[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]



 
                     LEGISLATION TO FURTHER REDUCE 
                    IMPEDIMENTS TO CAPITAL FORMATION 

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

                                HEARING

                               BEFORE THE

                  SUBCOMMITTEE ON CAPITAL MARKETS AND
                    GOVERNMENT SPONSORED ENTERPRISES

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                    ONE HUNDRED THIRTEENTH CONGRESS

                             FIRST SESSION

                               __________

                            OCTOBER 23, 2013

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 113-46


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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    JEB HENSARLING, Texas, Chairman

GARY G. MILLER, California, Vice     MAXINE WATERS, California, Ranking 
    Chairman                             Member
SPENCER BACHUS, Alabama, Chairman    CAROLYN B. MALONEY, New York
    Emeritus                         NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York              MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California          BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma             GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia  MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey            RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas              WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina   CAROLYN McCARTHY, New York
JOHN CAMPBELL, California            STEPHEN F. LYNCH, Massachusetts
MICHELE BACHMANN, Minnesota          DAVID SCOTT, Georgia
KEVIN McCARTHY, California           AL GREEN, Texas
STEVAN PEARCE, New Mexico            EMANUEL CLEAVER, Missouri
BILL POSEY, Florida                  GWEN MOORE, Wisconsin
MICHAEL G. FITZPATRICK,              KEITH ELLISON, Minnesota
    Pennsylvania                     ED PERLMUTTER, Colorado
LYNN A. WESTMORELAND, Georgia        JAMES A. HIMES, Connecticut
BLAINE LUETKEMEYER, Missouri         GARY C. PETERS, Michigan
BILL HUIZENGA, Michigan              JOHN C. CARNEY, Jr., Delaware
SEAN P. DUFFY, Wisconsin             TERRI A. SEWELL, Alabama
ROBERT HURT, Virginia                BILL FOSTER, Illinois
MICHAEL G. GRIMM, New York           DANIEL T. KILDEE, Michigan
STEVE STIVERS, Ohio                  PATRICK MURPHY, Florida
STEPHEN LEE FINCHER, Tennessee       JOHN K. DELANEY, Maryland
MARLIN A. STUTZMAN, Indiana          KYRSTEN SINEMA, Arizona
MICK MULVANEY, South Carolina        JOYCE BEATTY, Ohio
RANDY HULTGREN, Illinois             DENNY HECK, Washington
DENNIS A. ROSS, Florida
ROBERT PITTENGER, North Carolina
ANN WAGNER, Missouri
ANDY BARR, Kentucky
TOM COTTON, Arkansas
KEITH J. ROTHFUS, Pennsylvania

                     Shannon McGahn, Staff Director
                    James H. Clinger, Chief Counsel
  Subcommittee on Capital Markets and Government Sponsored Enterprises

                  SCOTT GARRETT, New Jersey, Chairman

ROBERT HURT, Virginia, Vice          CAROLYN B. MALONEY, New York, 
    Chairman                             Ranking Member
SPENCER BACHUS, Alabama              BRAD SHERMAN, California
PETER T. KING, New York              RUBEN HINOJOSA, Texas
EDWARD R. ROYCE, California          STEPHEN F. LYNCH, Massachusetts
FRANK D. LUCAS, Oklahoma             GWEN MOORE, Wisconsin
RANDY NEUGEBAUER, Texas              ED PERLMUTTER, Colorado
MICHELE BACHMANN, Minnesota          DAVID SCOTT, Georgia
KEVIN McCARTHY, California           JAMES A. HIMES, Connecticut
LYNN A. WESTMORELAND, Georgia        GARY C. PETERS, Michigan
BILL HUIZENGA, Michigan              KEITH ELLISON, Minnesota
MICHAEL G. GRIMM, New York           MELVIN L. WATT, North Carolina
STEVE STIVERS, Ohio                  BILL FOSTER, Illinois
STEPHEN LEE FINCHER, Tennessee       JOHN C. CARNEY, Jr., Delaware
MICK MULVANEY, South Carolina        TERRI A. SEWELL, Alabama
RANDY HULTGREN, Illinois             DANIEL T. KILDEE, Michigan
DENNIS A. ROSS, Florida
ANN WAGNER, Missouri



                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    October 23, 2013.............................................     1
Appendix:
    October 23, 2013.............................................    41

                               WITNESSES
                      Wednesday, October 23, 2013

Abshure, A. Heath, Arkansas Securities Commissioner, on behalf of 
  the North American Securities Administrators Association.......     8
Arougheti, Michael J., Chief Executive Officer, Ares Capital 
  Corporation....................................................    10
Ertel, J. Michael, Managing Director, Legacy M&A Advisors, LLC...    11
Frank, Alexander C., Chief Financial Officer, Fifth Street 
  Management LLC.................................................    13
Quaadman, Tom, Vice President, Center for Capital Markets 
  Competitiveness, U.S. Chamber of Commerce......................    16
Weild, David, Founder, Chairman, and Chief Executive Officer, 
  IssuWorks......................................................    18
Wunderlich, Gary K., Jr., Chief Executive Officer, Wunderlich 
  Securities, on behalf of the Securities Industry and Financial 
  Markets Association (SIFMA)....................................    14

                                APPENDIX

Prepared statements:
    Abshure, A. Heath............................................    42
    Arougheti, Michael J.........................................    58
    Ertel, J. Michael............................................    64
    Frank, Alexander C...........................................   104
    Quaadman, Tom................................................   108
    Weild, David.................................................   154
    Wunderlich, Gary K., Jr......................................   174

              Additional Material Submitted for the Record

Garrett, Hon. Scott:
    Letter to Representatives Garrett and Maloney from the 
      Financial Services Roundtable..............................   180
    Written statement of Joseph Ferraro, General Counsel, 
      Prospect Capital Corporation...............................   181
    Letter to Representative Elizabeth Esty from Michael F. 
      Foley, former President and CEO, Reflexite Technology 
      Corporation................................................   183
    Letter to Representatives Garrett and Maloney from the Small 
      Business Investor Alliance.................................   185
    Letter to SEC Chair Mary Jo White from various companies.....   187
Maloney, Hon. Carolyn:
    Letter to Representatives Garrett and Maloney from SEC Chair 
      Mary Jo White..............................................   191
Sherman, Hon. Brad:
    Letter to Representatives Garrett and Maloney from the 
      National Association of Federal Credit Unions..............   196


