    [House Hearing, 115 Congress]
    [From the U.S. Government Publishing Office]

                        LEGISLATIVE PROPOSALS TO IMPROVE

                       SMALL BUSINESSES' AND COMMUNITIES'

                               ACCESS TO CAPITAL

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

                                    HEARING

                                   BEFORE THE

                        SUBCOMMITTEE ON CAPITAL MARKETS,
                           SECURITIES, AND INVESTMENT

                                     OF THE

                        COMMITTEE ON FINANCIAL SERVICES

                         U.S. HOUSE OF REPRESENTATIVES

                         ONE HUNDRED FIFTEENTH CONGRESS

                                 FIRST SESSION

                                   __________

                                NOVEMBER 3, 2017

                                   __________

           Printed for the use of the Committee on Financial Services

                               Serial No. 115-54

      [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

                               _________

                   U.S. GOVERNMENT PUBLISHING OFFICE

     30-773 PDF              WASHINGTON : 2018

                     HOUSE COMMITTEE ON FINANCIAL SERVICES

                        JEB HENSARLING, Texas, Chairman

    PATRICK T. McHENRY, North Carolina,  MAXINE WATERS, California, Ranking
        Vice Chairman                        Member
    PETER T. KING, New York              CAROLYN B. MALONEY, New York
    EDWARD R. ROYCE, California          NYDIA M. VELAZQUEZ, New York
    FRANK D. LUCAS, Oklahoma             BRAD SHERMAN, California
    STEVAN PEARCE, New Mexico            GREGORY W. MEEKS, New York
    BILL POSEY, Florida                  MICHAEL E. CAPUANO, Massachusetts
    BLAINE LUETKEMEYER, Missouri         WM. LACY CLAY, Missouri
    BILL HUIZENGA, Michigan              STEPHEN F. LYNCH, Massachusetts
    SEAN P. DUFFY, Wisconsin             DAVID SCOTT, Georgia
    STEVE STIVERS, Ohio                  AL GREEN, Texas
    RANDY HULTGREN, Illinois             EMANUEL CLEAVER, Missouri
    DENNIS A. ROSS, Florida              GWEN MOORE, Wisconsin
    ROBERT PITTENGER, North Carolina     KEITH ELLISON, Minnesota
    ANN WAGNER, Missouri                 ED PERLMUTTER, Colorado
    ANDY BARR, Kentucky                  JAMES A. HIMES, Connecticut
    KEITH J. ROTHFUS, Pennsylvania       BILL FOSTER, Illinois
    LUKE MESSER, Indiana                 DANIEL T. KILDEE, Michigan
    SCOTT TIPTON, Colorado               JOHN K. DELANEY, Maryland
    ROGER WILLIAMS, Texas                KYRSTEN SINEMA, Arizona
    BRUCE POLIQUIN, Maine                JOYCE BEATTY, Ohio
    MIA LOVE, Utah                       DENNY HECK, Washington
    FRENCH HILL, Arkansas                JUAN VARGAS, California
    TOM EMMER, Minnesota                 JOSH GOTTHEIMER, New Jersey
    LEE M. ZELDIN, New York              VICENTE GONZALEZ, Texas
    DAVID A. TROTT, Michigan             CHARLIE CRIST, Florida
    BARRY LOUDERMILK, Georgia            RUBEN KIHUEN, Nevada
    ALEXANDER X. MOONEY, West Virginia
    THOMAS MacARTHUR, New Jersey
    WARREN DAVIDSON, Ohio
    TED BUDD, North Carolina
    DAVID KUSTOFF, Tennessee
    CLAUDIA TENNEY, New York
    TREY HOLLINGSWORTH, Indiana

                      Kirsten Sutton Mork, Staff Director
          Subcommittee on Capital Markets, Securities, and Investment

                       BILL HUIZENGA, Michigan, Chairman

    RANDY HULTGREN, Illinois, Vice       CAROLYN B. MALONEY, New York,
        Chairman                             Ranking Member
    PETER T. KING, New York              BRAD SHERMAN, California
    PATRICK T. McHENRY, North Carolina   STEPHEN F. LYNCH, Massachusetts
    SEAN P. DUFFY, Wisconsin             DAVID SCOTT, Georgia
    STEVE STIVERS, Ohio                  JAMES A. HIMES, Connecticut
    ANN WAGNER, Missouri                 KEITH ELLISON, Minnesota
    LUKE MESSER, Indiana                 BILL FOSTER, Illinois
    BRUCE POLIQUIN, Maine                GREGORY W. MEEKS, New York
    FRENCH HILL, Arkansas                KYRSTEN SINEMA, Arizona
    TOM EMMER, Minnesota                 JUAN VARGAS, California
    ALEXANDER X. MOONEY, West Virginia   JOSH GOTTHEIMER, New Jersey
    THOMAS MacARTHUR, New Jersey         VICENTE GONZALEZ, Texas
    WARREN DAVIDSON, Ohio
    TED BUDD, North Carolina
    TREY HOLLINGSWORTH, Indiana

                                C O N T E N T S

                                  ----------
                                                                       Page
    Hearing held on:
        November 3, 2017.............................................     1
    Appendix:
        November 3, 2017.............................................    33

                                   WITNESSES
                            Friday, November 3, 2017

    Bullard, Mercer, Butler Snow Lecturer and Professor of Law,
      University of Mississippi School of Law........................     4
    Gerber, Michael F., Executive Vice President, Corporate Affairs,
      FS Investments.................................................     5
    McCoy, Patrick J., Director of Finance of the Metropolitan
      Transportation Authority of New York, on behalf of the
      Government Finance Officers Association........................     2
    Quaadman, Thomas, Executive Vice President, Center for Capital
      Market Competitiveness, U.S. Chamber of Commerce...............     8
    Stevens, Paul Schott, Chief Executive Officer, Investment Company
      Institute......................................................     7

                                    APPENDIX

    Prepared statements:
        Bullard, Mercer..............................................    34
        Gerber, Michael F............................................    57
        McCoy, Patrick J.............................................    65
        Quaadman, Thomas.............................................    69
        Stevens, Paul Schott.........................................    79

                  Additional Material Submitted for the Record

    Huizenga, Hon. Bill:
        Letter to Jay Clayton, Chairman, U.S. Securities and Exchange
          Commission.................................................   103
        Response letter from Jay Clayton, Chairman, U.S. Securities
          and Exchange Commission....................................   105
        Letter dated October 13, 2017 regarding The Consumer
          Financial Choice and Capital Markets Protection Act........   108
    Emmer, Hon. Tom:
        Letter from the Association of Minnesota Counties............   110
    Hultgren, Hon. Randy:
        Letter from the State Financial Officers Foundation..........   111
    Lynch, Hon. Stephen:
        Letter from Thomas Koch, Mayor of Quincy, Massachusetts......   113
    Rothfus, Hon. Keith:
        Letter from the Association for Financial Professionals......   115
        Letter from the Association of School Business Officials
          International..............................................   117
        Morningstar article entitled, ``Money Market Funds on Life
          Support''..................................................   119
    Stivers, Hon. Steve:
        White paper from the Coalition for Small Business Growth.....   123
        Written statement from the Coalition for Small Business
          Growth.....................................................   136
        Clarification from Mr. Jonathan Bock, Wells Fargo............   140
    Meeks, Hon. Gregory:
        Written responses submitted for the record from Michael
          Gerber.....................................................   142
    Quaadman, Thomas:
        Presentation from Treasury Strategies........................   146

                        LEGISLATIVE PROPOSALS TO IMPROVE

                       SMALL BUSINESSES' AND COMMUNITIES'

