[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
JOBS ACT IMPLEMENTATION UPDATE
=======================================================================
HEARING
before the
SUBCOMMITTEE ON INVESTIGATIONS, OVERSIGHT AND REGULATIONS
OF THE
COMMITTEE ON SMALL BUSINESS
UNITED STATES
HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRTEENTH CONGRESS
FIRST SESSION
__________
HEARING HELD
APRIL 11, 2013
__________
[GRAPHIC] [TIFF OMITTED] TONGRESS.#13
Small Business Committee Document Number 113-010
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HOUSE COMMITTEE ON SMALL BUSINESS
SAM GRAVES, Missouri, Chairman
STEVE CHABOT, Ohio
STEVE KING, Iowa
MIKE COFFMAN, Colorado
BLAINE LUETKEMER, Missour
MICK MULVANEY, South Carolina
SCOTT TIPTON, Colorado
JAIME HERRERA BEUTLER, Washington
RICHARD HANNA, New York
TIM HUELSKAMP, Kansas
DAVID SCHWEIKERT, Arizona
KERRY BENTIVOLIO, Michigan
CHRIS COLLINS, New York
TOM RICE, South Carolina
NYDIA VELAZQUEZ, New York, Ranking Member
KURT SCHRADER, Oregon
YVETTE CLARKE, New York
JUDY CHU, California
JANICE HAHN, California
DONALD PAYNE, JR., New Jersey
GRACE MENG, New York
BRAD SCHNEIDER, Illinois
RON BARBER, Arizona
ANN McLANE KUSTER, New Hampshire
PATRICK MURPHY, Florida
Lori Salley, Staff Director
Paul Sass, Deputy Staff Director
Barry Pineles, Chief Counsel
Michael Day, Minority Staff Director
C O N T E N T S
OPENING STATEMENTS
Page
Hon. David Schweikert............................................ 1
Hon. Yvette Clarke............................................... 1
WITNESSES
Mr. Lona Nallengara, Acting Director, Division of Corporation
Finance, United States Securities and Exchange Commission,
Washington, DC................................................. 3
Mr. John Ramsay, Acting Director, Division of Trading and
Markets, United States Securities and Exchange Commission,
Washington, DC................................................. 3
Ms. Jean Peters, Managing Director, Golden Seeds, Midlothian, VA,
testifying on behalf of the Angel Capital Association.......... 17
Mr. William Klehm, III, President and CEO, Fallbrook Technologies
Inc., San Diego, CA, testifying on behalf of CONNECT........... 18
Mr. Kevin Rustagi, CEO, Evolutions of Noise, Co-Founder, Ministry
of
Supply, Austin, TX, testifying on behalf of the SBE Council.... 20
Mr. James J. Angel, Associate Professor, McDonough School of
Business, Georgetown University, Washington, DC................ 22
APPENDIX
Prepared Statements:
Mr. Lona Nallengara, Acting Director, Division of Corporation
Finance, United States Securities and Exchange Commission,
Washington, DC............................................. 30
Mr. John Ramsay, Acting Director, Division of Trading and
Markets, United States Securities and Exchange Commission,
Washington, DC............................................. 30
Ms. Jean Peters, Managing Director, Golden Seeds, Midlothian,
VA, testifying on behalf of the Angel Capital Association.. 46
Mr. William Klehm, III, President and CEO, Fallbrook
Technologies Inc., San Diego, CA, testifying on behalf of
CONNECT.................................................... 55
Mr. Kevin Rustagi, CEO, Evolutions of Noise, Co-Founder,
Ministry of Supply, Austin, TX, testifying on behalf of the
SBE Council................................................ 61
Mr. James J. Angel, Associate Professor, McDonough School of
Business, Georgetown University, Washington, DC............ 66
Questions for the Record:
None.
Answers for the Record:
None.
Additional Material for the Record:
Letter from Hon. Chris Collins, Member of Congress to the
Hon. Elisse Walter, Acting Chairman, Securities and
Exchange Commission........................................ 80
NASE - National Association for the Self-Employed............ 81
JOBS ACT IMPLEMENTATION UPDATE
----------
THURSDAY, APRIL 11, 2013
House of Representatives,
Committee on Small Business,
Subcommittee on Investigations, Oversight and
Regulations,
Washington, DC.
The Subcommittee met, pursuant to call, at 10:00 a.m., in
Room 2360, Rayburn House Office Building. Hon. David Schweikert
[chairman of the subcommittee] presiding.
Present: Representatives Schweikert, Bentivolio, McHenry,
Luetkemeyer, and Clarke.
Chairman SCHWEIKERT. Let us call this hearing to order.
Good morning. I have a wonderfully written opening
statement but I was going to do something slightly different.
Being someone who actually bathed and lived in the JOBS Act
when it was individual bills moving through the system and the
once we actually consolidated it and ran it up, think of this.
In the previous years it really was in many ways our only
really great bipartisan success. There was great optimism,
great hope, on, April 12th, when the president signed it. Now
we are this much time, a year beyond some of the rule sets, and
yet I go around the country and I've spoken to different groups
that are very optimistic and looking forward to an opportunity
to use this new path of options to raise capital for small
businesses. Our bottleneck right now is within the rule
writing. I accept there are great difficulties. You have had
leadership transitions.
So I am going to ask for my friends who are on the
Committee, today's goal is not to beat up the SEC. It is to
have a dialogue on what do you need? What are our expectations
both in drafting and time that you are able to share with us?
Are there any things we should be doing as members of Congress?
Do you need us to provide a piece of legislation that provides
more detail? Do you need us to stay out of your way for a
while? What gets it done? In many ways the goal here is
actually to have the positive that will come, I believe, once
the rule sets are done and the crowdfundings, the Reg A's, the
others are able to start to stimulate a tier of our economy and
our small business access to capital. And with that I hand over
to the ranking member for an opening statement.
Ms. CLARKE. Thank you, Mr. Chairman. I am going to stick to
the script.
I would like to welcome everyone to this morning's hearing.
For the past two years our nation's economy has experienced
positive private sector job growth. However, these gains have
not been enough to overcome our nation's above average
unemployment which currently stands at 7.6 percent. Minority
unemployment for African-Americans and Latinos, while
retreating, remains at a 13.3 and 9.2 percent, respectively.
These facts, along with last week's job numbers illustrate
the work we have yet to complete. Creating nearly two-thirds of
all new jobs, our small businesses must remain front and center
to our recovery. For our national economy to experience a more
robust recovery, our entrepreneurs and small businesses must
play their traditional job-creating role, and for that we must
have access to capital.
For entrepreneurs who have a solid business plan yet lack
immediately marketable products, equity capital has been a
crucial aspect of getting their businesses off the ground. Many
are turning to crowdfunding to finance their businesses,
however, the number of small businesses that can access capital
is severely limited due to the prohibitions on equity investing
via crowdfunding.
In response, Congress has passed the Jumpstart our Business
Startups or JOBS Act in 2012, which provided a new exemption
from SEC requirements to register public offerings for equity
investing via crowdfunding. This exemption has the potential to
unlock the virtually untapped resources of millions of ordinary
investors to small businesses; however, as evidenced by the
rigorous congressional debates before passage of the act, a
balanced approach to investor protection must be in place
before allowing the general public in this inherently more
risky realm of small business investing. Pursuant to the JOBS
Act, the SEC was mandated to create rules to do just that.
However, the SEC has yet to complete the rulemaking process;
thus, preventing full implementation of the JOBS Act, missing
several congressionally mandated deadlines.
In today's hearing, we will discuss the SEC's delays in
implementing the JOBS Act and the needs of our small business
community. While no one is happy waiting for these rules to be
drafted, we must remember that it is vitally important that the
SEC strike the appropriate balance between investor protection
and producing a functional system that provides the capital for
small businesses and entrepreneurs to create jobs.
I want to thank you again, Mr. Chairman, for holding this
important hearing, and I yield back the balance of my time.
Chairman SCHWEIKERT. Thank you, Ranking Member Clarke.
Maybe I should have stuck with the script.
Our first two witnesses representing the SEC, Mr.
Nallengara and Mr. Ramsay. You are both probably very familiar
with the lighting system. My understanding is you are going to
be sharing your five minutes on the opening statement. When you
hit yellow, just talk faster.
Mr. Nallengara, please.
STATEMENTS OF LONA NALLENGARA, ACTING DIRECTOR, DIVISION OF
CORPORATION FINANCE, UNITED STATES SECURITIES AND EXCHANGE
COMMISSION; JOHN RAMSAY, ACTING DIRECTOR, DIVISION OF TRADING
AND MARKETS, UNITED STATES SECURITIES AND EXCHANGE COMMISSION
STATEMENT OF LONA NALLENGARA
Mr. NALLENGARA. Thank you. Good morning, Chairman
Schweikert, Ranking Member Clarke, and Members of the
Subcommittee. My name is Lona Nallengara. I am the Acting
Director of the Division of Corporation Finance of the
Securities and Exchange Commission. Joining me today is John
Ramsay. John is the Acting Director of the Commission's
Division of Trading and Markets.
Thank you for the opportunity to testify on behalf of the
Commission. Implementing the JOBS Act is one of the
Commission's top priorities. As you know, the JOBS Act made
significant changes to the federal securities laws. While
certain provisions of the JOBS Act were effective immediately,
others required Commission rulemaking. In addition, the JOBS
Act required the Commission to conduct several studies and send
reports to Congress.
Since enactment, the Commission staff has taken steps to
inform the industry of how the JOBS Act operates. For instance,
the staff provided guidance about the IPO on-ramp provisions by
publishing answers to frequently asked questions. These
questions address such things as how emerging growth companies
could use these new provisions, including those related to
research reports, test the waters materials, and scaled
disclosures. The staff also provided guidance on the amendments
to the registration requirements of 12(g) of the Exchange Act.
With respect to rulemaking, the JOBS Act required the
Commission to adopt rules that revised Rule 506 of Regulation D
to allow general solicitation and advertising for offers and
sales of securities under that rule and to implement a new
crowdfunding exemption and a new exemption from broker-dealer
registration for funding portals that facilitate crowdfunding
transactions. And finally, to create a new exemption for
offerings of up to $50 million.
To fulfill this responsibility, we have formed rule-writing
teams consisting of staff from across the Commission, including
economists from our Division of Risk, Strategy and Financial
Innovation, who are considering the potential economic impact
of the rules we are considering.
To aid the rulemaking process and increase the opportunity
for public comment, we have allowed interested parties to
submit comments and recommendations on the JOBS Act provisions
through the Commission's website even before we have proposed
rules. The Commissioners and staff have participated in
numerous meetings with a wide array of interested parties. The
input the Commission and the staff have received in these
written submissions and these meetings has been very helpful to
the rule-writing teams as we consider the implementation of
these mandates.
As you may know, there has been significant interest in the
provisions requiring the Commission to revise Rule 506 to allow
for general solicitation and advertising. Under the rule
proposal the Commission issued last August, companies issuing
securities in an offering conducted under Rule 506 would be
permitted to advertise and solicit potential purchasers
provided that the company takes reasonable steps to verify that
the purchasers of those securities are accredited investors.
