[House Hearing, 114 Congress]
[From the U.S. Government Publishing Office]
LEGISLATIVE PROPOSALS TO IMPROVE
THE U.S. CAPITAL MARKETS
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON CAPITAL MARKETS AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED FOURTEENTH CONGRESS
FIRST SESSION
__________
DECEMBER 2, 2015
__________
Printed for the use of the Committee on Financial Services
Serial No. 114-64
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HOUSE COMMITTEE ON FINANCIAL SERVICES
JEB HENSARLING, Texas, Chairman
PATRICK T. McHENRY, North Carolina, MAXINE WATERS, California, Ranking
Vice Chairman Member
PETER T. KING, New York CAROLYN B. MALONEY, New York
EDWARD R. ROYCE, California NYDIA M. VELAZQUEZ, New York
FRANK D. LUCAS, Oklahoma BRAD SHERMAN, California
SCOTT GARRETT, New Jersey GREGORY W. MEEKS, New York
RANDY NEUGEBAUER, Texas MICHAEL E. CAPUANO, Massachusetts
STEVAN PEARCE, New Mexico RUBEN HINOJOSA, Texas
BILL POSEY, Florida WM. LACY CLAY, Missouri
MICHAEL G. FITZPATRICK, STEPHEN F. LYNCH, Massachusetts
Pennsylvania DAVID SCOTT, Georgia
LYNN A. WESTMORELAND, Georgia AL GREEN, Texas
BLAINE LUETKEMEYER, Missouri EMANUEL CLEAVER, Missouri
BILL HUIZENGA, Michigan GWEN MOORE, Wisconsin
SEAN P. DUFFY, Wisconsin KEITH ELLISON, Minnesota
ROBERT HURT, Virginia ED PERLMUTTER, Colorado
STEVE STIVERS, Ohio JAMES A. HIMES, Connecticut
STEPHEN LEE FINCHER, Tennessee JOHN C. CARNEY, Jr., Delaware
MARLIN A. STUTZMAN, Indiana TERRI A. SEWELL, Alabama
MICK MULVANEY, South Carolina BILL FOSTER, Illinois
RANDY HULTGREN, Illinois DANIEL T. KILDEE, Michigan
DENNIS A. ROSS, Florida PATRICK MURPHY, Florida
ROBERT PITTENGER, North Carolina JOHN K. DELANEY, Maryland
ANN WAGNER, Missouri KYRSTEN SINEMA, Arizona
ANDY BARR, Kentucky JOYCE BEATTY, Ohio
KEITH J. ROTHFUS, Pennsylvania DENNY HECK, Washington
LUKE MESSER, Indiana JUAN VARGAS, California
DAVID SCHWEIKERT, Arizona
FRANK GUINTA, New Hampshire
SCOTT TIPTON, Colorado
ROGER WILLIAMS, Texas
BRUCE POLIQUIN, Maine
MIA LOVE, Utah
FRENCH HILL, Arkansas
TOM EMMER, Minnesota
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
PETER T. KING, New York BRAD SHERMAN, California
EDWARD R. ROYCE, California RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas STEPHEN F. LYNCH, Massachusetts
PATRICK T. McHENRY, North Carolina ED PERLMUTTER, Colorado
BILL HUIZENGA, Michigan DAVID SCOTT, Georgia
SEAN P. DUFFY, Wisconsin JAMES A. HIMES, Connecticut
STEVE STIVERS, Ohio KEITH ELLISON, Minnesota
STEPHEN LEE FINCHER, Tennessee BILL FOSTER, Illinois
RANDY HULTGREN, Illinois GREGORY W. MEEKS, New York
DENNIS A. ROSS, Florida JOHN C. CARNEY, Jr., Delaware
ANN WAGNER, Missouri TERRI A. SEWELL, Alabama
LUKE MESSER, Indiana PATRICK MURPHY, Florida
DAVID SCHWEIKERT, Arizona
BRUCE POLIQUIN, Maine
FRENCH HILL, Arkansas
C O N T E N T S
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Page
Hearing held on:
December 2, 2015............................................. 1
Appendix:
December 2, 2015............................................. 39
WITNESSES
Wednesday, December 2, 2015
Carcello, Joseph V., EY and Business Alumni Professor, and
Department Chair, Department of Accounting and Information
Management, Haslam College of Business, University of
Tennessee, Knoxville........................................... 10
Grundfest, Hon. Joseph A., William A. Franke Professor of Law and
Business, Stanford Law School; and former Commissioner, U.S.
Securities and Exchange Commission............................. 6
Hahn, Brian, Chief Financial Officer, GlycoMimetics, Inc., on
behalf of the Biotechnology Industry Organization.............. 8
Mathieu, Chris, Chief Financial Officer, Horizon Technology
Finance, on behalf of the Small Business Investor Alliance
(SBIA)......................................................... 11
Quaadman, Tom, Senior Vice President, Center for Capital Markets
Competitiveness, U.S. Chamber of Commerce...................... 13
APPENDIX
Prepared statements:
Carcello, Joseph V........................................... 40
Grundfest, Hon. Joseph A..................................... 49
Hahn, Brian.................................................. 58
Mathieu, Chris............................................... 66
Quaadman, Tom................................................ 73
Additional Material Submitted for the Record
Garrett, Hon. Scott:
Letter from Hon. Joseph A. Grundfest, dated December 8, 2015. 83
Hinojosa, Hon. Ruben:
Written statement of Public Citizen.......................... 85
Written statement of Jennifer Taub, Professor of Law, Vermont
Law School................................................. 89
Quaadman, Tom:
Letter to the Public Company Accounting Oversight Board,
dated October 7, 2009...................................... 98
LEGISLATIVE PROPOSALS TO IMPROVE
THE U.S. CAPITAL MARKETS
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Wednesday, December 2, 2015
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 10:06 a.m., in
room 2128, Rayburn House Office Building, Hon. Scott Garrett
[chairman of the subcommittee] presiding.
Members present: Representatives Garrett, Hurt, Huizenga,
Duffy, Stivers, Fincher, Ross, Wagner, Messer, Schweikert,
Poliquin, Hill; Maloney, Sherman, Hinojosa, Himes, Ellison,
Carney, Sewell, and Murphy.
Ex officio present: Representative Hensarling.
Also present: Representatives Green and Sinema.
Chairman Garrett. Good morning. And we are not going to go
by the clock on the wall, which I see is a little bit behind.
The Subcommittee on Capital Markets and Government
Sponsored Enterprises is hereby called to order. And without
objection, the Chair is authorized to declare a recess of the
subcommittee at any time.
Also, without objection, members of the full Financial
Services Committee who are not members of the Subcommittee on
Capital Markets and Government Sponsored Enterprises shall be
permitted to participate in today's hearing.
Now, as we indicated on the website, today's hearing is
entitled, ``Legislative Proposals to Improve the U.S. Capital
Markets.'' With that, I welcome our witnesses to the hearing
today. Some of them are familiar faces and there are new faces
as well.
I thank you all for coming and I thank you for appearing
before us.
Before we get to the panel, however, I will recognize
myself for 2\1/2\ minutes for an opening statement.
So today's hearing, as I said, will examine a generalized
topic, and in so doing we will be looking at five legislative
proposals. And in so doing we will be continuing our work over
the last 5 years to modernize those securities laws and help to
improve the U.S. capital markets.
Now, four of these bills would build upon the success, if
you will, of the 2012 JOBS Act by lowering barriers to capital
formation for small and growing businesses. And I want to take
this time to thank the sponsors on both sides of the aisle for
their work on those issues.
The fifth bill we will discuss today is one that I have
introduced and that is H.R. 3798, the Due Process Restoration
Act. This legislation would allow defendants in litigated SEC
enforcement cases to have their cases be removed to a Federal
district court, thereby availing themselves of the due process
protections that currently do not exist in the SEC
administrative proceedings.
And you may ask, why is this necessary? Well, in recent
years the SEC has transformed itself into a veritable judge,
jury, and executioner as it has brought more and more
enforcement cases before its own in-house tribunal where they
are heard then by administrative law judges who are themselves
actually employees of the SEC.
Let us look at the numbers. In fact, in Fiscal Year 2014
the SEC brought nearly half of its litigated actions through
administrative proceedings, and that was an increase of about
35 percent over 2012. And its win rate in these cases is, not
surprisingly, extraordinarily high.
So while prosecuting more cases in this manner is maybe
more efficient and leads to lower expenditures for the SEC, we
must realize that these efforts come with a significant cost.
The cost is less due process protection for defendants who find
themselves beholden to a seriously flawed system that violates
the constitutional rights of the accused.
And despite recent attempts by the SEC to address some of
the concerns that have been raised, its in-house courts still
lack many of the protections provided under the Federal Rules
of Civil Procedure and the Federal Rules of Evidence, such as
full discovery rights and the right to jury trial.
So the solution envisioned under the Due Process
Restoration Act, my bill, is a simple one: Simply allow
defendants the option to have their cases moved to a district
court where robust due process protection exists.
The legislation maintains the ability of the SEC to
commence an administrative proceeding in cases where the SEC,
for example, may be seeking to bar someone from practicing from
their Commission. And importantly, the bill does not mandate
that certain cases automatically move to a district court.
Instead, it leaves the decisions up to the defendant.
So if the administrative proceedings are as fair and
impartial as the SEC says they are, under the bill those
defendants would have the ability to remain within the SEC's
in-house tribunal.
Hopefully, we can all agree that enforcement is an
essential part of the SEC's mission, but we can also agree that
the rights of the innocent must also be protected when the SEC
takes actions that can destroy the career and reputation of an
individual.
So the Due Process Restoration Act would help protect the
innocent against government overreach. And I look forward to
hearing from our witnesses today on this important matter.
With that, I yield to the gentlelady from New York for 3
minutes.
Mrs. Maloney. I thank the gentleman for calling this
hearing and for yielding to me.
And this hearing will address a series of legislative
proposals, most of which address capital formation issues. They
are intended to make it easier for companies to raise capital.
I am proud to be a cosponsor of one of the bills, the SEC
Small Business Advocate Act, which my colleague Mr. Carney has
worked so hard on. This bill would create an Office of the
Advocate for Small Business Capital Formation within the SEC
and would also create a permanent Small Business Advisory
Committee at the SEC.
This is a common-sense proposal. It is actually modeled off
of the provision in the Dodd-Frank Act which established the
SEC's Investor Advisory Committee.
Ms. Sinema and Mr. Fitzpatrick also have a bill that would
provide very targeted relief on the auditor attestation
requirement in the Sarbanes-Oxley Act. All of the Democrats on
this committee, myself included, voted against a bill last
Congress that would have provided a blanket exemption from this
requirement for roughly 75 percent of all public companies.
But I am intrigued by this compromise bill from Ms. Sinema,
which is substantially more narrowly targeted. In effect, the
bill would only provide limited relief and only to companies
that can prove that they don't have enough revenue to pay for
the auditor attestation requirement.
So I will be very interested in hearing more from our
witnesses about this proposed compromise.
Finally, the Due Process Restoration Act would overhaul the
SEC's administrative courts. I am very concerned about making
changes that could weaken the SEC's enforcement authorities as
well as their ability to quickly and fairly prosecute
wrongdoers.
It is also important to remember that the SEC has long had
the authority to try certain cases in an administrative forum
rather than in Federal court. And we simply expanded this
authority in Dodd-Frank because it has been such a useful tool.
In fact, people forget that much of our insider trading law
was developed in an administrative case, the insider trading
case of Katie Roberts in 1961 was an administrative opinion and
the Supreme Court later adopted much of the Katie Roberts
analysis as the basis for insider trading law.
So I think the SEC's administrative forum has been a useful
tool. And I will be interested to hear from our witnesses about
this proposal.
I look forward to all of your testimony and the exchange we
will have. Thank you for being here, and I yield back.
Thank you.
Chairman Garrett. Thank you. The gentlelady yields back.
I now yield to the vice chairman of the subcommittee for
2\1/2\ minutes.
Mr. Hurt. Thank you, Mr. Chairman--
Chairman Garrett. For 1\1/2\ minutes.
Mr. Hurt. Thank you, Mr. Chairman.
