[Senate Hearing 112-482] [From the U.S. Government Publishing Office] S. Hrg. 112-482 SPURRING JOB GROWTH THROUGH CAPITAL FORMATION WHILE PROTECTING INVESTORS--PART II ======================================================================= HEARING before the COMMITTEE ON BANKING,HOUSING,AND URBAN AFFAIRS UNITED STATES SENATE ONE HUNDRED TWELFTH CONGRESS SECOND SESSION ON CONSIDERING PROPOSED CHANGES TO THE SECURITIES LAWS THAT ARE INTENDED TO STIMULATE INITIAL PUBLIC OFFERINGS (``IPO'') OF SECURITIES AND HELP STARTUPS AND EXISTING BUSINESSES TO RAISE CAPITAL WHILE PROMOTING JOB GROWTH AND PROTECTING INVESTORS __________ MARCH 6, 2012 __________ Printed for the use of the Committee on Banking, Housing, and Urban Affairs [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] Available at: http: //www.fdsys.gov / _____ U.S. GOVERNMENT PRINTING OFFICE 75-178 PDF WASHINGTON : 2013 ----------------------------------------------------------------------- For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop SSOP, Washington, DC 20402-0001 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 Dean Shahinian, Senior Counsel Kara Stein, Counsel Laura Swanson, Policy Director Erin Barry, Professional Staff Member Levon Bagramian, Legislative Assistant Andrew Olmem, Republican Chief Counsel Michelle Adams, Republican Counsel Mike Piwowar, Republican Chief Economist Gregg Richard, Republican Professional Staff Member Dawn Ratliff, Chief Clerk Riker Vermilye, Hearing Clerk Shelvin Simmons, IT Director Jim Crowell, Editor (ii) C O N T E N T S ---------- TUESDAY, MARCH 6, 2012 Page Opening statement of Senator Reed................................ 1 Opening statements, comments, or prepared statements of: Chairman Johnson Prepared statement....................................... 34 Senator Crapo................................................ 2 Senator Schumer.............................................. 3 Senator Moran................................................ 5 Senator Bennet............................................... 6 WITNESSES William D. Waddill, Senior Vice President and Chief Financial Officer, OncoMed Pharmaceuticals, Inc., on behalf of the Biotechnology Industry Organization............................ 7 Prepared statement........................................... 34 Responses to written questions of: Chairman Johnson......................................... 70 Jay R. Ritter, Cordell Professor of Finance, Warrington College of Business Administration, University of Florida.............. 8 Prepared statement........................................... 39 Responses to written questions of: Chairman Johnson......................................... 71 Kathleen Shelton Smith, Co-Founder and Chairman, Renaissance Capital, LLC................................................... 10 Prepared statement........................................... 43 Responses to written questions of: Chairman Johnson......................................... 72 Timothy Rowe, Founder and CEO, Cambridge Innovation Center....... 11 Prepared statement........................................... 48 Responses to written questions of: Chairman Johnson......................................... 79 Lynn E. Turner, Former Chief Accountant of the Securities and Exchange Commission, and Managing Director, Litinomics, Inc.... 13 Prepared statement........................................... 56 Responses to written questions of: Chairman Johnson......................................... 81 Additional Material Supplied for the Record Exhibits 1-10 submitted by Lynn E. Turner........................ 82 SPURRING JOB GROWTH THROUGH CAPITAL FORMATION WHILE PROTECTING INVESTORS--PART II ---------- TUESDAY, MARCH 6, 2012 U.S. Senate, Committee on Banking, Housing, and Urban Affairs, Washington, DC. The Committee met at 10:04 a.m., in room SD-538, Dirksen Senate Office Building, Hon. Jack Reed, presiding. OPENING STATEMENT OF SENATOR JACK REED Senator Reed. Good morning. I call the hearing to order the hearing this morning, entitled ``Spurring Job Growth through Capital Formation while Protecting Investors, Part II.'' Unfortunately, Chairman Johnson had a prior commitment with the Energy Committee today and will not be able to attend. I understand also that Senator Shelby will not be able to attend. So Senator Crapo and I will do our best. We want to thank you all for the valuable time and valuable insights that you will provide us this morning. Senator Johnson also asked that I submit his statement for the record, and without objection, his statement and all the statements will be submitted for the record. Senator Reed. When I conclude my remarks, I will recognize Senator Crapo, then ask my colleagues if they have any opening remarks also. This is the fourth in a series of hearings by the Banking Committee on capital formation issues, including one held by Senator Tester in the Subcommittee on Economic Policy and one held by the Subcommittee that I chair on Securities, Insurance, and Investment. Job creation and revitalizing the growth of American businesses are two of the top issues facing our country right now. These are the issues that Americans are rightfully urging us to find ways to address. Entrepreneurial businesses need access to capital to fund the search for new ideas, the development of new products, and ultimately the hiring of new workers. At the same time, as we know from our country's own history, investors are more willing to invest when they are appropriately protected, so raising capital and assuring investors go hand in hand. This morning, we will focus on some of the legislative proposals introduced in this area, including creating an on- ramp for emerging-growth companies, Regulation A and its offering limit, Regulation D and its requirements on solicitation, the 500 shareholders of record threshold for private banks and other companies to become public, and the issue of crowdfunding. The first Federal securities laws followed in the wake of the stock market crash of 1929, and the Securities Act of 1933, enacted as the ``Truth in Securities Act,'' required disclosures. As President Roosevelt stated at the time, ``This proposal adds to the ancient rule of `caveat emptor,' the further doctrine `let the seller also beware.' '' It puts the burden for telling the whole truth on the seller. It should give impetus to honest dealing in securities and thereby bring back public confidence. With the fragile economic recovery and continued high unemployment, directing the flow of capital to enterprises that would improve the economy is vital to putting people back to work. However, we must not forget that gaps in regulation and lack of transparency were contributing factors to the enormous losses suffered as a result of the financial crisis. As we consider these capital formation bills, we must be mindful to not re-create the very problems that we just tried to solve when we enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act. Indeed, even with these steps, as we go forward, unfortunately, we are seeing incidents of market irregularities, from insider trading to micro stock capital fraud schemes. There remains the potential for investors to be harmed, and we have to recognize that potential. Today's hearing will continue the Banking Committee's examination of different proposals to update and streamline our capital-raising process. This process requires finding the right balance between ensuring entrepreneurial businesses have access to capital to fund new products and provide jobs while providing accurate information to investors so they have the opportunity to make sound investment choices. And I look forward to our witnesses' and to my colleagues' presentations. With that, let me recognize Senator Crapo. STATEMENT OF SENATOR MIKE CRAPO Senator Crapo. Thank you very much, Mr. Chairman. I appreciate the fact that we are holding this hearing, and I look forward to the information that our witnesses will provide to us, and I welcome the witnesses. As the December 1st and 14th hearings highlighted, we can do more to expand economic activity by removing unnecessary restrictions on capital formation to enhance access to capital for early stage startups as well as later-stage growth companies. Later this week, the House of Representatives is expected to pass a package of reforms that include increasing the 500-shareholder registration threshold, expanding the scope of Regulation A offerings to $50 million, permitting general solicitation of investors in Regulation D offerings, allowing small businesses and startups to raise capital from small- dollar investors through crowdfunding, and, finally, providing an on-ramp that would provide emerging-growth companies up to 5 years to scale up to IPO regulation and disclosure compliance. In the Securities Subcommittee hearing in December, Kate Mitchell of Scale Venture Partners talked about the fact that during the past 15 years, the number of emerging-growth companies entering capital markets through IPOs has plummeted relative to historical norms. From 1990 to 1996, 1,272 U.S. venture-backed companies went public on U.S. exchanges, yet from 2004 to 2010, there were just 324 of those offerings. This decline is troubling as more than 90 percent of company job growth occurs after an IPO. The IPO Task Force recommended providing an on-ramp that would provide emerging-growth companies up to 5 years to scale up to regulation and disclosure compliance. During this period emerging-growth companies could follow streamlined financial statement requirements and minimize compliance costs and be exempted from certain regulatory requirements imposed by Sarbanes-Oxley and Dodd-Frank. On December 8th, SBA Administrator Karen Mills and National Economic Council Director Gene Sperling posted a joint online statement about helping job creators get the capital they need by passing legislation relating to crowdfunding, Regulation A mini-offerings, and creating an on-ramp for emerging-growth companies. There is strong bipartisan support for these proposals, and I look forward to working together with my colleagues and others to enact necessary changes to promote investment and American job growth while protecting the investors. Again, Mr. Chairman, I appreciate the fact that we are holding this hearing. I look forward to the input that our witnesses will provide to us today. Senator Reed. Thank you very much, Senator Crapo. Following the early bird rule, let me ask if Senator Tester has an opening statement or any comments. No? Then, Senator Schumer, the next Democrat. STATEMENT OF SENATOR CHARLES E. SCHUMER Senator Schumer. I do. Thank you, Mr. Chairman. And I thank you for holding this hearing. It is the fourth time in recent months--and I thank Chairman Johnson as well, as well as Senator Shelby. It is the fourth time in recent months that this Committee or one of our Subcommittees has considered the issue of capital formation and the legislative proposals being discussed here today. This week, the House Republican leadership is scheduled to vote on a package of bills encouraging capital formation for growing companies. If the House package looks familiar, it is because it includes several proposals already advancing in the Senate. Speaking on behalf of some of us here in the Senate, we are glad to see the House endorsing a few of our ideas. The House package, for instance, borrows from a bill proposed by Senator Toomey and myself that would provide a transition period for emerging-growth companies to make it easier for these companies to go public. The House package also includes a measure to raise the offering limit under Regulation A from $5 million to $50 million, a proposal championed in the Senate by Senator Tester and supported by Senators Toomey and Menendez. In addition, Senators Warner and Toomey have joined Senator Carper on a bill that recognizes the reality that companies are taking longer to go public and would, therefore, help fast- growing companies use stock to pay their employees without undergoing a cumbersome SEC registration process ordinarily designed for companies issuing stock to the general public. The proposal also made it into the House package being voted on this week. So the House package took a lot of bipartisan Senate proposals that had bipartisan support in the House and put it together, which is good. There is no reason why the Senate should not bundle these same proposals together, just like the House has, and we will. Leader Reid has already indicated the Senate will assemble a bipartisan package. The Senate version will probably go a little further than the House version, and I would hope that we would also take up some needed precautions on investor protection, which Senator Jack Reed and others have reminded us is important. Given the level of bipartisan support for many of these proposals, passage in the Senate appears not to be a question of if but of when. I expect a comprehensive Senate proposal could be announced in the coming days, and this is an important area for the Senate to address. Many recent IPOs and proposed IPOs--Zynga, Groupon, Facebook--have generated a lot of hype, but the actual numbers, if you are a small startup, not one of the ones that gets a lot of focus and glamour, that tells a different story. There have been ups and downs over the years, but the number of U.S. IPOs has actually drastically declined since the mid-1990s, and companies are taking almost twice as long to go public than they were then. I agree with some of today's witnesses who argue that there is not one simple reason for decline in U.S. IPOs, but I do think Congress has an ongoing obligation to ask whether the policy framework for public offerings is striking the right balance between facilitating capital formation on the one hand and attempting to protect investors on the other. That is always a needle we have to thread. If you ask the people running emerging-growth companies and looking to raise capital to build their businesses, they will tell you why our bill is important. In a recent survey, 79 percent of those CEOs said the U.S. IPO market is not accessible for small companies, and 85 percent said going public is not as attractive today as it was in 1995. The primary reasons cited were regulatory and compliance burdens. This matters because a threat to the U.S. IPO market represents a direct threat to U.S. job creation. Historically, over 90 percent of job creation at U.S. public companies has occurred post-IPO. And according to testimony we will hear from Mr. Rowe, ``Data show that companies that go public grow their headcount approximately 5-fold.'' It is also important to point out that our IPO on-ramp is designed to be temporary, transitional, and limited. At any given time, only 11 to 15 percent of companies will qualify as emerging-growth companies, and those companies will only account for about 3 percent of market capitalization. Big-name companies who have gone public recently would not have qualified as emerging-growth companies. Neither Groupon nor Zynga would have qualified, and, of course, Facebook is not even in the ballpark. Finally, I should note that the IPO on-ramp we are proposing is not mandatory. If investors feel they require more protection, they would be free to request it from the issuer. Indeed, Carlyle recently filed to go public, and its registration statement included a provision that would have prevented investors from suing in court for securities fraud claims. Investors objected; Carlyle and its advisers amended the terms of the offering to remove the provision. In conclusion, Mr. Chairman, all of the bills we are considering today would advance the goal of capital formation and job creation. They all have bipartisan support from Members of this Committee. I see Michael Bennet has walked in, and he has another proposal that we are working on as well. Many have passed the House with over 400 votes, and I am glad to see our Committee devoting so much time to the issue of capital formation. I look forward to working with Chairman Johnson, Ranking Member Shelby, and the rest of my colleagues to see that the Senate passes a significant package of legislative proposals to help small companies raise capital and grow their businesses, and I am confident we will be successful. Thank you for the time, Mr. Chairman. Senator Reed. Senator Corker? Senator Corker. As is my custom, I think we benefit so much more listening to our witnesses than listening to us, so I look forward to that. Senator Reed. Senator Moran, do you have a comment? Senator Moran. While I agree with the Senator from Tennessee, I do have an opening statement. [Laughter.] Senator Schumer. He was not directing it at you, Mr. Moran. STATEMENT OF SENATOR JERRY MORAN Senator Moran. It did not seem like a very good segue. Mr. Chairman, thank you. It is a privilege to be here and to hear our witnesses, and I look forward to that moment. I just wanted to highlight legislation that I and Senator Warner, also a Member of this Committee, have introduced, which is called the Startup Act, and a significant component of the Startup Act is capital formation provisions. It also includes items related to regulatory balance, to employment of entrepreneurial and highly skilled talent, and promotion of commercialization for research done using Federal dollars. We are also working to bring in others with the ideas that Senator Schumer and others have mentioned in their opening remarks, provisions of Senator Tester's legislation, provisions that Senator Bennet supports, Senator Toomey, and Senator Crapo. We discovered in reviewing the research done by the Kauffman Foundation in Kansas City that startup companies that are less than 5-years old accounted for nearly all net jobs created in the United States from 1980 to 2005. And as we look at trying to balance our budget, grow our economy, and put people to work, the ability to create an environment in this country that is entrepreneurial is so critical. And so we look forward to working with the Majority Leader and others as they craft legislation that is designed to create opportunities for greater entrepreneurial efforts in the United States and try to create the opportunity for success. So we welcome the opportunity to work with the Senators I mentioned as well as those who are interested in this topic, and I appreciate the opportunity to be here to hear these witnesses that Senator Corker so appropriately indicated were more articulate and more highly educated and informing than the Senator from Kansas. Senator Reed. We thank the Senator from Kansas. Senator Bennet, do you have a comment? STATEMENT OF SENATOR MICHAEL F. BENNET Senator Bennet. I am nowhere near as bold as the Senator from Kansas, so I am going to avoid the derision of the Senator from Tennessee and not make an opening statement. I do want to recognize Lynn Turner, who is here from the great State of Colorado--thank you very much for testifying--and simply say, Mr. Chairman, how important this discussion is for our economic future. A lot of people do not know that our gross domestic product is actually higher today than it was before we went into this recession. The reason they do not know that is because we have become so productive as an economy that we are producing that economic output with a lot fewer people, and we are seeing median family income continue to decline in this country. That is a huge problem. And the only way it is going to be resolved, I think, is through the kind of initiatives that the Senator from Kansas has talked about and by educating our people. Those are the two things that we need to do in order to drive an economy that is actually creating jobs and lifting income in the United States. So I look forward to hearing the witnesses. Senator Reed. Thank you very much. Senator Reed. Let me now introduce the panel. Our first witness is Mr. William Waddill. He is the Senior Vice President and Chief Financial Officer of OncoMed Pharmaceuticals, Incorporated. It is a privately held company based in Redwood City, California. He has decades of experience in life science and public accounting and has helped startups grow. Thank you very much, sir. Our next witness is Professor Jay Ritter. Professor Ritter is the Cordell Professor of Finance at the University of Florida. Over the past 25 years, Professor Ritter has authored many articles and books on IPOs and is one of the most cited authorities on this subject. Thank you, sir. Our next witness is Ms. Kathleen Shelton Smith. She is the founder and principal of Renaissance Capital. Founded in 1991, her firm, which is headquartered in Greenwich, Connecticut, is a leader in providing institutional research and investment management services for newly public companies, and she has done a tremendous amount of data gathering and analysis related to IPOs, and we look forward to your testimony. Thank you. Our next witness is Mr. Tim Rowe. Mr. Rowe is the founder and Chief Executive Officer of Cambridge Innovation Center located in Cambridge, Massachusetts. Previously, he has served as a lecturer at the MIT Sloan School of Management, as a manager with the Boston Consulting Group, and has over a decade-long experience with startups and early stage venture capital. Thank you, Mr. Rowe. Our final witness is Mr. Lynn Turner, who is no stranger to this Committee. He is a former Chief Accountant of the Securities and Exchange Commission and is currently a Managing Director of LitiNomics, which has offices in Mountain View, Oakland, and Los Angeles, California. His expertise in issues related to accounting and investor protection has been helpful to the Committee in the past, and I look forward to his testimony. Thank you. I want to welcome all of you again. Thank you for your willingness and your insights today. Mr. Waddill, you may proceed with your testimony. STATEMENT OF WILLIAM D. WADDILL, SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER, OncoMed PHARMACEUTICALS, INC., ON BEHALF OF THE BIOTECHNOLOGY INDUSTRY ORGANIZATION Mr. Waddill. Thank you and good morning, Mr. Chairman, Members of the Committee, ladies and gentlemen. My name is Will Waddill. I am Senior Vice President of OncoMed Pharmaceuticals out in Redwood City, California. I want to thank you for the opportunity to speak with you today about unique hurdles of innovation companies like OncoMed that are facing and the opportunity that the Congress faces to try and get us past those hurdles. It takes decades and more than $1 billion to bring therapies to market in my sector of the world. In order to finance research and development, we must cultivate a wide range of public and private investors. Startup companies depend on venture capital in the early stages and later look to public markets to pay for the more expensive clinical trials as we develop our compounds. However, due to the current economic climate and economic realities that are hitting the venture capital community, public markets are both slow to recover, as has been noted this morning, which creates a barrier for us to progress our therapies. The issue facing all of us across the board in the innovation sector really is the ability to access that capital, so I strongly support Senator Schumer and Senator Toomey in the effort to create an on-ramping for public market for emerging companies like mine. One of the key components of the on-ramp is the 5-year transition period to comply with Sarbanes-Oxley Section 404. That could have an immediate impact on capital that I will be able to divert more toward developing a product instead of paying for administrative costs in the company. Currently, these opportunity costs of compliance can be quite damaging and cause delays while I go out as a chief financial officer with other members of our management team to raise capital. Newly public companies have virtually no product revenue, so all operating capital must come from investors. Now, this is a key point to understand that when you are in an innovation stage, you are shooting for products, you are developing products, and you want to have all your capital go toward those products versus building infrastructure to comply with the regulations. Because of this facing my company, which is a private company, we do fit into that 86 percent that looks at this and says, hey, you know, this is a cost burden for us and will cause us significant costs in the first few years of being a public company. So for companies that are still too small for the public markets, another portion of this legislation is Regulation A. And the current regulation, which was set in 1992, $5 million, the proposal is to raise that to $50 million, and this, again, will open up barriers in front of us to raise more capital. I support Senators Tester and Toomey's legislation to increase this to $50 million. This higher limit would raise Regulation A to match the realities of the current marketplace. Specific to my industry, it costs anywhere from $800 million to $1.2 billion to get a product through clinical trials and onto the marketplace. It is an enormous sum of money, and it is an investment time that I talked about earlier, while you are in the innovation stage, that is critical that you have your focus on not only your people but also your capital in developing those products. Our hope would be to do that and get to the point where we could be a Genentech, where we could be a Gilead out in the world. And when you look across the bay in various sectors where we live, we would want to be a Hewlett-Packard. We want to have job creation that gets up to a 10,000-, 20,000-, 30,000-person company. But we cannot do that unless we have early stage capital. So by creating this IPO on-ramp, reforming Regulation A, that is an opportunity for us to do exactly that. So with that, I would like to thank the Members for being here, and I am happy to answer questions when we get to them. Thank you. Senator Bennet. [Presiding.] Thank you for your testimony. Professor Ritter. STATEMENT OF JAY R. RITTER, CORDELL PROFESSOR OF FINANCE, WARRINGTON COLLEGE OF BUSINESS ADMINISTRATION, UNIVERSITY OF FLORIDA Mr. Ritter. Thank you. My name is Jay Ritter. I am a Professor of Finance at the University of Florida, and I have studied initial public offerings for more than 30 years. I will first give some general remarks on the reasons for the low level of IPO activity this decade and the implications for job creation and economic growth and then a few suggestions on specific bills that the Senate is considering. First of all, there is no disagreement about the huge drop, prolonged drop in small-company IPOs that we have seen for 11 years now. But there is disagreement about the reason for the prolonged decline, the implications for the economy, and what should be done, if anything, to rejuvenate the IPO market and spur capital formation. The conventional wisdom is that a combination of factors, including heavy-handed regulation such as Sarbanes-Oxley and a drop in analyst coverage of small companies, have discouraged companies, especially small companies, from going public. I agree with this conventional wisdom in terms of being causes of the decline in IPOs, but I think that this is only a minor cause for the huge and prolonged decline. I think the more general problem is the lack of profitability of small companies, and this is not so much a private versus public company issue as a big company versus small company issue. I think that there has been a long-term worldwide trend favoring big companies that can realize economies of scale, economies of scope, bring products to market more quickly. And this is one of the reasons for the increased right-skewness in the income distribution in the world, income distribution and wealth distribution, and I think the IPO market in the United States is just a microcosm, one of the trees in the big forest. And if this is the fundamental reason why very few small companies are going public, because small is not the optimal way of organizing a lot of businesses, but instead getting big fast has become more important than it used to be, then I think a lot of these proposed changes are going to have minimal effects on spurring small-company investing and rejuvenating the IPO market. Now, consistent with this idea that the problem is being small in many industries is a lot less advantageous than it used to be, there is a whole body of facts consistent with this. For one thing, small companies that are publicly traded have had a long-term down trend in their profitability. Indeed, of the small companies that have gone public since 2000, over the last 11 years, only 27 percent of them have had positive profits in one of the 3 years after going public. Investors have earned very low returns, way below investing in bigger companies, in the last decade, and that was true in the 1990s and the 1980s as well. And it is true not only in the United States, but it is true in Europe, that if you look at European markets for small companies, the returns that investors have earned have been far below the returns on bigger-company IPOs