                               ACCESS TO CAPITAL

                                  ----------

                            Friday, November 3, 2017

                         U.S. House of Representatives,
                               Subcommittee on Capital Markets,
                                    Securities, and Investment,
                               Committee on Financial Services,
                                                       Washington, D.C.
        The subcommittee met, pursuant to notice, at 9:17 a.m., in
    room 2128, Rayburn House Office Building, Hon. Bill Huizenga
    [chairman of the subcommittee] presiding.
        Present: Representatives Huizenga, Hultgren, Stivers,
    Poliquin, Hill, Emmer, Mooney, MacArthur, Davidson, Budd,
    Hollingsworth, Hensarling, Maloney, Sherman, Lynch, Scott,
    Himes, Sinema, Vargas, and Gottheimer.
        Also present: Representative Rothfus.
        Chairman Huizenga. The committee will come to order. And
    without objection, the Chair is authorized to declare a recess
    of the committee at any time.
        This hearing is entitled ``Legislative Proposals to Improve
    Small Businesses' and Communities' Access to Capital.''
        Just to get everybody on the same page here, they have
    moved up votes a little bit on us this morning. We have an
    anticipated voting time somewhere between 10:15 and 10:45. With
    agreement with the Ranking Member here, we are foregoing our
    opening statements, because it is about you actually. Hard to
    believe that Congress folks wouldn't want it to be about them.
    But it is about you, to hear from you all, and to make sure
    that we get to questions.
        Just for the members, depending on our timing, the Chairman
    may exercise our prerogative to shorten your 5-minute question
    period. We want to get through as many folks as we possibly can
    in a timely fashion.
        And with that, without objection, the gentleman from
    Pennsylvania, Mr. Rothfus, is permitted to participate in
    today's subcommittee hearing. Mr. Rothfus is a member of the
    Financial Services Committee, and we appreciate his interest in
    this important topic. And we are pleased that our final
    witness, was stuck in one of our famous lines here in getting
    into the office building, so we are glad you are here, Mr.
    Gerber.
        So with that, today, we welcome the testimony of Mr.
    Patrick McCoy, the Director of Finance for the Metropolitan
    Transportation Authority of New York, on behalf of the
    Government Finance Officers Association; Mr. Mercer Bullard,
    Butler Snow Lecturer and Professor of Law, University of
    Mississippi School of Law; Mr. Michael Gerber, Executive Vice
    President, Corporate Affairs of FS Investments; Mr. Paul
    Stevens, who is the Chief Executive Officer of the Investment
    Company Institute, ICI; and Mr. Tom Quaadman, Executive Vice
    President for the Center for Capital Market Competitiveness to
    the U.S. Chamber of Commerce.
        Each of you will be recognized for 5 minutes to give your
    oral presentation and your testimony. And without objection,
    each of your written statements will also be made part of the
    permanent record.
        With that, Mr. McCoy, you are recognized for 5 minutes.

                      STATEMENT OF PATRICK J. MCCOY

        Mr. McCoy. Thank you.
        Chairman Huizenga, Ranking Member Maloney, and
    distinguished members of the committee, I am honored to be here
    today on behalf of the Government Finance Officers Association
    to share with you our comments on H.R. 2319, the Consumer
    Financial Choice and Capital Markets Protection Act of 2017,
    and its importance to public finance.
        My name is Pat McCoy, and I serve as the President of the
    Government Finance Officers Association. But today, I will be
    speaking in that capacity and not in my other role as Director
    of Finance for the Metropolitan Transportation Authority in New
    York.
        Founded in 1906, GFOA represents over 19,000 public finance
    officers from State and local governments, schools, and special
    districts throughout the United States. This includes about
    2,500 Michigan and 1,500 New York national and State GFOA
    members. GFOA is dedicated to advancing fiscal strategies,
    policies, and practices for the public benefit, including
    topics related to issuing tax exempt bonds and investing public
    funds.
        I am here to testify in support of H.R. 2319. Money market
    funds are an important means of financing capital requirements
    for State and local governments. But the SEC's (Securities and
    Exchange Commission's) change of net asset value, or NAV,
    accounting methodology from stable to floating has negatively
    impacted our ability to use them. H.R. 2319 would allow State
    and local governments to return to utilizing suitable
    investments as defined by State and local government officials
    rather than by the SEC.
        GFOA has identified two key issues that should be weighed
    as Congress considers this legislation to improve access to
    capital. First, money market funds have been utilized
    effectively to both manage liquidity for public sector
    investments and to provide a reliable source of working capital
    to fund public services and finance infrastructure investment.
    Legislation such as this would allow governments to seamlessly
    continue accessing the capital markets without increasing costs
    for taxpayers. Money market funds are a widely used cash
    management tool for individuals, corporations, as well as for
    State and local governments.
        According to Federal Reserve data, State and local
    governments hold over $183 billion of assets in money market
    funds. Money market funds themselves are key purchasers of
    municipal securities. Historically, they have been the largest
    purchasers of short-term tax exempt debt.
        GFOA has supported and will continue to support initiatives
    that both strengthen money market funds and ensure investors
    have access to high-quality securities that can be bought and
    sold in an efficient market. However, the SEC rule change that
    requires a floating rather than a fixed NAV created unintended
    consequences that impact large governmental entities and small
    communities alike.
        Second, since the SEC rule changed from a fixed to a
    floating NAV, we have seen a negative impact on State and local
    governments. The original objective of the rule change was to
    protect investors in money market funds, but we think that
    those concerns were already addressed in the 2010 amendments to
    rule 2a-7. GFOA and other State and local government issuer
    groups supported those amendments. Despite the positive impact
    of the 2010 amendments, the SEC moved forward in adopting
    additional amendments to the rule in July 2014, which became
    effective just last year.
        Throughout that process, GFOA and public finance officers
    throughout the country submitted analysis showing that a
    floating NAV would do little to deter heavy redemptions during
    a financial crisis and would instead impose substantial costs
    on State and local governments.
        Between January 2016 and July 2017, tax exempt money market
    fund assets under management fell by half, from $254 billion to
    $135 billion, a dramatic shrinking of an important market for
    municipal debt. At the same time, municipalities issuing
    variable rate demand bonds saw their borrowing costs increase,
    nearly double the Federal Reserve's rate increases over the
    same period. Many State and local governments opted to issue
    higher fixed rate bonds because issuing variable rate debt to
    money market funds was costly. In both cases, the higher costs
    were shouldered by taxpayers and ratepayers.
        Finally, the SEC rule changes implications for the
    investments State and local governments rely on to protect
    public funds. Many have specific State or local statutes or
    policies that require them to invest in financial products with
    a stable NAV. This ensures that public funds are appropriately
    safeguarded. Thus, State and local governments commonly use
    money market funds with a stable NAV for managing operating
    costs--operating cash. Requiring a floating NAV creates an
    unnecessary obstacle that has steered State and local entities
    into very low yielding U.S. Government backed funds or other
    alternatives from what was already a safe and highly liquid
    market.
        Chairman Huizenga, Ranking Member Maloney, and
    distinguished members of the committee, public finance officers
    are encouraged by and support initiatives like H.R. 2319, the
    Consumer Financial Choice and Capital Markets Protection Act of
    2017. I thank you for the opportunity to speak with you here
    today, and I will be happy to take your questions.
        [The prepared statement of Mr. McCoy can be found on page
    65 of the Appendix]
        Chairman Huizenga. Thank you. We appreciate that.
        And with that, Professor Bullard, you are recognized for 5
    minutes.

                       STATEMENT OF MERCER BULLARD

        Mr. Bullard. Chairman Huizenga, Ranking Member Maloney,
    members of the subcommittee, thank you again for the
    opportunity to speak before you today.
        I will focus my comments this morning on the BD leverage
    proposal. And I would like to think that we can all agree that
    before permitting BDCs (business development companies) to
    increase their leverage, we need to know how much leverage BDCs
    actually use, and ensure this information is fully and
    accurately disclosed.
        It appears to me that neither condition is currently
    satisfied. We do not know how much leverage BDCs actually use.
    And if we do not know how much leverage they use, then it
    follows that BDC leverage is not being fully or accurately
    disclosed.
        Over the last three decades, since the banking crisis of
    the 1980's, banking regulation has evolved to employ diverse
    measures of risk that provide a more accurate view of the
    threat of bank failure. Traditional diversification,
    concentration, and leverage limits have been supplemented by
    risk-based capital ratios, value at risk measures, liquidity
    coverage ratios, off balance sheet contingency weightings,
    tiered asset categories, stress tests, and living wills. These
    measures have still not kept pace with the development of
    increasing complex financial instruments and capital
    structures, but they have them within site.
        The BDC leverage limit is a different story. It captures
    very little of the information one would need to evaluate a
    BDC's effective leverage. It does not consider the relative
    quality, priority, or term of BDC assets, nor does it capture
    the term reliability or portfolio income sensitivity of BDC
    loans. It does not reflect interest rate risk. Industry
    analysts agree the leverage limit is inadequate. One
    publication has stated, quote: ``In our view, the raw leverage
    measure, debt over equity, doesn't tell the whole story as
    loans that BDCs hold have various degrees of implicit
    leverage,'' end quote.
        This is a bit of an understatement as the effective ratio
    estimates by those same analysts bear little resemblance to the
    one-to-one statutory leverage limit. In the fall of 2015, for
    example, these analysts rated BDC leverage ratios as ranging
    from a low of .58 to 1 to a high of 7.57 to 1. The 7.57 ratio
    is obviously not consistent with the one-to-one statutory
    limit. The high of 7.57 to 1 is more than 13 times the low
    estimate, which shows a degree of variance that also does not
    comport with the statutory leverage eliminate.
        These high-leverage ratios are not disclosed to investors,
    nor is their potentially disastrous effect. The BDC that had
    the 7.57 to-1 ratio showed in a recent filing that a mere 10
    percent loss in the market value of its holdings would result
    in a 23.5 percent decline in the value of the shareholder
    stake. This disclosure is still inadequate. It posits that a 10
    percent decline is a worst-case scenario. The SEC should know
    better.
        In comparison, the Fed's worst-case scenario for its 2017
    supervisory stress test assumes a 50 percent decline in equity
    values and a 25 percent decline in housing prices and a 35
    percent decline in commercial real estate and a 10 percent
    unemployment rate. I submit that worst-case scenario disclosure
    must reflect at least a 20 or a 25 percent drop, if not a 40 or
    45 percent drop, in order to be useful.
        It is fitting that the picture on the cover of this 2015
    BDC scorecard is a photo of a man climbing a sheer rock face in
    running shoes without any ropes. I find that the inadequacies
    of BDC risk disclosure were matched by inadequate disclosure in
    other respects. A retail investor could not reasonably be
    expected to understand the mechanics of performance fees
    charged by BDC managers based on SEC mandated disclosure. I was
    unable to determine whether BDC managers that charge fees on
    top of fees charged by underlying funds or maybe a questionable
    practice were also double-dipping by being paid themselves by
    the underlying fund. Nor could I practicably determine whether
    and to what extent a BDC was actually investing consistent with
    its statutory mandate.
        I am also concerned about BDC's enforcement history. A
    recent article by a former SEC examiner, John Walsh, lists a
    pattern of BDC enforcement actions over just the last 10 years
    that is extraordinary in the light of the fact that the total
    number of BDCs has never been much over 100. I recommend that
    members consider this article which appears in Volume 14 of the
    Dartmouth Law Journal before making a final decision on the
    pending legislation.
        I again thank the subcommittee for the opportunity to
    appear before you today, and I would be happy to try to answer
    any questions you might have on this or other matters before
    the subcommittee. Thank you.
        [The prepared statement of Mr. Bullard can be found on page
    34 of the Appendix]
        Chairman Huizenga. Thank you very much.
        And with that, Mr. Gerber, you are recognized for 5
    minutes.

