. Although issues like our 
litigious legal environment and our outdated tax system impact the 
decision making in this area, today I will focus on two categories more 
directly in this Committee's jurisdiction--regulation of public 
companies and regulation of the exchanges and their competitors. And I 
would note that many of these conclusions are well supported by two 
recent Blue Ribbon studies: The President's Council on Jobs and 
Competitiveness and the IPO Task Force, which arose from the Treasury 
Department's Access to Capital Conference.
    Regulation of Public Companies: Too many times, regulation has been 
approached with a ``one size fits all'' solution. Yes, Sarbanes-Oxley 
comes to mind. As we look back on the enactment of Sarbanes-Oxley in 
the wake of Enron's collapse, while it can be said that Congress acted 
quickly and aggressively to restore investor confidence, the bill which 
was produced did not distinguish between the large companies listed on 
our Global Select Market, and the small companies listed on our Capital 
Market. The SEC and PCAOB have continued that approach with rules and 
legal obligations that usually assume that all public companies are 
large enterprises that can digest and respond to rules and regulations 
with the same ease. This is not the case, and it is chasing companies 
away from our markets and hurting job creation.
    We believe it is time for a new approach. We commend to the 
Committee the October 20, 2011, report of the IPO Task Force entitled 
``Rebuilding the IPO On-Ramp.'' This Task Force, whose members are some 
of the best experts on capital formation and represent diverse 
interests, set forth a detailed proposal to create a regulatory on-ramp 
for early stage growth companies, during which disclosure rules and 
compliance burdens would be phased-in, while maintaining investor 
protections. The Task Force also made detailed recommendations about 
how to improve research coverage for smaller companies. These 
recommendations merit careful consideration.

Market Structure Does Not Help Attract Companies to the Public Markets
    We believe that the daily operation of the markets and their 
increasing complexity hurt efforts to get companies to go public here 
in the U.S. Today's U.S. markets are increasingly fragmented and 
volatile. Liquidity in U.S. stocks is dispersed across 13 exchanges, 
over 40 other registered execution venues, and uncounted other trading 
facilities. The declining cost of launching and operating electronic 
order crossing systems has led to a proliferation of decentralized 
pools of liquidity that compete by offering their owners and customers 
reductions in fees, obligations, transparency and order interaction.
    Consider that today nearly one-third of public company stocks trade 
40 percent to 50 percent of their volume away from the exchanges. In 
the past 3 years the percentage of U.S. market share traded in systems 
that do not publicly post their bids and offers rose from 20 percent to 
over 30 percent. Many retail and core investor orders are executed away 
from the primary exchanges.
    We recognize that there are situational benefits and value to some 
orders trading away from the public. We also recognize that competition 
between markets has dramatically reduced investors' costs and improved 
market quality in listed securities through technological and 
structural innovation. However, the unintended consequences of the 
market fragmentation has been a lack of liquidity and price discovery 
in listed securities outside the top few hundred names and a disturbing 
absence of market attention paid to small growth companies by all 
market participants, including exchanges.
    Such fragmentation of trading creates a thin crust of liquidity 
that is easily ruptured, as occurred on May 6, 2010. In fact, the SEC 
and CFTC in their joint ``Flash Crash'' report pointed out: ``The 
Commission has noted that absent extraordinary conditions such as those 
occurring on May 6, 2010, retail orders are generally executed by 
internalizers away from exchanges and without pretrade transparency, 
exposure or order interaction.'' Fragmentation and current market 
structure may be raising investors' costs. In 2010, the U.S., which has 
perennially ranked first globally for institutional investor costs, 
fell to fourth in the world, behind Sweden, Japan, and France. Price 
discovery and available transparent liquidity are essential parts of 
vibrant market systems.
    We believe that, whenever possible, public price discovery should 
be encouraged to ensure a robust and balanced marketplace. Private 
transactions serve an important role at times and in those situations 
should be encouraged--when a customer can get price improvement, or 
when market impact for larger institutional orders can be minimized. 
That said, we must also ensure that there is ample liquidity 
contributing to the critical role of price discovery. Transparency is 
critical to efficient markets.
    Just as our markets continue to evolve and adapt, so must the 
regulatory structure of our markets. We need to strengthen regulation 
by modernizing systems and increasing transparency to regulators. We 
support the development of a consolidated audit trail with real time 
market surveillance and new regulatory tools to help regulators keep 
pace with technology advances and other changes in the markets.
    Additional steps the SEC should take include adopting modifications 
to the market data revenue allocation formula to emphasize the value of 
public quotations.
    Finally, we believe that companies should be able to choose the 
manner in which their shares trade, particularly for smaller companies 
in the period following an IPO when an efficient and liquid market is 
still developing.

Small Companies Need a Strong Venture Exchange To Grow and Create Jobs
    In our markets the number one source of job creation is 
entrepreneurship. Just as business incubators nurture small companies 
until they are ready to leave the security of that environment and 
operate independently, there should be a space for incubating small 
public companies until they are ready to graduate to a national 
listing. The U.S. must create a space for these companies just as our 
foreign competitors have successfully done.
    Canada, the United Kingdom, and Sweden have successful venture 
markets with significant numbers of listed companies and substantial 
capital-raising success. These markets list hundreds of small companies 
that create jobs at a fast rate. Venture market companies regularly 
grow and then graduate to the main markets in those countries. The U.S. 
has no equivalent exchange-supported, organized venture market.
    In just 5 years, the Swedish First North Market, run by NASDAQ OMX, 
has grown to 141 listings with a total capitalization of 2.8 billion 
Euros. Twenty-two First North companies have graduated to the main 
market since 2006. All of this in a country of 9 million people. The 
Toronto Stock Exchange's TSX Venture Exchange may be the most 
successful of these venture markets. The TSX Venture Exchange lists 
2,100 companies with a total market capitalization of $37.8 billion and 
a median size of $4.2 million. And 451 TSX Venture Exchange companies 
have graduated to the Toronto Stock Exchange since 1999. Graduates 
account for more than $87 billion in market capitalization. According 
to the London Stock Exchange, The London AIM Market has been one of the 
fastest growing markets in the world for the last decade. They have 
listed over 1,200 companies, including 234 international listings, some 
of which are American firms, and 141 AIM Market listings have graduated 
to LSE's main market. These markets have successfully used special 
listing standards and adopted innovative market structures targeted 
towards smaller companies.
    BX Venture Market Can Be the U.S. Home for Small Companies. The 
NASDAQ OMX Group has received approval to create a new listing venue on 
the former Boston Stock Exchange. The BX Venture Market will have 
strict qualitative listing requirements, similar to other exchanges, 
but lower quantitative standards that would attract smaller, growth 
companies. The availability of the BX Venture Market will facilitate 
their ability to raise capital to continue and expand their businesses, 
creating jobs and supporting the U.S. economy. The BX Venture Market 
will provide a well-regulated listing alternative for companies that 
otherwise would transfer to, or remain on, the largely unregulated Pink 
Sheets or OTCBB, where there are no listing requirements, no public 
interest review, limited liquidity, and limited transparency, or list 
on junior tiers of non-U.S. markets.
    However, under existing structures, these companies will receive 
little regulatory benefit from opting to subject themselves to these 
additional requirements. For example, unlike companies listing on other 
exchanges with higher quantitative listing requirements, they will 
still be subject to the State's Blue Sky laws. We believe that there 
should be incentives provided to these smaller companies that list on a 
public company, such as the on-ramp described in the IPO Task Force 
Report. We also believe that steps should be taken to limit the 
fragmentation of trading in these smaller companies.

NASDAQ's Recommendations for Strong Public Capital Markets
    Our capital markets require multifaceted actions to help invigorate 
the atmosphere for entrepreneurs to help their companies' access 
capital and create jobs. We believe that these reforms would restore 
the ecosystem that once existed and is necessary to nurture, sustain 
and grow public companies and reinvigorate the U.S. engine of job 
growth.