And I thank the witnesses for appearing today in this
important hearing.
I represent a rural district in Virginia, Virginia's 5th
District. It stretches from the northern part of Virginia in
Fauquier County to the North Carolina border. As I travel
across my district, I am reminded by my constituents again and
again that the number one concern that they face is jobs and
the economy. At a time when our economy is still struggling,
Congress must do everything possible to help our small
businesses achieve success.
These entities are our Nation's most dynamic job creators
and their success is essential to our economy and American
working families depend upon their success.
Every one of the measures we are considering today is
designed to achieve that goal, whether that means establishing
an office for small business capital formation, reducing the
size of the administrative state or helping startups market
their securities to a larger poll of investors, the goal is to
help our Nation's small businesses achieve that success.
One such measure we are considering today is the Helping
Angels Lead Our Startups Act, or HALOS Act. If enacted, this
legislation would help startups by allowing them to better
market their securities and to take part in economic
development events like demo days where these startups can
interface with potential investors without the risk of
violating Federal securities law.
If adopted, the HALOS Act would alleviate the burden placed
on startups with regard to privacy and compliance concerns
which often require entrepreneurs and startups to take on
burdens that are unnecessary and disproportionately expensive
for small firms. These burdens have a significant impact on an
entrepreneur's ability to deal with investors because of the
risk of having their interactions with investors viewed as
general solicitations or advertisements in violation of the
Federal securities laws.
The adoption of the HALOS Act would be an important step in
continuing the success that this committee has achieved in the
bipartisan JOBS Act.
I look forward to the testimony of each of our
distinguished witnesses.
I thank the chairman and yield back the balance of my time.
Chairman Garrett. Thank you, and the gentleman yields back.
And now for 2 minutes, Ms. Sinema.
Ms. Sinema. Thank you, Chairman Garrett and Ranking Member
Maloney, for holding this legislative hearing.
I have heard from companies throughout my district that
burdensome and unnecessary regulations continue to stifle their
ability to grow and succeed. My bipartisan bill, the Fostering
Innovation Act, provides targeted regulatory relief for
companies on the cutting edge of scientific and medical
research.
The bill adds an additional 5 years to the current JOBS Act
exemption from auditing requirements under Sarbanes-Oxley for
emerging growth companies that have an annual average revenue
of less than $50 million and less than $700 million in public
float.
This common-sense exemption will help ensure that costly
regulations don't stand in the way of success for companies
with a research-driven business model.
I am also a sponsor of the Helping Angels Lead Our Startups
Act, or the HALOS Act. This bipartisan bill provides a clear
path for startup businesses to connect with angel investors and
venture capitalists through demo days without being subject to
onerous verification requirements.
Demo days are business-planned competitions, startup days,
innovation summits, and other public forums that introduce
entrepreneurs to potential investors. But because of confusion
under current law, small businesses that need equity capital
may forgo these events, losing opportunities to meet not only
accredited investors, but also students, professors, and
business professionals whose input and eventual investment
could be invaluable.
I am committed to working with my colleagues on both sides
of the aisle to ensure that Arizona's innovative small
businesses have every opportunity to thrive.
So thank you to Mr. Chabot, Mr. Hurt, and Mr. Fitzpatrick
for working with me on these common-sense, bipartisan bills.
And thank you again to Chairman Garrett and Ranking Member
Maloney for holding today's hearing.
I yield back my time.
Chairman Garrett. The gentlelady yields back.
The gentleman from Maine is recognized for 1 minute.
Mr. Poliquin. Thank you, Mr. Chairman.
I want to thank Chairman Garrett and Chairman Hensarling
for bringing forward the Small Business Capital Formation
Enhancement Act in a draft format today that I am sponsoring.
I also want to thank Congressman Juan Vargas from
California who will be the lead cosponsor on this bill.
We all know that 80 percent of the new jobs in America are
created by small businesses. But often, small businesses can't
get the traditional loans from banks that they need to grow and
expand and to hire more workers, so it is so important for our
small businesses to be able to access our capital markets, the
most liquid in the world, to make sure they have that lifeline.
Now, it doesn't matter if you are a boat builder in
Ellsworth, Maine, or you are a call center in Lewiston, Maine,
those jobs are critically important to our district and other
employers throughout the country.
Now, during the past 35 years, as required by law, the SEC
holds a forum that combines government officials and the
private sector to make sure we come up with the best ideas
possible on how our small businesses can access capital so they
can grow and hire more workers. And we get the best academics
and businesspeople, industry people and attorneys and
government folks in the same room so we can come up with the
recommendations.
Now, one of the problems we have, Mr. Chairman, is that
this group every year comes up with some terrific
recommendations that should become part of the rulemaking here
in Congress or part of legislation that we sometimes advance
here in this committee. But the SEC is not required to do
anything with these recommendations.
So all this Act does is require that the SEC access this
information, take it very seriously, and issue a public
statement on whether or not they are going to use these
recommendations to further capital access in America.
So with that, Mr. Chairman, again I want to thank you very
much for letting me introduce this legislation in draft form.
And I thank Congressman Juan Vargas for being a lead
cosponsor on this bill.
Chairman Garrett. The gentleman's time has expired. And I
thank the gentleman for his work on the legislation and for him
introducing the bill.
We will now turn to our panel. And again, I welcome
everyone here on the panel and I thank you very much for being
with us. You have all submitted written testimony. I have
reviewed it, and I suggest the subcommittee has reviewed it as
well.
You will be given at this point 5 minutes to address the
subcommittee. For those of you who have not been here before,
there should be in front of you indicator lights: green menas
you have 5 minutes; yellow means you have 1 minute left; and
red means you are out of time. And without objection, each of
your written statements will be made a part of the record.
So with that, we will turn to the professor, Mr. Grundfest.
Welcome to the panel, and you are recognized for 5 minutes.
STATEMENT OF THE HONORABLE JOSEPH A. GRUNDFEST, WILLIAM A.
FRANKE PROFESSOR OF LAW AND BUSINESS, STANFORD LAW SCHOOL; AND
FORMER COMMISSIONER, U.S. SECURITIES AND EXCHANGE COMMISSION
Mr. Grundfest. Great. Thank you, Chairman Garrett, Ranking
Member Maloney, and distinguished members of the subcommittee.
I would like to thank you for the opportunity to address
matters that are important to the enforcement of our Nation's
securities laws in general and to the issues that are raised by
H.R. 3798, the Due Process Restoration Act of 2015 in
particular.
A few brief words of introduction. I am the William A.
Franke professor of law and business at Stanford Law School. I
am senior faculty at the Rock Center on Corporate Governance at
Stanford University. And I served as a Commissioner of the
United States Securities and Exchange Commission from 1985 to
1990.
The substance of my testimony this morning can be
summarized in a single word: balance. There should be a
reasonable balance between the cases that the Commission
decides to pursue through its internal administrative
proceedings and those it decides to pursue in Federal court.
And as for cases brought as administrative proceedings, there
should be a reasonable balance between the respondent's rights
to mount an effective defense and the Commission's reasonable
interests in the prompt and effective enforcement of our
Nation's securities laws.
There is, however, cause for concern that both processes
are out of balance from many different perspectives.
Legislative proposals of the sort that this committee is
exploring this morning can, I believe, help restore a more
effective equilibrium.
The SEC's administrative procedures have been criticized
for decades. Critics have complained of a lack of depositions,
the imposition of a rocket docket, the admission of hearsay
evidence, the absence of a jury, bias by administrative law
judges, long delays in appeals to the Commission itself, and
the incongruity of an appeal to the same body that initially
authorized the complaint.
These concerns have recently been compounded by SEC
statements suggesting a plan to increase the number of
enforcement actions filed as administrative proceedings and
correspondingly to reduce the number of actions filed in
Federal civil court.
The Commission has also clearly signaled its intent to
insist on Chevron deference to its interpretation of the
Federal securities laws, even when a significant number of
Federal judges disagree with the Commission. Indeed, a sitting
Federal judge has warned of serious adverse consequences for
the evolution of the Federal securities laws if the Commission
succeeds in this endeavor.
For all of these reasons, concern has mounted about the
fairness of the SEC's internal administrative procedures and
the frequency with which the agency resorts to administrative
proceedings and not to Federal court.
To the Commission's credit, it has not been deaf to these
concerns. It has recently proposed to amend its rules governing
administrative proceedings so that instead of prohibiting all
depositions, respondents will now be permitted to take up to
five. But these are minor concessions given the litany of
concerns that have been raised about the Commission's internal
procedures.
Indeed, as a leading commentator in The New York Times
recently observed, these are, ``at best, small steps in
responding to criticisms over truncated rights.''
The challenge for Congress is to consider a legislative
strategy that might help restore a more effective balance in
the Commission's internal procedural rules and in the process
by which the Commission decides which cases to file in Federal
court and which to bring as administrative proceedings.
One possible approach to this challenge would be to
consider legislation that would help assure that appropriate
cases are heard in Federal courts and by administrative law
judges, and the same legislation could provide incentives for
the Commission to reform its internal procedures so that they
are viewed as reasonable by the Federal judiciary.
This proposal would categorize SEC enforcement proceedings
as falling into one of three groups. The first group of cases
would involve proceedings that Congress determines can remain
in the administrative process and that don't, as a rule,
require the greater safeguards available under the Federal
Rules of Civil Procedure or the Federal Rules of Evidence.
Examples of these cases might include late filing cases, net
capital violations, and a host of other matters that should not
clutter the dockets of the already overburdened Federal courts.
The second group of cases would be composed of cases that
raise questions that Congress considers particularly well-
suited for resolution in Federal court. Examples of these cases
might include insider trading prosecutions, or fraud in the
sale of securities. As to these cases, respondents would have
an unconditional right of removal, much as they would under the
legislation being considered today, H.R. 3798.
The third group would be composed of cases that fall in
neither the first nor second categories. Respondents in these
cases could have a right to petition the Federal courts for an
order of removal that would be granted at the discretion of the
judge. The entire process could be modeled on Federal Rule of
Civil Procedure 23(f) which creates a right to petition for
interlocutory review of decisions on motions for class
certification.
This tripartite approach can, I believe, lead to an
appropriate balance that does not interfere with the SEC's
legitimate interest in the fair and efficient enforcement of
the Nation's securities laws and protects the legitimate
interests of respondents in these proceedings.
Thank you very much.
[The prepared statement of Mr. Grundfest can be found on
page 49 of the appendix.]
Chairman Garrett. I thank the gentleman.
Now turning next to the representative from the biotech
industry. Mr. Hahn, you are recognized for 5 minutes.
STATEMENT OF BRIAN HAHN, CHIEF FINANCIAL OFFICER,
GLYCOMIMETICS, INC., ON BEHALF OF THE BIOTECHNOLOGY INDUSTRY
ORGANIZATION
Mr. Hahn. Good morning, Chairman Garrett, Ranking Member
Maloney, and members of the subcommittee. My name is Brian Hahn
and I am the CFO of GlycoMimetics, a clinical stage biotech
company with 40 employees. We are conducting clinical trials to
treat patients suffering from sickle cell disease and acute
myeloid leukemia.
GlycoMimetics' story is mirrored by our colleagues cross
bio's membership. Our product candidates were developed by
brilliant scientists and our early research was funded by
venture capital. When it came time to conduct expensive
clinical trials, we turned to the public market for financing.
Growing biotechs do not generate product revenue. We are 12
years into our research and we are still years away from our
first dollar in product revenue. Because of this unique
development pathway, investment capital is vitally necessary to
support the $2 billion search for new medicines.
GlycoMimetics went public in January of 2014, raising $64
million that has funded our research for the last 2 years. Our
IPO was supported by the JOBS Act, which has stimulated more
than 180 biotech IPOs by granting company-enhanced access to
investors and reducing their regulatory burdens.
Spending capital on one-size-fits-all compliance
requirements is uniquely damaging to emerging biotechs. Every
dollar spent on a reporting burden is a dollar diverted from
the lab.
The JOBS Act has been so successful because it has allowed
emerging growth companies to focus capital on science rather
than compliance. In particular, I am thankful that the emerging
growth companies are given a 5-year exemption from compliance
with Section 404(b) of the Sarbanes-Oxley (SOX) Act.