                     LEGISLATION TO FURTHER REDUCE
                    IMPEDIMENTS TO CAPITAL FORMATION

                              ----------                              


                      Wednesday, October 23, 2013

             U.S. House of Representatives,
                Subcommittee on Capital Markets and
                  Government Sponsored Enterprises,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to notice, at 2:28 p.m., in 
room 2128, Rayburn House Office Building, Hon. Scott Garrett 
[chairman of the subcommittee] presiding.
    Members present: Representatives Garrett, Hurt, Royce, 
Huizenga, Grimm, Stivers, Mulvaney, Hultgren, Ross; Maloney, 
Sherman, Moore, Scott, Himes, Peters, Watt, Foster, Carney, 
Sewell, and Kildee.
    Ex officio present: Representative Hensarling.
    Also present: Representative Duffy.
    Chairman Garrett. Good afternoon. The Subcommittee on 
Capital Markets and Government Sponsored Enterprises is hereby 
called to order. And I welcome the panel and their indulgence 
as we just concluded votes for the morning until the next 
series of votes. Before we go to the panel, we will have 
opening statements, and I will begin by yielding myself 3 
minutes.
    Today's hearing, as you all know, is on legislation to 
further reduce impediments to capital formation for who? For 
America's small businesses. In a moment, I am going to 
recognize my colleagues for opening statements to introduce 
their legislative proposals. But first, I would like to briefly 
highlight a mixed bag, if you will, of recent developments in 
the area of small business capital formation.
    First, data continues to flow in on the early impact of the 
JOBS Act and the results are very encouraging. Thanks in large 
part to the law's self-executing IPO on-ramp provisions, this 
is helping to shape up to be one of the best years for IPOs 
since 2007, and with more than 150 of them through the first 
three quarters and counting, it is a good track record. And so 
for our tech savvy crowd, I guess you could simply say with a 
hash tag the JOBS Act is working.
    Now, in addition, while the SEC's statutory mission to 
promote capital formation has largely been ignored over the 
past 4 years, it does seem that the Commission is finally 
getting around to its responsibilities under the JOBS Act. Back 
in July, the SEC issued rules lifting the ban on general 
solicitation and advertising in connection with certain private 
security offerings to credit investors and that was mandated by 
Title II of the JOBS Act. So this rule change was expected to 
be a milestone on the road to improving small business capital 
formation through the private securities market.
    Unfortunately, in Washington these days things are never as 
simple as they should be. Instead of following Congress' 
straightforward and narrow mandate to lift the ban on general 
solicitation and advertising for certain private security 
offerings, the SEC also saw fit, over the objections of two 
Commissioners, to issue an additional, unrelated proposal to 
change the disclosure and filing requirements for these very 
same offerings.
    This proposal, which was not called for by the JOBS Act, is 
apparently intended to protect the already more sophisticated 
investors who may participate in these offerings. However, it 
is likely to impose additional new and significant costs and 
burdens on small businesses who are trying to seek to raise 
capital through private security offerings and thereby reduce 
the attractiveness of these offerings and thereby undermine the 
very purpose of the JOBS Act in the first place.
    So although Chair White wants the SEC to move expeditiously 
towards the adoption of this proposal, I would urge her and her 
colleagues on the Commission to seriously rethink whether it is 
the best option available to balance the SEC's important duties 
both to protect investors and to promote small business capital 
formation. Indeed, it seems that the SEC too often forgets that 
an important part of protecting investors is ensuring that they 
have access to a variety of investment options. And so with 
respect to the remainder of the JOBS Act, earlier today the SEC 
voted in favor of issuing proposed rules to implement Title 
III, the crowdfunding provisions. And, frankly, I have not had 
a chance to review the crowdfunding proposals. I hope that this 
time the SEC has stayed true to the terms of the statute. I 
also hope that a proposal from the SEC on regulation A will 
follow before the end of the year.
    Now, on top of the JOBS Act, more can and should be done to 
help small businesses raise much-needed capital to grow and 
create jobs during this period of record-breaking government 
red tape, tepid economic growth, and persistently high 
unemployment.
    And so, finally, to that goal, I would like to recognize 
the great work of Representatives Maloney, Grimm, Velazquez, 
and Mulvaney on their bills addressing the regulations of 
business development companies (BDCs). Also, we have 
Representative Huizenga on his bill addressing the regulation 
of mergers and acquisition brokers. Additionally, we have over 
here Vice Chairman Hurt on his proposal to create a voluntary 
filing exemption for small companies, and you have 
Representative Duffy's bill on his proposal to create the tick-
size pilot program, and finally Representative Fincher on his 
proposals to improve Title I of the JOBS Act.
    And with that, I will look to some of those Members later 
on for their opening statements, but at this point I would like 
to turn to the ranking member of the subcommittee, the 
gentlelady from New York, for 4 minutes.
    Mrs. Maloney. Thank you, Chairman Garrett, for holding this 
important hearing. And I want to particularly welcome Mr. 
Weild, Mr. Arougheti, and Mr. Frank, who are all from the 
district that I am privileged to represent. This legislative 
hearing is the product of two informative hearings that this 
subcommittee held earlier this year, and I hope that this 
hearing will move our process forward.
    The United States has the deepest, most liquid, and most 
effective capital markets in the world. The United States stock 
market is 13 times larger than the British and 14 times larger 
than Germany's. Simply put, the United States is where 
businesses come to raise money from investors. The sheer size 
of our stock market is attractive for investors because they 
know they will be able to sell their investment quickly if they 
need to.
    But, unfortunately, small businesses still have trouble 
raising funds in these markets. Between 1991 and 2007, the 
number of small companies that went public in our securities 
markets declined by 92 percent. Providing incentives for 
greater investment in our country's businesses and our 
entrepreneurs will allow these companies to innovate, hire new 
workers, launch new products, and ultimately grow our economy.
    However, we also need to keep in mind that one of the main 
reasons the U.S. markets are the envy of the world is the 
transparency and trust that come from public disclosure. I have 
always said that our markets operate more on trust and 
confidence than on capital.
    That is why it is so important that we get the right 
balance between increased incentives for capital formation and 
healthy public disclosure that benefits all investors. We also 
need to make sure that any reforms we consider passing don't 
harm the tremendous improvements our markets have made in the 
past 3 decades.
    As Chairman Garrett has noted, one of the big takeaways 
from the roundtable on market structure that he hosted earlier 
this year in New York was that today's retail investors have 
better access to the markets and at lower costs than ever 
before.
    It is important not to lose sight of these benefits. And 
given what we went through with the financial crisis, it is 
also important that we put safety and soundness concerns first. 
As SEC Chair White has said, if there is a way to increase 
incentives for capital formation in a way that also protects 
the safety and soundness of the system, then we should work 
together towards that goal.
    The bills that we are considering today represent a good 
faith and sometimes bipartisan effort to improve our markets 
and grow our economy. I look forward to a very informative 
discussion of these bills from our distinguished panel. Thank 
you for being here.
    Chairman Garrett. Thank you.
    Mr. Hurt is recognized for 2 minutes.
    Mr. Hurt. Thank you, Mr. Chairman. Mr. Chairman, I want to 
thank you for holding today's hearing on reducing barriers to 
capital formation. I am glad that this subcommittee is moving 
forward with additional proposals to increase access to capital 
for our small businesses and our startups.
    Our hearings over the summer have shown that while the JOBS 
Act has been successful, more still needs to be done to ensure 
that we remove or refine costly regulations, especially those 
disproportionately affecting small or public companies and 
those who are considering accessing capital in the public 
markets. While a single regulation's effect may appear 
insignificant, the combined costs of our regulatory climate 
produce exponential consequence. For that reason, I appreciate 
the subcommittee taking a holistic approach to examining our 
capital markets' regulatory structure and its impact on 
innovative companies.
    One such requirement is related to the use of Extensible 
Business Reporting Language (XBRL), which was mandated by the 
SEC in 2009 and designed to lower the cost of capital for 
smaller companies and provide more efficient access to 
information for investors. While the SEC's rule is well-
intended, this requirement has become another example of a 
regulation where the costs outweigh potential benefits. Smaller 
companies expend tens of thousands of dollars or more complying 
with the regulation, yet there is evidence that less than 10 
percentage of the investors actually use XBRL, further 
diminishing its potential benefits. That is why I am interested 
in legislation to provide relief from the disproportionate 
burdens of XBRL.
    The legislation under discussion would provide an exemption 
for emerging companies from complying with this regulation. It 
is important to note that nothing in the draft would preclude 
companies from utilizing XBRL for their regulatory filings with 
the SEC if they so choose. Rather, it allows these companies to 
assess whether the costs incurred with compliance are 
outweighed by any potential benefits from utilizing this 
technology.
    I believe the draft offers a practical step forward with 
XBRL requirements in line with the intent of the JOBS Act, 
ensuring that our regulatory structure is not 
disproportionately burdening smaller companies and 
disincentivizing innovative startups from accessing our public 
markets.
    I look forward to the testimony of our distinguished 
witnesses and thank them for their appearance before the 
subcommittee today. Mr. Chairman, I thank you, and I yield back 
the balance of my time.
    Chairman Garrett. The gentleman yields back.
    The gentleman from California is recognized for 2 minutes.
    Mr. Sherman. Thank you, Mr. Chairman.
    We always have to balance on the one hand transparency and 
investor protection, which brings capital into our markets, 
with minimizing the costs of those companies trying to raise 
money. We should keep in mind that it is only for less than 2 
centuries of human history that people invest with strangers, 
and they can do that only because we have a good and 
transparent accounting and financial reporting system that is 
reliable.
    We can provide more capital to the smallest businesses 
doing something that is outside the scope of today's hearings, 
and that is allowing credit unions to make business loans. We 
bailed out banks that still aren't making the small business 
loans that they ought to be making, some of the giant banks. 
Here we have credit unions who just want the U.S. Government to 
get out of the way and let them make business loans, and we 
should be acting on that bill.
    Finally, I want to recognize Mr. Quaadman of the Chamber 
for his work in preventing a grave threat to all business 
financings involving borrowing from a $100,000 bank loan to a 
multibillion-dollar bond indenture, and that is the proposal of 
the Financial Accounting Standards Boards to ``capitalize 
leases.'' This would add over $2 trillion to the liabilities 
listed on the balance sheets of unsuspecting businesses. 
Financial Accounting Standards Board exposure drafts are rarely 
on the front page of any newspaper, and so these businesses 
don't know what is about to possibly hit them. But most 
businesses that borrow have loan covenants, which means that if 
they added to their liabilities, even if they added an equal 
amount to their assets, and even if that addition wasn't a 
change in business but just a change in accounting principles, 
they would be in violation of their loan covenants and the 
money would be due immediately. That poses a risk to the 
financing of businesses that I hope this committee will look at 
separately.
    I yield back.
    Chairman Garrett. The gentleman yields back.
    The gentleman from New York, Mr. Grimm, is recognized for 
1\1/2\ minutes.
    Mr. Grimm. Thank you, Mr. Chairman.
    And thank you, Mr. Mulvaney.
    Chairman Garrett. We appreciated the help from the 
gentleman for paying attention.
    Mr. Grimm. Thank you for calling the hearing. I appreciate 
it because it is extremely important that we discuss several 
legislative proposals that would increase capital formation and 
further economic growth and job creation. I am very proud to 
have introduced one of the bills under consideration today, 
H.R. 1800, the Small Business Credit Availability Act.
    This commonsense legislation would increase the ability of 
business development companies, otherwise known as BDCs, to 
lend to small and midsized firms, the key drivers of new job 
growth in our economy. H.R. 1800 would allow BDCs to modestly 
increase their leverage, accurately reflect how their preferred 
stock is considered for regulatory purposes, and harmonize 
their securities issuance procedures with those of other 
registered firms.
    At a time when our economy is still struggling to create 
jobs and erase the damage done during the great recession, we 
must strive to do all that we can to ensure the flow of much-
needed capital to Main Street businesses and make sure they are 
not interrupted. In the wake of the financial crisis, BDCs 
filled an important void in the economy by continuing to 
provide much-needed capital to small firms. It is crucial that 
we ensure that they are able to continue in this vital role.
    So I look forward to hearing from all the witnesses today. 
I would like their thoughts on BDCs and the other important 
legislation that is before us. And I yield back.
    Chairman Garrett. The gentleman yields back.
    And Ms. Moore is recognized for 2 minutes.
    Ms. Moore. Thank you, Mr. Chairman. It sure is good to be 
back at work. I think that this is an auspiciously timed 
hearing after the whole shutdown debt ceiling episode, a step 
in the wrong direction, to be trying to now look at legislation 
that might promote positive, sustainable, and widespread 
economic growth.
    I think there are very varying degrees of merit to the many 
ideas that are coming before this committee today, but I do 
think that this is an opportunity for the authors, the sponsors 
of these drafts to help us come to some kind of consensus.
    I have not committed myself to any of these ideas, but I do 
think that proposals that my colleague from Wisconsin, 
Representative Duffy, on tick size, is of interest to me. The 
credit union business lending bill is of some interest to me. 
And I strongly encourage the sponsors to work with the SEC and 
State regulators on those proposals that impact the so-called 
accredited investors definition as a part of implementing the 
JOBS Act.
    After some of the more high profile cases, like Bernie 
Madoff, I think this is a really, really critical undertaking 
by the SEC, and the committee needs to work in sync and be 
mindful of that process.
    I thank you so much, Mr. Chairman and committee members, 
and I look forward to hearing from our witnesses.
    Chairman Garrett. Thank you. The gentlelady yields back.
    Mr. Huizenga for 1 minute, please.
    Mr. Huizenga. Thank you, Mr. Chairman, and Ranking Member 
Maloney.
    Since 2006, the Securities and Exchange Commission has 
highlighted the merger and acquisition broker proposal as one 
of its top recommendations to help small businesses. However, 7 
years later--count them, 7 years later--the SEC has not acted 
on this recommendation. I have been working with a constituent, 
Shane Hansen, who has been very involved in this, who had 
testified earlier, and that is why I, along with 
Representatives Brian Higgins and Bill Posey, introduced H.R. 
2274, the Small Business Mergers, Acquisitions, Sales, and 
Brokerage Simplification Act.
    This bipartisan legislation would create a simplified SEC 
registration system for brokers performing services in 
connection with the transfer of ownership of smaller, privately 
held companies. It has been estimated that approximately $10 
trillion, that is trillion with a ``T,'' of privately owned 
Main Street mom-and-pop type businesses will be sold or closed 
as baby boomers retire. We don't want them closed, we want them 
sold so that they can continue. We must streamline and simplify 
the regulatory structure so small and midsized businesses are 
able to safely, efficiently, and effectively sell their 
companies while preserving and protecting jobs at these 
companies.
    Thank you, Mr. Chairman. I appreciate the time.
    Chairman Garrett. The gentleman yields back.
    The gentleman from Georgia for 2 minutes.
    Mr. Scott. Thank you, Mr. Chairman.
    I think it is very important for us to understand why the 
BDCs were put together in the first place. Back in 1980, 
Congress created the BDCs as a specialized type of closed-end 
investment company whose primary goal is to invest in and 
provide managerial assistance to small and growing and 
financially troubled domestic businesses. Today, there are 68 
active BDCs with the total assets of $53.7 billion, and the 
BDCs are required to invest 70 percent--70 percent--of their 
funds in what are called eligible portfolio companies. These 
are private companies or publicly held companies with a public 
float of less than $250 million, and an eligible portfolio 
company does not include mutual funds, hedge funds, or other 
private funds. But the BDCs do have a broader discretion 
regarding the remaining 30 percent of funds, so they are quite 
flexible.
    Another feature of the BDCs is that they are also required 
to provide significant managerial assistance to eligible 
portfolio companies, which can include providing guidance on 
management, business operation of the company, and exercising 
or controlling influence over the company. And because they are 
publicly traded, BDCs provide a unique opportunity for retail 
investors to invest in private companies.
    But I do have one concern here, and I hope that the 
committee, as we go forward on these three bills with our 
assessment of the BDCs and questions of how we can reduce 
barriers of capital formation through legislative means, that 
we must be mindful of how such adjustments that we might make 
might inadvertently divert capital away from the small growing 
businesses that the BDCs were originally created to help. As 
always, the hallmark of this committee is the delicate balance 
that we seek.
    Thank you, Mr. Chairman.
    Chairman Garrett. And I thank the gentleman. The gentleman 
yields back.
    Mr. Mulvaney is recognized for 1 minute.
    Mr. Mulvaney. Thank you.
    As the chairman noted, the purpose of today's hearing is to 
investigate the possibilities of reducing impediments to 
capital formation. And along those lines I am appreciative of 
the opportunity to include in the discussion today H.R. 1973, 
the Business Development Company Modernization Act, a fairly 
simple bill. For some reason back in 1980, the last time we 
changed this, we limited BDCs and their ability to invest in 
financial services companies. They can only invest 30 percent 
of their capital in those businesses.
    I imagine that might have made sense in 1980. I have no 
idea why it would make sense today. These are companies that we 
excel at as Americans, excel at in their ability to employ 
people, to grow businesses, and I am interested in trying to 
see us get rid of what is admittedly an arbitrary cap. So I 
appreciate several members of the panel today who have said 
favorable things about H.R. 1973. I look forward to continuing 
that discussion today because I think it is a great opportunity 
for us to do exactly what we have talked about, which is 
improving capital formation.
    With that, I thank the chairman for the opportunity.
    Chairman Garrett. And I thank the gentleman for his 
legislation and for yielding back.
    And the last word on this will be Mr. Duffy for 1\1/2\ 
minutes.
    Mr. Duffy. Thank you, Mr. Chairman, and I appreciate the 
panel taking time out of their day to provide testimony to the 
committee. I have been working on legislation with the 
gentleman from Delaware, Mr. Carney, that would establish a 
pilot program that would allow emerging growth companies to 
trade at 5 and 10 cent increments. Why? We all know that 
America's number one job creators, our small businesses, still 
need help. Congress put aside partisan differences last year 
and passed the JOBS Act, which removed a number of barriers to 
raising capital to start a business. It is only logical that 
the next step is to help improve the liquidity of emerging 
growth companies once public.
    This is the main purpose of our proposal. It is no secret 
that the number of U.S.-listed IPOs raising less than $50 
million has declined since the 1990s. Then, there were 
typically more than 100 such IPOs. Last year, there were less 
than 10.
    Further, when the SEC implemented decimalization, larger 
companies saw an influx of investors, while our smaller 
companies saw their liquidity decrease. I believe that this 
issue can be partially remedied through reforms to our tick 
sizes for our small cap companies.
    I look forward to all of your comments on how we could 
create better liquidity with increasing our tick sizes. And 
with that, Mr. Chairman, I yield back.
    Chairman Garrett. And the gentleman yields back, which 
concludes, I believe, the opening statements.
    And now we can get to the matter at hand. So before you all 
begin, let me just remind you that your full written testimony 
will be made a part of the record, and you will now be 
recognized for 5 minutes. For those of you who have not been 
here before the committee before, you have a warning light that 
is in front of you: it is green when you start; yellow when it 
gets down to the last minute; and red when your time is up.
    I also will probably ask each and every one of you to make 
sure that you bring the microphone closer to you than it is for 
just about everyone right now, since the microphone is very 
sensitive to that.
    So with that being said, I now recognize Mr. Abshure, the 
Arkansas Securities Commissioner, testifying on behalf of the 
North American Securities Administrators Association. Thank 
you, and welcome to the panel.