Solution #1: Reform Sarbanes-Oxley
    All of the NASDAQ OMX executives who are engaged in selling the 
U.S. markets to companies around the world tell me, to a person, that 
Sarbanes-Oxley is the most quoted reason for not listing on NASDAQ. 
President Obama's own Council on Jobs and Competitiveness has called 
for sweeping reforms to regulation in this area. The President's 
Council stated:

        Amend Sarbanes-Oxley (Sox) to allow shareholders of public 
        companies with market valuations below $1 billion to opt out of 
        at least Section 404 compliance, if not to all of the 
        requirements, of Sarbanes-Oxley; or, alternatively, exempt new 
        companies from Sox compliance for 5 years after they go public.

    We believe that a further reduction in compliance costs could be 
obtained if the Section 404(b) examination were allowed to occur every 
2 years for exchange-listed companies that are found to have no 
significant weaknesses.

Solution #2: Reject Expensive and Expansive New Regulations on Public 
        Companies and Reexamine Existing Regulations
    Policy makers and regulators must also be careful about imposing 
new regulations that lack necessity, yet will raise a public company' 
costs. Congress, the SEC and other regulators should evaluate the 
global competitive landscape before imposing new regulations.
    One example is the recent PCAOB proposal to require public 
companies to rotate auditors. In 2005 after the PCAOB was created, a 
hearing was held in the House Financial Services Committee and then-
Chairman William J. McDonough was asked about the viability of required 
auditor rotation. Chairman McDonough wisely rejected the idea then, and 
it should be rejected now.
    Existing regulations should also be reexamined. In that regard, as 
noted earlier, we believe there is significant merit in the IPO Task 
Force's idea to ease compliance burdens during a small company's 
transition to being a public company. Recent regulations that have 
resulted in a dramatic reduction of research coverage for smaller 
companies should also be reviewed.

Solution #3: Support a Strong and Vibrant Venture Exchange With 
        Innovative Market Structure for Small Companies
    While we are certain the BX Venture Market is needed, we also 
believe that innovative trading rules are required to make the market 
successful. Small companies do not trade like big ones. As you look at 
the trading behaviors of small companies, building and maintaining 
liquidity can be a constant challenge. When we examine what has worked 
here and abroad in building liquidity for smaller companies, we believe 
these stocks should receive the same protections as Regulation NMS 
securities and that market data should be made widely available through 
existing data feeds.
    The most prevalent listed company concern we hear about equity 
market structure relates to volatility. It is time for the SEC to 
consider allowing certain IPO companies, especially smaller companies 
using the public market to fuel growth, for a period of up to a year, 
to choose the market structure they feel would best introduce their 
stock to the marketplace. Empower these IPO companies to restrict the 
fragmentation that occurs in their stock and causes volatility and 
limit their trading to a well-regulated, transparent market unless off-
exchange trading delivers real price improvement.
    The SEC should allow companies to pay for market quality by 
allowing the exchanges to establish programs to reward broker dealers 
for committing capital to a stock and meeting rigorous market-quality 
benchmarks established by the exchange. This has worked in our Nordic 
markets.

Solution #4: The SEC Should Act on the Market Structure Concept Release 
        and Allow Public Companies To Opt Out of a Fragmented Market
    The SEC's thoughtful market structure reform proposals have not 
moved forward while the agency has been focused elsewhere. Regulators 
must turn attention back to these proposals. Such action is consistent 
with the SEC's Congressional mandate to ensure that our markets are 
open, fair and orderly. Congressional input to regulators will restore 
this initiative.

Solution #5: Create Jobs by Allowing Companies To Hire the Employees 
        They Need
    One issue that we now mention to every Member of Congress and in 
testimony to every Committee we appear before is legal immigration 
reform. The United States achieved its economic prominence by inviting 
the best and the brightest from around the globe to unleash their 
creative capabilities on American soil and contribute to the American 
mosaic, culturally, politically, and economically. Immigrants have been 
some of the greatest contributors to business, science and technology 
in American Society. Twenty-five percent of technology and engineering 
companies from 1995 to 2005 had at least one immigrant key founder.
    Our economy and NASDAQ itself have directly benefited from the 
contributions of foreign-born talent. Looking just at the Fortune 500 
companies, we found at least 14 active NASDAQ companies that have 
foreign-born founders. These companies represent over $522 billion in 
market capitalization and employ almost 500,000 workers.
    Legal immigration is a source of economic growth in the United 
States and NASDAQ OMX is concerned that continued entanglement in the 
illegal immigration debate will only exacerbate our already anemic 
economy. Every year we send approximately 17,000 STEM graduate students 
back to their home countries after educating them here in the finest 
universities in the world. It is critical that we reform our 
immigration system to accommodate these graduates. If U.S. companies 
cannot hire them here, they will hire them for the same job overseas. 
Therefore, I recommend the following to the U.S. Congress:

    Debate legal immigration on its own merits: Do not link 
        legal reform to reform of illegal immigration--Americans are 
        losing jobs and opportunity while one issue drags down the 
        other. American workers, with good jobs, cluster around these 
        highly skilled workers. Achieving a comprehensive solution will 
        take years--years Americans who need jobs do not have.

    Enact a more flexible and stable regime for Legal 
        Immigration: Reform must convey economic priorities about job 
        growth and global competitiveness. Increasing H-1B numbers is 
        no longer enough. We need to admit and keep entrepreneurs here 
        so that the creative dynamism of our marketplace has the very 
        best skills and minds. The default should be ``yes,'' not 
        ``no.''

    Attack the ``job stealing'' myth directly: Opponents of 
        Legal Immigration reforms argue that when a foreign born 
        immigrant gets a job, American graduates are the losers. 
        Research tells a different story. The National Federation for 
        American Policy says that for every H-1B worker requested, U.S. 
        technology companies increase their employment by five workers.

    Thank you again for inviting me to testify. I look forward to 
responding to your questions.

              Additional Material Supplied for the Record

               STATEMENT SUBMITTED BY SENATOR CARL LEVIN













                LETTERS SUBMITTED BY SENATOR JOHN THUNE

















LETTER SUBMITTED BY R. CROMWELL COULSON, PRESIDENT AND CEO, OTC MARKET 
                              GROUPS, INC.

























   STATEMENT SUBMITTED ON BEHALF OF THE AMERICAN BANKERS ASSOCIATION

    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee, the American Bankers Association (ABA) appreciates the 
opportunity to submit this statement for the record on shareholder 
registration thresholds. ABA represents banks of all sizes and charters 
and is the voice of the Nation's $13 trillion banking industry and its 
two million employees.
    ABA members are grateful to Senator Kay Bailey Hutchison and 
Senator Mark Pryor for introducing S. 556, which would address this 
issue.
    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 banks have faced a rule that 
has remained in place for over 40 years without being updated. That 
rule, which implements parts of the Securities Exchange Act of 1934, 
causes small, local banks to be subject to the same costly reporting 
requirements as large public firms, even though banks are already 
comprehensively regulated and subject to other disclosure requirements.
    The Exchange Act has two tests to determine whether a company must 
register its securities with the Securities and Exchange Commission 
(SEC) and thus become subject to the SEC's significant reporting 
requirements: $10 million in assets and 500 shareholders of record. 
Since 99.5 percent of banks reach the asset threshold for registration 
as a public company, the only meaningful test of whether a bank should 
be registered as a public company is the number of shareholders. But 
while the asset threshold has been increased tenfold since 1964, the 
shareholder threshold has stayed the same.
    Banks that are nearing the 500 shareholder threshold may have 
nowhere to turn to raise capital they need to meet the credit needs of 
their communities. And once registered as a public company, banks are 
subject to disproportionately high financial and opportunity costs when 
compared to other smaller public companies. These regulatory 
requirements and costs eat into capital and limit banks' ability to 
make loans in their communities.
    ABA has long advocated that the shareholder threshold be increased, 
an update that is long overdue. ABA strongly supports the bill 
introduced by Senator Hutchison which would update the shareholder 
threshold for registration for banks to 2,000, providing much-needed 
regulatory relief. This change would enable banks to deploy their 
capital in lending rather than spend it on regulatory requirements that 
provide little incremental benefit to the banks, shareholders, or the 
public.
    In addition, this legislation would address the deregistration 
threshold for banks, which can occur when the number of shareholders 
decreases and banks that were once public can become private. 
Currently, the number of shareholders of record must fall below 300 
shareholders before the business can deregister. Raising the threshold 
for deregistration along with the threshold for registration makes a 
lot of sense from both a business and corporate governance perspective.
    The urgency to address this issue increases every day. Over the 
last several years, banks have faced increased regulatory costs. This 
is exacerbated by bank regulators piling on new requests for even 
greater levels of capital. Combined with hundreds of new regulations 
resulting from the Dodd-Frank Act, these pressures are slowly but 
surely strangling traditional banks, handicapping their ability to meet 
the credit needs of their communities. Increasing the shareholder limit 
would open up an avenue to bring capital into small local institutions.
    ABA is very interested in working with the Committee to move 
legislation forward that can accomplish these important changes, so 
that banks can continue to reach out to their local communities for the 
capital that is vitally important in our efforts to increase lending in 
their communities.
    As this Committee well knows, banks are part of a highly regulated 
industry governed by numerous statutes and regulations affecting almost 
every aspect of banking activity. Most banking institutions are 
regulated by two agencies: a primary Federal regulator and, in the case 
of State chartered banks, by the State regulator, as well. Significant 
financial and other information regarding every bank and savings 
association can be publicly viewed on the Web site maintained by the 
FDIC. All banks are required to make annual reports available to both 
their customers and investors. Most provide financial and other 
information to investors through their company Web sites. The advantage 
to the local banks from increases in the registration and 
deregistration thresholds would not be a lack of transparency, since 
keeping shareholders and the public fully informed about the bank's 
performance is essential to its presence as a community bank. Rather it 
is a reduction of regulatory burdens and reporting requirements that 
pose a disproportionate burden on smaller institutions.
    There are two points we would like to make today:

    Community based banks are disproportionally burdened by the 
        500 shareholder threshold; and

    A higher shareholder threshold more accurately reflects 
        public company status.

I. Community Banks Are Disproportionally Burdened by the 500 
        Shareholder Threshold
    Banks with 2,000 shareholders or less are local businesses with 
local shareholders. These institutions had median revenue of $9.15 
million and a median 182 full-time employees as of the second quarter 
2011. It is common for these banks to receive little or no analyst 
coverage, have a limited trading market, and attract little--if any--
institutional investment. Accordingly, any small benefit that banks may 
receive from being public is significantly undermined by the 
disproportionately high costs of regulatory compliance for small 
companies. It is well documented that the costs of being a public 
company are disproportionately borne by smaller public companies. \1\ 
Furthermore, banks are already subject to comprehensive regulation and 
disclosure requirements by the banking regulators while other small 
companies are not.
---------------------------------------------------------------------------
     \1\ See, generally, Foley and Lardner, ``The Cost of Being Public 
in the Era of Sarbanes-Oxley'' (August 2, 2007) available at http:/
www.foley.com/publications/pub_detail.aspx?pubid=4487; ``Exposure Draft 
of Final Report of Advisory Committee on Smaller Public Companies'', 
SEC Release No. 33-8666 (March 3, 2006) [71 FR 11090].
---------------------------------------------------------------------------
    These costs come directly out of capital, reducing banks' ability 
to lend. Capital is the foundation for all lending and is also critical 
to absorb losses when loans are not repaid. In fact, $1 worth of 
capital supports up to $10 in loans. The downward spiral of the economy 
has created losses and stressed capital levels; consequently, the bank 
regulators have pushed banks to raise their capital-to-assets ratio. 
Not surprisingly, when the economy is weak, new sources of capital are 
scarce. Capital may become impossible for banks that are nearing the 
500 shareholder threshold. The result is that these banks are forced to 
shrink--by making fewer loans in order to raise their capital-to-assets 
ratio. Clearly, it would be better to turn to additional investors to 
put new capital in place that would support additional community 
lending.
    Unlike other small businesses, most banks are broadly held by 
shareholders in their communities. Even without ever offering shares 
publicly, many banks have seen their shareholder base grow as 
successive generations distributed their stock holdings among their 
descendents. These factors exert significant pressure on banking 
organizations and other affected companies to reduce the number of 
shareholders in order either to avoid registration requirements or to 
deregister.
    Due to the increasing costs of being a registered public company, a 
number of small businesses, including some of our member banks, have 
determined that deregistration is in the best interests of their 
shareholders. However, companies that wish to deregister must either 
have less than $10 million in assets or less than 300 record 
shareholders. Since 99.5 percent of banks have greater than $10 million 
in assets, banks who wish to deregister must somehow reduce their 
shareholder base below 300 record shareholders.
    Reducing the number of record shareholders can be costly. Stock 
buybacks, reverse stock splits and the attendant legal costs are 
particularly expensive for small businesses. In addition, these 
transactions can have negative consequences for local communities. As 
much as local financial institutions would like to get out from under 
the heavy weight of SEC registration, they often have no desire to 
reduce the number of shareholders, especially if that means 
disenfranchising the localized ownership that makes these banks members 
of the community.
    ABA member Daniel Blanton, President and CEO of Georgia Bank 
Financial Corporation, recently testified on this before the SEC 
Advisory Committee on Smaller Public Companies:

        We are reluctant to [deregister] because the Bank was founded 
        on the belief that the Augusta [Georgia] area needed a locally 
        owned and operated, relationship-based bank. Most of our 
        shareholders live within our market and all but a few do some 
        business with the bank. This localized ownership is quite 
        common at community banks across the U.S. Often times, 
        investing in the local bank is the only remaining investment 
        members of a community can still make.

    In other words, not only do institutions benefit from having close 
relationships with local investors, but those same investors looking 
for ways to invest locally benefit from having local institutions to 
invest in that are not franchises or businesses otherwise related to 
companies that are headquartered outside the community. In addition, 
banks that cannot reasonably go private due to a large shareholder base 
could be forced to merge with a larger partner in order to spread out 
the cost of compliance. Such regulatory-induced mergers or 
disenfranchisement should be avoided as a matter of public policy.

II. A Higher Shareholder Threshold More Accurately Reflects Public 
        Company Status
    In 1964, when Section 12(g) was enacted to expand the registration 
and reporting requirements beyond companies traded on a national 
exchange, Congress understood the need for the regulation to be scaled 
and thus limited the reach of the provisions to ensure that ``the flow 
of proxy reports and proxy statements [would] be manageable from a 
regulatory standpoint and not disproportionately burdensome on issuers 
in relation to the national public interest served.'' \2\ Companies are 
not considered to have a large enough public market presence to be 
subject to significant reporting under the Exchange Act unless both the 
asset and shareholder thresholds are met.
---------------------------------------------------------------------------
     \2\ Securities Acts Amendments of 1964, Pub. L. No. 88-467, 78 
Stat. 565 (adding Section 12(g), among other provisions, to the 
Exchange Act); .S. Rep. No. 88-379, at 19 (1963).
---------------------------------------------------------------------------
    In the more than 40 years since Section 12(g) was adopted, the size 
of the investing market has grown substantially, as have the number of 
corporations and the number of investing shareholders. A small 
corporation today with a small investor footprint is significantly 
different from what it was 40 years ago. While the shareholder 
threshold of 500 at one time may have been an accurate reflection of a 
public market, it no longer is today.
    For the banking industry, the shareholder number is the only 
meaningful Section 12(g) measure because 99.5 percent of all banks have 
assets in excess of $10 million. Banks have large dollar assets because 
the loans they make are considered assets while the deposits they hold 
are considered liabilities. To give the Committee some perspective, the 
bank regulators define a small bank for purposes of the Community 
Reinvestment act as an institution with less than $1 billion in assets, 
\3\ so virtually all banks that are considered small, in at least one 
context, will exceed the asset size parameter of the Section 12(g) 
test.
---------------------------------------------------------------------------
     \3\ See, e.g., 12 C.F.R. 228.12(u).
---------------------------------------------------------------------------
    Over time, the asset measurement standard set by Congress in 1964 
has been adjusted ``to assure that the burdens placed on issuers and 
the Commission were justified by the numbers of investors protected, 
the size of the companies affected, and other factors bearing on the 
public interest, as originally intended by Congress.'' \4\ Nonetheless, 
while the asset size parameter has been increased tenfold from the $1 
million level initially required in 1964 to $10 million in 1996 to 
reflect the exponential growth in the securities market, the 500 
shareholder threshold has never been adjusted to reflect the dramatic 
increase in the number of securities investors, although the SEC noted 
in 1996 its intention to consider updating the threshold.
---------------------------------------------------------------------------
     \4\ Exposure Draft of Final Report of Advisory Committee on 
Smaller Public Companies, SEC Release No. 33-8666 (March 3, 2006) [71 
FR 11090, 11097].
---------------------------------------------------------------------------
Conclusion
    Community based banks are focused on developing and maintaining 
long-term relationships with customers--and shareholders--many of which 
live in and around their communities. The antiquated 500 shareholder 
rule limits banks' ability to reach out to their communities for the 
capital that is greatly needed to support lending. Updating this rule 
will provide another valuable capital tool as banks work to improve the 
economy in our local areas and in the whole of the United States.