The external attestation required by SOX does not provide
meaningful information to biotech investors, yet is extremely
costly for a pre-revenue company. Our investors demand
information about our science, our patients, and our regulatory
pathway, but they do not want us to spend up a million dollars
on compliance requirements that don't give any insight into our
business.
The JOBS Act's 5-year SOX exemption has saved millions of
dollars for growing biotechs, but most will still be pre-
revenue when the IPO on-ramp expires.
GlycoMimetics expects our annual expenses to increase by
upwards of $350,000 starting in year 6 on the market, capital
that could be used to treat over a dozen patients in the clinic
each year.
I strongly support the Sinema-Fitzpatrick Fostering
Innovation Act which would extend the JOBS Act 404(b) exemption
for an additional 5 years for certain small companies.
This bill would allow growing businesses to remain exempt
from Section 404(b) through year 10 on the market if they
maintain average annual revenues below $50 million and a public
float below $700 million.
If focusing on revenues is the key metric of a company,
size is vital to the reform. Public float is a measure of
investors' predictions about our future potential, but revenue
is a true window into a company's size today and our ability to
pay for expensive compliance requirements that are not
meaningful.
We are all working toward the first dollar of revenue.
Until that point, we need to focus all of our investment
capital on our research rather than on our compliance
obligations. This important bill recognizes that a low-revenue
company that has been on the market beyond the 5-year EGC
window is still very much an emerging, growing company.
The Fostering Innovation Act will build on the success of
the JOBS Act by reducing compliance costs for small businesses.
These cost savings will allow companies like mine to focus
solely on life-changing science, so I strongly support this
bill.
I also support efforts to encourage the SEC to enact
capital formation initiatives. The JOBS Act came out of
industry proposals that the SEC could have instituted on its
own, but Congress had to step in.
The SEC Small Business Advocate Act and the Small Business
Capital Formation Act would improve the SEC's policymaking
processes by bringing small businesses into the room, hopefully
encouraging smart policymaking that will support capital
formation and reduce regulatory burdens.
The JOBS Act has shown us the strong impact that a move
away from one-size-fits-all regulatory burdens can have on
capital formation.
I applaud the subcommittee for considering further cost-
saving initiatives and look forward to answering any questions
you may have.
[The prepared statement of Mr. Hahn can be found on page 58
of the appendix.]
Chairman Garrett. I thank the gentleman for your testimony.
Dr. Carcello, welcome to the panel, and you are recognized
for 5 minutes.
STATEMENT OF JOSEPH V. CARCELLO, EY AND BUSINESS ALUMNI
PROFESSOR, AND DEPARTMENT CHAIR, DEPARTMENT OF ACCOUNTING AND
INFORMATION MANAGEMENT, HASLAM COLLEGE OF BUSINESS, UNIVERSITY
OF TENNESSEE, KNOXVILLE
Mr. Carcello. Thank you. Good morning, Chairman Garrett,
Ranking Member Maloney, and members of the subcommittee. Thank
you for giving me the opportunity to speak with you today about
legislative proposals that would affect the U.S. capital
markets.
I can't reduce my testimony to one word, but I can reduce
it to one sentence: Capital markets do not exist without
investors.
I have served as a professor at the University of Tennessee
for over 20 years where I teach accounting, auditing, and
corporate governance. My remarks are also informed by my
service on the SEC's Investor Advisory Committee and the
PCAOB's Investor Advisory Group.
Turning first to H.R. 3784, it would establish an Advocate
for Small Business Capital Formation and a Small Business
Capital Formation Advisory Committee within the SEC. This bill
appears premised on a lack of access that small business has to
Congress and/or to the SEC.
The facts belie the existence of a problem, given recent
changes to small-business regulation contained in the Dodd-
Frank Act and in the JOBS Act. Even if Congress concludes that
the interests of small businesses need better representation,
the bill as drafted is flawed.
The advisory committee is essentially a lobbying group for
small businesses, a lobbying group that Congress would have
granted a government imprimatur to.
Finally, H.R. 3784, as well as a number of the other bills
being discussed this morning, seem to view any shortfall of
capital experienced by small businesses as a problem of demand.
That is, small businesses lack capital due to onerous and high-
cost regulation.
Leaving aside the veracity of this viewpoint, this argument
ignores the suppliers of capital: investors. Creating a quasi-
lobbying group to seek a more favorable regulatory climate for
small businesses may succeed in reducing the cost of
regulation, but at the potential cost of greater information
risk to investors. Such an outcome would actually be
counterproductive for small businesses as capital would either
exit the market or would only be available at a much higher
cost.
Turning to H.R. 3798, this bill would give defendants
subject to SEC proceedings before an ALJ the option to have
those proceedings terminated. If the SEC wanted to proceed, the
Commission would have to bring the charges in U.S. district
court.
Before changing the SEC's enforcement process, it is
important to remember that Congress, first in the Sabanes-Oxley
Act and then in the Dodd-Frank Act, made it easier for the
Commission to bring certain enforcement actions before an ALJ.
Congress should not underestimate the collateral damage that
may be done by changing the SEC's enforcement powers.
Giving defendants the right to effectively choose the venue
in which they will be tried is unlikely to be in the best
interests of society and will almost certainly make it more
difficult for the SEC to deter and punish securities law
violations, including fraud.
Finally, the Fostering Innovation Act would extend the
waiver of auditor reporting on the effectiveness of an issuer's
controls over financial reporting for certain emerging growth
companies from 5 years to as long as 10 years. Further
expanding the number of companies exempt from 404(b) is ill-
advised because auditor reporting on ICFR is valued by
investors.
In a recent survey by the PCAOB's Investor Advisory Group--
by the way, $13.4 trillion of capital was represented by those
respondents, 72 percent of surveyed institutional investors
indicated that they relied on the ICFR opinion either
extensively or a good bit.
Any decision to exempt smaller public companies from
auditor internal control testing ignores the ample evidence
that internal control problems are often most serious in
smaller public companies. In addition, those companies charged
with financial statement fraud by the SEC tend to be relatively
small.
If Congress decides to move forward with this proposal, I
have an alternative for Congress to consider. Rather than just
giving a blanket exemption after 5 years, assuming the $700
million threshold is not hit and the $50 million revenue is in
place, put it to a vote of the people who actually own the
company: the investors.
If my colleagues on this panel are right, they will
overwhelmingly vote for a further delay in that requirement.
And if they value 404(b), they won't. So let the market decide,
let investors who own the company make the decision.
I look forward to the committee's questions.
[The prepared statement of Dr. Carcello can be found on
page 40 of the appendix.]
Chairman Garrett. Thank you.
From Horizon Technology Finance, Mr. Mathieu, welcome to
the panel, and you are recognized for 5 minutes.
STATEMENT OF CHRIS MATHIEU, CHIEF FINANCIAL OFFICER, HORIZON
TECHNOLOGY FINANCE, ON BEHALF OF THE SMALL BUSINESS INVESTOR
ALLIANCE (SBIA)
Mr. Mathieu. Thank you. Good morning, Chairman Garrett,
Ranking Member Maloney, and members of the subcommittee.
I am here today representing the Small Business Investor
Alliance, or the SBIA, which is the trade association for
lower-middle-market private equity funds, SBICs, and business
development companies, or BDCs, and their institutional
investors. SBIA members provide vital capital to small and
medium-sized businesses across the country.
My name is Chris Mathieu, and I am the CFO and co-founder
of Horizon Technology Finance Corporation, an externally
managed, publicly traded BDC. I have been involved in the
accounting, finance, and venture debt industry for more than 25
years.
Horizon is a specialty finance company that lends to and
invests in development and growth stage companies in the
technology and life science industries. Our investments take
the form of secured loans or venture loans to companies backed
by established venture capital and private equity firms.
Having served as a steward of investor capital for the last
25 years in both public and private markets and for both
institutional and individual investors, I believe I have a wide
and deep perspective on the importance of having an advocate
among the decision-makers within an organization and industry
and its underlying sectors.
I am here to express our support for a bipartisan bill
called the SEC Small Business Advocate Act, or H.R. 3784,
introduced by Representatives Carney and Duffy.
In a speech given by former SEC Commissioner Daniel
Gallagher on September 17, 2014, the genesis of this Act was
born. In his opinion, Mr. Gallagher argued that the SEC does
not have adequate structure in place to consider the views of
small businesses. He argued that the SEC consistently overlooks
the impact of their decisions on small businesses and this
could be a detriment to capital formation.
We agree with Mr. Gallagher's assessment and believe
Congress needs to put a permanent structure in place at the SEC
to give a stronger voice to small business and capital
formation issues. The Act is the favored approach by the
industry to create this new structure.
The Act strengthens the voice of small business at the SEC
by making significant changes to the way the SEC hears from
small-business stakeholders, and responds to stakeholder
requests and makes recommendations to Congress and the SEC to
improve the ability of small business to access capital.
The advocate will have similar powers to the Dodd-Frank-
created Office of the Investor Advocate, giving small
businesses an equal footing with investors in influence over
the SEC actions.
For example, the legislation charges the advocate to
produce an independent annual report to Congress on its
recommendations. This report will provide a summary of the most
serious issues encountered by small business and small-business
investors, and recommendations for change to regulations and
other guidance that may be appropriate to resolve these
problems.
Congress would also benefit greatly from this office.
Legislating good policy generally includes technical assistance
and input from regulators. The technical assistance given to
Congress suffers from the same bias and focus on large
corporations. Congress would benefit from having small-
busineses' issues included in both the technical assistance it
receives and in the way regulations are crafted when
implementing legislation. Better information means better
legislation.
SBIA also supports the HALOS Act. This legislation helps
address a problematic issue in the raising of private capital
surrounding the definition of general solicitation in the
matching of investors with startup investment opportunities.
SBIA encourages the committee to pass this legislation to
provide associations like the SBIA and other fund managers that
are members of the association the protection they need to
facilitate the meeting of potential limited partner investors
and general partner investment managers.
We also support the Small Business Capital Formation Act.
This legislation would require the SEC to respond in a public
statement to each of the suggestions by the Government-Business
Forum on Small Business Capital Formation.
The bill requires that the SEC acknowledge the receipt of
the forum's suggestions and explains why they will or will not
adopt the suggestions.
I want to thank the committee again for holding this
hearing today on these important pieces of legislation. And I
look forward to answering any questions.
And I also ask for your support and cosponsor of this
legislation. Thank you.
[The prepared statement of Mr. Mathieu can be found on page
66 of the appendix.]
Chairman Garrett. I thank the gentleman.
Last, but not least, Mr. Quaadman from the U.S. Chamber of
Commerce, you have 5 minutes.
STATEMENT OF TOM QUAADMAN, SENIOR 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.
A prosperous, growing economy needs to have a strong and
fair securities regulator to facilitate efficient capital
markets. I know that is a priority of Chair White as well as
Director Ceresney, but we were looking at SEC enforcement long
before their tenure.
This past July, the Chamber released a report on SEC
enforcement that included 28 recommendations for how the SEC
can improve enforcement oversight and investigations and, what
I would like to talk about today, due process.
The use of administrative proceedings has changed radically
over the last 25 years that now today administrative
proceedings are the primary means of adjudicating violations.
Administrative proceedings are also not an even playing field.
The SEC has unfettered right to discovery, and can take years
to bring a case, whereas defendants have 90 days to prepare
their defense, lack adequate discovery, and no right to
deposition and have no protection of evidentiary rules.
The due process recommendations that we made this past July
included: alternative dispute resolution, so that the SEC can
quickly resolve very minor violations; clarifying the use of
administrative proceedings, so that those ministerial matters
can solely be handled through administrative proceedings; that
those serious offenses where there is well-settled law in
Article III courts could have a pathway to district courts;
that the 1993 rules of practice be replaced with new rules of
practice that include rights of discovery, ability to have
depositions, as well as the reliability of evidence including
hearsay evidence, as well as the right of removal to district
court and for the defendant, not the government, to decide the
right to a trial by jury.
The SEC, as has been mentioned, has proposed limited
amended rules of practice; I will call it a crawl in the right
direction. We are going to file a comment letter at the end of
this week, which we will be happy to provide to the committee.