                     STATEMENT OF MICHAEL F. GERBER

        Mr. Gerber. Thank you.
        Thank you, Chairman. Thank you, Ranking Member Maloney and
    the other members of the subcommittee, for the opportunity to
    participate in today's hearing. My name is Mike Gerber. I am an
    Executive Vice President at FS Investments, formerly named
    Franklin Square Capital Partners. We were founded in 2007 in
    Philadelphia with the mission of providing mainstream investors
    access to institutional quality alternative asset management.
        We have used the BDC, among other structures, to execute on
    this mission. In 2009, we launched the industry's first ever
    nontraded BDC. We listed that on the New York Stock Exchange a
    few years later, in 2014, creating a liquidity event for our
    investors. Today, we manage five BDCs, and we have more BDC
    assets under management than any other manager in the industry.
        We have investors from all 50 States. We have portfolio
    companies in 39 States. And across the industry, there are now
    more than 90 BDCs and more than $90 billion in assets under
    management in the BDC space.
        Importantly, no BDC failed during the Great Recession. We
    all know those were the worst economic times we have
    experienced as a country since the Depression. And I think it
    is a very important point to make because it is a very durable
    structure that has been protective of investors.
        As you all know, in 1980, BDCs were created through
    bipartisan efforts with an eye toward matching mainstream
    investor dollars with Main Street businesses. Because BDCs were
    designed with an eye toward retail investors, they are
    appropriately very heavily regulated. In fact, whether traded
    or nontraded, BDCs are among the most highly regulated
    investment vehicles in the marketplace. And because of our
    extensive public filings, BDCs are fully transparent to
    regulators, rating agencies, analysts, lenders, and investors
    alike.
        Specifically, BDC's register shares under the 1933 act and
    elect treatment as a BDC under the 1940 act. In addition, a BDC
    is subject to the 1934 act as a public company, meaning we must
    file 10-Ks, 10-Qs, 8-Ks, and proxy statements. Contained in
    every Q and K is a schedule of our investments, along with the
    details around those investments, such as the name of the
    portfolio company, the size of the investment, the position
    within the capital stack of that investment, interest rates,
    and current price marks.
        Other key protections in the BDC include mandatory third-
    party custody of BDC assets; a board of directors, the majority
    of whom must be independent; and board approval of key matters,
    such as management fees and quarterly evaluations of the
    investments in a BDC portfolio.
        In addition, our nontraded BDCs are also regulated by FINRA
    and by the Blue Sky regulators in all 50 States. Taken
    together, these laws and regulations ensure that BDCs are
    extremely transparent, minimize conflicts of interest, and
    provide investors with a high level of protection.
        One of the key mandates under the law is that BDCs must
    invest at least 70 percent of our assets in U.S. private and
    small cap companies. As a result, BDCs have provided a
    significant amount of capital to the middle market. Middle
    market businesses employ about 48 million people today, or one
    out of every three workers in the private sector. In fact,
    between 2011 and 2017, middle market firms generated 103.3
    percent job growth compared to small business at 7.4 percent
    and large firms at 52.3 percent. And now, 42 percent of middle
    market firm companies say they expect to grow in 2018. So we
    believe it is important that middle market lenders like BDCs
    are well positioned to provide the capital necessary to fuel
    that growth.
        There are two key aspects to this legislation, one that
    would streamline offering reforms making our offering of our
    securities more efficient for investors. Also, as the professor
    mentioned, would enable--there is a provision that would enable
    BDCs to increase leverage. We believe the increase in leverage
    is modest. First, BDCs--and important. First, BDCs would have
    more capital to deploy in the middle market, while keeping all
    investor protections that I mentioned in place.
        Second, this would enable BDCs to build safer portfolios,
    delivering the same or higher returns, while investing higher
    up in the capital stack of portfolio companies.
        Third, even with the proposed increase, two-to-one leverage
    would still be quite low when compared to other lenders in the
    marketplace. For example, banks are leveraged anywhere from 8
    to 1 to 15 to 1. Hedge funds may even be over 20 to 1. And
    neither of those lending structures offer the same transparency
    as--
        Chairman Huizenga. The gentlemen's time has expired.
        Mr. Gerber. Yes, sir. Thank you, sir.
        [The prepared statement of Mr. Gerber can be found on page
    57 of the Appendix]
        Chairman Huizenga. Thank you.
        And we are going to need to move to Mr. Stevens. You are
    recognized for 5 minutes.

                    STATEMENT OF PAUL SCHOTT STEVENS

        Mr. Stevens. Chairman Huizenga, Ranking Member Maloney, and
    members of the subcommittee, I appreciate the opportunity to
    testify today on proposals to improve access to capital for
    small businesses and communities.
        ICI is the leading association representing regulated funds
    globally, and our member funds are the vehicles through which
    more than 100 million Americans pursue important financial
    goals, including saving for retirement, college, or a first
    home. Registered funds also play a vital role in the U.S.
    economy. They channel capital from fund investors to the
    markets and users of capital. Funds help fuel innovation,
    growth, and job creation.
        One measure that could enhance this process is Mr.
    Hollingsworth's bill, the Expanding Investment Opportunities
    Act. ICI fully supports the discussion draft, because we feel
    its provisions to modernize offering rules for closed-end funds
    will provide significant benefits to these funds, to their
    shareholders, and to the enterprises that they can help
    finance.
        Like other registered funds, closed-end funds are
    comprehensively regulated under the Federal securities laws and
    Securities and Exchange Commission regulations. They differ
    from mutual funds, also known as open-end funds, because
    closed-end funds have flexibility to invest in a broader array
    of assets, such as stocks and bonds issued by small private
    companies.
        For investors, closed-end funds provide enhanced income and
    cash-flow, increased after-tax efficiency, and broader
    diversification. We estimate that more than 3 million American
    households held $271 billion in assets in 533 closed-end funds
    as of June of this year.
        Now, despite their numerous benefits, the number of closed-
    end funds has declined sharply, by more than 19 percent over
    the past decade. In 2016, only 8 new closed-end funds issued
    shares, and that is a decline of 81 percent from 2007. Clearly,
    this well-established, well-regulated investment vehicle has
    untapped potential to help fund our economy.
        Mr. Hollingsworth's bill would help reverse these trends.
    It would reduce the burdens of certain SEC registration and
    communications requirements that impose heavy costs on funds
    and their investors without commensurate investor protection
    benefits. The resulting cost savings would be passed on to fund
    shareholders, making these funds more attractive.
        Now, while the discussion draft provisions are quite
    technical, they actually follow well-established rules
    governing securities issued by operating companies. If closed-
    end funds could avail themselves of these rules, they would be
    subject to all of the same conditions as operating companies,
    plus the extensive investor protections of the Investment
    Company Act.
        When former SEC Chair Mary Jo White evaluated nearly
    identical legislative provisions in 2013, in that case with
    respect to BDCs, she concluded that, quote, ``In my view, these
    provisions do not raise significant investor protection
    concerns.'' We agree, and we believe that now is the time for
    Congress to act.
        Some will argue that these changes should be left to the
    SEC. In fact, the Commission suggested the need to modernize
    registration and communications requirements for closed-end
    funds in 2005. Unfortunately, it has not followed through, and
    the Commission has no fewer competing priorities today than it
    has had throughout the past dozen years. We believe that the
    discussion draft approach, giving the SEC 1 year to enact new
    regulations before the bill's provisions would take effect, is
    necessary and appropriate.
        We have also heard concerns that automatic shelf
    registration would allow closed-end funds, including some funds
    that are not traded on exchanges, to register new offerings
    without a full SEC review. This is true, but similar treatment
    for operating companies appears to have worked quite well for
    more than a decade. Moreover, closed-end funds that utilize
    these provisions already will have filed a registration
    statement, reviewed and declared effective by the SEC staff.
        For all these reasons, we wholeheartedly support Mr.
    Hollingsworth's discussion draft as a valuable set of reforms
    that will enhance financing for the economy, while maintaining
    stringent investor protections.
        Mr. Chairman, if I may briefly comment on one other
    measure. ICI also supports the proposed offering and
    communications reforms for business development companies. We
    do not object to the bill's provisions to grant BDCs more
    flexibility to use leverage.
        Mr. Chairman, Mrs. Maloney, members of the committee, thank
    you again for the opportunity to testify. I will be happy to
    take any questions.
        [The prepared statement of Mr. Stevens can be found on page
    79 of the Appendix]
        Chairman Huizenga. Thank you, Mr. Stevens.
        Mr. Quaadman, you are recognized for 5 minutes.