The proposing release explains that issuers should consider
the facts and circumstances of the transaction when determining
the reasonableness of the steps to take to verify that a
purchaser is, in fact, an accredited investor. Prior to and
after issuing this proposal, the Commission received
significant public comment, and the staff is now developing
recommendations for the Commission's consideration as to how to
move forward on the implementation of this mandate.
The JOBS Act also required the Commission to submit several
reports to Congress. First, it required a report on how
decimalization has impacted the number of initial public
offerings. That report, which was submitted to Congress in
July, recommended that the Commission conduct a roundtable to
discuss the impact of decimalization. That roundtable took
place in February. Second, the JOBS Act required a report on
how our disclosure requirements could be modernized and
simplified to reduce the costs and burdens for emerging growth
companies. The staff is in the process of completing that
report. And finally, it required a report examining the
Commission's authority to enforce the anti-evasion provisions
of Rule 12g5-1 of the Exchange Act. That report was submitted
to Congress in October.
In addition, the JOBS Act mandated the Commission to
provide information and conduct outreach to small- and medium-
size businesses and businesses owned by women, veterans, and
minorities about the changes made in the JOBS Act. The staff is
working to develop and implement an outreach plan tailored
specifically to these business communities. The Commission and
staff continue to work diligently to implement the JOBS Act
mandates, and we look forward to completing the remaining
provisions as soon as possible.
Thank you for inviting us to appear today, and we would be
happy to answer any of your questions.
Chairman SCHWEIKERT. Thank you. I will start with the first
five minutes and have a couple questions.
Mr. Ramsay, one of the big questions that I get around me,
what should our expectations be on rule sets coming out and
what do you think will be the first ones we see?
Mr. RAMSAY. Thank you, Chairman Schweikert. And again, we
appreciate the constructive tone that you have set for the
hearing.
It is very difficult for staff to create any specific
expectations in terms of timing, and so I will not attempt to
do that here. We understand there is a lot of interest. We
understand that there is a fair amount of frustration with the
pace at which the rulemaking process has taken. I will say
that, from the people that I talk to within the Commission,
there is a shared sense of interest in moving this forward. Our
new chairman, Chairman White, indicated in her recent testimony
that she saw this as a high priority, and so I will resist the
urge to make any specific predictions in terms of timing, but
certainly stress that this is a very high priority for us.
Chairman SCHWEIKERT. Is my being unrealistic that by
October, by fall? Part of this is I feel like many of us have
gone out around the country talking about the crowdfunding and,
a year later I feel like I am breaking people's hearts by
getting them excited and enthused and trying to line up
capital. Any window of the time of year?
Mr. NALLENGARA. Chairman, those are questions that we hear
as well from some of the same parties interested in taking
advantage of these new rules. And these are important rules.
These are important rules because you gave us a mandate, but
also important rules because of what is underlying that
mandate. What is underlying it is providing new ways for
businesses, but really focused on small businesses, to raise
capital and grow their companies, create jobs, and strengthen
the economy.
But what is also important about these rules is these rules
are in many respects fundamental changes to the way private
offerings have been conducted, and the rules--some were very
specific but some also provide discretion for the Commission.
Chairman SCHWEIKERT. Mr. Nallengara, in that case, what do
you think will be the first to come out understanding the
actual date is unknowable at this point?
Mr. NALLENGARA. Chairman, it would be hard for me to tell
you which would be the first to come out. Chairman White has
indicated that all congressional mandates are her priority and
specifically, the JOBS Act provisions are her priority. And the
three main rulemakings that we have are the Title II General
Solicitation, the Title III Crowdfunding, and the Title IV Reg
A+ Rulemaking. Those are all a priority. We have issued a
proposal already with respect to the General Solicitation
provisions, so that has already been proposed, and we have
received comment on that. The sequence of those rulemakings--
that will be for the Chairman and the other Commissioners to
determine. But the staff is working--we have independent rule-
writing teams on each one of those and the staff for each one
of those rulemakings is working as if their rulemaking is the
first one to go. So the staff is working very hard to get these
in place to get recommendations.
Chairman SCHWEIKERT. Mr. Nallengara, is there any way I
could organize like an X prize; the first one to get it done
wins something?
Mr. NALLENGARA. What would be the prize, Chairman?
Chairman SCHWEIKERT. Exactly.
Mr. NALLENGARA. Exactly.
Chairman SCHWEIKERT. Last one and then I will turn to the
ranking member. I would love some guidance because many of us
are starting to work on what should be the next act in the,
JOBS Act 2.0. Is there something we, as members of Congress can
do in the way we write it, in the way we ask for rule sets, to
make it run smoother? Do we need to provide more direction? Do
we need to provide substantially more detail? What would make
this process that our bottlenecks and the timing become
compressed? What do we do to do this better?
Mr. NALLENGARA. Chairman, the mandates you give us, we look
at them as you give us--as you give them to us, and we do our
best to implement the mandates you give us and the intent
underlying those mandates. So some of the mandates you give us,
and even within an individual title within the JOBS Act, have
specific requirements and some give us discretion. We look at
all of those questions that you provide us in the rules and
implement them in a way that, both the ones that are specific
and both the ones that give us discretion in a way that allows
us to further the purpose of legislation.
Chairman SCHWEIKERT. This is more than just an academic
discussion. It really is affecting people's lives. The next
generation of entrepreneurs, folks out there whose businesses,
as we will hear on the second panel, who are trying to get to
that next level where they can hire people and grow and help
both as a nation and their own futures. I hope you feel the
same sort of weight on your shoulders as we do on this side
that yes, getting it right is important, but getting it done is
crucial.
Mr. NALLENGARA. Absolutely, Chairman. The staff feels that
way and the direction from the Chairman and the Commissioners
is to get these rules done. And that is what we are committed
to do.
Chairman SCHWEIKERT. All right. We may end up with a second
round if we go fast enough.
Ranking Member Clarke.
Ms. CLARKE. Thank you very much, Mr. Chairman.
I want to do a follow-up to the chairman's question, Mr.
Nallengara and Mr. Ramsay. Can you give us an idea of the work
volume you are dealing with in concurrently developing the
rules for the JOBS Act while still engaged and fully
implementing Dodd-Frank?
Mr. NALLENGARA. Ranking Member, the Commission is facing an
unprecedented workload when you factor all of the
congressionally mandated rulemakings. There are over 90 Dodd-
Frank provisions that have rule-writing requirements and over
20 studies. Although we have completed 80 percent of those and
17 of those studies, there is still plenty to do. And some of
the rulemakings that are left to do, particularly the ones in
John's division, are related to systemic risk. And then when
you add the JOBS Act rulemakings, the three main rulemakings
but there are ancillary rulemakings and studies and reports to
do, that is an unprecedented level of work. And the ones
related to the JOBS Act, as I mentioned earlier, those are
fundamental changes to the way the capital markets--the private
offering markets--will work. Those are mandates you have given
us, but for us to implement them and implement them in a way
that achieves the goals that you mentioned in your statement,
which are to provide an efficient and effective way for small
business to raise capital but at the same time ensure that
investors feel safe and feel like they are getting a secure
investment and they are investing in a real business that
provides opportunity for return and growth to them, that
requires us to make sure that we are getting the rules done
right.
That being said, we need to get them done. We appreciate
that you gave us deadlines and those deadlines have passed, but
we are focused on getting those rules done.
Mr. RAMSAY. If I may, yes, Ranking Member Clarke, I think
just from the standpoint of my division, Title VII of Dodd-
Frank and all the derivatives reforms, which require us
essentially to adopt a whole new regulatory regime that did not
exist before over a huge international market, is an effort
that is consuming and has consumed huge amounts of resources
and continues to over a period of time. And this is all
mandated rulemaking as well. So we would ask people to
understand that we do not expect much sympathy for it, and we
are not really asking for any sympathy for it. As Lona said,
regardless of what else is on our plate, we know this
particular set of rules, as Chairman Schweikert said, is
something that is affecting people's lives and ability to raise
capital currently; it ought to be prioritized accordingly and
we take that to heart.
Ms. CLARKE. Yeah. I just thought, excuse me, it was
important to sort of put things in context. This is not
happening in isolation of many other responsibilities and
obligations of rulemakings that you are currently engaged in,
so I think it was just sort of important for us to get a sense
of the universe that you are working within. And, you know, I
think one of the things that would be helpful for all of us,
and maybe even for yourselves, is, you know, for you to sort of
set a timeframe for yourselves. Maybe it is an internal
timeframe but one that sort of drives this process to a timely
conclusion given the fact that things have already passed
deadlines. It is going to be important that there is some
motivating factor to really get this done.
Mr. Nallengara, some experts are concerned that a conflict
of interest could arise between funding portals and the
companies seeking funding, specifically financial interests of
the funding portals could lead to more lucrative, yet risky
deals receiving preferential treatment when presented to
potential investors. How does the SEC plan to address this
concern in the final crowdfunding regulations?
Mr. NALLENGARA. Ranking Member, I will start with the
answer and then I will turn it to John whose division has
primary responsibility for the funding portals. But the
legislation you provided us in the JOBS Act lays out a
regulatory regime for funding portals. It provides oversight by
FINRA and the rules that FINRA will adopt will be able to
monitor and watch those activities. Funding portals are
intended to be a portal between the investor and the companies
seeking money. They are intended to present the picture and the
idea of that entrepreneur, of that business, and let the
entrepreneur tell the story. But also serve as a gatekeeper,
serve as someone ensuring that both the company knows what they
are doing but also that investors understand what they are
investing in--understand the risks associated with the
investment and also understand the security they are investing
in.
Mr. RAMSAY. Yes, Congresswoman, an awful lot of the time
that we have been spending in our division has been devoted to
meeting with representatives of various funding portals or of
that part of the community that are interested in investing in
the space. As Lona said, many of the JOBS Act provisions are
intended to ensure that intermediaries for crowdfunding
offerings operate in a way that protects investors' funds, that
takes account of the privacy interests of investors, that makes
sure that investors get the right kind of disclosures that they
need, where there is a contingency on the amount, minimum
amount of offering that is a subscription that is required,
that that all takes place. These are all critically important
provisions and I would just say that our sense is there is a
lot of very capable, smart, creative people in this space who
want to do the right thing and who have an interest, as we do,
in making sure that the rules are written in a way that
excludes the bad actors as much as possible because I think
they would agree with us is my sense that nothing would
undermine the ability to use this as a capital-raising tool
faster than if the rules were written in such a way that they
do not exclude the bad actors as much as possible. So that is
part of the reason we want to be very careful about how they
are written.
Ms. CLARKE. Very well. Thank you both. Mr. Chairman, I
yield back.
Chairman SCHWEIKERT. Thank you, Ranking Member Clarke.
And I would like to extend a welcome to Patrick McHenry,
who is the chairman of the Financial Services Oversight
Committee and I appreciate you spending a moment or two with
us.
Mr. Luetkemeyer, you are next.