We support the Due Process Restoration Act, but would make
a couple of recommendations for amendments. First, we believe
that it should include the 1933 Securities Act, the Investment
Company Act of 1940, and the Investment Advisers Act of 1940.
This will allow for the major enforcement matters that have
well-settled law in Article III courts to have a pathway to
district courts.
We also believe that there should be one burden of proof.
We understand what the reasoning is behind the clear and
convincing standard, but we believe that there should be one
standard of proof so that there is balance.
I believe that the passage of an amended version of the Due
Process Restoration Act, as well as the other due process
enhancements that we had recommended, would allow the SEC to be
a strong enforcer of the law and give defendants the ability to
defend themselves.
We also support the SEC's Small Business Advocate Act of
2015. However, we believe there should be a couple of
amendments as well. First, the powers of the investor advocate
and small-business advocate should be similar and mirror each
other. So, for instance, the small-business advocate should
have the right to appoint a nonvoting member to the Investor
Advisory Committee.
Similarly, it is a very longstanding position of the
Chamber that advisory committees of the SEC and its subordinate
organizations also be transparent in their processes.
Therefore, we would recommend that the bill be amended so that
the Small Business Capital Formation Advisory Committee as well
as the Investor Advisory Committee be subject to the Federal
Advisory Committee Act and the Sunshine Act.
We also agree that the SEC has had a difficult time in
keeping up with evolving markets. We believe that the Small
Business Capital Formation Enhancement Act will allow the SEC
to modernize its regulations and overcome inertia.
We also support the HALOS Act. We believe that this will
help unlock capital. However, we also believe there need to be
strong investor protections in place and that information is
going to credited investors. We believe that there should be a
date-certain retrospective review after implementation for the
SEC to review if the HALOS Act is both facilitating investor
protection, promoting investor protection and facilitating
capital formation.
Finally, I would just like to thank Chairman Hensarling,
this subcommittee, and the Financial Services Committee for
including key capital formation improvements in the DRIVE Act.
We believe that those are very important and are an important
build upon the JOBS Act.
I look forward to working with the committee on these bills
and look forward to any questions you may have.
[The prepared statement of Mr. Quaadman can be found on
page 73 of the appendix.]
Chairman Garrett. Thank you. The gentleman yields back, and
I thank you for the testimony, and also amendment ideas.
But that is what these hearings are for, to see how we can
improve things.
So at this point, I recognize myself for 5 minutes for
questions.
I guess I will go to Mr. Quaadman first. You heard Dr.
Carcello's comments, and his last comment was on the Fostering
Innovation Act bill. One of his comments was, well, if you did
it, maybe what you should do is allow the markets to decide and
allow the investors in that field to be able to opt in or opt
out.
You heard that comment?
Mr. Quaadman. Yes, I did, sir.
Chairman Garrett. That was intriguing to me. So if we were
to go that way, maybe we shouldn't just apply that to that
sphere, maybe we should apply that to a whole myriad of Dodd-
Frank pieces of legislation and allow investors to be able to
opt out all of that.
I see Dr. Carcello agreeing.
Mr. Carcello. Yes.
Chairman Garrett. I will give Mr. Quaadman and Dr. Carcello
10 seconds on each one.
Mr. Quaadman. Sure. I think that is a very interesting
suggestion. I agree with you that if you want to go down that
logical road, then why not have that process for a whole myriad
of rules and regulations.
One thing I just want to do, throw out one area of concern
about, we do believe that internal controls are important for a
company to grow from small to big. In fact, BIO and the Chamber
have been working together to address some concerns with the
SEC and the PCAOB where those costs have actually ratcheted up
for many companies.
I think it is something worthy of discussion, but I think
we also need to be very concerned as well of an uneven playing
field.
Chairman Garrett. Yes.
Dr. Carcello?
Mr. Carcello. Just very briefly, I would extend it broadly.
I would even extend it to the external audit of the financial
statements. I think if that had to be selected by investors,
you would find greater competition and probably greater
responsiveness to market needs.
Chairman Garrett. I was initially troubled by your ideas
because I was thinking you were looking at this as a zero-sum
game as far as our U.S. markets. But I guess if you extended
this as far as you would go, you would actually potentially
open up our markets by making us on a more level playing field
as far as investor concerns across the spectrum. So, thank you
for that.
Let me go back to the other end of the dais here.
Mr. Grundfest, you laid out three pots if you will, three
silos as far as what these could fall into, three buckets, pro
forma matters that would remain here, the clear-cut ones that
were over here, and then other ones that are in the middle.
Maybe you could just spend 20 seconds on the ones in the
middle. What would be the criteria? Because if this is
basically left to a judge to decide, the judge is going to have
to have some sort of criteria in order to make that
determination, right?
Mr. Grundfest. Absolutely, Mr. Chairman. And if you take a
look at my written testimony, the very last footnote on the
very last page lays out six considerations in particular that a
court might view as what would be called core factors with an
analogy to rule 23(f). They would be first, the presence of
complex regulatory matters that are better resolved by an
administrative law judge than by a jury or an Article III.
Let's face it, there are certain levels of complexity that
belong with the SEC. You don't want to clutter the Federal
court docket if you have that kind--
Chairman Garrett. That is in the first category. I got
that.
Mr. Grundfest. Yes. I'm sorry?
Chairman Garrett. That is in the first category, clearly,
the ones that are clearly--
Mr. Grundfest. Actually, even in the toss-up cases.
Chairman Garrett. Okay.
Mr. Grundfest. Even in the toss-up cases, sometimes you
have complex regulatory matters. A judge can look at it and
say, we really need the expertise of the SEC and an ALJ to
address these types of issues.
Then you could look at the value of fact-finding by a jury
as opposed to an administrative law judge. Sometimes they say,
we have questions of credibility and we would rather have a
jury of 12 peers view these issues rather than have the
decision being made by an administrative law judge.
Chairman Garrett. Let me just stop you on that because I
can go through the other six in a moment.
Mr. Grundfest. Sure.
Chairman Garrett. But Mr. Grundfest, on that point, if you
ask the average person on the street, don't we have a right in
the United States to have a decision made on guilt or
innocence, if you will, by a jury of our peers? That doesn't
occur here, correct? The fact finder is not a jury of our
peers. And is that a violation of our Constitution? Is that a
usurpation of the powers of Article III judges, of Article III
of the Constitution?
Mr. Grundfest. Yes. And there have been a number of cases
that have been popping up where courts have been expressing a
lot of concerns regarding this use of administrative
proceedings.
We have now the system is set up that the government
decides whether or not there is going to be a trial by jury,
which puts defendants at a severe constitutional disadvantage.
Chairman Garrett. Right. And at the end of the day, what
are we talking about as far as the penalties that could be
imposed? Are these not life-and-death decisions actually being
made by these inside tribunals?
Mr. Grundfest. Yes. In fact, Russell Ryan, who is a former
Assistant Director of Enforcement at the SEC, wrote an op-ed in
The Wall Street Journal last year where he was citing that
these proceedings are being used as quasi-criminal proceedings.
So if you take someone like a Nelson Obus with Wynnefield
Capital--
Chairman Garrett. Okay.
Mr. Grundfest. --he was able to get into district court
under the old rules and was acquitted after 12 years and $13
million. He would not have the opportunity to do that today and
would not have had the discovery tools that allowed him to
unearth the evidence that acquitted him.
Chairman Garrett. Thank you very much.
And with that, I turn to the gentlelady from New York, the
rnaking member of the subcommittee, for 5 minutes.
Mrs. Maloney. Thank you.
Professor Carcello, I would like to ask you about the Due
Process Restoration Act. This bill would permit a defendant
rather than the SEC to choose the venue of the enforcement
action, essentially whether it is initially tried in an
administrative forum or the Federal district court.
Now when the SEC is bringing enforcement action, it can
choose the venue that best serves the interests of the
investors and the public. A defendant in an enforcement action,
on the other hand, would likely choose the venue that is in the
best interest of the defendant.
So the bill, for example, could potentially allow a well-
funded defendant to choose a district court knowing that the
Federal district courts are overwhelmed and that may delay a
trial, realistically, for many years.
In your opinion, do you think allowing a defendant to have
this choice is in the public interest?
Mr. Carcello. No. And the reason why--the choices here are
very clear. It is obvious to the defendant it is in his or her
interest to have a choice of venue. It is, I think, clear that
from a societal perspective the SEC is going to choose the
venue that they think best serves investors and best serves
society.
And I think it is important for Congress and this committee
to think carefully about the fact that the greater use of ALJ,
as I have talked about in my testimony, was facilitated by
actions Congress took. Congress took action in 2002 in Section
305 of SOX to facilitate the ability of the SEC to move in this
venue. They took action in Dodd-Frank in 929(p) to facilitate
the ability of the SEC to move in this venue.
Both of those Acts followed severe market disruptions,
massive financial fraud, to the point that our markets were
essentially paralyzed in 2001 and 2002.
And I would point out to this committee that in the vote
against SOX, there were fewer people who voted against SOX--
look it up--than voted against declaring war on Japan after
Pearl Harbor was bombed. Okay? And President Bush was the
President then, hardly a known liberal. So the markets were
paralyzed.
Dodd-Frank was not nearly as bipartisan, clearly, but
followed essentially close to the complete implosion of the
financial sector in this country. And so Congress viewed market
failures there. They viewed it as a situation where the SEC,
among many other things, needed greater enforcement tools.
So I think the question the committee needs to answer--and
it is really a very simple question--is what has changed? What
has changed? Why did the enforcement tools that you have
created within the last 15 years, it is not 50 years ago, this
is in the last 15 years, why are these enforcement tools no
longer needed?
Mrs. Maloney. To follow up, are you concerned that this
would hinder the SEC's ability to crack down on bad actors in
the securities market and especially with the funding
constraints? We were just told from the screen that the SEC is
funded 12 percent lower than what their requests are, even
though their responsibilities have grown.
So I would like to ask you to follow up on that, and then
anyone else on the panel who would like to comment on whether
you think this would hinder the SEC's ability to crack down on
bad actors.
Dr. Carcello?
Mr. Carcello. Very briefly, to give others some time, yes,
I think it clearly would. It would make it more difficult. I
think even in Professor Grundfest's testimony, part of his
testimony in his written remarks indicated that it would make
it more difficult at the margin.
And the SEC, in many ways, is an underfunded agency. I
think many people have viewed that for years. And so it is
certainly going to make it more difficult for them to enforce
the securities laws.
To the extent that there is, in the minds of some, a lack
of fairness to the defendant, I think that is a legitimate
concern. But I think there are other ways that can be dealt
with.
Mrs. Maloney. Would anyone else care to comment?
Mr. Quaadman. Yes, Ranking Member Maloney, if we repeal the
Bill of Rights a lot more people would be in jail, but we
wouldn't be a better country. The issue here is that if you had
sufficient rules of practice and administrative proceedings and
you had a right of removal, you would not have a stampede to
district court, but at least you would give defendants the
right to defend themselves.
The reason why we have a Bill of Rights is because
prosecutorial powers are so great, the Founding Fathers wanted
to put some safeguards there.
The issue here is we do not have constitutional safeguards,
which also means there is a presumption that somebody is guilty
until they are proven innocent.
Mrs. Maloney. But they can appeal to Federal court,
correct?
Mr. Quaadman. First, they have to--
Mrs. Maloney. Wouldn't that be a safeguard?
Mr. Quaadman. But first, they have to appeal to the
Commissioners themselves.
Chairman Garrett. The gentlelady's time has expired.
The gentleman from Virginia, the vice chairman of the
subcommittee, is recognized for 5 minutes.
Mr. Hurt. Thank you, Mr. Chairman.
Mr. Quaadman, I wanted to start with you. I was wondering
if you could briefly talk about the importance of the angel
capital markets and the importance of promoting policies here
in Congress that encourage more investment by angel investors
in startups.
Mr. Quaadman. Angel investors are an extremely important
investment tool for startup businesses. They are actually the
first line of accredited investors who are going into startups,
so they are critical for business formation.