                      STATEMENT OF THOMAS QUAADMAN

        Mr. Quaadman. Thank you, Chairman Huizenga, Ranking Member
    Maloney, members of the committee. Thank you for holding this
    hearing today. We appreciate the continued bipartisan
    leadership of this subcommittee on issues related to capital
    formation and job creation.
        Indeed, the passage of the JOBS Act and the recent
    introduction of reg S-K reforms by the SEC would not have
    happened without the efforts of this subcommittee. And the
    passage this week of bills by the House on testing the waters
    and accredited investor reforms show the continued dedication
    of this subcommittee on those issues. However, the situations
    of capital formation are still in dire straits, and much needs
    to be done to reverse the trends. To sum it up, the diminution
    of financial resources is calcifying entrepreneurship.
        During this past recession and for the first part of the
    recovery, for the first time ever, business destruction
    outpaced business creation. This occurred for a contracted
    period of time, and business creation rates have not come back
    to prerecession norms. Bank lending to small business is down
    and small business capital needs are not being met. Firms that
    are less than 5 years old are being particularly hard hit, as
    are business loans of under a million dollars. This data comes
    from the FDIC Community Reinvestment Act reports, the Federal
    Reserve, and the U.S. Census Bureau. Our 2016 corporate
    treasurer survey and 2017 small business survey back this
    government data up. But the situation is even worse.
        A 2016 study by the Economic Innovation Group found that
    between 2010 and 2014, 3 of 5 counties in the United States had
    more business exit than entries. And to make it even worse, 50
    percent of all business startups occurred in 20 counties in
    only 7 States, representing 17 percent of the American
    population.
        If we are to return to historic rates of economic growth
    and job creation, we need to fix these problems in a
    comprehensive and lasting way. The Chamber in a few weeks is
    going to issue an IPO report, and we look forward to working
    with this subcommittee on some of the comprehensive proposals
    we are going to make.
        But the bills before us today are a step in the right
    direction. The Small Business Credit Availability Act drafted
    by Mr. Stivers deals with business development corporations.
    BDCs have slowly been filling the void, since the recession, of
    financial firms that have left for regulatory reasons, both to
    middle market and small market capital areas. And BDCs need to
    be doing more.
        This bill would allow for a modest increase in leverage and
    would allow BDCs to deploy capital more efficiently. The SEC
    would continue to have oversight and regulations, and this bill
    would also allow for increased investor protections so that if
    there is an increase in leverage, investors have an
    opportunity, over a course of a year, to remove themselves from
    the BDC.
        The Expanding Investment Opportunities Act by Mr.
    Hollingsworth deals with expanding the well-known seasoned
    issuer status to closed-end funds. This will disseminate
    information more quickly, end duplication, reduce costs, and
    have capital be deployed--deployed more quickly. If we allow
    high school students to use a common app to apply for a
    college, we should do no less for America's job creators. The
    quick passage of these bills will help middle market and small
    businesses meet their capital needs.
        I also want to address a bill introduced by Mr. Rothfus,
    the Consumer Financial Choice and Capital Markets Protection
    Act. This bill shines a light on a capital formation problem
    that must be reviewed. The money market fund reforms
    implemented by the SEC have made corporate cash management more
    difficult and inefficient and has reduced the pool of
    productive working capital. A recent study by the Treasury
    Strategies, which we would like to submit for the record, shows
    that there is a $371 billion shortfall in business capital.
    More troubling, this has led to a crowding-out situation so
    that where big businesses are removing themselves from
    commercial paper and going into the bank lending space to meet
    their short-term needs, they are crowding out middle market
    companies and small businesses.
        In conclusion, we believe that we can work together to
    solve these issues and put America back to work. We look
    forward to working with the subcommittee to find comprehensive
    solutions to these problems and addressing America's capital
    formation crisis.
        Thank you, and I am happy to take whatever questions you
    may have.
        [The prepared statement of Mr. Quaadman can be found on
    page 69 of the Appendix]
        Chairman Huizenga. Thank you, Mr. Quaadman. I appreciate
    this.
        I am going to attempt to hold the standard and not use my
    full 5 minutes, but I will recognize myself for 5 minutes.
        The SEC's final rule provided money market funds with 2
    years to comply with these new requirements, which ultimately
    became effective October 14 of 2016, the final rule also
    permits government and retail MMFs to use the method to seek
    and maintain a fixed NAV. Some market participants have
    expressed the concern that the SEC's 2014 rule would result in
    the loss of short-term liquidity in the capital markets,
    particularly in the municipal securities market.
        Along with Ranking Member Maloney, we wrote to the
    Securities and Exchange Commission to review, and asked them to
    review the current landscape for MMFs (money market funds) and
    the impact of the 2014 rule on both short-term corporate and
    municipal financing. And without objection, I would like to
    enter into the record our letter to Chairman Clayton as well as
    his response letter.
        Mr. Quaadman, Mr. Stevens, how, really very quickly, has
    the industry changed, or have we seen significant shifts in the
    money market since the October 2016 implementation date? And
    then I am also curious how the industry has adapted to the new
    rules.
        Mr. Quaadman. We have seen--I will turn it over to Mr.
    Stevens in a second. We have seen a dramatic shift into
    government prime funds, and this is why you have also seen a
    dramatic retrenchment of businesses from using money market
    funds as a means of cash management. So it has actually changed
    the way that a corporate treasurer has to go out and manage
    their day-to-day activities in a negative way.
        What I would also say too, if you look at this rule in
    conjunction with the Volcker rule, Basel III, and a number of
    others, what it does is it places a premium on government funds
    or shifting money into U.S. treasuries, which is also a
    concentration of risk, which I think the regulators have
    ignored and really should look at as well.
        Chairman Huizenga. OK. Mr. Stevens.
        Mr. Stevens. I think that is a good summary. But what I
    would say is many of these effects were ones that were
    predicted at the time that these rules were in development. The
    ICI said many, many times that the proposals would have exactly
    the kinds of adverse effects that my colleague here has said in
    connection with municipal finance. And the way the rules are
    structured, prime assets have declined very precipitously and
    in their place rising just about as much have been government
    securities.
        Chairman Huizenga. OK. Mr. McCoy, how are municipalities
    currently meeting their short-term financing needs? And how has
    the 2014 reforms impacted how municipalities handle their cash
    management needs?
        Mr. McCoy. Sure. Thank you.
        I think in terms of short-term products available, there is
    really only one other meaningful product that municipalities
    use. It is an index-based note. So, for example, we take the
    SIFMA index or a percent of LIBOR and put a spread on that. And
    that can go out for 2, 3, 4, 5 years, whatever. That is really
    the only good alternative other than issuing short-term notes,
    which are not what I would characterize as a long-term
    financing vehicle. So I think from the issuance perspective, we
    have seen a dramatic reduction of State and local governmental
    issuers accessing this market.
        And then from an investment perspective, as I noted in my
    testimony, treasurers across the country that invest public
    funds typically are held to a fixed NAV construct for those
    investments. And with this rule, we have seen them leave this
    market.
        Chairman Huizenga. Chairman Clayton, in his letter, says
    that, basically, we should just take some more time and collect
    some data. I mean, do you have an opinion on this?
        Mr. McCoy. I think we are always looking at the data and
    what the data tells us. You know, we can't argue--
        Chairman Huizenga. It is more of a time element here,
    right?
        Mr. McCoy. Certainly time, yes. We have seen assets in this
    complex drop by half, anticipating the rule change and then
    after the rule change. So I would argue that we have had enough
    time, and we have seen the impacts of the rule change. I don't
    think they are necessary.
        Chairman Huizenga. OK. With that, I will yield back.
        The Ranking Member is recognized for up to 5 minutes.
        Mrs. Maloney. Thank you so much. And I want to welcome all
    of the panelists here, particularly Mr. McCoy from the great
    State of New York and the MTA, and thank him for his work on
    completing the Second Avenue Subway, the best subway in the
    Nation, which happens to be in my district. Thank you so much.
        I would like to continue on the Chairman's questioning and
    ask you about H.R. 2319. SEC Chairman Clayton, in his response
    to myself and Chairman Huizenga, stated that even if we
    repealed the NAV requirement from municipal and corporate
    funds, some investors might not come back to these funds. He
    stated, and I quote: ``While some investors might choose to
    leave government money market funds and return to prime and
    municipal funds, such a shift also might not occur if investors
    newly appreciate prime and municipal money market funds'
    inherent liquidity and principal stability risk and, therefore,
    choose to remain in government money market funds.''
        So what do you think of his comments? Do you think that
    investors who have left municipal funds would come back if the
    floating NAV requirement was repealed?
        Mr. McCoy. I do believe that that is the case. I believe
    that investors would take more comfort in this product if they
