[Senate Hearing 114-10]
[From the U.S. Government Publishing Office]





                                                         S. Hrg. 114-10


               VENTURE EXCHANGES AND SMALL-CAP COMPANIES

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

                                HEARING

                               before the

                            SUBCOMMITTEE ON
                 SECURITIES, INSURANCE, AND INVESTMENT

                                 of the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                    ONE HUNDRED FOURTEENTH CONGRESS

                             FIRST SESSION

                                   ON

EXAMINING HOW VENTURE EXCHANGES CAN AID CAPITAL FORMATION AND SECONDARY 
              TRADING FOR SMALLER BUSINESSES AND COMPANIES

                               __________

                             MARCH 10, 2015

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs



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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  RICHARD C. SHELBY, Alabama, Chairman

MICHAEL CRAPO, Idaho                 SHERROD BROWN, Ohio
BOB CORKER, Tennessee                JACK REED, Rhode Island
DAVID VITTER, Louisiana              CHARLES E. SCHUMER, New York
PATRICK J. TOOMEY, Pennsylvania      ROBERT MENENDEZ, New Jersey
MARK KIRK, Illinois                  JON TESTER, Montana
DEAN HELLER, Nevada                  MARK R. WARNER, Virginia
TIM SCOTT, South Carolina            JEFF MERKLEY, Oregon
BEN SASSE, Nebraska                  ELIZABETH WARREN, Massachusetts
TOM COTTON, Arkansas                 HEIDI HEITKAMP, North Dakota
MIKE ROUNDS, South Dakota            JOE DONNELLY, Indiana
JERRY MORAN, Kansas

           William D. Duhnke III, Staff Director and Counsel

                 Mark Powden, Democratic Staff Director

                       Dawn Ratliff, Chief Clerk

                      Troy Cornell, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                 ______

         Subcommittee on Securities, Insurance, and Investment

                      MIKE CRAPO, Idaho, Chairman

          MARK R. WARNER, Virginia, Ranking Democratic Member

BOB CORKER, Tennessee                JACK REED, Rhode Island
DAVID VITTER, Louisiana              CHARLES E. SCHUMER, New York
PATRICK J. TOOMEY, Pennsylvania      ROBERT MENENDEZ, New Jersey
MARK KIRK, Illinois                  JON TESTER, Montana
TIM SCOTT, South Carolina            ELIZABETH WARREN, Massachusetts
BEN SASSE, Nebraska                  JOE DONNELLY, Indiana
JERRY MORAN, Kansas

               Gregg Richard, Subcommittee Staff Director

           Milan Dalal, Democratic Subcommittee Staff Director

                                  (ii)

















                            C O N T E N T S

                              ----------                              

                        TUESDAY, MARCH 10, 2015

                                                                   Page

Opening statement of Chairman Crapo..............................     1

Opening statements, comments, or prepared statements of:
    Senator Mark R. Warner.......................................     2

                               WITNESSES

Stephen Luparello, Director, Division of Trading and Markets, 
  Securities and Exchange Commission.............................     4
    Prepared statement...........................................    20
    Responses to written questions of:
        Senator Warner...........................................    92
        Senator Vitter...........................................    94
Thomas W. Farley, President, New York Stock Exchange Group.......     5
    Prepared statement...........................................    27
Scott Kupor, Managing Partner, Andreessen and Horowitz...........     6
    Prepared statement...........................................    29
Nelson Griggs, Executive Vice President, Listing Services, Nasdaq 
  OMX Group......................................................     8
    Prepared statement...........................................    89

              Additional Material Supplied for the Record

Prepared statement of William Beatty, President, North American 
  Securities Administrators Association, Inc.....................    96
Responses to written questions of Senator Crapo from Kate 
  Mitchell, Co-Founder & Partner, Scale Venture Partners.........   103

                                 (iii)

 
               VENTURE EXCHANGES AND SMALL-CAP COMPANIES

                              ----------                              


                        TUESDAY, MARCH 10, 2015

                                       U.S. Senate,
     Subcommittee on Securities, Insurance, and Investment,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Subcommittee met at 10:02 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Mike Crapo, Chairman of the 
Subcommittee, presiding.

            OPENING STATEMENT OF SENATOR MIKE CRAPO

    Senator Crapo. Good morning. This hearing will come to 
order. This is the first hearing of this Subcommittee in this 
Congress, and I want to welcome our Ranking Member, Senator 
Warner, and all of the other Members of the Committee.
    There are a lot of productive opportunities for good reform 
and good progress to be made in the jurisdiction of this 
Committee, and we look forward to a productive Congress.
    Today's hearing will provide insights into the challenges 
of trading stocks of small companies and whether a venture 
exchange can aid capital formation and secondary trading for 
smaller companies. The U.S. capital markets have been and 
continue to be a vibrant ecosystem fueling economic growth. 
These markets provide financing and needed resources to a wide 
array of businesses from the smallest startups to the largest 
international companies. Smaller public companies, however, 
have had difficulty sustaining strong secondary market 
liquidity and trading.
    In 2013, the SEC Advisory Committee on Small and Emerging 
Companies stated, ``The Committee believes that current U.S. 
equity markets often fail to offer a satisfactory trading venue 
for the securities of small and emerging companies because they 
fail to provide sufficient liquidity for such securities and 
because the listing requirements are too onerous for such 
companies.''
    SEC Chair Mary Jo White wrote, in a letter dated December 
23, 2014, ``The market structure for stocks of smaller 
companies is one of the areas that demands attention. I have 
previously emphasized that we should no longer assume that our 
market structure should be one size fits all.''
    Her letter also references a 2014 SEC small-cap paper that 
finds that all metrics of market quality are significantly 
inferior for smaller capitalization companies compared to mid-
sized companies. I agree with SEC Chair White's assessment. 
While these metrics of market quality can be expected to be 
less favorable for smaller companies as compared to larger 
companies, the extent of the disparity documented in the small-
cap paper highlights the need to consider steps that might lead 
to improvements for smaller companies that at least narrow the 
gap.
    I look forward to hearing from our witnesses today whether 
a venture exchange can help narrow the gap and their insights 
into the following questions:
    How can a venture exchange aid capital formation and 
secondary trading for smaller companies?
    What are the key characteristics that will make venture 
exchanges meaningful and positive for small companies and 
investors?
    What are the regulatory or legislative steps that are 
needed to attract liquidity providers and market makers to 
stocks that trade less frequently?
    What are the tradeoffs that need to be weighed to promote 
investment in smaller public companies?
    I look forward to hearing from our witnesses on these and 
the other issues they want to present to us, and at this time I 
will turn to our Ranking Member, Senator Warner.

              STATEMENT OF SENATOR MARK R. WARNER

    Senator Warner. Well, thank you, Mr. Chairman, and I look 
forward to working with you closely as we have on so many other 
projects over the years, and I think you'll find this 
Subcommittee, as we all know, has an enormously important 
jurisdiction, and I think we are going to be a good team. I 
appreciate you holding this hearing. This is a subject that is 
near and dear to my heart since I have spent longer as a 
venture capitalist than I have as an elected official. And how 
we can get access to capital and grow small companies, startup 
companies, is critically important.
    I think oftentimes we talk as elected officials about the 
growth of America's economy as so often dependent upon small 
businesses. It is, although in reality, where most of the net 
growth of jobs has come over the last 30 years has come from 
startups. It has not come from traditional small businesses.
    As a matter of fact, from 1977 through 2010, according to 
research done by the Kauffman Foundation, approximately 3 
million new jobs each year, net new jobs, have come from 
startups. That, depending on your numbers, is somewhere between 
60 and 80 percent of all net new jobs created in the economy 
over the last 30 years.
    Now, 400,000, on average, startups, actually only about 15 
of those get to $1 billion market cap, so the notion of how can 
we help some of those companies along the way move on that path 
is terribly important.
    This is an area, though, where we have--over the last few 
years, there are a lot of things Congress has not done, but 
this is an area where we have made some progress, and 
bipartisan action on the JOBS Act a few years back made 
important changes in terms of tweaks, smaller companies in 
terms of being able to keep certain information confidential as 
they do their filing, it really helps in that process before 
you go on a road show to be able to submit that data on a 
confidential basis.
    Last year, I chaired a hearing on high frequency trading, 
and one of the things that came out of that hearing was, as we 
looked at small-cap companies, looking at--proposing a tick 
size project, I know some of you have got some views on that. I 
would like to see that, you know, where we widen the spreads a 
little bit on these smaller companies to protect these 
companies from predatory actions on some of the frontrunners 
that are taking place from the HFTs.
    Now, the SEC has supported that initiative. I am anxious to 
hear, though, why it continues to get delayed, and moving 
forward on the tick size project I think is terribly important.
    I also think we want to make sure--and I think the Chairman 
raised the appropriate questions. What are the tradeoffs as 
well in terms of investor protections? If these smaller 
companies are not going to have the market following, are not 
going to have the market analysis, are not going to have the 
research, are we really sure that the tradeoffs are valid?
    One of the two other things that I believe also are 
important that the SEC continues to move on is another aspect 
of the JOBS Act was modification to the Reg A filings. That has 
enormous opportunity and potential. I would love to hear some 
comments there. And as I mentioned to the witnesses before we 
came into the room, you know, I am intrigued by the idea of a 
venture exchange. I do wonder whether the goal is more about 
capital raising or liquidity. Sometimes for management, as 
somebody who was a venture capitalist, I do worry sometimes 
about management being able to exit the company before it gets 
to its level of stability. And one of the things I am also 
hopeful that people will make a comment on and my hope is that 
the SEC will finalize our activities on crowdfunding. I still 
believe that has enormous opportunity, and how crowdfunding 
platforms might intersect with a potential venture exchange.
    So, Mr. Chairman, I look forward to this hearing. I think 
it is one that brings great opportunities, and I am going to 
have a lot of questions for the witnesses. Thank you.
    Senator Crapo. Thank you, Senator Warner.
    Our witnesses today are: Mr. Stephen Luparello, Director of 
Division of Trading and Markets at the U.S. Securities and 
Exchange Commission; Mr. Thomas Farley, who is the President of 
the New York Stock Exchange Group, NYSE Group; Mr. Scott Kupor, 
Managing Partner and COO of Andreessen Horowitz; and Mr. Nelson 
Griggs, the Executive Vice President of listing services at 
Nasdaq OMX Group.
    Gentlemen, we welcome you. I think you have all been 
advised we like you to keep your initial presentation to 5 
minutes so that we have time and opportunity to engage with you 
in questions and answers. And we will proceed in the order that 
I just described. We will start with you, Mr. Luparello.

 STATEMENT OF STEPHEN LUPARELLO, DIRECTOR, DIVISION OF TRADING 
        AND MARKETS, SECURITIES AND EXCHANGE COMMISSION

    Mr. Luparello. Chairman Crapo, Ranking Member Warner, and 
Members of the Subcommittee, thank you for inviting me to 
testify on behalf of the U.S. Securities and Exchange 
Commission regarding exchanges focused on the listing and 
trading of stocks of smaller companies. Given the importance of 
smaller companies to the strength of our economy, the SEC 
welcomes the opportunity to discuss approaches that address the 
market structure needs of such companies.
    The SEC is considering innovative approaches that 
appropriately balance the needs of smaller companies for 
efficient secondary markets and the interests of and 
protections for their investors. Venture exchanges potentially 
could achieve such a balance by providing a transparent and 
regulated environment that offers both enhanced liquidity and 
strong investor protections. As such, venture exchanges could 
strengthen the capital formation for smaller companies; they 
could also expand the ability of all investors to participate 
through well-regulated platforms in the growth opportunities 
for such companies.
    Venture exchanges might include exchanges that operate 
nationally as well as local or regional markets that focus on 
companies from a particular geographic area. Their listings 
could include both smaller companies that do not qualify under 
the listing standards for the larger securities exchanges and 
smaller companies that do qualify under such standards but seek 
a market structure specifically geared to smaller-cap issuers.
    A good place to start when considering market structure for 
smaller companies is to recognize that the market for the 
trading of small companies is different from the market for 
larger companies. My written testimony provides tables with 
data that show some of these differences. Among other things, 
the tables indicate that liquidity and market quality metrics 
decline rapidly as company size decreases. The data serve to 
highlight the issue of whether the current U.S. market 
structure optimally promotes capital formation for smaller 
companies and the interests of their investors.
    Of course, the SEC has been focused on small company issues 
for some time. Among other things, the SEC approved a venture 
exchange in 2011, the BX Venture Market. That market was 
designed for companies that did not qualify under the listing 
standards of the larger stock exchanges. Importantly, it also 
included targeted measures designed to address investor 
protection concerns. Although approved in 2011, the BX Venture 
Market has not been launched. My understanding is that concerns 
around ensuring adequate liquidity in BX-listed issues and 
attracting liquidity providers at least in part have caused 
that decision.
    Potentially new venture exchanges might wish to explore 
various types of initiatives to address the difficulties in 
promoting liquidity to the extent possible in smaller company 
stocks. These might include mechanisms to centralize liquidity 
across price and size as well as measures to attract dedicated 
liquidity providers to the exchange.
    A key element that likely would be critical to the success 
of these types of efforts to maximize liquidity is the 
protection for the liquidity pool of a venture exchange. In 
this regard, two Exchange Act provisions provide standards for 
the SEC. They relate to off-exchange trading and listed 
securities and trading by other exchanges pursuant to unlisted 
trading privileges. Both impose substantial tests for the 
Commission before it can adopt or approve measures designed to 
protect the liquidity pool of a venture exchange.
    To sum up, competition in the equities markets can assume 
many forms across different stages in the listing and trading 
process. A key policy question is whether the current U.S. 
market structure for smaller companies enables competition in 
ways that ultimately redound most to the benefit of smaller 
companies and their investors. The potential benefits and costs 
of various forms of competition in the secondary market for 
smaller companies is an issue that warrants close consideration 
by Congress, the SEC, and the public.
    Thank you again for inviting me to discuss an issue of such 
importance to the U.S. equities markets and the economy. I look 
forward to answering your questions.
    Senator Crapo. Thank you very much.
    Mr. Farley.