I think what we have clearly seen with the JOBS Act is the
changes in general solicitation and the opening up of roadshows
have been wildly accredited with the increase in IPOs and
public company formation.
I think by helping to open up these venues for angel
investors, if done in the right way, which they can be, I think
that will certainly help business formation. And as I have
testified before, we have seen over the last 7 years historic
lows in business creation in the United States. So I think this
is a critical reform we need.
Mr. Hurt. And do you think that is particularly important
in light of the pressures that have been on other participants
in providing capital, namely banks and credit unions, the
pressures that they have suffered from over the last 8 years?
Mr. Quaadman. Yes. Clearly we have seen with the
implementation of the Basel III rules and other rules that are
happening, there are disincentives now for banks to loan either
through traditional business products or consumer financial
products that are used for startups. So that market has
receded, and we are now more dependent upon capital markets. So
I think reforms like this, as with the BDC legislation and
others, are very important in terms of moving forward.
Mr. Hurt. Thank you.
I wanted to talk to Mr. Hahn and Mr. Mathieu for this next
question. I was wondering if, beginning with you, Mr. Hahn, you
could talk a little bit about the current general solicitation
rules and how they unnecessarily impede the ability of startups
to access capital under Reg D Rule 506(c), if you could talk a
little bit about that, and then talk about our HALOS proposal
and whether or not you believe that this proposal gets to the
heart of solving that issue or improving that issue? And then
maybe leave some time for Mr. Mathieu.
Mr. Hahn. Thank you. I can kind of start working backwards
with the JOBS Act. We went public in January of 2014. And the
test-the-waters provision of the JOBS Act was instrumental.
That is why we had a successful IPO.
Working backwards toward that, though, most all of our
funding was from venture capitalists. And over the years, when
we were still private, we were always looking for different
ways to raise money. So any expansion for private companies to
get in front of more investors and to find more pockets of
capital, would be a tremendous success to help more companies
succeed.
Mr. Hurt. Do you think that the HALOS proposal that we are
considering today helps remove some of those barriers and
enhances the ability of startups to access that capital?
Mr. Hahn. Yes, if it works, kind of similar to test the
waters, it gives you more access with less barriers to get in
front of more potential investors to tell the story of the
company. In our case, our science is very complex, so it takes
more meetings, more time to get people comfortable with our
technology. I think that would definitely be helpful.
Mr. Hurt. Mr. Mathieu?
Mr. Mathieu. Yes, I would actually agree with Mr. Hahn. I
think that solicitation is a broad subject and it really goes
to common-sense of how you tell your story.
At Horizon, we often look at companies like Mr. Hahn's in
their earlier stages as well as being public, so we actually
like the stories, we like the time spent in developing the
relationship. So I think the solicitation, broadening that
flexibility is really important, not just to raise equity
capital in the private market, but also the public sector as
well.
Mr. Hurt. And I appreciate the testimony of both you and
Mr. Hahn, in support of the HALOS Act. Do you think that the
HALOS Act, if enacted, would help remove some of those
impediments and encourage more angel investing in startup
companies?
Mr. Mathieu. I do, yes. And I think it is really a path to
just improving a process that works, but can be improved.
Mr. Hurt. Excellent, thank you.
I yield back the balance of my time.
Chairman Garrett. The gentleman yields back.
Mr. Hinojosa is recognized for 5 minutes.
Mr. Hinojosa. Thank you, Mr. Chairman.
I ask unanimous consent to enter two statements into the
record regarding the legislative proposals we are considering
today. The first one is a statement from Jennifer Taub,
professor of law, Vermont School of Law, and the second is a
statement by Public Citizen, a public advocacy organization
here in Washington, D.C.
Chairman Garrett. Without objection, it is so ordered.
Mr. Hinojosa. Thank you.
I would like to thank the panelists for their appearance
and testimony here today.
Our capital markets are the envy of the world because they
are safe, transparent, and liquid. Emerging companies are the
lifeblood of our economy. So ensuring that emerging companies
have access to capital is an imperative if we are to maintain
our global and financial leadership.
As we consider the proposals that aim to improve our
capital markets, we must be careful not to undermine the safety
and the confidence in our markets.
My first question is to John Grundfest. Professor, in your
testimony you voiced some concerns that the SEC faces a crisis
of confidence over the fairness of its internal administrative
procedures. H.R. 3798, the Due Process Restoration Act, aims to
address some of the issues raised by the critics by providing
defendants to remove their case to a Federal district course, a
venue of their choosing, and by increasing the SEC's standards
from a preponderance of the evidence to a clear and convincing
standard.
My question to you is, do you think these measures will
address the concerns raised regarding the SEC's administrative
proceedings?
Mr. Grundfest. I think the bill is one approach that can be
taken to these issues. And I think the existence of the
challenge is actually effectively conceded by the Securities
and Exchange Commission itself.
I think it is valuable for this committee to recognize that
the Commission itself has decided that its historic approach of
saying no depositions in any of its proceedings may actually
not be fair, and for that reason the Commission itself has
proposed increasing the number of depositions to up to five.
Now, in some of the more complex matters, the number of
five could be viewed as being extraordinarily low, arbitrary,
and capricious, given a case that might involve hundreds of
thousands of documents, where the Commission itself may have
taken testimony from hundreds of witnesses. And in order to
have a modicum of fairness, you need not go to one extreme and
say we are going to depose absolutely everyone, but limiting
the number of depositions to five might be viewed as arbitrary
and also as unfair.
Mr. Hinojosa. That is your opinion. Do you believe this
bill will have the result of moving most, if not all, SEC
proceedings to an already overly burdened Federal court docket?
Mr. Grundfest. It could move a large number of important
cases to Federal court docket. And out of concern for the loads
that the Federal judges do face, an alternative approach might
be to look at the three categories that I have suggested where
you could carve out a set of cases where you don't have to have
any right to bring it to a Federal--
Mr. Hinojosa. The Federal courts in Brownsville all the way
to El Paso on the Texas/Mexico border are just overloaded with
different immigration cases and lots of other cases. And we
just don't have enough Federal judges to take on more like you
are suggesting.
My next question is to Joseph Carcello. The Small Business
Capital Formation Enhancement Act would require the SEC to
publicly assess the findings or the recommendations of the
annual Government-Business Forum on Small Business Capital
Formation. My question is, do you find it necessary to require
that the SEC to also formally respond to each recommendation?
Mr. Carcello. Yes, that is a concern. My understanding is,
last year the number of recommendations that came out of that
forum was 20. My understanding also is that any participant in
the forum can make a recommendation.
To the extent that these bills are patterned after Sections
911 and 915 of Dodd-Frank, and speaking as someone who, along
with Professor Grundfest, is on the Investor Advisory
Committee, I can tell you it is quite difficult for us to come
to a consensus. There are 20 members in that group. Each of the
five SEC Commissioners essentially have four picks. As you well
know, the SEC is pretty ideologically divided, so the IAC is
pretty ideologically divided.
Mr. Hinojosa. They seem to resemble Congress.
Mr. Carcello. Yes, they seem to resemble Congress.
Mr. Hinojosa. Do you think the bill will help the SEC--
Chairman Garrett. The gentleman's time--I will permit the
last question. Go ahead.
Mr. Hinojosa. I yield back.
Chairman Garrett. Okay.
Mr. Duffy is now recognized.
Mr. Duffy. Thank you, Mr. Chairman.
I am concerned about the arguments that are being made that
we can't allow due process because our Federal courts are
overburdened. If that were the case, maybe what we would do in
regard to criminal cases, we want to have the attorney
general's office set up some form of administrative law judge
so we can have the FBI investigate, the attorney general
prosecute, to administrative law judges who are hired by the
U.S. attorneys office. And then that therefore would be justice
in the American criminal system.
But I think most Americans would scream wildly that that is
not fair. And to think that we are going to now make the
argument that we can't go to Federal courts because they are
overburdened, the better outcome then would be stay at the SEC
and be guaranteed an adjudication of guilt is a better outcome
for defendants, is absolutely insane.
I agree with Mr. Garrett's bill. We should give defendants
an outlet to go to Federal courts and have their cases heard by
an impartial group of judges and potentially juries.
Mr. Quaadman, do you agree with that analysis? Am I wrong
on that? I am supposed to be spending my time on my own bill
with Mr. Carney, but this is, anyway--
Mr. Quaadman. No, Mr. Duffy, I think you have hit the nail
on the head. And the reason why I also mention about creating
new rules of practice was, if you have fair due process in
administrative proceedings, you are not going to have a
stampede to district courts either. You might have large cases
move over, but it is not going to be a stampede.
The other thing I just want to mention too, because this
also shows how Kafkaesque this is, what got us involved in this
to begin with was that a general counsel came in and talked
about a situation where they had an issue that both the IRS and
the SEC were investigating. And the IRS gave this company a
document giving all their rights and responsibilities during
the investigation and the SEC had nothing. So they are in
complete no-man's land from the start of the investigation
through. And then, when you go into the AP process, you have no
right to discovery or anything. So it is a completely tilted
playing field.
Mr. Duffy. I did well as a former State prosecutor, won a
lot of cases, but I have to tell you I would have had a much-
improved record if I was able to try my cases in front of my
own DA staff, no doubt. And I think that is why we see the
rates of success so high at the SEC.
I do want to transition to the bill that I worked on with
Mr. Carney in regard to our small-business advocate advocating
for better capital formation with regard to our small
businesses.
I think if you look at economic growth, we look at job
creation, it is coming from our small, emerging growth
companies and making sure that they have access to capital it
is incredibly important that we get that right.
And I appreciate Mr. Carney's hard work and the bipartisan
effort and the support that we have had on both sides of the
aisle for this proposal.
We all agree that we want to protect investors. That is a
really good thing. But we also want to make sure we have the
right balance, I would argue.
And maybe to Mr. Mathieu, do you think we have struck the
right balance between investor protection and capital formation
specifically in regard to small businesses?
Mr. Mathieu. I think currently, we are not fairly balanced.
I think that is what this legislation is actually trying to do.
Mr. Duffy. I would agree.
Mr. Mathieu. And so I think we are trying to say that the
SBIA supports this very strongly, because right now the small-
business investor and the small-business operators don't have a
fair say, a fair spot to express their position.
Mr. Duffy. I would agree. And I think to have an advocate
there who can talk about the good, the bad, and the ugly
specifically to the Commission would benefit our small
businesses and emerging growth companies.
I just want to make one comment. I know that some on the
right have made some complaints, people are concerned about the
growth of government. We have a really big debt. None of us
ran, at least on this side of the aisle, to grow government and
make it bigger. And some have said, well, this bill is a growth
of government.
But I think that making sure that you have an advocate
inside the SEC promoting policies that will support our small
businesses so they can access capital, they can grow, they can
create jobs, they are the next innovators, Mr. Hahn, of the
next lifesaving products or the next iPad or Apple or whatever
that technology may be.
To think that we are going to use the growth of government
argument against good policies that help American businesses, I
think is shortsighted.
Mr. Mathieu, would you agree with that?
Or Mr. Hahn, would you agree with that?
Does the growth of government for the small agency that is
funded by fees, not by appropriation, is that small in
comparison to what this does for the American small-business
community?
Mr. Mathieu. Yes, I think this is common-sense. It is a no-
brainer. The incremental cost, if any, far supports the
benefits that will come. The lack of support of small business
from day to day has to change.
Mr. Duffy. Mr. Hahn, quickly?
Mr. Hahn. The SEC doesn't often act on the recommendations
of the advisory committee or the Government-Business Forum. The
small-business advocate would bring those industry stakeholders
further into the SEC's decision-making process.
Mr. Duffy. Thank you, I yield back.
Chairman Garrett. Thank you.
There are some people on the right who are making that
argument. I appreciate that.
Mr. Green is now recognized for--oh, Mr. Carney is
recognized for 5 minutes.
Mr. Carney. Thank you very much, Mr. Chairman, and Ranking
Member Maloney for having this panel today and for all of you
who have come to testify.
A few years ago, I worked with my friend on the other side
of the aisle, Mr. Fincher, on the JOBS Act, and in particular
the IPO on-ramp. I come from the State of Delaware; my district
includes the whole State of Delaware. We pay very close
attention to corporate formation and business development
issues. Most of the 500 companies are incorporated in our
State.