    knew that a dollar was worth a dollar at all times. And, quite
    frankly, I think that is what we believe to be a core reason
    why investors fled this particular product in substantial ways
    that they did.
        Mrs. Maloney. OK. Then, Mr. Stevens, the Expanding
    Investment Opportunities Act is intended to modernize the
    offering rule for closed-end funds so that these funds are
    treated the same as normal operating companies like Google and
    GE. Of course, we know the SEC could make these changes on
    their own and decided not to extend the fast-track offering
    rules to closed-end funds back in 2005.
        So my question is why did the SEC not include closed-end
    funds in the 2005 offering reform rule? Was it just an
    oversight or are there differences between closed-end funds and
    operating companies that make it difficult to apply the fast-
    track offering rules to closed-end funds?
        Mr. Stevens. Thank you for your question, Mrs. Maloney. I
    don't think it is the second of those. I think it is a fairly
    straightforward proposition. The SEC at the time said, oh, we
    will get back to that. I am speculating now. But sometimes it
    is very difficult when you have two different divisions at the
    SEC with responsibility that overlaps. In the case of operating
    companies, that is the Division of Corporation Finance. In the
    case of the closed-end funds, it would be the Division of
    Investment Management to come together and converge on a set of
    changes that will affect regulated entities in both spaces.
        What we do know is that they said they would get back to
    it. And 12 years later, they haven't. And, unfortunately, I
    don't think there is any prospect that they will. I am very
    sympathetic to the limited regulatory rulemaking resources that
    they have and the many, many competing priorities. So with all
    the goodwill in the world, I just don't think, after a dozen
    years, we should think that they will return to the issue,
    absent some prompting.
        Mrs. Maloney. Thank you.
        And, Mr. Gerber, as you know, the Small Business Credit
    Availability Act would allow BDCs to double their leverage.
    This could, in theory, allow BDCs to lend more to small- and
    medium-sized businesses or it could allow BDCs to simply
    increase their risks.
        So my question is what would you use the additional
    leverage for? Would you lend to riskier companies or would you
    lend more to creditworthy small businesses? What would the
    impact be?
        Mr. Gerber. Well, I certainly can answer for FS
    Investments, and it would be the latter. It would enable us to
    invest in more companies higher in the capital stack reducing
    risk, but still maintaining the returns that our investors have
    come to expect from BDCs. And I think it is fair to assume that
    the rest of the industry would follow suit. And I say that
    because capital availability to poorer performing BDCs will not
    be the same as it would be for higher performing BDCs. In other
    words, those poor performers would not be able to do 501
    offerings, issuing new equity. They would not be able to draw
    down more debt from lenders, from the banks. So I think it is
    fair to assume that that would be an industrywide approach.
    Investing higher in the capital stack, taking on less risk.
        Mrs. Maloney. Well, I am sympathetic to the testimony of
    Mr. Quaadman where he said this would move more credit
    availability and investment to smaller-sized companies that
    often do not get the attention they deserve.
        Thank you very much. My time is up.
        Chairman Huizenga. The gentlelady's time has expired.
        With that, the Chair recognizes the Vice Chairman, Mr.
    Hultgren, from Illinois for 5 minutes.
        Mr. Hultgren. Thank you, Chairman. Thank you all for being
    here.
        Mr. Stevens, if I could address my first couple questions
    to you regarding the Expanding Investment Opportunities Act,
    the draft legislation that is being sponsored by Mr.
    Hollingsworth. From what I understand, this is a fairly simple
    piece of legislation that should have strong positive impact
    for investors and for our capital markets.
        Three questions here, if I could. In general, why do you
    believe the number of closed-end funds has declined in recent
    years? And then how will expanding investment opportunities in
    closed-end funds benefit investors? And then final part of
    that, can you speak to the significance of closed-end funds
    flexibility to invest in less liquid securities? I know on page
    2 of your testimony you talk about this. And what are some of
    the examples that come to mind and how will this contribute to
    capital formation? A lot there.
        Mr. Stevens. I hope I remember all three of those
    questions.
        Mr. Hultgren. First one, why closed-end funds have declined
    in recent years.
        Mr. Stevens. They compete in the ecosystem of financing
    with lots and lots of other alternatives, and including some
    innovations, like exchange-traded funds, which are
    extraordinarily popular now. They exceed $3 trillion in assets,
    in ETFs (exchange-traded funds), in the United States. There is
    a straightforward quality about ETFs. Closed-end funds are a
    slightly more complex vehicle. But I think the bill that Mr.
    Hollingsworth has in view, at the margin at least, provides a
    modernization for closed-end funds with respect to the way they
    can respond to market developments, bring their new issuances
    to market, inform their investors, and will make them at least
    marginally more competitive.
        Now, why is that important? I think it is important because
    they occupy, again, a unique space within the framework of
    regulated investment companies. They have opportunities to
    invest in small enterprises, in stocks and bonds that would not
    necessarily be ones that an open-end or a mutual fund company
    would. They have opportunities to leverage their portfolios in
    ways that mutual funds would not, and enhance the yield that
    they offer to investors. And they have opportunities to provide
    additional tax efficiencies.
        So in the broad array of investment opportunities, they
    occupy a specific place, and I think it is a good one. They
    have been part of our industry since 1940. And I think these
    modest reforms that are in view here will continue to make them
    an attractive option for investors without sacrificing any
    protections.
        Mr. Hultgren. Thank you.
        I want to move on to the money market fund legislation. And
    first, Mr. Chairman, I would like to enter a letter into the
    record dated December 1, 2016, which is addressed to Speaker
    Ryan from the State Finance Officers Association, requesting
    consideration of the Consumer Financial Choice and Capital
    Markets Protection Act, one of the three bills we are reviewing
    today.
        Chairman Huizenga. Without objection.
        Mr. Hultgren. Next, Mr. McCoy, if I can address this to
    you. I was wondering if you could speak to the merits of this
    legislation. What have the SEC's money market fund rules meant
    for your cost of financing?
        Mr. McCoy. Thank you for that question, Congressman. As a
    large issuer, we need access to all parts of the yield curve to
    finance long-term infrastructure. And what we have observed
    over many years of issuing bonds and notes and products into
    the money market complex is that our lowest cost of funding has
    always been achieved using variable rate products at the short
    end of the yield curve, which go right into the money market
    complex.
        Mr. Hultgren. Thank you.
        Mr. Stevens, going back to you. Does the SEC have the legal
    authority to amend these money market fund rules? And should
    Congress let the SEC review the data and decide how to move
    forward with this rule?
        Mr. Stevens. It would have the authority, Congressman. You
    know, I have spent many more than 5 years of my life since 2007
    on money market fund issues, through two sets of really
    extensive reforms of money market funds. I don't think, at
    least from the perspective of our membership, that there is a
    lot of conviction around going through yet another extended
    process at the SEC. And I am absolutely convinced that at the
    SEC they have other priorities that they would like to be
    addressing.
        Mr. Hultgren. Thank you.
        I will yield back a few extra seconds here as well. So
    thanks, Chairman.
        Chairman Huizenga. Much appreciated by everybody.
        So with that, the Chair recognizes the gentleman from
    Georgia, Mr. Scott, for 5 minutes.
        Mr. Scott. Yes. Thank you, Mr. Chairman.
        Mr. Gerber, let me start with you. But first let me, as one
    University of Pennsylvania graduate to another, welcome you to
    the Financial Services.
        MR. Gerber. Thank you, Congressman.
        Mr. Scott. Get back to Philadelphia, give my regards to the
    Wharton School of Finance.
        Mr. Gerber. We will.
        Mr. Scott. Let me ask you, I have worked on this bill with
    my good Republican friend Mick Mulvaney when he was here, he is
    now the budget director, that will help the small business
    development corporations that your bill will. And I understand
    that you, from my staff, that you and Mr. Stivers have made
    some changes to the bill, improvements to the bill, that
    address some of the concerns of the consumer advocates. Would
    you take a moment and share those with us?
        Mr. Gerber. Sure. Sure. Thank you, Congressman.
        You are right, when the bill was introduced in the previous
    Congress, and we had a hearing similar to this one a couple of
    years ago on that bill, there were five key provisions in that
    bill. And three of those five provisions are no longer in the
    bill--or are not reflected in the current discussion draft that
    Congressman Stivers has authored.
        One of those three that is no longer in there was the
    subject of an amendment addressed by Congressman Himes. And
    that provision would have expanded the definition of eligible
    portfolio companies. So as you know, we have to invest 70
    percent of our assets in private or small cap U.S. companies.
    And in that 30 percent bucket, we can invest in non-U.S., large
    cap, mid cap, and financial companies. And I think there was
    bipartisan concern over expanding the definition, particularly
    with the focus on not wanting BDCs to invest more in financial
    companies. That provision is no longer in the legislation. That
    has come out. And that was one that caused concern by consumer
    groups, investor protection groups, as well as both Republican
    and Democratic Members here in the House and in the Senate.
        Mr. Scott. Very good.