      STATEMENT OF A. HEATH ABSHURE, ARKANSAS SECURITIES 
   COMMISSIONER, ON BEHALF OF THE NORTH AMERICAN SECURITIES 
                   ADMINISTRATORS ASSOCIATION

    Mr. Abshure. Good afternoon, Chairman Garrett, Ranking 
Member Maloney, and members of the subcommittee. I am Heath 
Abshure, Arkansas Securities Commissioner. Until earlier this 
month, I was also the president of the North American 
Securities Administrators Association, or NASAA, the 
association of State and provincial securities regulators.
    Prior to serving NASAA as president, I served as the 
chairman of both NASAA's Special Committee on Small Business 
Capital Formation and NASAA's Corporation Finance Section. In 
addition, since 2011, I have served as an observer member of 
the SEC's Advisory Committee on Small and Emerging Companies, 
which has recently considered a number of the same questions 
that will be examined at the hearing today.
    I personally have a deep interest in small business finance 
and capital formation, and I am honored to testify for a second 
time before this subcommittee about these issues. In 2011, I 
testified before this subcommittee and expressed concern about 
many of the policies in the JOBS Act, including legislation 
directing the SEC to lift the ban on general solicitation in 
private securities offerings and to legalize equity 
crowdfunding. I remain deeply concerned that some of the 
policies enacted under the JOBS Act, including in particular 
the lifting of the ban on general solicitation in Reg D, Rule 
506 offerings, will be detrimental to investors and ultimately 
to the companies that rely on this method of capital formation.
    The SEC is currently considering a number of proposed 
amendments to the general solicitation rule adopted in July 
pursuant to Section 201 of the JOBS Act. State securities 
administrators strongly support many of the proposed 
amendments, and we consider it particularly essential that the 
Commission move swiftly to adopt the requirement that Form D be 
filed prior to the use of general solicitation.
    Today, the subcommittee is considering a number of new 
bills related to capital formation. NASAA's view regarding this 
new collection of bills is mixed. NASAA supports a number of 
these proposals, especially the proposed Small Business 
Mergers, Acquisitions, Sales, and Brokerage Simplification Act 
sponsored by Congressman Huizenga. NASAA also understands the 
need for some delay or regulatory forbearance for small 
businesses that may be struggling to meet the SEC's requirement 
that certain filings be made using Extensible Business 
Reporting Language.
    At the same time, NASAA has concerns with other legislation 
pending before the committee today. Most notably, NASAA is 
troubled by the proposal to further expand what are basically 
new, untested regulatory carve-outs for emerging growth 
companies. NASAA is additionally dismayed by proposals to 
increase leverage limits with respect to the investment 
activities of business development companies and strongly 
opposed to allowing BDCs to invest in financial services 
companies, including investment advisers. In our view, such 
policies would invite problems such as conflicts of interest, 
dilution of common shareholders, and investment risk due to 
lack of transparency. These policies would turn BDCs into 
speculative hedge funds for unsophisticated, nonaccredited 
investors.
    In addition, NASAA cannot help but observe that competition 
from financial services firms will not benefit traditional BDC 
portfolio companies, meaning small operating companies that 
produce goods or provide services. If Congress were to enact 
such changes, the result would be that small businesses which 
create jobs in the real economy would be forced into 
competition with financial firms for BDC capital. This would 
frustrate the subcommittee's goal of spurring job growth. BDCs 
were initially created for the purpose of providing capital to 
domestic small and medium-sized businesses that participate in 
the real economy and not jobs in the financial services 
industry.
    Finally, there are some bills before the subcommittee, 
including notably Congressman Duffy's bill dealing with tick 
sizes, on which NASAA does not have a strong stakeholder 
interest. In discussing these bills, I will offer my own 
personal observations based on my experience as a securities 
regulator, as well as the many discussions I have had with 
other regulators, academics, and industry participants as part 
of my work on the Advisory Committee.
    Thank you again, Chairman Garrett and Ranking Member 
Maloney, for the opportunity to appear before the subcommittee 
today. I would now be pleased to answer any questions you may 
have.
    [The prepared statement of Commissioner Abshure can be 
found on page 42 of the appendix.]
    Chairman Garrett. And the gentleman yields back. Thank you.
    Mr. Arougheti is now recognized for 5 minutes. And welcome 
to the panel.

  STATEMENT OF MICHAEL J. AROUGHETI, CHIEF EXECUTIVE OFFICER, 
                    ARES CAPITAL CORPORATION

    Mr. Arougheti. Chairman Garrett, Ranking Member Maloney, 
and members of the subcommittee, thank you for the opportunity 
to testify today. I am Michael Arougheti, the CEO of Ares 
Capital Corporation, a BDC that has invested more than $14 
billion in more than 450 small and medium-sized companies, 
creating tens of thousands of American jobs.
    Congress created BDCs in 1980 to encourage capital flows to 
small and medium-sized business at a time much like today when 
these businesses had limited options for securing credit. 
Uniquely, the BDC model allows ordinary investors to 
participate in this process, effectively Main Street funding 
Main Street.
    I have been asked today to testify on behalf of the BDC 
industry to express my support for the three pieces of proposed 
legislation, and I think it is important to note that the BDC 
industry is not seeking any government or taxpayer support or 
subsidy.
    Many of the challenges faced by BDCs arise out of their 
peculiar place in the regulatory framework. BDCs are more akin 
to operating companies and commercial finance companies than 
mutual funds. We are a proverbial square peg in a round hole.
    Three bills have been introduced into the House regarding 
BDCs. H.R. 1973, introduced by Congressman Mulvaney, offers 
welcome flexibility for BDC investment in financial 
institutions and finance companies. For example, a BDC 
investing in a growing leasing company might have to curtail 
useful lending to small business because of a limit that in 
context feels quite arbitrary.
    H.R. 31 and H.R. 1800 contain 4 nearly identical provisions 
which we believe illustrate the significant bipartisan support 
for these initiatives. First, both bills propose an increase in 
the BDC asset coverage test from 200 percent to 150 percent. We 
don't believe that this introduces more risk. Rather, it should 
broaden the universe of potential borrowers and allow BDCs to 
invest in lower yielding, lower risk loans that don't currently 
fit in our economic model. In fact, the current asset coverage 
test may ironically be forcing BDCs to invest in riskier, 
higher yielding securities in order to meet the dividend 
requirements of its shareholders.
    We also believe that this change will grant borrowers 
greater financing alternatives at a reduced cost and will 
benefit shareholders with more conservative diversified 
portfolios. This proposed change would apply to BDCs the same 
leverage ratio as small business investment companies, but 
unlike SBICs, without putting any government capital at risk. 
In fact, I also believe that this is extremely modest relative 
to typical bank leverage, which can exceed 10 times or greater. 
Under the current asset coverage test, most BDCs currently 
operate at leverage significantly less than allowed. A prudent 
manager would likely continue this practice if the asset 
coverage were to change.
    Second, both bills would allow BDCs to treat preferred 
stock as equity rather than as debt. Had BDCs been able to 
raise capital during the post-2008 period by issuing preferred 
shares as equity, many more loans could have been made and many 
more jobs created.
    Third, both bills direct the SEC to make specific technical 
amendments to certain securities offering rules that make 
raising capital cumbersome and inefficient. These rule changes 
aren't controversial and would merely place BDCs on equal 
footing with non-BDC entities.
    And fourth, both bills would restore BDCs' ability to own 
registered investment advisers, a right that was inadvertently 
structured away.
    Importantly, the first two provisions of these bills would 
become effective immediately upon passage. The other provisions 
will require action by the SEC.
    So in closing, we are encouraged by the bipartisan focus on 
this important initiative, and we look forward to working with 
Representative Grimm, Representative Velazquez, and 
Representative Mulvaney, as well as Chairman Garrett, 
Representative Maloney, and the rest of the committee in moving 
this important initiative forward. Thank you.
    [The prepared statement of Mr. Arougheti can be found on 
page 58 of the appendix.]
    Chairman Garrett. And I thank you.
    Mr. Ertel is recognized for 5 minutes. And welcome.

 STATEMENT OF J. MICHAEL ERTEL, MANAGING DIRECTOR, LEGACY M&A 
                         ADVISORS, LLC

    Mr. Ertel. Chairman Garrett, Ranking Member Maloney, and 
members of the Capital Markets Subcommittee, thank you for this 
opportunity to explain how today's one-size-fits-all system of 
regulating securities broker-dealers adversely impacts owners 
of privately held companies who seek professional advice and 
business brokerage services to sell, buy, or grow their small 
and midsized businesses through privately negotiated 
transactions.
    Public policy considerations supporting H.R. 2274 go back 
to at least 2005 and have been well-documented in the oral and 
written testimony submitted by Shane Hansen, securities law 
partner with Warner Norcross & Judd, who testified before this 
committee on June 12th.
    My testimony is based on my experience as co-chair of the 
Campaign for Clarity, a profession-wide effort to bring clarity 
to the regulation of M&A advisers and business brokers, which 
has been led by the Alliance of Mergers & Acquisitions Advisors 
and supported by at least 17 other regional, national, and 
international associations of M&A advisers, business brokers, 
and related professionals. My testimony is also based on my 
experience in providing business brokerage and M&A advisory 
services to sellers and buyers of privately held businesses 
since 2000 and being a small business owner myself.
    Since July 2011, I have been a registered representative 
with an SEC and State-registered broker-dealer and FINRA 
member, but I am not speaking for or representing that firm in 
my remarks today. I became a registered rep because in 7 years 
of persistent appeals by the Campaign for Clarity, the SEC has 
yet to address this critical small business issue through 
rulemaking.
    For most business owners, the sale of their business is one 
of the largest personal financial transactions of their lives, 
but something they may do only once. While they may be experts 
at managing and growing their own business, they have little or 
no experience in preparing their company for sale and getting 
it sold and closed. While their attorneys and accountants will 
provide valuable advice, astute business owners recognize they 
may need an experienced professional to quarterback the entire 
multidisciplinary business sale process from start to finish.
    Most business sales start with the buyer preferring to 
acquire business assets and the seller preferring to receive 
all cash at closing. Such a transaction would be exempt from 
Federal and State securities regulation. But for a variety of 
legitimate business and personal reasons, the structure of the 
transaction may morph to one that involves the purchase, sale 
of the company's stock or may include an earnout or a seller's 
note, any of which could arguably convert this business sale to 
a securities transaction. The final deal structure is generally 
not known until very late in the business sale process, which 
can run for months or even years.
    In facilitating the sale of an ongoing business, M&A 
advisers and business brokers are not in the business of 
selling securities, nor do they raise capital, nor do they hold 
anyone's funds or securities, nor do they invest funds for the 
account of others. Nonetheless, the current one-size-fits-all 
regulatory scheme requires business brokers and M&A advisers to 
hold the same FINRA classifications and comply with the same 
Federal and FINRA regulations as Wall Street investment bankers 
and retail securities brokers.
    The cost to organize and operate a FINRA member broker-
dealer for the first 12 months has been estimated at $150,000 
to $250,000. For most business brokers and M&A advisers, this 
is prohibitive. Since many business brokerage firms and M&A 
advisory firms do very few transactions per year, occasionally 
none in some years, and since not all transactions are subject 
to securities regulation, the cumulative cost attributable to 
an occasional securities transaction can be very, very 
substantial. Ultimately, these costs must be passed on to the 
business buyers and sellers.
    In summary, professional and cost-effective business 
brokerage services facilitate capital formation and promote 
economic growth, job preservation and creation by small and 
midsized businesses. H.R. 2274 would direct the SEC to create a 
simplified system of M&A broker registration through a public 
notice filing and would require disclosure to clients about the 
M&A broker similar to those required of investment advisers 
today. The bill would direct the SEC to review and tailor 
applicable rules to fit this business context. This directive 
from Congress to the SEC will ultimately free up resources to 
better protect our public markets and passive investors.
    I urge you to support H.R. 2274, and I look forward to your 
questions.
    [The prepared statement of Mr. Ertel can be found on page 
64 of the appendix.]
    Chairman Garrett. Thank you.
    Next, Mr. Frank. Welcome. You are recognized for 5 minutes.

STATEMENT OF ALEXANDER C. FRANK, CHIEF FINANCIAL OFFICER, FIFTH 
                     STREET MANAGEMENT LLC

    Mr. Frank. Thank you. Good afternoon, Chairman Garrett, 
Ranking Member Maloney, and members of the subcommittee, and 
thank you for the opportunity to speak today. My name is Alex 
Frank. I am the CFO and a partner in Fifth Street Management, 
with over $3 billion in assets under management and the SEC-
registered investment adviser of two publicly traded business 
development companies. Our team has a 15-year track record 
financing small and midsized companies, primarily in connection 
with investments by private equity sponsors.
    BDCs like Fifth Street play an essential role in the new 
world of middle market lending. As traditional banks have 
pulled away from lending to small and midsized private 
businesses, alternative lenders like BDCs have filled the void, 
emerging as the primary conduit between banks and smaller 
companies that are noninvestment grade credits. Consider that 9 
years ago, there were just four publicly traded BDCs. Today, 
there are roughly 10 times as many, and we estimate that within 
the next few years, BDC assets will exceed $100 billion.
    Despite the growing importance of BDCs in helping finance 
small and midsized companies in our economy today, the BDC 
industry is still operating with legacy regulations that cost 
the industry significant amounts of time and money each year. 
Since BDCs are pass-through vehicles, that cost is borne not 
just by BDC shareholders, but by small businesses we serve.
    Several aspects of H.R. 1800 and H.R. 31 could go a long 
way towards modernizing the BDC regulatory framework. Shell 
filing, incorporation by reference, and treating preferred 
equity as regulatory capital will bring parity to the industry 
vis-a-vis counterparts like REITs and MLPs. We also support 
allowing BDCs to own registered investment advisers as a 
shareholder-friendly step that would offer investors 
incremental fee-based revenue.
    As you can see, I join you today as a proponent of the 
proposed rule changes in virtually their entirety. However, as 
the CFO of a conservatively managed investment grade BDC, and 
having spent 22 years working at Morgan Stanley, including 
serving as the firm's global treasurer, I cannot endorse the 
move to a 2:1 leverage ratio.
    Today, the Securities and Exchange Commission does a highly 
effective job enforcing this leverage ratio. I believe the 1:1 
ratio and strict SEC oversight contributes to a reputation for 
safety that is appreciated by both BDC investors and nationally 
recognized rating agencies alike. Permitting 2:1 leverage might 
compel investors to reevaluate the BDC model, and retail 
investors may not appreciate the higher level of risk they are 
taking. And as rating agencies adjust their models, downgrades 
could follow. Even those BDCs who adopt a more conservative 
approach could be penalized and a noninvestment grade credit 
rating would increase a BDC's cost of capital.
    I would like to conclude my testimony with a discussion of 
effective leverage, which takes into account on a look-through 
basis leverage of the underlying assets in which a BDC invests. 
In other words, it is important to recognize that BDCs often 
provide expansion capital to their portfolio companies, which 
are often heavily leveraged themselves.
    Effective leverage is an important concept because it shows 
the true risk in a BDC's balance sheet. Wells Fargo Securities 
estimates the BDC peer group average at 3.5 times equity. But 
the most highly leveraged BDCs have effective leverage ratio 
estimates over 5.5 times. If the bills are enacted in their 
current form, BDCs with already high levels of effective 
leverage could essentially double their effective leverage up 
to 11 times.
    Not all BDCs are alike, and I am also not convinced that 
1:1 leverage is precisely the right level. During this period 
of high growth and increasing small business reliance on BDCs, 
completely removing the safety rails should be reconsidered. 
Having reduced the amount of risk in the financial system by 
requiring banks to hold more capital to support the risks 
associated with lending to noninvestment grade companies, only 
to shift that risk to entities like BDCs already operating with 
less risk, could significantly undermine the long-term vision 
the bill set out to achieve.
    Thank you, Chairman Garrett, Ranking Member Maloney, and 
members of the committee for allowing me to present my views on 
this critically important topic.
    [The prepared statement of Mr. Frank can be found on page 
104 of the appendix.]
    Chairman Garrett. And I thank you for your testimony.
    Mr. Wunderlich is now recognized, and welcome, for 5 
minutes.