And folks whom I know well, who do that business in the
Division of Corporations have been reporting to us that
companies were no longer going to IPO. And we had had a real
problem with that, a cutback, and there are lots of different
reasons.
And Treasury convened a group of business leaders. And out
of that confab came a number of ideas to try to promote
businesses, emerging growth companies to go to an IPO, because
the facts were that companies that sought public financing
through an IPO were in a growth stage creating more jobs. And
what had happened was for some of those companies that were
emerging, they were looking at a merger and acquisition kind of
an outlet, which actually resulted in fewer jobs.
And so the effort that we did in a bipartisan way to put
the IPO on-ramp together out of the work that Treasury had done
I think has produced some pretty good results and the facts
speak for themselves.
We heard the argument from BIO a while ago that biotech and
pharmaceutical-type companies, research companies take a longer
time to develop and therefore need a longer on-ramp. And I
think that is part of the reason for the bill that is before us
that Ms. Sinema and others have cosponsored.
Is there any concern? Originally when we had that testimony
a year or so ago, I was interested in providing an extension of
that on-ramp to bio-type companies. This would just do it to
any company that fits the definition, an emerging growth
company as defined by the original JOBS Act, and then had the
limitations of size as part of the bill.
Should we look at limiting it further to the kinds of
companies, Mr. Hahn, like yours, or not?
Maybe Mr. Quaadman could answer this more generally?
Mr. Hahn. In the last 18 or last 20 years, I have been in
early-stage startup companies. And I have been in
manufacturing, IT, and I have been in life sciences now since
2002. I would say, every one of those industries, every one of
those companies, I think this is beneficial across-the-board.
Mr. Carney. Okay, good. So the other issue that we
struggled with when we did the initial IPO ramp bill, and Mr.
Himes was arguing that maybe the size limitations were too big,
does anybody have--is there any concern, I guess from Mr.
Carcello, about the definition of emerging growth companies
under that piece of legislation, that it ought to be more
limited, or anybody on the panel?
Mr. Carcello. It is certainly significantly more limited
than the bill you considered last year. So if you are going to
move forward, I think the way you have structured it now is
certainly less risky to the market than the bill that was voted
down last year.
Mr. Carney. Okay, thank you.
So Mr. Quaadman, I didn't catch everything that you said
about the small-business advocate bill, but there was some
recommendation for a change that you mentioned. Could you
restate?
Mr. Quaadman. Sure. I appreciate your work on the bill. And
as I said, we support it.
The SEC has a tripartite mission, right: investor
protection; capital formation; and competition. And your bill
addresses capital formation and competition.
The two changes we recommended were: one, that the investor
advocate and the small-business advocate be on the same plane,
so that there should be an amendment that the small-business
advocate would have a similar right to appoint a nonvoting
member to the Investor Advisory Committee as the investor
advocate has with the Small Business Capital Formation
Committee. That is one.
Number two, and this has been a longstanding position that
we have advocated for, is that these types of advisory
committees, and I would say for the Small Business Capital
Formation Committee as well as for the Investor Advisory
Committee, that they be subject, that they be under the
jurisdiction of the Federal Advisory Committee Act so that
there is transparency with the proceedings, so that neither the
Investor Advisory Committee nor the Small Business Committee
could be a quasi-lobbying group that Mr. Carcello says.
Mr. Carney. I am running out of time, but I just want to
make a comment about that. To us, those of us who are
sponsoring the bill and supporting it, we think advocacy, for
some, advocacy is lobbying. We think it is advocacy and it is
appropriate in this context.
We do this in all kinds of different ways for small
businesses at State, local, and Federal Government. We think it
is appropriate in this context.
And I want to thank everybody again for being here today
and for your comments and input.
Chairman Garrett. Thank you. And the gentleman yields back.
Mr. Schweikert is recognized for 5 minutes.
Mr. Schweikert. Thank you, Mr. Chairman.
Mr. Hahn, you were kind enough in your testimony, in your
written testimony to talk a bit about some of the successes and
some of what was helpful in the JOBS Act.
First off, thank you from many of us who cared a lot about
that. But just for curiosity, what would you add? What would
you change? And what other legislation--the legislation we are
talking about here today, do you think it enhances both your
success and your use of the JOBS Act?
Mr. Hahn. Thank you. As I stated, the test-the-waters
meeting provision of the JOBS Act was great. It takes investors
some time to understand our technology and our science and what
we are doing.
I think the Fostering Innovation Act takes a targeted
approach to build onto the JOBS Act from the 404(b) exemption.
So for the first 5 years, we are 404(b) exempt. And the
company, GlycoMimetics, has been around since 2003. So here we
are in 2015 and we still don't have--we are still several years
out from a product to market and product revenue.
So we are going to be in year 6 and we have most of our
expenses, our top three expenses, are our payroll, our clinical
trials supplies, and clinical trial expenses.
So I think in year 6, we are looking to add upwards of
$350,000 in 404(b) attestation and we are still going to be 40
employees, I am still going to have a staff of 3, we are still
going to have vanilla financials.
Mr. Schweikert. Let me ask, within your specialty, how
common is this, particularly in biotech, research-intensive
sort of new intellectual capital to have as long an on-ramp as
you are having?
Mr. Hahn. Very common, very common. It takes upwards of $2
million and anywhere up to 10-plus years to get a product from
concept to FDA approval.
Mr. Schweikert. Okay. And do you think we are going far
enough on these pieces of legislation to give you that window
to tell your story, but also to have the capital without the,
shall we say, auxiliary expenses?
Mr. Hahn. I think it is a good, measured, targeted next
step. So the first 5 years, I think, a lot of companies, we are
in that stage now where hopefully we can get to years 6 through
10 and see how that works out. And then possibly expand more
and measure it.
Mr. Schweikert. Thank you.
Mr. Quaadman, in that same sort of realm of subject, I am
sort of doing a broad brush of, okay, here is our--we will call
our success from a couple of years ago the JOBS Act, here we
are doing some very small, incremental touches and
improvements, may be able to have some voices, some other paths
if you hit the wall of regulatory or litigation. What else
would you add? What are we failing to even engage in the
conversation on?
Mr. Quaadman. First off, I think both the Small Business
Advocate bill as well as Mr. Poliquin's draft bill go a long--
those bills, if they are implemented, will have far-ranging
consequences because we will actually start to have a real
debate about capital formation and competition within the SEC.
Mr. Schweikert. Okay. But first on the Poliquin bill, and I
think we are still just in draft or discussion draft at this
point?
Mr. Poliquin. Yes.
Mr. Schweikert. Does it actually provide the path that you
believe is necessary?
Mr. Quaadman. Yes, because what you are doing is you are
creating a mechanism that the Commission actually has to
respond to recommendations. Because remember, the JOBS Act was
a series of recommendations that advisory committees and the
SEC had been making for years and nothing had ever happened. So
rather than things just going over the transom and being
ignored, this actually starts to force mechanisms for something
to happen.
So I think it is also important, for it allows the SEC to
take the self-initiative to try and keep up with the markets
rather than having Congress having to bear down on them.
Mr. Schweikert. Okay, sort of the second half of this, and
I don't mean to get ethereal. With what I am seeing in much of
the capital formation marketplace, we all see the numbers that
today we have, what, a third, or 40 percent fewer publicly
traded companies, but we see the movement in private equity, we
see the movement now on versions of capital raises that are
happening online.
Are we being robust enough in understanding that the way we
raise capital today, but over the next decade, is going to look
really different than it did last decade?
Mr. Quaadman. The capital markets are always evolving. So I
can guarantee you that 10 years from now, it is going to be
much different than it is today. Remember, we are seeing online
lending start to ramp up.
Mr. Schweikert. Yes, peer-to-peer, the Lending Club models
are exploding.
Mr. Quaadman. Yes.
Mr. Schweikert. But are we being sort of future-proof in
the designs of how we are addressing this? And are we being
prescriptive enough to the SEC?
And I know, Mr. Chairman, thank you for your patience.
But for many of us, we sat here for 3 years waiting for the
rule sets on crowdfunding we all thought was going to be pretty
simple. So asking the SEC to promulgate rule sets has become a
disaster. And we almost have to be prescriptive in what we do,
which also means we have to get it right.
Mr. Quaadman. Yes. The one other thing that I would mention
that should occur is also, what are the policies and
regulations that are driving public companies out of that
space? So what is the outflow problem? And I don't think we
have really addressed that one.
Mr. Schweikert. Okay.
Mr. Chairman, thank you for your patience.
Chairman Garrett. Thank you. The gentleman's time has
expired.
The gentleman from California is welcome and recognized for
5 minutes.
Mr. Sherman. Thank you. I think it is critical that we get
capital to small business. Outside the scope of this hearing,
most businesses borrow most of their capital. And what I am
seeing is that if you are borrowing money at prime-plus-3, you
can get the money. If you want to borrow money at 33 percent
annual, well, there is an advertisement every few minutes about
how you get your money the next day.
But the prime-plus-6, prime-plus-8 loan, prime-plus-5 loan
that I was used to seeing when banks and other lenders took
some limited risk seems to be gone. But here we are focused on
capital and shareholders' equity rather than loans.
Mr. Carcello, beyond the JOBS Act, what proposals can you
come up with that will help small and medium-sized businesses
get access to equity capital?
And perhaps others would have a comment as well.
Mr. Carcello. I initially thought, as I read through these
bills, that the HALOS Act was good. And so this gives me an
opportunity to talk about that Act. And as these panelists have
talked about it, they have focused on angel investor groups,
and I actually think those are quite good and quite helpful,
and I think would be bipartisan.
What threw me when I read that Act, though, is the
expansion of that Act into venues such as not-for-profits and
universities and governmental entities. And for someone who has
worked in a university for over 25 years, I can tell you most
people who work there are not accredited investors, most people
who work there are not sophisticated investors. And I think
that poses tremendous pressure.
Mr. Sherman. You mean my professors were not as smart as
they told me they were?
[laughter]
Go on.
Mr. Carcello. Not about financial matters. Most Americans,
as you probably know, Mr. Sherman, being a CPA, are not quite
knowledgeable about financial matters.
Mr. Sherman. Does anyone else have a comment? If not, I
will move on to the next question.
Mr. Quaadman, I am a cosponsor of the SEC Small Business
Advocacy Act, which would create an Office of Advocate for
Small Business Capital Formation. Do you think this new office
would help energize the capital markets for small and medium
size in initial public offering companies?
Mr. Quaadman. Yes, I think it would allow for that voice
for capital formation to be heard within the halls of the SEC
where it hasn't been before. And as I said before, I think it
would also force the SEC to modernize rules that would prevent
Congress from having to go through a JOBS Act exercise again.
Mr. Sherman. Dr. Carcello, should we be providing
additional exemptions from Section 404, I believe it is 404(b),
dealing with reporting on a company's internal controls? I know
this is a cost for some companies and it seems like an
unwarranted cost except when it discloses a problem.
Mr. Carcello. Right. Yes, I don't think we should. I think
if the Congress decides to move forward, as I suggested to the
committee, I would at least give the investors, the owners of
the company, the right to elect. So at the end of 5 years, put
it to a vote, put it to a shareholder vote. And if it is as
good an idea as all of the people to my left and right think it
is, then the shareholders will overwhelmingly approve it.
I do think that 404 has produced tremendous benefits. There
is a lot of research, not just in the academy. The Financial
Executives Research Foundation recently released a study where
financial executives, approximately half of them, have said the
benefits of the internal control attestation far exceed the
costs.
Again, it was put in place because of problems with
financial reporting, restatements, fraud. And when that
happens, confidence in the capital markets evaporates and
capital dries up. So if we are concerned about capital
formation, don't lose sight of that other side.
And if you would give me the ability, I want to make a very
small comment, if I could, about the Small Business Advocate
Act. I think it is important--
Mr. Sherman. I do want to. I have just a few more seconds
and it wouldn't be a committee hearing if I didn't rail about
the Financial Accounting Standards Board (FASB) and their
decision to put $2 trillion on the balance sheet of businesses,
chiefly small and medium-sized businesses.