Mr. LUETKEMEYER. Thank you, Mr. Chairman.
I had a number of questions from some of my constituents
with regards to the delay on issuing the Rule 506 Reg D
situation. Can you explain what happened there? That should
have been done last summer and here it is almost nine months
later and we are still not anywhere near it. What is going on.
Mr. NALLENGARA. You are correct, Congressman. You provided
us a deadline, which was 90 days after enactment, and we did
not meet that deadline. We did issue a proposal in August. That
proposal, as I outlined in my opening remarks, provided a
framework for the implementation of the rule. We received
significant comments before and after the proposal, and the
Commission is considering those comments right now. We have had
some transition in our Chairman's office, but our Chairman,
Chairman White, has indicated that the JOBS Act rulemakings,
and in particular the one related to 506, are a priority to be
moved forward.
Mr. LUETKEMEYER. Why would the transition of a new chairman
change the ability of you to be able to do your job? How many
people do you have working on this project? Let me start there.
Mr. NALLENGARA. We have a number of people in my division
who are principal rule writers. We have economists in our
Division of Risk, Strategy and Financial Innovation.
Mr. LUETKEMEYER. Do you have a particular group that works
on just this rule or they work on all sorts of other rules as a
whole?
Mr. NALLENGARA. On this particular rule we have a group of
attorneys in our chief counsel's office.
Mr. LUETKEMEYER. Is this their full-time job that they work
on just this one rule?
Mr. NALLENGARA. It is not their full-time job to work on
just this rule.
Mr. LUETKEMEYER. How much time do they spend on this then?
Mr. NALLENGARA. They spend as much time as is necessary.
Mr. LUETKEMEYER. Well, they are not spending very much if
it is nine months later and we still have not got a rule; are
they? My concern is that it does not seem to have the attention
of the SEC. And this is a real big deal because, you know, we
as a Congress have not agreed on a heck of a lot over the last
two or three or four years here. And we actually finally got to
agree on something. This is a way to help small business. And
we are very concerned about the lack of action here because we
have small business groups out there that would love to be able
to put together offerings, expand their businesses, buy new
businesses. Entrepreneurs are sitting on the sidelines.
I can tell you from the past two weeks of going around and
talking to a lot of my constituents, they are sitting on the
sidelines waiting to get into some of these businesses but
cannot because the rules are not there. And I know you proposed
it a long time but yet it was pulled. The chairman, I guess,
killed the rule, so what is the problem with it? Why did you
kill the rule once it was proposed?
Mr. NALLENGARA. Congressman, I do not think anyone killed
the rule. I think what you are referring to----
Mr. LUETKEMEYER. It was proposed and then it was withdrawn;
okay?
Mr. NALLENGARA. I think what you are referring to is at one
point the Commission was considering moving forward on the rule
with an adopted rule immediately, rather than proposing the
rule for public comment and considering that comment. And just
to frame how our rule-writing process works, almost all of our
rules, virtually all of our rules are proposed and adopted in a
manner where----
Mr. LUETKEMEYER. You withdrew your proposal; correct?
Mr. NALLENGARA. No. No, we did not withdraw our proposal.
The Commission considered it in August, considered a proposed
rule.
Mr. LUETKEMEYER. The Commission withdrew it?
Mr. NALLENGARA. No, the Commission did not withdraw it.
Mr. LUETKEMEYER. We do not have one. How come it has not
gone forward. Put it that way.
Mr. NALLENGARA. Congressman, we do have a rule proposal.
Almost all of our rules are proposed and provide a comment
period for the public. The public gets to look at the rules and
comment on it, give us their ideas.
Mr. LUETKEMEYER. When do you think you are going to get
this one finalized?
Mr. NALLENGARA. Our new Chairman has indicated----
Mr. LUETKEMEYER. Is he going to give you 90 more days? Is
it a priority?
Mr. NALLENGARA. She has indicated it is a priority. So if
she has indicated it is a priority, it is a priority for us.
Mr. LUETKEMEYER. So what is a priority? Is it 90 days or 9
months?
Mr. NALLENGARA. I cannot say.
Mr. LUETKEMEYER. We are at a year on this now. I mean, it
does not seem to be a priority of the SEC. This is a big deal.
This is how we are going to get our economy going. I do not
think you see the importance of your job. You help create
economic activity in this country, sir. Your agency does. And I
do not think--and now you are standing in the way of it, and I
think that is a big problem. And if you hear frustration in my
voice it is there because I am only venting to you what is
being vented to me. And I think that we have to find a way to
get things back on track.
I see my time is up and I appreciate you being here this
morning. Thank you.
Mr. NALLENGARA. Thank you.
Chairman SCHWEIKERT. Thank you, Mr. Luetkemeyer.
Mr. Bentivolio.
Mr. BENTIVOLIO. Chairman, Ranking Member, thank you for
holding this very important hearing.
Our country has a jobs crisis, and in my district it breaks
my heart to drive through industrial parks and office parks and
see ``For Sale,'' ``For Lease,'' or ``Available'' signs rather
than ``Help Wanted Signs.'' Last year both parties recognized
that the creativity and ingenuity of our citizens could be
unleashed if they had greater access to capital. They
recognized the power of start-up businesses to create
opportunity and jobs, and the result was the JOBS Act. The SEC
has the important job of creating rules and regulations that
walk a fine line between creating access to capital and
protecting investors. I have a few short questions. Thank you
very much for being here.
Companies that are required to file reports with the SEC
are given deadlines; correct?
Mr. NALLENGARA. Yes.
Mr. BENTIVOLIO. Are there consequences for missing those
deadlines?
Mr. NALLENGARA. Yes.
Mr. BENTIVOLIO. So would it be correct to say that the SEC
understands the concept of deadlines?
Mr. NALLENGARA. Yes, Congressman.
Mr. BENTIVOLIO. Well, I am not sure I agree. The JOBS Act
became law over a year ago and you have missed two important
deadlines. One was more than nine months ago. Does the SEC
believe they can miss deadlines stated in law because they are
too busy?
Mr. NALLENGARA. Congressman, all the deadlines that you
provide us in the legislation that you mandate are important
deadlines. We work as hard as we can to meet those deadlines.
Mr. BENTIVOLIO. Does the SEC believe they can miss
deadlines because of changes in leadership; yes or no?
Mr. NALLENGARA. No. I am not sure the question you can
answer with a yes or no, but the closest I can get is to no.
How about that?
Mr. BENTIVOLIO. Great. The SEC expects reporting companies
as the regulator to respect their deadlines. Congress is your
regulator. Is it fair for us to expect you to respect our
deadlines?
Mr. NALLENGARA. We do, Congressman.
Mr. BENTIVOLIO. Well, it is debatable. And I think it is
reasonable for Congress to be more than a little upset about a
federal agency's failure to meet the deadlines set forth in the
laws we create, especially when it has a big impact on our
economy and job creation.
I have a question about the modification of Reg A, which
increases the limit to $50 million from $5 million. There was
no deadline in the act about this change, which is probably
good for you or it would have been strike three. Are you in
this process and when should we expect the rules to be
finished? Can I have a date?
Mr. NALLENGARA. Congressman, I cannot provide a date. I am
not the one who is setting the dates. I can say that Chairman
White has indicated that getting rules proposed and completed
on Regulation A+ is a priority for her, so it is a priority for
us.
Mr. BENTIVOLIO. No date? No real deadline? Just when you
get around to it? That is the impression I am getting. I am
getting a lot of verbal moonwalking but I am not getting
anywhere.
Mr. NALLENGARA. Congressman, I cannot provide you dates but
I can provide you that we are committed to get the rules done
as quickly as we can.
Mr. BENTIVOLIO. Mr. Ramsay, regarding crowdfunding, what
are you doing to ensure the cost of compliance is not too high,
especially when many investors may only want to invest $20 or
$50?
Mr. RAMSAY. Well, Congressman, in terms of the requirements
on intermediaries I will defer to Lona on the rest of it, but I
think that we have been, as I said earlier, talking to--have
had dozens of meetings with people who are in this community
currently to understand what practices they follow now, what
best practices are in their area, what kinds of requirements
might pose a significant cost burden issue for them. That
certainly is an issue that we have been looking at closely in
terms of looking at the comment letters that have already come
in. So on issues like how do intermediaries--what do they have
to do in order to protect privacy interests; what kind of
arrangements can they have for holding customer funds; what
obligations do they have in terms of providing issue disclosure
and how can that be provided? A significant part of our focus
has been on trying to make sure that that is done in as cost-
effective a way as possible.
Mr. BENTIVOLIO. Thank you very much.
Mr. Chairman, I yield back my time.
Chairman SCHWEIKERT. Thank you, Congressman.
Mr. McHenry.
Mr. McHENRY. Mr. Chairman, thank you for allowing me to
step in and visit your Subcommittee. Thank you for your
leadership on financial services issues and your interest here,
especially your offering within the JOBS Act the piece dealing
with Reg A in particular.
Chairman SCHWEIKERT. You had something to do with this I
think somewhere.
Mr. McHENRY. Well, crowdfunding is my deep and abiding
interest within the JOBS Act. Reg D rules as well. That is
certainly something we care about. The crowdfunding piece.
Certainly, you will have heard from me and from my staff.
Mr. Ramsay, Mr. Nallengara, thank you for your service to
our government. I certainly appreciate it. I am certainly
aware, as members of Congress are, that you are the lead staff
in terms of your divisions within the SEC. However, the SEC,
with the five Senate-confirmed members of that board, set the
agenda. In particularly the chairman sets the agenda for your
agency, your very important agency, that is supposed to
facilitate capital formation and protect investors. Of course,
that is a balancing act, and I certainly do appreciate your
willingness to testify today.
But Mr. Nallengara, in terms of my colleague, Mr.
Luetkemeyer's questions, I do want to give you an opportunity,
and there was some hesitation with his questions, but just to
correct the record and make sure that this is accurate.
According to my understanding, the staff recommendation to the
board last summer when it dealt with Reg D rulemaking, the
staff recommendation was to offer a final rule during the
August SEC Commissioner's meeting. Is that true?
Mr. NALLENGARA. That was our initial recommendation. Yes,
Congressman.
Mr. McHENRY. And there was a decision made to pull back and
open back up for comments on that what then became a proposed
rule. Is that correct?
Mr. NALLENGARA. Yes.
Mr. McHENRY. Okay. I just want to make sure that is correct
because in terms of these questions, the staff recommendation
was for a final rule. The comments have been heard. Based on
the e-mail traffic that I have now received, these are
documents that have been provided to Congress. That was clearly
the case and the then chair, Chairman Shapiro, had an enormous
pullback and a huge change of approach based on being contacted
by the consumer federation lobbyists. I wrote a letter to Mary
Shapiro to that regard at the end of last year, and I am
certain that you all are aware of that. So, I just want to make
sure that record is corrected.
Mr. Ramsay, in terms of intermediaries when it comes to
crowdfunding, broker-dealers are allowed to participate and
there are pure intermediaries that are allowed as well under
the law. I just want to confirm that the intention is to time
the rulemaking for both those entities is the same. The date
will be the same for both those different types.