and more established companies. So investors have gotten burned way too many times on investing in small companies, and it is the lack of small companies that become successful big companies that is largely responsible for the lack of investor enthusiasm. They do not want to get burned time and time again. Now, that is not to say that Sarbanes-Oxley costs and other things have not had some effect on the profitability of small companies, but in work that I have done with co-authors, we have computed how many of them would have been profitable if they did not have the extra compliance costs. And we find that there would be some effect, but still that long-term down trend in profitability would still be there. Now, in terms of the implications for job growth, there have been a lot of numbers put out by Kate Mitchell before this Committee that have been repeated in the Wall Street Journal. One number that has been out there is 22 million jobs would have been created if IPO activity had just continued to be what it used to be. I have actually been doing some work currently for the Kauffman Foundation looking at the actual job growth of all the companies that have gone public since 1996, and the numbers we are coming up with are dramatically lower. Companies that have gone public in the late 1990s that have had 10 years of experience on average increased their post-IPO employment by 60 percent, a compound growth rate of 4.8 percent per year. Now, the numbers are higher for venture-backed companies than, for instance, for older, more mature companies that have gone public. But I do not think increasing the number of IPOs is automatically going to spur an enormous amount of job growth. That said, I would like to see a healthy IPO market where good companies can get financing at terms that reflect their prospects and create wealth for society, investors, and spur employment. Senator Bennet. Thank you, Professor. Ms. Smith. STATEMENT OF KATHLEEN SHELTON SMITH, CO-FOUNDER AND CHAIRMAN, RENAISSANCE CAPITAL, LLC Ms. Smith. Thank you. Members of the Committee, thank you for inviting me to testify today. Capital formation, when accomplished through the IPO market, plays an important role in funding our best entrepreneurial companies. So it is no surprise that in looking to spur job growth, all eyes would turn to the IPO market--America's most admired system for funding entrepreneurs. We share the concerns of lawmakers about the IPO market and are honored to be asked for our thoughts. For over 20 years, Renaissance Capital has had a singular focus on the IPO market. We are involved in IPOs in three ways: we are an independent research firm providing institutional investors with analysis of IPOs; we are an indexing firm creating IPO indices that measure the investment returns of newly public companies; and we are an investor in newly public companies through a mutual fund and separately managed institutional accounts. I will start by examining the condition of the U.S. IPO market, including where we stand globally and the importance of investor returns in the equation. I will then make suggestions on the specific bills under consideration. IPO markets around the world were hurt by the 2008 U.S. financial crisis and the 2011 European sovereign debt crisis. And yet the United States accounted for 32 percent of global IPO proceeds during each of those years, larger than any other IPO market in the world. So despite what appears to be low IPO issuance levels in recent years, much of the U.S. IPO market is functioning quite well under challenging conditions. The IPO Task Force provided helpful data about large and small IPO issuance since 1991. This data, which is contained in my written testimony, shows that while smaller IPOs have disappeared, larger companies raising over $50 million in IPO proceeds continue to access the IPO market. We find little evidence that these larger issuers are deterred from wanting to tap the IPO market. Today we count over 200 companies in our U.S. IPO pipeline, 92 percent with deal sizes over $50 million. They are seeking to raise over $52 billion in total, the biggest we have seen in a decade. All these companies have undergone financial audits, implemented Sarbanes-Oxley policies, and filed full disclosure documents with the SEC. On the other hand, as the IPO Task Force concluded, smaller, sub-$50 million IPOs have practically disappeared from the market. Now, we can ease the path for IPO issuance for these smaller companies, but it only works if real investors are interested in buying these IPOs. At present, the trading market for IPOs is highly volatile with share turnover on the first day of trading at times exceeding the number of shares offered. This suggests that IPO shares are being placed with short-term trading clients of the IPO Underwriters. We urge policymakers to study ways to encourage IPO Underwriters to allocate IPOs to a broader base of long-term investors. But the most powerful way to fix the IPO market is to improve returns for IPO investors. There is a chart in my written testimony that shows how positive returns drive IPO issuance, and how poor returns shut down the market entirely. Unfortunately, there is very little policymakers can do about this. The bursting of the Internet bubble over 10 years ago devastated IPO investors, far worse than the rest of the equity markets overall. Over 70 percent of those IPOs during that period were unprofitable companies whose offerings were promoted by the IPO Underwriters' research analysts. No wonder in the years following that disaster investors have avoided small IPOs. Our suggestions on the proposed bills include the following: First, properly define ``emerging-growth company'' to target the really smaller issuers seeking to raise up to $50 million who have disappeared from the IPO market. Second, strike the proposed informational rules in the bills that permit Underwriters' research analysts to promote offerings and obtain access to special information during the IPO process. And, third, the proposed private company bills should assist the smaller companies and add a market capitalization limit to prevent larger IPO-ready companies from enjoying an active trading market in their shares while avoiding public disclosure. To summarize, a well-functioning IPO market is based on the principle of full, transparent, and honest disclosure of company information available evenly to all public investors. The U.S. IPO market has been functioning well under the stressful conditions of a global financial crisis. While policy initiatives may help the most vulnerable, sub-$50 million issuers to enter the market, it is positive returns that will lead the way to a rising appetite by IPO investors for smaller IPOs. Waiving certain disclosure and stock promotion rules that result in misallocating capital to weak or fraudulent companies will only endanger the recovery of the IPO market. Thank you for inviting me to appear before you today. Senator Bennet. Thank you very much for your testimony. Mr. Rowe. STATEMENT OF TIMOTHY ROWE, FOUNDER AND CEO, CAMBRIDGE INNOVATION CENTER Mr. Rowe. Thank you very much, Chairman. Senator Bennet. I like the sound of that. [Laughter.] Senator Bennet. It is fleeting, though. Mr. Rowe. Isn't everything? I want to thank Senator Bennet and Senator Merkley and Senator Brown, who is not on this Committee, for bringing forward crowdfunding proposals. I want to talk about that today. I think they are very exciting. First let me just briefly introduce myself. I am Tim Rowe. I run Cambridge Innovation Center. Cambridge Innovation Center is a facility in Kendall Square that sits next to MIT. We have about 450 startups going in this one office tower. We are told that we have more startups in one building at CIC than anywhere else in the world. And it is my background, having worked with these guys and, you know, about 1,000 startups overall over our history, that I bring to this discussion. What is exciting to me about the moment we are in is that we have the potential to really radically change the system by which we create new companies in this country. As Senator Moran raised when he quoted Kauffman Foundation data, we think now that most new jobs are coming from startups, companies 5-years old and younger. I was told I could not really show slides here, but I am going to cheat and turn my laptop around. [Laughter.] Mr. Rowe. This is the Kauffman Foundation chart that I think you are all familiar with. You have probably seen it in other people's presentations. The blue is the jobs created by startups. The black is the jobs lost by existing companies, all companies 6-years old and older. This data has been pretty broadly vetted. Oh, it went dark. Did you see it before? All right. So it has been pretty broadly vetted, and what it says is that we need more startups. Now, we have got 80 percent of the world's venture capital in this country. We are awesome at this stuff. We are really good at innovation. This is where we are leading. Unfortunately, that venture capital only is good for the small percentage of companies that are very high growth companies, perhaps will be worth $1 billion. Most of the new companies in this country, as we all know, are local businesses. It may be a restaurant, somebody starting a construction company, somebody launching a plumbing business. These businesses are not going to be financed by venture capitalists, and for the large part, they are not going to be financed by angel investors. And, generally speaking, we have resorted to Government support through SBA loans and other programs like that. What we have in front of us is the possibility, through Senator Merkley's bill, through your bill, together with you, Senator Bennet, and Senator Brown's bill, to really change this and make it legal for people to help each other, for neighbors to help neighbors, people on your PTA committee, people in your Facebook friends circle, to help you start your business. This is a really healthy thing. We have seen this kind of thing happen in other countries. People talk about microfinance and so forth. It is just really exciting. I do not think there is really any disagreement that it is exciting. I think the disagreement or the concern--and it is well placed--is: Is there going to be fraud? Are bad people going to take advantage of good legislation to somehow, you know, screw us over? We have got to make sure that does not happen. So I have been on the phone with people from all over the country and around the world trying to learn about this. I am not a legislative guy. I am not an expert in this stuff. But I have been asking a lot of questions and pulling together data. It turns out there is a crowdfunding investing company that exists already. It is up and running; it is working. And the only reason it is legal is it is in the U.K. where they already have laws that permit this. And so they have a lot of data. They have only been up and running for about a year, but the data show, interestingly, that they have had zero claims of fraud so far through this system. What they are doing is very similar to what eBay does. When you go on there and you list something, they have systems to make sure that what is listed is true. They do background checks. They do make sure that the basic offering is OK. I thought, well, do we know any more? I looked at some U.S. companies that do crowdfunding lending. There is a company called Prosper that does. There is AngelList, which does Regulation D or accredited investor crowdfunding out of California. And there is a U.K. company that does micro lending. I went to all of them. They all said, ``We have had zero fraud.'' So we can get more into the details of this, but the bottom line is it seems like these intermediaries, kind of like eBay, do make these things work. There are some specifics in my written testimony that I would like to refer people to about exactly how we do it, but I do not think that is the big point. The big point is let us get this done. Let us get a compromise that works for everybody and change the way the country works. Thank you very much for your time. Senator Bennet. Thank you very much for your testimony. Lynn welcome. We will hear your testimony now. STATEMENT OF LYNN E. TURNER, FORMER CHIEF ACCOUNTANT OF THE SECURITIES AND EXCHANGE COMMISSION, AND MANAGING DIRECTOR, LITINOMICS, INC. Mr. Turner. It is good that both of us are from God's Country. Mr. Rowe. Aren't we all from God's Country? Mr. Turner. I will leave that one alone. But it is good to be here. It is an honor to be here again. As some of you know, I have been a founder of a venture- backed startup company that was highly successful, that did create jobs. I have been at the SEC. I now serve on the Board of Trustees and Investment Committee of a $40 billion fund that does invest in this market through investments in venture capitalists. So certainly important to all of us, and I think everyone in the room would agree that the more jobs we create, the better off we are. Having said that, though, I would like to talk about some of the things that bring us here, and I think some misnomers that in general the IPO market is off because of regulation, and let me quote from Goldman Sachs, which is in the written testimony. ``Legal and regulatory factors probably do matter, and policy reform might strengthen New York's competitiveness. Nonetheless, we do not see them as the critical drivers behind the shift in financial market intermediation, even in the aggregate. Quite simply, economic and geographic factors matter more.'' I think that is borne out if you look at the charts on page 3 and 4 of my written testimony. The IPO market has always tracked what is going on with the general economy. When the general economy is doing well, we have a good, vibrant IPO market. When the general economy is not doing so well, it has not done well. This includes at times in the 1970s, 1980s, and 1990s, all before Sarbanes-Oxley was ever passed. So it certainly has nothing to do with the issue of SOX in that regard. In fact, if you look at the London AIM market that everyone mentions or points to, in Charts 5 and 6 and 7, you will see that in London they have had the same drop--in fact, their drop has even been more dramatic in London in the lightly regulated A market than it has been here in the United States. In fact, as we heard in the testimony from Renaissance Capital, the bottom line is people invest in IPOs when they think they can get a decent return. If you cannot get a decent return out of that company, people simply are not going to invest in them. Why should they? In fact, in the London AIM market, if you look at the statistics on page 7, you will see that since that market was created in 1995-96, if you put $1,000 in it at that point in time, you would have $700 to $800 of that left, while the other components, the more regulated components of the London market gave you 50 to 250 percent return. Perhaps more compelling is the chart on page 8, the venture capital returns. It highlights the great growth that came along with the IPO market in the 1990s, and keep in mind, the 1990s was a once-in-a-lifetime economic event. The economy has never done as well before, and it has certainly never done as well since the 1990s. And that IPO market during the 1990s is not necessarily something that in its entirety we want to replicate. In fact, when I was at the Commission, we had the leadership at the Business Roundtable come and meet with Chairman Levitt and myself at the time, and they were very highly critical of that IPO market because of misallocation of capital and losses that they thought it would bring and, in fact, did bring. What the chart on the venture capitalists shows is, quite frankly, our bigger problem, as Goldman suggests, is infrastructure. We have not invested in this country in the infrastructure that creates the opportunity for these small businesses to grow, become successful, then get capital, and then even grow further. Things such as the incubators--and I myself have served in two incubators--are very critical. Education, which I know is very near and dear to Senator Bennet's heart, as McKinsey said a year ago in a study, our investment in infrastructure which gives these companies the people they need is a serious shortcoming and has caused a real problem with these companies being able to get the talent and the issues we have in this country with the visas and being able to keep and retain really talented people who have come here and got their education, really hurts and impacts these companies as well, far more than the regulatory issues, just as Goldman Sachs mentioned. So, with that, let me just make a couple points on the bill. One, on page 13 it shows this bill will affect 98-plus percent of IPOs, so this is a fundamental shift in the regulation of IPOs. This is not for a portion. This is almost for all of them. It will be an impact for a long period of time. Five years is a very, very long period of time. The stuff on the control stuff, let me just close by saying good companies have good controls, and the stats, as the written testimony shows, it is very, very clear we get higher returns when we can invest in companies with good controls, not bad controls, and you are taking that transparency away from us as an investor. With that, thank you, Mr. Chairman. Senator Bennet. Thank you, Mr. Turner, and thank you to all the witnesses. I would ask the clerk to put 5 minutes on the clock, and with that, I will turn it over to Senator Reed. Senator Reed. [Presiding.] Thank you very much, Mr. Chairman, Mr. Chairman, Mr. Chairman. [Laughter.] Senator Reed. Mr. Ranking Member, Mr. Ranking Member, Mr. Ranking Member. Senator Bennet. Your Excellency, Your Excellency. Senator Reed. Yes, yes. I apologize. I had to go down to the Armed Services Committee. General Mattis and Admiral McRaven are down there on another topic equally as challenging as crowdfunding and Regulation A. Professor Ritter, you have done a lot of work on IPOs, and the sense I had from reviewing your testimony is that there are, as you say, numerous factors to support the idea that small companies are not going public, being small is not best, whether private or public, particularly in this international marketplace. And it goes, I think, to some of the themes that my colleagues have spoken about with respect to even if we do make these changes--and many of them are very thoughtful--is that going to have the impact we desire because of these market structure issues? And you might elaborate on what these issues are. Mr. Ritter. In terms of the market structure issues, are you including analyst coverage and smaller bid-ask spreads? Senator Reed. Analyst coverage, smaller bid-ask spreads, not having markets, secondary markets in some cases for the stock, employee stock. There are a whole bunch of issues, but you might be best to define what you think the most important ones are in commenting. Mr. Ritter. Yes. I think that there are a lot of tradeoffs, as the Committee is fully aware, between lowering the transaction costs, the compliance costs for companies, but still providing protection for investors. And as has been pointed out in the testimony of others here, having intermediaries who can do some vetting and potentially protect investors, protect investors from themselves, might be a good way of allowing some small companies to get access to capital without needing to go through formal angel investors, formal venture capital firms. When there are no protections for investors, it seems there are just too many con men and too many unsophisticated investors. But as the example of eBay has shown and crowdsourcing in the United Kingdom, sometimes intermediaries that do some of the vetting that have some things at stake can protect investors. So one possibility might be to put restrictions in some of the laws that require the use of certain intermediaries as a way of keeping out the fraudsters and possibly allowing a couple of years of experimenting to see does this work, and kind of go from there. Maybe it will not work, and hardly any capital will be raised. But maybe it will turn out to be a lot more successful than some people might expect. Senator Reed. I think your response raises three issues, and I will sort of put them on the table, and I might ask anyone else who wants to respond. One is that it presumes that the issuer is going to provide adequate disclosure to either the retail buyer or the intermediary. Second, if you have an intermediary structure, somehow it is going to have to police the intermediaries to ensure that they are really working on behalf of the investor and not on their own behalf. And then a lot of the issues we will talk about in the context of this legislation is, well, so what liabilities are on each of these different actors? Is it a very loose negligent standard, we tried our best, did not quite get it? Or is it much more significant? And those are some--and I have just seconds left, so, Mr. Rowe, could you respond? And then perhaps Lynn, but very quickly. Mr. Rowe. Just very quickly, I think Professor Ritter said it well. I think intermediaries should be required as I believe the Bennet, Merkley, and Brown bills do require, and I think that that has shown that it does block fraud. Senator Reed. Mr. Turner? Mr. Turner. Senator Reed, I would probably put a strict liability on that, and probably to establish accountability, I would put a fiduciary standard on that intermediary, a reasonable fiduciary standard. We do not want to go overboard here in that regard. In some of the information I provided the Committee, though, there is a paper by Professor Jay Brown from the University of Denver that gets into the issue of provisions for bad actors in the intermediary or one of the other roles. I would certainly turn around and take a look at that because I think that is one piece--there is some good stuff in these bills, but I think the lack of accountability is what is driving a lot of investors and consumers batty about these bills. They do not see it. So I think you have got to get the bad-actor provisions and you have got to get the liability and the fiduciary standard in there, or it will take us back to the bucket shops and penny stock frauds. Senator Reed. Thank you. Thank you, Mr. Chairman. Senator Warner. [Presiding.] Senator Corker. Senator Corker. Thank you, Mr. Chairman. Senator Warner. I know. I am not even going to get a couple comments in. Senator Corker. Senator Corker. If you would like to make comments---- Senator Warner. No, no. Senator Corker.----in advance of a lowly minority Member, that would be fine. Listen, we thank all of you for your testimony today, and I think all of us care greatly about access to capital and ensuring that our economy flourishes, and I find this testimony today very interesting. I was most interested in the beginning on the scale issue that was brought up regarding larger companies having greater returns than smaller companies. Mr. Waddill, since you sort of represent the smaller-company issue now, and Professor Ritter was referring to that, do you have any comments regarding why that is the case? Mr. Waddill. It is probably tied to the fact that we all want to be bigger companies, right? I think what is really important to point out is access to capital. Without that access to capital you cannot be a big company. You cannot get through--and I certainly hope that the 1990s were not a once- in-a-lifetime thing. I look back at the companies in my industry that were successful going through the 1990s, the biggest one being Genentech, a venture-backed company that got early access to capital, became one of the biggest biotech companies in the world. Senator Corker. And conditions have changed since that time so that Genentech could not have done that in 2012? Mr. Waddill. Certainly in the past 10 years, conditions have changed. Part of that, you know, you have to pay attention to--and I agree with what Lynn was saying--what happened in the economy. But what is another portion of this--and I can state as a CFO, an informed investor is a good investor. I want them to be informed because then they can get in lockstep with me and what I am trying to do. But I think there needs to be an appropriate balance in that. If we look at the past 10 years of the ups and downs in the economy, certainly IPOs have tracked along with that. But with this legislation, what is really being proposed is to unleash the access to capital. And as the economy comes back in an upswing right now in what clearly in my lifetime is the biggest financial crisis that I have seen, unless these burdens of compliances and these costs of compliances are loosened, you know, over, say, that 5-year period, this is going to be an anchor. It is going to be a negative factor, a negative multiplier that is going to prevent us from really growing jobs going forward in an appropriate way. Senator Corker. Mr. Ritter, U.S. PIRG, I guess, has mentioned that reducing compliance costs, meaning people not exactly knowing what they may be purchasing, will actually increase the cost of capital. I wonder if you might have any comments regarding that. Mr. Ritter. It is certainly possible that investors are going to demand higher promised returns if they have got greater concerns about having lack of transparency, having more bad apples in the barrel, that the good apples wind up subsidizing the bad apples. There are costs of compliance, and getting that balance exactly right in terms of imposing costs on all of the apples to reduce the number of bad apples does involve difficult balancing issues. Senator Corker. Mr. Turner, you mentioned the need right now for greater infrastructure. That is more important: incubators, education, visa issues, which I think many of us up here agree, especially on the visa issues. What was it about the 1990s that--I guess we were doing far less of that at the time. What was it about the 1990s, in your opinion, that caused IPOs and just the economy in general to flourish, whereas now we are looking at a lot of micro issues here to make that happen? Mr. Turner. Thank you, Senator. There were things going on. There was an increase in debt that was occurring over that period of time that was funding increases, if you go back and look at the issuances of debt and the debt that individuals, households, and companies were taking on, were financing a fair amount of that growth, even at a national level, as everyone knows these days, through an acquisition of debt; whereas, now we are in a more austere environment, if you will. There was probably also an environment, as you saw, the high-tech industry, which really only came about at about the end of the 1960s, early 1970s. You really saw the tech industry as an industry as a whole take hold and grow. We had a phenomenal amount of manufacturing still going on at that point in time, but as we reached toward the end of the 1990s, we started outsourcing. I was an executive in a large high-tech company at the time. Quite frankly, we started out first with much more manufacturing. We started to take a lot of our technology offshore as we came to the end of that decade. And as we did that and we stopped building the debt--or, you know, people started maxing out on debts, it has put us into the current economic situation we have now. So two vastly different economies, not only here, if we look around the rest of the globe, as the charts on London show, you had the same effect going on in other countries. And, of course, this decade has seen the growth of emerging markets like India and China. And some of that and the success of the markets is due to the fact that at the Commission we spent a lot of time, at the urging of this Committee and others, to go educate everyone else on how to build really good capital markets. And everyone else went and really built good capital markets. And if you have ever sold stock in a market, you know that it is best if you sell the stock in your home market with your home investors because that is where you get ultimately the greatest turnover in your stock and the greatest ownership. If you were doing a sale of stock in a U.S. company today and you went to the Japanese Mother market, 6 months later all those shares would be back trading in the United States, so why do it anyway? Well, it is the same thing for Chinese and Indian companies. When they list, they tend to list on their own markets. They have got good markets now that they did not have before. So there is a reason they go to those markets, and we have to be very particularly sure in that case, because of that, that we keep our market the most competitive, and that means it has to give the highest return to investors. In our $40 billion fund, we will put that money wherever we have got to go in the world to get the highest return for the half million people in Colorado because they depend on that money when it comes to retirement. And so if someone else is able to have more transparency and higher returns, we will go there, and we