LETTER SUBMITTED BY CHAIRMAN JOHNSON FROM WILLIAM F. GALVIN, SECRETARY 
           OF THE COMMONWEALTH, COMMONWEALTH OF MASSACHUSETTS







 LETTER SUBMITTED BY BARRY E. SILBERT, FOUNDER AND CEO, SECONDMARKET, 
                                  INC.





     STATEMENT SUBMITTED BY THE BIOTECHNOLOGY INDUSTRY ORGANIZATION

    Thank you for the opportunity to submit a written statement to the 
Senate Committee on Banking, Housing, and Urban Affairs. BIO represents 
more than 1,100 innovative biotechnology companies, along with academic 
institutions, State biotechnology centers, and related organizations in 
all 50 States. Entrepreneurs across the biotech industry are conducting 
groundbreaking science and are deeply invested in treating the severe 
illnesses that families around the Nation and world face.
    Biotechnology has incredible potential to unlock the secrets to 
curing devastating disease and helping people to 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 this 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?
    Biotech leaders must deal with the day-to-day challenges of running 
small businesses. Of great import in the biotechnology industry is the 
constant struggle to find working capital. It takes 8 to 12 years for a 
breakthrough company to bring a new medicine from discovery through 
Phase I, Phase II, and Phase III clinical trials, on to FDA approval of 
a product. The entire endeavor costs between $800 million and $1.2 
billion. For the majority of biotechnology companies that are without 
any product revenue, the significant capital requirements necessitate 
fundraising through venture capital firms. Unfortunately, due to the 
high-risk nature of our industry, venture capital firms are turning 
elsewhere to make their investments.
    A recent survey conducted by the National Venture Capital 
Association found that 41 percent of venture capital firms have 
decreased their investments in the biopharmaceutical sector in the past 
three years. Additionally, 40 percent of venture capitalists reported 
that they expect to further decrease their biopharma investments over 
the next 3 years. Therapeutic areas that affect millions of Americans 
will be hit by this change in investment, including cardiovascular 
disease, diabetes, and cancer.
    Additionally, venture capital firms are affected by the commitment 
that other countries are putting into their biotech industries. Forty-
two percent of venture capitalists surveyed said they already have 
health care investments outside of the United States, while 44 percent 
foresee significant investment increases forthcoming in emerging powers 
in Asia. Such a decline in venture capital will hinder our companies 
from making it onto the public markets where later stages of research 
are funded for large-scale and expensive clinical trials. Fewer initial 
public offerings will result in a decrease in job growth.
    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 1.42 
million Americans directly employed by biotech are driven to treat and 
heal the world, but in order for them to be able to do so, Congress 
must remove the barriers to innovation that we face. Innovation in 
biotechnology leads to the medical breakthroughs that cure and treat 
devastating diseases like cancer and Alzheimer's and allow real people 
to see their grandkids graduate from college or walk their daughters 
down the aisle.
    Congress has the opportunity to help speed lifesaving cures and 
treatments to patients by removing burdens to innovation in our 
industry. Below are some proposals that Congress has been considering 
that will help alleviate some of the financial struggles that our 
companies face.

SEC Regulation A (Direct Public Offerings)
    Regulation A, adopted by the SEC pursuant to Section 3(b) of the 
Securities Act of 1933, was created to provide smaller companies with a 
mechanism for capital formation with streamlined offering and 
disclosure requirements. Updating it to match today's market conditions 
would provide an important funding source for small biotechnology 
companies.
    Regulation A allows companies to conduct a direct public offering 
valued at less than $5 million while not burdening them with the 
disclosure requirements traditionally associated with public offerings. 
The intent of Regulation A was to give companies which would benefit 
from a $5 million influx (i.e., small companies in need of capital 
formation) an opportunity to access the public markets without weighing 
them down with onerous reporting requirements.
    However, the $5 million offering amount has not been adjusted to 
fit the realities of the costs of development and Regulation A is 
mostly not used by small companies today. The current threshold was set 
in 1992 and is not indexed to inflation, pushing Regulation A into 
virtual obsolescence. As it stands, a direct public offering of just $5 
million does not allow for a large enough capital influx for companies 
to justify the time and expense necessary to satisfy even the relaxed 
offering and disclosure requirements.
    Regulation A could have a positive impact for small biotechnology 
companies if its eligibility threshold was increased from $5 million to 
$50 million while maintaining investor protections. This increase would 
allow companies to raise more capital from their direct public offering 
while still restricting the relaxed disclosure requirements to small, 
emerging companies. Regulation A reform could provide a valuable 
funding alternative for small biotech startups, giving them access to 
the public markets at an earlier stage in their growth cycle and 
allowing them to raise valuable innovation capital.
    The Small Company Capital Formation Act, H.R. 1070, which would 
raise the Regulation A eligibility threshold from $5 million to $50 
million, passed the House in November. Senators Tester and Toomey have 
introduced companion legislation, S. 1544, in the Senate. This bill 
would provide an important avenue for small biotech companies to raise 
innovation capital. BIO thanks both Senators for championing this 
issue, and we look forward to working with them to pass this meaningful 
legislation.

SEC Reporting Standard (Shareholder Limit)
    Although the SEC in general monitors public companies, the agency 
also keeps tabs on private companies when they reach a certain size. 
Modifying the SEC's public reporting standard would prevent small 
private biotechnology companies from being unnecessarily burdened by 
shareholder regulations.
    Once a private company has 500 shareholders, it must begin to 
disclose its financial statements publicly. Biotechnology companies are 
particularly affected by this 500 shareholder rule due to our 
industry's growth cycle trends and compensation practices. Currently, 
the IPO market is essentially closed to biotechnology, leading many 
companies to choose to remain private for at least 10 years before 
going onto the public market. This long timeframe can easily result in 
a company having more than 500 current and former employees, most of 
whom have received stock options as part of their compensation package. 
Under the SEC's shareholder limit, a company with over 500 former 
employees holding stock, even if it had relatively few current 
employees, would trigger the public reporting requirements. Exempting 
employees from any shareholder limit is a minimum necessary measure to 
ensure growing biotech companies are able to hire the best available 
employees and compensate them with equity interests, allowing them to 
realize the financial upside of a company's success.
    Also, including accredited investors in the private company 
shareholder count does not serve the intended purpose of protecting 
retail investors. The SEC recognizes that accredited investors are a 
unique class that does not require the same level of protection as 
other investors. By including them in the 500 shareholder limit, 
growing private companies are forced to rely primarily on institutional 
investors because they need to maximize funding without triggering the 
limit. This excludes retail investors, whom the SEC was originally 
trying to protect, from taking part in this process.
    Increasing the shareholder limit above 500 would relieve small 
biotech companies from unnecessary costs and burdens as they continue 
to grow. As it stands, the limit encumbers capital formation by forcing 
companies to focus their investor base on large institutional investors 
at the expense of smaller ones that have been the backbone of our 
industry. Further, it hinders a company's ability to compensate its 
employees with equity interests and negatively affects the liquidity of 
its shares.
    BIO applauds Senators Toomey and Carper for introducing S. 1824, 
the Private Company Flexibility and Growth Act, which would increase 
the shareholder limit from 500 to 2,000 and exempt employees from the 
count. Representative Schweikert has introduced similar legislation, 
H.R. 2167, in the House. Increasing the shareholder limit and exempting 
employees are measures that, together, would remove significant 
financing burdens from small, growing companies.