Mr. RAMSAY. Yes, Congressman. I believe that is the intent.
The registered broker-dealers, since they are already
registered as broker-dealers would not need any further
authorization. Firms who would be operating as funding portals
would need to register with the Commission and with FINRA. We
have been working closely with FINRA to make sure that their
program will be in place so, as you say, firms will be in a
position to choose which of those paths they want to go down.
Mr. McHENRY. So there is a cap on the amount--and back to
you, Mr. Nallengara--in terms of the rulemaking, SEC has to
write rules when it deals with capping individual investors,
the amount that they can invest in a crowdfunding offering;
right?
Mr. NALLENGARA. Yes.
Mr. McHENRY. And so looking at the cost of crowdfunding
offerings, this is a tricky issue based on what the final
senate language came back with, with a cap of $2,000 or 5
percent of a person's income. It is segmented out. Is the SEC
looking at having a very simple way of tracking individuals'
crowdfunding investments?
Mr. NALLENGARA. Congressman, that is a question that we
have received from many of the crowdfunding or the future
crowdfunding participants asking how are they going to be able
to track investments because that cap is intended to be across
any crowdfunding investment you made. There are a number of
ways to proceed. One of the ways that proponents have
recommended to us is self-certification. You tell the issuer,
you tell the crowdfunding portal how much you may have
invested. That is something we are certainly considering and
certainly that is what the Commission will consider as well.
Mr. NALLENGARA. So that is on the table as one of the ways
to implement that provision.
Mr. McHENRY. Are there other ideas on the table?
Mr. NALLENGARA. Well, I mean, as part of our rulemaking,
when there are choices we need to consider all the choices. We
need to look at those choices and look at the costs and look at
the benefits of every choice. And I know you all want us to do
that. So we will do that.
Mr. McHENRY. Yes. I, in particular, want you weigh both the
costs and the benefits. Yes. I have been a major proponent of
that. But thank you for acknowledging it.
Mr. Ramsay, I am sorry.
Mr. RAMSAY. No. So Congressman, with respect to costs on
funding portals, certainly, on questions of how do you--how
does one ascertain whether the investors are within the limits
or not, it certainly has been an important focus of our
discussions with them and the rule-writing efforts to think of
those costs. We are certainly cognizant of the concern that, if
there were a significant new structure that would be required
to be put in place, that they would have to fund it in order to
do that, that that could create some significant costs that
would deter them from participating.
Mr. McHENRY. Thank you. Thank you both for your service,
and thank you for testifying. We have the acting chair
testifying next week to the Oversight Subcommittee on Financial
Services, Elise Walter, so we will follow up on some of these
questions there. I know that your staff sitting behind you will
pass that along I am sure.
Chairman Schweikert, thank you so much for your
graciousness in allowing me to sit in, and thank you for your
leadership.
Chairman SCHWEIKERT. Chairman McHenry, is this the nicety
language? I am still working on that southern thing.
Mr. McHENRY. The bowtie is southern enough; right?
Chairman SCHWEIKERT. Patrick, thank you for giving us some
of your time. It is appreciated.
We are now heading towards the lightning round. My
understanding is it was last year court ruled that they were
not particularly happy with how the SEC was doing its cost
benefit analysis; is that correct?
Mr. NALLENGARA. I think, Chairman, you are referring to the
proxy access decision.
Chairman SCHWEIKERT. Yeah, actually, it is on top of my
desk and I wish I had grabbed it. I know it was D.C. Circuit,
which would be everything.
Mr. NALLENGARA. Right. I think from that decision our
Commission, led by our economists in our Division of Risk,
Strategy and Financial Innovation and our General Counsel's
office, put out new guidance on how we are supposed to conduct
our economic analysis.
Chairman SCHWEIKERT. Where I am heading is what has that
done to the timeline internally within the process?
Mr. NALLENGARA. I think the role of economic analysis in
our rulemaking has always been there. What we have done with
the new guidance is we have put a framework around it, and we
have provided it to everyone. It is on our website. The
questions we ask and the considerations we make with respect to
costs and benefits, with respect to identifying the baseline,
with respect to identifying the regulatory fix or the market
failure that your mandates are trying to achieve, all of those
questions were questions we asked in our rulemaking before.
What we have now done is formalize them in the form of that
guidance.
Chairman SCHWEIKERT. And that puts you in compliance with
what you believe the D.C. Circuit requested?
Mr. NALLENGARA. We think the guidance that the Commission
has provided related to our economic analysis keeps us in
compliance with what the APA requires for our rulemaking.
Chairman SCHWEIKERT. This is going to be probably closer to
a statement than a question. One of the reasons parts of the
JOBS Act that I believe are really important, whether it be
within the crowdfunding, some of the broker-dealer solicitation
mechanics, is when I look at small business, it is not only the
business side of the ledger but there are also small investors.
We have this habit of, in particular even the design of our
Committee, we fixate on business as we should. But if I do not
have a million dollars--actually on one of the definitions, you
know, when we start saying, okay, you get to be a qualified
investor, qualified to assess the risk and could bear such
risk. If I am the young electrical engineer, I may not have
accumulated my million dollars to be a qualified investor, but
I am an expert in that. So if I am going to invest in a
business that is doing that, it is my fear you are bifurcating
the society. You are polarizing parts of the society. Here is
the folks that are there, they get to be qualified, they get to
know what is out there, they get to invest. Because you have
not met a threshold that is defined by wealth, you do not get
to participate. One of my great hopes that things like
crowdfunding actually created a much more egalitarian access to
participate in ultimately the American dream. So this is more
than just the access to capital for businesses. This is the
access to financial security and growth for a huge portion of
our nation's population.
Ranking Member.
Ms. CLARKE. Thank you, Mr. Chairman.
Along those lines, Mr. Ramsay, sophisticated investors
typically have protections in place and distribute their
funding over time to protect their financial interests. Due to
the nature of crowdfunding, investors are less likely to be
sophisticated and lack the ability to negotiate similar
protections. What steps has the SEC taken to address the
shortcoming of the crowdfunding model as regulations are being
drafted?
Mr. RAMSAY. I appreciate the question, Congresswoman.
I think there are a number of measures that are in the
legislation which will be important parts of the rules that we
provide in this area to make sure, number one, that investors
are given very clear risk disclosures; that intermediaries take
steps in order to make sure that they fully understand all of
the risks that are provided; that they receive appropriate
disclosure from the issuers that allow them to evaluate the
investment in a reasonable way. It's particularly important
that the customers' funds and securities are adequately
protected. In this regard, the legislation was clear that
broker-dealers who are fully registered are able to handle
customer funds and securities. Funding portals would not by
themselves. They need to have a separate bank escrow agent to
hold those funds. We think that is an important protection as
well. Certainly, making sure that customers' personally
identifiable information is protected and that their privacy
interests are protected as well. All of these are respects in
which we are trying to make very sure, as I said before, that
this is a capital-raising tool that investors will want to use
because we are very concerned that, if there is, particularly
at the outset, bad experience in a few significant cases, that
that could deter people from using this mechanism, and that is
something that would not be in accord with what the
congressional intent is.
Ms. CLARKE. Mr. Nallengara, clearly much of the debate over
crowdfunding regulation comes down to investor protection
versus access to capital for small business, again, along the
lines of the chairman's rationale. Has the SEC investigated
current platforms, like Kickstarter for predictors of fraud to
incorporate into the equity-based crowdfunding rules?
Mr. NALLENGARA. Ranking Member, we have had the opportunity
to meet with a number of non-securities-based crowdfunding
proponents. There are a number. Kickstarter is one, but we have
met with a wide variety of them. And what we found, what we
learned is that the evidence of fraud or the existence of fraud
on those platforms is very low. The ability for people
participating in the offerings, the crowd, their ability to
comment on a potential campaign, as they call them is a
remarkably powerful way to determine whether this idea is
something that is viable. And that will be a part of the rules
that the Commission proposes. An ability for the crowd and to
provide the wisdom of the crowd, as crowdfunders like to refer
to it, to provide their idea on whether this is a good
business, whether it is viable, whether it has a real
opportunity for success. And that vetting by the crowd has been
very powerful in the non-securities-based crowdfunding. And the
crowdfunding proponents are hoping that will be the diligence
tool for investors. So you will have people who are smart in
that area be able to look at what this business venture is
offering and be able to ask questions and be able to give their
views on whether that is a viable opportunity.
Ms. CLARKE. Mr. Chairman, I have one final question.
The JOBS Act explicitly mandates an effort by the SEC to
reach out to the minority veteran-owned small businesses. Can
you give us an update on this ongoing process?
Mr. NALLENGARA. Yes, Ranking Member. Our Office of Minority
and Women Inclusion, as well as my division, and in particular,
our Small Business office, are focused on implementing that
mandate. So there are a number of ways we hope to do that. Our
OMWI office has a number of ways which, through Commission
activities, we reach out to those communities. We are going to
piggy back on those same outreach efforts and use those as
opportunities to explain what the JOBS Act will bring. Much of
this effort will come when we get the rules in place so there
is something to talk about that is more tangible, but we are
beginning that process. And we have a number of ways through
our Small Business office where we provide information and
discuss what the JOBS Act has done. And as the rules come
online we will be able to be more meaningful in that regard.
Ms. CLARKE. Thank you very much, Mr. Chairman. I yield
back.
Chairman SCHWEIKERT. Thank you, Ranking Member.
You touched on one thing there. I will encourage you in
more simple language. I love the idea of there are crowdfunding
platforms; that there is also associated, absolutely open
discussion, whether you refer to it as blogs, where if I am an
expert in that area, if I am not, if I am just, passing by, but
that access to information, it is sort of the new world of
ratings. I mean, how many of us these days before we buy a
product go on and look at customer reviews. It is sort of the
new era of egalitarian access to reviews and information.
Gentlemen, thank you for your time. I appreciate it. As you
start to get windows on timelines, I know a number of members
on the panel would be just elated to hear it.
And with that we will seat our second panel. Thank you.
I am going to do each introduction. So I will introduce Ms.
Peters, have her give her testimony, and we will actually work
our way down the line.
So shall we now call the second panel up? I do not know if
you heard it before. The lighting system is a five-minute
clock, as is sort of the humor around here. When you see
yellow, just talk faster.
I would like to introduce the second panel of witnesses
here with us today.
First up we will have Jean Peters, managing director of
Golden Seeds, Angel Capital Network. Jean Peters is an angel
investor based out of Richmond, Virginia. Through Golden Seeds
Angel Network, Ms. Peters invests her own money and time to
support women-owned entrepreneur start-up business. Jean also
serves as a board member for the Angel Capital Association
which she is testifying on behalf of. Welcome to the Committee.
We actually look forward to hearing what you have to say.
Ms. Peters.