STATEMENT OF GARY K. WUNDERLICH, JR., CHIEF EXECUTIVE OFFICER, 
WUNDERLICH SECURITIES, ON BEHALF OF THE SECURITIES INDUSTRY AND 
             FINANCIAL MARKETS ASSOCIATION (SIFMA)

    Mr. Wunderlich. Chairman Garrett, Ranking Member Maloney, 
and members of the subcommittee, thank you for the opportunity 
to appear before you today to discuss various legislative 
proposals to promote capital formation and job creation. My 
name is Gary Wunderlich, and I am CEO of Wunderlich Securities. 
I am testifying today on behalf of the Securities Industry and 
Financial Markets Association.
    Wunderlich Securities is an independent investment firm and 
full service broker-dealer headquartered in Memphis, Tennessee, 
with 28 offices in 16 States employing over 450 people. We 
provide a full range of financial services to retail and 
institutional clients, including investment banking, 
institutional sales, trading, and research.
    So on behalf of SIFMA and its member firms, I am here to 
express our appreciation for this committee's dedication to a 
review of the environment for capital formation.
    America's success depends on a vibrant financial system 
that provides access to capital and credit at a reasonable 
price, and regional firms, such as the one I founded 17 years 
ago, play an integral role in our financial services system, 
particularly to assist smaller issuers.
    Turning to the legislative proposals before us today, I 
would like to begin by discussing our views of one area of 
capital formation that has been frequently debated over the 
past few years: The impact of decimalization on liquidity of 
small cap and midcap issuers. Many have suggested that the move 
to decimalization has contributed to lower levels of liquidity 
in those stocks and that along with other factors has impeded 
capital formation for those companies. This question has been 
posed in a variety of forums of late, including Chairman 
Garrett's recent roundtable, as well as the SEC roundtable on 
decimalization.
    SIFMA and its members have also been engaged in an active 
dialogue about the impact of decimalization on small and midcap 
issuers, and we generally believe that a pilot program which 
widens quote increments for small and midcap issuers would 
increase trading liquidity in those securities.
    SIFMA supports a carefully structured pilot designed with 
very clear metrics for determining success to increase 
liquidity in the small and midcap market and create a more 
fertile environment for small and emerging growth companies to 
access the public markets. We know that these companies can be 
an engine for economic growth, and Congressman Duffy is to be 
commended for considering new ways to incentivize interest in 
small cap issuers seeking growth.
    While SIFMA is supportive of a pilot that explores how a 
wider tick size could benefit small cap issuers, we do oppose 
any pilot program that would restrict trading within the spread 
as the current discussion draft contemplates. Any restriction 
against trading inside the quoting increment would be an 
unprecedented alteration of market practice and would prevent 
broker-dealers from providing price improvement to retail 
investors and deter the commitment of capital for market-making 
activities.
    With respect to market price, trading within the quoted 
spread has always been permitted. Before Reg NMS and before the 
establishment of the stock exchanges themselves, market 
participants have always been able to meet in the middle on a 
negotiation over price. Perhaps more importantly, a trading 
restriction would have a negative impact on Main Street savers 
and retail investors. A consensus of most every market 
structure discussion in recent months is that it has never been 
better to be a retail investor, as the options for routing 
trades have increased, and as a result trading costs have 
substantially decreased.
    Just a few years ago, the SEC considered and rejected a 
trading restriction when it adopted the current penny-wide 
quoting increment, concluding that such price improvement 
benefits retail investors and is in the public interest. The 
SEC's conclusion that it is in the public interest to allow 
trading within the spread is as relevant in 2013 as it was in 
2005.
    Moving on, I would note that SIFMA supports efforts to 
modernize regulation of business development companies as 
contemplated in the three bills we are discussing here today to 
better enable BDCs to fulfill their mission. The BDC structure 
was created to promote public vehicles as a means to bring 
capital to small and medium-sized businesses, and by regulation 
70 percent of BDCs' investments must be in private and small 
cap companies.
    BDCs offer a critical source of capital to eligible 
companies not met in today's environment by traditional 
lenders. In fact, Wunderlich Securities has supported the 
efforts of some 17 BDCs this year alone resulting in more than 
1.3 billion in capital formation.
    Further, Congressman Fincher's discussion draft, which 
would modify existing regulation of EGCs, is also laudable, and 
SIFMA supports each of the four provisions in the discussion 
draft. These modifications remove some technical inefficiencies 
to the JOBS Act on-ramp so as to reduce uncertainty in 
regulatory treatment and allow EGCs more flexibility to launch 
their offerings in a timely manner.
    In conclusion, SIFMA welcomes your continued interest in 
supporting capital formation through appropriate regulatory 
relief. Many in government often try to distinguish Main Street 
from Wall Street, but the capital allocation function provided 
by my firm and thousands of others across this country supports 
the creation and expansion of tens of thousands of small 
businesses which are truly the backbone of our economy and the 
best hope we have for robust job creation moving forward.
    Thank you for the opportunity to testify before you today, 
and I look forward to your questions.
    [The prepared statement of Mr. Wunderlich can be found on 
page 174 of the appendix.]
    Chairman Garrett. Thank you for your testimony.
    From the U.S. Chamber, Mr. Quaadman, welcome.

 STATEMENT OF TOM QUAADMAN, VICE PRESIDENT, CENTER FOR CAPITAL 
       MARKETS COMPETITIVENESS, U.S. CHAMBER OF COMMERCE

    Mr. Quaadman. Thank you, Chairman Garrett, Ranking Member 
Maloney, and members of the subcommittee for the opportunity to 
testify before you today. I would also like to take this time 
to thank the subcommittee for its continued leadership in 
ensuring that the United States has the deepest and most 
efficient capital markets. And I think today's release of the 
crowdfunding rules by the SEC, albeit a lot later than I think 
a lot of us would have liked, is a testament to the leadership 
of this subcommittee.
    A free enterprise system needs diverse capital markets. 
Capital is the fuel that drives our economic engine and 
different businesses have different financing needs. Filling 
those needs is a dynamic marketplace in response to an ever-
changing economic, legal, and regulatory landscape. The 2008 
financial crisis has had obvious impacts upon Main Street 
businesses.
    To take one example out of Dodd-Frank, there is going to be 
a comment period that closes next week on credit risk 
retention, that if the rule is not properly implemented, 
collateralized loan obligations, which finance businesses to 
the tune of $300 billion, could no longer be an attractive form 
of capital formation. Basel III is having direct impacts on 
business lending by small and midsized banks, and Basel III 
also specifically disincentivizes the extension of commercial 
lines of credit by banks.
    The bipartisan legislation that is being presented here 
today by the committee, which the Chamber supports, is keeping 
pace with those dynamic markets and is not lagging behind it.
    Business development corporations are filling a void and 
are a growing source of financing for small and midsized 
businesses. As businesses are looking to be acquired rather 
than go public, the extension of reporting requirements and 
easing of reporting requirements for merger and acquisition 
brokers is key. The tick-size pilot program is an experiment to 
increase liquidity and look at regulatory innovations through 
factual evidence. The XBRL exemption, as well as security laws 
changes for emerging growth companies, are building upon the 
IPO on-ramp created by the JOBS Act.
    However, we do have suggested improvements to these bills. 
With business development corporations, as has been stated 
before, they are close-ended funds that are open to retail 
investors and not just accredited investors, and they have 
higher yields, as well as higher risks. We believe that the 
SEC, in developing implementing regulations, should be directed 
to reexamine disclosures so that investors know what they are 
investing in.
    With XBRL, we believe that the rule 406T grace period 
should be extended for 2 years for large issuers and 5 years 
for smaller issuers. We also believe that there should be a 
requirement for an annual SEC report to Congress on the SEC's 
progress on XBRL, the cost to businesses for XBRL 
implementation, the use of XBRL by investors, and that there 
should also be a report by the SEC to periodically report to 
Congress on the retrospective review of obsolete and 
unnecessary disclosures.
    To give one example that I have in my testimony, one 
Federal agency, working under the auspices of President Obama's 
regulatory reform executive order, took 120 outdated 
regulations off the books on May 17th, and that was the Federal 
Communications Commission, some of those regulations dating 
back to the 1930s. With tick size, we believe that there should 
be a safe harbor from litigation so that as directors and 
management decide on a tick size, it is recognized that they 
are operating within their fiduciary duty for the best 
interests of the corporation and that they should not be 
subject to unnecessary litigation.
    With emerging growth companies, we believe that Rule 701 
should be modernized so that the dollar limit on private 
offerings may conform to the JOBS Act section 12(g) changes. So 
while the JOBS Act changed the number of investors that could 
be subject to private offerings, the $5 million limit that was 
put in place by the SEC in 1988 no longer is indicative of the 
market forces, so if you even just change that for inflation, 
that number today would be $10 billion.
    There is a cost of inaction if these bills are not passed. 
If these bills are not passed, we will see continued economic 
underperformance, sluggish job growth, and business caution. If 
these bills are passed, combined with the implementation of the 
JOBS Act, we can break that cycle and stoke the smoldering 
engines of growth.
    Thank you, Mr. Chairman. I am happy to take any questions 
you have.
    [The prepared statement of Mr. Quaadman can be found on 
page 108 of the appendix.]
    Chairman Garrett. And I thank you, Mr. Quaadman.
    And finally, Mr. Weild is recognized for 5 minutes. And 
welcome to the committee as well.

