[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
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TWELFTH CONGRESS
EXAMINING JOB GROWTH THROUGH CAPITAL FORMATION
DECEMBER 1, 2011
Printed for the use of the Committee on Banking, Housing, and Urban
Available at: http: //www.fdsys.gov /
U.S. GOVERNMENT PRINTING OFFICE
74-738 WASHINGTON : 2013
For sale by the Superintendent of Documents, U.S. Government Printing Office,
http://bookstore.gpo.gov. For more information, contact the GPO Customer Contact Center, U.S. Government Printing Office. Phone 202�09512�091800, or 866�09512�091800 (toll-free). E-mail, email@example.com.
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
C O N T E N T S
THURSDAY, DECEMBER 1, 2011
Opening statement of Chairman Johnson............................ 1
Prepared statement........................................... 42
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 2
Senator Reed................................................. 4
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
Statement submitted by Barbara Roper, Director of Investor
Protection, Consumer Federation of America..................... 119
SPURRING JOB GROWTH THROUGH CAPITAL FORMATION WHILE PROTECTING
THURSDAY, DECEMBER 1, 2011
Committee on Banking, Housing, and Urban Affairs,
The Committee met at 10:05 a.m., in room SD-538, Dirksen
Senate Office Building, Hon. Tim Johnson, Chairman of the
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 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
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
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
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
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
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
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
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
STATEMENT OF KAY BAILEY HUTCHISON, U.S. SENATOR FROM THE STATE
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
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
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
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
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
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
Chairman Johnson. Thank you, Senator Pryor.
Senator Brown, please proceed.
STATEMENT OF SCOTT P. BROWN, U.S. SENATOR FROM THE STATE OF
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
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
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
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
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
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
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.
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
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
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
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
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
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
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.
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
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
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.
Chairman Johnson. Thank you, Professor Coffee.
Would Senator Toomey care to share some comments about Mr.
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
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
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
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
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
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
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
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
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.
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
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
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
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
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
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
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
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
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-
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
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
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
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
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
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
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,
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
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
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
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
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
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
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
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
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
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
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
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
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
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,
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
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
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.
Senator Schumer. Would you choose our bill as the one that
would do the most?
Mr. Cutler. Of course, yes.
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.
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
Community banks and small businesses form the backbone of our
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
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
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
\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.
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
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,
the number of shareholders and other triggers for public
the restriction on general solicitation in private
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
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
\2\ See, SEC Announces Formation of Advisory Committee on Small
and Emerging Companies (Sept. 13, 2011), http://www.sec.gov/news/press/
\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),
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.
\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)]
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
\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.
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\
\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/
\11\ See, 2009 Annual SEC Government-Business Forum on Small
Business Capital Formation Final Report (May 2010), http://www.sec.gov/
\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/
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
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
\13\ See, Rule 502(c) of Regulation D and Release No. 4552, Non-
Public Offering Exemption, (November 6, 1962).
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\
\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).
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\
\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/
\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'').
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
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.
\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.
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
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\
\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/
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
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
\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
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
what limitations should be placed on the aggregate amount
of funds that can be raised by a company and invested by an
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
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.
\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 . . . .''
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
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
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
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
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
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
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
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
\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://
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
In short, the oversight of these offerings should be done by State
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
Individual investments are limited to $1,000 per year, per
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
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
Individuals and companies that have criminal records or
have violated securities laws will be precluded from using the
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-
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
\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
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
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.
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
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''
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
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
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
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
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
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
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
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
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
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
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.
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
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,
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
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://
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/
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.
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
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
Solution #5: Create Jobs by Allowing Companies To Hire the Employees
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
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
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
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
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
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
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
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
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
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)
\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].
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,
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
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
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
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
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
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
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.
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
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
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.
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.
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
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
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
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
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
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.
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
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
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
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
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\
\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.
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.
\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.
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.
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
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.