SEC Regulation D (Ban on General Solicitation)
    Another potential avenue for capital formation in the biotech 
industry is SEC Regulation D. Under Rule 506 of Regulation D, companies 
can conduct offerings to accredited investors without complying with 
stringent SEC registration standards. This exemption allows companies 
to access accredited investors (who do not need as much SEC protection) 
without burdensome disclosure requirements. However, the upside of this 
fundraising avenue is hindered by the ban on general solicitation in 
Rule 506. Companies are limited in their investor base by this Rule, 
meaning that a vast pool of investors remains untapped. If the ban on 
general solicitation were lifted, growing biotech companies would be 
able to access funds from the entire range of wealthy SEC accredited 
investors without undergoing the full SEC registration process.
    BIO supports S. 1831 and H.R. 2940, the Access to Capital for Job 
Creators Act, which would require the SEC to revise Regulation D to 
permit general solicitation in offerings under Rule 506. If enacted, 
this legislation would enhance fundraising options for growing biotech 
companies searching for innovative cures and treatments.

Sarbanes-Oxley Section 404(b) Exemption
    As you know, the Sarbanes-Oxley Act was passed in 2002 with the 
intent of protecting public investors from corporate fraud. At the 
time, President Bush praised it as a collection of ``the most far-
reaching reforms of American business practices since the time of 
Franklin D. Roosevelt.'' While we can all agree that investors benefit 
from greater transparency, some of the regulations found in SOX, namely 
Section 404(b), are unnecessarily burdensome on smaller companies, and 
often involve onerous compliance with little to no benefit to investors 
or the general public. In fact, many biotech companies facing their 
first few years on the public market 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 already limited resources being driven 
away from a company's search for cures and treatments.
    The biotechnology sector is especially disadvantaged by the 
compliance burden of Section 404(b) due to the unique nature of our 
industry. The long, capital-intensive development period intrinsic to 
biotechnology often causes companies to have a relatively high market 
capitalization (caused by multiple rounds of venture financing prior to 
going public) but little to no revenue. All public companies with 
market caps greater than $75 million are forced to comply with Section 
404(b), even though most biotech companies in a cash-strapped financial 
position can ill afford to pay for expensive external attestation of 
internal financial controls.
    The main problem that these regulations cause for emerging public 
biotechnology companies is the need to divert resources away from 
innovation development to compliance for Section 404(b). The compliance 
costs 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 biotech companies is found in scientific 
milestones and clinical trial advancement toward 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.
    Section 989G of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act is an important acknowledgment by Congress that Section 
404(b) of Sarbanes-Oxley is not an appropriate requirement for many 
small reporting companies. Dodd-Frank sets a permanent exemption from 
Section 404(b) for companies with a public float below $75 million. 
This provision is particularly important because it provides 
consistency to companies who now have a clear understanding as to 
whether or not they are exempt. However, it is too narrow in 
practicality and must be raised. Because of the business model of 
innovative industries like biotechnology, companies generally have very 
low revenues compared to their market capitalizations. For example, it 
is not uncommon for a newly public biotech company to have a market 
capitalization in excess of $600 million but have product revenues of 
$1 million or less. Such a company would be required to fully comply 
with Section 404(b) despite its lack of revenue with which to pay for 
compliance.
    In 2006, the SEC Small Business Advisory Board recommended that the 
permanent exemption be extended to companies with public floats of less 
than $700 million to better fit the business model of industries like 
biotechnology. The Advisory Board's proposed ceiling would allow small 
innovative companies to focus on speeding cures and treatments to 
patients rather than SOX compliance.
    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 fuller picture. 
Revenue should be a critical consideration when determining the 
appropriateness of Section 404(b) compliance, along with public float. 
The addition of a revenue test would better serve the congressional 
intent behind Sarbanes-Oxley by reflecting the truly small nature of 
companies with little or no product revenue. 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.
    BIO strongly supports Congressman Fincher's efforts to raise the 
public float exemption to a more practical level. H.R. 3213, the Small 
Company Job Growth and Regulatory Relief Act, would provide companies 
with a public float of $350 million or less an exemption from Section 
404(b). In conjunction with raising the public float exemption, BIO 
supports the use of a revenue test that exempts companies with product 
revenues below $100 million.
    Additionally, BIO supports the concept of an IPO ``on ramp,'' 
particularly as it provides relief from 404(b) requirements for newly 
public companies. BIO looks forward to reviewing upcoming legislation 
that addresses this issue.
    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. Additionally, the medical 
breakthroughs happening in labs across the country could unlock the 
secrets to curing the devastating diseases that affect all of our 
families. There are many pitfalls and obstacles endemic to this effort, 
including scientific uncertainty and the high costs of conducting 
research. Congress has the opportunity to support and inspire 
biotechnology breakthroughs by unburdening startup companies and 
allowing innovators and entrepreneurs to continue working toward 
delivering the next generation of medical breakthroughs--and, one day, 
cures--to patients who need them.

Executive Summary
    The Biotechnology Industry Organization (BIO) represents 
        more than 1,100 innovative biotechnology companies, along with 
        academic institutions, State biotechnology centers, and related 
        organizations in all 50 States.

    BIO supports S. 1544 and H.R. 1070, the Small Company 
        Capital Formation Act. This would increase the eligibility 
        threshold of SEC Regulation A from $5 million to $50 million 
        while maintaining the same disclosure requirements.

    BIO supports S. 1824 and H.R. 2167, the Private Company 
        Flexibility and Growth Act, which would raise the reporting 
        trigger under the Securities Exchange Act of 1934 by increasing 
        the shareholder limit and exempting employees from the count.

    BIO supports S. 1831 and H.R. 2940, the Access to Capital 
        for Job Creators Act, which would require the SEC to revise 
        Regulation D to permit general solicitation of accredited 
        investors in private offerings under Rule 506.

    BIO supports legislation to relieve small companies from 
        the unnecessary burden and expense of conducting an audit under 
        Section 404(b) of Sarbanes-Oxley (SOX). H.R. 3213, the Small 
        Company Job Growth and Regulatory Relief Act, would provide 
        companies with a public float of $350 million or less an 
        exemption from Section 404(b). BIO supports the addition of a 
        revenue test with regard to the exemption from Section 404(b).
                                 ______
                                 
  STATEMENT SUBMITTED BY THE COMPUTING TECHNOLOGY INDUSTRY ASSOCIATION

Introduction
    Chairman Johnson, Ranking Member Shelby, and distinguished Members 
of the Committee, on behalf of the Computing Technology Industry 
Association (CompTIA) we appreciate the opportunity to submit testimony 
for the record. We wish to thank Chairman Johnson and Members of this 
Committee for holding this hearing on spurring job growth through 
capital formation. The topic of this hearing is critical. The majority 
of American job growth and innovation comes from small companies. In 
order to fuel economic expansion, we must assure that entrepreneurs and 
small businesses have the requisite capital to grow, innovate, and 
create jobs.

About CompTIA
    The Computing Technology Industry Association (CompTIA) is a 
nonprofit trade association representing the $3 trillion global 
information technology (IT) industry. CompTIA membership includes over 
2,000 members and 1,000 business partners. Our members are at the 
forefront of innovation and provide a critical backbone that supports 
broader commerce and job creation. These members include computer 
hardware manufacturers, software developers, technology distributors, 
and IT specialists that help organizations integrate and use technology 
products and services. CompTIA is dedicated to serving its membership 
by advancing industry innovation and growth through its educational 
programs, market research, networking events, professional 
certifications, and public advocacy.