    STATEMENT OF DAVID WEILD, FOUNDER, CHAIRMAN, AND CHIEF 
                  EXECUTIVE OFFICER, ISSUWORKS

    Mr. Weild. Thank you, Mr. Chairman. Chairman Garrett, 
Ranking Member Maloney, and members of the subcommittee, thank 
you for inviting me to speak today on legislation to further 
reduce impediments to capital formation. My name is David 
Weild. I am chairman and CEO of IssuWorks Holdings, which was 
recently founded to develop technologies to improve capital 
formation in the public markets. I was formerly vice chairman 
of the NASDAQ stock market with responsibility for all of its 
listed companies, and I ran the equity new issues business at 
Prudential Securities back when Prudential Securities was one 
of the 10 largest underwriters in the United States.
    Improving access to equity capital in the United States is 
simply one of the most important needs for our economy. It 
fuels job growth and innovation, which in turn enables free 
markets to solve problems from poverty to unemployment to 
finding cures for cancer, global warming, and many of the other 
challenges that this generation and every other generation will 
face.
    I would like to start by thanking you for the terrific 
bipartisan work that culminated with the signing into law of 
the JOBS Act on April 5th of 2012, but while the JOBS Act 
created the so-called on-ramps to facilitate companies getting 
public, it did nothing to improve the after-market for these 
companies and their investors. So one might legitimately ask, 
have we created the on-ramp to nowhere?
    We are generally supportive of all of the bills in this 
group and our specific comments are contained in our written 
testimony. We have included other recommendations on capital 
formation and job growth in our written testimony and we hope 
that this committee will take it under advisement. However, I 
would like to focus on Mr. Duffy's bill because it speaks to 
after-market support, and without after-market support for 
small cap equities, the U.S. economy will languish.
    Our listed stock markets are in the midst of a protracted 
collapse, and I call your attention to data which is contained 
in our statement that was recently compiled by the CFA 
Institute's Jason Voss. The United States today has fewer 
publicly listed companies than at any point since all the way 
back to 1975. In fact, we have fewer than 4,900 publicly listed 
companies. We have lost half of them from the markets. And we 
should have, if we hadn't done anything to market structure in 
the 1990s, closer to 13,000 publicly listed companies.
    We published a study for the Organization of Economic 
Cooperation and Development in July, and in it we found that 
the United States has the lowest after-market incentives of any 
of the 26 largest IPO markets in the world. Very simply, we are 
starving our markets. Consumer activists who promote low-cost 
trading in stocks are promoting fool's gold. There is no free 
lunch. In fact, low-cost trading in illiquid stocks harms 
consumers by depriving them of higher disposable incomes while 
wreaking havoc on the lowest socioeconomic classes of our 
society. It also seems obvious that the great growth companies 
of tomorrow, those very companies that will find the cure to 
Alzheimer's and global warming and advance the technologies for 
sourcing renewable energy, need a United States IPO market that 
is as vibrant as it used to be when companies like Intel, 
Microsoft, and Amgen went public. We are doing 135 IPOs since 
the end of the dot-com bubble. We were doing over 500 a year 
before the dot-com bubble, and on a GDP-weighted basis we 
should be doing closer to 900 IPOs a year today.
    So we not only support this bill, we hope that this bill 
will, in addition to 5 and 10 cent tick-size increments within 
nano-cap stocks defined as stocks under $100 million in market 
value, consider a 20 cent tick option. The bill should require 
that trading be done only at a minimum tick-size increment, not 
within the tick size.
    And I am going to take issue actually with the SIFMA 
testimony in this regard because much of that is a view that is 
proffered by dark pool interests with the larger firms. You 
have to be very careful not to gut the tick-size incentives and 
takeaway by allowing people to trade within the economic 
incentive and to actually take away the inventive for smaller 
firms to provide value, which is research, capital, commitment, 
and sales support to these stocks. There should also be no 
payment for water flow allowed that would make a mockery of the 
intent of this structure.
    Higher after-market incentives through higher tick sizes 
will lead to more liquidity, which will bring more 
institutional investment, which will raise stock prices in 
smaller stocks, and lead to more IPOs and more job creation 
that will grow the U.S. economy. Today, there are already fewer 
than 3,700 operating companies in the Wilshire 5000 index.
    So with this in mind, we urge Congress to come together and 
get behind this bill and give Americans an on-ramp to 
prosperity. Thank you, Mr. Chairman.
    [The prepared statement of Mr. Weild can be found on page 
154 of the appendix.]
    Chairman Garrett. And thank you for your testimony.
    I welcome everyone, and thank you all for your testimony. 
At this point, we will turn to questions, and I will recognize 
myself for 5 minutes. I will just start with Mr. Abshure.
    Do you see any benefits, either in jobs or benefits to the 
economy, for financial services investment companies, financial 
institutions?
    Mr. Abshure. I guess I am--
    Chairman Garrett. I say that, because your opening comments 
were opposed to the legislation that is before us today that 
would expand for the asset classes the type of assets that they 
may invest in?
    Mr. Abshure. The type of asset classes that BDCs could 
invest in.
    Chairman Garrett. Yes.
    Mr. Abshure. Do I see a benefit of BDCs investing in 
financial services companies?
    Chairman Garrett. Do financial services companies not 
provide the economy with growth to the economy? Do they not 
provide the economy with new jobs and the like?
    Mr. Abshure. They invest in companies that do that. But if 
you already have--
    Chairman Garrett. But they don't provide them jobs and what 
have you in amongst themselves?
    Mr. Abshure. Not in the way that BDCs were designed. You 
have a carve-out specifically for BDCs that was designed for 
small companies, startup companies, and financially distressed 
companies. And then you have that mechanism for unaccredited 
investors to invest in those companies. Financial services are 
something different. And my point is, if you allow BDCs to 
invest in financial services companies that are, in turn, going 
to be a conduit for that capital to go somewhere else, you have 
just inserted a second step that provides no benefit but more 
cost. If BDCs can invest in what a financial services company 
can invest in, why do they need to be there?
    Chairman Garrett. Okay. I see your point. You are 
suggesting that we are not getting any benefits from those 
financial institutions in and amongst themselves. I would 
disagree with that.
    Turning to the questions that Mr. Weild was talking about, 
you seem fairly passionate about the issue of the--I guess on 
the Duffy language and the trade-out rule. In your testimony, 
you said trading should be done only at the ``outer bounds of 
minimum tick size increments, not within the tick increment.'' 
And you go on to say this may be controversial.
    First, why do you say that may be controversial?
    Mr. Weild. We don't trade stocks, so we don't have a horse 
in this race. I can step back and I think be objective.
    There are lots of interests right now that provide so-
called price improvement to investors, a tenth of a penny, 
something that is relatively trivial. Large cap markets can 
perform very well because there are lots of buyers to offset 
sellers. There is a network effect. It is what academics will 
call symmetrical order book markets. But in small cap markets, 
which are asymmetrical--big buyer, no seller; big seller, no 
buyer--somebody has to provide value capital, and they have to 
provide salesmen to find the other side of the order. So you 
need an economic incentive to do that, and the minute they 
start trading within the tick size, the market devolves and it 
starts competing exclusively on price, so the whole thing 
starts to fall apart again.
    So I don't think it will work, Chairman Garrett, in my 
view, and I think that if you give people a real nickel, and 
everybody trades, say at 10 by 1005, then what it will do is it 
will cause the firms to think about how to provide value to 
attract order flow, to create order flow, and it will start to 
bring capital into these micro-cap markets, lift them, which 
will then make them more attractive to move market IPOs into.
    Chairman Garrett. So if we do something along the lines of 
setting--I will open this to you and other members, Mr. 
Wunderlich, if you wanted to join in--if we do something along 
the lines of setting of a pilot program, are there ways to do 
it such that you could set up measurement matrices to actually 
measure what you are talking about, and also measure liquidity 
in the marketplace on this?
    Mr. Weild. Sure. You could set up different baskets of 
stocks where you actually test where you have pull sanctity to 
the tick size, where you allow maybe even, it has been said 
trade at one price point within the tick size so that, for 
instance, if it was a nickel tick, you can trade at 2.5 cents, 
but that is it. And then, sort of the status quo. And you could 
test three buckets.
    You have to be careful though because Wall Street sometimes 
can be very crafty and they can ``paint the tape,'' to use an 
old term.
    Chairman Garrett. What do you mean?
    Mr. Weild. Meaning that you can have some interest that if 
you have a basket of 100 stocks, that if they want to 
demonstrate that there is more volume in one particular size, 
they may actually push volume through one pile, which could be 
very careful to control.
    Chairman Garrett. Yes, okay.
    Mr. Wunderlich, do you want to join in on that?
    Mr. Wunderlich. Our position, SIFMA's position is that 
there is value in the off-exchange pools and there is price 
improvement that we think is very demonstrable. Any restriction 
or prohibition on trading, on free market trading, we think 
would be a deterrent and distort actual market valuation and 
efficiency.
    I can speak on behalf of Wunderlich Securities. In my firm, 
we are market makers. Our market-making activities have come 
way down from when decimalization was put in place. And a part 
of it is, so it is not, ``Wall Street trying to make more 
money,'' it is managing risk. And so if I know now I have to 
trade at a nickel, or a dime, or even 20 cents, I am less 
likely to commit as much capital to market-making activities as 
I would if I knew that I could negotiate a price as a buyer and 
seller.
    Mr. Weild is right in that it can be a somewhat inefficient 
market, certainly without market makers. There are large buyers 
at some times and a few sellers, and there are large sellers 
and sometimes a few buyers. And market-making activities which 
we would undertake are to facilitate those orders. We could 
potentially take one side of that trade in order to facilitate 
an order from a customer who had a position, whether buying or 
selling. But we are less likely to do that if we are being 
prohibited or restricted on how we can liquidate that position.
    Chairman Garrett. How you do the trade--yes? I can keep on 
going on this, but my time is up. And before I yield to the 
gentlelady from New York, I would just like to recognize the 
former chairman of the Financial Services Committee, who is not 
only looking at me in the face now, but is also looking over my 
shoulder as well, and welcome Chairman Oxley.
    It is good to be with you again.
    And of course I should point out that he is one of the 
reasons why I am even on this committee here in the position I 
am in today, so thank you for that as well, Mr. Chairman.
    At that, I will yield to the gentlelady from New York.
    Mrs. Maloney. I likewise would like to recognize the 
gentleman who is literally on the wall, usually in the 
chairman's seat. It is very good to see you again, Chairman 
Oxley. It is wonderful to see you.
    I would like to start with Mr. Frank. You testified that 
basically, allowing BDCs to double their leverage would magnify 
the risk to shareholders, which are often retail investors. 
Mary Jo White, the Chair of the SEC, shares your concern in a 
letter that arrived today, and I would like to ask unanimous 
consent to make that letter a part of the record.
    Chairman Garrett. Without objection, and it should be 
indicated that this is a letter with which I am familiar. This 
is a letter from Ms. White in her individual capacity and not 
from the SEC.
    Mrs. Maloney. Right.
    Chairman Garrett. Without objection, it is so ordered.
    Mrs. Maloney. Thank you.
    And I would like to know, do any other panelists agree with 
Mr. Frank's position on this issue? Does anybody else agree 
with him? No one else does? Does anyone disagree with him, and 
would they like to give their position? Mr. Arougheti?
    Mr. Arougheti. I would be happy to, for a counterpoint.
    First of all, representing the BDC industry today, to my 
knowledge, I think Fifth Street is the only member of this 
growing industry who has come out in opposition of an increase 
in leverage or a change in the asset coverage ratio. I have 
difficulty reconciling that with the fact that they also signed 
a letter of support for the proposed legislation with a host of 
other industry participants that came from the SBIA to the SEC 
a couple of weeks ago.
    In order to really understand this, I think it is important 
to just maybe take a step back and understand how the assets 
that BDCs invest in are already getting leveraged in the market 
and how the market participants are thinking about the 
increased risk.
    First, I think it is also worth clarifying that about 40 
percent of investors in BDC stocks today are sophisticated 
institutions and not retail, and it may be a misconception that 
retail investors are driving growth in the BDC space.
    If you look at BDC balance sheets today, BDCs, depending on 
who you are, pursue different business models. Some BDCs invest 
in riskier mezzanine loans, which on their face are not 
leverageable due to their higher risk, and to use Mr. Frank's 
language, have a higher effective leverage and therefore will 
not command leverage at the portfolio level. Other BDCs, such 
as ourselves, pursue a less risky strategy focusing on senior 
secured loans, which by definition carry less risk and 
therefore can command greater leverage. So the idea of leverage 
of loan collateral is something that is well-documented and 
already in practice in the BDC space in the financial services 
industry generally.
    To put a finer point on that, leverage in the BDC industry 
today is about 50 percent provided by banks. To use Ares as an 
example, we have about $2 billion of leverage that we get from 
the banking community, from notable lenders such as JPMorgan, 
Merrill Lynch, and Bank of America, et cetera, and we have 50 
percent of our leverage that comes from the institutional debt 
markets.
    If you drill down into how the underlying documents work 
for these loan agreements, you will see that there are actually 
borrowing bases that are already in place where the bank 
lending community has assigned different risk to different 
asset classes that BDCs invest in, and based on that perception 
of risk have a willingness today, as does the institutional 
market, to either increase leverage on lower-risk assets or 
decrease leverage on higher-risk assets.
    So I think the mechanisms are already in place. The 
overarching constraint is the regulatory restriction on 
leverage. So I don't believe that leverage in and of itself 
means increased risk. I think the markets have reached a level 
of complexity and sophistication today to handle the 
differentiation between low-risk assets and high-risk assets. I 
think to not allow a change in the asset coverage ratio flies 
in the face of the policy mandate that BDCs were created for 
today, which is to make sure that we can get capital to small 
companies and grow jobs.
    Mrs. Maloney. Mr. Abshure?
    Mr. Abshure. I just wanted to make sure, apparently I 
didn't nod my head sufficiently vehemently enough. State 
securities regulators share the concerns voiced by both Mr. 
Frank and Chair White in her letter. However, I don't feel that 
I could put those concerns anywhere near as eloquently as Mr. 
Frank and Chair White did.
    Mrs. Maloney. Mr. Quaadman?
    Mr. Quaadman. Ms. Maloney, I think one is the change in 
leverage from 1:1 to 2:1 is actually a modest change in 
leverage. If you look at a well-capitalized bank, obviously 
there are different companies, but a well-capitalized bank has 