Mr. Quaadman and I have been trying to prevent this
unwarranted damage to our business system. And members of the
subcommittee should be aware that the FASB has said they are
going to go forward with this with virtually no input from any
part of the public that isn't already in their own Rolodex.
And it is just illustrative of the fact that we should
never have that much governmental power located in Norwalk,
Connecticut.
I yield back.
Chairman Garrett. Thank you. The gentleman yields back.
The gentleman from Maine is recognized for 5 minutes.
Mr. Poliquin. Thank you, Mr. Chairman. I appreciate it very
much.
When we have an opportunity to get government together with
the business community, the folks who are on the ground,
growing their companies and creating jobs, it is a better time
and a better place for all Americans and all job creators.
That is why I am excited about discussing with you your
experience when it comes to the small business capital
formation forums that the SEC has been having over the past 35
years.
Now, it is my opinion if we are going to get all this
talent together, folks who are taking time out from running
their businesses to try to inform government officials, in
particular in this case the SEC, on the best way to allow small
companies to borrow money and grow and hire more individuals
and grow the economy, then we should listen to the results they
come up with.
Now, what I would like to do is start with you, Mr. Hahn. I
believe that you were not or have not participated specifically
in these business-government forums that the SEC has been
holding the last 35 years, but you represent folks who do.
And could you, to the best of your ability, inform all of
us here on this committee and the public as to what experience
your folks have had with respect to this forum? Have the
recommendations been useful?
Mr. Hahn. I think from my understanding, as I said earlier,
a lot of--the SEC often doesn't act on the recommendations of
the advisory committee and the Government-Business Forum.
However, they are published. I think it was Congress that took
parts of the JOBS Act out of those recommendations--
Mr. Poliquin. Right.
Mr. Hahn. --which was a tremendous success.
Mr. Poliquin. So these specific recommendations from past
forums ended up in legislation that was passed through this
committee. Correct?
Mr. Hahn. Yes.
Mr. Poliquin. So it was pretty useful.
Mr. Hahn. Very useful.
Mr. Poliquin. Okay. And doesn't it therefore make sense
that not just that one example in the JOBS Act, but on an
ongoing basis we have the body, the SEC, that is holding these
and organizing these forums to make sure that every
recommendation that comes out of these forums they address,
they comment on in a public format. And if they are going to
adopt some of the recommendations, fine. And if not, why?
Doesn't that make sense?
Mr. Hahn. Total sense.
Mr. Poliquin. And that would be helpful to those in this
space to make sure they know what rules coming down the pike
might affect them when it comes to raising money for their
companies.
Mr. Hahn. Also, it makes you wonder what else has been
missed.
Mr. Poliquin. Say that one more time.
Mr. Hahn. It also makes you wonder what has been missed,
what hasn't come out of those recommendations that could be
helping businesses like mine.
Mr. Poliquin. Absolutely. I was about to morph into that.
And Mr. Mathieu, maybe you can comment on this. If you have
35 years of forums that are coming up with all of these experts
from their field, in government, in academia, attorneys even,
that are coming up with these ideas, doesn't it make sense that
if you publicly come out and you comment on each of these
recommendations, then you don't have to start over the next
year?
You now have a wealth of information, a database of
recommendations that might make sense going forward such that
we can go forward instead of repeating what we have just done
the last few years.
Mr. Mathieu. That completely makes sense. First, thanks for
introducing the legislation.
Mr. Poliquin. You bet.
Mr. Mathieu. It is very important. What is crazy about this
is that, as you said, there are a lot of people who spend a lot
of time preparing for those forums, the structure makes a lot
of sense, it gets a lot of people, thoughtful-thinking people
into group sessions, breakout sessions where they are really
spending a lot of their emotion and mental efforts to come up
with really great ideas to help small business.
They put them in a package, they come up with the idea, and
then it just goes nowhere.
Mr. Poliquin. It sits on the shelf.
Mr. Mathieu. It goes into the atmosphere, which is just
crazy. That is like, have every small business spend a week-
and-a-half doing business development or strategic planning and
then throw it in the trash and the shredder right after they
have finished it. It doesn't make sense.
Mr. Poliquin. Yes. We have a fellow named Tom Coyte from
Atlantic Financial in Maine who runs a VC shop, who came down
and participated in some of these forums. So, it is close to
our heart.
Mr. Quaadman, if I could end with you, I just have a short
amount of time here. Doesn't it make sense to also require the
SEC to not only participate in these forums, but make sure that
their recommendations are not only public, but they are
relevant to the dynamic nature of our markets?
One of the great things about our economy and why it has
been so strong for so long, notwithstanding the recent period
of time we are going through, is that we have a dynamic and
growing, evolving and creative capital markets system, the envy
of the world.
These regulations should evolve along with our capital
markets, shouldn't they?
Mr. Quaadman. Yes. And I agree with all the other comments
that were said. The other thing I would say too, and the reason
why it is important for the SEC to be a part of that and to
respond to it is because it should also focus them on areas
where they are not looking and where they should be looking.
So, I think there is a win-win here.
Mr. Poliquin. I thank all of you gentlemen very much for
participating. I appreciate it very much.
Thank you, Mr. Chairman. I yield back my time.
Chairman Garrett. The gentleman's time has expired.
Mr. Ellison, for 5 minutes, if he is--
Mr. Ellison. Thank you, Mr. Chairman, and the ranking
member. I appreciate the recognition.
Professor Carcello, thank you for your service on the
Securities and Exchange Commission's Investor Advisory Board. I
do appreciate it.
Anyone following the Presidential election knows that many
people think that the rules are rigged in favor of powerful
companies. H.R. 3798 seems to further rig this, in my view, by
allowing big companies, the defendants, to pick a more
favorable venue for investigations into their alleged
misconduct.
The SEC now chooses a venue for enforcement that serves the
interests of investors and the public, yet this bill would
allow a well-funded defendant to choose a district court venue.
We know that district courts are often overwhelmed, so this
type of forum shopping may delay trial for up to a decade in
some cases.
How is allowing a defendant to essentially forum shop in
the public interest?
Mr. Carcello. Yes, I am not convinced it is in the public
interest. And here is a thought experiment for the committee.
Imagine if 15 years ago, the SEC thought there was a problem
with Bernie Madoff, and they brought it in Federal court
because they were forced to as a result of this, and there was
a long delay. And during that time, he continued to collect
money and ruin people's lives. Does this committee really want
that obligation on their head?
Mr. Ellison. Dr. Carcello, I think I can say on behalf of
all of my colleagues on both sides of the aisle, no. So I think
we should take steps to address it.
When you served on the Investor Advisory Committee, one of
the areas the committee considered was the prevalence of
contracts and bylaws that contained mandatory arbitration
clauses. In fact, Commissioner Aguilar called to end mandatory
arbitration.
I wonder what your views are on the issue of, say, this
committee bringing a bill to allow defendants to choose the
venue of the enforcement action while not allowing investors
the same option.
Mr. Carcello. Not just investors, Congressman Ellison. How
about every person in the United States? There was a powerful
series of stories by The New York Times about a month ago that
everyone should read, about how the United States has
essentially become a land where every citizen in this country,
all of your constituents are routinely every day signing away
their rights to jury trials in employment, in consumer
purchases, in virtually every sphere of their life. And there
is no outrage about that, but there is outrage about due
process for largely well-monied financial professionals.
It is far from clear to me, and I think it would be far
from clear to most people in the United States, why that is in
the interests of the republic.
Mr. Ellison. I actually have a bill called the Investor
Choice Act, H.R. 1098, that would prohibit predispute mandatory
arbitration clauses in investment contracts. I urge all my
colleagues to sign it.
But if I may just ask you a few more questions. In your
testimony you detail a number of concerns with both small-
business bills we are considering today. One of your concerns
is that H.R. 3784 requires redundant authority. And I will just
quote your testimony, the Small Business Advisory Committees,
``create a quasi-lobbying group to seek a more favorable
regulatory climate for small businesses. This may succeed in
reducing the costs of regulation, but at the potential cost of
greater information risk to investors.''
You note the advisory committee created a rigged system
that lacks ideological balance and seems gerrymandered. If
Congress mandated the Small Business Advisory Committee, should
it require that investor and public interests are represented
and have voting powers? And can you give us a few ideas to make
it less of a quasi-lobbying group?
Mr. Carcello. Exactly. That is exactly right. The IAC,
which this is arguably patterned against, has--as I said
earlier, five Commissioners have four picks. Look at this
committee. Professor Grundfest is here representing the
Republicans; I am here representing the Democrats. We are both
on the IAC.
The SEC is highly split, so the 20 members on the IAC bring
an ideological diversity to our discussions. It forces us to
seek consensus solutions.
If you look at the proposed Small Business Advisory
Committee, it is essentially officers, directors, advisers, and
investors, which sounds good until you realize it is venture
capital, largely, which are heavily owners in that company with
a different stake than the kind of mom-and-pop retail investor,
and it is not at all comparable to the IAC.
So if you are going to move forward with that group, first
of all, I think one thing that should be thought about,
Congressman Ellison, there is this implicit undertone here that
investors are one constituency and small business is another.
Why don't we have an advisory committee for midsize business
and large business and biotech businesses?
Investors are every single adult in this country.
Chairman Garrett. The gentleman's time is way over.
Mr. Ellison. Thank you so much, sir.
Chairman Garrett. Mr. Huizenga is recognized for 5 minutes.
Mr. Huizenga. Thank you, Mr. Chairman.
And I will turn to you, Mr. Grundfest. Do you care to
comment on that riff that we just heard? I would love to hear
from you.
Mr. Grundfest. Yes. Just one simple point, in terms of
point of accuracy. I think many of the issues that we are
dealing with today aren't Democratic or Republican issues. Not
that it means anything; I am a registered Democrat, and have
always been a registered Democrat, and I don't view myself as
being here representing the Republican side or the Democratic
side.
I think there are fundamental questions of fairness about
how the process is actually operated. I agree with Mr. Ellison
that fairness is an issue that needs to be considered for all
people in all forums of all proceedings.
Fairness can be in the eye of the beholder. That is why I
go back to that one word that I think is the focus of my
testimony. The question is, how do we achieve an appropriate
balance? Clearly, there are situations where investors' rights
and the SEC's rights need to be very aggressively protected.
But by the same token, you can't have a situation where I
think the SEC acts as judge and jury and as summary prosecutor
and eliminates the rights of everyone else involved in the
process.
It is a difficult question. Let us admit that it is a
difficult question. But let us not try to polarize the issues
more than they already are.
Mr. Huizenga. I appreciate that.
Mr. Hahn, I want to quickly turn to you. The Fostering
Innovation Act and the high costs associated with the SOX
404(b) compliance has been cited repeatedly by small and
emerging companies as one of the deterrents from listing in the
U.S. public markets. I wanted to get your comment on that.
And then also regarding Sarbanes-Oxley, obviously, that is
an admirable goal to protect investors. However, many argue
that the cost of Section 404(b) far outweighs any perceived
benefit for most small, public companies. You suggest in your
testimony that investors in biotech companies do not list
404(b) compliance as a top priority of their own due diligence.
Could you describe what types of information are used by
investors and people looking at that?
So if you want to touch on the 404(b), and then give me a
profile.
Mr. Hahn. On the 404(b) side, I think it is important to
note that just because we are 404(b) exempt currently, we do
have a strong internal control framework in place and we do
have an outside party that audits our controls and reports
directly to the Audit Committee.
I spend maybe $15,000 a year on that. As the current now in
year 6 when I have to be 404(b) compliant, my expenses in that
go to $350,000 and nothing is going to change from our business
from year 5 to year 6. We are still going to have 40 employees,
I still have a staff of three. So that is kind of the impact on
the 404(b) side.
As it relates--I'm sorry, what was the second part of your
question?
Mr. Huizenga. Yes, just, if they are not looking at 404(b),
what type of information are investors in small biotech
companies looking at?
Mr. Hahn. As I stated earlier, for the test-the-waters IPO,
we met with 90-plus investors. And since we have been public in
January of 2014, we have met with approximately 130 more
investors. So about 220 one-on-one investor meetings in about
the last 2\1/2\ years. All of the questions around
understanding our technology, our science, the indications that
we are going after in our current clinical trials. I think the
only financial-related questions I get are, what is your cash
balance and what is your runway, and how long is that going to
get you? The only questions, no other financial questions that
way.