Background
    Small businesses are the backbone of the American economy. There 
are approximately 30 million small businesses in the United States, 
which represent over 99 percent of all employer firms and employ over 
half of all private sector employees. Many participants in the IT 
industry are independent small businesses that provide a variety of 
functions for customers they serve. A sizeable portion of anticipated 
work force growth will emanate from start-up and small- and medium-
sized (SMB) information technology firms. The SMB sector of the IT 
industry accounts for about 40 percent of industry jobs, or more than 2 
million workers, and 163,000 employer businesses that maintain a 
payroll. The tough economic climate of the last few years has placed 
severe strains on many of these small businesses, with little relief in 
site. One of the most critical concerns has been the lack of access to 
capital. Whether seeking equity or debt financing, small businesses 
have significant difficulty gaining access to capital, which stunts 
their growth potential.

The Issue
    For some time, CompTIA has been calling on Congress and the Obama 
administration to advance technology progress and job creation by 
providing small businesses and entrepreneurs greater access to growth 
capital. We believe that the Government can play a valuable role in 
paving the way for access to capital for small IT firms, which have a 
unique capacity to create jobs, produce commercial and technological 
innovations, and spur long-term economic growth. Better access to 
capital would allow these firms to develop new products, expand 
distribution channels, open new export markets, secure new customers, 
and fortify infrastructure. In this regard, CompTIA has called for 
direct-lending opportunities for small, growth-oriented technology 
firms. This need has been especially highlighted in view of the 
shortcomings of the Small Business Lending Fund legislation, which 
provides indirect assistance (with significant obstacles) to small 
businesses.
    While we continue to support efforts to increase loans to growth-
oriented small businesses, there are additional measures that should be 
taken to increase access to debt and equity capital. However, because 
of strict, complicated, and costly equity investment regulations and 
requirements, most small businesses have been effectively cut off from 
raising equity investments for their businesses. However, we believe 
that modest steps can and must be taken that will benefit small 
businesses in dire need of equity capital and also assure necessary 
safeguards for investors. This can be a win-win situation for 
investors, small businesses, unemployed citizens, and our national 
economy.

Crowdfunding
    We have examined two proposals dealing with crowdfunding: H.R. 
2930, ``Entrepreneur Access to Capital Act,'' which passed the House by 
a wide margin on November 3, 2011, and is now awaiting action in the 
Senate; and S. 1791, ``Democratizing Access to Capital Act of 2011,'' 
as introduced by Senator Brown on November 2, 2011. This Senate bill is 
currently under the jurisdiction of this Committee awaiting further 
action.
    First, let us say that our membership is broadly supportive of 
efforts to enact simplified crowdfunding procedures. We view this as 
one avenue of revitalizing small business investment, which is needed 
to grow our economy and create jobs. With that said, we have analyzed 
both pieces of legislation and will summarize our specific 
recommendations.
    In general, the House-passed legislation allows for a higher 
individual level of investment but contains additional compliance 
burdens for small businesses. CompTIA is concerned that the regulatory 
requirements in H.R. 2930 will add undue complexity and cost to the 
very reasons crowdfunding legislation was explored and introduced in 
the first place. The Senate bill eases regulatory burdens on small 
businesses but lowers the individual level of investment. Both bills 
would allow up to $1 million to be raised in a 12-month period; the 
House bill would allow up to $2 million if audited financial statements 
are provided to the investors. CompTIA supports inclusion of the 
optional $2 million limitation provided by the House version. We 
believe that businesses should be allowed the higher limitation when 
audited financials are provided.
    Further, CompTIA supports the higher individual investment 
limitation of $10,000, limited to 10 percent of income as provided 
under the House version. We understand that the Senate version seeks to 
protect investors by limiting exposure to a maximum of $1,000; however, 
$1,000 is simply too low, especially in situations where the company 
provides additional documentation, such as audited financial 
statements. Also, in many situations, investors will actually be other 
small businesses that are quite familiar with the issuer, as opposed to 
uninformed individuals. We do understand the need for safeguards to 
protect unwitting investors. However, we need to balance this with the 
benefits to be gained by legitimate offerings and the resultant value 
to our economy as a whole; neither can or should be absolute.
    Generally, we support the requirements detailed under the Senate 
bill for issuers who do not use an intermediary in the offering. Under 
that legislation, issuers would be required to:

    Disclose to investors all rights of investors, including 
        complete information about the risks, obligations, benefits, 
        history, and costs of offering; and

    File such notice with the Commission as the Commission 
        shall prescribe.

    While we understand the intent of the detailed provisions contained 
in the House version is to protect investors, the many requirements 
placed on issuers would likely mire down the process and increase the 
cost of the offering, which is contrary to the goal of this 
legislation: Streamline the offering process for small businesses in 
order to increase equity investment. The basic question is how much 
should be required of the issuer in order to both protect the investor 
and maximize the issuer's ability to raise equity investment. We 
believe that rather than detailing each specific step, the safeguards 
provided in the Senate version requiring full disclosure and SEC notice 
reporting is a reasonable balance.
    Finally, we commend the inclusion of State preemption in this 
legislation. Both bills would provide a level playing field for 
investors and issuers to come together across State lines under a 
common set of rules. Businesses are continually burdened with 
compliance requirement from the multiplicity of Federal, State, and 
local jurisdictions. A single set of rules that would apply nationally 
is critical to the success of crowdfunding legislation.

Other Proposed Access to Capital Reforms
    Increase Exemption for Small Company Public Offerings. CompTIA 
supports legislation that would amend Regulation A of the SEC rules as 
it pertains to filing compliance. In short, H.R. 1070/S. 1544, the 
``Small Company Capital Formation Act of 2011,'' would reduce the 
filing and compliance burdens for certain small businesses that seek to 
raise capital through a public offering of stock. Simply put, this 
bipartisan legislation would increase the current $5 million limitation 
up to $50 million. This move is simply an updating of the antiquated $5 
million limitation. As we have stated before, our economy clearly needs 
additional equity investment. Increasing the Regulation A exemption is 
an obvious adjustment that should be made immediately.
    General Internet Solicitation in Public Offerings. There also have 
been discussions concerning a possible amendment of Regulation D of the 
SEC rules so that the Internet could be used to solicit public 
offerings. In today's economy, both investors and businesses survive 
and prosper with Internet applications and transactions. Clearly, the 
Internet offers issuers the ability to broaden their visibility and 
access to investors. With proper safeguards, it is no longer rational 
to bar issuers from employing the Internet in developing and promoting 
their equity offerings. The time has come for our securities laws to 
recognize that the Internet is here to stay and that it can actually be 
used to by issuers and investors alike to increase opportunities for 
equity investment in our economy.

Conclusion
    America is clinging to its spot as the world leader in technology 
innovation. Unless we move to improve the ability of small businesses 
and entrepreneurs to access capital, our current economic climate will 
continue to stagnate. Congress can take modest, fiscally responsible 
steps to provide a better climate to improve access to capital for our 
small businesses. Nowhere is this more important than the fiercely 
competitive global IT industry. Clearly, increasing the ability of 
small businesses to raise equity capital is needed and will fuel job 
growth and our recovering economy.
    So, in conclusion, we urge Congress to (1) increase the ability of 
our small businesses to raise equity capital through crowdfunding; (2) 
increase the small issuer exemption; and (3) allow companies to use the 
Internet, the linchpin of our economic structure. These steps will 
certainly contribute to our economic recovery.
                                 ______
                                 
STATEMENT SUBMITTED BY BARBARA ROPER, DIRECTOR OF INVESTOR PROTECTION, 
                     CONSUMER FEDERATION OF AMERICA
    As Chairman Johnson so aptly noted in his opening statement at this 
hearing, ``Our Nation is facing an unemployment crisis. Nearly 14 
million Americans are unable to find a job, and over 5 million have 
been unemployed for 6 months or longer.'' These Americans deserve 
serious proposals to put the Nation back to work, not poorly thought 
out legislative experiments that are at least as likely to increase the 
cost of capital for American companies as they are to promote 
sustainable job growth. Unfortunately, most of the proposals under 
consideration in this hearing fall into the latter category; even the 
best of the proposals are unlikely to result in meaningful job 
creation.
    The bulk of the small company ``capital formation'' proposals are 
founded on a series of false premises. For example:

    Advocates of these proposals routinely highlight the fact 
        that small companies disproportionately create jobs. But they 
        conveniently overlook the fact that small companies also 
        disproportionately destroy jobs. Proposals that 
        indiscriminately encourage small company capital formation, 
        without regard to the company in question's ability to grow and 
        prosper, risk diverting capital from more sustainable 
        enterprises, with a net negative effect on overall job growth.