   STATEMENT OF THOMAS W. FARLEY, PRESIDENT, NEW YORK STOCK 
                         EXCHANGE GROUP

    Mr. Farley. Chairman Crapo, Ranking Member Warner, and 
Members of the Subcommittee, we at the New York Stock Exchange 
appreciate your interest in capital raising for small-cap 
companies. My name is Tom Farley, as you know, and I am 
President of the New York Stock Exchange Group. I have been in 
the business of running CFTC- and SEC-regulated exchanges for 
most of my career.
    The New York Stock Exchange Group includes the iconic New 
York Stock Exchange as well as two additional equities 
exchanges, two options exchanges, and a bond trading platform. 
Across these venues we list and trade cash equities, equity 
options, exchange-traded products, and debt securities which 
are accessible to all investors through their broker-dealer. Of 
our listing exchanges, NYSE MKT has traditionally been the 
listing venue for smaller public companies. Over the years 
there have been several efforts in the United States to address 
the needs of smaller companies seeking access to capital 
through both exchange and nonexchange solutions. In fact, NYSE 
recently announced a midday auction for less liquid securities 
that we intend to launch later this summer if approved by the 
Securities and Exchange Commission.
    As many of you know, the data around smaller companies 
accessing the public markets for capital is discouraging when 
compared to the data of the late 1990s. Companies are spending 
more time as private companies in part due to increased 
regulatory hurdles to becoming and being a public company and, 
once public, a lack of liquidity in the trading of shares of 
smaller public companies. As a listing exchange, we have 
witnessed the negative impact on liquidity in shares of smaller 
public companies as the incentives for market makers to 
participate in these securities have diminished over time. As a 
result, venture capital is locked up in companies for longer 
periods of time, which in turn decreases the availability of 
venture capital for new companies.
    NYSE believes that the idea of venture exchanges is worth 
Congress' attention and may be of value to smaller companies 
seeking capital and their venture capital investors seeking a 
liquidity event that will free up money for new investment. 
While we believe many of the concerns raised about venture 
exchanges can be addressed through education, we also recognize 
that companies available for trading on venture exchanges will 
have a higher rate of failure and could potentially shed a dark 
cloud over the rest of the U.S. public markets. Consequently, 
we believe it will be important that companies listing on 
venture exchanges have an appropriate level of financial 
disclosure and that, in addition to the added oversight a 
venture exchange listed security would receive from the 
exchange's Self-Regulatory Organization, venture exchanges, 
broker-dealers, and investment advisors should also 
differentiate a venture exchange-traded security from one 
listed on a national securities exchange.
    NYSE believes that the U.S. capital markets are one of the 
best avenues available for companies of all sizes to access 
growth capital. We are protective of the confidence investors 
have in the U.S. capital markets but believe that, if designed 
appropriately, venture exchanges may give small companies 
access to capital not currently available to them and investors 
the ability to invest in smaller companies with greater 
regulatory scrutiny than is currently available in the over-
the-counter market for unlisted securities.
    Thank you.
    Senator Crapo. Thank you, Mr. Farley.
    Mr. Kupor.

  STATEMENT OF SCOTT KUPOR, MANAGING PARTNER, ANDREESSEN AND 
                            HOROWITZ

    Mr. Kupor. Chairman Crapo, Ranking Member Warner, Members 
of the Subcommittee, thank you very much for the opportunity to 
speak with the Committee regarding capital formation and the 
topic of venture exchanges.
    It has been well documented by various commentators that 
the number of IPOs in the United States has fallen 
significantly since 1997, and while in large part due to the 
passage of the JOBS Act by this institution we have seen a more 
robust IPO environment in 2013 and 2014, the volume and 
characteristics of those IPOs remain very different.
    In particular, small-cap IPOs have remained below 25 
percent of all IPO volume for nearly 15 years. In contrast, in 
the period from 1991 to 1997, as many as one-half to two-thirds 
of IPOs were for small-caps.
    In the IT sector, which is the area in which we invest, the 
industry produced just north of 2,400 venture-backed IPOs from 
1980 to 2000. In contrast, in the period from 2001 to 2014, 
there were a total of approximately only 500 IPOs. Relatedly, 
the time to IPO has significantly elongated over the same time 
period--6-1/2 years in the 1980-2000 time period versus 9 years 
for the 2001-14 cohort.
    So why should we care about this? Well, in addition to the 
strong nexus between IPOs and job and economic growth, we are 
at risk of creating a two-tiered capital market structure, one 
in which the majority of the appreciation accrues to those 
institutions and wealthy individuals who can invest in the 
private markets, and a second for the vast majority of 
individual Americans who comprise the retail investor base.
    In the current state of affairs, the private markets will 
continue to develop their own solutions to enable private 
companies to stay private longer. In fact, today we see hedge 
funds, sovereign wealth funds, family offices, large 
technology-focused buyout firms, and mutual funds filling in 
the void in the late-stage private market. If we want to 
address these trends, we must address the underlying issues 
that are impacting companies' decisions to stay private longer. 
Those are both economic issues as well as what does the post-
trading environment look like once they go public.
    With respect to the economic costs of listing, while there 
are always more ways to streamline the economic costs of 
becoming and remaining a public company, the JOBS Act has done 
a very good job of lessening the burden for emerging growth 
companies. When we talk with our portfolio companies, there is 
far less of an impediment to going public today on the basis of 
the regulatory costs associated with that.
    But the most significant remaining deterrent to companies 
going public is the after-market environment in which they will 
have to function as public companies. More specifically, the 
after-market environment is directly correlated to the market 
cap and ultimately the liquidity of the company post-IPO. If a 
company's market cap is large enough, it can attract research 
support and market-making resources from the sell side 
investment banks and, hence, liquidity. In contrast, for small-
cap companies, the economics simply do not work to attract 
these resources, and as a result, liquidity and institutional 
support remain low. And, therefore, many issuers simply choose 
to postpone an IPO until they are big enough to attain a market 
cap sufficient to engender adequate liquidity. This explains, I 
believe, the substantial decrease in the sub-$50 million IPO 
market.
    Among the reasons for low liquidity is the move to 
decimalization and is why we have advocated for the tick six 
pilot program that is currently pending before the SEC. But 
given the above, how would venture exchanges impact capital 
formation? With respect to the economic costs, a successful 
venture exchange would need to employ a regulatory framework 
that at a minimum incorporated the JOBS Act regulatory 
requirements. However, if the goal were to enable a significant 
proportion of sub-$50 million IPOs, we would probably need an 
even more scaled down framework, probably similar to the Reg A 
Plus regulations that are pending before the SEC.
    Turning to the post-IPO trading environment, at a minimum a 
venture exchange would need the flexibility to set appropriate 
tick sizes to foster trading liquidity at fewer price 
increments. As a result, I strongly believe that any decision 
to explore venture exchanges should not obviate the need to 
ensure that the pending tick size pilot program is implemented 
and with sufficient time and detail to garner real empirical 
results.
    There are also a number of open questions and concerns that 
I believe we would need to address.
    First, adverse selection in the form of companies that 
elect to list on the venture exchange. The most attractive 
companies that can raise private capital through other means, 
as some are doing today, may simply continue to do so and, 
thus, only those who run a weaker position may choose to list 
on the venture exchange.
    Second, there is a real risk that separating out the 
venture exchange from the existing national market structure 
may create, in fact, less liquidity for small caps. That is, 
institutional investors may simply wait for venture exchange 
companies to graduate to the national market exchanges instead 
of investing in them as venture exchange issuers.
    In summary, I would offer the Committee the following 
observations: Fostering more IPOs, in particular more small-cap 
IPOs, is important to job creation and to the long-term 
competitiveness and fairness of the U.S. securities markets. In 
the absence of structural capital market changes, good 
companies will continue to tap private sources of capital and 
delay going public. Independent of whether a venture exchange 
is the right solution, we must solve the core liquidity 
challenges that exist in today's small-cap market. Thus, 
proceeding with a robust tick size pilot program I believe is a 
first crucial step toward investigating the proposed venture 
exchange.
    Thank you for your time, and I look forward to the 
Committee's feedback.
    Senator Crapo. Thank you, Mr. Kupor.
    Mr. Griggs.