STATEMENTS OF JEAN PETERS, MANAGING DIRECTOR, GOLDEN SEEDS;
WILLIAM KLEHM, PRESIDENT AND CEO, FALLBROOK TECHNOLOGIES; KEVIN
RUSTAGI, CEO, EVOLUTIONS OF NOISE; JAMES J. ANGEL, ASSOCIATE
PROFESSOR, MCDONOUGH SCHOOL OF BUSINESS, GEORGETOWN UNIVERSITY
STATEMENT OF JEAN PETERS
Ms. PETERS. Thank you, Chairman Schweikert, Ranking Member
Clarke, and the Subcommittee members. Thank you for inviting
the Angel Capital Association to speak.
I am Jean Peters. I am a managing director of Golden Seeds,
the fourth largest angel group in the country. Our 280 members
collectively have funded more than $50 million in equity to 60
women-led startups. Golden Seeds is a charter member of the
Angel Capital Association on whose behalf I am testifying
today.
ACA is the world's leading association of accredited angel
investors. We have 200 angel groups from across the continent
and there are 8,500 individual angel members. We share the
Committee's concern with the length of time the SEC is taking
for rules, but also with the substance of the prepared rules.
So let me briefly describe angel investing. By definition,
angels are accredited investors who invest from our personal
pocketbooks. Most are former entrepreneurs, or were successful
in business, and we want to help others up that ladder. We
invest in the most primal point of capital formation--small
business startups with high growth potential.
We also speak for the 250,000 accredited investors across
the U.S. who already fund startups each year. These are just a
subset of 8 million people who meet that definition and are an
untapped source of capital that could become active.
Angels are the only source of equity for most startups and
supply up to 90 percent of all outside equity for seed-stage
companies according to the Kauffman Foundation. In fact, angels
fund 20 times as many startups as venture capital. In 2011,
angels provided $23 billion of capital to 66,000 startups,
while VCs put a couple of billion into 1,800 startups in total.
Angels work for Main Street, not Wall Street. And angel-
funded companies are crucial for job growth. According to the
Census Bureau, startups make up less than 1 percent of all
companies, but they create 10 percent of all new jobs in a
given year. Without angel funding, these companies would never
get off the ground.
We bring disciplined due diligence and deep experience to
the table. We have to. Capital comes out of my own pocket. We
understand that what we do is highly risky and extremely
illiquid. We give our time and expertise without compensation
and often without liquidity for 8 to 10 years. We do this to
make a return, but we also do it to give back, to keep up with
our industries, and because entrepreneurs value what we do.
So this brings me to a key part of the JOBS Act, Title II,
which ends the ban on general solicitation for issuers who sell
securities only to accredited investors, angels.
We understand entrepreneurs desperately need capital.
Companies that could get bank loans or at least small business
credit cards are now shut out. So the potential for
crowdfunding and general solicitation are exciting. We also
understand that these vehicles have high risks for the unwary,
and we appreciate the efforts to safeguard those risks. But the
rules provide the issuer to take reasonable steps to verify
that investors are accredited. The problem is the SEC has not
provided any clarity on what those steps are. Instead, they say
they will determine that on a case-by-case basis.
This lack of any safe harbor leaves investors and
entrepreneurs in a deeply uncertain position. The ACA surveyed
its investors who said they are likely to not invest if they
have to turn over financial records to entrepreneurs. Their
lawyers are telling them not to invest. This would cause a
dramatic slowdown in angel funding. We recommend that the final
rules specify safe harbors.
At last fall's SEC Forum on Small Business Capital
Formation there was a unanimous recommendation to make
reputable angel groups a safe harbor for general solicitation.
Angels have a history of disciplined due diligence, deal
screening, governance, and almost total absence of fraud. As
investors enter this class, the ACA will lead in providing
those professional standards. We will be the adult supervision
for crowdfunding and general solicitation and social networks.
We will be there when companies that crowdfund need that extra
capital. We will be the sorting mechanism for these startups
that are most promising. We will ensure that companies seeking
funding are legitimate, appropriately structured, managed, and
valued, and that will mean that the innovation that is now
bubbling up on every professional district and job-seeking
community will stand the better chance for success for the
entrepreneur, for its employees, and for the investor that is
willing to take that risk.
I thank you.
Chairman SCHWEIKERT. Thank you, Ms. Peters. That is
interesting.
Bill Klehm, the next witness with us is--do you prefer Bill
or William?
Mr. KLEHM. Bill is fine.
Chairman SCHWEIKERT. Bill Klehm is CEO of Fallbrook
Technologies. Fallbrook Technologies is an automotive company
focused on the development and manufacturing of energy-
efficient vehicle transmissions. I actually spent some time on
the Internet looking at some of your technology. It is
fascinating what you have accomplished. Prior to joining
Fallbrook, Bill served in various executive positions in the
automotive industry with Visteon.
Mr. KLEHM. Excuse me, Visteon.
Chairman SCHWEIKERT. Visteon Climate Control Systems at
Ford Motor Company. Bill is testifying on behalf of CONNECT, a
San Diego-based California innovation trade organization.
Bill.
STATEMENT OF WILLIAM KLEHM
Mr. KLEHM. Thank you. Good morning, Chairman Schweikert and
Ranking Member Clarke, as well as other Committee members.
First of all, thank you for the invitation to be here. It
is an honor to appear before this Committee today and testify
on the challenges those of us have raising capital for early
stage innovative new companies in the face of this financial
and regulatory environment. I commend you for calling this
hearing to check up on the status of the JOBS Act
implementation to ensure the goals of the JOBS Act get
accomplished, namely to increase access to capital for
America's innovators.
My name is Bill Klehm. I am the Chairman and CEO of
Fallbrook Technologies. I have served as Fallbrook's CEO since
2004 and have over 20 years of automotive-related experience.
We are a private company based in San Diego, California and
Austin, Texas. We manufacture and market proprietary
continuously variable transmission products and support our
global partners in the design and development of our
proprietary transmission technology.
Fallbrook currently holds over 500 patents and 15,000
patent claims. Our mission is to deliver the best performing,
most versatile and most reliable mechanical power transmissions
on the planet. We employ 133 people in the U.S., including
approximately 25 of the best transmission engineers in the
sector.
We have passed the commercial test of physics and
economics. We have partnered with worldwide industry leaders,
including national leaders like Allison Transmission of
Indiana, Dana Holding Corporation of Ohio, and TEAM Industries
of Minnesota. Our proprietary variable transmission technology
is potentially applicable to any product that uses a
transmission. It replaces conventional transmission technology
that uses gears to transfer raw power to managed power.
As you might imagine, transmissions are ubiquitous. They
are in virtually every electromechanical system today on the
planet. The most obvious examples are motor vehicles, but they
exist everywhere. The range of applications should give you a
sense of the size of the opportunity we are trying to address.
Today, for the market opportunities that we are currently
investing in, it is about a $30 billion market opportunity for
us. Our technology allows the next generation transmissions to
increase fuel efficiency, reduce emissions, and improve overall
vehicle performance, serving as an important function in
protecting the environment.
Our great country prides itself on entrepreneurship and
innovation. In my opinion, Fallbrook is the poster child for
those values. From an idea starting in San Diego in 1998 with
negligible revenue through 2009, to over $43 million in revenue
last year and all that money being poured back into the
business to help it grow sounds like a good start, but the maze
in which small business and innovative companies must navigate
to acquire capital is becoming increasingly challenging. We
have an opportunity to grow faster and drive innovation faster.
The only thing preventing us today is access to affordable
capital. Our ability to access capital is the most significant
challenge we face as a business. I personally spend 50 percent
of my time on it.
With additional capital we could expand our manufacturing
base in Texas, build out our engineering and development team
which would create new high-tech jobs, accelerate our product
development and partnership opportunities. It is important to
note that expansion would also have a significant impact
outside of our particular company in that both our suppliers
and customers would also benefit from that job growth. This
Committee should remember that high-tech engineering and
manufacturing jobs are the kind of jobs this economy needs, not
only because they enhance America's competitiveness but they
also pay above average wages compared to other sectors. That is
why Congress's bipartisan work to pass the JOBS Act was so
important and why regulatory hurdles should not slow us down
now. The jobs and innovation will materialize once the JOBS Act
is fully implemented.
The changes enacted by the JOBS Act will make acquiring
capital less challenging for America's new innovators. The
current Regulation A cap of $5 million is outdated and
unworkable, and Congress was absolutely right to modernize that
for today's innovation climate.
To meet our needs at Fallbrook an incremental $5 million
round simply would not fund the type of development and growth
we are targeting at Fallbrook. Additionally, the opportunity
cost to file a registration statement with the SEC, including
legal accounting fees and printing costs for a company our size
amounts to hundreds of thousands to millions of dollars. Middle
and large cap companies that raise public equity benefit from
their scale of the transactions relative to their
administration costs but small and emerging companies across
this country in various tech sectors are robbed of that benefit
until the Reg A rules are implemented. This means that new
well-paying jobs are not created, new technologies sit dormant,
and new products do not affect lives for the common good.
The changes in the JOBS Act will enable Fallbrook to
accelerate our development and commercialization, driving
innovation growth, which creates jobs.
Thank you very much.
Chairman SCHWEIKERT. Thank you very much, Mr. Klehm.
Our next witness is Kevin Rustagi, CEO of Evolutions of
Noise and cofounder of Inc. Magazine's 2012 Coolest College
Startup, Ministry of Supply.
Mr. RUSTAGI. Yes, that is correct.
Chairman SCHWEIKERT. Kevin graduated from MIT Technology in
2011 with a degree in mechanical engineering. Prior to
graduating, Kevin cofounded Ministry of Supply, a dress shirt
company with MIT classmates in 2010. Kevin is currently CEO of
Evolution of Noise, a product development company that is
working on several new customer products, including a re-
engineering of business cards using laser etching.
Mr. RUSTAGI. That is correct.
Chairman SCHWEIKERT. I was teasing Kevin earlier that when
I run into someone as brilliant as he is at his age I am always
fearful I am going to wake up one day and be working for you.
Kevin, share with us.
STATEMENT OF KEVIN RUSTAGI
Mr. RUSTAGI. Good morning, Chairman Schweikert, Ranking
Member Clarke, members of the Subcommittee. I am so glad to be
meeting with you and that you will take the time to hear my
testimony.
As Chairman Schweikert mentioned, I graduated from MIT in
2011 with a degree in mechanical engineering focused on product
design. My senior year I got into Stanford Business School. I
have deferred that for three years to work on interesting new
high-tech and high-growth startups. I have had experience with
different types of funding, family and friends' loans, angel
investors, and most recently donation crowdfunding through
Kickstarter.com.
The company I last founded, Ministry of Supply creates
high-tech business apparel for men. I am actually wearing one
of the shirts right now. I just want to talk a little bit about
on what we did on Kickstarter. Our goal was to raise $30,000
last July. You have to meet or exceed that goal to maintain
those funds. We raised in a little over a month a grand total
of $429,000.
The JOBS Act will greatly increase an entrepreneur's chance
of success by going beyond things like crowdfunding and really
talking about crowd investing when you need further access to
capital as we did, and I will talk about it today.