    Advocates frequently highlight the fact that roughly 92 
        percent of job growth occurs after a company goes public. And 
        yet they propose to dismantle precisely those characteristics 
        of the public markets that make them such successful venues for 
        capital formation--the ready availability of reliable 
        information on which to make investment decisions, the 
        existence of a liquid secondary market for shares, and robust 
        protections against practices that advantage insiders at the 
        expense of other shareowners, to name just a few.

    In crafting their proposals, advocates tend to focus 
        exclusively on the compliance costs associated with becoming a 
        registered public company and ignore the substantial benefits 
        that flow from the accompanying regulations. It is not a 
        coincidence that American public companies have enjoyed the 
        lowest cost of capital in the world. They do so precisely 
        because the risk premium imposed for investing in transparent, 
        well regulated markets is lower. If an increase in fraud or 
        even non- fraud-related investor losses results from proposals 
        to diminish transparency and weaken investor protections, 
        investors can be expected to demand an increase in the risk 
        premium that at least equals and may well exceed any reduction 
        in compliance costs, negating any job promoting benefits.

    Finally, advocates of these proposals have chosen to blame 
        recent investor protection regulations rather than acknowledge 
        the major changes in the market that have made small company 
        IPOs less attractive than they were in the early years of the 
        1990s. But the institutionalization of the market that has 
        occurred since that time has fundamentally changed the options 
        for emerging companies seeking to raise capital, making a 
        public offering (or at least an early stage public offering) 
        less necessary. At the same time, the economics of the 
        brokerage industry have changed radically--as a result of such 
        factors as decimalization, electronic trading, and the 
        emergence of alternative trading venues--making it unlikely 
        that the extensive support that once existed for smaller IPOs 
        can be recreated in today's markets.

    In basing their proposals on false assumptions, supporters of these 
measures don't just incur the risk that their legislative proposals 
will be ineffective in promoting job growth. A side-effect of the 
increased risk to investors and reduced transparency is all too likely 
to be an increase in the cost of capital for American companies, 
particularly the smaller companies these proposals are intended to 
benefit, with a corresponding negative effect on capital formation and 
job growth. A further risk is that advocates of this deregulatory 
agenda will take any such failure to promote job growth not as evidence 
that their basic premise was misguided, but rather as an invitation to 
a further round of regulatory weakening, with the predictable result 
that fraud and investor losses will rise and that the cost of capital 
will rise along with them.
    While most share a common set of largely false assumptions, the 
specific proposals under consideration in this hearing vary greatly in 
their approach and in the degree of risk they pose to investors and to 
market integrity.

Regulation A Revisions (S. 1544, ``The Small Company Capital Formation 
        Act of 2011'')
    While we do not support this bill in its current form, we do 
recognize that it is among the more thoughtful of the capital formation 
legislative proposals under consideration. In particular, its sponsors 
deserve credit for recognizing that there are benefits to providing 
investor protections along with the expanded Regulation A exemption, in 
the form of up-front disclosure, periodic reporting, audited financial 
statements, Securities and Exchange Commission (SEC) oversight, and a 
negligence-based litigation remedy. We are concerned, however, that the 
bill imposes no cumulative limit on use of the Regulation A exemption 
in multiple years and gives the SEC unlimited authority to increase the 
ceiling for Regulation A offerings. The latter is of particular concern 
because, in our view, the bill is unlikely to result in a dramatic 
increase in use of the exemption given the availability of more 
attractive options for raising capital either under Regulation D or 
from venture capital firms. If the bill fails to dramatically increase 
use of Regulation A, past experience has taught us that that is likely 
to be seen as a reason to raise the ceiling even further rather than to 
reexamine the assumptions underlying the approach. Absent a reckless 
expansion of this sort, however, and with the additional changes we 
have suggested, we believe the bill is relatively unlikely to do any 
serious harm and could possibly offer an attractive option for some 
small companies.

Crowdfunding (S. 1791, ``Democratizing Access to Capital Act of 2011,'' 
        and S. 1970, ``Capital Raising Online While Deterring Fraud and 
        Unethical Non-Disclosure Act of 2011'')
    The purpose of these bills is to create an Internet-based mechanism 
to allow start-up companies to raise relatively small amounts of seed 
money (up to $1 million in a 12-month period) from a dispersed group of 
small investors. The companies that take advantage of this option are 
likely to be those who are either not yet ready or have failed to 
attract backing from other sources, such as angel investors or venture 
capital firms. As a result, the start-up companies that rely on 
crowdfunding are likely to be among the riskiest, most speculative 
investments an investor could make.
    For these reasons, we would expect to see very high losses for 
crowdfunding investors, even if appropriate steps are taken to ensure 
that crowdfunding sites do not become Mecca for fraud. In the 1980s, 
for example, it was estimated that investors had a 7 in 10 chance of 
losing some or all of their money in penny stocks simply because of the 
highly speculative nature of these investments. This risk of losses in 
penny stocks rose to 9 in 10 when the risk of fraud was included. 
Ultimately, Congress stepped in and adopted legislation to strengthen 
investor protections. But penny stocks were, if anything, less 
inherently speculative and better regulated than the kinds of companies 
that would take advantage of a crowdfunding options. Failing to learn 
the lessons of the past, the various crowdfunding bills that have been 
proposed would permit these highly speculative companies, and the con 
artists who would inevitably be attracted to the market, to hype their 
companies on the Internet and raise money from an unlimited number of 
investors with, under all the various bills except S. 1970, minimal if 
any regulatory oversight.
    We appreciate the steps that Senate sponsors have taken to redress 
the most serious flaws in the House bill. Even S. 1791, while it falls 
well short of what is needed to prevent crowdfunding from becoming a 
haven for fraud, offers significant improvements over its House 
companion. In particular, it reduces the ceiling on individual 
investments from $10,000 per offering to a far more appropriate $1,000; 
it requires, rather than simply permits, use of an intermediary; and it 
subjects those intermediaries to a more robust set of regulatory 
requirements. While this is a step in the right direction, only S. 1970 
includes a set of investor protections commensurate with the risks in 
crowdfunding. Among the most important of these are:

    the individual aggregate cap, which would help to ensure, 
        in a way neither of the other bills does, that no individual 
        could lose everything betting on these speculative investments;

    its requirement that crowdfunding intermediaries be 
        registered with the SEC either as a broker-dealer or as a 
        ``funding portal'' and subject to inspection and appropriate 
        regulatory oversight;

    its more robust requirements with regard to the duties of 
        the intermediary, which include a duty to monitor and enforce 
        the aggregate individual investment limit, limits on conflicts 
        of interest, and SEC authority to prescribe measures to reduce 
        the risk of fraud;

    its prohibition on active solicitation by any crowdfunding 
        site that is not registered as a broker-dealer; and

    its preservation of State authority.

    We frankly question the wisdom on the crowdfunding proposals as a 
general matter. No one has yet explained to us why it is good public 
policy to allow even the most unsophisticated individuals to put 
substantial funds at risk investing in the most speculative of 
companies. S. 1970 at least offers some assurance that this effort 
would not simply recreate the boiler rooms of an earlier era in a 
riskier high-tech form. Without that assurance, there is every reason 
to believe crowdfunding will become a haven for fraud, where 
unsophisticated investors are hoodwinked out of their limited savings, 
and no new jobs are produced. Even with the necessary protections 
incorporated in S. 1970, we see very little reason to believe this will 
contribute in any meaningful fashion to overall job growth. As with 
penny stocks in the 1980s, the money lost is likely to greatly exceed 
the money that is successfully invested in sustainable enterprises, 
with no appreciable benefits in terms of job growth and significant 
damage to investor confidence in the integrity of our capital markets.