 STATEMENT OF NELSON GRIGGS, EXECUTIVE VICE PRESIDENT, LISTING 
                   SERVICES, NASDAQ OMX GROUP

    Mr. Griggs. Thank you, Chairman Crapo, Ranking Member 
Warner, and Members of the Subcommittee for the opportunity to 
testify on venture exchanges.
    With our first initial public offering in 1971, Nasdaq 
created the modern IPO, and we have become the destination of 
choice for emerging, high-growth companies. Nasdaq brought to 
capital markets a new view that companies could go public 
earlier by recognizing that most companies need capital and 
investors want access to ownership when companies are at 
earlier stages of their growth cycle.
    However, changes to the regulatory landscape over the years 
have reduced Nasdaq's and our partners' abilities to facilitate 
stable, reliable, and cost-effective capital formation for many 
emerging companies. The one-size-fits-all approach of our 
regulatory structure has had a negative consequence for small 
companies. While the JOBS Act did ease several burdens on 
companies, the extent of that relief has not reached all small 
venture companies.
    The continued aversion of small companies to the public 
markets has created a sense that there is a need for a new type 
of a separate venture exchange. From Nasdaq's point of view, 
this notion is somewhat misplaced. What we believe is needed is 
within the small-cap listing tiers of existing exchanges are 
simple reforms to make the market structure more attractive 
again for growth companies. Nasdaq's approach to helping 
venture companies has two paths:
    First, change certain trading rules and both listing and 
governance requirements within then small-company market tier 
to encourage and facilitate the ability for growth companies to 
raise capital on the public markets and thrive.
    Second, further leverage the JOBS Act from which Nasdaq has 
built and is operating a growth platform today for companies 
wishing to stay private--the Nasdaq Private Market.
    To reinvigorate the capital formation benefiting small 
companies, we suggest the following changes:
    Exempt certain growth companies from the tick price 
provision of Regulation NMS and delegate the authority to 
define the tick sizes to the listing exchange. The tick size is 
a surprisingly important--and extremely sensitive--variable in 
trading quality. Too wide and trading costs become burdensome 
to investors; and too small and volatility increases and 
liquidity is limited.
    Modify the definition of a ``penny stock'' in Rule 3a51-1. 
In 2004, the SEC essentially froze exchange listing standards 
by defining any security not meeting those requirements to be a 
penny stock. This has inhibited innovation in listing 
requirements over the last decade.
    Next, adopt limited regulations to prevent aggressive short 
selling of smaller companies, which lack the resources to 
combat manipulative short selling and are consequently more 
vulnerable. We recommend disclosures of short positions in 
smaller companies similar to the same disclosures of long 
positions, providing companies and investors with more 
transparency.
    For growth companies, provide issuers a choice to suspend 
unlisted trading privileges. Affording certain growth company 
issuers with input into their market structure through this 
option to suspend unlisted trading privileges in their stock 
would refocus competition among orders in that stock by placing 
them all on a single platform.
    Next, permit market maker support programs. Currently, 
Nasdaq allows ETF issuers to establish a fund to subsidize 
market makers who enhance liquidity in those shares. We believe 
that such programs would help support growth companies, and 
these programs have successfully enhanced liquidity and market 
quality for investors in Europe for several decades.
    Last, for the private markets, our suggestions are--or last 
for the public markets, I apologize, eliminate certain 
requirements for shareholder approval for smaller companies. 
The SEC has made strides to reduce the time necessary for 
public companies to register and sell securities by allowing 
shelf registrations. However, the requirements imposed by 
Nasdaq on listed companies for obtaining shareholder approval 
of certain financing transactions have not followed suit. We 
are currently examining these requirements and hope that any 
proposal we present to the SEC to address this will be met with 
an understanding that rules applied to the world's largest 
companies may not be appropriate to apply equally to emerging 
growth companies.
    Concluding with private market recommendations, several 
provisions in the JOBS Act allow companies to remain private 
longer, and many are doing so. In light of the growing demand 
for liquidity in these companies' shares, especially by their 
early investors and employees, we created the Nasdaq Private 
Market. The Nasdaq Private Market is a company-controlled 
platform that leverages technology solutions to serve the 
unique needs of private companies within the framework of 
securities laws. We are seeking an important adjustment to that 
framework. The JOBS Act and prior laws make it very clear that 
companies can sell shares to accredited investors without 
registering the transaction. In theory, this category of 
investor does not need the protections that registration 
requirements afford, due to their net worth, income, and 
sophistication. However, the subsequent sale of shares from an 
existing shareholder to another accredited investor does not 
enjoy the same legal status, despite the fact that the policy 
rationale for an exemption is similar to that for issuer 
transactions. Consequently, companies and investors are 
shouldering unnecessary legal and regulatory costs.
    Thank you again for inviting Nasdaq to testify on this 
important issue, and we look forward to your questions.
    Senator Crapo. Thank you very much, Mr. Griggs, and I 
appreciate the testimony of all of you.
    Let me start out by just asking one general question. I 
assume that all of you, from your testimony--it indicates that 
all of you agree that the existing one-size-fits-all system in 
our markets needs to be revised and strengthened. Is there 
anybody who disagrees with that? I just want to, with that 
question, create the emphasis that we need to move and engage 
on these issues, both Congress and the SEC.
    Second--and I will start with you, Mr. Luparello--with 
regard to the SEC, you indicated in your testimony that there 
are a number of potential initiatives that a venture exchange 
might explore to promote liquidity, and some of those you 
mentioned were to limit all trading to particular times of the 
day through particular mechanisms; to attract dedicated 
liquidity providers with a package of obligations for making a 
market in listed companies, balanced by benefits for providing 
high liquidity; and then, finally, to explore different minimum 
tick sizes, which has been brought up by a number of the other 
witnesses.
    Could you just briefly--and I do mean try to do it 
succinctly--describe the benefits you see from those actions?
    Mr. Luparello. I will start with the tick pilot, which has 
been mentioned by my fellow panelists as well. The Commission 
has demonstrated a desire to explore whether widening out the 
tick size for certain securities under $2 billion in market cap 
may actually improve liquidity. That is why we have been--we 
asked the exchanges and FINRA to create a pilot plan, which 
they have filed with us and we are currently considering and 
should act on very soon. That I think is the first way to look 
at whether there is additional liquidity that can be brought to 
currently listed issuers.
    I think on the question of whether we can attract issuers 
who are not in the public markets now, the idea is that we have 
heard from a variety of market participants around either 
exclusivity or concentrations of liquidity. I think we will 
always be open to considering--obviously we want to balance 
them at the same time against both investor protection and 
market efficiency concerns, but we tend to think, properly 
structured, these things can potentially work and bring 
liquidity where liquidity has not existed before, and do so in 
a way--especially if there is a minimization of investor 
confusion, in a way that is consistent with investor 
protection.
    Senator Crapo. Let me interrupt there and just ask the rest 
of the panel, do you all agree that focusing on the tick size 
is one of the areas that we could successfully achieve some 
significant progress?
    Mr. Farley. Yes. Senator, if I could just----
    Senator Crapo. Yes, Mr. Farley, you want to----
    Mr. Farley. If I could just make one remark about that, I 
absolutely agree, and we worked diligently with the SEC and 
others in the industry to help construct a reasonable tick 
pilot proposal. I just want to highlight one nuance. There are 
over 50 trading venues of consequence in this country, and only 
a dozen of those are actually fully regulated exchanges. And 
one thing to keep in mind is that securities trade on all of 
those venues; whereas, the tick pilot you could imagine--or 
changing tick sizes at the exchanges will only impact, roughly 
20 percent of the market. And so it is important to keep in 
mind, as we think about tick sizes, that there is a whole other 
market out there that is not the fully regulated exchanges. In 
order to really get the full range of benefits that I heard 
from my colleagues here on the panel from revising tick pilots 
for smaller companies, you really have to do that on a market-
wide basis.
    Senator Crapo. Thank you.
    Anybody else want to comment on that?
    Mr. Griggs. No, we agree with the comment.
    Senator Crapo. All right. Thank you.
    Mr. Farley, let me come back to you. The NYSE, I believe, 
has already indicated a strong interest in venture exchanges or 
the need for them, but I would like you to clarify that. And I 
guess my question would be: If venture exchanges were made a 
viable option, would the NYSE be interested in creating a 
platform?
    Mr. Farley. Sure. The short answer, if I can go back to a 
question you asked 3 or 4 minutes ago, do we believe the kind 
of one-size-fits-all makes sense and we need to kind of think 
differently about different companies, I absolutely agree with 
that, and I just want to highlight that. The midday auction 
that was referenced in the written testimony but that I did not 
mention today in the interest of time, that we are 
implementing, we are actually only implementing for our less 
liquid securities. And so that is an anecdote that demonstrates 
we absolutely agree. And it is also an anecdote that 
demonstrates that we are committed to bringing additional 
capital formation to less liquid securities, also lesser 
capitalized companies, which gets to your direct question about 
the venture exchange. We are indeed interested. Whether or not 
it comes in the form of a venture exchange or modifying our 
existing listing venues to accommodate these smaller companies 
and create a more constructive environment for capital 
formation for those securities, we are indifferent for the most 
part. But we are--presuming that Congress and the SEC and our 
colleagues in the industry put in place a system along the 
lines that we have described in our testimony and, quite 
frankly, that some of my colleagues on the panel here have 
described, we indeed would, the New York Stock Exchange, 
support it and look to create a business based on that.
    Senator Crapo. All right. Thank you. My 5 minutes has 
expired. We will have a couple of rounds, but, Senator Warner, 
do you want to go ahead?
    Senator Warner. Yes, thank you, Mr. Chairman. And let me 
just--I want to be convinced, but I have got a couple 
questions. And, Mr. Chairman, I have also got a statement here 
from Mr. William Beatty, who is the President of the North 
American Securities Administrators Association for the record.
    Senator Crapo. Without objection.
    Senator Warner. First of all, Mr. Luparello, one of the 
things I would hope, as we think about these new platforms, I 
would just strongly urge you--as I have urged your 
commissioners--that we would have a lot more knowledge if we 
could actually get the tick size project out, if we could 
finish the Reg A Plus regulations, and we are now approaching 4 
years on the JOBS Act, and we still do not have final 
crowdfunding rules. These are all tools to help small-cap 
companies. Do you want to make a comment, or do you want to go 
ahead and make a commitment for the record about when all those 
projects will be finalized?
    Mr. Luparello. I can, on the record, too, I can quote the 
Chair, who has said on a number of occasions that finishing the 
crowdfunding rules and Reg A Plus are among her highest 
priorities for this year.
    Senator Warner. But that was also, I think, a comment she 
made last year, too.
    Mr. Luparello. On the tick size pilot, which is in my 
division, we noticed the pilot plan in December--I am sorry, 
November. We received a significant number of comments through 
the comment period, which closed toward the end of the year. 
Our statutory deadline for acting is early May, and we have 
every intention of hitting that deadline.
    Senator Warner. Good. I think it is very important because 
it is kind of like you could actually question whether a 
venture exchange might undermine the tick size pilot, so, you 
know, I think getting that data would be very helpful.
    Mr. Luparello. We absolutely agree.
    Senator Warner. One of the other things I would simply ask, 
and maybe some of you have got the data, and I have to say I 
was part of this effort so I am guilty as well in the late 
1990s of having a whole series of companies, dot-com companies 
in particular, that had huge valuations that very quickly went 
to zero. So while I think it is great that we can get small-cap 
companies onto exchanges, I would like to get some record of 
particularly the number of those late 1990s companies that went 
public that were still in existence 3 or 4 years later, if we 
could get that for the record.
    I guess one of the questions I have got for everyone is 
that--you know, I saw Arthur Levitt's comments about venture 
exchanges saying, you know, a solution in search of a problem. 
Do you all want to comment? We know that Nasdaq has got the 
ability to start a new exchange in 2011. I know the American 
Stock Exchange had a plan; I think it was called the Emerging 
Company Marketplace in 1992. It never went forward. The 
Canadian Stock Exchange has got a venture-type exchange. The 
Brits have got one. You know, do we have any success records 
that we can point to? Are the British the most successful so 
far? Mr. Griggs, do you know--we talked earlier in the outer 
room. You might want to share some of your comments about----
    Mr. Griggs. Sure.
    Senator Warner.----why you have not taken advantage of the 
opportunity that you got granted in 2011.
    Mr. Griggs. Yeah, thank you for the question. Our belief is 
that through smart regulation a smaller-cap venture market can 
work, but the best way to do that is through addressing the 
challenges that the current small companies face that are 
already public, and letting that take hold and then spill over 
to new companies potentially looking to go public.
    The challenges of starting a brand-new listing venue or 
exchange due to the necessity of having connectivity, data 
feeds, et cetera, and the limited economics that are involved 
in it make a brand-new platform extremely challenging. So I 
think when you look at it, our view would not be to open the 
flood gates and have an exchange that lists every OTC company 
that is on the market on this exchange, but first and foremost 
fix some of the issues we have talked about through the tick 
pilot, through potentially suspending the UTP privileges as 
well as the market maker program, and create a more sound 
small-company market for existing companies first.
    Senator Warner. Would anybody else care to make a comment 
or comment about some of the other smaller exchanges around the 
country or around the world?
    Mr. Farley. I would only add to my colleague's comments 
that the other thing to look at are the minimum listing 
standards and whether or not it would be worthwhile to revise 
those minimum listing standards to allow companies that are, in 
effect, smaller to also be able to list on those exchanges.
    Mr. Luparello. I am probably the only one here old enough 
to remember the AMEX EMC, and its failure was in part because 
of the quality of the issuers that were brought forward. And I 
think what we have seen in conversations now, including the 
issues around the BX market, there was a much greater focus on 
that element of investor protection of issuer scrutiny. I think 
anything we do in this space has to have that as a very 
important component. That plus, you know, making sure we are 
doing everything we can to prevent investor confusion are 
clearly things that need to happen for a venture exchange to be 
successful.
    Senator Warner. Because it seemed to me, Mr. Chairman, just 
the Canadian experiment seems to be such small-cap that it is 
almost a bit sketchy--a technical term. You know, whereas, the 
British exchange seems to have a little more parameters. But I 
will come back on the next round.
    Senator Crapo. Thank you, Senator Warner, and thanks for 
those answers to those questions from the witnesses.
    A number of you indicated that the regulatory environment 
needed to be addressed, particularly the JOBS Act, and if I 
understood you correctly, those of you who raised the JOBS Act 
were making the point that it needs to--its provisions need to 
be strengthened and, in fact, perhaps even adjusted to deal 
with this issue of the smaller companies on a venture exchange.
    Would any of you like to elaborate on how we should deal 
with the regulatory environment in general and, in particular, 
how we should deal with the JOBS Act? Mr. Griggs?
    Mr. Griggs. Sure. I think as stated by my fellow panelists, 
the most attractive provision today in the JOBS Act is the 
confidential filing, and we do feel that could be expanded to 
other types of offerings. In particular, PIPEs and other forms 
of secondary transactions would be valuable to the smaller-cap 
companies is one area.
    I think we do look at--the JOBS Act did also have 
provisions that certainly allow for companies to stay private 
longer, and I think the Committee should not overlook the fact 
that some of the challenges in the private--in the venture 
space today can be solved in the private market as well. So we 
make a recommendation of clarifying the definition of 
accredited investors in our statement, as well as looking at 
how the transaction between accredited investors are officially 
recognized or approved are important. So that would be our view 
as two examples that should be looked at in the next version of 
the JOBS Act.
    Senator Crapo. Mr. Kupor, do you want to add to that?
    Mr. Kupor. Yeah, I would agree with that. But I would also 
say I think in terms of the regulatory framework around which 
companies are going public, I think the JOBS Act has actually 
done a very good job there. So I think, you know, having 
reduced the filing requirements, you know, things like the 
confidential filings, test-the-waters provisions I think has 
been very effective. So I see that as less of an issue of 
companies making the decision to go public than certainly it 
was prior to the JOBS Act. But I would agree that certainly we 
could strengthen some of those provisions particularly as it 
relates to the private markets as well.
    Senator Crapo. Mr. Farley or Mr. Luparello, do you want to 
weigh in on this?
    Mr. Farley. I agree with the comments of my colleagues. I 
would just note that I have been more focused on and we have 
been more focused on at the New York Stock Exchange with 
respect to the regulatory provision, not extension of the JOBS 
Act per se, although I do indeed agree, but some more of the 
items that have already been discussed: number one, more 
discretion around tick sizes for these smaller companies, but, 
number two--and if I can kind of step back and give you a 
little bit of context, going back 20 years ago, the New York 
Stock Exchange for a New York Stock Exchange-listed company 
traded 100 percent of the volume of those stocks or 
thereabouts. And then there was something called UTP that came 
into the market, which enabled and required that those stocks 
be traded on multiple venues, which by and large was a very 
healthy construct for the market. And when you think about it 
for a stock like, say, Bank of America, it has no really 
deleterious impact on the liquidity of Bank of America stock, 
because it is so liquid all day long, with a continuous bid-
offer, even though it was spread across many venues, but it was 
a one-size-fits-all model that was put upon the market. And so 
for these smaller companies, some of which trade only multiple 
times a day, maybe once a day--some trade many times a day, but 
they are still relatively illiquid. They, too, have this UTP 
obligation, and it would require, as I understand it, an act of 
Congress in order to provide discretion, whether the company's 
discretion or the exchange's discretion or even the SEC's 
discretion, to look at those small companies and say, well, 
wait a minute, do we really want to fragment liquidity for a 
small company like this? Or do we want to bring it back 
together? There may be some resistance in general toward doing 
that because people may say, well, wait a minute, is this the 
exchanges looking to just bring more business and establish 
some sort of, say, monopoly or duopoly? But this is a very, 
very small part of what we do in terms of revenue, in terms of 
volume. This is more about what can we do to help the little 
guy. And I think those kind of changes coupled with some of the 
things my colleagues said could be quite helpful.
    Senator Crapo. Thank you.
    Mr. Luparello, do you have anything to add?
    Mr. Luparello. I would just point out on the issue of 
whether there needs to be a legislative fix on the unlisted 
trading privileges issue, that is something the staff at the 
Commission has studied for a while, and is in the process of 
formulating a position. There is certainly a way that you could 
read the statute that is very restrictive, and that, in fact, 
may be the conclusion, but that is not a conclusion we have 
reached yet. So it seems incumbent upon us to make a 
determination that we do not have the authority before we come 
and ask for the authority.
    Senator Crapo. Well, thank you. It seems to me what I take 
from the collective testimony here is that there is some very 
profitable potential for congressional changes that would 
either improve or strengthen the JOBS Act or focus on getting 
the right level of discretion for the tick size or for other 
decisions about this matter. And it would be very helpful if 
you would help us to summarize where Congress needs to act to 
help improve the potential for these markets.
    Senator Warner?
    Senator Warner. Thank you, Mr. Chairman. I want to follow 
up on Mr. Farley's comments.
    I would agree as well that if we were going to go down this 
path, you need to concentrate these trades on a single exchange 
so that there is enough volume and focus to have a market maker 
and hopefully to generate the research.
    You know, I am--and with apologies if--in my prior life, I 
would be sitting on your side of the table. But, you know, 
could a cynic say that a venture exchange is just a quicker way 
for VCs to get out of their investments or, to management, to 
get liquid earlier on? Obviously, we have got lots of examples 
of when VCs leave or management teams leave, early stage 
companies do not do as well. How do we guarantee the lockups 
and some of the protections that--especially if you were 
suddenly bringing in less informed investors and the public?
    Mr. Kupor. Yeah, I think, Senator, it is a very fair point. 
One thing I would point out is, number one, this is happening 
today in the private markets in the absence of a venture 
exchange. So there is a liquidity market that has been created 
initially for employees, and so, you know, obviously Nasdaq 
Private Market has been a part of this, and so I am sure Mr. 
Griggs can----
    Senator Warner. But that is generally with accredited 
investors, isn't it?
    Mr. Kupor. It is, yes, right. But I think what we are 
seeing is there is certainly a lot of--to your question about 
whether this is kind of venture capitalists or management 
looking for liquidity, there are alternative avenues for them 
to achieve liquidity, albeit to your point to accredited 
investors.
    I also agree with your general point, which is I think the 
only way that this venture exchange works and we do not have a 
repeat, obviously, of some of the companies that, you know, you 
mentioned from the early 1990s--or late 1990s, excuse me, is we 
would have to have, you know, a regulatory regime that would 
actually ensure that there is, you know, a more structured way 
for people to actually exit these markets. So I agree with you 
that if this were perceived as people trying to kind of, you 
know, run for the gates on the liquidity side, I do not think 
it works. I do not think the market maker is going to be there 
to support it. You know, the interesting--the opposite is also 
true, which is in the absence of these changes, I think the 
venture capitalists are actually quite fine, even if we do not 
make these changes. So from an economic perspective, it just 
means they will hold their stocks longer. It may mean that they 
have to change their limited partner structures in order to 
enable longer hold periods. But it probably means also, you 
know, very significant appreciation still accrues to them in 
that respect.
    So I think this is more about making sure that we can kind 
of find an appropriate time for the public investors to also be 
able to participate in some of that appreciation.
    Mr. Griggs. I will just add to that. I think those are 
great points that Scott made. If you look at what is happening 
in the private markets and how long companies are staying 
private, it is not just the founder or the CEO looking for 
liquidity. It is also the employees who have been there for 7, 
8, 9 years. It is the early investors who have been in the 
portfolio or a company for a very long period of time, and 
giving them access to liquidity does help them recycle that 
cash into new investments into the economy. So I think 
providing some liquidity when we have seen this dramatic 
expansion of how long companies stay private is fairly 
important. So that would be an additional viewpoint.
    Senator Warner. I think one of you all raised what about 
the adverse selection issue. You could say the good companies 
that are still roaring with huge market caps are going to go 
straight to Nasdaq or New York. You know, will--how do we 
protect against that at least perception or reality? Would you 
encourage that everybody would start on a venture exchange? Or 
any comments on that?
    Mr. Griggs. Yeah, I will make a comment. I think that is 
our viewpoint, that leveraging the existing market that exists 
today with some smarter regulation is a preferred path by 
Nasdaq as opposed to creating a brand-new venture market that 
would be, again, very challenging to attract that first 
company. And if you look at the existing pool of companies on 
the Nasdaq Capital Market, there are about 600 companies. I am 
not saying that is the right size of companies that would be in 
this venture exchange, but if you would look at that as a 
subset and then how far down you want to go in terms of what 
the different qualifying standards are, that would be a 
discussion we would want to have. But I think that is how you 
would start this, again, not open it up to 2,000, 3,000 
companies that may, if you look at the Toronto exchange, other 
exchanges around the world that are venture-like, they are that 
expansive. And I think our viewpoint would be that we limit the 
number of companies and hopefully deflect some of the adverse 
selection.
    Mr. Farley. As reflected in our written testimony--again, I 
did not deliver all of it here today--we are not cavalier about 
moving to this kind of venture exchange idea, and we have some 
of the same concerns that you do. And so we need to at a 
minimum be very deliberate about how we implement it.
    One of the things we suggested in our testimony and I did 
mention today is that the existing listing standards today are 
reasonable. So to the extent that we lower those listing 
standards, we think that we would need to provide additional 
disclosure to the end investor and not just us, the exchange, 
but also there would be an obligation on the broker-dealers.
    You mentioned Canada. My understanding of the venture 
market in Canada is they actually have a ticker where they flag 
for every single stock that it is a ``V'' for a venture stock, 
which I think is a reasonable approach.
    My guess is your adverse selection concern is not--it is 
not theoretical. That is exactly what would happen. And Uber is 
not going to choose to list on a venture exchange, if you will. 
And so it is important and it is incumbent upon all of us and 
you to make sure that there is the appropriate level of 
disclosure for the companies that would choose to list using 
these lower standards.
    Senator Warner. Mr. Chairman, I guess my time is up and go 
back to your round, but I do think we ought to--I think this is 
a very good hearing, but we ought to get from the panel and 
others, you know, what steps we can take within some of the 
existing frameworks, because my sense is that venture exchanges 
have been tried, maybe we need to move toward that. But there 
are a series of things--I am coming back to you, Mr. 
Luparello--that if we can get the SEC to go ahead and finish 
some of the work they are already working on, we might have 
some--we would have more good data.
    Could I just get--the Chairman has been generous to give me 
one more question. I was quite excited 5 years ago when the 
notion of crowdfunding came about. You know, it has been slower 
to develop, partially because of the lack of rules, partially 
as well even in other countries that have been more forward 
leaning. Do you all want to make any comment on what you see as 
the future of crowdfunding? You know, will it be the kind of 
broad-based capital-raising tool? I particularly thought it was 
a potential for more rural areas and areas where companies did 
not have access to sophisticated venture money. Or is it going 
to be--you know, still remain kind of a niche? Comments?
    Mr. Kupor. I will make a comment on it. So I agree with 
your position, which is I think it is more likely a viable 
source of capital for things that probably are not accessible 
to the broader venture capital market, and I think for that, 
that is actually quite valuable and could be helpful.
    You know, I will also say, you know, I do have a concern 
that it is a little bit the same adverse selection concern that 
we have talked about here with respect to venture exchanges, 
which is we are talking about obviously the riskiest portion of 
the market. We are talking about seed capital where we know the 
failure rates are tremendously high. And I do worry a little 
bit about the dichotomy here, which is we have--we are granting 
access to potentially unaccredited investors even to be able to 
invest in what is probably the riskiest portion of the market. 
At the same time we keep kind of pushing out the IPO timeframe 
and, you know, kind of restricting to accredited investors the 
much later end of the market, you know, maybe even some of 
these larger offerings that we are seeing out there.
    So, to me, my concern would be just, you know, do we really 
feel like we have enough of a regulatory framework to be able 
to kind of protect against bad actors in that market? And if 
so, I think it can be a very viable economic alternative. But I 
do think it could also end up as a significant opportunity for 
people to find that there is greater risk than I think can be 
appreciated at the time of investment.
    Mr. Griggs. We tend to agree with the comments. When we 
look at the JOBS Act, when it did come out, we were very 
excited about some of the private market provisions, and they 
go down the path of the Nasdaq Private Market. But I think a 
comment was made initially by Mr. Luparello about geographical 
areas so that will echo Mr. Kupor's comment about the fact that 
this would be--is not needed in certain parts of the 
marketplace that are very robust from angel investing today. 
But there are certain parts that certainly could be beneficial, 
but you would have to be extremely vigilant on the adverse 
selection because there will be some great stories on the 
positive side, but there is also going to be quite a bit of 
downside risk there as well.
    Senator Warner. I do think for rural underserved areas, you 
know, the ability to--because there is no seed capital, there 
are no angel investor networks, it has the potential for--that 
we still need to push. And, Mr. Luparello, I am going to try to 
hold the Chair's comments about making sure that we get those 
final regulations out.
    Mr. Chairman, I really appreciate you holding this hearing. 
I think it has been a very informative one.
    Senator Crapo. Well, thank you, Senator Warner. And, again, 
thanks to the witnesses.
    I have a ton of other questions, but we are going to 
probably have to wrap up here. What I would like to do is to 
follow up on Senator Warner's suggestion that we ask each of 
the witnesses to provide--you were asking, I think, for a list 
or a description of what steps we could take, short of creating 
a formal venture exchange, to help improve the dynamics. We 
have heard a lot of discussion about that here today, but if 
the witnesses could--even though you have it in your written 
and in your oral testimony here today, provided and said a lot 
of this, if you could just succinctly give us a statement of 
what you think those steps might be that we could take now even 
before the creation of an exchange, if the creation of an 
exchange is a good idea, I think that would be very helpful.
    Senator Crapo. And then I would like to add a request for 
another list, and that would be a list of what you think the 
necessary regulatory and legal fixes need to be made or 
structure needs to be of an existing--the creation of a venture 
exchange. And let me just give you an example of what I am 
thinking here.
    In terms of the information that we have received so far, 
it seems that there has been a strong suggestion that the 
potential characteristics of any venture exchange should be to 
have scaled disclosure requirements and more basic listing 
standards, wider tick sizes for securities trading, and some 
have said that the trading of venture exchange-listed 
securities should be limited to occur only on a venture 
exchange. If there are other characteristics that a venture 
exchange should have, I would love to have you give us that 
list as well so that we can help to continue narrowing and 
identifying the scope of the discussion and the action that we 
may need to take here.
    Senator Crapo. Do you have anything else, Senator Warner?
    Senator Warner. No. Thank you.
    Senator Crapo. I would like to thank each of you. Your 
written as well as your oral presentations have been 
outstanding and are very helpful to us. And as I said at the 
beginning of this hearing, I think that there is a tremendous 
amount of potential for us to do some good things in this next 
Congress. And I will also state again I am elated to be able to 
have as my co-partner here in this endeavor on this 
Subcommittee, Senator Warner. He and I are good friends, but we 
also are committed to making sure we have a bipartisan effort 
to build good policy.
    And so, again, thank you all for coming. Without anything 
else, this hearing will be adjourned.
    [Whereupon, at 10:57 a.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follows:]
                PREPARED STATEMENT OF STEPHEN LUPARELLO
  Director, Division of Trading and Markets, Securities and Exchange 
                               Commission
                             March 10, 2015
    Chairman Crapo, Ranking Member Warner, and Members of the 
Subcommittee:

    Thank you for inviting me to testify on behalf of the U.S. 
Securities and Exchange Commission (``SEC'' or ``Commission'') 
regarding exchanges focused on the listing and trading of stocks of 
smaller companies. Smaller companies are important to the strength of 
our economy. The SEC welcomes the opportunity to discuss approaches 
that address the market structure needs of smaller companies and their 
investors, which can serve to facilitate capital formation for such 
companies--an important part of the agency's mission.
    The SEC is considering innovative approaches that appropriately 
balance the needs of smaller companies for efficient secondary markets 
and the interests of investors in smaller companies. Venture exchanges 
potentially could achieve such a balance by providing the investors a 
transparent and well-regulated environment for trading the stocks of 
smaller companies that offers both enhanced liquidity and strong 
investor protections. As such, they could strengthen capital formation 
and secondary market liquidity for smaller companies and expand the 
ability of all investors to participate through well-regulated 
platforms in the potential growth opportunities offered by such 
companies.
    Venture exchange listings could include both smaller companies that 
do not qualify under the listing standards of the large securities 
exchanges and smaller companies that do qualify under such 
standards.\1\
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    \1\ Venture exchanges potentially could include existing or new 
exchanges that operate nationally. The Commission could also consider 
local or regional exchanges that focus on companies from a particular 
geographic area.
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    My testimony today will provide an overview of market structure 
challenges for smaller companies, efforts that the SEC already has 
taken and is taking in this area, and statutory provisions that set the 
context for SEC review of venture exchange proposals. It is important 
to consider, as part of our review of current market structure, the 
distinctive needs of smaller companies and their investors.
I. Market Structure Differences for Smaller Companies
    The market for small companies is different from the market for 
large companies. While smaller companies contribute significantly to 
the U.S. economy, the opportunities for smaller companies seeking 
capital and for investors seeking to invest in smaller companies are 
not comparable to such opportunities with respect to larger companies.
    For example, the smaller the company, the lower the level of 
ownership by institutional investors, which act as intermediaries for 
much of the available capital in the modern U.S. equity markets. 
Smaller companies face the challenge of attracting the attention of 
these institutional investors that typically seek to invest in large 
sizes that are significant given the size of their portfolios. 
Moreover, given that most smaller companies will inevitably have a 
significant percentage of ownership by individuals who are self-
directed investors, small companies face the challenge of attracting 
the attention of these individual investors, who often do not have the 
time and resources of institutional investors to evaluate companies. To 
illustrate, Table 1 below sets forth ownership data for exchange-listed 
companies categorized by their market capitalization. As can be seen, 
institutional investors dominate ownership (83.5 percent) in Table 1's 
category of largest companies, which are defined as those with more 
than $1 billion in market capitalization. In contrast, for companies 
with less than $100 million in market capitalization, individuals 
dominate ownership with 80.1 percent of ownership or higher.
                                Table 1
        Percentage Ownership of Exchange-Listed Companies \2\
---------------------------------------------------------------------------
    \2\ Jeffrey M. Solomon, CEO, Cowen and Company, ``SEC's Advisory 
Committee on Small and Emerging Companies--Panel Discussion'' at 13 
(September 17, 2013) (``Solomon Presentation'') (citing Bloomberg and 
Capital IQ as of September 6, 2013 for listings on major U.S. 
exchanges), available at http://www.sec.gov/info/smallbus/acsec/acsec-
091713-jeffreysolomon-slides.pdf). A recent academic working paper 
found that, between 1980 and 2010, institutional investors increased 
their holdings of the smallest companies that make up 10 percent of the 
value of the market from 3.5 percent to 10.2 percent. See Marshall E. 
Blume and Donald B. Keim, Working Paper, Institutional Investors and 
Stock Market Liquidity: Trends and Relationships, 1 (Aug. 21, 2012), 
available at http://finance.wharton.upenn.edu/keim/research/
ChangingInstitution
Preferences_21Aug2012.pdf. While the study uses market value 
percentages, and thus is not directly comparable to an analysis using 
percentages of the number of stocks, it provides evidence of a 
potential upward trend in institutional ownership of small-cap stocks.


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



    These major ownership differences between small companies and large 
companies are reflected in their coverage by research analysts. Table 2 
below sets forth data on the research coverage of NASDAQ-listed 
companies categorized by market capitalization. For Table 2's largest 
category of companies with more than $1 billion in market 
capitalization, only 1 percent have no coverage, and the median number 
of analysts is 14. For companies with less than $100 million in market 
capitalization, the median number of analysts is 1 or less, and 40 
percent or more of companies have no research coverage.
                                Table 2
        Research Coverage of NASDAQ-Listed Companies \3\
---------------------------------------------------------------------------
    \3\ Solomon Presentation, citing CapitalIQ as of September 6, 2013.
   
   [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
   
   
    
    Tables 1 and 2 also illustrate that not all ``small'' companies are 
alike. Although all companies with less than $1 billion in market cap 
often are considered small-cap or micro-cap companies,\4\ there are 
major differences in ownership and research coverage even within this 
category. They range from 62.4 percent institutional ownership and a 
median of 7 research analysts for NASDAQ-listed stocks with $501 
million to $1 billion market cap, to 10.9 percent institutional 
ownership and a median of 0 analysts for NASDAQ-listed companies with 
less than $50 million market cap.
---------------------------------------------------------------------------
    \4\ For example, the S&P SmallCap 600 Index includes companies with 
market capitalizations that range from $400 million to $4 billion. See 
S&P Dow Jones Indices, available at http://us.spindices.com/indices/
equity/sp-600. The Russell Microcap Index includes companies with 
market capitalizations that average $560 million and range as high as 
$3.47 billion. See Russell Investments, available at https://
www.russell.com/indexes/americas/indexes/.
---------------------------------------------------------------------------
    These differences among tiers of smaller companies are also 
replicated in various measures of secondary market liquidity. The 
Office of Analytics and Research in the Division of Trading and Markets 
posted a research paper in September 2014 that analyzed the market 
quality for small capitalization U.S. equities.\5\ Among other things, 
the paper sets forth differences in volume, bid-ask spreads, and order 
book depth for exchange-listed companies with different market 
capitalizations and stock prices (see Table 3).
---------------------------------------------------------------------------
    \5\ Charles Collver, ``A characterization of market quality for 
small capitalization U.S. equities'' (September 2014) (``Small Cap 
White Paper''), available at http://www.sec.gov/marketstructure/
research/small_cap_liquidity.pdf.
---------------------------------------------------------------------------
                                Table 3
        Market Quality Measures for Small and Medium Cap Exchange-
                Listed Stocks in 2013 \6\ Stock Price from $10-19.99
---------------------------------------------------------------------------
    \6\ See Small Cap White Paper at 4, 7, 15, and 17.
   