a leverage ratio of 7 or 8 to 1. So one is, that change 
actually will allow BDCs to provide more liquidity. The SEC 
also has a number of different tools at its disposal to see if 
the BDC is acting properly, is being an appropriate, active 
participant. And that is also one of the reasons why we ask for 
more disclosures for investor protection.
    Mrs. Maloney. Mr. Chairman, my time has expired, but may I 
ask for a few seconds for Mr. Weild to respond? His hand was in 
the air.
    Mr. Weild. Thank you. We actually commented on this in our 
written testimony, and we just said that a higher leverage 
ratio my boost yields to investors and result in an increase in 
share price values. And we had actually called for some 
scenario analysis, some stress test analysis. Because these are 
already fairly highly leveraged businesses. It is the mezzanine 
debt finance market, debt plus warrants, and to understand in 
an inverted yield curve environment to where, in a deep 
recessionary environment how these portfolios are going to 
perform, I think would be only prudent. We are not averse to 
going to 1.5:1, but we would just like more information on how 
the portfolios would perform.
    Mrs. Maloney. My time has expired. Thank you.
    Chairman Garrett. All right. And I would just ask you to 
maybe provide us some measurement tools on how you would do 
that, how we would gather that information.
    But with that, I will yield now to Mr. Hurt for 5 minutes.
    Mr. Hurt. Thank you, Mr. Chairman.
    I want to thank each of you for your testimony here today 
and for the work of our colleagues in trying to improve access 
to our capital markets.
    My questions relate, as I said in my opening statement, to 
the XBRL. And I want to say how much I appreciate the useful 
comments made by the Chamber as it relates to this issue.
    With that in mind, Mr. Quaadman, I was wondering if you 
could talk a little bit about what the benefits are of XBRL in 
the big picture? You point out in your testimony that perhaps a 
2-year delay in the compliance might be a good idea. I am 
wondering, what are the benefits and how would a delay be 
consistent with those benefits?
    Mr. Quaadman. Sure. There would be a number of different 
benefits with a delay. One is that XBRL is still a work in 
progress, and the whole theory behind XBRL is that you are 
going to move away from a paper-based system to a digital-based 
system, and then investors can pick and choose what information 
they want to analyze a company with.
    The problem is the SEC has, quite frankly, had a number of 
different problems with getting this off the ground. Some of 
the exemptions that we are talking about actually allow 
companies that are in XBRL to furnish instead of file reports 
under XBRL, and that is important because if it is furnished 
there is no liability; if they are filed, there are.
    So the reason why we are asking for a delay is, one, is to 
get the SEC's house in order, to get the system up and running 
as best as they can. The other issue, and this is the reason 
why we asked for reports, is it is also important for Congress 
and the SEC to know how exactly are investors using XBRL, are 
they using it or not, and currently they really aren't.
    Mr. Hurt. Right, and why is that?
    Mr. Quaadman. Because they think there are a number of 
different sources that are out there that investors can use to 
access information if they like. It is available in a number of 
different sources and formats. Theoretically, if you can get 
them all in under XBRL at the SEC, it will make it easier. It 
will be one-stop shopping. That just hasn't existed. So it is 
sort of the savvy investor who knows where to find the 
information can get it now; others can't.
    Mr. Hurt. Okay. And you mentioned this, I think there is a 
study that shows that less than 10 percent of investors use the 
system at all.
    Mr. Quaadman. That is correct.
    Mr. Hurt. And I think it must go without saying that there 
is already an obligation. To the extent that SEC should promote 
transparency, I think we would all agree that is one of the 
cornerstones of our capital markets and the SEC's fundamental 
mission.
    But with that said, these issuers have that responsibility 
going forward. It is not like they can, without XBRL, somehow 
have some added incentive or added ability to hide information. 
Is that a fair statement?
    Mr. Quaadman. That is correct. And the challenge that has 
existed, and there has been a frustration in the issuer 
community on this, the SEC has had a concept release out now 
for over 3 years on how to overhaul proxy plumbing systems. And 
this actually goes back to XBRL as well, because all of the 
systems in terms of how you report these issues, the 
disclosures, the corporate governance issues, they are all 
rooted in a 1930s technology, and the SEC has sort of just 
allowed this to languish. So XBRL to some degree is a little 
bit of a symptom, but there is a disease out there, and we need 
to overhaul these systems into the 21st Century.
    Mr. Hurt. The Chair of the SEC has talked about disclosure 
overload. We think about the benefits and what we hope that 
XBRL will bring, or what the SEC hopes it will bring to the 
table, but there are real costs to this for issuers and 
potential issuers. That is what we have heard certainly through 
our work on this as we have talked to folks about this issue. 
Would you agree with that?
    Mr. Quaadman. Yes. The disclosure overload harms both 
investors and issuers. So if you look at disclosures today, 
they are well over 100 pages and probably at least double what 
they were 15 years ago. And if you looked at disclosures in the 
1950s, you could have had a concise report that was 6 pages 
long. So the problem is, it is more difficult for companies to 
communicate with their investors. The investors just have 
information dumped on them and it is difficult for them to sort 
through what they think is actually material or not.
    And that actually gets to the core of the issue, is that 
the SEC--and this is what Chair White was also referencing in 
her speech--has moved away from what is material to investors. 
And the more we have moved away from that, the more inefficient 
the capital markets become. So we need to reorient the reports 
in a readable format, we need to make the information in there 
more material, and therefore there can be actual real 
communications between companies and their investors.
    Mr. Hurt. Excellent. Thank you for your answers. My time 
has expired.
    Chairman Garrett. The gentleman's time has expired.
    The gentleman from California is recognized for 5 minutes.
    Mr. Sherman. Thank you, Mr. Chairman, and thanks for this 
series of hearings because it is very important that we get 
capital, particularly to small business.
    Without objection, I would like to enter into the record a 
letter from NAFCU, the National Association of Federal Credit 
Unions, dealing with the role that they can play in financing 
small businesses if we were to make a few changes in the laws 
regulating credit unions.
    Chairman Garrett. Without objection, it is so ordered.
    Mr. Sherman. Previously entered into the record is a letter 
from the Chair of the SEC, and I would like to highlight on 
page 4 of that letter a statement that two of the bills, one of 
which would amend Section 60 and permit BDCs to purchase 
securities issued by registered investment advisers, and 
another one that would direct the Commission to revise certain 
rules under the Securities Act of 1933 to put BDCs on parity 
with other issuers that are required to file certain reports 
with the SEC under the 1934 Act. The chairman says that in her 
view these provisions do not raise significant investor 
protection concerns, so we should congratulate the authors of 
those two bills.
    Mr. Frank, there are two possible changes dealing with BDCs 
that would increase the upside and downside risk to those who 
invest in the common shares of the BDC. One would open the door 
to more issuance of preferred stock. The other would allow 
greater leverage. And I can see how you wouldn't want to harm 
the brand name of BDCs among retail investors. They are looking 
for a moderate level of risk and here is an opportunity to have 
more risk, both upside and downside.
    Should we create a new designation, the high-leverage BDC, 
that would be allowed to get the benefit of those preferred 
share issuances and the higher leverage, and in that way just 
let investors know that you can invest in a regular, old-
fashioned BDC or you can invest in the Ferrari that might 
crash? Would that solve the problem allowing some BDCs to go 
Ferrari style and some to be, what should I say, a Volvo with 
lots of air bags?
    Mr. Frank. No, I don't think it would. But first, I would 
just like to say that I think that allowing BDCs to include in 
their capital structure some level of preferred equity, which 
had the appropriate characteristics around capital permanence, 
is not something that we would think is necessarily imprudent 
and probably there is a place in the capital structure for 
that.
    Mr. Sherman. But you would object to the idea of having 
high-leveraged BDCs identified as such, allowed to have 
different coverage ratios than regular BDCs? You would object 
to that?
    Mr. Frank. I would, yes. I think that would introduce a 
level of complexity in the industry that would--it is already a 
fairly complex structure for investors, particularly retail 
investors to understand, and I also think that--
    Mr. Sherman. I have to reclaim my time because I have other 
questions on other issues. We are dealing with so many issues 
here.
    Mr. Quaadman, XBRL software, why does it cost $20,000 per 
filing for even a small company to use that software?
    Mr. Quaadman. I don't know the reason for why it costs that 
much. But--
    Mr. Sherman. Excel is free.
    Mr. Quaadman. I think you just made the point right there.
    Mr. Sherman. Could the solution to this be to not exempt 
smaller companies from using it, but to make sure that the 
charge for using it is closer to $1,000 a filing rather than 
$20,000 a filing?
    Mr. Quaadman. I would hope that with the length of time 
that can be done to get this right, we would have costs that 
are much more realistic. We need to go to some digital-based 
form of reporting, but we need to do it right and the SEC needs 
the time to get it right.
    Mr. Sherman. So we might have a circumstance where we would 
delay a requirement due to the difficulty of government getting 
the computer technology right. That is interesting. Thank you.
    Mr. Quaadman. Sure.
    Mr. Sherman. I yield back.
    Chairman Garrett. Yes, there we go. That is right.
    Mr. Huizenga for 5 minutes.
    Mr. Huizenga. Thank you, Mr. Chairman. I appreciate that.
    And I would like to kind of open it up on a couple of 
different fronts to a few of you. Under our existing system, 
there is a one-size-fits-all approach with SEC registration for 
the brokers, and I am curious why you believe the SEC should be 
more tailored in its registration system for M&A brokers. I 
know Mr. Abshure and Mr. Ertel and a few others had talked 
specifically about our bill here.
    But, Mr. Ertel, do you want to start off, maybe, and Mr. 
Abshure?
    Mr. Ertel. Having been through the process of getting the 
FINRA certifications to be a registered rep, they really bear 
little resemblance to the work that I do in helping a business 
owner get his business ready to sell, take it to market 
confidentially, sort through the various offers, and work with 
the various advisers to get that deal closed. So it poses an 
inordinately burdensome level of regulation on a transaction 
for which historically there have been very few bad actors, 
there have been very few cases where anybody has been injured.
    Mr. Huizenga. And we have had testimony before this 
committee--Shane Hansen, whom I mentioned in my opening 
statement, Alliance of Merger and Acquisition Associates, I 
believe that you are advisers, you are familiar with him, he 
had said setup and compliance-related costs often exceed 
$150,000. I think you had said $150,000 to $250,000 in your 
testimony, correct? And then ongoing compliance often exceeding 
$75,000 per year. Talk a little bit about that impact for a 
smaller M&A person.
    Mr. Ertel. A lot of business brokerage firms and M&A 
advisory firms are very small shops--many sole practitioners, 
many firms of just two or three practitioners. So if you take 
that cost and spread it over the few transactions that they do 
a year, it is a very significant burden per transaction.
    Mr. Huizenga. Mr. Abshure?
    Mr. Abshure. Yes, I think if you go back and look at the 
historic definition of a broker under the securities laws, 
which is--and see that buy securities for its own account and 
for the--on the account of others, and you look at the existing 
system of regulation, both at the SEC and State level and also 
FINRA, you will learn that the system of regulation and the 
requirements is not really designed for the business in which 
an M&A broker engages. And I believe in your opening remarks 
you point--or perhaps Mr. Ertel pointed that out--that 
oftentimes an M&A deal, how it is structured is determined by 
the tax treatment. The M&A broker goes in, looks at the 
financial statements of the entity to be sold, helps clean that 
up, and makes some management advice. And then you get ready to 
do the deal, you look at the tax treatment, and decide whether 
it is an asset deal or a stock deal. If it is an asset deal, he 
is not a broker. If it is a stock deal, he is a broker. So it 
doesn't really make sense.
    Mr. Huizenga. Even though that is the exact same transition 
and transaction, basically?
    Mr. Abshure. True M&A brokers are business advisers that 
specialize in the business of advising a company that is 
looking to change management, is putting itself on the market. 
And as long as they stay within that narrow frame, I think that 
the States are fine with creating alternative registration and 
compliance systems for those.
    The problem is that it is a very thin line between changing 
ownership and just selling a large block in connection with a 
capital-raising transaction. So we would have concerns that the 
distinctions are clearly drawn.
    Mr. Huizenga. All right. I have around a minute-and-a-half 
here. Under my bill, H.R. 2274, M&A is exempt from FINRA, while 
subject to some of these SEC rules relevant to the limited 
nature of what M&A broker activities are. But should FINRA 
regulate M&A brokers? Anybody care to comment on that?
    Mr. Abshure. No.
    Mr. Huizenga. Excellent. Okay.
    Mr. Ertel. I would agree.
    Mr. Huizenga. I am curious why, if you want to elaborate.
    Mr. Abshure. It goes back to why you are talking about 
exempting or changing the structure of M&A brokers. The entire 
FINRA system, regulatory system, is set up to govern brokers 
that are in the business of buying securities either for their 
own accounts or for the accounts of their client. That is not 
what these guys do. So there is no reason--and plus the numbers 
are so much smaller than what we are going to see from a 
regular broker-dealer standpoint--there is no reason, it would 
be extremely inefficient to set up a third level of regulation 
for business brokers considering the very narrow nature of 
their business.
    Mr. Huizenga. This is government we are talking about, so 
there is not always a concern about efficiency. But there is 
from this member, and I know from many members of this 
committee. And ultimately, I will part on this, who ultimately 
bears the cost of the fees associated with registration and 
compliance associated for the M&A brokers? I think we probably 
all know the answer, but if anybody cares to jump in?
    Mr. Ertel. It ultimately passes through to the buyer and 
seller of the business. I have made the statement that if the 
deal was all cash and you marked the bills that were brought to 
closing, the buyer brings all the money and the broker takes 
home some of it. So a lot of it falls to the buyer. Some of it 
falls to the seller.
    Mr. Huizenga. Right, thank you. My time has expired. I 
appreciate that. I just wish Mr. Hensarling was here, our 
Chairman Hensarling was here to hear again how important that 
this bill is. But I am glad he was here for opening statements. 
So, thank you.
    Chairman Garrett. Okay. The gentleman from Georgia is 
recognized for 5 minutes.
    Mr. Scott. Thank you, Mr. Chairman. This is certainly a 
fascinating hearing.
    I have two lines of questions. First of all, it seems to me 
we are sort of turning the BDCs on their head here, and so I 
think it is important that the first question I want to ask is 
that by permitting the BDCs to invest all of these funds in 
financial firms instead of the nonfinancial small businesses, 
would not that divert capital from the small, growing 
businesses that the BDCs were originally created to help? Am I 
off base there? Do you all have any concerns that might be 
happening?