With Kickstarter, it is very interesting. For consumer-
packaged goods what I focus in, it has really become a preorder
destination. And what was phenomenal about our product and
service is that we did what in the start-up world is known as
``going viral.'' So our global viral PR strategy enabled us to
get over 100,000 views of our videos with preorders from over
two dozen countries.
Unfortunately, what ended up happening afterwards, what was
so exciting is we had so much funding that we began to rapidly
scale a supply chain and hire new employees. However, the money
that we were offered from multiple investors around the world,
many of whom were smaller investors, we were unable to take
based on lack of legal precedent and vetting tools. We
experienced the deep irony of having a great business
opportunity and having to turn investors away.
I just want to delineate the difference between equity-
based and donation-based. Donation-based crowdfunding is a
great opportunity. However, it is not nearly as reliable as
equity-based as dictated through the JOBS Act. One of the
interesting things as well with high-tech hi-growth startups is
dilution. When you have a limited number of investors, say an
angel investor community, surrounds the entrepreneur or venture
capital associations, you deal with smaller potential
valuations. Simply, the entrepreneur is subject to whatever
valuations the market will bear, given the number of investors
they have. If you open it up to the crowd, I believe this will
have a leveling smoothing effect that will enable further
growth.
The timing of the JOBS Act is very important with regards
to the global stage. MassChallenge, a Boston-based startup
competition--it is one of the largest in the world--actually
received applications last year from 35 countries.
MassChallenge, like the marketplace, is judged solely based on
traction and market adoption. Competition is now a highly
global democracy. It is very important that America matches the
speed of global competition. I believe the JOBS Act will help
us do that.
I believe also that crowd investing would be used. There
are limitations on other types of investing. Angel investing,
you are talking about connections in the liquid market
surrounding the entrepreneur. Venture capital, it is the idea
of being ``proven.'' They reject 98 percent of startups that
walk in their door. In crowd donation you are really dealing
with the time window. Does your product exactly match that
window? As far as I know in terms of entrepreneurs that I have
met over the past six years, given new effective crowdfunding
tools we would make quick use of them.
In conclusion, crowd investing within the JOBS Act clearly
demonstrates or will demonstrate America's continued commitment
to developing the next generation of small businesses and
startups. It remains vital to consider all elements of
supporting startups, especially other items that are caught up
in legislation, including the Startup Visa.
New businesses are very difficult ventures to undertake.
There are a ton of risks, and I have found, as well as my
colleagues, that we spend a lot of our time fund-raising as
Bill mentioned.
As I have noted, I have used a variety of tools to create
new ventures, both for product design and business development.
My hope is that my colleagues and I can continue to create new
ventures in a way that leads and inspires the world. I eagerly
await the day that I can fully utilize crowdfunding and crowd
investing to help create successful new ventures.
I thank you for this opportunity to explain the concerns of
the startup community and welcome any questions.
Chairman SCHWEIKERT. Kevin, thank you for sharing with us.
I would like to yield to the ranking member. Ranking Member
Clarke.
Ms. CLARKE. Thank you very much, Mr. Chairman.
It is my pleasure to introduce James Angel. He is an
associate professor of finance at Georgetown University's
McDonough School of Business. He currently is on leave where he
is serving as a visiting associate professor at the Wharton
School of the University of Pennsylvania. He specializes in the
structure and regulation of financial markets and has expertise
in the IPO process and capital formation. Dr. Angel's current
academic research focuses on market regulation and he has
previously testified before Congress about issues relating to
the design of financial markets. He holds degrees from Cal
Tech, Harvard, and Cal Berkeley. Welcome, Mr. Angel.
STATEMENT OF JAMES J. ANGEL
Mr. ANGEL. Thank you. It is an honor to be here, and I want
to thank the Committee for taking the time to investigate this
very, very important topic.
Now, as you know, the JOBS Act was passed in reaction to
the twin crises we face. First, there is the jobs crisis of the
Great Recession, but there is also a crisis in capital
formation. The most obvious symptom of this is what is
happening in our public equity markets. We have less than half
as many public companies as we used to have 15 years ago.
You may have heard of the Wilshire 5000 index that
represents all the U.S. exchange-listed companies. Well, guess
what? There are no longer 5,000 companies there. There are no
longer 8,000 like there used to be. Now there are less than
3,600 companies in the Wilshire 5000. Our markets have been
steadily shrinking.
Now, there are many contributing factors to this crisis,
and I would be more than happy to sit down with any of you or
your staff and go into it in a lot of detail, but it is
something that was one of the things that was addressed in the
JOBS Act with many of these contributing factors.
Now, and I want to thank Congress for really doing such a
good bipartisan job of addressing many of these different
factors. You know, there is no one silver bullet that affects
everything. But many of the parts of the JOBS Act make it
easier to avoid becoming a public company because of the
burdens we have placed on public companies. Well, that is fine
for smaller companies, but I think we really need to pay
attention to also fixing the public markets and not just making
it easier to avoid the public market.
Now, a lot of the stuff in the JOBS Act could have very
easily been done by the SEC on its own authority. The SEC has
very broad rulemaking authority, very broad exemptive
authority. They could have done almost everything in the JOBS
Act by themselves without needing an act of Congress. So the
real question to ask is ``Why did they not?'' How is it that
this specialist agency, which is tasked with making this
tradeoff between consumer protection, economic growth,
competition, capital formation, market efficiency--they are
told to make the right tradeoff. How is it that they have
consistently failed over the years to do this? And it is not
the fault of any one commissioner or any one staff member.
Congress really needs to take a look at the big regulatory
picture and say ``Why is this agency not getting it right? Why
did we have to step in with this very precise law and here a
year later why did we have to grill these staff members as to
why they have not implemented the law?
Well, if you think about it for a minute, the SEC had long
ago decided that they did not want to do any of the things the
law said, so it is not really a surprise that they have been
dragging their feet. And indeed, despite their protestations
that it is a high priority, they have been spending their time
on other things that were not mandated by Congress in either
Dodd-Frank or the JOBS Act. For example, they just released a
377-page rule finding on Regulation SCI, which yes, it is an
important area. No doubt about it. But it is not one of the
things that Congress mandated with specific deadlines to get
done now while we have 11 million people standing in an
unemployment line.
So anyhow, let us look at the other issues here, like
crowdfunding. Simple idea. And yes, there are serious consumer
protection concerns there. We do not want the fraudsters
running in and ripping off Aunt Sally. But we do not want to
study it to death either. No matter what they do, they are
never going to get it perfect. No human is going to do that.
There will be unintended side effects that nobody has thought
about. And like good regulators, they are paralyzed by the fear
that that is what is going to happen.
Now, there is a common sense solution to this. The common
sense solution is to put out interim temporary rules, learn
from the experience, and then fix it. They are not going to get
it right the first time or even the second time. So we need to
adopt an attitude of innovation, try it, see what works, and
when we find a problem, fix it.
The same thing on tick size. Again, another technical
matter I would be more than happy to sit down with you or your
staff to talk about the pros and cons. But one thing we know is
that the optimal tick size is not the same for every company.
So the real public policy question is not, oh, let us study it
for five years. No, the real question is who decides? Do we let
the SEC come up with a ``one tick fits all'' policy like they
did in Rule 612? I do not think that is the right approach. Who
has the incentive to get it right? The issuers do. So why do we
not let the companies themselves fix it?
So anyway, thank you very much, and I look forward to your
questions.
Chairman SCHWEIKERT. Thank you. I hope you will forgive me
for throwing this in but I find this just fascinating what you
are all doing.
Kevin, something I have been trying to partially get my
head around and also I am trying to encourage the SEC and
others is let us say you and I have an equity crowdfunding
platform.
Mr. RUSTAGI. Great.
Chairman SCHWEIKERT. If you were designing it or your
personal experience of out there raising money using
technology, is access to information, you know, my comment
before of affiliated blogs, how would you do that? Because if I
am a believer that information is the ultimate regulator and
vetter, what would you do?
Mr. RUSTAGI. So I completely agree, Chairman Schweikert,
that information is key. So this is very important. With
Kickstarter we had over 1,000 conversations with different
potential customers given that it is a preorder facilitator. So
if we were to make and create a crowdfunding platform, there
would have to be a couple things that we would do. One, we
would have to have transparency about who is involved in the
company, especially at the managing partner level. For
instance, if Bill is going to go on a crowdfunding platform and
create a company, a cupcakery as was mentioned in the briefing
here, we would have to know who is his main baker, who are any
past financiers, as well as who is really managing the team.
Specifically, I completely agree with the idea of a blog
detailing progress about the company and also basic financials.
Chairman SCHWEIKERT. Okay. Ms. Peters, when you are
actually out there working with your Angel Network--just as a
side question and this sort of passes back to what Kevin was
just saying--information on the management, the individuals,
when you are weighing, how much are you all investing in the
concept or investing in the people?
Ms. PETERS. Well, with startups, a lot of time there is no
revenue. There is a very nascent business model and you are
really investing in the jockey very much. And so angels do get
together in groups and we do a very substantial amount of due
diligence. We end up looking at everything, from management
capabilities, from the competitive arena, from past history of
the management. We do reference checks. Angel Capital Investing
and Accredited Investor investing is not something you do on
PayPal. I mean, it is negotiated. You work very closely with
the companies. We go on their boards and we offer advice. We
offer strategic advice. We spend time with those companies
throughout their history.
So transparency is just imperative. We require information
rights with any company that Golden Seeds invests in and most
angel groups do that.
Chairman SCHWEIKERT. Thanks, Ms. Peters.
Mr. Angel, being someone who is actually very interested in
the tick size mechanic. Not only seeing the crisis of the
number of publicly traded equities out there, but also how the
curve seems to be pulling further and further out. The big caps
are traded and the smaller ones are orphans. Obviously tick
size, are we to the point now where I need to try to put
together a bipartisan piece of legislation and drive it through
our process? Because many of us have had the discussion of do
you do a sliding scale? Do you just allow the company, the
exchange, the interested parties to basically pick a tick and
say, hey, we are going to be a five cent, we are going to be a
10 cent. The last part of that is would you go 5 to 25? How
much range would you create?
Mr. ANGEL. Why thank you. Thank you.
For those watching on TV who are not as familiar with the
tick size, the tick is the minimum price variation. Now, you
can trade a stock right now at $10 or $10 and a penny, but you
cannot trade it at $10 and a half penny. And it sounds like a
very technical issue, and it is, but what that really indicates
is how much you have to pay to jump ahead of other people who
are bidding the same price you want to pay. So if right now
other people are out there bidding $10, if you want to jump to
the front of the line you have to bid $10 and a penny.
Now, it sounds very technical. It sounds like a minor
thing, but it has a big impact on the way people trade. And the
real question is what is the optimal tick size? I have
published papers with mathematical formulas of this and it is
really a function of many different things--everything from the
size of the company to how many people know about it, and it is
not the same for every company. So if we try to have a ``one
formula fits all,'' we would miss a lot of stuff and we
probably would not get it perfectly right. So I am of the
opinion that the best thing to do is to ask who has the right
incentive? That is what good economic analysis is all about. It
is not about did the SEC properly manage or properly count how
many paperclips will be used in implementing a law or a rule;
it is the question of did they get the economics right to make
the right tradeoff between consumer protection, capital
formation, market efficiency, and competition.