have gone there. Senator Corker. Mr. Chairman, thank you. I think you performed in an exemplary manner as Chairman, and I just want to say that I appreciate the efforts of so many on this Committee to create additional access to capital. But it seems to me the big issue that so many people, again, at this dais have worked on is getting the macro issues right, and if we could deal with some pro-growth tax reform and entitlement reform and deficit reduction, many of these issues that are being dealt with in a very micro-targeted way would go away, and that the market would function very, very well. And I appreciate your leadership in that regard, too. Senator Warner. Thank you, Senator Corker, and I am anxious to get to my time. I will call on Senator Tester next, but I would just make the comment that the appropriate role for intermediaries, but the intermediaries as trusted intermediaries in the late 1990s, I am not sure that that track record in terms of the ultimate result of a lot of those companies ended up being a great value-add for the investors. Senator Tester? Senator Tester. Yes, thank you, Mr. Chairman, and I appreciate that perspective. I also want to thank Senator Corker for his comments about the work that the Members of this Committee have done--I very much appreciate that, too--to craft proposals that really will, I think, help small businesses grow through access to capital. Let me say at the outset I am very pleased with Senator Reid's announcement about the consideration of a package of capital formation bills in the near future. I know you are working on one, too, Mr. Chairman, and hopefully we can get something to the floor that is going to work and get it passed in a bipartisan way. It is really an indication of the good work that is being done here on the Banking Committee, important legislation to open up markets for small businesses under the leadership of Senator Johnson and Senator Shelby. This Committee has seen some partisan battles in the recent past. We have been able to set those differences aside on several bipartisan bills that have the potential to become law, I think create jobs, and can happen this year, and I hope we will move forward and focus really on results instead of politics. Members of this Committee and Senators Reid and McConnell I looked forward to working with to put together a bill, passing it on the floor, and I am confident that with some strong leadership we can get a package of legislation signed by the President. It is good to see Senator Toomey here. We have been working on legislation since July when I had an access-to-capital hearing in my Economic Policy Subcommittee. The key takeaway from that hearing was we need to ensure the capital markets within the reach of startups at various stages of their development, particularly in the stages before they are ready to go public. As a result of that hearing, we had a chance to take a closer look at updating Regulation A and better enable small businesses, including many of the innovative biotech firms in Montana and Pennsylvania and around the country, to raise capital through these public offerings. These capital-intensive firms face unique challenges in raising the significant amounts of money necessary to complete clinical trials and complete development of cutting-edge drugs. Mr. Waddill talked about that in his testimony, and I appreciate the partnership we have had working on this bill, a bill that passed the House 420-1. It makes a number of updates to Regulation A, increasing the amount of capital that can be raised through these offerings to $50 million, while providing a host of new additional investor protections that include a requirement of annual audited financial statements, and the bill provides the SEC with the ability to require issuers to provide additional information regarding the financial condition of businesses to prohibit bad actors from participating in such offerings. The bill maintains the most attractive elements of Regulation A, including the ability of issuers to test the waters before registering with the SEC, and preserves the nonrestrictive status of securities sold through Regulation A offerings, a bill that, along with many others, I hope we can get passed here in the U.S. Senate. My first question is for Mr. Waddill. In your testimony you talk about the opportunity that modifications to Regulation A present to startup biotech firms. Can you talk a little bit about how and at what stage of development a firm like yours might use Regulation A and what an adjustment of that cap from $5 million to $50 million might mean for your company? Mr. Waddill. Certainly. So OncoMed is a biotechnology company. We are doing discovery and development work on cancer therapies. We are currently in clinical trials. Clinical trials are extraordinary expensive. For every patient that is in a Phase I--and there are three phases of the clinical trial process. For every patient that is in Phase I is approximately $50,000. Get to Phase II, it gets to be about $75,000. So to access $50 million when I look at my company's plans, that would get me from discovery for a therapy to the end of Phase II. Now, the end of Phase II is a very important marker, milestone, because that is when you reach what we call ``proof of concept,'' where you have shown that your drug has potential to move forward into Phase III, but the science that you have been working on for a number of years has gotten to that point. Now, in terms of would my company try to access $50 million time and time again, the answer is no because what I have to be cognizant of is when I raise $50 million, my previous shareholders are getting diluted a little bit. They own a little bit less of the company when I raise that money. So we try to be very strategic when trying to go for those sums of money and direct them specifically to what we think are the promising therapies within our pipeline. Senator Tester. I think your testimony also said it was 1991 it was set at $5 million, and I do not know how long you have been in the business, pharmaceutical business, but---- Mr. Waddill. Twenty years. Senator Tester. Well, we are there, then, 1992. Mr. Waddill. Yes. Senator Tester. How have the costs increased since then? In other words, $5 million I would imagine in 1992, as in agriculture, bought you a hell of a lot more than it is going to buy you today. Mr. Waddill. Yes, absolutely, the difference being--and this gets a little complex--that the recognition in the marketplace of what is valuable has changed. Senator Tester. Yes. Mr. Waddill. So back in the 1990s, when I first got into biotechnology, you could have $5 million, go for a couple of years, and shareholders would respond to the value you created with $5 million. That has changed dramatically in that you have to not go from just discovery but all the way to the end of Phase II before they will look at you. Senator Tester. Got you. Mr. Waddill. And that is a key understanding in all of this, that the data that flows through my financial statements talk about what is going on financially in the company. We disclose everything appropriately, but the science underlying it is really as important, if not more important. Senator Tester. Just a little liberty, Mr. Chairman. You can make this answer very, very concise, if you would. There is some anticipation that people would use this offering multiple times. Could you talk about that very briefly, if you see that as something that your company would do, or if it is something we need to be concerned about? Mr. Waddill. No, that would be dilutive to my current shareholders, and I would not have a job. Senator Tester. Got you. Thank you very much. Thank you, Mr. Chairman. Senator Warner. Thank you, Senator Tester, and thank you for your leadership on this issue. It seems to me--now when I get to my turn, I will speak a little bit about the fact that there is a lot of commonality amongst a number of these bills. I know Senator Toomey has been very active on a series of them, and this sure ought to be one where we could find some common ground and a broad bipartisan bill as opposed to a Democrat and Republican alternative. Senator Toomey? Senator Toomey. Thanks, Mr. Chairman, and I do appreciate your interest and leadership in this, as well as that of Senator Tester. You know, when we go back home to our respective States, I am sure we all hear the vocal complaints, legitimate complaints, from our constituents about how little is getting done, how little we work together, how this place has devolved into this partisan battling that has been downright counterproductive for our economy and for our country. I really believe that we are on a topic here today that is a complete exception to this entire idea. And since I got to the Senate a year ago, I have been delighted to work with colleagues on the other side of the aisle to advance bills that are very broadly, almost universally supported, and I think it is time we move on this. I am, frankly, delighted that we have got a strong interest in the House to move a series of bills. I am delighted that there is interest here. If ever there was an opportunity to do something that is unambiguously constructive for the economy, pro-growth, good for job creation, this is it. And an awful lot of the heavy lifting has already been done. So, really, I am glad we are having this hearing. I hope this is to drive home this message that now is the time to move. Senator Tester referred to a bill that he and I have together that passed the House 421-1. We have many cosponsors on both sides of the aisle. I have a bill with Carper--it is known as the ``shareholder bill''--that would limit the permissible cap on the number of shareholders. It passed the House Financial Services Committee, which is a big committee, by a voice vote in October of last year. It is my understanding some version of that will be included in the House package. Then there is the bill S. 1933 that I have done with Senator Schumer, which the nickname for this is the ``on-ramp bill.'' This one, of course, would facilitate an IPO by diminishing some of the burdens of registration that currently attends to an IPO. This bill passed the House Financial Services 54-1. These bills, if not every one of them certainly the first and the last, are supported by the President in part of the Startup America Plan. So I hope we will move on this very soon. My quick question for Mr. Waddill: One of the things that has been stressed to me by some of the folks in the life sciences in Pennsylvania is how critical the multiple stages of capital raising is, from infancy right through IPO, and there are a lot of pieces, a lot of steps along the way. It seems to me that if you facilitate access to capital at any step along the way, let us say even the IPO, you increase the opportunity and the chances and the ability to raise money at the earlier stages because one stage in many ways depends on subsequent stages. So could you comment on whether you agree with that, whether that is, in fact--and, in other words, if you facilitate raising capital at one stage, are you really helping that company out throughout its entire life cycle? Mr. Waddill. Oh, there is no doubt about it. I can tell you 10 of my 20 years in the industry was spent consulting and help start 34 different companies, some of those in Massachusetts, some of them in California. And predominantly they were the early stage companies, predominantly venture capital-backed. And those early stages, to raise $5, $10, or $15 million to establish a lab in biotechnology was just absolutely key. You cannot progress the science forward unless you set up that infrastructure. So it is remarkably important, and you can connect the dots between the later-stage raise and the earlier-stage raise. And if you get a high-quality investor in that process, they will stay with the company for a period of time because they will believe and understand what you are doing. Senator Toomey. So would it be your judgment that if we passed some package of these bills, that could actually facilitate angel investment, early venture capital, even in respects that are not directly addressed by the bills? Mr. Waddill. Yes. So when you look at venture capital investing, part of their collective problem right now is they have no exit for their investment. They cannot cash out. And that is due to economic climate and the barrier to go and be a public company. Part of that barrier is the cost of compliance. I am a numbers guy, so I can share some numbers with you. For my company to try and prepare for it Sarbanes-Oxley compliance would be somewhere between $3 to $3.5 million. On an ongoing basis, if we use the SEC study that came out, the medium cost to comply with 404 is in the $400,000 to $450,000 per year range. So an easy way to think about that, for every $1 million of compliance, I am prohibited, because I do not have the funds, to hire 15 to 20 scientists--those 15 to 20 scientists will be key in developing the science further--and, more importantly, another 15 or 20 patients that I cannot treat in the clinic. For us to be successful in our sector, we have to be treating patients to progress forward. Senator Toomey. Mr. Chairman, if you would just indulge me for 1 second, I notice Mr. Rowe seemed to have something to indicate. If you want to respond to this question, I would appreciate it. Mr. Rowe. Yes, I do. I spent part of my time with New Atlantic Ventures, which is an early stage venture capital firm. One of the things that we're seeing is that the exits that are prevalent today are primarily acquisition as opposed to IPOs. There is much less upside for a venture capitalist if you go down the actual path. And, incidentally, unlike in IPOs where it is somewhere between a 60-percent increase and a 5- fold increase, depending on whose data you look at in jobs, typically after acquisition you let go people because there are redundancies. So this is very important to the venture capital industry. Senator Toomey. Thank you very much, Mr. Chairman. Thanks to the witnesses. Senator Warner. And thank you for your leadership on these issues. Senator Menendez? Senator Menendez. Thank you, Mr. Chairman, and thank you all for your testimony. I had two lines of questioning I wanted to ask. One, how should we address the counting of beneficial owners of stock rather than owners of record? In my own view, I think it makes sense that we should be counting beneficial owners and raising the threshold to a higher number, and not necessarily be counting a broker of record that has stock from many shareholders as a shareholder. But I would be interested in hearing some of your views. Mr. Waddill. It is a cumulative number. I agree with you that the number needs to be raised. I am not sure what that number is. I can tell you that one of the predominant issues in my industry is that we compensate employees with stock options. We do that from the president of the company down to the glass washer in the lab. And over the course of time, a lot of shares will be issued to a number of people. So that is another cumulative set that needs to be added to what you are addressing. Mr. Ritter. Senator Menendez, I am in complete agreement with you that the regulations do need to be changed given that the concept of shareholders of record is dramatically different now than it used to be because individuals for public companies are holding stock in street name. Now if you have got a company that before going public might have had 1,000 beneficial shareholders and after going public has 2,000 beneficial shareholders, the shareholders of record might have only increased by 10 people. So the regulations do need to be changed to reflect stock being held in street name. Senator Menendez. Anyone else? Ms. Smith. Ms. Smith. Yes, I would add to that that I think that the ability to do online activities has helped us so much, for example, with disclosure. EDGAR enables information to reach the hands of investors so elegantly and has made such a big impact on transparency. However, when it comes to the private placement market, the issues that we have, even with the 500-shareholder rule, actually developed because of the ability to connect online with investors of all kinds, and hopefully they are all qualified. We have had a situation where Facebook, for example, even under the 500-shareholder rule, has benefited from a lively trading market in its stock at prices that have valued the company before they filed for the IPO, something over $80 to $100 billion, the size of McDonald's. A major company that can then have the benefit of this lively trading market beyond any of their existing employees but involving outside shareholders and yet not take on the responsibility of full disclosure. So with these rules on the numbers, it appears to us that it is not the number that--with technology, 500 may even look like a big number because we can move information around very quickly among a lot of people. That the real issue is to target the smaller companies and to put some kind of a market cap limit. For example, if the company's market valuation is below $300 million, and below $300 million in total valuation, and it gets to 500 shareholders, fine, we can have this market. But if it goes beyond that, we then do not want to establish what I would call a shadow IPO market of major companies that should be disclosing and yet accepting the ability to have a lively trading market in their stock. A shadow IPO market is probably not in the best interest of promoting a strong IPO market here in the United States. Senator Menendez. And a final question, Mr. Waddill. You mentioned in your testimony a number of avenues where financing could be potentially raised by small private and public companies, and in 2010, Congress passed my therapeutic discovery project tax credit. My understanding is your firm was awarded credits through the program. From your experience, can you talk about whether you found this program beneficial, for example, small biotech capital formation? And do you believe that an extension of the credit would help other small innovative biotech firms as they compete against competitors around the world? Mr. Waddill. Absolutely. So we applied for five, we got five. That equated to $1.2 million into my company. And I can specifically tell you that we had--we did not have funds to progress one of our therapeutic areas, and that $1.2 million provided that. So as I sit here today, that for us is a major initiative in the company which just would not have happened. And it was one of several areas. So if you equate that to a smaller company than mine, certainly it would have been beneficial to advance the technology, so it was a tremendous help. Senator Menendez. Thank you, Mr. Chairman. Senator Warner. Senator Bennet. Senator Bennet. Thank you, Mr. Chairman. Thank you so much for holding this hearing. I wanted to associate myself with Senator Toomey's remarks. This is a place, I think, where there is very broad bipartisan support and that we ought to figure out how to advance these bills in a bipartisan way. So much of the debate that we have around this place is this left-right discussion that no one at home really understands and, frankly, find meaningless. And we are at a position now, I think, where as a Congress we can actually support what is the most innovative economy in the world still and drive this innovation in a way that actually is promoting job growth here in this country and promoting wage growth in the country, the two biggest issues that the people that I represent face, frankly. And as the testimony pointed out, we are at a moment in the economy where the productivity increases, the productivity gains that legacy firms have achieved, which is great, are not driving the job growth that we need, and it is going to be the company that is founded tomorrow and next week and the week after that that is actually going to drive job growth. The other point I want to make before asking one question is the critical importance that education plays in all of this. You know, the worse the unemployment rate ever got for people with a college degree in the worst recession since the Great Depression, the recession we just went through, was 4.5 percent, and there is a reason for that. And if we are not educating the people in this country to be able to do these jobs, the capital formation that we are all talking about here is going to go someplace else to find human capital that actually can drive these new businesses. So that is not within the jurisdiction of this Committee, but it is a very important part of what we are dealing with. Mr. Rowe, I appreciated very much your comments about crowdfunding, the bill that Senator Merkley and I and Senator Brown have been working on. I wonder if you could talk a little bit about what kind of businesses you would expect to take advantage of crowdfunding if we were able to pass this. Is it just somebody who has got an initial idea, existing small businesses, someone who has got the need for additional capital? And then, finally, as we look to formulate a consensus bill on crowdfunding, which I believe we can do, you know, what thoughts do you have about the lessons that we can learn from existing Web sites like Kickstarter, which you mentioned in your testimony, which has enabled individuals to donate to film production and the arts? So run with it. Mr. Rowe. Thank you, Senator Bennet. I really appreciate your question and the whole Committee's time again. Let us put sort of the potential of this in a little bit of perspective. Apparently, Americans save in long-term savings about $30 trillion. This is 401(k)s, you know, pension funds, IRAs and so forth. Author Amy Cortese framed this by saying if Americans took 1 percent of their saving and put them into-- instead of saving it in a 401(k), invested it with another business somewhere in their town, just 1 percent of their money, that would create a pool of money 10 times bigger than all the venture capital that we invest every year in this country. It would create a pool of capital that is half as big as all outstanding small business loans. So the size of this, just first of all, is simply huge, and the Kickstarter analogy--this came out I think in Talking Points Memo recently, and there was some debate about the accuracy of the figures, but I think they really nailed it now. They found that Kickstarter, which is one crowdfunding site that instead of investing, you get a thing, to kind of work around the laws today you get an item from the person you are investing in, you do not get equity. Kickstarter raised for the arts alone half as much as the NEA, the National Endowment for the Arts, raised for arts last year in 2011. And they are predicting that in 2012 it will tie the NEA in money raised for the arts. This is everything from video games to film to paintings and so forth. So the impact of this, just the scale, is huge. I predict that this is going to be your everyday business. I think that you are going to have somebody in your community who starts a catering business, and they are going to go on Facebook, and this is the general solicitation part. This is why that is important, because if you post on Facebook that is a solicitation and it would be illegal today. They are going to go on Facebook, and they are saying, ``I am starting a catering business.'' They are going to go to their friends from college and say, ``Would you back me? Would you put 500 bucks or 250 bucks in to help me get this thing going? I need to buy an oven.'' That is the kind of business that I think this is going to really--this is where it is really going to hit the ground running. And where it really is different from what, you know, for instance, happened in the late 1990s with the IPO boom and the venture capital, that happened in a very small part of the country, in a very small type of business. The rest of the country did not see those benefits. I think we are talking about something which is timeless and which is growing. So that is the first part. If you are interested, I do have some very concrete suggestions, having talked to dozens of people about your bill and other bills. I think there is a potential for a compromise bill here that is 99 percent what is already in all the bills, and there are a couple little tweaks that people would like to see, or we can come back to that afterwards. Senator Bennet. Great. My time is up, but I for one would love to hear those suggestions, and I am sure that Senator Merkley would as well. I just think the last point is so important. These initiatives will inject capital throughout the country, throughout the entire geography of the country, in a way that we have not seen before. This really is about Main Street, and we need to do everything we can do to make sure we protect the investors that will come. But I think the potential here is just enormous, so thank you, Mr. Chairman. Senator Warner. Thank you, Senator Bennet. Senator Merkley? Senator Merkley. Well, thank you very much, Mr. Chair, and I will follow up by saying I had highlighted in your testimony, Mr. Rowe, the comment about the $30 trillion. So I think it is a reminder of the potential, and that is just retirement savings. As we wrestle with the crowdfunding platform, the goal that I brought to this, and my colleagues who have joined me in the bill, is to establish a successful system, because if it gains a taint of fraud on the front end, it will be very hard to improve on that in the future. And one philosophy we brought to that was portal neutrality, so the portal itself is not involved in any sort of pump scheme that might discredit its legitimacy. A second was accountability for accuracy among the officers and directors, and I know you have made the point in your testimony that maybe that is going too far. I think that is an important conversation for us to have, at least at the startup of this, and as we search for a way to try to give folks confidence that what they are reading is accurate. And the third was having statements reviewed under 500K and audited over 500K as three of these approaches. But I thought I would just invite you to share your concern that the accountability for accuracy might be going too far. And, Mr. Turner, I think if you would like to follow up on that, I would appreciate it. Mr. Rowe. Thank you. So on the accountability, I think we are very close. I think the definition you used in your bill is almost identical to the--and I am not an expert in this, but the SEC Rule 10b-5, which Lynn probably authored, which defines the accountability for fraud in private exempt offerings of securities today under the SEC. It is identical to yours with one exception. They do not hold the officers liable if there was no intent of malfeasance or negligence. So in the basic standard in the bill today, it just says if you misstate something, then you are liable. And we are concerned that if you have got 100 investors and one of them gets made at you because of, you know, maybe a personal dispute or something, they sue you ad you are liable because you accidentally misstated something, we are hoping that would not be included. The standard SEC fraud clause works fine. It just says you are liable as long as you did not--as long as there was malfeasance, or I think they call it--you are probably going to be able to do a better job with this. On the other bits, I think that reporting is great. There was some suggestion that maybe reporting should be quarterly. Again, for these small businesses it would be really great if that could be annual. I mean, this is a catering business. They do not do quarterly accounting typically, and it is an extra cost. It is that kind of level of tweak that we are really talking about. I do not think we are in disagreement at the overall level. Senator Merkley. Thank you very much. I think it is very helpful to chew on these things. Mr. Turner, do you want to make a comment on that? Mr. Turner. Thank you, Senator Merkley. In general, I like the notion in your legislation that there is a degree of accountability. I think it needs to be more than just an intent-based thing. If, in fact, you go out and mislead people, you ought to be held accountable. And on the flip side of that, if you are the intermediary representing someone trying to raise the money, then I think you ought to have a fiduciary standard to that investor that you are held to. And I think it goes beyond just being something with scienter or fraud. I think that if people recklessly go out there and exhibit gross negligence in doing this and misrepresent things, certainly those people should be held accountable. If it is merely an oversight, you know, I do not think an oversight, but, nonetheless, there is a danger to the system here. We have a very good history with these types of situations in the past, as recent as Congress did the penny stock fraud reform act in this building. So we have a history that when people are out attracting this type of money, unless you have a fair