        Let me go to you for a moment, Mr. McCoy, on another bill
    that I have worked on prior to that, and that is Congressman
    Rothfus' bill, which is the Consumer Financial Choice and
    Capital Markets Protection Act, along with my Democratic
    colleague, Ms. Moore. And I wanted to make sure that you would
    share with the committee some of the issues. There has been an
    incredible disruption that I have seen in the marketplace for
    money market funds, specifically for the tax-exempt funds. And
    would you comment on that in particular and see how this
    legislation improves that?
        Mr. McCoy. Sure. Thank you. You know, as I noted in my
    testimony, the significant retreat from this product by retail
    investors who have typically invested in money market funds,
    tax-exempt money market funds, has had an effect to cause State
    and local governmental issuers who have historically been very
    active in that market to retrench and, as I noted, to go into
    other products, most predominantly fixed rate bonds which, of
    course, carry a higher cost of interest than a money market
    product than a variable rate demand bond. So that has had an
    effect on our ability to access, again, what we believe to be
    is the most efficient part of the yield curve, again, for
    building infrastructure.
        Mr. Scott. OK. Well, thank you very much.
        And, Mr. Chairman, may I make just a brief inquiry to you?
    And I want to ask if you would be kind enough, you and Chairman
    Hensarling, to--would it be possible for us to move these
    bills? They are both bipartisan bills. And I know we are
    getting to crunch time at the end of the year. Do you think,
    working with Chairman Hensarling and you, that we could get
    these bills on the floor for a vote and over to the Senate
    before Christmas?
        Chairman Huizenga. The gentleman's time has expired. No. We
    will certainly be giving this full consideration. As you can
    see, we have the hearing today for the purposes of gathering
    that information and working toward that. The fact that there
    is broad bipartisan support helps any and all issues coming out
    of this committee, and certainly helps over on the other side
    of the Capitol as well.
        Mr. Scott. Yes, sir. Thank you, Mr. Chairman. I appreciate
    it.
        Chairman Huizenga. Now the gentleman's time has expired.
        All right. With that, the Chair recognizes the gentleman
    from Arkansas, Mr. Hill, for 5 minutes.
        Mr. Hill. Mr. Chairman, I wanted to talk to Mr. Stevens a
    little bit more about the closed-end funds issue. Thank you for
    the discussion you had with my colleague about their
    competitive position and compared to ETFs. And one of the
    strong, I think, issues is that they can pursue strategies that
    involve some leverage and disclose that.
        Would you say that that is really one of the principal
    advantages in this ecosystem you are talking about? I mean,
    from an investor point of view, the transparency of the data,
    and reflect a little bit more on that, both on fixed income and
    equities.
        Mr. Stevens. Well, the current closed-end fund business is
    about maybe 60 percent fixed income investment and about 40
    percent equity. And, yes, I think, Congressman, their ability
    to use a bit of leverage in their portfolio is something that
    is characteristic of closed-end funds and provides them an
    opportunity to enhance their return to their investors. And
    that, I think, in part, is what makes them attractive; in a
    sense, that gives them advantages in terms of tax management
    and things of that nature. So, again, it is a unique
    characteristic that they have. And we are talking about a range
    of different investment options.
        But as I said in my testimony, I think there is untapped
    potential there. I don't know how large it is, but untapped to
    be a source of financing to small enterprises and for other
    purposes in the economy. And that is a good thing, in my view.
        Mr. Hill. And do you think they have an advantage over
    attracting, as you say, smaller market cap stocks into that--as
    a collective format rather than some of their competitors?
        Mr. Stevens. Well, if you think about mutual funds and
    ETFs, the nature of their investments, ETFs are largely index
    products, so they are looking at, in many instances, large cap
    issuers and the like. Mutual funds tend to be larger in terms
    of their size. And so just their ability to invest in much
    smaller businesses, the stocks and bonds, is going to be
    constrained in a way that, with a smaller closed-end fund,
    would not necessarily be the case.
        Mr. Hill. Yes. Because I think that has, over of the years,
    really become a real challenge both in--we have talked in this
    committee many times about the cost of being public. But even
    if you move that down from very, very high market cap levels to
    smaller, you still have the coverage issues and the
    institutional investor interest area, even if it is a worthy
    company. And so we don't have many collective places for people
    to experiment with different market cap sizes.
        And, again, I agree with you on indexing that it, for the
    most part, drives the larger more liquid names, as it should
    be, by definition of being an index or a near index-type
    process.
        Do you know of a closed-end fund trend where they really do
    seek out smaller market cap names? Have you seen that among
    some of your members that have really been a source of looking
    for that emerging company that doesn't fit with a Morningstar
    style box that doesn't have the market cap required by a larger
    ETF requirement?
        Mr. Stevens. I think those are exactly the investment
    opportunities that many of them are seeking out.
        Mr. Hill. So you would say that that business is changing
    before our eyes, and you think that these proposals today would
    make that a more compelling and easier for them to pursue that
    strategy?
        Mr. Stevens. It is going to make them be able to get to
    market more quickly with respect to new issuance. It is going
    to facilitate their communications with the investing public.
    Now, I don't think this is going to be some revolution
    overnight. But at the margins, it is modernizing the ways in
    which they engage in a marketplace.
        Mr. Hill. But I just think this is a really interesting
    capital formation question.
        Mr. Stevens. I agree.
        Mr. Hill. Because you can't say that a closed-end strategy
    per se can compete with large cap growth international per se,
    although we have closed-end funds that do that. And so this to
    me is an opportunity maybe for the industry to transform itself
    and change and adapt, while so many of what we would think is a
    traditional collective investment have moved to lower cost
    different formats.
        Mr. Stevens. And that is why we support the changes.
        Mr. Hill. Yes. I appreciate the time.
        I yield back, Mr. Chairman.
        Chairman Huizenga. We are on a roll. The gentleman yields
    back.
        With that, the Chair recognizes the gentleman from
    California, Mr. Sherman, up to 5 minutes.
        Mr. Sherman. I want to add my voice to Mr. Scott's, that I
    hope we move forward on a markup. I would like to thank the
    Chair for holding these hearings and hope that it actually
    leads to a markup, as the gentleman said, well before
    Christmas.
        I want to first talk about small business development
    companies, because if you look at the capital structure of the
    United States, we have a lot of systems that move money to
    large corporations, to government bonds, to real estate. And
    yet the national interest, I think, requires that we are able
    to have vehicles that move money to small businesses, and that
    is where the technological changes that will give us high GDP
    growth are going to come from.
        I would point out that the discussion draft, Small Business
    Credit Availability Act, is patterned after a bill that passed
    through this committee 53 to 4. And it is my understanding that
    it is now a skinnier bill which incorporates, I believe, Mr.
    Himes' amendment. So you have a chance to start with a 54 to 3,
    depending upon what Mr. Himes says later. I am not speaking for
    him. That is a pretty good starting point.
        Mr. Gerber, in his testimony, Professor Bullard states that
    markets and regulators lack adequate method for estimating BDC
    leverage and its effect. The professor sites one industry
    measure that suggests that effective BDC leverage is actually
    several multiples of the current one-to-one limit. Can you tell
    us more your understanding of this concept of effective
    leverage?
        It seems like we are using a ruler with inches on it to
    measure the leverage of banks and other institutions in our
    society. And the professor is suggesting that we use
    millimeters to measure the leverage of BDCs. I am all for the
    metric system, but then we would, in order to put things in
    context, also have to use millimeters for measuring the
    leverage of all the other financial entities.
        So tell me what you--explain this effective leverage, as
    you understand it, and how it would allow--how your leverage
    compares, whether we are using millimeters or inches, to
    leverage off other financial institutions.
        Mr. Gerber. Thank you, Congressman. As I stated in my
    testimony and in one of my answers to an earlier question, BDCs
    are required, under the law, to provide a very significant
    amount of transparency into our portfolios; far more
    transparency than the banks are required to provide with
    respect to their lending practices or the portfolio companies
    to which they lend money; far more than other capital providers
    in the capital markets like hedge funds. So we are already
    starting off with a very transparent model.
        One of the disclosures that is required of BDCs is that of
    how much leverage is being used by the BDC. Financial leverage.
    I mean, how much money has been borrowed by the BDC so that the
    BDC manager can deploy that borrowed capital alongside the
    equity capital. That is fully transparent. That is financial
    leverage.
        I think the effective leverage, and I am using air quotes
    on that, the effective leverage factor or formula is one that
    was designed by an analyst. And I think it speaks to the
    transparency of the BDC model. That analyst was able to take
    the information that is provided in our disclosures every
    quarter to come up with this formula. And I think if you were
    to talk to that analyst, and I can't speak for him, but I think
    if you were to talk to that analyst what he would tell you is