   
   [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
    
    This research illustrates that significant measures of market 
quality rapidly deteriorate as market capitalization decreases. Smaller 
companies generally will have less favorable metrics of market quality 
than larger companies. Among other things, smaller companies on average 
have less public float than larger companies, which yields less 
potential for trading volume.\7\ Most market quality metrics are highly 
correlated with trading volume. The key issue for the Commission to 
consider is whether the current U.S. market structure optimally 
promotes capital formation for smaller companies and the interests of 
their investors, which necessarily requires an analysis of whether 
smaller companies can maximize their volume and other measures of 
liquidity and market quality.\8\ The data in Tables 1-3 counsel an 
ongoing evaluation of how market structure can be changed to improve 
secondary market liquidity for smaller companies and their investors.
---------------------------------------------------------------------------
    \7\ Some of the lower liquidity of small cap stocks also may be due 
to greater informational asymmetries, hence, higher information risk 
for small caps. See Easley, David, Soeren Hvidkjaer, and Maureen 
O'Hara, 2002, Is Information Risk a Determinant of Asset Returns? 
Journal of Finance 57(5), pp. 2185-2221.
    \8\ Low secondary market liquidity may be reflected in a higher 
cost of capital, which can potentially have adverse effects on capital 
formation. For example, research has shown that investors in less 
liquid stocks demand a return premium, which translates into a higher 
cost of capital for issuers, and hence may affect the allocation of 
resources in the economy. See Amihud, Yakov, 2002, Illiquidity and 
Stock Returns: Cross-Section and Time-Series Effects, Journal of 
Financial Markets 5(1), pp. 31-56. Amihud, Yakov, Haim Mendelson, and 
Lasse Pedersen, 2005, Liquidity and Asset Prices, Foundations and 
Trends in Finance, now Publishers Inc., Hanover, MA. Brennan, Michael, 
Sahn-Wook Huh, and Avanidhar Subrahmanyam, 2013, An Analysis of the 
Amihud Illiquidity Premium, Review of Asset Pricing Studies 3(1), pp. 
133-176. The illiquidity premium is concentrated among small stocks. 
See Ben-Rephael, Azi, Ohad Kadan, and Avi Wohl, 2013, The Diminishing 
Liquidity Premium, Journal of Financial and Quantitative Analysis 
(forthcoming), available at: http://ssrn.com/abstract_id=1099829.
    A recent study estimates the monthly illiquidity premium to be 0.5 
percent. This study also finds that return anomalies are attenuated 
when liquidity increases and concludes that policies to stimulate 
liquidity and ameliorate trading costs improve capital market 
efficiency. See Chordia, Tarun, Avanidhar Subrahmanyam, and Qing Tong, 
2014, Have Capital Market Anomalies Attenuated in the Recent Era of 
High Liquidity and Trading Activity? Journal of Accounting and 
Economics 58(1), pp. 41-58. Investment banks' fees in seasoned equity 
offerings (SEOs) are also significantly higher for firms with less 
liquid stock. See Butler, Alexander, Gustavo Grullon, and James P. 
Weston, 2005, Stock Market Liquidity and the Cost of Issuing Equity, 
Journal of Financial and Quantitative Analysis 40(2), pp. 331-348.
---------------------------------------------------------------------------
II. SEC Efforts to Improve Market Structure for Smaller Companies and 
        Their Investors
A. SEC Advisory Committee on Small and Emerging Companies
    The challenges facing smaller companies and their investors have 
been a focus at the SEC for some time. This focus has been highlighted 
in the SEC's Advisory Committee on Small and Emerging Companies 
(``Advisory Committee''). The Advisory Committee's mandate relates to 
small and emerging privately held businesses and publicly traded 
companies with less than $250 million in public market capitalization. 
Its mission is to provide the Commission advice with respect to 
protecting investors, maintaining fair, orderly, and efficient markets, 
and facilitating capital formation, as they relate to capital raising, 
trading, public reporting, and governance requirements in the 
securities of these small companies.
    In March 2013, the Advisory Committee recommended to the Commission 
the creation of a separate U.S. equity market that would facilitate 
trading in the securities of small and emerging companies.\9\ The 
supporting materials for that recommendation indicate that two of the 
most significant challenges facing such companies in the secondary 
market are attracting the attention of a wide range of investors and--
closely related--achieving a liquid secondary market.
---------------------------------------------------------------------------
    \9\ The Advisory Committee's materials are available at http://
www.sec.gov/info/smallbus/acsec-archives.shtml#recommendations.
---------------------------------------------------------------------------
B. Prior Approval of Venture Exchange
    Traditionally, exchanges have offered a suite of services that are 
tailored to meet the needs of two key constituencies of an equity 
market--listed companies and investors. For listed companies, exchanges 
can offer heightened visibility and a more liquid trading market than 
might be available in the unlisted markets. For investors, exchanges 
can offer important investor protections, such as heightened 
transparency of trading, and effective oversight of trading and listed 
company standards. These investor protections help promote confidence 
in the integrity of the trading market and listed companies. In 
addition, a good secondary market can support capital formation and 
issuers' ability to raise capital on more favorable terms. By offering 
greater liquidity and more efficient pricing, a good secondary market 
helps assure that investors will have an efficient means of liquidating 
their positions in a company if and when they choose. And a strong 
secondary market generates price discovery that helps efficiently 
allocate capital to the companies most able to put it to productive 
use.
    In addressing the unique needs of smaller companies and their 
investors certain considerations need to be addressed. For example, 
smaller companies generally involve greater investment risk. For 
investor protection purposes, it is vital that investors understand 
those risks and that the nature and size of their investment is 
suitable for their investment objectives. Exchanges, the SEC, and other 
regulators must be aware of the risks associated with smaller companies 
and put appropriate protections and surveillances in place to help 
minimize them.
    The Commission also has previously approved market-driven proposals 
that appropriately balance the benefits and risks of smaller companies, 
while protecting investors. For example, the Commission approved a 
venture exchange in 2011--the BX Venture Market created by NASDAQ OMX 
BX, Inc.\10\ The BX Venture Market is designed for securities of 
smaller companies being delisted from another national securities 
exchange for failure to meet quantitative listing standards and for 
smaller companies contemplating an initial exchange listing. The goal 
of the BX Venture Market is to provide an opportunity for smaller 
businesses to have their securities traded in an environment that 
offers the potential for enhanced transparency, liquidity and 
regulatory oversight, which could make these companies more attractive 
to potential investors. The BX Venture Market's rules include a variety 
of measures to address investor protection concerns. These include 
rigorous vetting of listing applicants, such as background checks and 
independent investigators, enhanced surveillance of trading, and clear 
disclosure to investors that BX-listed securities differ from other 
exchange-listed securities because they generally present more risk, 
among other things.
---------------------------------------------------------------------------
    \10\ Securities Exchange Act Release No. 64437, 76 FR 27710 (May 
12, 2011).
---------------------------------------------------------------------------
    In approving the exchange, the SEC noted that the exchange could 
provide small companies with an alternative to being quoted on the 
unlisted market by offering these companies the opportunity to list 
their securities on an exchange, in an environment that offers the 
potential of enhanced liquidity, transparency and oversight. Moreover, 
providing an alternative to the over-the-counter market could also 
facilitate competition for the quotation/listing of securities of 
smaller issuers. In addition, the SEC noted that the availability of an 
exchange listing, and the prospect of more efficient secondary market 
trading, could facilitate smaller issuers' ability to raise capital and 
invest in the growth of their businesses. Finally, the Commission 
believed that clear disclosures distinguishing BX Venture Market from 
the NASDAQ Stock Market would reduce the potential for investor 
confusion.
    To date, however, the BX Venture Market has not been launched. My 
understanding is that concerns about ensuring adequate liquidity in BX-
listed securities and attracting liquidity providers, at least in part, 
have caused the delay.
C. Tick Size Pilot
    The Commission also has sought to address concerns about improving 
liquidity in the secondary market for smaller companies through the 
development of a pilot program that would allow smaller companies to 
trade at wider tick sizes. In June 2014, the SEC directed the equity 
exchanges and FINRA to act jointly in developing and filing a national 
market system plan to implement a tick pilot program.\11\ The 
Commission noted particularly that a pilot program could facilitate 
studies of the effect of tick size on liquidity, execution quality for 
investors, volatility, market maker profitability, competition, 
transparency, and institutional ownership in the stocks of small-
capitalization companies.
---------------------------------------------------------------------------
    \11\ Securities Exchange Act Release No. 72460, 79 FR 36840 (June 
30, 2014).
---------------------------------------------------------------------------
    The efforts to develop a tick size pilot for smaller companies have 
progressed over the last year. In November 2014, the SEC published for 
public comment a national market system plan submitted by the SROs to 
implement a tick size increase for the stocks of smaller companies.\12\ 
The comment period ended on December 22, 2014, and the SEC is closely 
considering the comments in assessing how to proceed.\13\ The data from 
the pilot program could help the SEC and market participants assess the 
impact of wider tick sizes for small and mid-cap companies.
---------------------------------------------------------------------------
    \12\ Securities Exchange Act Release No. 73511, 79 FR 66423 
(November 7, 2014).
    \13\ The SEC recently extended the time period for considering the 
proposed tick pilot plan until May 6, 2015. Securities Exchange Act 
Release No. 74388, 80 FR 12054 (March 5, 2015).
---------------------------------------------------------------------------
    Although widening tick sizes potentially could improve liquidity in 
smaller company stocks, it may not be a complete solution to the 
challenges faced by smaller companies as discussed in Section I above. 
For example, the smallest of these companies have average daily dollar 
volume of less than $10,000 and bid-ask spreads of more than 28 cents. 
For these and other smaller company stocks, it appears that other 
regulatory initiatives are worthy of consideration.
III. Exchange Act Provisions that Govern Venture Exchange Proposals
    As with other types of national securities exchanges, venture 
exchanges are required to register with the SEC. Their rules and other 
material aspects of their operations are subject to a public notice and 
comment process, and, ultimately, SEC approval. To approve an exchange 
rule proposal, the SEC must find that it is consistent with the 
relevant provisions of the Securities Exchange Act of 1934 (``Exchange 
Act'').
    As it did with the BX Venture Market, the SEC will carefully 
consider any efforts of exchanges to fashion innovative services that 
are particularly designed to meet the needs of smaller companies and 
their investors. The SEC will continue to be attentive to both the 
benefits and potential risks of venture exchanges, with a particular 
focus on whether it can facilitate capital formation and address 
concerns about investor protection. For example, venture exchanges must 
operate in ways that are transparent and forthcoming regarding the 
risks of investing in venture exchange companies. In general, the SEC 
has considerable flexibility to interpret the Exchange Act in ways that 
recognize the particular needs of smaller companies and their 
investors.
    For example, the BX Venture Market adopted quantitative listing 
standards, such as stockholders' equity, that were lower than those of 
any other national securities exchange with an active listings program, 
but these lower listing standards were balanced by rigorous vetting, 
surveillance, examination, and disclosure requirements to protect 
investors. In addition, stocks to be listed in the BX Venture Market 
are not considered national market system securities under Section 
11A(a) of the Exchange Act. They therefore are not subject to 
Regulation NMS, which applies only to national market system 
securities.
    As discussed below, several Exchange Act provisions, however, do 
limit the flexibility available to the SEC in approving any proposed 
venture exchange models, particularly with respect to how they maximize 
liquidity in secondary market trading. As evidenced by the market 
quality statistics above, maximizing liquidity is likely to be 
essential to the success of venture exchanges.
    In this regard, there are a variety of potential initiatives that a 
venture exchange might explore to promote liquidity. One option would 
be to limit all trading to particular times of the day or through 
particular mechanisms. Such an option could include running batch 
auctions at particular times that are designed to centralize liquidity 
across both price and time. Another option would be to attract 
dedicated liquidity providers with a package of obligations for making 
a market in listed companies, balanced by benefits for providing high-
quality liquidity. A third option would be to explore different minimum 
tick sizes in ways not limited to those under consideration in a tick 
size pilot.
    A key element that likely would be essential to the success of 
these and other efforts is protecting the liquidity pool on the venture 
exchange. If trading venues other than the venture exchange could 
execute trades in the venture exchange's listings and thereby bypass 
the mechanisms designed to maximize liquidity, the effectiveness of 
these liquidity-enhancing mechanisms might well be impaired.
    Trading volume in U.S.-listed equities today is widely dispersed 
across a variety of different venues, including 11 exchanges, 46 dark 
pool ATSs, and more than 200 broker-dealers. This dispersal of trading 
volume is even greater for the stocks of smaller companies. For 
example, the table below breaks out the trading volume in January 2015 
across the three tiers of NASDAQ-listed stocks--NASDAQ Global Select 
(``NGS''), NASDAQ Global Market (``NGM''), and NASDAQ Capital Market 
(``NCM''). The initial financial and liquidity requirements for the NGS 
tier are higher than those for the NGM tier and, likewise, the initial 
listing requirements for the NGM tier are higher than those for the NCM 
tier.
                                Table 4
        Dispersal of Volume Across NASDAQ Listing Tiers\14\
---------------------------------------------------------------------------
    \14\ See NASDAQ OMX, Inc., available at https://
www.nasdaqtrader.com/trader.aspx?ID=marketsharedaily. The column for 
Total Volume captures relative trading volume across the three tiers of 
NASDAQ-listed stocks, while the columns for NASDAQ, NASDAQ TRF, and 
Other Exchange and TRF capture relative trading volume within each 
listing tier.
---------------------------------------------------------------------------

---------------------------------------------------------------------------
    \15\ The NASDAQ TRF (Trade Reporting Facility) reflects trades 
reported by off-exchange venues. Across all NASDAQ-listed stocks, the 
NASDAQ TRF represents approximately 93% of off-exchange volume. The 
other 7% of off-exchange volume in NASDAQ-listed stocks is reported to 
the NYSE TRF.