degree of accountability so that investor can go recover, you turn around and create a situation where there will be damage done and people withdraw from doing these. Rather than increasing them, you are going to decrease them if we go back to the whole penny stock frauds or bucket shop days that we have had a couple times. We have tried this a couple times, and it never worked. So if we are going to try it a third time, you have got to build in transparency, you have got to build in full disclosure of conflicts, and you have got to put in a decent level of liability if you take people's money and misappropriate it or mislead them on it. Senator Merkley. So, Mr. Turner, I am running out of time, but I will look forward to following up with you on this issue of platform fiduciary responsibility, because I think we had really worked to frame this as a facilitator rather than a vetter, and I think a couple alternative perspectives are being presented here to chew on. Mr. Chair, can I extend for a moment here? Yes, Mr. Rowe? Mr. Rowe. Yes, I think that probably the word ``vet'' is the problem because it could mean different things to different people. What seems to be working well is where the facilitator does background checks, makes sure that the offering descriptions are very complete, does a bunch of other stuff to make sure that these are not fraudsters; but does not try to say this is a good catering business or a bad catering business. That is the line that I think they should not cross. And I think that is also what you are saying as a facilitator. If you look at AngelList, which is working very successful now under Regulation D for just accredited investors, they describe the offerings. They also do clever things. They describe well-known people who are investing in these things, well-known people in the community that have already privately vetted them, and they say, you know, if Mitch Kapor wants to invest in this--they do not say this overtly. They say, ``Here are the people who are investing. You draw your own conclusions.'' So there are very clever ways that they can get the intermediary without actually directly vetting can facilitate and prevent fraud. Senator Merkley. Mr. Chair, I have two more questions, if we have time. I want to throw both of these out there at once. One is that another challenge for small investors--because they are looking at the front end, and they figuring in a couple years this company is going to sell out or be purchased or is going to merge. How do you ensure that there is some protection for the small investor who is so key in the success on the front end, but the deals struck by management when they sell the company might basically undermine any return to that small investor. So that is one question. A second is: Should there be the possibility for intermediary funds? For example, let us say I think it would be quite interesting to put 1 percent of my retirement funds into small companies, but I have no time or desire to vet those companies. Should I be able to put 1 percent of my money into basically an intermediary fund that would then invest in crowdfunding? So I will throw those two questions out for any thoughts or insights you might have. And, Mr. Ritter, I think that you might want to start, or if you would like to start, related to this issue of protecting the small investor when M&As come up. Mr. Ritter. Right. In regard to your first issue, with a lot of startup businesses, they fail, and investors, I think, will certainly be aware that there is a possibility of failure. But there is also an issue, what if the company is very successful? One possible thing that could go on is the small investors wind up ex post being diluted out. For instance, the first- round financing might be Class A shares, and then later on some venture capitalist or brother-in-law of the entrepreneur comes in and is issued Class B shares that have conversion rights of 100:1 into Class A shares. So the company is very successful, but the original Class A investors wind up owning 0.1 percent of the company and they do not get to share much in that upside potential. I think that, you know, angels, venture capitalists, are aware of these possibilities. They insist on fine-print anti- dilution rights. A lot of individual investors are not going to be thinking about all of these concerns, and if they are talking about investing $1,000 in a company, it is certainly not worth their while to go out and hire a securities lawyer before they decide to invest this $1,000, to put the $1,000 in. So one possibility might be to craft the legislation to have certain defaults, anti-dilution provisions or something as the base case that these Class A shareholders would have to vote to override if they are overridden. Mr. Rowe. If I may, I do think it is a very valid concern, and I would say there are other concerns, similar concerns, such as if it does very well, what if it just does not sell the stock for a long time, does not make dividends. You know, when does this investor get out, for instance? So this is why I believe that you should require intermediaries, and I know you do in your bill. The intermediaries will compete to be attractive to these small investors. What is already happening in England is that they are looking at--the intermediaries are looking at putting in just such these provisions themselves in order to be more competitive to draw small investors. I think this actually is an area where we can leave the intermediaries to figure out what is the best deal. How can we structure this with standard docs and standard provisions that will be attractive to these small investors? The intermediary who loses all the investments or whose investors hate it because they lost all their money will go out of business very quickly and I do not think realistically will set up in the first place. Senator Merkley. Thank you. And I am way over my time, so I am going to return it to the Chair. Senator Warner. Thank you, Senator Merkley. And I want to also thank all the witnesses and all the good work of the folks on the Committee. This was my business for 20 years in the venture business, and I believe there is enormous opportunity here to jump-start capital access, because, frankly, our recent efforts in terms of the small business bill and some of the other capital access bills have not been very successful. I am very intrigued with the crowdfunding notions. I do think these questions around--having been that, you know, bad venture capitalist coming in at times, you know, there are real concerns about dilution interests, trying to protect those early stage investors. But the flip side is if the company is not doing well, the market drives some of this. So the question of how you get the intermediary right is, I think, an important one. I know Senator Merkley has been working on this. Clearly, the intermediary in and of itself, though, we had very ``trusted'' intermediaries in the late 1990s, I am not sure all the products that were put out in the marketplace, you know, their performance record was obviously not that good. I still recall a number of companies I had that had, you know, momentary billion-dollar caps that went to zero as the tech bubble burst. One of the things that I am--and I have great respect for Lynn Turner, but I do believe that the regulatory burdens of Sarbanes-Oxley, 404 and others, are stopping companies from choosing to pursue that route. And I think some of the bills that I've been working with Senator Toomey and Senator Schumer on, on the on-ramp approach, make some sense. I would argue that one of the things that is different than the bucket shop era is that the power of the Internet bringing more and more transparency and being able to more quickly identify bad actors through this tool I think is something that might preclude some of this bad behavior, and I would just be curious to hear folks' comments on that. And, Lynn, I would love to have your rebuttal as well to that presumption. Mr. Waddill. Well, I can tell you from our company's point of view, when we look at the use of capital, it clearly comes into the equation. Do we want to spend $3 million ramping up into Sarbanes-Oxley compliance? Do we want to spend $2 million over the next 5 years, $1 million plus? Do I need to hire a couple more staff to support this internally? It comes up, because every dollar is precious. One thing that is just fundamentally different than the crowdfunding--crowdfunding, they have a product. I am in an innovation stage where I am shooting for a product, and this is something that is interesting to cut across industries that when you are in that zone, when you are spending your capital to get to the point where you can make hopefully millions and tens of millions of dollars and build a company, that is when the funds are really critical. Ms. Smith. Just to comment on the power of the Internet and having a IPO market perspective, we can do much more. It may be outside of these bills, but we are not using the power of the Internet enough to help the IPO market, which is ultimately the end game for so many of these companies. For example, in early IPO trading, we know very little about who owns the shares as soon as they are allocated and during the first days they trade. The transparency of our trading markets is extremely poor, which hurts and scares a lot of investors in the market. They do not understand the trading volatility. And I think we can use more transparency. The ease of information when a stock ownership gets to be over 5 percent is poor. We should not have to wait for days to find out who owns that stock. So there is a whole lot we can do to make our IPO market better. And that is regarding the trading. When it comes to information, I mentioned how important EDGAR Online has been to the market. There is so much more that we can do. We file registration statements that are lengthy, and when they are updated, we do not know--we are not given a red line as to what the update is online. Companies' talk at road shows, why aren't they transcribed? Information is there, and it does not cost much to get it out to investors. And I believe that if we could add that kind of attention, it would help. The market is what it is--we are not going to be able to change too much. It is about returns. But the more information that we can give investors would help the IPO market that these smaller companies are trying to address. Senator Warner. Lynn? Mr. Turner. Senator Warner, we do totally agree that the Internet is bringing out more of the bad actors. The problem is, as we have seen it with the Chinese companies--and keep in mind, all these bills are applicable to the Chinese companies-- is that the Internet is getting it out after the fact. So while it is good it is getting out earlier before losses can get as big as perhaps they might have been in the past, it is still water over the dam, and the money is gone. And so while it gets out sooner, it ultimately does not prevent the losses. So from that, it is not a workable thing. And as we have seen with the Chinese companies, that IPO market has totally dried up, and people went away from it because they do not trust it. No one is going to play at a Vegas casino, which is what that IPO market was. As far as the SOX 404 stuff, yes, we would probably respectfully disagree on that point. SOX 404, I went through two companies, including a fairly new software company that had done it. I actually found that in the long run--one was Sun Microsystems. We found that we actually had tremendous savings from getting the company run the way it should be and the way it controls when we put that in. As the data in the testimony shows, companies that do not have those controls way underperformed the market, way underperformed their peers. And yet this year--I got an email just yesterday from a service that tracks this. They said something like 22 percent of the 2011 filers so far have reported problems with their controls, and there are a number of studies now underway to look at these IPO companies and see how long it is between the IPO and when we are all of a sudden seeing this, because you actually trade in the market. What we have found is you can make money, good money, as a trader in the market by trading against the companies that have the poor controls because they underperform versus the companies with good controls. So when I was at Glass Lewis, when we put out this type of research, we actually found funds trading on the data and making good money just by identifying the companies with poor controls. They do underperform. So if a company goes public with poor controls, sooner or later it is going to impact on the stock. There has also been research that shows that that has a contagion effect now. It not only impacts that company, but it impacts the stock price of other companies in the trading, especially with all the trading and all that is going on today. And so especially given the fact--you cannot say SOX 404 cost you that much at IPO because it is not until the second annual report 2 years later that you are doing your first SOX 404. We also know that a high percentage of these companies in terms relative, you know, are still not getting that fixed, so it is having an impact on them, and it is having an impact on the investors in those companies. And why is it that you are going to take that away? Why are you all of a sudden going to say in a situation where before you would have told me they had bad controls, now you are going to let them hide it for 5 years? Senator Warner. I would take issue. I do not think that the on-ramp proposals that we are laying out allow you to hide it. I think there are appropriate balance controls for these companies to ramp up. I do think having been on boards and investors in many of these entities, it is a burden and hurdle that slows the IPO market. That brings me to my next question, which is, you know--and I would like anybody's comments on this. One of the challenges with a much more limited IPO market is not only the fact that less companies get access to that capital, but I think there is a competitive price our overall economy pays when companies are forced through their only virtual exit to be a merger and application. I can tell you in the telcom business, you know, the ability of the big guys to take over the innovative guys and a way to stifle innovation, to continue to control the market, to not have as competitive of a landscape, I think does damage to our economy. And I would just be curious--we have talked a lot about the capital part, but more on the macro standpoint here of, you know, having companies only having kind of an M&A exit strategy, whether any of you agree that that also has a negative effect on overall innovation growth in our economy. Mr. Rowe? Mr. Rowe. Yes, just very briefly, and in my experience sitting on boards in the venture capital context, we see--and I will not name names, but over and over again the companies that are acquired very frequently end up dying. The buying company may pay a high price, but they do not really have the spirit or the passion that the entrepreneur had. The entrepreneur cashes out and leaves. And I do not know. Maybe there is some research on this. I would love to see it. But I see this in practice all the time. And if these companies can instead go public and that entrepreneur becomes the next Bill Gates running that company for another decade or two, that is where you see real impact on this country. You know, Harvard Business School's Bill Sahlman said this nicely yesterday at a forum on crowdfunding. He said, you know, we should distinguish between fraud, which is illegal and we should clamp down on that and make sure it does not happen and enforce it, and failure. He said failure has been the thing that has made this country great. The fact that we are willing to take risks, the fact that we are willing to start companies and try to be Apple, try to be Microsoft, try to be Zynga or Facebook, that is what is great about this country, and if we try to legislate out failure, we are making a great mistake. Mr. Waddill. I can tell you that my last company, we did sell the company. It was a great transaction. It was great for investors. The company got sold to Amgen, another U.S.-based company, and the result of that was people were rewarded, but the employees that were there that were incented to get to the point where they could sell the company are starting another company and continue on in the same vein. So certainly out in the Bay Area, once you get the bug, you just keep on doing it. It is an avenue for exit, and there is some chance that the technology is going to go away. But the incentives are in place in the capitalist society to perpetuate this. Senator Warner. Although one of the things by having a broader-based IPO market, you know, my hope would be we would have this innovation not just taking place in the valley or Northern Virginia, but around---- Mr. Waddill. Sure. Senator Warner. And I think, again, some of the opportunities. We have got to get this balance right on crowdfunding and crowdsourcing. You know, that does open up enormous, enormous opportunities elsewhere. I will just simply close, and I want to again thank the panel for their good work and good comments. This is an area where a group of us on this Committee and others are looking at combining a series of these bills and launching a bipartisan effort. It would be, I think, great for startup companies, but it would also be great in terms of sending a message that there are actually issues that Democrats and Republicans can work together on, get done, and end up jump-starting greater job growth in our economy. Again, my thanks to the panel, and with that the hearing is adjourned. [Whereupon, at 11:53 a.m., the Committee was adjourned.] [Prepared statements, responses to written questions and additional material supplied for the record follow:] PREPARED STATEMENT OF CHAIRMAN TIM JOHNSON Today we will have our second full Committee hearing on ``Spurring Job Growth through Capital Formation While Protecting Investors.'' It is our fourth hearing overall on capital formation, following Senators Reed and Crapo's Securities Subcommittee hearing on ``Examining Investor Risks in Capital Raising'' and Senators Tester and Vitter's Economic Policy Subcommittee hearing on, ``Access to Capital: Fostering Job Creation and Innovation Through High Growth Startups.'' Growing small businesses is critical to building a stronger American economy, and today we meet to consider how to help small business and entrepreneurs access the capital they need through stock markets. The intent is to help them grow and create new jobs, while having suitable protections so investors are assured they will not be taken advantage of if they put their money at risk. Businesses may attempt to raise more capital if the process of selling stock is made easier and less costly. At the same time, investors are more likely to buy stock when they have adequate reliable information and fair trading markets. Last week in the Committee, in response to my question, Fed Chairman Bernanke said, ``Startup companies--companies under 5-years old--create a very substantial part of jobs added to the economy'' and he encouraged assisting startups. SEC Chairman Schapiro has said, ``companies seeking access to capital should not be overburdened by unnecessary or superfluous regulations At the same time, . . . we must balance that responsibility with our obligation to protect investors and our markets.'' In previous hearings, witnesses have discussed how public markets allocate capital and help create jobs, SEC requirements for a company to go public, why some firms prefer to remain private, how investors may be solicited to buy stock, how institutional investors decide whether to buy a company's IPO shares, the importance of liquidity in the secondary markets, the importance of investor protections, measures to reduce the cost of selling stock and their potential impact on the cost of capital and other considerations. Today, we will hear testimony from experts analyzing the history and state of the IPO market, the needs of startup and small businesses, why investors buy IPOs, the role of accounting and other disclosures, analyst conflicts of interest and other matters. Members of this Committee on both sides of the aisle including Senators Schumer, Crapo, Tester, Reed, Vitter, Merkley, Toomey, Bennet and Johanns have been working hard on bipartisan proposals and I welcome our witness to provide their insights on these measures and others on the topic. I look forward to working with the entire Committee and with Senate Leadership to quickly move bipartisan legislation forward. ______ PREPARED STATEMENT OF WILLIAM D. WADDILL Senior Vice President and Chief Financial Officer, OncoMed Pharmaceuticals, Inc., on behalf of the Biotechnology Industry Organization March 6, 2012 Executive SummaryThe 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. It can take over a decade and more than $1 billion to develop a single biotechnology therapy. Venture capital fundraising is stagnant and the IPO market is largely closed, forcing innovative companies to delay research on promising scientific breakthroughs. BIO supports S. 1933, the Reopening American Capital Markets to Emerging Growth Companies Act, which would create an ``on-ramp'' to the public market for ``emerging growth companies.'' Most newly public biotech companies have no product revenue, so the 5-year transition period into compliance with Sarbanes-Oxley (SOX) Section 404(b) and certain accounting and disclosure requirements would allow growing biotechs to focus on the search for cures and treatments rather than costly regulations. BIO supports S. 1544, the Small Company Capital Formation Act, which would reform SEC Regulation A by expanding its eligibility requirements to include companies conducting direct public offerings of up to $50 million, an increase from the current threshold of $5 million. This increase would provide a valuable funding alternative for small biotech startups, giving them access to the market at an earlier stage in their growth cycle and allowing them to raise valuable innovation capital. BIO supports S. 1824, the Private Company Flexibility and Growth Act, which would increase the limit that requires private companies to register with the SEC from 500 to 2,000 shareholders, giving growing biotech companies more investor options to finance their early stage research. The bill would also exempt employees from the shareholder count, allowing biotech companies to attract and hire the most qualified researchers and scientists. BIO supports S. 1831, the Access to Capital for Job Creators Act, which would require the SEC to revise Rule 506 of Regulation D to permit general solicitation in direct public offerings, broadening the investor base. * * * * * Good morning Chairman Johnson, Ranking Member Shelby, Members of the Committee, ladies, and gentlemen. My name is William Waddill, and I am the Senior Vice President and Chief Financial Officer of OncoMed Pharmaceuticals in Redwood City, California. I am also the Co-chairman of the Finance and Tax Committee at the Biotechnology Industry Organization (BIO). I want to thank you for the opportunity to speak with you today about the unique hurdles that innovative biotechnology companies face as they work toward developing cures and breakthrough medicines to treat crippling illnesses that affect families across the Nation. Biotechnology has incredible potential to unlock the secrets to curing devastating disease and helping people to live longer, healthier, and more productive lives. My company, OncoMed Pharmaceuticals, is working at the cutting edge of oncology research, focusing on a specific set of cells within tumors that drives the growth of the tumor and can morph into various cell types within the tumor. We have developed the ability to isolate and monitor these tumor initiating cells, and our studies have shown that they are more resistant to standard chemotherapy agents. Some current treatments may succeed at initially decreasing the size of a cancer, but leave behind an increased proportion of these most malignant cells. We have developed a portfolio of antibodies that target biologic pathways critical for survival of tumor initiating cells, with the goal being to stop those cells from replicating. We believe these models are more representative of the effects of these treatments in cancer patients than traditional models using cancer cell lines, which may no longer accurately reflect the properties of the original tumor. Currently we have three antibodies that target tumor initiating cells in Phase I and are developing other promising therapeutic candidates. BIO represents more than 1,100 innovative companies like mine, along with academic institutions, State biotechnology centers, and related organizations in all 50 States. Entrepreneurs across the biotech industry are conducting groundbreaking science like ours, and are deeply invested in treating the severe illnesses that families around the Nation and world face. At the same time, biotech leaders must deal with the day-to-day challenges of running a small business. 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 and 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 any source available, particularly venture capital firms. Later, we must turn to the public markets in the final stages of research to fund large-scale and expensive clinical trials. Startup companies depend on venture capital fundraising to finance the early stages of research and development. In fact, many companies, including mine, rely on venture financing to fund even middle- and late-stage clinical trials. However, the current venture landscape has made this type of funding difficult. In 2011, we saw only 98 first round venture deals with biotechnology companies, a significant drop from the industry's peak of 141 in 2007. Last year was only the third time since 2000 that the number of deals dropped below 100. Small, startup companies are the innovative heart of our industry, but depressed financing means that potential cures and treatments are often left on the laboratory shelf. Further, venture capitalists expect this downward trend to continue. A recent survey conducted by the National Venture Capital Association (NVCA) found that 41 percent of venture capital firms have decreased their investments in the biopharmaceutical sector in the past 3 years. Additionally, 40 percent of venture capitalists reported that they expect to further decrease biopharmaceutical investments over the next 3 years. Therapeutic areas that affect millions of Americans will be hit by this change in investment strategy, including cardiovascular disease, diabetes, and cancer. A significant reason for reluctance in venture investing has been the inaccessibility of the public markets. Venture capital investors need to know that they will have an exit through which they can get a return on their investment; often, they look for this exit when a company enters the public market. Unfortunately, due to the current economic climate, it is becoming harder for biotech companies to go public. As a result, venture capital firms are turning elsewhere to make their investments, leading to a dearth of innovation capital for biotechnology. Despite the desire on the part of companies and private investors for a clear path to a public offering, public markets remain essentially closed to growing biotech companies. There was only $1 billion in public financing for biotechnology last year, just a third of the total from 2007. Though funding totals are slowly climbing back toward pre-recession levels, this progress has been made almost entirely by larger, more mature companies. These more established companies are getting better deals and emerging companies making their first forays onto the public market are getting squeezed out. The weak demand for public offerings for smaller companies is restricting access to capital. This then hampers critical research, forces companies to stay private for longer, and depresses valuations of later-stage venture rounds. Although the industry is slowly recovering from its recession-induced nadir (in 2008 there was only one biotechnology IPO), this progress is not fast enough for struggling biotechs that need funding to innovate or patients waiting for breakthrough medicines. These disturbing investment trends could be ameliorated by allowing emerging growth companies increased access to the public markets. In a recent survey conducted by NASDAQ and the NVCA, 86 percent of chief executive officers cited ``accounting and compliance costs'' and 80 percent cited ``regulatory risks'' as key concerns about going public. If burdens on public financing were removed, private investors would have greater certainty that they would have an avenue to exit, leading to augmented venture capital investment, the lifeblood of the biotechnology industry. Additionally, companies on the cusp of a public offering would have the confidence that a successful IPO could fund their late-stage trials and push therapies to patients who desperately need them. Public Market On-Ramp Senators Schumer and Toomey have introduced S. 1933, the Reopening American Capital Markets to Emerging Growth Companies Act. This bill would create a new category of issuers, called ``emerging growth companies,'' and ease their transition onto the public market. The legislation would give newly public companies much-needed relief by allowing them to transition into full regulatory compliance over time as they grow. This transitional ``on-ramp'' will encourage biotechnology companies and other small businesses on the cusp of going public to venture onto the public market. One of the key components of the on-ramp is the 5-year transition period before emerging growth companies are subject to full Sarbanes- Oxley (SOX) Section 404(b) compliance. While we can all agree that investors benefit from greater transparency, the unintended consequence of the regulations found in Section 404(b) is the diversion of precious invested capital away from innovative product development and job growth to onerous, costly compliance with little to no benefit to investors or the general public. The opportunity cost of this compliance can prove damaging, resulting in delays to developing cures and treatments during a necessary and often prolonged search for investment capital. SEC studies have shown that SOX compliance can cost companies more than $2 million per year. The biotechnology sector is especially disadvantaged by this burden due to the unique nature of our industry. Newly public biotech companies have little to no product revenue, so they are essentially asking investors to pay for SOX reporting rather than research and development. 