    his formula is not measuring the financial leverage in a BDC.
    It is trying to put a score on the portfolio construction of
    the BDC by looking at where in the capital stack the BDC is
    deploying its assets. And so the lower in the capital stack any
    one investment is, the higher the score would be. And then he
    makes a bunch of assumptions.
        So he just puts a number on mezzanine debt. He puts a
    number on CLO debt. He puts a number on equity. But he doesn't
    actually look at the underlying portfolio company to determine
    how much debt is on that underlying portfolio company to come
    up with this score. So it is a shorthand way to enable BDC
    investors to compare BDCs. It is not a measurement of financial
    leverage. And I think that is a very important distinction. I
    would also add--
        Chairman Huizenga. The gentleman's time has expired. I'm
    sorry. We have got to get to other questions.
        Mr. Gerber. Yes.
        Chairman Huizenga. The gentleman from Maine, Mr. Poliquin,
    is recognized for 5 minutes.
        Mr. Poliquin. Thank you, Mr. Chairman. I appreciate it.
    Thank you all very much for being here, gentlemen.
        I represent rural Maine, and I am very concerned about
    small businesses. We don't have very many large businesses in
    the State of Maine. We have got a lot of mom-and-pops and a lot
    of mid-sized companies, small companies. And access to capital
    is absolutely critical. This is always something that is on my
    mind. Second of all is we have a lot of small savers, a lot of
    small investors who are looking to save for their kid's college
    or technical education or their own retirement. So cost and
    transparency is also very important when you are looking at
    various investment vehicles.
        Mr. Gerber, if I could ask you a question, and just give
    you a--just a couple--just a bit of information here, and you
    probably already know this, is that the State of Maine has
    benefited from BDC investment to the tune of about $76 million,
    including investments in Auto Europe, CashStar, Fiber
    Materials, Native Maine operations, tools and technology and
    what have you. So we are very grateful for the structure, the
    investment vehicle that you folks represent, you represent here
    on this panel today.
        One of my questions is what about valuing the underlying
    portfolios? Tell me how this works. If you are a publicly
    traded BDC, do you have to mark to market any specific time?
    And what if you are not publicly traded? And what if I am an
    investor? I am worried about the little guy, the little
    investor, and I want to participate in a vehicle that you
    offer, how often do you folks mark to market as required by
    law, and should that change?
        Mr. Gerber. Yes, sir. So whether a BDC is nontraded or
    traded, it is required under the law every quarter to post the
    schedule of all investments in the portfolio. The law also
    requires a BDC to mark at least 25 percent of that portfolio
    every quarter, so 100 percent on the year. Now, at FS, we
    happen to do 100 percent of the portfolio every quarter.
        Mr. Poliquin. So if I am an investor and a small investor,
    I am trying to get access to the information that you are
    providing such that I can determine if your investment vehicle
    is right for me, then the best I can do is--especially for a
    BDC that is not traded, is every quarter get a valuation of my
    investment?
        Mr. Gerber. That is right. And I think it is important to
    note that those valuations are handled by third-party valuation
    firms, and then have to be approved by a majority of the
    independent directors on the board of the BDC. So not only do
    you have the transparency, but you have a couple of layers of
    independent protections.
        Mr. Poliquin. Where does an investment in a BDC fit for a
    middle class family in Maine or any other place around the
    country? And how would that compare to someone investing in a
    venture capital fund, for example?
        Mr. Gerber. Sure. So the investment strategies used by BDC
    managers are quite different than venture capital strategies.
    Venture capital, you are usually taking a position--an equity
    position in a startup company.
        Mr. Poliquin. Qualified investors.
        Mr. Gerber. Qualified investors or credit investors in some
    case, but usually qualified investors. And usually, that
    venture capital firm strategy is to make a bunch of bets
    knowing that most of them will fail and hoping that a couple of
    them will really hit it. And so it is a much riskier venture.
        With BDCs, we are investing primarily in senior secured
    debt of established companies. So you don't have the risk of a
    startup and you don't have the risk of taking an equity
    position. Now, that is not to say that BDC portfolios won't at
    times have exposure to equity and have a percentage of the
    portfolio in equity investments. But most BDCs are
    predominantly investing in senior secured loans or debt of a
    private company.
        Going back to the beginning of the question about the
    investor, why would an investor consider a BDC? It is an
    opportunity to diversify a portfolio. So the way we manage
    assets and the types of investments we make tend to be less
    correlated with the markets than a publicly traded stock or a
    publicly traded bond, because we are investing in private
    companies.
        Mr. Poliquin. Thank you, Mr. Gerber. Thank you very much.
        Mr. Stevens, if you could comment a little bit on the fit
    of a closed-in fund when it comes to a working class family in
    our society that is looking to save for the future for their
    nest egg or they are putting the kids through school or what
    have you. Where would a closed-end fund fit, in your opinion,
    as compared to a BDC?
        Mr. Stevens. Well, we have an investor base of 3 million
    households.
        Mr. Poliquin. Right.
        Mr. Stevens. Our understanding is that closed-end fund
    shares are not uncommonly held, for example, in an individual
    retirement account. That may be a vehicle that can be held
    longer term for retirement purposes, again, as a way of
    diversifying your exposure to different kinds of assets. And we
    think that is commonplace among the investors in these
    vehicles.
        Mr. Poliquin. Thank you, gentlemen, very much for being
    here. I appreciate it very much.
        Chairman Huizenga. The gentleman's time has expired.
        With that, the gentleman from Massachusetts, Mr. Lynch, for
    5 minutes.
        Mr. Lynch. Thank you, Mr. Chairman. I want to thank the
    witnesses for helping the committee with its work this morning.
        Mr. Chairman, I ask unanimous consent to submit a letter
    from the Office of the Mayor of the city of Quincy,
    Massachusetts, Tom Koch, a dear friend of mine, in support of
    the Consumer Financial Choice and Capital Markets Protection
    Act of 2017. That is H.R. 2319.
        Chairman Huizenga. Without objection.
        Mr. Lynch. Thank you.
        Tom Koch is a great pal of mine. We are not necessarily in
    harmony on our thoughts on this bill, but that is because every
    city is not run as well as Quincy, Massachusetts. Let me just
    put that out there.
        And I want to turn to the other--the BDC bill there for a
    minute. I was one of the four Members who voted against the BDC
    last time. I think the bill has been enormously improved by Mr.
    Himes' amendment, the gentleman from Connecticut, but I am
    still not there yet.
        Let me just ask Professor Bullard, in your testimony, you
    cite the fact that--at least in the earlier iteration of this
    bill, BDCs were allowed to invest, I think, 30 percent of the
    corpus of their funds in financial institutions. A lot of
    investment was going into financial institutions and structured
    products, collateral loan obligations and things like that,
    that weren't necessarily helping small- and medium-size
    operating businesses.
        Look, if we were just talking about that, I would be with
    this bill, because I do believe that we need access to capital
    for those smaller- and medium-size businesses. My problem is
    that we have allowed this significant part of this bill to be
    directed toward, previously, financial institutions and
    structured products that allow, I think, an amplification of
    the leverage and risk that is involved here. And, also, it does
    not help. It does not help those small businesses and mid-size
    businesses that we are supposed to be assisting in this bill.
        Is there a rebalancing? Is there a rebalancing that could
    be possible here, in addition to what Mr. Himes is doing--and I
    applaud his good work--to make sure that the lion's share, or
    almost the lion's share, of good here is really directed to
    those companies that need the help?
        Mr. Bullard. Well, I guess I would like to first say that
    in the last week of reading through registration statements, I
    have been very impressed by the number and diversity of
    investments in BDCs. I hadn't done that reading before, and
    with the weekend coming up, I recommend that highly to the
    members of the subcommittee.
        Mr. Lynch. Not likely, but thank you.
        Mr. Bullard. But the answer to your question is that it is
    hard to know exactly what the right percentage is for a
    leverage limit. But one direct response would be simply to
    require that additional leverage go 100 percent to the
    companies for which it is intended so to not allow doubling of
    leverage to be used to double the amount invested in that 30
    percent window.
        Also in my testimony, I have asked why, given that there
    may have been reasons in the 1980s you needed a 30 percent
    basket, why not reduce that and also directly provide for more
    assets to those economies? And then, third, in looking through
    the structure of these BDCs, many, if not most, have
    significant buffer between the limit they are allowed, meaning
    that they have made .5 to .6 ratios as opposed to a 1 to 1. And
    if a prudential rule of this nature is structured correctly,
    that should not be the case.
        The way the rule like this should work and works in other
    context, insurance, banking, similarly in money market funds,
    is that you go up to the limit. There is a mechanism that if
    you are pushed across it by changing asset values, which Mr.
    Gerber mentioned in his testimony, then there should be a grace
    period. It should be that you can't take on additional debt,
    but that that shouldn't cause you, by something outside of your
    control, to be in violation of the limit. And I believe there
    should be a way in order to make adjustments. It may be the