Now, if you make the tick too wide, that puts a floor on
the bid-ask spread. That is a transaction cost. So if you make
the tick too wide you are driving up costs. That is going to
hurt the stock price. On the other hand, if you make the tick
too small you are not providing enough protection to people who
provide liquidity in the market and that will hurt the stock
price.
Chairman SCHWEIKERT. Would you use a sliding scale? Would
you use a volume adjustment? Would you just allow the company
and the Exchange to pick a number and then review it on
velocity of trade?
Mr. ANGEL. Right. I would let the companies pick their own
tick size because they have the incentive to get it right. It
is their stock that is being traded, and if they get the wrong
number they should have the flexibility to experiment with
different stock.
Chairman SCHWEIKERT. We may be calling you because I am
frustrated on this one and maybe actually trying to draft----
Mr. ANGEL. Happy to assist.
Chairman SCHWEIKERT. Mr. Klehm, you have a great interest
in what we refer to as the Reg A. You know, it is now a $50
million offering, a simplified process, and as you and I have
talked about. The $50 million allows you to be on the big
exchanges and the great hope of then becoming a covered stock
where researchers are following you, which makes additional
offerings possible. In a company like yours with the growth and
the technology and the capital intensive you need, is $50
million an appropriate threshold?
Mr. KLEHM. We are actually a capital light business. So we
run a mix of intellectual property licensing as well as
manufacturing. So the business model that we employ has the
flexibility to be able to do all those things. So a $50 million
capital raise--so for the first time in nine years my angel
investors, my 203 angel investors, I do not have to go out and
raise money because we are going to be a cash flow positive
business this year. So this is the time to raise money. But
what we will require money for is that next jump in growth. We
went from $8.7 million in revenue to $43 million in revenue in
one year.
Chairman SCHWEIKERT. Tell us where you are going. Let us
say you had the 50 million in new capital. You were able to
go--what does that do to your employment base? What does that
change in your local economy?
Mr. KLEHM. So for us we have relied on licensing and
contract manufacturing. We have small manufacturing in Austin,
Texas, and what this would allow us to do is to expand that
manufacturing base. So as I think about the business, I think
about the business as a triangle. So the base of the business
is the manufacturing and creating of products, so that covers
the expenses for the business. Then the licensing, we go into
markets that we are not organized or capitalized to be able to
address, like full-blown automotive transmissions. We license
those to other markets. But for the markets that we can get our
great return for our shareholders and be very economically
efficient, we would look to manufacture that. So the capital we
would look to employ is to bring that manufacturing capability
in-house and build manufacturing jobs.
Chairman SCHWEIKERT. Okay. Thank you, Mr. Klehm.
Ranking Member Clarke.
Ms. CLARKE. Thank you, Mr. Chairman. This testimony is
truly fascinating. I want to thank all of you for your
testimony here today.
My first question is for Dr.--is it Angel or Angel?
Mr. ANGEL. You can call me Jim.
Ms. CLARKE. Well, thank you. Excuse me.
The JOBS Act included some investor protections, including
restrictions on the amount ordinary investors can invest in
each company based on income levels. As you know, the SEC has
grappled with balancing capital raising by small businesses
with investor protections in the past. In your opinion, are
investment caps enough to protect investors with limited wealth
and financial knowledge from crowdfunding issuers?
Mr. ANGEL. By itself, no. Whenever you have money, money
attracts flies just like garbage attracts fleas. And so that is
why there are other good things in the JOBS Act, for example,
that require criminal background checks of the people running
these operations because we do not want the fraudsters to come
in, set up bogus operations, sell them on the Internet, and run
away with the proceeds. So definitely this is something that is
contemplated in the Act, and we just need to move forward with
it.
Ms. CLARKE. I want to follow up on a question from your
written testimony. You pointed out the challenges public
companies face with regards to possible litigation and how that
can be a disincentive for private companies to go public. Given
that litigation can at times be an investor's only recourse,
how would you mitigate that concern for private companies who
may want to go public?
Mr. ANGEL. Well, one thing is that Congress and the SEC can
create various safe harbors for disclosure in that whenever
something bad happens to a company that not only do the
stockholders suffer because the price goes down, but then the
strike suits come in and basically the shareholders end up
suing themselves and paying twice. So better safe harbors I
think are one very important thing. But you are right. We need
to strike a balance and that is a tricky thing to do.
Ms. CLARKE. Let me thank you.
To Mr. Rustagi, as someone who has successfully used the
Kickstarter platform to raise capital for your small business,
what recommendations would you make to the SEC to ensure that
new equity-based crowdfunding rules are workable for both
investors and issuers?
Mr. RUSTAGI. So I think that is really interesting. With
Kickstarter, what happens is a lot of it is centered around the
companies themselves and the videos that create. And so as
Chairman Schweikert was mentioning, a lot of it is very review-
based. So there is a lot of back and forth there.
I think the SEC would have to create something very simple.
If they were to--just from the company's perspective or from
the investor's perspective, I would want a lot of that
regulation bottled up into the crowdfunding or crowd investing
platforms themselves. It is imperative that the system is very,
very simple. The biggest thing in startups is time. So the
longer something takes, the longer the process takes, the more
you spend on legal, the less likely it is that you are to use
that. And so a lot of friends and colleagues of mine have been
coming to me asking about Kickstarter advice, because it is
such a simple and elegant tool. There is a large backend for
the companies and there should be for investors as well.
Ms. CLARKE. And my final question to you is what is high-
tech apparel?
Mr. RUSTAGI. That is the eternal question.
So we create synthetic materials that have specific
properties. So the easiest one to explain is the dress shirt
that I am wearing. So a regular dress shirt has issues with
wrinkling and holds moisture; this one does not. So it has
special properties, like you can wear it for four or five days
because it does not smell. It has an antimicrobial coating. It
has a phase-change material inside of it, which is the same
thing used in space suits. So it can hold your body heat, store
that, so if you are out on a hot day it will pull that heat
away. And if you go into a cool environment it will release it
back to you. So it is basically, as the blog dog tech crunch
put it, a magic shirt.
Ms. CLARKE. The magic shirt.
Thank you Mr. Chairman.
Chairman SCHWEIKERT. It just sets your mind a racing, does
it not it?
Mr. Bentivolio.
Mr. BENTIVOLIO. Thank you very much, Mr. Chairman. I think
it is more appropriately named the ``smart shirt.''
Mr. RUSTAGI. Thank you.
Mr. BENTIVOLIO. It is a very good idea.
Actually, my questions are for Ms. Peters. I am sorry I was
not here to hear your initial testimony, but I got the gist of
it and I have a few quick questions.
A startup. Somebody wants to raise money for a good idea
what they think is a good idea, they should put together a
business plan I am assuming. Do you help them with that? Do you
have a format or a style?
Ms. PETERS. There are a number of tools that startups use.
There are some technological systems that they can go on that
show them what they need to do, how to put up an executive
summary, a business plan. They need a business plan for their
business. I mean, we do not write that for them. If they are
not capable of writing that, that is one of the signals we
would have about how likely they are to succeed. They need to
be able to understand and provide us with financials and
financial projections and the basis for those projections.
So there are a whole array of templates that you can see on
the Angel Capital Association site for entrepreneurs. There are
a number of other sites that do that as well. These have been
around for many years. Then also, entrepreneurs come through
economic development, through incubators in their towns,
through accelerators, through tech transfer offices of colleges
and universities, and frankly, a lot of the schools that used
to promote their MBAs are now promoting their masters in
business entrepreneurship, not administration. So you are
finding entire course curriculum around how to create a startup
and develop the sources of capital that you need.
Mr. BENTIVOLIO. That is great. That is great.
One other thing, Mr. Rustagi?
Mr. RUSTAGI. Rustagi.
Mr. BENTIVOLIO. In another Committee we were discussing
military uniforms. Is there any chance you could get involved
with us on that, in developing a smart uniform?
Mr. RUSTAGI. I could speak with my former partner about it.
There is an SBIR out about a year and a half ago that we were
going to apply to, but certainly. Yeah.
Mr. BENTIVOLIO. That would be great.
And just one last question. How can I get you to come to my
district and give a seminar on how to do a startup?
Mr. RUSTAGI. My e-mail is just my full name at gmail.com.
Mr. BENTIVOLIO. Great. Thank you very much. Thank you. I
yield back my time, Mr. Chairman.
Chairman SCHWEIKERT. Oh, it is not fair. We wanted to get
him to our district first.
Mr. BENTIVOLIO. He is going to be sought after.
Chairman SCHWEIKERT. Thank you. This was one of those
unique occasions. I have sat through hundreds of hearings from
my time in the state legislature to here in Congress. As a
collection of witnesses, you are singularly the most
interesting group I think I have ever had in front of me. It is
rare for me to look out and say I would love to sit down and
have a coffee with each one of you. So thank you for joining us
today. You may find that we may send you some questions to put
into the record, so let me make sure I do the proper closing.
Okay.
And with that I ask unanimous consent that the members have
five legislative days to submit statements and supporting
materials for the record. Without objection, so ordered. The
hearing is now adjourned.
[Whereupon, at 11:42 a.m., the Subcommittee was adjourned.]
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Testimony of
William G. Klehm III
Chairman and CEO of Fallbrook Technologies
on behalf of CONNECT
U.S. House of Representatives
Committee on Small Business
Subcommittee on Investigations, Oversight and Regulations
Hearing on
JOBS Act Implementation Update
April 11, 2013
Good Morning Chairman Schweikert and Ranking Member Clarke.
It is an honor to appear before the committee today and testify
on the challenges those of us raising capital for early stage,
innovative new companies face in this financial and regulatory
environment. I commend you for calling this hearing to check up
on the status of JOBS Act implementation to ensure the goals of
the JOBS Act, namely to increase access to capital for
America's innovators, get accomplished.
I am Bill Klehm, Chairman and CEO of Fallbrook
Technologies. I have served as Fallbrook's CEO since 2004 and
have over 20 years of automotive related experience. I have
held several positions with management responsibilities in the
automotive business, including finance, marketing, sales,
product development, and manufacturing operations.
We are a private technology company based near Austin,
Texas and San Diego, California, dedicated to improving
products relying on mechanical transmissions. We both
manufacture and market proprietary continuously variable
transmission products, and support our global partners in the
design and development of our proprietary transmission
technology.
Fallbrook currently holds over 500 patents and pending
applications worldwide.
Our mission is to deliver the best performing, most
versatile and most reliable mechanical power transmissions in
the world. We believe the next generation of transmissions
including our technology will be less expensive and more
effective.
We employ 133 people in the U.S., including approximately
25 of the best engineers in the transmission sector.