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    These data show that stocks in the NASDAQ listing tier (NGS) with 
the most extensive listing requirements account for the largest share 
of trading volume, relative to stocks in the bottom two listing tiers. 
When considering the composition of trading volume by trading venue for 
stocks in each NASDAQ listing tier, NASDAQ exchange trading accounts 
for a larger share of trading volume (29.02 percent) for stocks in the 
highest listing tier relative to stocks in the bottom two listing tiers 
(22.06 percent and 20.47 percent). Conversely, the off-exchange portion 
of trading (represented by NASDAQ TRF) accounts for a smaller share of 
trading volume (30.78 percent) for stocks in the highest listing tier, 
relative to stocks in the bottom two listing tiers (41.54 percent and 
36.13 percent).
    The broker order-routing practices that led to these statistics for 
NASDAQ-listed securities would likely be similar for venture exchange-
listed securities. As a result, venture exchanges might seek to adopt 
rules applicable to their members, or request the SEC to adopt market-
wide rules applicable to all exchanges and broker-dealers, that limit 
the extent to which other venues could bypass the venture exchange's 
mechanisms for centralizing and maximizing liquidity.
    Two Exchange Act provisions provide standards for the SEC to adopt 
or approve measures to protect the liquidity pool of a venture 
exchange.
    Section 11A(c)(3) authorizes the Commission to prohibit broker-
dealers from executing transactions otherwise than on an exchange, 
provided that the Commission is able to make certain findings. For 
example, Section 11A(c)(3)(A)(i) requires a finding that the fairness 
or orderliness of the markets has been affected in a manner contrary to 
the public interest or the protection of investors, and Section 
11A(c)(3)(A)(iii) further requires a finding that the maintenance or 
restoration of fair and orderly markets may not be assured through 
other lawful means under the Exchange Act. Moreover, Section 
11A(c)(3)(A)(ii) requires a finding that ``no rule of any national 
securities exchange unreasonably impairs the ability of any dealer to 
solicit or effect transactions'' for its own account. Accordingly, 
Section 11A(c)(3)(A) imposes a substantial test for the Commission 
before it can adopt rules that restrict the ability of broker-dealers 
to execute off-exchange trades in stocks listed on venture exchanges. 
It is worth noting that Section 11A(c)(3) was adopted in 1975, when a 
major congressional concern was the dominance of trading volume by the 
major stock exchanges in their listings.
    The other Exchange Act provision limiting the extent to which a 
liquidity pool of a venture exchange can be protected is Section 12(f), 
which was enacted in 1994. It generally grants exchanges the right to 
trade securities listed on other exchanges (``unlisted trading 
privileges'' or ``UTP'') as long as the UTP exchange has appropriate 
rules in place to govern such trading. As with Section 11A(c), Congress 
adopted Section 12(f) when the major stock exchanges dominated trading 
in their listed companies. In the context of initial public offerings 
(``IPOs''), the statute gives the Commission authority to delay 
unlisted trading in IPO shares for a certain period after the IPO's 
launch, with Section 12(f)(1)(C) setting an initial interval of two 
trading days. Consequently, even with respect to IPOs, Section 12(f) 
presents a meaningful test for approving an extended period when 
exchange trading may occur only on the listing exchange, particularly 
for periods sufficient to enable smaller companies to reach adequate 
levels of liquidity such that UTP restrictions were no longer 
reasonably necessary.
    Of course, the Commission would need to carefully evaluate whether 
rules protecting the liquidity pool of a venture exchange would serve 
the needs of small companies, their investors, and the broader markets. 
Simply allowing a venture exchange or its liquidity providers to enjoy 
monopoly trading privileges would not be the justification or 
objective, and such rules could be approved only after a full 
opportunity for public notice and comment. As with any rule where the 
Commission must determine whether an action is necessary or appropriate 
in the public interest, the Commission must also consider the 
protection of investors and whether the action will promote efficiency, 
competition, and capital formation. Moreover, the Commission would have 
to evaluate whether and when any period of liquidity pool protection 
would need to end if a listed company reached significant size and 
levels of liquidity.
    The Commission must also consider how efforts to protect a venture 
exchange's liquidity pool would affect competition. While such efforts 
would restrict one form of competition--that is, competition among 
trading venues for order flow in a particular group of securities--it 
could potentially open up new forms of competition. Multiple venture 
exchanges might compete to fashion market structures designed to 
maximize liquidity for small companies and investors that currently are 
unavailable under the existing Exchange Act regulatory scheme. Such 
competing venture exchanges could be created by existing exchange 
groups or others, such as groups of dealers who believe they have the 
ability to offer innovative and competitive services to smaller 
companies. It is also possible, however, that high costs and other 
barriers to entry, such as network effects or cost-related economies of 
scale, may result in a more concentrated market with few active venture 
exchanges. The success or failure of the exchanges would largely depend 
on the extent to which the various venture exchanges were able to 
attract small companies and their investors.
    In sum, competition in the equities markets can assume many forms 
across different stages in the listing and trading process. A key 
policy question is whether the current U.S. market structure for 
smaller companies enables competition in ways that ultimately redound 
most to the benefit of smaller companies and their investors. 
Particularly if combined with strong measures to promote investor 
protection and market integrity, opening up new forms of competition in 
the listing and trading of smaller companies potentially could offer 
significant benefits to smaller companies and their investors. 
Conversely, protecting the liquidity pools of venture exchanges in 
their listings and thus eliminating off-exchange competition for 
trading volume from broker-dealers may affect execution costs, 
resulting in potentially larger transaction costs for investors. The 
potential benefits and costs of various forms of competition in the 
secondary market for smaller companies is an issue that warrants close 
consideration by Congress, the SEC, and the public.
IV. Conclusion
    Thank you again for inviting me to discuss an issue of such 
importance to the U.S. equity markets and economy. I look forward to 
answering your questions.
                                 ______
                                 
                 PREPARED STATEMENT OF THOMAS W. FARLEY
                President, New York Stock Exchange Group
                             March 10, 2015
    Chairman Crapo, Ranking Member Warner and Members of the 
Subcommittee, we appreciate your interest in capital raising for small-
cap companies. My name is Tom Farley and I am President of the New York 
Stock Exchange Group (NYSE). I have been in the business of exchanges 
for most of my career including as President and COO of ICE Futures US 
(formerly the New York Board of Trade) and as Senior Vice President of 
Financial Markets at Intercontinental Exchange (ICE) where I oversaw 
the development of initiatives within ICE's financial markets.
    NYSE Group includes the iconic New York Stock Exchange as well as 
two additional equities exchanges, two options exchanges and a bond 
trading platform. Across these venues we list and trade cash equities, 
equity options, exchange traded products and debt securities which are 
accessible to all investors through their broker-dealer. Of our listing 
exchanges, NYSE MKT has traditionally been the listing venue for 
smaller public companies. Over the years there have been several 
efforts in the United States to address the needs of smaller companies 
seeking access to capital through both exchange and non-exchange 
solutions.\1\ In fact, NYSE recently announced a mid-day auction for 
less liquid securities that we intend to launch later this summer if 
approved by the Securities and Exchange Commission (SEC).
---------------------------------------------------------------------------
    \1\ In 1992 the American Stock Exchange launched the Emerging 
Company Marketplace which was closed in 1995. More recently several 
private markets have launched platforms for the trading of 
nonregistered securities and Congress enacted the JOBS Act, of which 
several provisions are designed to help capital raising for Emerging 
Growth Companies. In addition, last summer the national securities 
exchanges that trade cash equities and FINRA proposed an NMS Plan pilot 
to study the impact of wider tick sizes on the trading of smaller 
public companies.
---------------------------------------------------------------------------
    As many of you know, the data around smaller companies accessing 
the public markets for capital is discouraging when compared to the 
data of the late 1990s.\2\ Companies are spending more time as private 
companies in part due to increased regulatory hurdles to becoming and 
being a public company and, once public, a lack of liquidity in the 
trading of shares of smaller public companies. As a listing exchange, 
we have witnessed the negative impact on liquidity in shares of smaller 
public companies as the incentives for market makers to participate in 
these securities have diminished. As a result, venture capital is 
locked up in companies for longer periods of time, which decreases the 
availability of venture capital for new companies.
---------------------------------------------------------------------------
    \2\ Securites and Exchange Commission Chairman Mary Jo White, June 
5, 2014; http://www.sec.gov/info/smallbus/acsec/slides-acsec-meenting-
030415-venture-exchanges-weild.pdf.
---------------------------------------------------------------------------
Venture Exchanges
    NYSE believes that the idea of venture exchanges is worth 
Congress's attention and may be of value to smaller companies seeking 
capital and their venture capital investors seeking a liquidity event 
that will free up money for new investment. While we believe many of 
the concerns raised about venture exchanges can be addressed through 
education, we also recognize that companies available for trading on 
venture exchanges will have a higher rate of failure and could 
potentially shed a dark cloud over the rest of the U.S. public markets. 
Consequently, we believe it will be important that companies listing on 
venture exchanges have an appropriate level of financial disclosure and 
that, in addition to the added oversight a venture exchange listed 
security would receive from the exchange's Self-Organization (SRO), 
venture exchanges, broker-dealers and investment advisors should 
differentiate a venture exchange traded security from one listed on a 
national securities exchange.
Listing Standards
    In addition to the appropriate levels of differentiation, NYSE 
believes there should be minimum listing standards in place that a 
venture exchange can develop and change over time to ensure that the 
intended companies are targeted. We believe two likely standards would 
be based on a minimum level of public float and a minimum number of 
shareholders. These thresholds can be set relatively low. We would 
suggest a public float of around $1 million and a minimum of 50 
shareholders. We would warn against requiring a minimum price threshold 
for the venture exchange securities and, for this reason, believe that 
Congress should strongly consider exempting venture exchange securities 
from the penny stock requirements.\3\ Venture exchange companies should 
also be expected to graduate from a venture exchange to a national 
securities exchange where higher listing standards and greater 
financial scrutiny exists. Such thresholds for graduation could be 
designed around the current minimum listing standards for national 
securities exchanges.
---------------------------------------------------------------------------
    \3\ See Exchange Act Section 15(h) and Exchange Act Rules 3a51-1 
and 15g-1 through 15g-100. http://www.ecfr.gov/cgi-bin/text-
idx?c=ecfr&tpl=/ecfrbrowse/Title17/17cfr240_main_02.tpl.
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    Venture exchanges should be required to register as national 
securities exchanges, which are self-regulatory organizations. Through 
its obligations as an SRO, a venture exchange would be responsible for 
venture companies' compliance with listing standards and the 
surveillance of trading activity taking place on the venture exchange. 
In fulfilling that obligation, NYSE would require and confirm that 
companies meet the minimum listing standards prior to listing and 
monitor for companies' compliance with the continuing listing 
standards. An SRO would also conduct background checks of directors and 
senior management of the venture companies both prior to listing and 
upon any change of directors or senior management.
Market Structure
    Several suggestions have been made with regard to the market 
structure for trading of venture companies. Among the suggestions is 
whether a venture exchange should be permitted to trade securities 
listed by another venture exchange. These unlisted trading privileges 
(UTP) are currently granted by Section 12(f) of the Securities Exchange 
Act of 1934 and permit an exchange to trade securities listed on 
another national securities exchange immediately following an initial 
public offering. It is this statutory privilege that allows NASDAQ OMX 
to trade NYSE listed securities and vice versa. Many have argued that 
eliminating UTP would result in less fragmentation of liquidity in 
venture securities and, thus, encourage market makers to post more 
liquidity at better prices. While we support eliminating UTP for 
venture exchange securities because it would have the effect of 
centralizing liquidity among venture exchanges, it is important to note 
that off exchange venues, such as dark pools, would continue to be able 
to trade venture securities away from venture exchanges in the over-
the-counter market. If helping small companies source liquidity and 
raise capital is the goal, we believe it is essential that rules also 
be adopted to require lit liquidity at the National Best Bid (NBB) or 
National Best Offer (NBO) be given primacy over dark liquidity at the 
NBB and NBO, and that exceptions to the rule be limited to instances 
when brokers are matching trades of large size or when the orders 
receive meaningful price improvement better than the NBB or NBO. 
Without such a rule being adopted, we believe the incentive for market 
makers to participate in venture exchanges will be lost and liquidity 
will remain anemic in these securities. Eliminating UTP will, however, 
allow for each venture exchange to design its own market structure with 
regard to tick sizes and execution design (e.g., continuous trading or 
periodic auctions). This flexibility would give the venture exchanges 
the ability to test new designs and find the right balance that is best 
for venture exchange listed securities.
    Another key topic is with respect to preemption of State 
registration of securities listed on a venture exchange. Again, if 
Congress's intent is to create a venue with minimal hurdles to success, 
we believe Congress should give serious consideration to preempting 
State registration just as it has previously done for listed companies 
and products on national securities exchanges. If Congress does not 
preempt State registration, we recommend adopting a provision that 
gives the SEC the ability to preempt State registration after a stated 
period of time if it is determined by the SEC that State registration 
is an inhibitor to the success of venture exchanges. We recognize the 
efforts of State securities commissioners to establish an easier path 
to registration and can see value in testing that option.\4\ However if 
that effort does not succeed once it is further tested, it would be 
prudent to have a mechanism in place as a backstop.
---------------------------------------------------------------------------
    \4\  http://www.sec.gov/info/smallbus/acsec/chart-meeting-030415-
coordinated-review-chart.pdf.
---------------------------------------------------------------------------
Conclusion
    NYSE believes that the U.S. capital markets are one of the best 
avenues available for companies of all sizes to access growth capital. 
We are protective of the confidence investors have in the U.S. capital 
markets but believe that if designed appropriately, venture exchanges 
may give small companies access to capital not currently available to 
them and investors the ability to invest in smaller companies with 
greater regulatory scrutiny than is currently available in the over-
the-counter market for unlisted securities.
                                 ______
                                 