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. Companies are the most vulnerable during their first few years on the public market, yet they are forced to shift funds from core research functions to compliance costs. 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. In 2010, Congress made the important acknowledgement that SOX Section 404(b) is not an appropriate requirement for many small reporting companies. The Dodd-Frank Wall Street Reform and Consumer Protection Act sets a permanent exemption from Section 404(b) for companies with a public float below $75 million. Additionally, the SEC Small Business Advisory Board in 2006 recommended that the permanent exemption be extended to companies with public floats of less than $700 million. Similarly, the Reopening American Capital Markets to Emerging Growth Companies Act would allow emerging growth companies time to find their footing on the public market without diverting precious funds to onerous SOX reporting. I support giving these companies 5 years to transition onto the public market, providing them with time to create jobs and continue research before entering full regulatory compliance. Additionally, an on-ramp transition period would allow emerging growth companies to provide only 2 years of previous audited financial statements prior to going public rather than the 3 years currently required. Similar to the transition into SOX compliance, this change would save emerging biotech companies valuable innovation capital that could be used for important research and development. I fully appreciate and agree that strong auditing standards can enhance investor protection and confidence and I support this goal. However, overly burdensome auditing standards impose a significant cost burden on emerging growth companies without providing much pertinent information to their investors. By allowing for limits on the look-back requirements for audited financial statements, a public market on-ramp would balance the goals of cost-efficient auditing standards and investor protection. Two years of audited financials is sufficient for investors to gather information about companies going public. Further, most biotech investors look to scientific and development information when making investment decisions, so the extra year of audited financials imposes costs without providing benefit. Requiring just 2 years of audited financial statements would continue to protect investors but would allow emerging growth companies to expend more of their capital on the search for breakthrough medicines. An on-ramp approach would also exempt emerging growth companies from certain rules issued by the Public Company Accounting Oversight Board (PCAOB), particularly a proposal being considered regarding mandatory audit firm rotation. Audit fees would most certainly increase with the implementation of audit firm rotation. There would be a steep learning curve for any new audit firm, and the additional resources necessary to educate the audit firm about business and operations would raise audit fees. Companies might even need to hire more compliance personnel to avoid disruption of day-to-day operations, further increasing the cost burden. Audit firms have also suggested that audit firm rotation could increase the challenges and costs to maintain high-quality personnel. The cost associated with these scenarios would be transferred to the company while making relationships between the audit firm and the company more difficult to establish. Each new cost burden would require funds to be diverted from research and development to the transition between audit firms, slowing the progress of cures and treatments for which patients are waiting. I support the ongoing efforts to incentivize emerging growth companies to go public and make their transition smoother while continuing to protect investors. Easier access to the public market will improve the health and stability of the biotechnology industry, both for companies considering an IPO and for those which are still seeking private investment. Financial Services Capital Formation Proposals While easing entry onto the public market is a key component of capital formation for growing companies, there are several proposals being considered that would benefit companies that are not yet suited to enter the public markets but face their own unique burdens as they grow. These proposals would strengthen the fundraising potential for small, innovative biotech companies developing solutions to the health problems that our Nation faces. 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 could provide an important funding source for small private biotechnology companies. Regulation A allows companies to conduct a direct public offering valued at less than $5 million while not burdening them with the disclosure requirements traditionally associated with public offerings. The intent of Regulation A was to give companies which would benefit from a $5 million influx (i.e., small companies in need of capital formation) an opportunity to access the public markets without weighing them down through 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 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. Senators Tester and Toomey have introduced a Regulation A reform bill, the Small Company Capital Formation Act (S. 1544), which I believe would have a positive impact for small biotechnology companies. The legislation increases the Regulation A eligibility threshold from $5 million to $50 million while maintaining the same disclosure requirements. 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. The Small Company Capital Formation Act 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. I support this legislation. SEC Reporting Standard (Shareholder Limit) Although the SEC generally monitors public companies, the agency also keeps tabs on private companies when they reach a certain size. Modifying the SEC's public reporting standard would prevent small private biotechnology companies from being unnecessarily burdened by shareholder regulations. Once a private company has 500 shareholders, it must begin to disclose its financial statements publicly. Biotechnology companies are particularly affected by this 500 shareholder rule due to our industry's growth cycle trends and compensation practices. As I have mentioned, 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. Senators Carper and Toomey have introduced legislation, the Private Company Flexibility and Growth Act (S. 1824), which would address these barriers to private company growth. Their bill would increase the shareholder limit from 500 to 2000, relieving small biotech companies from unnecessary costs and burdens as they continue to grow. As it stands, the 500-person 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. The legislation would also exempt employees from the shareholder count, allowing growing biotech companies to attract and hire the most qualified researchers and scientists. I support the Private Company Flexibility and Growth Act, as it 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 sophisticated 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. I support Senator Thune's Access to Capital for Job Creators Act (S. 1831), which would require the SEC to revise Rule 506 and permit general solicitation in offerings under Regulation D. If enacted, this legislation would enhance fundraising options for growing biotech companies searching for innovative cures and treatments. Closing Remarks 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. However, the regulatory burdens I have discussed continue to stand in our way without providing any real benefit to the investors the laws purports to protect. By making targeted changes that support emerging growth companies in the biotechnology industry and elsewhere, Congress can unburden these innovators and job creators while maintaining important investor protections. Congress has the opportunity inspire biotechnology breakthroughs and allow innovators and entrepreneurs to continue working toward delivering the next generation of medical breakthroughs--and, one day, cures--to patients who need them. ______ PREPARED STATEMENT OF JAY R. RITTER Cordell Professor of Finance Warrington College of Business Administration, University of Florida March 6, 2012 Chairman Johnson, Ranking Member Shelby, and Members of the Committee, I want to thank you for inviting me to testify. My name is Jay R. Ritter, and I am the Cordell Professor of Finance at the University of Florida's Warrington College of Business Administration. I have been studying the initial public offering (IPO) market for over three decades, and I have published dozens of peer-reviewed articles on the topic. I have consulted with private companies, Government organizations, and law firms on IPO-related matters. I will first give some general remarks on the reasons for the low level of U.S. IPO volume this decade and the implications for job creation and economic growth, and then make some suggestions on the specific bills that the Senate is considering. First, there is no doubt that fewer American companies have been going public since the tech stock bubble burst in 2000, and the drop is particularly pronounced for small companies. During 1980-2000, an average of 165 companies with less than $50 million in inflation- adjusted annual sales went public each year, but in 2001-2011, the average has fallen by more than 80 percent, to only 29 small firm IPOs per year. The patterns are illustrated in Figure 1. [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] Although there is no disagreement about the existence of this prolonged drought in small company IPOs, there is disagreement about a) the causes of the decline in IPOs, b) the implications for the economy, and c) what should be done, if anything, to rejuvenate the IPO market and spur capital formation. My opinions about the causes of the decline are at odds with the conventional wisdom. My opinions about the implications for the economy are not too different from those of some, such as Prof. John Coates of Harvard Law School, who testified before this Committee on December 14, 2011. These opinions are different, however, from those of the IPO Task Force, whose chair, Kate Mitchell, also testified on December 14, and those of the Wall Street Journal's editorial writers. My opinions about what should be done are similar to those of several witnesses, but in disagreement with those of several others who have a much different opinion about the causes and implications than I do. The Causes of the Decline in IPO Volume The conventional wisdom is that a combination of factors, including a drop in public market valuations of tech companies, heavy-handed regulation such as Sarbanes-Oxley (SOX), and a drop in analyst coverage of small companies, have discouraged companies, especially small companies, from going public in the United States in the past decade. I agree with the conventional wisdom that these factors have discouraged small companies from going public, but I believe that only a small part of the drop in small company IPO volume can be explained by these factors. Instead, I think that the more fundamental problem is the declining profitability of small firms. In many industries, over time it has become more important for a firm to be big if it is to be profitable. Emerging growth companies (EGCs) are responding to this change in the merits of being a small, stand-alone firm by merging in order to grow big fast, rather than remaining as an independent firm and depending on organic (internal) growth. Numerous facts support the idea that small companies are not going public because being small is not best, whether private or public. These facts are documented in ``Where Have All the IPOs Gone?'', coauthored with Xiaohui Gao and Zhongyan Zhu.\1\ My co-authors and I document that U.S. public market investors have earned low returns in the 3 years after the IPO on the IPOs of small companies, defined as firms with less than $50 million in pre-IPO annual sales (2009 purchasing power), in every decade for at least 30 years. Furthermore, we show that for both recent IPOs and for public companies that have been traded for at least 3 years, the fraction of small companies with positive earnings has been on a long-term downtrend, starting far before the tech stock bubble burst in 2000. Other studies have documented that a larger and larger fraction of aggregate corporate earnings are being earned by the largest firms, and that the fraction of public firms that earn positive profits in a year has been on a long-term decline.\2\ --------------------------------------------------------------------------- \1\ See ``Where Have All the IPOs Gone?'' Xiaohui Gao, Jay R. Ritter, and Zhongyan Zhu, March 2012, unpublished University of Florida working paper. Many additional tables can be found on the ``IPO Data'' page of my Web site (just Google ``Jay Ritter''). \2\ See DeAngelo, Harry, Linda DeAngelo, and Douglas Skinner, 2004, ``Are Dividends Disappearing? Dividend Concentration and the Consolidation of Earnings,'' Journal of Financial Economics, 72, 425- 456; and Fama, Eugene F., and Kenneth French R., 2004, ``New Lists: Fundamentals and Survival Rates,'' Journal of Financial Economics, 73, 229-269. --------------------------------------------------------------------------- In the last decade, a larger fraction of venture capital-backed firms have sold out in trade sales rather than go public, as documented by Kate Mitchell in her December 14, 2011 testimony to this Committee. The IPO Task Force interprets this evidence as suggesting that the IPO market is broken. My coauthors and I show that, of the small companies that do go public, there has been an increase over time in the fraction that is subsequently acquired, and as well as the fraction that subsequently make acquisitions. This ``eat or be eaten'' evidence is consistent with the notion that getting big fast has become more important over time, and does not imply that the IPO market is broken. My co-authors and I also show that in the last decade there has been no deterioration in analyst coverage for companies that do go public, inconsistent with the assertion that a lack of analyst coverage is deterring IPOs. My co-authors and I address whether the low profitability of small publicly traded firms in the last decade can be attributed to the costs of compliance with SOX's Section 404. To ascertain whether this is important or not, we add back to earnings an estimate, provided by the U.S. SEC, of the SOX costs incurred by small firms. We report that the downtrend in profitability would be present even if these costs did not exist. Furthermore, as Prof. John Coates mentioned in his December 14th testimony, there has been no resurgence of small company IPOs after the SEC altered the regulations to lessen these costs. If the U.S. IPO market is broken for small companies, but being a small independent firm is still attractive, we might expect to see many small U.S. firms going public abroad. In fact, as documented by several studies, only a few U.S. firms per year have gone public abroad in recent years.\3\ In ``Europe's Second Markets for Small Companies,'' my co-authors and I document that European public market investors have earned low returns on European IPOs from 1995-2009 that listed on Europe's markets that cater to emerging growth companies.\4\ Furthermore, we document that 95 percent of the listings on London's Alternative Investment Market (AIM) have been ``placings,'' restricted to qualified institutional buyers (QIBs). Most of these IPOs have been for very small amounts, and no liquid market ever developed. The reality is that very few of the AIM IPOs would have qualified for Nasdaq listing. --------------------------------------------------------------------------- \3\Doidge, Craig, G. Andrew Karolyi, and Rene M. Stulz, 2009, ``Has New York Become Less Competitive than London in Global Markets? Evaluating Foreign Listing Choices over Time,'' Journal of Financial Economics 91, 253-277. \4\See ``Europe's Second Markets for Small Companies,'' by Silvio Vismara, Stefano Paleari, and Jay R. Ritter, European Financial Management, forthcoming. --------------------------------------------------------------------------- In addition, if being small but public was unattractive relative to being small but private, we might see many U.S. publicly traded small companies going private. Instead, the vast majority of small companies that have voluntarily delisted have done so by selling out to a larger company, rather than by staying independent and going private.\5\ --------------------------------------------------------------------------- \5\See Table 8 of Gao, Ritter, and Zhu (2012). --------------------------------------------------------------------------- To summarize, there is a large body of facts supporting the view that the drop in small company IPO activity is due to the lack of profitability of small stand-alone businesses relative to their value as part of a larger organization. In my opinion, this is the major reason why venture capital-backed firms are selling out (merging) rather than going public. This is a large firm vs small firm choice, not a private firm vs. public firm choice. Although the IPO market may need reforms, private firms are not avoiding IPOs because the IPO market is broken, but because being part of a larger organization creates more value. Implications for the Economy of the Decline in IPO Volume In ``Post-IPO Employment and Revenue Growth for U.S. IPOs, June 1996-December 2010,'' my co-authors and I document the employment and revenue growth for U.S. companies that went public from June 1996- December 2010.\6\ For the 2,766 domestic operating company IPOs from this period, we find that the average company added 822 employees since their IPO. In the 10 years after going public, the average company increased employment by 60 percent, amounting to a 4.8 percent compound annual growth rate (CAGR).\7\ --------------------------------------------------------------------------- \6\ Martin Kenney, Donald Patton, and Jay R. Ritter, work in progress for the Kauffman Foundation on ``Post-IPO Employment and Revenue Growth for U.S. IPOs, June 1996-December 2010.'' \7\ The 60 percent cumulative average growth in employment and 4.8 percent CAGR numbers are based on the 1,857 IPOs from June 1996- December 2000. --------------------------------------------------------------------------- One can use these numbers to calculate the number of jobs that would have been created if the average annual volume of domestic operating company IPOs from 1980-2000 had continued during 2001-2011, rather than collapsing. In 1980-2000, an average of 298 domestic operating companies per year went public, whereas an average of only 90 domestic operating companies per year have gone public since then, a difference of 208 IPOs per year. Over the eleven year period 2001-2011, this amounts to a shortfall of 2,288 IPOs, with 822 jobs per IPO lost. Multiplying these two numbers together results in a figure of 1.88 million jobs that were not ``created'' due to the IPO shortfall. This calculation assumes that these employees would have been sitting at home watching TV if they weren't hired by the recent IPO firm, and that the roughly $100 million raised per IPO would not have been invested in anything else. But, in a mechanical sense, 1.88 million jobs have been ``lost.'' This 1.88 million figure is dramatically lower than the 10 million jobs figure that Delaware Governor Jack Markell used in his March 1, 2011 WSJ opinion piece ``Restarting the U.S. Capital Machine,'' or the 22.7 million figure used in the IPO Task Force report presented to the U.S. Treasury and this Committee in late 2011 by task force chairwomen Kate Mitchell. The 22.7 million number comes from a 2009 Grant Thornton white paper, ``A Wake-up Call for America,'' written by David Weild and Edward Kim. Weild and Kim make four different assumptions than my coauthors and I do in order to generate their 22.7 million jobs lost figure. First, Weild and Kim make the reasonable assumption that IPO volume should be proportional to real GDP, and since the U.S. economy has grown over the last 30 years, one would expect IPO activity to rise rather than be flat. Thus, our number, which assumes that IPO activity would be constant over time, is biased downwards. Second, on page 26 Weild and Kim make the assumption that the normal level of IPO activity is that of 1996, the peak of the IPO market, and that the volume should grow from this level. This assumption, that the 1996 number of 803 IPOs is normal, biases their number upwards. Third, they assume that each IPO that didn't occur would have had 1,372 employees before going public, and post-IPO employment grows at a CAGR of 17.8 percent, a number that implies employment growing by 415 percent in the 10 years after an IPO. The 17.8 percent per year number is justified based on a ``select'' group of prior IPOs. In other words, they assume that thousands of companies that didn't go public would have grown as fast as companies such as Google if they had! This assumption, which I would tend to categorize as completely ridiculous, has a huge impact on their calculations. Fourth, they assume that there was an IPO shortfall starting in 1997, rather than 2001, and that more than 1,500 additional firms would have gone public in 1997-2000 and then grown their employment by 17.8 percent per year for more than a decade. This 1997-2000 shortfall assumption, combined with the 17.8 percent CAGR assumption, adds at least 9 million lost jobs to their 22.7 million total. What Should Be Done If the reason that many small companies are not going public is because they will be more profitable as part of a larger organization, then policies designed to encourage companies to remain small and independent have the potential to harm the economy, rather than boost it. Not all EGCs should stay private or merge, however, and to the degree that excessive burdens associated with going public, and being public, result in less capital being raised and wisely invested, standards of living are lowered. I do not think that the bills being considered will result in a flood of companies going public. I do not think that these bills will result in noticeably higher economic growth and job creation. In thinking about the bills, one should keep in mind that the law of unintended consequences will never be repealed. It is possible that, by making it easier to raise money privately, creating some liquidity without being public, restricting the information that stockholders have access to, restricting the ability of public market shareholders to constrain managers after investors contribute capital, and driving out independent research, the net effects of these bills might be to reduce capital formation and/or the number of small EGC IPOs. I think that Prof. John Coates zeroed in on the tradeoffs in his December 14, 2011 testimony. He stated ``While the various proposals being considered have been characterized as promoting jobs and economic growth by reducing regulatory burdens and costs, it is better to understand them as changing, in similar ways, the balance that existing securities laws and regulations have struck between the transaction costs of raising capital, on the one hand, and the combined costs of fraud risk . . . ``As he notes, fewer investor protections can potentially result in more fraud, with rational investors responding by demanding higher promised returns from all companies, resulting in good companies receiving a lower price for the securities that they sell. Good investor protection laws, and their timely and effective enforcement, can lower the cost of capital for good companies, but investor protection does impose compliance costs on all companies. I will now comment on some of the specific bills under consideration by the Senate: 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'' These bills deal with Regulation D and its requirements on solicitations, and crowdfunding. In general, they reduce constraints on the ability of parties seeking capital to reach out to unsophisticated investors, potentially increasing the amount of fraud. Fraudsters are happy to relieve unsophisticated investors of their cash. An increase in fraud if these bills are passed is not, however, an automatic result. When eBay and Craigslist were created, a concern was raised about whether fraud by sellers, and bounced checks from buyers, would be so prevalent that an electronic exchange that matched buyers and sellers of nonfinancial goods and services would fail. In practice, both organizations have been successful at matching buyers and sellers, even if there are some unsatisfactory outcomes. In financial markets, as with eBay and Craigslist, it is possible that organizations will evolve that provide sufficient voluntary policing and certification to minimize the amount of fraud and create value by bringing buyers and sellers (investors and entrepreneurs) together. I am not certain what problem crowdfunding is solving. Many startups are able to get funding from angel investors, and, once a certain threshold of size has been reached, venture capital (VC) firms have billions to invest. If VC firms were demanding excessively onerous terms, one might expect to see extremely high returns for the limited partners (LPs) of VC funds. Over the last decade, however, the bigger problem has been low returns. The market is not failing when firms with poor investment prospects are unable to get funding. The market is working when firms with good prospects are able to get funded at reasonable cost and grow, and firms with poor prospects are deprived of capital that would be wasted. S. 1970 appears to offer some protections to investors that are not present in S. 1791. I am modestly supportive of S. 1970, but not enthusiastic about S. 1791. S. 1824 ``The Private Company Flexibility and Growth Act'' This bill increases the 12(g)(1) of the 1934 Act threshold at which public reporting of financial statements is required from 500 to 2,000 shareholders of record, and Section 3 removes current and past employees from the count. The number of beneficial shareholders, of course, may be far in excess of the number of shareholders of record since individuals normally hold shares in street name. On December 1, 2011, Prof. John Coffee of Columbia Law School testified that the shareholders of record requirement should be supplemented with a public float requirement: if either the 2,000 shareholders of record threshold is passed, or if the public float is above $500 million, public reporting should be required. My suggestion would be to keep the 500 shareholders of record threshold, but exclude current and former employees from the count, and to add a public float requirement. Alternatively, the ``shareholders of record'' requirement should be changed to reflect the fact that for publicly traded firms, individuals keep their shares in street name. S. 1933 ``Reopening American Capital Markets to Emerging Growth Companies Act of 2011'' This bill establishes a new category of issuers, called emerging growth companies (EGCs) that have less than $1 billion in annual revenue at the time of SEC registration, and exempts them from certain disclosure requirements, such as executive compensation. The exemptions would end either 5 years after the IPO or when the annual revenue exceeds $1 billion. From 1980-2011, 7,612 operating companies went public in the United States, excluding banks and S&Ls and IPOs involving units, an offer price below $5.00, or partnerships. Ninety-four (94) percent of these companies had annual sales of below $1 billion when they went public, including Carnival Cruise Lines and AMF Bowling. Section 3 deals with disclosure obligations. I cannot think of any reason for why public market investors should not need to know how much executives are paying themselves, nor have a say on this cost through shareholder voting. Section 6 deals with coverage from sell-side research analysts. As I interpret it, this legislation would abolish quiet period restrictions on the ability of sell-side analysts that work for an underwriter to provide research to institutional investors for EGCs, which historically have comprised 94 percent of all IPOs. Because the sell-side analysts are potentially privy to inside information, they will be at an informational advantage relative to other analysts. This proposed legislation is completely at odds with the logic of Reg FD, which seeks to create a level playing field. The proposal may have the effect of crowding out unbiased independent research. As I mentioned earlier in this testimony, my research shows that there has been no lack of analyst coverage of companies conducting IPOs in the last decade.