We have secured major partnerships with global players in
the automotive sector to design and develop applications of our
transmission technology. We have passed the commercial tests of
physics and economics and have partnered with industry leaders
like Allison Transmission of Indiana, Dana Holding of Ohio and
TEAM Industries of Minnesota. Our proprietary continuously
variable transmission technology is potentially applicable to
any product that uses a transmission. It replaces conventional
transmission technology that uses gears to transform raw power
to managed power with a mechanism that seamlessly provides an
unlimited number of ratios within its ratio range.
Transmissions are ubiquitous in anything that has a power
source, from your bicycle or vacuum to the most obvious
example, the motor vehicle. That range of applications should
give you a sense of how big an opportunity we have in front of
us--more than $30 billion in just the markets we are active in
today. Our technology allows next-generation transmissions to
increase fuel efficiency, reduce emissions, and improve overall
vehicle performance.
We've grown from negligible revenue in 2009 to more than
$43 million last year. And that is money that we are investing
back into the business to grow. This is a good start, but we
have an opportunity to grow faster and to drive innovation
faster. The only thing preventing us from doing this is
affordable capital. Our ability to access capital is one of the
MOST significant challenges we face. I spend over 50 percent of
my time on it.
We have raised more than $15 million in capital. Our early
investors were angels from California, individuals that
recognized the benefits our technology could bring to the
mechanical transmission sector. VC investors from California
came in next, followed by a VC from Switzerland and more
recently corporate investors from Canada, Indiana and Ohio.
The maze through which small innovative companies, like
Fallbrook, must navigate to acquire capital is becoming
increasingly challenging. Our great country prides itself on
entrepreneurship and innovation. Fallbrook is a poster child
for those values. From an idea in San Diego in 1998 to the
launch of our first commercial product, right through to the
automotive development agreements we signed last summer.
With additional capital we could expand our manufacturing
base in Texas and build-out our engineering and development
team which would create new high technology jobs to accelerate
our product development and partnership opportunities. We also
believe there would also be a significant impact on new job
opportunities within both our suppliers and end user customers,
such as automobile manufacturers. This committee should
remember that high-tech engineering and manufacturing jobs are
the kinds of jobs this economy needs because not only do they
enhance America's competitiveness, but they pay above the
average salary and wages compared to other sectors. That is why
Congress' bipartisan work to pass the JOBS Act was so important
and why regulatory hurdles shouldn't slow down the jobs and
innovation that will materialize once the JOBS Act is fully
implemented.
The changes enacted by the JOBS Act will make acquiring
capital less challenging for companies like Fallbrook,
specifically the Regulation A change which simply raises the
limit on capital a company can currently raise from $5 million
to $50 million. Regulation A is already law and is already
enforced by the SEC. But the $5 million cap is outdated and
unworkable and Congress was absolutely right to modernize the
cap for today's innovation climate and to provide more access
to capital for America's innovators.
To meet our needs, an incremental $5 million round is
simply not sufficient to fund the type of development and
growth that we are targeting at Fallbrook. Under the status
quo, to raise more than $5 million we are required to file a
registration statement with the SEC. The opportunity cost of
that filing, including the legal and accounting fees and
printing costs, is significant for a company of our size,
amounting potentially to hundreds of thousands of dollars. Mid
and large cap companies that raise public equity benefit from
the scale of their transactions relative to the cost of the
registration statement. But innovative companies all across the
country in various tech sectors that are the size of Fallbrook
are robbed of that benefit until the JOBS Act Regulation A
rules are implemented. This means that new, well-paying jobs
aren't created, new technologies sit dormant, and the public
misses out on new products that could change their lives or
advance the common good.
The changes in the JOBS Act will increase access to capital
for companies like Fallbrook. They will enable us to accelerate
our development and commercialization; driving innovation and
growth, which creates jobs. New jobs will be created not only
local to Fallbrook but also across the nation within the supply
and customer chain both upstream and downstream of our
proprietary technology. Fallbrook's technology can have a
meaningful impact on the mechanical transmission market, using
energy more efficiently through the art of simplicity.
Fallbrook is not the only company that will benefit from Reg A
implementation. I know of several other companies ready to
utilize this new option for accessing capital. I encourage the
sub-committee to help us in this goal by ensuring the full and
speedy implementation of the changes proposed by the JOBS Act.
Thank you Mr. Chairman, Ranking Member and Committee Members.
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``JOBS Act Implementation Update''
Testimony of
Kevin Rustagi
CEO
Evolutions of Noise
April 11, 2013
Before the
Small Business Committee
United States House of Representatives
The Honorable David Schweikert, Committee Chairman
The Honorable Yvette Clarke, Ranking Member
Good morning, Chairman Schweikert, Ranking Member Clarke,
and members of the Committee. It is an honor and privilege to
be here today to share my experiences and knowledge with the
committee.
My name is Kevin Rustagi, and I am an American entrepreneur
and product designer.
As an alumnus of the Massachusetts Institute of Technology,
I've had the privilege of working with firms such as Apple on
the iPhone 5 and GE during my undergraduate career. Over time,
the entrepreneurship community at MIT drew me to the world of
high-tech, high-growth early stage startups. I opted for a
multi-year deferral from Stanford Business School to explore
startup opportunities.
Since then, I have been a student of the modern economy and
sought to start ventures using highly mobile labor and capital.
As such, I have experience with loans from family and business
partners, angel investing with accredited investors, and most
recently, donation-based funding through Kickstarter.com. I am
also an active member of the young startup community, acting as
a sounding board in the early venture space.
A recent company that I co-founded, Ministry of Supply
(MoS0, creates high-tech business apparel for men and held the
record in the fashion category on Kickstarter for the latter
half of 2012 by taking pre-orders for our new space-age dress
shirts. Our goal was $30,000. In 33 days, we raised over 14
times that for a total of $429,000. Since inception, we have
created 14 new jobs.
Though new technologies such as viral marketing and rapid
prototyping are highly effective, the need for accessible
funding and backing remains as pertinent and challenging as
ever.
Today, I aim to discuss how funding has played a role in my
ventures as of late, and how access to new methods of
fundraising, as cited in the Jumpstart Our Business Startups
Act, or the JOBS Act, would greatly increase every
entrepreneur's chance of success in starting new ventures,
thereby stimulating the creation of new jobs and economic
growth.
Kickstarter and `going viral'
Kickstarter is one of the web's primary curated crowd-
donation sites, and is known for taking only a 5% cut of
donations to a project. As with MoS's high-tech dress shirts,
the site has in part evolved into a pre-order destination for
new consumer products.
Despite its focus on early creative projects, launching on
Kickstarter requires substantive concept development. For
example, multiple prototypes are generally required for market
adoption. Started in late 2010, MoS raised angel funding before
going on Kickstarter to increase our odds of success. We waited
one-and-a-half years to launch on Kickstarter, engaging a viral
PR strategy using social media to raise awareness. Surprisingly
effective, our story was featured online in Australia, India,
Sweden, China, and the United States, sparking pre-orders in
over two-dozen countries.
With global traction and roughly 100,000 views of our
videos, we experienced what is known in the startup world as
`going viral'.
Involuntarily rejecting crowd-investors
As a young company, we used the money from pre-orders to
feverishly grow, but we required further funding to build a new
supply chain and hire new employees. Given the buzz from
Kickstarter, we had multiple offers from investors around the
world. However, many were smaller investors (in the $1,000-
$15,000 range). Absent sufficient regulation, legal precedent,
and vetting tools, we experienced the deep irony of having to
turn them away.
Albeit ultimately fruitful, the company's continued search
for angel funding has taken valuable time away from vital
product and business development.
The difference between equity-based and donation based
funding
Donation-based funding remains the holy grail of early
stage ventures, due to its ability to help bootstrap a business
without dilution. Crowd donation is based on goodwill; equity
based funding is based on a mutual higher expected value.
While donation-based is ideal, real-world constraints
necessitate a more continuous stream of funding, especially in
environments with disjointed demand and a difficult path to
profitability. Equity-based funding is simply a much more
reliable model because there is a higher tangible monetary
benefit for both the venture and the investor.
Different levels of funding are required for different
stages
One of the greatest challenges entrepreneurs face with
funding is dilution. If they are forced to sell shares when
their company is worth less, they give up more shares. If I
need to raise $200,000, but my company is worth only $40,000, I
would be forced to give up half of my company that I can't get
back. This not only impacts founders, but also all future
stakeholders.
When companies have to pursue angel funding in a less
robust market, as we did with our interest in consumer
products, they are subject to often-difficult negotiations with
potential investors. There is now less of the pie to be shared.
Crowd investing would allow for a smoothing effect here,
balancing the playing field.
The timing of the JOBS Act and the global stage
The startup community is very excited about the JOBS Act.
Colleagues of mine are eager to test out models that will allow
them to work on their projects. Crowd investing would allow
entrepreneurs to take on projects with greater ease.
MassChallenge, a Boston-based startup competition, has been
recognized by the White House as a key partner in the Startup
America initiative. Last year, 1,237 companies applied for 125
finalist spots, garnering free office space and a summer
program with mentors with several companies receiving a cut of
$1,000,000 in prize money. They received applications from 35
countries. MassChallenge, like the marketplace, is judged
solely based on traction and market adoption. Competition is
now a highly global democracy. America must stay competitive.
Supporting a culture of entrepreneurship and innovation
America holds a nearly unparalleled legacy of
entrepreneurship and innovation. My grandfather, Merton Purvis,
was one of over 1,200 PhDs at Bell Labs at its peak in the
1960s--widely considered to be one of the most innovative
organizations in modern history. Since then, startups have
taken its place as America's innovation engine. Support for
startups must match the speed of global competition.
Programs like Startup Chile provide funding to startups
willing to locate in Chile for 7 months, demonstrating the rest
of the world's desire for the latest new high-tech and high-
growth jobs. Other nations are at the forefront, while America
demurs. Sound regulation for the JOBS Act will change that.
Would crowd investing be used?
In short, yes. Angel investing's limitations are
connections and the liquid market. In venture capital, it is
the idea of being `proven.' In crowd-donation, too long before
or after a certain stage of development, and the donation
community may not accept your story. Moreover, crowd investing
provides a unique tool. The entrepreneurs I have met over the
past 6 years are extremely resourceful and, if given effective
new crowd-funding tools, would make quick use of them.
Conclusion
Crowd investing within the JOBS Act demonstrates America's
continued commitment to developing the next generation of small
businesses and startups. It will provide a real opportunity to
strengthen the economy from the ground up. It remains vital to
consider all elements of this, including items that are still
caught up in legislation, especially the Startup Visa.
New businesses are difficult ventures to undertake, and
anything that safely and effectively puts the advantage in the
hands of the innovator is greatly desired and beneficial to the
economy. Crowd investing through the JOBS Act will be a unique
and exciting way to promote new businesses.
As I've noted, I have used a variety of tools in creating
new ventures, both for product design and business development.
My hope is that my colleagues and I can continue to create new
ventures in a way that leads and inspires the world. I eagerly
await the day that I can fully utilize crowd funding and crowd
investing to help create successful new ventures.
I thank you for this opportunity to explain relevant
concerns of the startup community surrounding the JOBS Act and
crowd investing.
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