Shareholder of Record Requirements (S. 1824, ``Private Company 
        Flexibility and Growth Act'')
    This bill makes it easier for even very large companies to avoid 
providing the periodic disclosures on which transparent markets depend. 
It does this by simultaneously raising the limit on the number of 
shareholders of record who can hold a stock without triggering 
reporting requirements from 500 to 2,000 and exempting employees who 
hold company stock from the count. In addition, it would allow banks 
and bank holding companies to ``go dark'' if the number of shareholders 
of record dropped below 1,200. Moreover, it does all this without 
addressing the outdated and easily manipulated reliance on 
``shareholders of record'' in making this determination. While we 
question the benefits of a proposal that is designed to reduce market 
transparency and reduce the incentives companies have to go public, the 
very least Congress should do if it feels compelled to adopt such a 
policy is to use a measure that is less subject to manipulation and 
less likely to permit even very large companies with large numbers of 
investors to evade basic reporting requirements.

IPO On-Ramp (S. 1933, ``Reopening American Capital Markets to Emerging 
        Growth Companies Act of 2011'')
    In some ways, this is the most cynical of the ``capital formation'' 
bills, because it offers the false promise that delaying compliance 
with a few investor protection and corporate governance requirements 
for a new class of ``emerging growth'' companies can magically restore 
the more IPO-friendly conditions that prevailed in the markets in the 
early 1990s and encourage more companies to go public. (Does anyone 
seriously believe, for example, that the requirement that public 
companies have a ``say on pay'' vote every 3 years is a serious 
impediment to capital formation?) Moreover, the bill extends its ``on-
ramp'' even to very large companies that could easily afford the cost 
of compliance. And it attacks, not just existing investor protections, 
but the independent accounting and audit standard-setting processes.
    As we discussed above, the real causes of the drop-off in IPOs can 
be traced to such factors as the institutionalization of the capital 
markets, changes that made Rule 144A offerings more attractive to small 
companies and institutional investors alike, and changes to the 
economics of the brokerage industry that made these firms less willing 
and able to offer extensive analyst coverage to or to otherwise support 
small company IPOs. Since it doesn't address these issues in any 
meaningful way, there is no reason to believe it will measurably change 
the considerations companies make when deciding to go public. On the 
other hand, it will measurably reduce investor protections adopted in 
the wake of episodes of widespread and very damaging fraud.
    The bill's ``on-ramp,'' which gives companies that go public 5 
years to come into compliance with a number of the requirements of 
being a public company, perpetuates a dangerous trend that has emerged 
in recent years of enabling companies to go public before they are 
prepared to comply with the basic standards that go with raising money 
from average, unsophisticated investors. Indeed, this bill validates a 
prediction we made when it was first suggested that small companies be 
given a special exemption from SOX 404--that once policy makers started 
down the road of creating small-company carve-outs from the 
requirements for public companies, there'd be no end to their appetite 
for new and more expansive small company exemptions. As this bill makes 
clear, there need be no evidence that the carve-outs are necessary or 
justified or would have a significant impact on capital formation. The 
ultimate and inevitable conclusion of this approach is the creation of 
a small company ghetto in the capital markets that investors will learn 
to shun because of the risks they face there.
    It is particularly troubling that this bill continues to scapegoat 
SOX 404(b) for a drop-off in small company IPOs that cannot in good 
conscience be laid at its door. If SOX 404(b) were a determining 
factor, we would have expected to see a further drop-off in IPOs once 
the requirement was implemented. But charts showing U.S. IPO statistics 
pre- and post-SOX clearly show that IPOs were rebounding before the 
2008 financial crisis disrupted the market. By the same token, if SOX 
404(b) were a significant factor affecting small company IPOs, we would 
have expected to see a significant up-tick in such IPOs once the small 
company exemption was made permanent more than a year ago. But no such 
surge has occurred. In short, there is simply no evidence that SOX 
404(b) significantly inhibits IPOs, or that allowing companies to delay 
implementation will lead to an increase in IPOs. \1\
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     \1\ Some have suggested that SOX 404(b) is often cited by foreign 
companies that decide against listing in U.S. markets. But these 
companies are unlikely to acknowledge other factors, such as the limits 
that exist here on siphoning off IPO proceeds to enrich a few insiders 
and on affiliated transactions on terms that disadvantage general 
shareholders. SOX 404(b) is a convenient scapegoat for companies whose 
real goal is to avoid far more basic investor protections that come 
with a U.S. listing.
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    The bill's backers seem to forget that SOX 404(b) was adopted in 
response to widespread fraud. We know, moreover, that the requirement 
to have effective internal controls over financial reporting, which had 
been on the books since the 1970s, was simply ignored until SOX added 
the requirement for an outside audit of those controls. Similarly, 
research since SOX was adopted has shown that management's attestation 
regarding internal controls is more likely to ignore existing 
weaknesses absent that independent evaluation. There is no reason to 
believe that ``emerging growth'' companies would be immune from these 
problems of lax compliance.
    Indeed, by delaying implementation of SOX 404(b), the bill would 
give companies with up to $1 billion in gross revenues up to a full 5 
years in which to raise money from the public without appropriate 
protections in place to prevent earnings management and other 
accounting irregularities. It is true, of course, that companies that 
engage in earnings management tend to hire, and even to over-hire, in 
the short term. \2\ But they then shed those jobs--and, often, many 
others--very quickly when the fraud comes to light. In fact, research 
has shown that the public companies that had to restate their earnings 
in 2000 and 2001 subsequently lost between 250,000 and 600,000 jobs.
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     \2\ Simi Kedia and Thomas Philippon, ``The Economics of Fraudulent 
Accounting'' (January 2005). AFA 2006 Boston Meetings Paper. Available 
at SSRN: http://ssrn.com/abstract=687225.
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    The sponsors of this bill ignore extensive evidence such evidence 
that argues against this approach. Research has shown, for example, 
that the cost of compliance has come down significantly in the 10 years 
since SOX was adopted, that compliance with 404(b) improves the quality 
of financial reporting, and that, as a result, 404-compliant companies 
enjoy a lower cost of capital than noncompliant companies. Ironically, 
the bill would perpetuate for all new companies one of the key factors 
contributing to the initial high cost of implementing SOX 404(b): the 
cost of retrofitting controls onto established system. Because it 
simultaneous exaggerates the benefits that would flow from delaying 
implementation of SOX 404 and ignores the potential costs, the 
legislation adopts an approach that is at least as likely to inhibit 
job growth as it is to spur it. Worse, experience tells us that, when 
this bill fails to deliver the promised up-surge in IPOs, its backers 
will be back with further proposals to spur growth by undermining 
investor and market protections.

Conclusion
    One of the things that is discouraging about these bills is the 
degree to which they reflect our policy makers' apparent inability or 
unwillingness to learn from the past. The Internet bubble and bust, the 
analyst scandals, the accounting scandals, and the recent financial 
crisis all had a devastating impact on our markets. All seriously 
inhibited capital formation and job growth, with particularly severe 
and lingering effects in the case of the most recent financial crisis. 
And each in its own way was the direct result of fatal weaknesses in 
financial regulations designed to protect investors, promote 
transparency, and ensure the integrity and stability of our financial 
markets. By ignoring the lessons of those events, the majority of these 
so-called ``capital formation'' bills offer at best gimmicky solutions 
to a serious problem and at worst offer ``solutions'' that will 
actually make the problem worse. It is a cruel and cynical tactic to 
exploit the jobs crisis to ram through special-interest deregulatory 
proposals that, in the long run, could trigger even more financial bad 
news and even more lost jobs. The millions of out-of-work Americans who 
are victims of our last experiment with financial deregulation deserve 
better.

        Consumer Federation of America (CFA) is a nonprofit association 
        of approximately 280 national, State, and local proconsumer 
        organizations. It was founded in 1968 to advance the consumer 
        interest through research, advocacy, and education.
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