                   PREPARED STATEMENT OF SCOTT KUPOR
                 Managing Partner, Andreessen Horowitz
                             March 10, 2015
    Chairman Crapo and Ranking Member Warner, thank you very much for 
the opportunity to speak with the Committee regarding capital formation 
and the topic of venture exchanges. I applaud this Committee for your 
efforts to examine liquidity challenges existing in today's small cap 
market. This is a critical issue to the health of our markets, 
entrepreneurship and the American economy.
    By way of background, I am the Managing Partner for Andreessen 
Horowitz, a $4.5 billion multi-stage venture capital firm focused on 
IT-related investments. We invest in both consumer-facing IT companies 
and those that sell primarily into corporate enterprises. We have been 
operating this business for just over 5 \1/2\ years and some of the 
companies in which we have invested and with which you may be familiar 
include Facebook, Twitter, AirBnB and Pinterest.
    Prior to joining Andreessen Horowitz, I held several executive 
positions in a publicly traded software company named Opsware, which we 
sold to Hewlett Packard in 2007. Prior to Opsware, I was an investment 
banker servicing technology companies at both Credit Suisse First 
Boston and Lehman Brothers.
The Current Landscape
    Before jumping into the specific topic of venture exchanges, I'd 
like to spend a minute on the current state of capital formation for 
venture-backed startups in the United States.
    It's been well documented by various commentators that the number 
of Initial Public Offerings (IPOs) in U.S. markets has fallen 
significantly since 1997. This is, at least in part, a reason why the 
total universe of listed companies in the United States has fallen by 
nearly 50 percent over that same time period. [See David Weild, ``The 
U.S. Need for Venture Exchanges,'' March 4, 2015--attached hereto as an 
exhibit].
    And while it is also true that, in large part due to the work of 
this institution through the passage of the Jumpstart our Business 
Startups (JOBS) Act, we have seen a more robust IPO environment in 2013 
& 2014, the volume and characteristics of those IPOs remain very 
different.
    In particular, IPOs that raise $50 million or less, a proxy for 
truly micro-cap companies with market capitalizations of $250-500 
million, has remained below 25 percent of all IPOs for nearly 15 years. 
In contrast, from 1991-1997, as many as one-half to two-thirds of IPOs 
raised $50 million or less in proceeds.
    Looking at the IT sector, which is the area in which we invest, we 
have seen similar trends.
    From 1980-2000, the industry produced just north of 2,400 venture-
backed IT-related IPOs. In contrast, for the 14-year period from 2001-
2014, there were a total of approximately 500 IPOs.
    Relatedly, time to IPO has significantly elongated over the same 
time periods: in the 1980-2000 time period, the median time to exit for 
IT-related IPOs was 6.5 years; for the 2001-2014 cohort, it was over 9 
years. In 2014 alone, the median time to IPO was 11 years. [These data 
are published by Jay Ritter, ``Initial Public Offerings: Updated 
Statistics,'' December 20, 2014].
    Combining these various data points, we see the following trends--
the total number of IPOs has declined significantly, the average time 
to IPO has elongated and, correspondingly, the relative maturity of 
companies at the time of IPO has also grown (as an example, the median 
sales at time of IPO for the 1980-2000 class was $30 million, compared 
with just shy of $100 million for the 2001-2014 class).
Why should we care about this?
    In addition to the strong nexus between IPOs and job growth, we are 
at risk of creating a two-tiered capital markets structure in which the 
vast majority of investment appreciation accrues to those institutions 
and wealthy individuals who have access to invest into the private 
markets, at the expense of public market investors (and, in particular, 
the vast majority of individual Americans who comprise the retail 
investor base).
    That is, when companies do in fact go public, because they do so at 
a later stage of financial development, they are of course lower risk 
investments, but also with the attendant lower return potential. As an 
example, public investors in Microsoft have seen an appreciation in the 
public stock price of approximately 500 times the initial public 
offering price. For public investors in Facebook to see this level of 
public market appreciation would require that Facebook grow to a market 
cap that exceeds the entire market cap of the global listed markets 
today.
    In the absence of doing something to address these trends, we will 
continue to see the private markets developing their own solutions to 
enable private companies to remain private. In fact, today we see 
larger amounts of institutional capital being made available in the 
late-stage private markets--both in the form of primary capital and in 
the form of secondary sales intended to provide partial liquidity to 
employees. These transactions are being funded by hedge funds, 
sovereign wealth funds, family offices, large technology-focused buyout 
firms and mutual funds. With the exception of the last category of 
investor, none of these investors services the retail investor.
What are potential ways to address these trends?
    Doing so requires that we address the underlying issues that are 
impacting companies' decisions to stay private longer:

    Economic issues--e.g., the one-time costs associated with 
        going public and the ongoing costs associated with regulatory 
        compliance

    The post-IPO trading environment--i.e., how will my stock 
        trade in the aftermarket; will I be able to raise additional 
        capital as a public company; will I achieve the benefits of 
        going public without being an orphaned stock?
Economic Issues
    While there are always more ways to streamline the economic costs 
of becoming and remaining a public company, the JOBS Act has done a 
good job of lessening the burden for emerging growth companies 
(``EGCs'') in this area. When we talk with our portfolio companies, 
this is far less an impediment to going public, although it is more 
acute for smaller companies where the public company compliance costs 
as a percentage of their total cost base is still significant.
    It should also be noted that the Confidential Filing provisions of 
the JOBS Act have been very significant in making the on-ramp to an IPO 
much smoother. Companies no longer have to expose themselves in a long 
quiet period, where their competitors have an unfair ability to paint 
their story without the company's ability to respond adequately.
Post-IPO Trading Environment
    Thus, the most significant remaining deterrent to companies going 
public is the after-market environment in which they will have to live 
as a public company.
    Outside the scope of this hearing--but an important issue 
nonetheless--has been the growth of activist shareholders and the 
tendency toward short-term investing more generally. Particularly in 
technology companies, where the product cycles ultimately drive most of 
the enterprise value, investments in R&D that have the near-term impact 
of depressing earnings per share to create long-term growth and 
competitive advantage can be difficult to make if subject to activist 
and other short-term investor pressures. This is the reason why you see 
a significant amount of dual class stock listings among recent tech 
IPOs--this is the best way to protect against short-term influences 
that could detract from R&D investments.
    More fundamentally, the after-market trading environment is 
directly correlated to the market capitalization and ultimately 
liquidity, of the company post-IPO. If a company's market cap is large 
enough (a minimum of $1 billion), it can attract research support and 
market-making resources from the sell-side investment banks. As a 
result, this firm will garner institutional investor support, robust 
liquidity and, ultimately, the ability to tap the public markets for 
additional growth capital.
    In contrast, for small market cap companies, the economics simply 
don't work for either sell-side research or market-making investments 
and, as a result, liquidity and institutional investor support are very 
low. The details of this phenomenon have been described more fully in 
the Equity Capital Markets Task Force November 2013 report to the 
Treasury Department (which is attached hereto as an exhibit).
    Among the reasons for low liquidity is the move to decimalization 
and is why we have advocated for the robust tick size pilot program 
that is currently pending before the SEC. Empirical data is required to 
demonstrate that clustering trades at fewer price increments will 
enhance trading liquidity and thus reduce the ``tax'' that 
institutional investors face when trying to enter or exit such stocks. 
That is, any attempt to buy a low liquidity stock causes the stock 
price to increase on entry and attempts to sell similarly drive down 
the stock price.
    As a result of this challenged after-market trading environment for 
small cap stocks, many issuers simply choose to postpone an IPO until 
they matured to a point where they can attain a market cap sufficient 
to engender adequate liquidity--this explains the substantial decrease 
inthe sub-$50 million IPO market. Liquidity is required to create a 
stable after-market, to enable meaningful stock price appreciation 
through the attraction of institutional investors and to permit 
companies to raise follow-on growth equity financing in the public 
markets. This liquidity seldom exists in the current market for small 
cap stocks.
Venture Exchanges
    Given the above, how would venture exchanges impact capital 
formation? I'd like to offer a few thoughts in relation to the economic 
issues and post-IPO trading environment concerns noted above.
    With respect to economic issues, a successful venture exchange 
would need to employ a regulatory framework that at a minimum 
incorporated the JOBS Act EGC filing/ongoing requirements. However, if 
the goal were to enable a significant proportion of sub-$50 million 
IPOs, it would likely require a framework that could scale down to Reg 
A+-like regulations for smaller companies. This approach would likely 
reduce the costs sufficiently to no longer serve as a barrier to 
participation in the marketplace. Blue-sky pre-emption would also be a 
critical component of any well functioning venture exchange. Any 
regulatory regime, however, would need to be evaluated as well based 
upon its ability to attract and protect investors from bad actors.
    Turning to the post-IPO trading environment, at a minimum a venture 
exchange would need the flexibility to set appropriate tick sizes (and 
likely trade-at requirements) to foster trading liquidity at fewer 
price increments. As a result, I strongly believe that any decision to 
explore venture exchanges should not obviate the need to ensure that 
critical changes are made to the pending tick size pilot, as the 
empirical data from a well-designed pilot with an adequate length of at 
least 3 years would prove critical to determining the right trading 
rules for a venture exchange.
    There are also a number of open questions and concerns that I 
believe need to be investigated further before determining whether a 
venture exchange is a better alternative to simply implementing the 
small-cap market reforms for which we have been advocating to date.
    First, adverse selection in the form of the companies that elect to 
list on the venture exchange, as opposed to staying private longer and 
waiting until they meet the existing national market listing 
requirements, is a legitimate concern. The most attractive companies 
that can raise capital privately through other means, as some are doing 
today, will simply continue to do so and only those that are in a 
weaker position will choose to list on the venture exchange. In a 
sense, this is a chicken and egg problem in that if the market works as 
designed and is policed appropriately to root out fraud and bad actors, 
it will attract good companies, but it needs to attract good companies 
in the first place to create a well-functioning market.
    Some commentators have suggested that setting the listing 
requirements high for the first set of potential issuers, accepting 
market capitalizations of up to $2 billion and having a dedicated and 
strong SEC enforcement organization are ways in which the adverse 
selection problem may be mitigated. In addition, one may need to 
consider economic incentives--at least at the outset--to attract the 
best companies to list on the exchange. However, whether these 
suggestions in fact solve the adverse selection problem remains an open 
empirical question for which further study is required.
    Second, there is a real risk that separating out the venture 
exchange from the existing national markets creates less liquidity for 
small caps by causing institutional investors to simply wait for 
venture exchange companies to ``graduate'' to the national markets 
instead of investing in them as venture exchange issuers. Again, the 
ultimate determination of whether this risk is real depends upon the 
success of the venture exchange--if liquidity is attractive in this 
market and the economic incentives are such that the sell-side can in 
fact support research and market-making activities, the institutional 
investors are likely to follow. As with the adverse selection risk, 
further study is required to determine the potential liquidity impacts 
of a dedicated venture exchange.
Summary
    In summary, I would offer the Committee the following observations:

    Fostering more IPOs--in particular, more IPOs at an earlier 
        stage of company maturity--is important to job creation, to the 
        long-term competitiveness of the U.S. securities markets and to 
        extending significant stock appreciation opportunities to 
        retail investors in the public markets.

    In the absence of structural capital market changes, good 
        companies will continue to tap private sources of capital and 
        delay going public until employee liquidity needs cannot be 
        satisfied in the public markets and a currency is required for 
        broad, strategic M&A activity. This means that more value 
        accretion will continue to accrue to private market investors 
        at the expense of public market investors.

    Independent of whether a venture exchange is the right 
        solution, we must solve the core liquidity challenges that 
        exist in today's small cap market. Thus, proceeding with a 
        robust tick size pilot program of sufficient length (three 
        years) is a crucial first step at a minimum to gathering the 
        empirical data required to set-up the proper trading rules for 
        a proposed venture exchange. In addition, empirical research 
        should be undertaken to inform the adverse selection and 
        liquidity bi-furcation risks noted above.

    I thank you for your time and look forward to the Committee's 
feedback.


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


                                 ______
                                 
                  PREPARED STATEMENT OF NELSON GRIGGS
      Executive Vice President, Listing Services, Nasdaq OMX Group
                             March 10, 2015
    Thank you Chairman Crapo and Ranking Member Warner. I deeply 
appreciate the opportunity to share Nasdaq's experience and views on 
the important subject of ``Venture Exchanges and Small Cap Companies.''
    Nasdaq owns 24 securities markets spanning the globe, including 18 
that trade equities. Our First North Markets in Stockholm, Copenhagen 
and Helsinki are venture exchanges that list emerging growth companies 
in Europe. Seventy exchanges in 50 countries trust our trading 
technology to run their markets while at the same time, markets in 26 
countries rely on our surveillance technology to protect investors--
together driving growth in emerging and developed economies.
    Upon the launch of its first initial public offering in 1971, 
Nasdaq created the modern IPO and has become the destination of choice 
for emerging, high growth companies. Nasdaq brought to the capital 
markets a trusted listings venue and a new view that companies could go 
public earlier in their growth cycle. We broke the Wall Street mold 
that kept companies from exchange listings--for example, there were 
rules that required companies to be profitable for 3 years and applied 
revenue hurdles that ruled out small companies. Nasdaq recognized that 
most companies need capital, and investors want access to ownership 
when companies are at earlier stages of growth. Around Nasdaq has 
emerged a diverse ecosystem of brokers, investors, legal advisors, and 
analysts that give growth companies unprecedented access to capital. 
Companies who go public on Nasdaq--such as Apple, Microsoft, Google, 
Intel, Staples, Biogen and Gilead Sciences--use that capital to make 
the cutting edge products and medical breakthroughs that enhance our 
daily lives. As public companies they grow rapidly and sustainably, and 
their growth drives the U.S. economy forward and ultimately creates 
jobs for millions of Americans. It is our unique heritage that drives 
our support of a renewed marketplace that supports and empowers 
cutting-edge, high growth companies.
    However, changes to the regulatory landscape in recent years have 
reduced Nasdaq's ability to facilitate stable, reliable and cost-
effective capital formation for many emerging companies. Importantly, 
the one-size-fits-all approach of our regulatory regime has had 
unexpected and serious negative consequences for smaller companies--
even as it has effected revolutionary improvements around more actively 
traded companies. While the 2012 JOBS Act did ease the disclosure 
burden on companies going public, the extent of that relief hasn't 
reached small, venture size, companies. The disclosure and governance 
requirements for these small companies need to be further tailored to 
the financial realities and distinct challenges they face.
    The continued aversion of small companies to public markets has 
created a sense among many that there is a need for a brand new type of 
market, a separate ``venture market.'' From Nasdaq's point of view, 
this notion is somewhat misplaced: what's needed--whether in a separate 
exchange or within the small cap listing tiers of existing exchanges 
like Nasdaq--are simple reforms to make the market structure attractive 
again for growth companies. Nasdaq's approach to reform has two paths:

    First, change certain trading rules and listing 
        requirements within a small company market tier to encourage 
        and facilitate the ability for growth companies to raise 
        capital on the public markets and thrive as publicly listed and 
        traded companies--this includes the need for Nasdaq and other 
        exchanges to evaluate and adjust their own listing standards 
        and corporate governance standards to better serve venture 
        companies.

    Second, further leverage the Jumpstart Our Business 
        Startups Act (JOBS Act) from which Nasdaq has built and is 
        operating a growth platform for companies wishing to stay 
        private--the Nasdaq Private Market.

    If Congress seeks to reinvigorate the already robust and vibrant 
U.S. capital infrastructure to support small companies, we respectfully 
suggest the following regulatory and legislative policy changes:

    Exempt certain growth stocks from the ``tick price'' 
        provision of Regulation NMS and delegate the authority to 
        define tick sizes to the listing exchange: The tick size is a 
        surprisingly important--and extremely sensitive--variable in 
        trading quality. Too wide and trading costs become burdensome 
        to investors; too small and volatility becomes rampant. It is 
        our view that the listing exchange is in the best position to 
        optimize tick size policy, and to do so in a way that is 
        responsive to the ever-changing needs of listed companies. 
        Since exchanges do not benefit from wide spreads which large 
        tick sizes can impose, they can impartially assess the 
        tradeoffs and protect the interest of investors and listed 
        companies.

    Modify the definition of a ``penny stock'' in Rule 3a51-1: 
        In 2004, the SEC essentially froze exchange listing standards 
        as they then existed by defining any security not meeting those 
        requirements to be a penny stock. This has inhibited innovation 
        in listing requirements in the last decade. We believe that the 
        SEC should reconsider this definition to allow exchanges 
        greater flexibility to adopt novel listing standards for growth 
        companies. Moreover, if we hope to attract new growth companies 
        to our markets, beyond those already on exchange tiers for 
        smaller companies, we will need to adjust the listing standards 
        so they can qualify without being subject to burdensome penny 
        stock and blue sky requirements.