\8\ If the purpose of Section 6 is to create incentives for analyst coverage because none exists, this legislation is based on a faulty premise. --------------------------------------------------------------------------- \8\ Table 6 of Gao, Ritter, and Zhu (2012) shows that essentially all IPOs with a midpoint of the file price range of above $8 receive coverage. This $8 cutoff is a good proxy for IPOs that are large enough to attract institutional investors. --------------------------------------------------------------------------- ______ PREPARED STATEMENT OF KATHLEEN SHELTON SMITH Co-Founder and Chairman, Renaissance Capital, LLC March 6, 2012 Chairman Johnson, Ranking Member Shelby, and Members of the Committee: I want to thank you for inviting me to testify today. Capital formation, when accomplished through a transparent IPO market open to all investors, plays an important role in allocating capital to our best entrepreneurial companies, spurring significant and sustainable job growth. We are all concerned about economic growth and job creation, so it is no surprise that our eyes would turn to the IPO market--America's most admired system for funding entrepreneurs. The issue we address today is access to capital by entrepreneurial companies. When America's job-creating smaller companies are unable to access the IPO market, we need to understand why and what we can do about it. Measures to ease costly regulatory burdens that weigh most heavily on small firms may be helpful. At the same time, care must be taken in waiving certain disclosure and stock promotion rules that could result in misallocating capital to weak or fraudulent companies. Weak companies that ultimately fail cause job losses, not job creation, and result in serious stock market losses to investors who abandon the IPO market, as was the case after the Internet bubble burst. Renaissance Capital's IPO Expertise We share the concerns of lawmakers about the IPO market and are honored to be asked for our thoughts on this important policymaking process. For over 20 years, Renaissance Capital has had a singular focus on the IPO market. We are involved in IPOs in three ways: 1. We are an independent research firm. We provide institutional investors with research on IPOs. We analyze every IPO in the United States and we cover the international IPO market. 2. We are an indexing firm. We create and license IPO indexes that measure the investment returns of newly public companies. These indices are used by IPO investors as a benchmark of performance. 3. We are an IPO investor. We invest in newly public companies through a mutual fund and separately managed institutional accounts. Regulators around the world often reach out to us about our views on IPO issuance, valuation and research. These regulators are studying the best practices of the U.S. IPO market. They know that a well- functioning IPO market can be the most efficient way for them to allocate capital to their growing enterprises. A well-functioning IPO market is based upon full and honest disclosure of company information made available evenly to all public investors. I will start by examining the condition of our IPO market, including where we stand in global IPO market share, what is working and what is not, and the importance of investor returns in the equation. I will then make suggestions on the specific bills under consideration. The U.S. IPO Market is Doing Well Relative to IPO Markets Around the World While there is legitimate concern that recent issuance in the U.S. IPO market has been below long-term trends, the U.S. market is not alone. IPO markets globally have been hurt by the 2008 U.S. financial crisis and the 2011 European Sovereign debt crisis. However, in the context of weak global IPO markets, the United States has actually gained market share, accounting for 32 percent of global IPO proceeds in 2008 and again in 2011. In 2011, when international IPO issuance fell 50 percent, U.S. IPO issuance fell only 6 percent. This tells us that when put to the test of a financial crisis, investors trust the disclosure, transparency and depth of the U.S. IPO market more than any other IPO market in the world. So, despite the low IPO issuance levels, much of the U.S. IPO market is functioning as well as can be expected under challenging conditions. [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] Larger Issuers Continue to Access the IPO Market The IPO Task Force provided helpful data about IPO issuance since 1991. This data shows that while smaller IPOs have effectively disappeared, larger companies raising over $50 million in IPO proceeds continue to access the IPO market. From 2000 to date, investors have experienced the weakest period of stock market returns in decades. As the chart shows, during this period, the larger issuers have dominated the IPO market. In weak markets, investors gravitate to the perceived safety of larger, more liquid IPOs. [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] Furthermore, despite our current regulatory regime, we find little evidence that these larger issuers have been deterred from tapping the IPO market. Today, we count over 200 companies in the U.S. IPO pipeline seeking to raise over $52 billion in aggregate proceeds who have undergone financial audits, implemented Sarbanes-Oxley policies and filed full disclosure documents with the SEC. This is the largest backlog of companies lined up to go public that we have seen in over a decade. Over 92 percent of these companies are larger issuers seeking to raise over $50 million in IPO proceeds. The U.S. IPO Market is Closed to Small Issuers On the other hand, as the IPO Task Force concluded, smaller IPOs of $50 million proceeds or less have become a reduced presence in the IPO market. Prior to 1999, smaller IPOs represented 50 percent or more of the IPO market, currently they represent less than 15 percent. Helping these smaller job-creating companies lower the cost of accessing the IPO market, while protecting investors, may help somewhat in boosting the presence of smaller IPOs in the market. However, opening the path for easier issuance by smaller companies only works if investors are interested in buying these IPOs. Thus, it is even more critical to address the investor side of the equation. At present, the trading market for IPOs is highly volatile with average IPO trading turnover on the first day often equal to the number of shares offered. This suggests that IPO shares are being placed with short-term trading clients of the IPO Underwriters. IPO shares placed with a broader base of fundamentally oriented investors would go a long way to help open the IPO market to smaller issuers. We urge policymakers to study ways to encourage IPO Underwriters to allocate IPOs to a broader base of long-term investors. Ultimately the IPO Market Opens Up When IPO Investors Earn Positive Returns While policy to ease the way for more small issuers to accomplish an IPO may be helpful, the most powerful fix for the IPO market would be to improve returns for IPO investors. Unfortunately, there is little policymakers can do on this front, short of creating a Government fund that purchases shares in every small IPO--which we would not recommend. Returns to IPO investors matter because good returns for IPO investors drive future IPO activity. IPO issuance grows when returns are positive. The IPO market closes when returns are negative. [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] After a long run through the 1990s of positive equity returns for all investors, the bursting of the Internet bubble devastated IPO investors, causing losses of -49 percent and -61 percent in 1999 and 2000, respectively, far worse than the rest of the equity market. No wonder in the years following that disaster, investors were cautious about smaller IPOs, shutting off IPO issuance for these important job- creating small companies. Over 70 percent of the IPOs during that period were unprofitable companies whose offerings were promoted by the IPO Underwriters' research analysts. We caution lawmakers to avoid new policies that would pave the way for IPO Underwriters to engage in these types of promotional activities again. We are encouraged that following the poor returns of 2008 and 2011, returns for IPO investors have turned strongly positive so far in 2012. These positive returns will startup the IPO issuance engine again. We believe that an extended period of positive returns for IPO investors is the most powerful solution to increasing IPO market activity leading to a greater presence of smaller sub-$50 million issuers. In the meantime, policies that assist these smaller IPOs to lower the cost of accessing the IPO market and improve IPO allocation to attract a broader base of long-term investors could provide some helpful relief. * * * * * Renaissance Capital's Recommended Improvements to the Proposed Legislation 1. Focus on the companies seeking to raise under $50 million that are currently shut out of the IPO market by properly defining Emerging Growth Company as smaller issuers seeking to raise up to $50 million. 2. Strike the proposed informational rules in S. 1933 Section 6 that permit IPO Underwriters and issuing companies to promote offerings and provide special information to selected clients during the IPO process to avoid re-creating the Internet bubble. 3. Encourage larger private companies (e.g., Facebook) to file public disclosure (i.e., go public) when active trading markets develop in its shares, by adding a public float requirement to the proposed private company legislation. Recommendation #1: Refine the definition of ``Emerging Growth Company'' to focus on the small companies seeking to raise up to $50 million, replacing the proposed $1 billion revenue rule The S. 1933 legislation defines Emerging Growth Company as a firm with $1 billion in revenue. By this definition, we would be giving relief to over 90 percent of the companies going public, effectively the entire IPO market, and would include companies with very large market capitalizations. The real Emerging Growth Companies that need to be targeted are smaller issuers seeking to raise under $50 million in capital. Based upon our analysis, an Emerging Growth Company should be redefined as one seeking to raise up to $50 million with an implied market capitalization under $200 million. This would target the part of the market that needs attention. Recommendation #2: Strike the proposed rules that permit IPO Underwriters and issuing companies to promote offerings and provide special information to select clients during the IPO process We agree that more research on companies would be favorable for stock trading, but Section 6 in the S. 1933 legislation, as written, would allow IPO Underwriters to engage in promotional activities. After the Internet bubble burst, investors suffered devastating losses of -49 percent and -61 percent in 1999 and 2000, respectively, from purchasing overvalued IPOs pumped up by underwriter research. Over 70 percent of the IPOs during that period were unprofitable companies, many of which went out of business. As we know from bitter experience, research by broker dealers and their affiliates that underwrite the IPO is inherently biased, used as a marketing tool to sell shares in the IPO and, without some restrictions, provides an informational advantage to the IPO Underwriters' research analysts and proprietary clients, contrary to Regulation FD. Recommendation #3: Improve legislation expanding the size and dollar thresholds of the private placement market by adding another threshold that would encourage private companies, whose shares are actively trading, to go public The various bills seeking to expand the size of the unregistered (``no-doc'') private market from $5 million to $50 million and the number of accredited investors from 500 to 1,000, may help to open up more capital raising opportunities for smaller issuers. However, these changes may have the unintended consequence of creating a shadow IPO market of larger private companies. These private IPO-ready companies would reap the benefit of being public without taking on disclosure responsibilities. For example, even under the existing 500-shareholder limit, active private transactions in Facebook shares have occurred prior to its IPO filing at large cap valuations of $100 billion, the size of McDonald's. We recommend adding a provision to these new rules that encourage private companies (e.g., Facebook), who meet certain thresholds of transactional activity, to go public, providing full disclosure to all investors. We support the market capitalization limit proposed by Columbia University Professor John Coffee of $500 million or less. This would help the IPO market. Summary A well-functioning IPO market is based upon the principal of full and honest disclosure of company information made available evenly to all public investors. The U.S. IPO market is functioning amazingly well under the stressful conditions of a global financial crisis. While there may be initiatives that can help improve the functioning of the IPO market, especially as it pertains to the most vulnerable smaller companies, the IPO market will heal itself starting with the larger, more established private companies. Waiving certain disclosure and stock promotion rules that could result in misallocating capital to weak or fraudulent companies will only endanger the recovery of the IPO market. It is the positive returns that investors earn from these larger issuers that will lead to more issuance for smaller IPOs. ______ PREPARED STATEMENT OF TIMOTHY ROWE Founder and CEO, Cambridge Innovation Center March 6, 2012 Thank you for inviting me to speak today. As you know, I am the CEO and Founder of Cambridge Innovation Center (CIC). CIC houses approximately 450 startup companies in a large office tower in Kendall Square, Cambridge, Massachusetts. We are told that CIC has more startups under one roof than any other building anywhere. More than $1.5B dollars have been invested in these companies. We have been a launch-pad for several well-known companies, including Google Android and Great Point Energy. I also serve as the President of the Kendall Square Association. Kendall Square is home to the Massachusetts Institute of Technology (MIT) and more tech and biotech companies per square mile than anywhere else in the world, and includes such global leaders such as Amgen, Biogen, the Broad Institute, Google, MIT, Microsoft, Novartis, Genzyme, VMWare, and the Whitehead Institute. Our goal is to ensure that Kendall Square remains a place where the world gathers to develop breakthrough discoveries that positively impact our society. In other responsibilities, I serve on the investment committee for New Atlantic Ventures, a $120M early stage venture capital firm. Together with my partners, we have helped make dozens of investments in small companies. This past December, Massachusetts was asked to send a delegation to the Startup America Summit at the White House to share what we believe to be the national priorities for helping grow jobs through entrepreneurship. Many Massachusetts leaders got involved, and together we settled on five key measures: 1) Crowdfunding, 2) IPO on-ramp legislation, 3) easier Visas for overseas entrepreneurs who want to come create jobs in the United States, 4) better mid-skills job training, and 5) limitations on noncompete agreements in employment contracts (some States already ban them). I was selected by the group to present our conclusions, and I will do my best to do so again today. Given the topic of today's hearing, I plan to talk about the first two measures. We believe startups are at the root of restoring the United States to full economic health. As is now well known, a Kauffman Foundation study using U.S. Census data recently found that, over the last quarter century, all net new jobs in the United States have come from companies 5-years old and younger. Existing firms (those 6 years old and older) collectively lost jobs during that same quarter-century period analyzed (1980 to 2005). For every job lost by existing firms, new firms generated three. It seems clear that supporting startups and entrepreneurship is the key to job creation in the United States. Enabling better access to capital will be the single most impactful step Government can take. I will speak in particular to two proposals: 1) Crowdfunding (S. 1791 and S. 1970) Risk capital is distributed unevenly in our country. Startups do not today have adequate places to go to find the money to start a new business. Everyday businesses that are the bread and butter of our communities--businesses like restaurants, small construction companies and the like--are starved for capital. There are, for instance, nearly 8 million women-owned businesses in the United States, yet only a few hundred a year are able to raise venture capital.\1\ --------------------------------------------------------------------------- \1\ Estimated to be between 140 and 280 deals per year based on data from the Kauffman Foundation at http://www.kauffman.org/research- and-policy/gatekeepers-of-venture-growth.aspx and http:// www.pwcmoneytree.com. --------------------------------------------------------------------------- I believe that crowdfunding legislation can change this. As we have all heard, the Internet changes everything. One of the things that the Internet has changed is the ease with which an organization can broadcast its needs and attract supporters online. Another thing that has changed is that it is much harder for bad actors to hide from the scrutiny of the masses. Many companies have sprung up to help individuals and small businesses find loans, donations, and first customers this way. Politicians have found the Internet effective to raise campaign donations. In an example that shows the power of crowdfunding, popular Web site Kickstarter, which collects money from fans to support principally film, arts and design-oriented projects, raised almost half as much money for the arts in 2011 as the National Endowment for the Arts (NEA). Due to its rapid growth, it appears likely to roughly tie the NEA in 2012.\2\ The NEA acknowledged this, stating ``Kickstarter and the other platforms that crowdsource donations for arts organizations and projects are becoming increasingly important in helping the arts.'' --------------------------------------------------------------------------- \2\ Analysis from Talking Points Memo at http:// idealab.talkingpointsmemo.com/2012/02/the-nea-responds-to-kickstarter- fundingdebate.php?m=1. --------------------------------------------------------------------------- Crowdfunding proposes to harness this same power to help people start new businesses, and create new jobs. It will enable individuals to make small equity investments in others' businesses without the usual regulatory burdens associated with a public offering. Many of us in the startup community believe that such a mechanism will allow far more startups to get going in the United States, thereby creating much-needed new jobs. This is evidenced by a petition started by some entrepreneurs in my center, which can be found at Wefunder.com. They obtained commitments from more than 2,500 individuals to invest over $6M through crowdfunding. How big could the impact of crowdfunding be? Americans have about $30 trillion dollars in savings plans (401Ks, IRAs, and the like). Amy Cortese, author of the book Locavesting, points out that if Americans diverted just 1 percent of this amount into crowdfunding type investments, the amount raised would equally half of all small-business loans in the country, and would be about 10 times the total amount of venture capital invested each year in the United States. The potential benefit to the country from this is very large. The chief concern with crowdfunding is the threat of fraud. Some have voiced a concern that unscrupulous individuals might take advantage of unsophisticated investors, misrepresenting risks, and effectively stealing investors' money. While this concern is understandable, the data show that Internet intermediaries have been successful at blocking such fraud. United Kingdom-based crowdfunding startup Crowdcube, for instance, reports zero fraud claims after a year in business (see attached letter from its CEO). They achieve this in part by thoroughly vetting the opportunities they present for investment. Similarly, Prosper.com, a crowd-lending business operating under SEC regulation claims to have raised $124M in loans and to have no reports of fraud or misrepresentation. Funding Circle, out of the U.K., another crowd- lending platform, claims to have raised 26M in 569 transactions and reports no fraud (and only 5 defaults so far). AngelList is a crowdfunding platform in the United States that works only with accredited investors. It operates under the SEC's Regulation D, and has raised ``more than $100M'' in equity investments using its online platform. AngelList claims zero reports of fraud. Net-net, I conclude that if crowdfunding legislation requires that any investments be made through an SEC-licensed intermediary, the fraud problem can be resolved. To draw a broader analogy from a different industry, as we all know, eBay is a Web site that permits one to buy items from people they have never met, and never will meet, based solely on an online description. On the face of it, this would similarly seem to be a hotbed for fraud. Yet any eBay user will tell you that the incorporation of a system that tracks the reputation of buyers and sellers significantly mitigates fraud. We believe that the analogous mechanisms will be developed by competing crowdfunding intermediaries, leading to an enviable investment environment that is safe and free from undue regulation. To the extent that there are continued concerns about fraud, one additional attractive market-based solution could be fraud insurance. Given the low actual incidence of fraud, crowdfunding proponents have attracted the interest of insurers who have voiced an openness to issue policies protecting crowdfunding investors against fraud. I understand that there are efforts underway to create a ``consensus'' crowdfunding bill that would incorporate the best of the various bills under consideration. Having studied the topic closely, I would urge the drafters to do so, and to incorporate the following provisions: a) Require the use of SEC-licensed intermediaries. Intermediaries, playing the ``eBay'' role, are the key to eliminating fraud. Intermediaries will compete to be attractive to investors, offering such incentives as anti-fraud insurance. Intermediaries would creatively develop competing mechanisms to reduced fraud, be that by manually vetting the deals, or using some other mechanism such as crowd input. I don't think we should legislate how the do it, since this is an area where we want creative innovation. Instead, any intermediaries deemed ineffective at eliminating fraud would simply be subject to losing their license. It is important that the regulations that intermediaries should be subject to enable them to flexibly, and at low-cost handle these small transactions (e.g., not subject to the full brunt of onerous broker-dealer regulations, but only the specific intermediary requirements spelled out in the bills, which all look fine). To the extent that a workable definition of such an intermediary can be agreed upon, ideally it would also be extended to the aforementioned Reg-D-based crowdfunding intermediaries as well, since they face the same issues. b) Enable investments larger than $1,000 for those who can afford it. Some of the proposed bills provide formulas for determining limits. Data show that 90 percent+ of the dollars raised in crowdfunding initiatives are from people investing more than $1,000, so it is highly desirable to enable larger investments. See attached chart. One way to address this concern would be to set a higher limit, say $100,000, or no limit, on the amount accredited investors can invest under crowdfunding legislation, effectively extending this same concept of crowdfunding through intermediaries to cover both crowdfunded & accredited investments. c) Don't burden the process with unnecessary restrictions that would render crowdfunding legislation meaningless. For instance, it is essential that the degree of interaction required with individual States be limited. Fifty States and 50 different sets of rules, and these small companies can't handle that amount of complexity. Limited State filings for the issuer's State and a State in which the majority of the issuer's investors live are reasonable, but, in general, it is imperative that State securities laws be preempted by the crowdfunding exemption (with the exception of State anti-fraud laws). Additionally, it is important that overly burdensome disclosure obligations are not placed on issuers. These rules were created with large issuers in mind, and would stifle crowdfunding. Instead, follow the example of Crowdcube-they have a strong incentive to eliminate fraud and do not list opportunities they believe to be inadequately described, or where stories don't check out. d) Don't burden crowdfunding issuers with excessive liability. Issuers should be subject to collective action by investors if they commit wrongs, but some provisions would appear to create the possibility for individual rights of action, and that would create an untenable risk for issuers. e) Do require a periodic ongoing review of how this is going, as called for in S. 1970. 