Mr. Huizenga. Okay. So is that information not useful or is
it just not relevant really to the biotech space?
Mr. Hahn. It is not, I would say, it is not relevant, not
primarily relevant to the investors. It is a secondary issue.
They want to understand the science and the technology and they
want to know that we are spending our resources and our money
on the R&D side and not on the administrative side.
Mr. Huizenga. All right.
Mr. Quaadman, you said something that I don't even remember
how many speakers ago it was or questioners ago, but the
outflow problem on businesses, and I want to give you the last
little bit here to talk about that problem, because I am very
concerned about that as well.
Mr. Quaadman. Sure. We have half as many public companies
in the United States as we did in 1995. The number of public
companies has gone down every year, for 19 of the last 20
years. Clearly, something is wrong and something is broken.
Mr. Huizenga. Isn't it just a bad economy? That is what we
hear.
Mr. Quaadman. No. Remember, 1995, 1996, 1997, those were
awfully good years and that is when the decline started, right?
So we have to really match up our policies with capital
formation.
Two other points I just want to quickly mention. To
Professor Carcello's notion of, let's put this out for a
shareholder proposal, 54 percent of institutional investors say
our current corporate disclosures are too voluminous and don't
provide relevant information.
Mr. Huizenga. In other words, sometimes too much
information really doesn't give you any information.
Mr. Quaadman. Correct. So you know what? Let's crank up the
shareholder proposals because that will be faster than the SEC
with the disclosure effectiveness project.
Secondly, what we really have to also pay attention to
while we are looking at these issues is that Europe is trying
to replicate what we are doing. So we should also remember that
as well.
Chairman Garrett. Thank you.
Mr. Huizenga. Thank you, my time has expired.
Chairman Garrett. The gentleman's time has expired.
Mr. Green, you are recognized for the next-to-the-last
word.
Mr. Green. Thank you, Mr. Chairman.
And I thank the witnesses for appearing today.
I am exceedingly concerned about the conflating of criminal
and civil law today. Whether by accident or design, this seems
to have taken place. All of you are scholarly people and you
know that out of the same set of circumstances, you can have a
criminal case or you can have a civil case.
And in a criminal case, the standard of proof is guilt
beyond a reasonable doubt, the doubt in the mind of a
reasonable person. If it exists, then you must say by your
verdict, ``not guilty.''
In a civil case, generally speaking, most of the time it is
preponderance of the evidence, the greater weight and degree of
credible testimony.
If you differ with what I have just said, will you kindly
raise your hand? Let the record show that no one differs.
And it is also true that these hearings with the SEC
actually go before an independent arbiter known as an
administrative law judge? And the administrative law judge
makes a finding of facts and issues and also conclusions of
law?
If you differ with what I have just said, raise your hand.
How do you differ, sir?
Mr. Quaadman. The administrative law judge is an employee
of the SEC; they are not independent.
Mr. Green. If this is the case, the judge who hears my case
in court, who also hears my motion for a new trial, is it
inappropriate for that to happen, to take place?
Mr. Quaadman. No, what the point here is, and I think Mr.
Duffy was making this point earlier, if we were to look at it
in that way, the district attorney would also be the judge. And
that is currently--
Mr. Green. I am pleased that you said that because it has
been my experience that most judges are former DAs.
If you differ with what I have just said, raise your hand.
The point to be made is this. If you are talking about
preponderance of the evidence in a civil case that can be
appealed to the Commission, correct, and then from the
Commission to a Federal judge, why would you have clear and
convincing evidence as a standard at the administrative hearing
and then when you go to the Federal judge you have
preponderance of the evidence?
Do you agree that can occur? If no one agrees, then I will
have to make the case again. Do you agree that can occur? If
you have preponderance of the evidence in the Federal district
court, and you have clear and convincing evidence before an
administrative law judge, you now have the same set of facts,
two arbiters, different standards of proof.
Mr. Carcello, do you agree?
Mr. Carcello. Yes.
Mr. Green. Okay. Let us find someone who differs. Who
differs? Who differs that we would have two standards of proof
with the same set of facts?
Mr. Quaadman. Mr. Green, as I mentioned in my opening
statement--
Mr. Green. Would you kindly do this? Would you start with
yes, I agree, or no, I don't agree? Because sometimes when
people finish, I don't know whether they have said yes or no.
Mr. Quaadman. No. We had suggested an amendment to the bill
that there be one standard of evidence.
Mr. Green. So you agree with what I have said. The question
is, do you agree with what I have just said? You agree. So if
you agree with what I have just said, and you understand the
difference between criminal and civil law, O.J. not guilty
criminal case, O.J. guilty civil case, these things exist and
they have been decided clearly by Federal courts that they are
constitutional. There is no unconstitutionality here.
And I would also add this. To say, to use terminology of
finding a person guilty before an administrative law judge,
now, you heard that said earlier. Why would a professor of law
not correct that in the record? The administrative law judge
doesn't find anyone guilty or any corporation guilty.
If you differ with what I have just said, raise your hand.
Let the record reflect that nobody differs.
Dear friends, we have to take these issues seriously when
we are talking about changing the laws that impact not only
corporate America, but also the citizens of the United States
of America. Investors are citizens. They are taxpayers. They
deserve fairness, too.
Bernie Madoff treated a lot of investors unfairly. And but
for the SEC's ability to go before an administrative law judge,
I am not sure how that would have ultimately ended.
So I thank you for your time, Mr. Chairman, and I yield
back.
Chairman Garrett. The gentleman yields back.
Mr. Hill is recognized for 5 minutes.
Mr. Hill. Thank you, Mr. Chairman.
And I appreciate the witnesses' forbearance today.
I think I want to start out and continue on that theme.
And Mr. Quaadman, if you would just, I think, for the
committee state the difference between mandatory arbitration
and the SEC administrative proceedings. Because having been in
the brokerage business for many years, we have had mandatory
arbitration and it has worked, I think, very effectively. Fifty
percent of those cases tend to reach a conclusion before they
even go to a hearing panel.
But I think we ought to clarify the difference between
these two.
Mr. Quaadman. These are two completely different things.
And we are talking about two completely different universes.
Mandatory arbitration deals with two private entities
engaged in a transaction, and they go before a neutral third
party if there is a dispute. That actually has been a system
which has worked very well with keeping cases out of the
courts, which people have talked about overburdened court
dockets.
What we are dealing with here, with administrative
proceedings with the SEC, is we are actually having the
government prosecute, whether or not we want to talk about
whether it is civil or criminal, but there are prosecutions
that will destroy a person's career. So these are completely
different items altogether.
Mr. Hill. Thank you. I appreciate that clarification for
the record today.
I have spent a lot of my career in private placements for
small business. And so I appreciate the effort of my colleagues
on this subject. And I have also on and off been involved in
small-cap public companies and I know about the cost of trying
to manage small-cap enterprises.
One concern I have always had is this quarterly cost to be
public. And many years ago, I was associated with a company
with a market cap of around $70 million and around $10 or $12
million in EBITDA. And if my memory is right, and I am going
from memory, I didn't prepare for this conversation, it was
about $400,000 a quarter to do a Q and K prep and internal
control work and that kind of thing. This is both the audit fee
as well as the preparation-type costs. And that is substantial.
So anything that affects costs, I think is one of the
barriers to Mr. Quaadman's talk about why we have declining
numbers of IPO companies, despite efforts in recent years to
reverse that trend.
Section 404, what is a way to, in my view, look at the
marginal difference in 404? In other words, sure, there is some
benefit by having a robust internal control system. But haven't
we gone overboard in the prescriptive nature of it and perhaps
the costs really do outweigh the benefits, particularly for
small, simple businesses where they are really being held to a
404(b) standard that goes a lot deeper than you would have to
do in a simple, straightforward business?
Mr. Hahn, do you want to start out on that? Because I know
you are preparing essentially for this feature.
Mr. Hahn. I have been involved in four startup companies
and implemented the accounting systems and the process and
procedures. And every one of those, as I have learned over the
last 18 years, is measured controls, appropriate controls
measured that are appropriate to the business and the business
processes.
If you put too many controls on, you just clamp down the
business and people can't operate.
I think the 404(b) should take that same approach where we
are exempt now, but it seems that this one-size-fits-all; that
we are held to the same standards as these large corporations,
we have a $130 million market cap, we cut 125 checks a month,
we have two check signers. So to hold us to the same standards
as these large corporations, I just don't feel is appropriate.
Mr. Hill. It is like in the bank regulatory environment
where we are all held to a high IT standard for data security
in commercial banks. Some banks are more simple than others,
but the regulation is written the same for Citibank's IT
protocol as for a small community bank.
And I think 404(b) over the years, because the accounting
industry wants to be conservative in their approach, they have
to be certified, they have to be peek-a-boo licensed, and so
they don't make a distinction perhaps enough, I think, for
small businesses.
Any comments on the crowdfunding proposal? In my seconds
left, who wants to tackle the comments on the SEC's
crowdfunding proposal? Does anybody have any thoughts on that?
It just got published in the last couple of weeks.
Mr. Quaadman. I think we are going to have to see how that
is going to progress. I think that has been an innovative
portion of the JOBS Act. We have argued for strong internal
controls. I know Europe is trying to do some similar things.
So I think that is something where we had also called for,
as we did with the HALOS Act, a retrospective review after a
couple of years to see how it is working and what needs to
happen to make it better.
Mr. Hill. Thank you, Mr. Chairman. I yield back.
Chairman Garrett. The gentleman yields back.
This brings us to the end. But since one of the Members
raised a point, and I will yield to you another minute if you
want, but just to clarify a point since I think he was
referring to me when I used the term ``guilt'' or not.
I will just ask Mr. Quaadman for 1 minute the question, is
this a case where there is a distinction without a difference?
Truly, there is a difference between a criminal and a civil
matter, but as far as the ability of the SEC to impose a fine
or require restitution or to require that you lose your
license, is that a distinction without a difference? Because
you can basically devastate an individual, take all his
livelihood away and take all of his assets away by an SEC
enforcement action.
Mr. Quaadman. That is correct. And not only have we seen
APs change in the way that they are used, but the way that the
civil tools are used, they are now quasi-criminal trials and
cases. So I think we can quibble, but I think you are exactly
right. We are talking about a distinction without a difference.
Chairman Garrett. And since I went over our time, does Mr.
Carney have anything else for another minute?
Mr. Carney. Yes. I would just like to take a minute again
to go back to the characterization, which I think is troubling
to hear the small-business advocate referred to as a lobbying
kind of thing.
The thing that I hear most from my business constituents,
large businesses and small businesses, is that there is no
advocate, there is no voice for small businesses in a lot of
administrative procedures.
My history is more at the State and local government level.
And many of these big bureaucracies that we deal with here in
Washington, it is an entirely different thing. And maybe it is
that our politics are so poisoned by that word being such a
negative thing.
But the essence of the bill is to bring small-business
concerns, which are varied and different, to the SEC in their
processes to facilitate policies and regulations that don't
hurt small businesses and capital formation.
I think some of the work that has been done through the
JOBS Act, again, my effort was with Mr. Fincher on the IP on-
ramp as the attempt is to get beyond characterizations that are
pejorative or whatever in such a way to try to move the ball so
that we do do something that makes it more beneficial for a
company to be a public company, for companies in particular to
be incorporated in the great State of Delaware, and not to get
in these political battles back and forth.
That is not to diminish the concerns, Dr. Carcello, that
you have. I acknowledge those, and I will look at those in
relationship to the legislation.
But if we are going to make progress, I think we have to
think about the language that we use as we characterize these
things.
Mr. Chairman, thank you, and I yield back.
Chairman Garrett. Thank you.
I thank the panel, all of our witnesses here today, for
your written testimony and also for your testimony today and
your questions as well.
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.
And with that, without objection, this hearing is
adjourned.
[Whereupon, at 12:00 p.m., the hearing was adjourned.]
A P P E N D I X
December 2, 2015
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