    Mr. Abshure. The State securities regulators share your 
concern.
    Mr. Scott. And I am also concerned about the fact of the 
other thing. Right now, it is prohibited in the hedge funds. 
And would BDCs and their allowing them to invest entirely in 
private funds, including hedge funds, would not that allow the 
BDCs to circumvent the general prohibition on selling interest 
in private funds to retail investors?
    Mr. Abshure. If you will recall, in my opening remarks I 
said that in the State securities regulators' opinion, the 
changes in the BDC laws that are being proposed would 
effectively allow hedge funds for unaccredited investors.
    Mr. Scott. Okay, thank you. And would not this turning this 
on its head eliminate all of the provisions intended to protect 
preferred stock investors? Holders of preferred stock could 
find that dividends not paid during lower earnings periods are 
never paid, even if the BDC subsequently prospers. Is that not 
a true statement? Shouldn't we be concerned about that, that 
these investor protections would be lost here?
    Mr. Arougheti. If I may, I think we may be talking about 
apples and oranges. And there was testimony introduced into the 
record by Prospect Capital around some of these issues. I think 
it is important to differentiate between finance companies and 
financial services companies. My understanding of the dialogue 
is in regard to traditional commercial finance structures such 
as equipment leasing companies, commercial finance companies, 
and franchise finance companies, all of whom occupy a very 
important role in the capital formation for small companies.
    Under current regulations, BDCs are actually prohibited 
from investing in those types of businesses, and it is those 
types of businesses that are part of the formula for getting 
capital to small business. When we are talking about structures 
like private equity funds and hedge funds, to Mr. Abshure's 
point, I do think that could be worthy of further reflection 
and discussion insofar as those are fund structures, not 
operating companies. And I think it is important to make a very 
clear distinction between those two types of structures.
    Mr. Scott. Okay. Now, let's go to the tick sizes. There is 
a tick size that is being advocated of 5 cents or 10 cents. 
There are even some who want the continuation of the 1 cent or 
the penny. So there is not a unified position in the community 
on what size this split should be, which there should be. So my 
point is, given that there are some who want 5, there are some 
who want 10, there are some who want a penny, and some even 
want less than that, my question is would it be appropriate to 
enshrine the tick sizes in the statute with this split and 
difference in your community?
    Mr. Weild. May I take a shot at that, Congressman? Any 
increase in tick sizes for small micro-cap stocks is going to 
be a step in the right direction. I think then it is a question 
of how we actually implement it. And I share this view with 
Professor James Angel from the University of Georgetown, who 
was a proponent of the issuer choice tick size model, because 
we think that what will happen is, by discussing what the 
appropriate tick size is with the securities firms, the 
investment banks, the value providers, and the institutional 
investors, that the companies will figure out an appropriate 
tick for the share price. A 5 cents tick size in a $10 share 
price is twice the value of a 5 cent tick size in a $20 share 
price.
    So it is not going to be a one-size-fits-all. Where we came 
out was let the market decide, let individuals get into a 
discussion, and that we would start to see liquidity bands and 
we would start to see individual ticks sort of gravitate to 
certain underlying liquidity bands as a result of market input.
    Mr. Scott. One quick point and I am through, Mr. Chairman. 
But is everybody in agreement that a penny and a subpenny tick 
size is central to the decline of the U.S. IPO market over 
recent years?
    Mr. Quaadman. Mr. Scott, if I could just take a stab at 
that. Number one, decimalization actually lowered costs for 
investors and actually provided for price discovery. What we 
are having now is a debate about whether or not, if you are 
going to have a pilot program on tick size changes, is that 
going to help drive liquidity to smaller issuers? So I think we 
need to differentiate different parts of the market from the 
other.
    The other point to your first question is, I think it is 
important to leave it in the hands of the companies to decide, 
if there is a pilot program, decide what is best for the 
company, but then it is really going to be incumbent on the SEC 
to really research it in terms of, is it providing that 
liquidity to those companies, is it allowing people to look at 
smaller companies in a closer way than they are now, but also 
what is it doing in terms of cost to investors? So is it 
helping retail investors go to invest in smaller companies? 
What does it mean for mutual funds? Is it going to increase 
cost or lower cost for mutual funds? Is it going to have them 
become a bigger investor in smaller companies?
    So I think the SEC, if there is a pilot program, needs to 
look at this holistically to see if this program is going to 
work, and then we should all come back and decide what the next 
step should be.
    Mr. Scott. Thank you, Mr. Chairman, for that extra time. It 
was very helpful. Thank you.
    Chairman Garrett. Mr. Grimm?
    Mr. Grimm. Thank you, Mr. Chairman.
    Mr. Arougheti, we are hearing a lot of different opinions 
on the role of BDCs and the impact that it could have. So I 
wanted to hone in on a few things regarding the kind of BDCs 
that you specialize in, like yours. What is their current 
ability, the kind of firms that BDCs like yours finance, the 
ones that you are providing capital to, what is their current 
ability to access capital to grow either via a bank or the 
other capital markets?
    Mr. Arougheti. Thank you, Mr. Grimm. Maybe just to take a 
quick step back to understand the ecosystem that we operate in 
and to really understand the critical role that BDCs play, if 
you think about the traditional financing alternatives 
available to a small and growing company, there are community 
banks and local banks that can meet the needs of small 
businesses as they grow, with government subsidy or without 
government subsidy. However, they are limited in the 
flexibility of their product. Oftentimes, they are limited in 
their risk tolerance. Many times, they are limited in the size 
of capital commitment that they can give to a growing company.
    So the BDC industry really begins to become relevant at the 
point in which the needs of a small and growing business 
outgrow the traditional small company alternatives, and we grow 
with that business all the way up to the point at which they 
can access the debt or equity capital markets. That goes hand 
in hand with the policy mandate that we provide strategic and 
managerial assistance to these companies. So one of the ways I 
have always thought about BDCs, and it is inherent in the 
growth in the industry, is we effectively grow with these 
companies as they graduate through the capital markets 
ecosystem.
    When you look at the type of companies that we lend to, we 
will lend to venture companies that are investing pre-revenue 
and pre-cash flow in new technology and innovation, all the way 
up to more mature companies. But the borrowers that find their 
way to the BDC space find their way to us for a reason, because 
their needs are being unmet by traditional alternatives.
    Mr. Grimm. And right now, just approximately last year, 
say, how many in loans did you provide capital for?
    Mr. Arougheti. Ares is the largest industry participant, 
and we committed about $4 billion in new capital into the 
middle market.
    Mr. Grimm. And if this bill were to pass and the leverage 
ratio was increased, which I think is a very modest increase, 
from $1 to $2, how much do you think you would be able to 
increase your capability of loaning money to these small and 
midsized firms?
    Mr. Arougheti. Significantly, and it goes back to my prior 
commentary. I think the increase in leverage will actually 
encourage BDCs to seek out lower-risk borrowers in a part of 
the ecosystem that they currently can't serve. When you look at 
the BDC structure as a pass-through entity, the yield 
requirement on BDC dividends for the more conservative players 
like us is 8 percent, and some of the ``riskier players'' the 
market is already differentiating with yields in excess of 11 
or 12 percent. My expectation is that with a modest increase in 
leverage you would see the ability of BDCs to further meet the 
needs and serve the needs of their existing customer base.
    I would also highlight, if I may, if you look at the SBIC 
debenture program, which has been very successful and is a very 
good indicator of the underlying performance of these types of 
loans, to put that in perspective, in Fiscal Year 2012, the 
SBIC debenture program extended about $3.1 billion in loans, 
and I would highlight that the SBIC debenture program currently 
allows for leverage of 2:1, consistent with the proposed 
legislation, as opposed to the 1:1 under the existing BDC 
regulation.
    Mr. Grimm. I apologize. I really want to get this in with 1 
minute left, so please be as concise as you can because I think 
this is important. What level of losses would a BDC like yours 
need to experience to wipe out its equity at these ratios, the 
proposed ratios?
    Mr. Arougheti. Commissioner White had in her letter a 
description of increased risk, saying that the loss rate would 
have to go from 50 percent to 33.3 percent to harm BDC 
shareholders. I think it is worth pointing out that the BDC 
industry over the last 10 years has experienced actual realized 
loss rates of about 60 basis points and some of the more 
conservative structures like Ares have actually had positive 
realizations, i.e., no net losses. So as we come off of the 
experience of the great recession and see how these middle 
market companies and this middle market collateral have 
performed, I struggle to craft a scenario where we--
    Mr. Grimm. Did any BDCs fail in the 2008 crises because of 
too much leverage?
    Mr. Arougheti. There have been no BDCs that have failed or 
gone bankrupt.
    Mr. Grimm. Thank you. I yield back.
    Chairman Garrett. The gentleman yields back.
    Mr. Foster is now recognized.
    Mr. Foster. Thank you, Mr. Chairman.
    In Mr. Abshure's testimony he notes that one of his 
concerns with the BDC bills is the proposal that would allow 
them to invest in investment adviser firms. And his concern was 
that it might create a potential conflict of interest for the 
investment advisers to recommend to their clients that they 
invest in the BDC or their portfolio companies. And I was 
wondering if any of the other witnesses have a comment on this 
potential conflict-of-interest concern?
    Mr. Quaadman. I would just add, I think that is one of the 
issues that the SEC can look at. I think that is what Mr. 
Sherman was sort of driving at, is that if you go forward with 
this legislation, you allow them to become bigger liquidity 
providers in the market and you provide for more investor 
protections, if you know that there are different types of 
strategies that are involved, the SEC has the tools, through 
stress tests and others, to see if they are acting 
appropriately and the like. So I think there are ways to 
monitor that and then to come back and see if more needs to be 
done.
    Mr. Foster. Is anyone willing to venture a guess as to what 
fraction of BDC holdings might be expected to flow into 
investment advisers if the restrictions are lifted? Is this 
going to be a little pimple on the whole industry or does this 
have the potential to be a dominant component? Any feeling at 
all? All right.
    If I can move to tick size, would it be a good idea if the 
tick-size experiments were conducted both with and without bans 
on trading between the ticks? Is that an interesting element of 
the pilot proposals? Because there is sort of a different 
opinion as to how big an effect that would be and whether it 
would effectively vitiate the tick-size proposals.
    Mr. Weild. I think that was a recommendation we made way 
back at the February 5th roundtable on decimalization, and if 
you really want to create a pilot you can segregate different 
groups of stocks and you can extract interesting comparable 
information.
    Mr. Wunderlich's comment, I agree and I don't agree with 
the comment about market makers, risk taking. There are 53 
different trading venues in the United States now so markets 
are structurally very different from the days when we had over-
the-counter market makers, when we did control risk by 
essentially being able to put stock out within the bid and the 
ask side of the market. So it is not clear that is actually 
going to be the way that market makers control risk today given 
that a dark pool might siphon off just mounds and mounds of 
liquidity as investors are searching out lowest possible price 
as opposed to value provision.
    I just honestly think we have to get started and try some 
stuff and we have to keep doing it and keep trying it because 
the problems are so extreme and the impact on the economy is so 
extreme that the upside for the American people is 
extraordinary. And so we may not get it right the first shot, 
but doesn't mean that we don't take a second or third shot at 
getting it right.
    Mr. Foster. Is it anticipated that the tick-size changes 
would result primarily in changes in the amount of technical 
trading or research-based trading or sales commission-based 
trading? And which is the kind of trading and liquidity that 
you are trying to encourage here?
    Mr. Weild. Real liquidity is when there is no order and 
somebody goes out and creates an order to offset a buyer or 
offset a seller. And that usually takes human beings to do. 
Machines don't do that. And there has to be an economic model 
to incent somebody to get on the phone. Right now there is no 
economic model to do that.
    Mr. Foster. But that could be based on a statistical 
analysis of previous price points, which I would consider to be 
technical trading, or based on actually a study of the 
fundamentals of the company. And I am just trying to figure out 
which one you are trying to incent mainly, or which will you 
end up incenting mainly with the tick-size changes.
    Mr. Weild. We would be incenting real brokers, human 
beings, talking to institutional investors or retail investors 
about stocks and creating visibility in those names, in those 
stocks, which is activity for the most part which is going out 
of the market today.
    We would also hope to be incenting capital commitment to 
facilitate the positioning of a block of stock before they find 
a buyer that is real liquidity on the other side for that block 
of stock. So we would expect that if these pilots were 
structured appropriately that one of the metrics you would look 
at is block liquidity. If block liquidity starts to go up 5,000 
shares--right now things are put through the electronic 
mixmaster and you are looking at 100-share, 150-share trades ad 
nauseam, and if you start seeing the numbers creep up in terms 
of size of the trade, I think that is a sign that this system 
is having its intended effect.
    Mr. Foster. Right. Thank you. My time is up. I yield back.
    Chairman Garrett. Thank you. The gentleman yields back.
    Mr. Duffy is recognized for 5 minutes.
    Mr. Duffy. Thank you, Mr. Chairman. And again, I appreciate 
all of the conversation around tick sizes and maybe the 
benefits or drawbacks that you guys all have provided your 
opinions on.
    First, I want to thank Mr. Quaadman for bringing up the 
issue of a safe harbor. I think that is a good point. If we are 
going to have a successful tick-size pilot program, we want to 
make sure there is no liability. And I think that is a 
conversation we want to pursue. But I appreciate you bringing 
that point up.
    And I want to be clear, we don't have any interest, I am 
not trying to engage in the larger argument between our dark 
pools and exchanges, and I think we have entered into a space 
that has some people excited. We truly are trying to create 
more liquidity for small cap companies. That is the true intent 
here. And I know that people are looking down the road and it 
might take some signaling of our proposal that we are trying to 
have a greater impact on a market structure, and that is not 
the intent.
    But maybe to Mr. Wunderlich, if we allow just a quote at, 
aren't we really undermining the purpose of a tick-size bill? 
We don't get the full impact of this experiment, this pilot 
program?
    Mr. Wunderlich. Yes and no, in that it does seem sort of 
counterintuitive, right, that you are going to quote it in 
nickels and dimes and then you are going to trade it maybe in 
between. So maybe it does seem a little counterintuitive. But 
the issue, it is sort of, I guess, I would go back to a point 