2) IPO on-ramp legislation (S. 1933) While most jobs are created by companies 5-years old and younger, an exception is larger companies that go public and raise substantial amounts of capital. Data show that companies that go public grow their headcount approximately 5-fold, often creating thousands of jobs. Unfortunately, the current regulatory frameworks impacting public companies have had the unintended consequence of substantially reducing the number of companies that are able to go public. It costs an estimated $2.5M for a company to go public today, and $1.5M per year to stay public. These are heavy burdens for young companies to bear. Proposed legislation would reduce this regulatory and paperwork burden for so-called ``Emerging Growth Companies'': smaller, younger companies that are less likely to go public otherwise. This category, by virtue of being comprised of young companies, today represents only a small 3 percent of the total value of publicly traded companies. At the same time, it represents our future. It is important that we nurture it. Under this proposal, regulation would ``scale'', growing with a company's compliance abilities. I believe it is important to note that I personally applaud the intent of many of the regulations that are scaled under this bill. I believe each regulation was created with good intentions, and under the proposed legislation, each will, in time, be applied to every company that goes public. This bill simply delays the day that these companies must face the economic burden of compliance. I am hopeful that the Senate will find these proposals have merit and that Congressional enactment is necessary to jumpstart our economy. This is a time when we must be creative and work together to find solutions to help America get back to work. [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] ______ PREPARED STATEMENT OF LYNN E. TURNER Former Chief Accountant of the Securities and Exchange Commission, and Managing Director, Litinomics, Inc. March 6, 2012 Thank you Chairman Johnson and Ranking Member Shelby for holding this hearing and it is an honor to be invited to testify before you. I am sure everyone here at the hearing today can agree that increasing employment in the United States, and bringing back jobs that have left the country, is vitally important to our economy and the well being of America, and Americans. The destructive effect of the most recent financial crisis on American jobs, the United States (U.S.) capital markets, retirement and savings accounts, and families provides us stark lessons in this regard, if we choose to learn from them, rather than repeat them. Background Let me begin by noting my comments today are framed by my past experiences including: Having been involved as an executive in starting up a successful venture backed company that created jobs. Having served on a Commission formed in my State in the 1980s to explore what could be done to improve the success rates of startup businesses and smaller companies. Serving as a trustee for two institutional investors, including on the investment committees. One of those institutions does invest in startup and/or growing companies via investments in venture capital and private equity. Serving as the U.S. Securities and Exchange Commission (SEC) Chief Accountant, responsible for advising the SEC Chairman and Commission on matters of disclosure, transparency and auditing affecting all public companies. Serving as a Vice President and Chief Financial Officer at a semiconductor and storage systems company. Attracting capital and financing was critical to the company's success as we made major investments and purchases in manufacturing plants and the jobs in them. We spent 2 years preparing for an Initial Public Offering (IPO), including preparation of filing documents, selection of underwriters, and working with sell side analysts as they wrote research reports in anticipation of the offering. Ultimately, due to the downturn brought on by the Asian Crisis and its contagion effect on the capital markets, the IPO was not completed. Spending 20 years of my career with a Big 4 accounting and consulting firm, including spending considerable time in the Emerging Business Services Group that advised and audited emerging and growing businesses. This included working with companies inside two business incubators in Boulder and Denver Colorado for which the Boulder Incubator Board presented me with the Board Partnership Award. Initial Public Offerings Public offerings of stock by companies to investors are an important factor in the success of our capital markets. The number of offerings completed, as well as the amount of money raised, tracks the economy in general. This was noted in the Goldman Sachs Global Economics Weekly report February 7, 2007 which stated: Several recent reports have fuelled anxiety that Wall Street is losing out . . . most keenly to London and is doomed to lose its perch as the world's pre-eminent capital market. Studies have pointed to strict legal and regulatory practices in the United States as reasons why issuers are increasingly looking elsewhere for IPOs. These issues are typically contrasted with London's light touch regulation, more hospitable legal regime and ease of migration. The regulatory climate does matter, and policy reform might strengthen New York's competitiveness. Nonetheless, we do not think this is the main problem nor indeed that Wall Street is losing out in a regrettable way. Instead we see the growth of capital markets outside the United States as a natural consequence of economic growth and market maturation elsewhere. The United States has in fact been losing market share for several decades, and it trails Europe in trading of FX and many derivatives.'' Legal and regulatory factors probably do matter, and policy reform might strengthen New York's competitiveness. Nonetheless, we do not see them as the critical drivers behind the shift in financial market intermediation, even in the aggregate. Quite simply, economic and geographic factors matter more. The reason IPO's track the economy is that investors invest to earn a return. When the economy is growing, companies can grow. That growth in revenues, profits, cash and investments such as employees fuels the growth in companies' stock and the returns investors seek. However, when the economy has stalled or is declining, and companies are not growing, investors simply cannot achieve the types of returns they need to justify making an investment. The following chart highlights that. As a result of the downturns in the economy that occurred during much of the 1970's brought on in part by withdrawal from Vietnam, the recession brought on by inflation at the beginning of the 1980s, the dot com bubble and corporate scandals, and the most recent great recession, investors became concerned about returns that could be earned in the markets and IPO's declined. As the economy and employment have recovered after each of these downturns, so has the IPO market. [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] During the 1990s, the U.S. economy experienced high growth rates, which has not since been matched. Charts 1 and 2 illustrate how the IPO market reached an unprecedented level during the 1990s not achieved before or after. Some argue that is because the U.S. regulations protecting investors are overly onerous. Often they cite Sarbanes-Oxley and its Section 404(b) requirement for companies, mandating an audit of their internal controls as an unjustified cost. But the facts simply don't bear this out, and those arguments have a lot in common with the too common refrain--``the sky is falling.'' Those making this argument also cite the London AIM market as an example of a ``lightly'' regulated market the United States should attempt to emulate. However, a close examination of the issue does not support these individuals. First of all, the U.S. IPO market had very significant declines in the 1970s, 1980s, and as the last century came to a close. Some of those declines occurred before current regulator financial reporting requirements were adopted, and certainly before Sarbanes- Oxley was adopted in 2220. In addition, if one looks at the following charts for the AIM market, one can see that market also experienced deep declines in its IPO market. And its recovery has significantly trailed those in the United States as the U.S. economy has outperformed that in Britain. One can only ask, why would a reasoned and thoughtful person want to copy that? [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] A number of years ago, a former SEC Commissioner caused a ruckus when he made reference to the AIM market as being somewhat akin to a Las Vegas Casino. He had a point. As noted in the following chart, this lightly regulated market was started in the 1995/96 timeframe. If one had invested in the AIM market index at the time with a $1,000, one would no longer have the $1,000, as the market has generated a negative return for investors. It is no surprise then that The Daily Telegraph in the U.K. recently stated that: ``Recent research for The Daily Telegraph has also shown that at least 80 leading money managers do not have confidence in the current regulation of natural resource companies on AIM.'' (See Exhibit 1). [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] Despite a market that has risen from the despair of 2009, investors remain cautious about giving their money to companies. The aggregate returns they have earned since 1999 have been somewhat meager when compared to the 1980s and 1990s. Baby boomers have seen their 401-K's turned into 201-K's by the scandals and dot com bubble at the beginning of the last decade with the most recent financial crisis burning them badly. Both the Nasdaq and Dow Jones Indexes remain well below their highs. And just a couple of weeks ago, an article in the Wall Street Journal noted that in 37 of the past 40 weeks, investors had pulled cash out of investments in small cap companies. Again, investors invest to make a reasonable return. But just as such returns have been fleeting for them, they have also been lower for Venture Capitalists (VC's). My experience has shown that VC's are astute at picking the companies and management teams to invest in, that will yield them and the investors in their funds, the highest possible returns. And they bring great insights and expertise to these companies, greatly aiding them in their efforts to grow and become highly successful. Yet despite all this experience, knowledge and expertise, as noted in the following chart, VC's and the investors in their funds have experienced the same impact from the downturns in the economy everyone else has. And that should be no surprise to anyone who understands fundamental, basic economics. It takes a growing economy such as existed in the United States in the 1990s, and exists now in China, India and certain other emerging countries in the world, to generate returns for investors. [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] Critical Success Factors for an IPO I have often counseled that not all companies should do an IPO. If you take someone's money, you should do so ONLY if you think it is likely, you will be able to yield them a reasonable return on their money. After all, they are owners of the business once they have bought stock and should be treated accordingly. Those who go public thinking that ``possession is 9/10ths of the law'' when it comes to cash, are in for a very rude awakening. When I served on a Colorado Commission that explored why so many small companies were failing in Colorado at the time, and how their success rate could be improved, we found that access to capital was not the primary cause of failure. Rather it was a lack of sufficient expertise and management within the company including in such areas as marketing and operations. While access to sufficient capital for any company is important, I have found that those emerging companies with better management teams and proven products, or products with great growth potential, are able to obtain it. Those are the types of companies VC's and private equity seek out. My experience has also taught me that many IPO's are not a success. We are all very mindful of the Googles, Apples, HP's, and Microsofts that have become great successes. In fact, the vast majority of the jobs they created have been created after an IPO, not before. In an American Enterprise Institute Paper titled ``Are Small Businesses The Engine of Growth'' Veronique de Rugy, the author states: It is a common belief among entrepreneurs and policymakers that small businesses are the fountainhead of job creation and the engine of economic growth. However, it has become increasingly apparent that the conventional wisdom obscures many important issues. It is an important consideration because many Government spending programs, tax incentives, and regulatory policies that favor the small business sector are justified by the role of small businesses in creating jobs and is the raison d'etre of an entire Government agency: the Small Business Administration (SBA). This paper concludes that there is no reason to base our policies on the idea that small businesses are more deserving of Government favor than big companies. And absent other inefficiencies that would hinder small businesses performances, there is no legitimate argument for their preferential treatment. And in the paper titled ``What Do Small Businesses Do?'' professors Erik Hurst and Benjamin Wild Pugsley state: In Section 3 of the paper, we study job creation and innovation at small and/or new firms. First, using a variety of data sets, we show that most surviving small businesses do not grow by any significant margin. Most firms start small and stay small throughout their entire lifecycle. Also, most surviving small firms do not innovate along any observable margin. We show that very few small firms report spending resources on research and development, getting a patent, or even copywriting or trade marking something related to the business (including the company's name). Furthermore, we show that nearly half of all new businesses report providing an existing good or service to an existing market. This is not surprising in light of the most common small businesses. A new plumber or a new lawyer who opens up a practice often does so in an area where existing plumbers and existing lawyers already operate. They go on to conclude: Recognizing these characteristics common to many small businesses has immediate policy implications. Often subsidies targeted at increasing innovative risk taking and overcoming financing constraints are focused on small businesses. Our analysis cautions that this treatment may be misguided. We believe that these targets are better reached through lowering the costs of expansion, so they are taken up by the much smaller share of small businesses aspiring to grow and innovate. In fact, the U.S. Small Business Administration already partners with venture capitalists whose high powered incentives are aligned with finding these small businesses with a desire to be in the tail of the firm size distribution. In fact, during the heydays of the IPO market of the 1990s, many companies went public and took money from investors that never should have. Yet shortly after going public, as Exhibit 2 notes, many failed, causing investors great losses in their retirement and college education savings accounts, and destroyed over a hundred thousand jobs. Many large pension funds have never been able to recover to their pre dot com bust funding levels, leaving Americans wondering where the money will come for their retirement. At the height of the bubble, leadership of the Business Roundtable invited then SEC Chairman Arthur Levitt and me to dinner. At the dinner, they urged us to prohibit many of these companies from taking investors money. (The SEC did not have that regulatory power as the United States appropriately has a disclosure rather than merit based system.) They argued that rather than the investments going to companies who could put it to good use, investing in plants, jobs and research, the money was flowing into young, unproven companies that lacked adequate management, let alone revenues, profits and a substantive business plan. They turned out to be right. The capital was poorly allocated, and many American investors, businesses and workers paid a stiff price. Not too long after that, I had lunch with a managing director of one of the ``Bulge Bracket'' investment banks who had done many public offerings. By that time the market had cratered taking trillions of dollars of wealth with it. He said that in fact, Wall Street, the venture capitalists, attorneys and other gatekeepers, had facilitated the IPO of many companies that never should have gone public. He went on to say that whereas before the IPO market bubble got way out of hand, companies had to have attained at least certain levels of revenues for an established period of time, to demonstrate they were viable companies who could earn a reasonable return for their investors. But in the bubble, he said all that was thrown out the window, and any company they could take public they did. When I asked him why, he responded ``Because if we didn't do it, the next guy would!'' Conclusion on Legislation For any capital market to work effectively, it must provide investors with high quality, timely and complete financial information that is accurate. Conflicts inherent in the markets must preferably be prohibited and at a minimum must be clearly and completely disclosed to all participants. And there must be an enforcement mechanism that ensures a fair and orderly market. In the past, the U.S. capital markets have had a reputation for appropriate regulatory and enforcement mechanisms, and continues to attract capital, including from foreign investors. But the scandals of the last decade has damaged our reputation, beginning with the dot com IPO market bubble, to the Wall Street analysts scandal, to mutual fund market timing and trading frauds, to Madoff and other ponzi schemes, along with the once in a lifetime financial crisis brought on by extremely lax regulation by securities and banking regulators, and by people who originated bad loans, collected huge fees for doing so and then sold the worthless paper to investors. Lax regulation, in some cases the result of acts of Congress, has hammered the investment accounts of retirees and baby boomers that no longer have sufficient time to recover from the losses incurred. Laws that were passed by this Committee, including the Gramm-Leach-Bliley Act, and the Commodities Modernization Act of 2000, which prohibited regulation of derivates; were driving factors behind too big to fail companies; and resulted in a $600 trillion dollar unregulated derivatives market, both of which AIG and Lehman engaged in. These laws neither protected investors nor taxpayers, but certainly did allow them to be taken advantage of. It is not sufficient to say legislation will protect investors, it must actually do it. As I review the legislation before the Committee, I find it reduces the level of transparency and amount of information investors will receive. It removes critical investor protections put in place to protect against a repeat of past scandals. It decreases the credibility of the information one will receive. It not only allows market participants such as analysts to once again engage in behavior and activities that were associated with prior market disasters, it treads on the independence of independent standard setters such as the Public Company Accounting Oversight Board (PCAOB) established by this Committee, as well as the Financial Accounting Standards Board (FASB). If ill-conceived amendments regulating the cost benefit analysis the SEC would have to perform, that were adopted in the U.S. House of Representatives, I suspect investors would be well served to understand that handcuffs had been put on the SEC, rather than bad actors. The proposed legislation is a dangerous and risky experiment with the U.S. capital markets, and the savings of over 100 million Americans who depend on those markets. The evidence does not support the need for it. In fact, it contradicts it. I do not believe it will add jobs but may certainly result in investor losses. If jobs are created, as the evidence above indicates, it will come from growth in the economy, not this legislation. And finally, there has not been the type of cost benefit study performed with respect to the proposed legislation that Congress itself mandates the SEC must do before adopting such regulations. Senator Shelby has been correct in noting there was insufficient study performed before enactment of Dodd/Frank. There has been even less study of the bills that are the subject of this hearing today. As a result, I do not support the various bills including the IPO on ramp and crowd funding legislation. I share many of the concerns voiced by others including the Council for Institutional Investors, Consumers Federation, Americans for Financial Reform, AFL-CIO to name a few. Their concerns are set forth in greater detail in Exhibit 3 which I include for inclusion in the record. Comments on Particular Bills I do offer the following specific comments on the legislation for your consideration. Senate Bill 1933. Section 2 Definitions The definitions included in this bill would make it applicable to companies under $1 billion in revenue, and $700 million in market capitalization, for up to 5 years or until they broke those thresholds. While these companies are defined as ``emerging', that is serious a misnomer. As the charts below illustrate, this would scope in over 98 percent of all IPO's. And the vast majority of public companies currently filing periodic reports are under these thresholds according to raw data from Audit Analytics. [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] Given the nature of the experiment being run through this proposed legislation, I would strongly urge the threshold be reduced to $75 million. Experimenting with such a large segment of public companies and IPO's, as the proposed thresholds would, is highly risky and chances putting millions of Americans at risk. Section 3 Disclosure Obligations This section would reduce by a third, the amount of credible, audited financial information investors would receive. That information is the lifeblood of the capital markets and necessary for making informed decisions on where capital should be allocated. Yet this vital information is proposed to be seriously restricted by this legislation. My experience tells me that successful IPO's, are done by companies with sufficient track records to demonstrate they are worthy of an investment. If a company has been established for more than 2 years, then it should continue, as has been the practice for decades, to present 3 years of audited financial information to investors. If companies are unable to do this, I would be seriously concerned if they are ready for the ``prime time'' of being a public company, and are not likely to generate sufficient returns to warrant an investment. This section also impinges on the independence of the FASB as it exempts emerging companies from having to adopt new accounting pronouncements. As a result, if the FASB were to adopt a new pronouncement in response to a significant problem such as the off balance sheet special purpose entities of Enron or the off balance sheet reporting at Lehman, emerging companies may well avoid having to implement such standards for a period of time, leaving investors once again in the dark. As noted at Exhibit 4, Senator Shelby has correctly defended the independence of standard setters such as the FASB. His counsel should be heeded once more and this provision regarding accounting pronouncements should be removed from the legislation. Section 4 Internal Controls Audit As discussed earlier, Sarbanes-Oxley Section 404(b) has not been the reason there has been a decline in the number of IPO's. Companies under $75 million in market capitalization have never had to implement SOX 404(b) so it cannot be the reason such companies have not gone public. And for those companies that do go public, they have not had to implement SOX 404(b) at the time of the IPO or at the subsequent annual report filed with the SEC. It is only at the time of the second annual report that a public company must complete an audit of its internal controls. This is a reasonable exemption from the requirements of SOX 404(b) that should be retained rather than replaced. Data has clearly demonstrated that prior to the enactment of SOX, thousands of companies were not complying with the internal control provisions of the Foreign Corrupt Practices Act of 1977. As SOX was implemented, the chart below highlights the numbers of companies that were found not to have complied with the law. SOX 404(b) did bring much greater transparency to the number of companies that had inadequate internal controls, and that as a result, had to correct their financial statements. [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] As SOX 404(b) was implemented, erroneous financial statements, that in most instances had previously been attested to by the executives, came to light in record numbers. In a February 2007 report by Glass Lewis, where I was the Vice President in charge of the research, found: Companies with U.S.-listed securities filed 1,538 financial restatements in 2006, up 13 percent from what had been a record number in 2005. About one out of every 10 public companies filed a restatement last year, compared with one for every 12 in 2005. Of the latest restatement batch, 118 were by foreign issuers. If there was any lingering question about whether these figures matter, consider this: The median stock return of companies that filed restatements last year was minus 6 percent. That was 20 percentage points lower than the return of for the Russell 3000 stock index in 2006. The report went on to list key findings: Key Findings 1,244 U.S. companies and 112 foreign companies--1 of every 10 companies with U.S.-listed securities--filed 1,538 financial restatements to correct errors 2,931 U.S. companies, about 23 percent, filed at least one restatement during the last 4 years; 683 companies restated two or more times Restatements by companies required to comply with SOX 404 declined 14 percent; restatements by non-SOX 404 companies rose 40 percent Difference in audit fees between SOX 404 and non-SOX 404 companies pales in comparison to cost of corporate accounting frauds and executive compensation One-third of larger companies and two-thirds of microcap companies that restated still claimed to have effective internal controls over financial reporting The median 1-year stock return of companies that restated last year was 20 percentage points lower than the return of the Russell 3000 stock index in 2006. Companies with deficient internal controls tend to be poorly managed companies that underperform their peers in the markets, and which yield lower returns to investors. Accordingly, information on the quality of internal controls is very important to investors. The chart below highlights this issue, and notes that investors in companies that have poor internal controls and restatements cost investors dearly. However, those who question the costs of SOX 404(b) often disregard such data, caring only about the cost to the company and not the huge economic benefit to investors. [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] The General Accountability Office and SEC have also issued studies and reports on their findings on the benefits of SOX 404(b). One such report captioned ``United States General Accounting Office Report to the Chairman, Committee on Banking, Housing, and Urban Affairs, U.S. Senate (October 2002) FINANCIAL STATEMENT RESTATEMENTS Trends, Market Impacts, Regulatory Responses, and Remaining Challenges'' GAO-03-138 found: The 689 publicly traded companies we identified that announced financial statement restatements between January 1997 and March 2002 lost billions of dollars in market capitalization in the days around the initial restatement announcement. For example, from the trading day before through the trading day after an initial restatement announcement, stock prices of the restating companies that we analyzed fell almost 10 percent on average (market adjusted). We estimate that the restating companies lost about $100 billion in market capitalization, which is significant for the companies and shareholders involved but represents less than 0.2 percent of the total market capitalization of NYSE, Nasdaq, and Amex. However, these losses had potential ripple effects on overall investor confidence and market trends. Restatements involving revenue recognition led to greater market losses than other types of restatements. For example, although restatements involving revenue recognition accounted for 39 percent of the 689 restatements analyzed, over one-half of the total immediate losses were attributable to revenue recognition-related restatements. Although longer term losses (60 trading days before and after) are more difficult to measure, there is some evidence that restatement announcements appear to have had an even greater negative impact on stock prices over longer periods. The growing number of restatements and mounting questions about certain corporate accounting practices appear to have shaken investors' confidence in our financial reporting system. This finding is very consistent with research and findings of the Staff of the SEC while I was Chief Accountant. As a result, I believe the data clearly supports that the benefits of SOX 404(b) to investors significantly outweigh the costs. Congress should conduct a cost benefit test, consistent with what it mandates of the SEC, if it exempts any additional companies from SOX 404(b). Section 5 Auditing Standards Section 5 is troubling for two reasons. First, Congress established the PCAOB to regulate auditors of public companies. At the time it did so, it acknowledged that such an entity would be able to do a better job of that than Congress itself. The PCAOB has a project on its agenda, as the direct result of very troubling findings arising from its inspections of public companies. This project as instituted because auditors have been found to be lacking in independence, professional skepticism and reasonable judgment. The project is in the early stages and a concept release seeking public comment has been released. Yet, at this very early stage Congress is proposing to step in and override the PCAOB, preventing it from adopting rules on mandatory rotation. Audits are only worth paying for, if they are independent. A dozen years ago, the SEC rewrote the auditor independence rules. But these rules were watered down as a result of undue pressure from Congress as it bowed to the