    Expand availability of confidential filings: The ability to 
        submit a confidential draft registration statement to the SEC 
        is one of the most widely used provisions of the JOBS Act and 
        is heralded with encouraging a large number of companies to go 
        public, making their securities available to public investors. 
        We believe that this ability will also be useful to smaller 
        companies once they are listed, allowing these companies to 
        prepare for a potential secondary offering without facing 
        reputational risk and business uncertainty if they determine 
        not to proceed with a registered offering.

    Adopt limited short selling regulations: We would encourage 
        tailored rules to prevent aggressive short selling (selling at 
        or below the best bid) of smaller companies, which lack 
        resources to combat manipulative short selling and are 
        consequently more vulnerable. We also recommend consideration 
        of disclosures of short positions in smaller companies that are 
        similar to the disclosures required of long positions, 
        providing companies and other investors with transparency.

    Issuer choice to suspend ``unlisted trading privileges'' 
        for certain growth companies: the purpose of the regulatory 
        changes in U.S. equity markets over the past several decades 
        was to encourage multiple markets to compete with each other. 
        This revolutionized trading in many liquid securities, in 
        particular by enabling innovative new technologies, 
        dramatically increasing the speed and throughput of exchange 
        systems, and by encouraging price competition. Unfortunately, 
        these benefits are not meaningful to small, illiquid companies. 
        As the SEC itself points out in a 2005 rulemaking:

        `` . . . [C]ompetition among multiple markets trading the same 
        stocks can detract from the most vigorous competition among 
        orders in an individual stock, thereby impeding efficient price 
        discovery for orders of all sizes . . . Impaired price 
        discovery could cause market prices to deviate from fundamental 
        values, reduce market depth and liquidity, and create excessive 
        short-term volatility that is harmful to long-term investors 
        and listed companies.''--Securities Exchange Commission, 
        Release No. 34-51808; File No. S7-10-04.

    Affording certain growth companies issuers with input into their 
market structure through the option to suspend unlisted trading 
privileges in their stock would refocus competition among orders in 
that stock by placing them all on a single platform. To the extent that 
this competition results in improved spreads and deeper liquidity, 
growth companies electing this option could enjoy many benefits, 
including reduced capital costs.

    Permit market maker support programs: Currently, Nasdaq 
        allows ETF issuers to establish a fund to subsidize market 
        makers who enhance liquidity in those shares. We believe that 
        such support programs would also help growth companies. Market 
        quality incentive programs of this kind have successfully 
        enhanced liquidity and market quality for investors in Europe 
        for several decades.

    Eliminate certain requirements for shareholder approval for 
        smaller companies: Over the last decade, the SEC has made 
        strides to reduce the time necessary for public companies to 
        register and sell securities by allowing shelf registrations. 
        However, the requirements Nasdaq imposes on its listed 
        companies for obtaining shareholder approval of certain 
        financing transactions have not followed suit. As a result, 
        these approval requirements now can delay many transactions, 
        causing companies to consider less favorable structures to 
        avoid these requirements. This can be especially onerous for 
        smaller companies that have an ongoing need to raise capital to 
        fund their businesses. We are examining these requirements and 
        hope that any proposal we present to the U.S. Securities and 
        Exchange Commission to address this will be met with an 
        understanding that rules applied to the world's largest 
        companies may not be appropriate to apply equally to emerging 
        growth companies.
NASDAQ PRIVATE MARKET IS A VENTURE MARKET
    There are improvements that can be made in the world of private 
companies as well. The JOBS Act, passed by Congress and signed by the 
President in 2012, allows companies to remain private longer. In light 
of the growing demand for liquidity in these companies' shares 
(especially by their employees) we created the Nasdaq Private Market to 
help private companies provide selective liquidity in their equity 
securities. Nasdaq Private Market uses technology solutions to serve 
the unique needs of private companies within the legal framework set 
forth by the securities laws using Nasdaq's established competence to 
help ensure transparency and investor protection. The platform has had 
encouraging success in the short time that it has been operational. It 
has a growing universe of companies and continues to build out a robust 
toolkit specifically designed for private companies. However, from a 
legislative standpoint, private markets such as our own still need 
assistance to make them robust capital markets for companies wishing to 
stay private.
    The JOBS Act and prior laws make very clear that companies can sell 
shares to accredited investors without registering the transaction. In 
theory, this category of investor does not need the protections that 
registration requirements afford--due to their net worth, income and 
sophistication. However, the subsequent sale of shares from an existing 
shareholder to an accredited investor does not enjoy the same legal 
status, notwithstanding the fact that the policy rationale for an 
exemption is similar to that for issuer transactions. Due to a lack of 
certainty concerning the legal requirements for exempt secondary 
transactions, a range of market practices have developed. As a result, 
these transactions often do not occur, and, when they do, they take 
place amidst uncertainty and risk, as companies and their investors 
shoulder unnecessary legal and regulatory costs to facilitate such 
transactions. The time has come to provide clear guidance for secondary 
transactions where accredited investors--who are already deemed not to 
need registration level protection--are the purchasers. For these 
reasons, we encourage you to pass legislation exempting from 
registration transactions where an existing shareholder in a private 
company sells shares to an accredited investor. The SEC should further 
be encouraged to consider changes to the accredited investor 
definition, so that an investor can establish their sophistication 
through means other than their net worth and income. Regardless of any 
future modifications, antifraud provisions must remain in effect for 
both issuer and non-issuer transactions, whether registered or exempt.
    Thank you again for inviting Nasdaq to testify on this important 
issue. We believe that Nasdaq is uniquely positioned to help more 
companies go public, provide investors with access to companies earlier 
in their growth phase, employ the higher risk/reward inherent in 
venture companies and bring our deep experience and competencies of 
market transparency, quality and surveillance to these markets. We 
believe that our approach to reforming the public and private markets 
is the best road forward for venture-class companies. Thank you and I 
am happy to answer your questions.

  RESPONSE TO WRITTEN QUESTIONS OF SENATOR CRAPO FROM STEPHEN 
                           LUPARELLO

Q.1. What steps short of creating a venture exchange could help 
to improve the dynamics for smaller companies?

A.1. There are a variety of potential initiatives exchanges we 
could explore to promote liquidity in smaller companies that 
would not necessarily require the creation of a separate 
venture exchange. Exchanges could consider, for example, 
approaches designed to promote smaller company liquidity, such 
as running batch auctions at particular times, attracting 
dedicated liquidity providers with a package of obligations and 
benefits for making a market in listed companies by providing 
high-quality liquidity, or exploring different minimum tick 
sizes in ways not limited to those under consideration for the 
Commission's own tick size pilot program. Of course, any 
exchange rule proposing any of these approaches or other 
mechanisms for promoting liquidity would need to be carefully 
evaluated by the Commission in accordance with the Federal 
securities laws.
    Facilitating capital formation is an important part of the 
Commission's mission, and we continue to consider ways to 
consider ways to facilitate small and emerging companies' 
access to capital. These include:

   LJOBS Act Rulemakings--The Commission recently 
        adopted amendments to Regulation A to enable companies 
        to raise up to $50 million over a 12-month period. SEC 
        staff also is working on a recommendation to the 
        Commission for final rules on crowdfunding, which 
        remains an important priority. These exemptions from 
        the registration requirements of the Securities Act 
        should provide new ways for smaller companies to raise 
        capital and provide investors with additional 
        investment opportunities.

   LTick Size Pilot--The Commission recently approved a 
        pilot program that would test whether wider tick sizes 
        could positively impact liquidity and trading in some 
        smaller companies.

   LDisclosure Effectiveness Review--Staff in our 
        Division of Corporation Finance is conducting a 
        comprehensive review of the disclosure requirements for 
        public companies. The goal is to find ways to improve 
        the disclosure regime for the benefit of both companies 
        and investors. Part of this initiative includes 
        evaluating whether additional scaling of the disclosure 
        requirements for smaller companies would be 
        appropriate.

    SEC staff also is continually working to ensure that the 
views of small business owners, investors, and other 
stakeholders in the small and emerging business community are 
heard. For example, we organize an annual small business forum 
to provide a platform to highlight perceived unnecessary 
impediments to small business capital formation and whether, 
consistent with investor protection, they can be eliminated or 
reduced. The SEC also benefits from the expertise of its three 
advisory committees: the Advisory Committee on Small and 
Emerging Companies, the Investor Advisory Committee, and, most 
recently, the newly created Equity Market Structure Advisory 
Committee. Each of these committees has members with 
significant expertise investing in, advising, or trading small 
and emerging companies.

Q.2. What necessary regulations or legislative changes can be 
made/need to be made to aid the creation of a venture exchange? 
What characteristics should venture exchanges have including 
whether it should include:

   LScaled disclosure requirements and more basic 
        listing standards

   LWider tick sizes

   LLimit trading to only a venture exchange

   LAnything else we view as necessary

A.2. Exchanges play a vital role in assuring the proper 
functioning of our securities markets. They have a statutory 
responsibility for overseeing trading on their markets and 
their members' compliance with applicable statutory and 
regulatory provisions. They establish the rules by which 
securities are listed and traded and listing companies are 
vetted, and set standards of conduct for their members. They 
also generally are responsible for enforcing both their own 
rules and the relevant provisions of the Exchange Act, 
including the rules and regulations thereunder. In addition, 
they must have a robust and resilient technological 
infrastructure and operational integrity. Exchanges are 
required to register with the Commission and are subject to 
Commission examination and enforcement. Additionally, their 
rules and other material aspects of their operations are 
subject to a public notice and comment process, and, 
ultimately, Commission approval in accordance with the relevant 
provisions of the Exchange Act.
    In general, the SEC has considerable flexibility to 
interpret the Exchange Act to accommodate a venture exchange 
business model. A venture exchange may seek to have disclosure 
requirements and listing standards it believes are suitable to 
the unique characteristics of smaller companies. In addition, 
robust vetting, surveillance, and examination programs by an 
exchange could help protect investors, and the exchange 
environment, from potential ``bad actors'' on the exchange.
    There are, however, certain Exchange Act provisions that 
may limit the Commission's flexibility regarding venture 
exchanges, particularly with respect to how a venture exchange 
might be able to maximize liquidity on the exchange:

   LSection 12(f) of the Exchange Act grants unlisted 
        trading privileges to exchanges as long as they have 
        appropriate rules in place to govern such trading. For 
        IPOs, the statute gives the Commission authority to 
        prescribe the duration of a time period after an IPO 
        before unlisted trading can begin. Section 12(f)(1)(C) 
        set an initial interval of two trading days, and under 
        current Commission rules unlisted trading privileges 
        are extended to a security when at least one 
        transaction in that security has been effected on the 
        listing exchange. Commission staff is looking at what 
        flexibility there may be to establish an extended time 
        period for centralized trading for smaller company 
        securities.

   LSection 11A(c)(3)(A) of the Exchange Act authorizes 
        the Commission to prohibit broker-dealers from 
        executing transactions otherwise than on an exchange 
        (i.e., over-the-counter trading) provided that the 
        Commission is able to make certain findings, such as a 
        finding regarding the fairness and orderliness of 
        markets and a finding that an exchange rule does not 
        unreasonably impair the ability of any dealer to 
        solicit or effect transactions for its own account. 
        This test must be met before the Commission can adopt 
        rules restricting the over-the-counter trading of 
        broker-dealers that would allow a venture exchange to 
        establish mechanisms to protect the liquidity pool on 
        the exchange.

    There are a variety of ways that a venture exchange might 
structure its operations to address the capital formation needs 
of smaller companies, including, but not limited to, measures 
to promote liquidity through mechanisms to protect the 
liquidity pool on the venture exchange and obligation/incentive 
packages to attract liquidity providers to the exchange. The 
Commission would need to evaluate any such mechanisms as part 
of its review of a venture exchange's registration application 
to the Commission to determine whether such mechanisms were 
permissible under the securities laws and regulations and 
whether they would serve the needs of small companies, their 
investors, and the markets as a whole.
                                ------                                


  RESPONSE TO WRITTEN QUESTION OF SENATOR VITTER FROM STEPHEN 
                           LUPARELLO

Q.1. Mr. Luparello, in your testimony, you stated, ``The SEC is 
considering innovative approaches that appropriately balance 
the needs of smaller companies for efficient secondary markets 
and the interests of investors in smaller companies. Venture 
exchanges potentially could achieve such a balance by providing 
the investors a transparent and well-regulated environment for 
trading the stocks of smaller companies that offers both 
enhanced liquidity and strong investor protections. As such, 
they could strengthen capital formation and secondary market 
liquidity for smaller companies and expand the ability of all 
investors to participate through well-regulated platforms in 
the potential growth opportunities offered by such companies.''
    When do you believe the SEC will be ready to announce these 
``innovative approaches'' and what is the reason to delay?

A.1. The SEC has supported innovative efforts to promote an 
appropriate secondary market structure for smaller companies. 
For example, the Commission recently approved a pilot program 
that will test the impact of wider quoting and trading 
increments, or ticks, on the securities of smaller 
capitalization companies. The pilot program is a significant 
market structure initiative and it will generate data on 
whether wider tick sizes enhance the market quality for the 
stocks of smaller capitalization issuers.
    Another example, noted in my written testimony on behalf of 
the Commission, was the Commission's approval of the BX Venture 
Market in 2011. To date, however, the BX Venture Market has not 
been launched. My understanding is that concerns about ensuring 
adequate liquidity in BX-listed securities and attracting 
liquidity providers, at least in part, have caused the delay 
for the launch.
    In light of these developments and broader discussions 
about improving markets for smaller issuers, Commission staff 
is assessing the hurdles facing exchanges that seek to maximize 
secondary market liquidity for such issuers. One focus is the 
design of approaches that would protect the exchange's 
liquidity pool for a smaller company's stock.
    The three primary provisions of the Securities Exchange Act 
of 1934 that bear on efforts to protect an exchange's liquidity 
pool are the national market system requirements of Section 
11A(a), the unlisted trading privilege (``UTP'') provisions of 
Section 12(f), and the off-exchange trading provisions of 
Section 11A(c)(3).
    As noted in my testimony, stocks to be listed on the BX 
Venture Market were not considered national market system 
securities and therefore would not have been subject to the 
provisions of Regulation NMS. With respect to Section 12(f) and 
Section 11A(c)(3), Commission staff is considering the extent 
to which interpretations or exemptions would be appropriate to 
help promote the efforts of exchanges to protect their 
liquidity pools for smaller companies.
    In addition to these staff efforts, the Commission staff 
remains open to considering other innovative initiatives from 
exchanges or others that appropriately balance the needs of 
smaller companies for efficient secondary markets and the 
interests of investors in smaller companies. I anticipate that 
we would respond to such efforts in a timely and constructive 
manner.

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