in history when we tried to do it in 8ths and 16ths. We always 
traded between the bid and the ask. It has been done 
historically. And I think liquidity in our experience was a lot 
better before decimalization in small and midcap stocks; not 
necessarily the case in larger cap stocks.
    The other issue is, from where I sit from a market-making 
standpoint we do think that it is taking more risk if you are 
committing to basically having to trade in larger increments. 
And the other side it is just sort of market valuation and 
efficiency. Markets, liquid markets are very efficient over 
time as far as where things should or shouldn't be priced. And 
I don't want to say it is manipulation or price fixing, but in 
a sense you kind of are, if you are mandating you have to be at 
this dime or this nickel or 20 cents.
    That being said, I will reiterate, we are for the pilot, 
again, but we think we ought to be able to trade between the 
bid and the ask.
    Mr. Duffy. And we are creating a financial incentive here, 
aren't we? That is the purpose.
    Mr. Wunderlich. I'm sorry, I didn't hear you.
    Mr. Duffy. We are trying to create a financial incentive 
here.
    Mr. Wunderlich. That is correct.
    Mr. Duffy. And that incentive may be diminished if we allow 
more price improvement, trading between the ticks. Yes?
    Mr. Wunderlich. No, sir. I think I would go the other way. 
The incentive is for whom? Right? Is it for the investor or is 
it for the brokerage firm, is it for the issuer? There are 
several constituents involved. And one is for us to have an 
incentive to even traffic in these stocks. And if we view that 
to an outsized business risk where we are mandated to have to 
take a price, then we are less likely to commit capital to 
something like that than if we were able to trade freely 
between the bid and the offer. Did that answer your question?
    Mr. Duffy. Kind of. Maybe we can talk about it a little 
more later.
    Mr. Weild, do you agree with that? Do you think we diminish 
the pilot program, our tick-size pilot program if we allow 
trading between the ticks?
    Mr. Weild. I think we do on the margin. Step back for a 
second and look at the study that we did on the 26 foreign IPO 
market, the 26 largest. And we have a convention in this 
country where we don't allow--most brokerage firms don't allow 
brokers to solicit stocks or put them on margin if they are 
under $5 a share. So it arbitrarily keeps our stock prices 
high. So the United States has zero stock, zero percent stocks 
that have a 1 percent or higher tick size that are sub-500 
million that are micro-cap or smaller, whereas the high IPO-
producing countries, which are countries like Singapore, 
Australia, Canada, weighted for GDP, 70 percent or more of 
their micro-cap stocks have 1 percent or higher tick sizes 
because they split the stocks down to levels where a penny, at 
50 cents, a penny can make 2 percent difference incentive.
    I do believe that a nickel or a dime and having some 
integrity to the tick size will ultimately cause the market to 
compete on providing sales, capital, value support, and it 
won't let the market compete on price, which is the problem in 
micro-cap markets.
    I totally agree with the point of view, I think Tom said 
this earlier, large cap stocks that are innately liquid stocks 
actually become more liquid with smaller tick sizes, but the 
academic literature clearly shows that innately illiquid stocks 
become less liquid with smaller tick sizes. So the reverse of 
that, which is increase the tick and respect the tick size, 
will bring liquidity to these stocks.
    Mr. Duffy. And, Mr. Wunderlich, do you agree with that?
    Mr. Wunderlich. Yes, I do.
    Mr. Duffy. Thank you, I yield back.
    Chairman Garrett. The gentleman yields back.
    For the last word, Mr. Carney is recognized.
    Mr. Carney. Thank you, Mr. Chairman, and thank you for 
holding the hearing today. Thank you to all the witnesses. I 
have been working with Mr. Duffy on this tick-size issue, so I 
have been listening very carefully to the discussion over the 
last three questioners.
    And our objective is pretty simple, Mr. Duffy laid it out, 
is to drive more liquidity, more activity to the smaller cap 
companies. And do I interpret everybody to say that you are for 
a pilot of some kind. Mr. Wunderlich? Mr. Quaadman? The last 
three had the most discussion, right?
    Mr. Wunderlich. Yes.
    Mr. Carney. So the question is, how to get it right. I was 
interested in the suggestion that Mr. Foster had about having 
both maybe a quote at and trade at provision in the pilot. Does 
that make sense? I will start with you, Mr. Wunderlich. You 
have a problem with our current approach, so what about the 
approach of having both?
    Mr. Wunderlich. Clearly, and let me speak for myself and 
maybe not SIFMA here--
    Mr. Carney. Sure, sure.
    Mr. Wunderlich. I will speak for SIFMA in this regard. One, 
we need to have very clear metrics. And I think Mr. Weild said 
earlier, we want to make sure that if you do something on it, 
we want to compare apples to apples, and it needs to be very 
clear.
    Mr. Carney. And by the way, that is my last question, and 
that would be the metrics in terms of the evaluation of this 
pilot. So to the extent that you independently can provide us 
with something in writing about what they ought to be, you have 
mentioned some of those, that would be much appreciated. 
Please.
    Mr. Wunderlich. And now I have forgotten your question. I 
apologize.
    Mr. Carney. The question was, the pilot that included both 
a quote at and a trade at, so that you have two different looks 
at trading within the spread.
    Mr. Wunderlich. And I will speak for myself and Wunderlich 
Securities severally. I do believe that being able to trade 
between the bid and the--between tick sizes would be better. 
That being said, ultimately, I am for a pilot in some way, 
shape, or form. And if it means having two pilots then I would 
be personally, and I will speak for myself and Wunderlich 
Securities here, I would be for that, versus not having a pilot 
at all.
    Mr. Carney. Okay.
    Mr. Quaadman, do you have a view of that?
    Mr. Quaadman. Let me take it in reverse order.
    Mr. Carney. Sure.
    Mr. Quaadman. We are supportive of a pilot program. We 
think there needs to be exhaustive metrics on that.
    Mr. Carney. And you have a view of what things ought to be?
    Mr. Quaadman. Yes. We will work with both you and Mr. Duffy 
on that.
    As to your last point, I think there is some attraction to 
that, and I want to think about that some more and get back to 
both you and Mr. Duffy on that.
    Mr. Carney. Okay, sure.
    Mr. Weild, do you want to take both of those pieces?
    Mr. Weild. We have done some work already on what we think 
the metrics should be. There is also a committee that has been 
advising Treasury, an ad hoc committee that includes some 
institutional investors that has done some work. So let me pull 
that together and I will just get it back to you on what we 
think metrics should be.
    Clearly, the things that require people investments, on a 
short-term pilot people are not going to make long-term 
investments in research and things like that, but when you look 
at the trading characteristics, you will get a sense, I think 
pretty quickly with the right metrics, whether or not it is 
working. And so, I think this is eminently--
    Mr. Carney. So we have a duration in the bill. Any comment 
on the duration? A 5-year duration is too long, too short, 
about right?
    Mr. Weild. I think longer is better, and then if it proves 
to be working, then just make it permanent. Because the problem 
with a short-term pilot is people might game it. If it is a 1-
year pilot, which I think has been recommended in some circles, 
like in the Citigroup article that came out in the Wall Street 
Journal today, I think they recommended a year, I think that is 
too short.
    Mr. Carney. Mr. Quaadman, you look like--
    Mr. Quaadman. I think a 5-year pilot is fine, but I would 
recommend that the SEC come out with some interim report either 
at 2 or 3 years so you get a snapshot early on.
    Mr. Carney. Any comment on the definition of companies that 
would be eligible either in terms of total cap size or other? 
Right now the definition pretty much tracks the emerging growth 
company definition in the JOBS Act, I believe. So is that too 
limited, too expansive? Any comments on that?
    Mr. Quaadman. No, I actually think that is the right way to 
go, because that is a defined universe that Congress has 
already picked out, and it makes sense to go with that universe 
for this pilot program.
    Mr. Carney. Okay. Are there other comments?
    Mr. Wunderlich. I would agree.
    Mr. Weild. We would agree. I would also in our testimony, 
page 11, just call your attention to just show you, if you just 
use this one metric, sub-$2 billion market value companies, 
they only represent 6.6 percent of total market value. Said 
another way, you could trade yourself silly in the large cap 
markets, and that is the vast majority of market value, and 
these small stocks are just fundamentally different. About 81.1 
percent of all listed companies are sub-$2 billion in market 
value, the institutional definition of small cap, and they 
represent only 6.6 percent of aggregate market value. You are 
comparing apples to oranges structurally. So, EGC definition is 
fine, gets to the same, close to the same place.
    Mr. Carney. I want to thank each of you for your help, and 
your testimony today, and I thank my colleague from the other 
side. I yield back.
    Chairman Garrett. The gentleman yields back.
    And we have been joined by Mr. Mulvaney for the last 
questions.
    Mr. Mulvaney. Mr. Chairman, I apologize to both you and the 
panel for having to run back out and back in. It has just been 
that kind of day.
    Mr. Abshure, I was here for your testimony, but I was not 
here for some of the follow-up questions. But as I understand 
it, you have a difficulty with retail investors being exposed 
to investments in hedge funds and private equity. Is that 
correct, sir?
    Mr. Abshure. Yes.
    Mr. Mulvaney. Okay. And I guess in theory I can sympathize 
with that a little bit, but don't pension funds face the same 
issue? And aren't there other instruments out there already 
that expose retail investors to investments in hedge funds and 
private equity funds?
    Mr. Abshure. I don't think so on the levels that you are 
talking about here. You are talking about unaccredited, 
unsophisticated investors having access.
    Mr. Mulvaney. Unaccredited, unsophisticated investors. Does 
that not describe most pensioners who work for CalPERS?
    Mr. Abshure. Sure.
    Mr. Mulvaney. Don't they invest in hedge funds and private 
equity funds?
    Mr. Abshure. No.
    Mr. Mulvaney. They don't? Pensions funds don't invest in 
hedge funds and private equity funds?
    Mr. Abshure. No. Unaccredited investors can invest in 
pension funds, but unaccredited investors cannot invest in 
hedge funds.
    Mr. Mulvaney. Okay. Don't the managers of both of those 
types of entities, of pension funds--
    Mr. Abshure. The difference is you have a manager.
    Mr. Mulvaney. I'm sorry?
    Mr. Abshure. The difference is you have a manager in a 
pension fund as opposed to an unaccredited or an 
unsophisticated investor deciding to invest in the BDC all on 
his own, and then that BDC making decisions.
    Mr. Mulvaney. I have never invested in a BDC. I have 
invested in a closed-end mutual fund before and it was readily 
apparent to me what the closed-end mutual fund had invested in. 
Is that same information available to somebody who invests in a 
BDC? If I want to know what they are investing in before I buy 
a share of a BDC, do I get to know what they are investing the 
money in?
    Mr. Abshure. No.
    Mr. Mulvaney. That is a secret.
    Mr. Abshure. I don't think a registered BDC is going to 
disclose all of its investment on the front end--
    Mr. Mulvaney. Mr. Arougheti, help me out here. Do you tell 
your investors what you invest in?
    Mr. Arougheti. Just a minor correction. By regulation, BDCs 
are required to have a detailed investment listing of every 
single security and investment.
    Mr. Mulvaney. Okay. That is not a minor clarification. That 
is the exact opposite of what Mr. Abshure just said.
    Mr. Arougheti. No, every quarter BDCs, by regulation, are 
required to provide a detailed investment listing by security 
that they hold on their balance sheet.
    Mr. Mulvaney. Okay, Mr. Abshure, so is he wrong?
    Mr. Abshure. No. You provide that every quarter after the 
purchase has been made, correct?
    Mr. Mulvaney. Go ahead. You can respond, Mr. Arougheti.
    Mr. Arougheti. Correct. We have full transparency as to 
what resides--
    Mr. Abshure. So if I am a BDC owner on January 1st, I am 
going to learn what you did with my money at the end of that 
quarter.
    Mr. Mulvaney. But you are also going to know on the day 
that you purchased the stock where that money is invested, 
correct?
    Mr. Abshure. But in terms of what happens on day number 2 
then, I will know at the end of the quarter.
    Mr. Mulvaney. I didn't stay in the State government long 
enough to participate in that State pension, but a lot of my 
friends have. I have teachers in the South Carolina retirement 
system. How are they treated any differently than your 
hypothetical BDC investor? Do they know when they put money 
away for their pension where that money is going on a daily 
basis or do they get regular updates?
    Mr. Abshure. No.
    Mr. Mulvaney. They don't know, do they? There is no 
difference here. I guess what I am trying to get at is, why 
would we treat BDCs any different from pensions when it comes 
to hedge funds and private equity funds?
    Mr. Abshure. I think there are many differences between 
BDCs and pension funds.
    Mr. Mulvaney. And I am asking you for some of them.
    Mr. Abshure. I think just the entire structure, the entire 
goal behind the pension funds, the required payouts of the 
pension funds, the way that pension funds are structured to 
provide payments over time, the way that pension funds are 
constantly monitored to make sure that they have assets to meet 
the payout responsibilities.
    Mr. Mulvaney. And there is another difference, which is a 
lot of times, for example, if I am a teacher in South Carolina 
I don't even get the choice to participate or not, I have to 
participate. So there are actually certain areas where it is 
actually worse to be in a pension.
    Let me ask you this, because the SEC raised similar 
questions. I think it was a lot more well-articulated than what 
we have been through today. But, Mr. Arougheti, aren't there 
ways to handle this? That is really the concern. If there is 
legitimate concern that you don't want to end up with these 
entities being pass-through entities to simply fund hedge 
funds, aren't there ways to deal with that?
    Mr. Arougheti. Yes, Mr. Mulvaney. I apologize, in prior 
commentary I thought that it was worth making the distinction 
between finance companies and funds. And as I said earlier, I 
do believe that there are parts of the financial ecosystem--
leasing companies, franchise finance companies, et cetera--that 
are a valuable provider of capital, that are very distinct in 
the way that they operate and bring capital than the hedge 
funds and private equity funds.
    Mr. Mulvaney. So to the extent Mr. Abshure's questions are 
legitimate, let's assume for the sake of discussion that they 
are, we can fix that, can't we?
    Mr. Abshure. Absolutely.
    Mr. Mulvaney. Thank you.
    I yield back the balance of my time.
    Chairman Garrett. The gentleman yields back. And I think 
that was the last word.
    So at this point I want to, again, thank you all on the 
panel. And I ask unanimous consent to put 3 letters into the 
record from the Financial Services Roundtable, Reflexite, and 
Prospect, and also from SBIA. They are letters with regard to 
today's hearing, so they are put into the record. Without 
objection, it is so ordered.
    Now, I can say thank you all for coming and for your 
testimony, which has been very illuminating and educational. 
And if we had any questions that we threw out to you that we 
didn't get back, we would appreciate you responding in writing 
for the record.
    The Chair notes that some Members may have additional 
questions for this panel, which they may wish to submit in 
writing. Without objection, the hearing record will remain open 
for 5 legislative days for Members to submit written questions 
to these witnesses and to place their responses in the record. 
Also, without objection, Members will have 5 legislative days 
to submit extraneous materials to the Chair for inclusion in 
the record.
    So with that, I again thank you all. And this committee is 
hereby adjourned.
    [Whereupon, at 4:30 p.m., the hearing was adjourned.]



                            A P P E N D I X



                            October 23, 2013

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