[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
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Available at: http://www.fdsys.gov/
U.S. GOVERNMENT PUBLISHING OFFICE
94-374 PDF WASHINGTON : 2015
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Publishing
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800;
DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC,
Washington, DC 20402-0001
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\
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
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.
ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]