whims of the auditing profession lobby. That turned out to be a disastrous decision as Enron, WorldCom, Adelphia, Xerox and a host of other corporate scandals arose in which it appeared the auditors lacked independence. Congress is now poised to make the same mistake, yet again. Instead, it should allow the process to run its normal course, obtain the comments from the public, conduct the 4 public hearings it has undertaken, and wait for the outcome of the deliberations. The second concern with Section 5 is that it requires the SEC to perform a cost benefit analysis of each new rule the PCAOB promulgates. The legislation wording as currently crafted, puts a premium on the cost to the company rather than the benefit to investors and capital markets. And I understand it, any cost benefit study would need to be completed within 60 days of the adoption of a new PCAOB rule. Often that is simply not possible, and so the legislation in essence would exempt emerging companies as defined from new PCAOB rules. At a minimum, the language should be changed to balance any cost benefit analysis. The SEC should also be given a reasonable period of time to conduct such studies. In addition, while I was Chief Accountant, the industry refused to provide data useful to a cost benefit study. If the industry was once again to refuse to provide necessary data to the SEC or PCAOB, those agencies should be exempted from the cost benefit study requirement provided they can demonstrate any new rule would adequately protect investors and was in investors' best interests. It is also worth noting that the restrictions that Congress proposes to place on the SEC, the PCAOB and the FASB apply to all companies defined as emerging companies. This would include for example, the population of Chinese companies that in recent years have become an emerging scandal in and of themselves. Investors have and continue to suffer losses in investments of such companies. One must ask, is it really good public policy to roll back regulations as proposed for such companies when the problems grow larger by the day. I would urge the Committee to consider adding to this section of the legislation, the bi-partisan proposal by Senator Reed and Grassley that would enhance the transparency of the enforcement activities of the PCAOB. As the press and public have rightly pointed out, this would enhance the credibility of the agency and permit investors to understand whether there are serious questions about the quality of audits they are receiving from certain auditors. Section 6 Availability of Information About Emerging Growth Companies This is an ill-conceived and poorly thought out section of the bill. As a CFO, I watched as analysts engaged in ``marketing'' the underwriting of IPO's and public companies to investors. They were anything but independent and their research was misleading. They were in essence, an extension of sales and underwriting arms of the investment banking firms. This led to the Wall Street Analyst Scandal discussed further at Exhibit 5. It also resulted in investors being mislead and suffering significant losses on their investments. Unfortunately this legislation legitimizes this type of behavior. And it fails to recognize the importance of independent research as well as meaningful disclosure of conflicts that do exist. Rather it establishes a process whereby analysts can once again engage in issuing conflicted reports and avoid accountability for their actions. Below is a chart that reflects the type of reporting this legislation is likely to bring about. As noted, even after the dot com bubble had burst, and just before the largest corporate scandals in this country erupted, analysts were still touting stocks. [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] At a minimum, the legislation should adopt the investor protection measures encompassed in the well known Wall Street settlement. This includes provisions that ensure the analyst has to remain independent of the underwriting and investment banking function, and that any conflicts are disclosed in a complete and transparent fashion. With the Wall Street settlement requirements having lapsed, behavior among Wall Street analysts has quickly returned to what it was before the settlement. No one should be surprised if the outcome and history is repeated once again. Other The Administration has indicated, and the title of the hearing today would suggest, that the legislation should include investor protections. Currently Senate Bill 1933 and the other bills have fallen way short in this respect. Other commenters and people who have already testified have eloquently pointed that out. I hope the Committee will give due consideration to those points. For example, at Exhibit 6, the ICI has voiced its strong opposition to general solicitations noting they are not appropriate for the U.S. capital markets. At Exhibit 7, Professor Jay Brown has noted some reasoned changes that should be made. And at Exhibit 3, several organizations have made meaningful suggestions very worthy of consideration and acceptance. In addition to those improvements to the legislation, I would add: 1. Private offerings, which in all likelihood will reduce rather than increase the number of IPO's, should be regulated. Currently, the SEC does not have the resources to engage in meaningful regulation. Accordingly, the State securities regulators should be permitted to regulate offerings and protect investors in their communities when the SEC is unable to. 2. Recent reports have highlighted the level of recidivism that has occurred on Wall Street and gone unchecked. I would urge the Committee to adopt stronger enforcement penalties that ratchet up as recidivism occurs. Penalties such as those included in SOX for auditors are much more appropriate today than existing penalties given changes in the markets. 3. Sanctions should be strengthened for both private and public offerings, when it is found a seller of securities has failed to undertake and ensure the suitability of a security for the investor, or has failed to conduct meaningful and necessary due diligence. All too often we have seen underwritings in which the investment bankers failed to ensure adequate disclosure of key risks and financial data. This is especially true when one relaxes rules governing solicitation. 4. The definition of an accredited investor should be changed. Tying this definition to wealth is inappropriate as we saw with many of the investors in recent Ponzi schemes, such as in the Madoff matter. The seller should be required to obtain a statement from the investor that they not only have a specified level of assets, but also have a reasonable working knowledge to permit them to appropriately analyze the intended investment. If the broker has knowledge that contradicts this, then the investor should not be accredited. Summary More jobs and a larger number of qualified IPO's is something we all strive for. But IPO's have to be successful for not only those selling stock, but also for those buying shares. This legislation is currently unbalanced and likely to result in more unsuccessful investments for investors. In the long run, history has judged clearly that such incidents serve to reduce IPO's, cost jobs, and cost investors money sorely needed for retirement and education. RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN JOHNSON FROM WILLIAM D. WADDILL Q.1. What do you feel are the primary reasons for the decline in the number of initial public offerings for smaller companies? Do you foresee a return to the number of IPOs from the late 1990s? A.1. Did not respond by publication deadline. Q.2. In S. 1933, an ``emerging growth company'' would include companies with up to $1 billion in revenues. What are your views on whether this is the appropriate number and whether revenues is the appropriate metric to identify companies that should get reduced regulatory requirements? A.2. Did not respond by publication deadline. Q.3. What would be the effects of exempting an ``emerging growth company'' from having its auditor attest to the effectiveness of its internal financial controls on the company and on investors? A.3. Did not respond by publication deadline. Q.4. What types of companies would you expect to use crowdfunding to raise capital, instead of going to other sources of funds such as private equity fund, venture capital fund or banks? What types of investors do you expect to invest through crowdfunding? A.4. Did not respond by publication deadline. Q.5. Professor Ritter in his testimony identified the possibility that if a company is very successful, and has multiple rounds of financing, there is a possibility that ``the small investors wind up exposed, being diluted out.'' Mr. Rowe stated that ``it's a valid concern.'' How do you feel that this issue should be addressed for small investors in crowdfunding offerings? A.5. Did not respond by publication deadline. Q.6. Ms. Smith testified that ``the transparency of our [IPO] markets are very poor, which hurts and scares a lot of investors in the markets.'' She suggested greater use of the SEC's EDGAR Onliner system to post transcripts of road shows or a red-lined copy of amended registration statements. Do you feel that the transparency of the IPO market could be enhanced in ways that would encourage more investors to invest in IPOs? A.6. Did not respond by publication deadline. Q.7. You testified that ``For my company to try and prepare for Sarbanes-Oxley compliance will be somewhere between $3 million to $3.5 million.'' You later testified ``from our company's point of view, when we look at the use of capital . . . do we want to spend $3 million ramping up into Sarbanes-Oxley compliance?'' Costs are a relevant factor to this discussion. Please describe the types of costs that you have identified for your company to comply with Sarbanes-Oxley that would total a cost of $3-$3.5 million. A.7. Did not respond by publication deadline. ------ RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN JOHNSON FROM JAY R. RITTER Q.1. What do you feel are the primary reasons for the decline in the number of initial public offerings for smaller companies? Do you foresee a return to the number of IPOs from the late 1990s? A.1. I think that the primary reason for the decline in IPOs, especially small company IPOs, is a lack of investor enthusiasm due to low stock market returns, which in turn is due to the lack of profitability of most small companies after going public. From 1980-2009, 3,761 companies went public in the United States that had less than $50 million ($2009) in annual sales in the year before the IPO. From the closing market price on the first day until their 3-year anniversary, the average small company IPO had a 3-year buy-and-hold return of only 4.7 percent, and performance relative to the broader stock market of -35.7 percent. The small company IPOs from 1980-2000 were unprofitable (negative EPS) in 58 percent of their first three fiscal years after the IPO. This percentage has increased to 73 percent for the small company IPOs from 2001-2009. I believe that the deteriorating profitability of small company IPOs is attributable to a long-term trend in many sectors of the global economy, especially in the technology industry, that is favoring big companies. Many sectors are now ``winner takes all'' markets, where getting big fast has become more important than it used to be. Small companies are accomplishing this by selling out to a bigger company, rather than staying independent. Thus, the issue is big vs. small, not public company vs. private company. Q.2. In S. 1933, an ``emerging growth company'' would include companies with up to $1 billion in revenues. What are your views on whether this is the appropriate number and whether revenues is the appropriate metric to identify companies that should get reduced regulatory requirements? A.2. I believe that revenue is an appropriate measure, although $1 billion may be too high. Q.3. What would be the effects of exempting an ``emerging growth company'' from having its auditor attest to the effectiveness of its internal financial controls on the company and on investors? A.3. I am in favor of dropping the auditor attestation requirement. A more effective way of deterring securities fraud is to penalize the people who commit the fraud. Q.4. What types of companies would you expect to use crowdfunding to raise capital, instead of going to other sources of funds such as private equity fund, venture capital fund or banks? What types of investors do you expect to invest through crowdfunding? A.4. I do not expect crowdfunding to be very successful. Venture capitalists provide both money and advice. I do not think that there are a lot of great investment opportunities out there that will be identified and funded through crowdfunding. Q.5. Professor Ritter, in your testimony you identified the possibility that if a company is very successful, and has multiple rounds of financing, there is a possibility that ``the small investors wind up exposed, being diluted out.'' Mr. Rowe stated that ``it's a valid concern.'' How do you feel that this issue should be addressed for small investors in crowdfunding offerings? A.5. One possibility would be to have anti-dilution provisions as the default. It is very possible that private sector intermediaries will insist on this without Government requirements. Q.6. Ms. Smith testified that ``the transparency of our [IPO] markets are very poor, which hurts and scares a lot of investors in the markets.'' She suggested greater use of the SEC's EDGAR Online system to post transcripts of road shows or a red-lined copy of amended registration statements. Do you feel that the transparency of the IPO market could be enhanced in ways that would encourage more investors to invest in IPOs? A.6. Her suggestion to flag changes in the S-1 s is a good idea. One issue that was not discussed is why investment banking fees (the gross spread) are much higher in the United States than in Europe. If a company sets an offer price of $10 per share and pays a gross spread of 7 percent, the company nets $9.30 if the stock trades at $11.00, the company has received $9.30 for shares worth $11.00, and this $1.70 cost (direct and indirect) is more than 15 percent of the $11 market price. If these costs were lowered, more companies would go public. ------ RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN JOHNSON FROM KATHLEEN SHELTON SMITH Q.1.a. What do you feel are the primary reasons for the decline in the number of initial public offerings for smaller companies? A.1.a. While the global financial crisis in 2008 and 2011 reduced investor interest in stocks overall, as well as IPOs; it is the outsized losses that investors suffered from owning stocks of smaller newly public companies when the Internet bubble burst in 2000 that is the primary reason for the decline in the number of offerings for smaller companies. After the Internet bubble burst, many unprofitable and overvalued smaller newly public companies went out of business. Investors lost trust in this segment of the IPO market and in the underwriting firms that promoted these offerings. Q.1.b. Do you foresee a return to the number of IPOs from the late 1990s? A.1.b. The high IPO activity levels of the 1990s were above historical norms and the culmination of 20 years of strong stock market returns following the weak 1970s. However, we could foresee achieving above average IPO levels again, but only after investors experience a sustained period of positive stock market returns. As investor confidence returns, more capital will be allocated to equities and a rising number of smaller companies will be able to access the IPO market. Q.2. In S. 1933, an ``emerging growth company'' would include companies with up to $1 billion in revenues. What are your views on whether this is the appropriate number and whether revenues is the appropriate metric to identify companies that should get reduced regulatory requirements? A.2. We believe that revenue is not an appropriate metric to identify a company as an ``emerging growth company''. Differences in revenue recognition and profit margins among companies in different industries make revenue a poor measure to judge company size. We believe that market capitalization (a measure of company value) is the most appropriate metric to measure the size of a company. We define an emerging growth company as one having a market capitalization below $250 million, a definition also used by the SEC (see attached). Our data shows that companies with less than $250 million in market capitalization typically offer IPOs of $50 million or less. It is these companies seeking to raise $50 million or less that have had difficulty accessing the public markets as shown by the IPO Task Force data. Q.3. What would be the effects of exempting an ``emerging growth company'' from having its auditor attest to the effectiveness of its internal financial controls on the company and on investors? A.3. Investors may be more cautious about investing in an emerging growth company that is exempt from the auditor test. This could result in a higher cost of capital for the company. However, for a smaller company (<$250 million in market capitalization), improved earnings from the savings of audit costs, may offset this higher cost of capital. Q.4. What types of companies would you expect to use crowdfunding to raise capital, instead of going to other sources of funds such as private equity fund, venture capital fund or banks? What types of investors do you expect to invest through crowdfunding? A.4. Crowdfunding will likely be used by weak businesses unable to access funding from knowledgeable investors/bankers. We would expect those who invest through crowd funding would be unsophisticated consumers. Q.5. Professor Ritter in his testimony identified the possibility that if a company is very successful, and has multiple rounds of financing, there is a possibility that ``the small investors wind up exposed, being diluted out.'' Mr. Rowe stated that ``it's a valid concern.'' How do you feel that this issue should be addressed for small investors in crowdfunding offerings? A.5. Anti-dilution provisions, tag along rights, board representation, convertible preferred structures favorable in bankruptcy, and many other protections are common in contracts used by knowledgeable private investors. While it may be difficult to replicate all these protections in a crowdfunding scenario, we recommend requiring participants (companies, intermediaries, platforms) in this market to comply with securities and consumer protection laws. Q.6. Ms. Smith, you testified that ``the transparency of our [IPO] markets are very poor, which hurts and scares a lot of investors in the markets.'' She suggested greater use of the SEC's EDGAR Online system to post transcripts of road shows or a red-lined copy of amended registration statements. Do you feel that the transparency of the IPO market could be enhanced in ways that would encourage more investors to invest in IPOs? A.6. We believe that the transparency of the IPO market could be enhanced in two ways that would encourage more investors to invest in IPOs. One is more timely disclosure of the share ownership of newly public companies and the other is further modernization of corporate disclosure on EDGAR. At present, the trading market for IPOs is highly volatile with average IPO trading turnover on the first day often equal to the number of shares offered. This suggests that IPO shares are being placed with short-term trading clients of the IPO underwriters. We believe that the IPO allocation process should be subject to SEC supervision. At the time an IPO is priced and prior to its trading, we recommend that underwriters file confidentially with the SEC the name of the account receiving an IPO allocation and the number of shares allotted and to disclose certain of this information publicly (as is done in Hong Kong). In aftermarket trading, to the extent an investor's share ownership exceeds 5 percent of the public float, we recommend that notice be made to the marketplace immediately (the standard 10-day notice is too long). IPO shares placed with a broader base of fundamentally oriented investors would help open the IPO market to smaller issuers and additional timely disclosure of share ownership would help calm the volatile trading market for newly public companies. We recommend continuing to modernize corporate electronic disclosure through EDGAR to make it easier for investors to obtain and analyze information. We suggest showing red-lined amendments to registration statements and providing transcripts of company presentations. Efficient and open access to information about newly public companies is the best way to encourage an informed public viewpoint about new companies, which ultimately benefits smaller issuers. [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] ------ RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN JOHNSON FROM TIMOTHY ROWE Q.1. What do you feel are the primary reasons for the decline in the number of initial public offerings for smaller companies? Do you foresee a return to the number of IPOs from the late 1990s? A.1. I am not an academic, but I can say anecdotally that I regularly hear smaller companies speak of the pain of being a public company. They focus in particular the time and distractions from the core business that the requirements of being public pose. Q.2. In S. 1933, an ``emerging growth company'' would include companies with up to $1 billion in revenues. What are your views on whether this is the appropriate number and whether revenues is the appropriate metric to identify companies that should get reduced regulatory requirements? A.2. I think the threshold should be set such that it accomplishes two goals: a) high enough that the new scaled regulations are available to most companies that might otherwise shy away from going public due to regulation, while b) not being so high as to include many companies that don't need this incentive. One billion ($1B) seems reasonable in this context. Q.3. What would be the effects of exempting an ``emerging growth company'' from having its auditor attest to the effectiveness of its internal financial controls on the company and on investors? A.3. In all things, there is a balance. In a costless environment, it would always be preferable to have more audits and more reviews. But every review implies a cost. I believe there is a logic that the smaller the company, the lower costs of regulation that we ought impose on them. If we do not make this choice sometimes, the engine of commerce will be impaired. I believe it is incumbent on regulators to measure the total cost to society of the regulation and compare it with the total cost to society of the losses incurred as a result of malfeasance. I have not seen such an analysis, but I would welcome it. It would shed light on this debate. Q.4. What types of companies would you expect to use crowdfunding to raise capital, instead of going to other sources of funds such as private equity fund, venture capital fund or banks? What types of investors do you expect to invest through crowdfunding? A.4. I'm as eager as all of us to see how this plays out. I'm hopeful that it will serve local businesses: a new catering business here, a plumbing business there, as well as innovation-driven businesses such as Gotham Bicycle Defense, that recently raised money for its theft-resistant bike lights on Kickstarter. If you look at examples from England, companies include, for example, a natural salad dressing provider, an organic soap manufacturer and a regional pro soccer team. Q.5. Professor Ritter in his testimony identified the possibility that if a company is very successful, and has multiple rounds of financing, there is a possibility that ``the small investors wind up exposed, being diluted out.'' Mr. Rowe, you stated that ``it's a valid concern.'' How do you feel that this issue should be addressed for small investors in crowdfunding offerings? A.5. I'm pleased that the final legislation requires the use of intermediaries. I believe that in order to stay in business, crowdfunding intermediaries will naturally be driven to ensure that both sides of the transaction are taken care of. Investors must be protected by fair investment terms, and investees must have the flexibility to run their businesses. Fair terms are settled on every day in the venture investing world. It is a straightforward matter for the crowdfunding portal do develop a menu of ``model'' investing terms that it enforces. I don't believe at this time that it is necessary for Government to define these terms, as I believe the market will evolve the most balanced solutions on its own through the self-regulation structure embodied in the legislation. Q.6. Ms. Smith testified that ``the transparency of our [IPO] markets are very poor, which hurts and scares a lot of investors in the markets.'' She suggested greater use of the SEC's EDGAR Online system to post transcripts of road shows or a red-lined copy of amended registration statements. Do you feel that the transparency of the IPO market could be enhanced in ways that would encourage more investors to invest in IPOs? A.6. Again, there is a balance in all things. Transparency is good, but it comes at a cost, both in time to prepare, limitations on what can be shared spontaneously, and in terms of exposure of private commercial information to competitors. I don't consider myself the expert that Ms. Smith is in these matters. I would simply caution that ``more transparency'' is not universally always useful: we need to strike an appropriate tradeoff here. One exception is that were information is already required to be publicly available, I strongly agree that it should be made available in an easy-to-access manner, such as providing it to EDGAR. Q.7. Mr. Rowe, you testified that ``in my experience sitting on boards in the venture capital context, we see . . . over and over again the companies that are acquired very frequently end up dying. The buying company may pay a high price, but they do not really have the spirit or the passion that the entrepreneur has.'' Please provide additional information on your experiences and how these acquired companies died and, to the extent of your knowledge, the impact on jobs. A.7. Here is an excellent article in the popular press on the subject: http://www.xconomy.com/san-francisco/2012/03/05/ googles-rules-ofacquisition-how-to-be-an-android-not-an- aardvark/ Quoting from the article: Acquisitions so often go awry that it's a wonder big corporations keep shelling out to buy smaller ones at all. I believe this would be a valuable area for academic research. Anecdotally, most observers of venture capital would agree that companies that go public are far more likely to succeed than companies that are acquired. ------ RESPONSE TO WRITTEN QUESTIONS OF CHAIRMAN JOHNSON FROM LYNN E. TURNER Q.1. What do you feel are the primary reasons for the decline in the number of initial public offerings for smaller companies? Do you foresee a return to the number of IPOs from the late 1990s? A.1. Did not respond by publication deadline. Q.2. In S. 1933, an ``emerging growth company'' would include companies with up to $1 billion in revenues. What are your views on whether this is the appropriate number and whether revenues is the appropriate metric to identify companies that should get reduced regulatory requirements? A.2. Did not respond by publication deadline. Q.3. What would be the effects of exempting an ``emerging growth company'' from having its auditor attest to the effectiveness of its internal financial controls on the company and on investors? A.3. Did not respond by publication deadline. Q.4. What types of companies would you expect to use crowdfunding to raise capital, instead of going to other sources of funds such as private equity fund, venture capital fund or banks? What types of investors do you expect to invest through crowdfunding? A.4. Did not respond by publication deadline. Q.5. Professor Ritter in his testimony identified the possibility that if a company is very successful, and has multiple rounds of financing, there is a possibility that ``the small investors wind up exposed, being diluted out.'' Mr. Rowe stated that ``it's a valid concern.'' How do you feel that this issue should be addressed for small investors in crowdfunding offerings? A.5. Did not respond by publication deadline. Q.6. Ms. Smith testified that ``the transparency of our [IPO] markets are very poor, which hurts and scares a lot of investors in the markets.'' She suggested greater use of the SEC's EDGAR Online system to post transcripts of road shows or a red-lined copy of amended registration statements. Do you feel that the transparency of the IPO market could be enhanced in ways that would encourage more investors to invest in IPOs? A.6. Did not respond by publication deadline. Additional Material Supplied for the Record [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]