    dividend requirement. It may be that banks are just not very
    flexible on renegotiating the one-to-one covenant, I guess.
        Mr. Lynch. Right.
        Mr. Bullard. But if this bill goes through, I think they
    are going to have to renegotiate the covenant anyway. So I
    think there is a way that would let them get the full benefit
    of the current one-to-one. And what that would do is, firms
    like Mr. Gerber's and I have looked at their structure, and the
    concern is not his type of BDC, it is the one that is at the
    far end of the spectrum and is going to make life a nightmare
    for his BDC if there is a severe liquidity event and it fails.
        So I would look into that as a way of allowing BDCs to get
    the benefit of the leverage limit we intend, and I--
        Chairman Huizenga. The gentleman's time has expired.
        Mr. Lynch. I am out of time. Thank you, Mr. Chairman. Thank
    you, Professor Bullard.
        Chairman Huizenga. With that, the gentleman from Minnesota,
    Mr. Emmer, is recognized for 5 minutes.
        Mr. Emmer. Thank you, Mr. Chair. I would like to request
    unanimous consent to enter into the record a letter from the
    Association of Minnesota Counties, which expresses their
    support for the Consumer Financial Choice and Capital Markets
    Protection Act. And I share their support for the legislation,
    and thank Mr. Rothfus for his work on the issue.
        Chairman Huizenga. Without objection.
        Mr. Emmer. Mr. Quaadman, in your written testimony, you
    mentioned that Congress should, quote, ``look at creating the
    legal framework to allow for venture exchanges in an effort to
    improve secondary market trading for small public companies.''
        Can you just comment on some of the issues that you see
    these small public companies currently face in today's market
    structure and how you think venture exchanges could help?
        Mr. Quaadman. Yes. Thank you for that question, Mr. Emmer.
    I think the two underlying issues that are at the heart of the
    capital formation problem here are: One, our liquidity; and
    two, is research and information. I think one of the things
    that the venture exchange could do is to help drive liquidity
    to those small cap companies. And I think if you look at it in
    conjunction with the bills that we are talking about here
    today, you would take a multifaceted approach to try and drive
    liquidity into those markets.
        I think some of the WKSI issues that we are talking about
    as well are going to activate other participants. And I think
    that helps to get at the liquidity issue. I think we are going
    to have to do some other things in terms of trying to drive out
    research and information as well.
        Mr. Emmer. Thank you very much. And because of our time and
    the votes pending, I am going to yield the balance of my time
    to my colleague from Ohio, Mr. Stivers.
        Mr. Stivers. I would like to thank the gentleman for
    yielding.
        And I have a yes or no question for Professor Bullard.
    Professor Bullard, in preparation for this testimony, did you
    by any chance have a chance to talk to Jonathan Bock from Wells
    Fargo, who is the analyst who came up with the effective
    leverage ratio method that you quoted so extensively in your
    testimony?
        Mr. Bullard. No, I haven't, and I am not endorsing that
    leverage ratio.
        Mr. Stivers. Thank you. And I did have a chance to talk to
    him. And I got an email through Wells Fargo from him this
    morning at 7:21.
        Mr. Chairman, without objection, I would like to enter it
    into the record.
        Chairman Huizenga. Without objection.
        Mr. Stivers. Thank you.
        So I would like to quote from the email that Mr. Bock sent
    me, the statement, and I will just quote some excerpts, but the
    whole statement will be entered into the record.
        He said he wanted to offer some additional color on the
    effective leverage statistic in his BDC scorecard, because he
    is concerned many of the items are being taken grossly out of
    context. Those are his words. He says that, first, effective
    leverage should not be confused with financial leverage, which
    is what the bill changes. Effective leverage is a chance to
    look at BDCs' risk profile between each other based on their
    asset composition. Then he goes on to say: This isn't exact,
    and in no way is the gauge of financial leverage taken on by a
    BDC.
        Then he goes on later to say: Also taking a step back, if
    folks would like to talk about imbedded leverage risks with
    BDCs and pass it off as financial leverage, then those same
    individuals might want to reexamine all bank and REIT balance
    sheets whose leverage would skyrocket.
        And, in fact, Mr. Chairman, I would like to enter into the
    record an analysis of some banks using the effective leverage
    ratio, the lowest of which would be 49, the highest of which
    would be 93.
        Chairman Huizenga. Without objection.
        Mr. Stivers. Thank you.
        It then, Mr. Bock goes on to say: The major point missed is
    that investors, through this analysis and BDC transparency,
    have actual ability to understand the overall risk composition
    of each BDC. Banks don't offer that same kind of transparency.
    Then he says, last, folks arguing that effective leverage is
    too high, then in quotes, thus, this isn't a reason to look at
    the bill, missed the fact--and closed quotes. Missed the fact
    that increasing leverage--the leverage constraint will actually
    make effective leverage ratios fall, not rise. At the current
    leverage constraints, several BDC managers are actually
    reaching for risk owning low-quality subordinated securities,
    CLO, or sub-debt, to try to hit yield bogeys for investors.
        So I will stop there on that and yield back the balance of
    my time. I look forward to my time later to talk more.
        Chairman Huizenga. The gentleman from Minnesota?
        Mr. Emmer. I yield back.
        Chairman Huizenga. The gentleman from Minnesota yields
    back.
        With that, the Chair recognizes the gentleman from
    Connecticut, Mr. Himes, for up to 5 minutes.
        Mr. Himes. Thank you, Mr. Chairman. And thank you to all of
    you for being with us.
        And I would like to say a special thank you to Mr. Stivers.
    I was one of the lonely opposition votes to the Mulvaney bill
    in the last Congress, really exclusively because of the
    leverage that one might imagine in that 30 percent bucket where
    investments in financial companies, in particular, are
    permitted. Not inconceivable that a financial company could
    have 10X, 15X leverage itself, you double that, you get into
    some pretty heady numbers. And I opposed it on that basis.
        And I really thank Mr. Stivers for making the change,
    including the one I proposed in the amendment, which I offered
    and withdrew. So I guess my neighbor in Massachusetts is not
    quite there, but I am supportive of the bill in its revised
    form.
        Professor, you, in your testimony, write something, though,
    that is interesting to me because of my concern about that
    leverage and the 30 percent bucket. In your written testimony,
    you say it is not clear that that 30 percent basket serves any
    purpose in modern financial markets. This of course, was
    established when BDCs were created initially.
        What I would love to do with my remaining time, I am going
    to go to you and Mr. Gerber. I think that is an interesting
    question, and it certainly catalyzed my leverage concerns in
    the last Congress. So I wonder if I could give each of you a
    minute to reflect on the public good associated with that 30
    percent basket. And, actually, Professor, let me, since Mr.
    Gerber is in the business, let me ask him to start, and then
    you can respond to what Mr. Gerber has--anyway, Mr. Gerber.
        Mr. Gerber. Thank you, Congressman. I think as a threshold
    matter it is important to note that that 30 percent basket
    doesn't just cover financial companies; it covers large cap,
    mid cap U.S. companies, it covers non-U.S. private, small cap,
    mid cap, large cap companies, as well as financial companies.
        How an individual BDC manager chooses to use that 30
    percent bucket is a different issue, but I just think it is
    important to recognize that, in that basket, you could have a
    very diverse set of assets, not just financial companies. I
    think that is an important point, number one.
        Number two, that basket is often used for the benefit of
    investors because there is an opportunity to use that basket to
    help generate yield. And part of our mission is to deliver
    strong returns to our investors. And so while very limited,
    because only in that 30 percent bucket there is an opportunity
    to use that effectively to generate returns for investors.
        I would say, number three, that just because a company is a
    financial company doesn't mean it doesn't have value in the
    broader capital markets. We have financial company assets in
    our portfolios. We believe they are good companies. They are
    operating companies. They run lending businesses. They are
    lending to smaller businesses than we lend to, whether it is
    through equipment leasing programs, factoring programs, or just
    doing smaller deal sizes than we can do because of our scale.
    And those underlying portfolio companies play a very important
    role in the capital market.
        So I would say there are benefits to investors and there
    are benefits for the capital markets in giving us the ability
    to deploy assets in that 30 percent bucket which, again, are
    not all necessarily financial companies.
        Mr. Himes. Great. Thank you.
        Professor, let me give you my remaining 90 seconds to
    reflect on that.
        Mr. Bullard. I guess the short finance answer would be if
    investors want the additional yield from the 30 percent, they
    should get it from a vehicle that is designed to provide that.
    If BDCs want to compete effectively with each other, they
    should compete on the basis of their BDC investments, not
    depending on whether the BDC invests a lot or a little of the
    30 percent in small- and mid-size companies.
        So from an efficiency point of view, it is much more
    efficient, unless there is some reason that they needed this
    release valve, which is probably what in 1980 this was intended
    to provide. And given the liquidity of current markets and the
    ability of very, very large BDCs to find the investments they
    need, it seems to me highly unlikely that there would be any
    serious impediment to their ability to do that, and it would
    enhance their status, essentially, as what has become a unique
    asset to reduce that percentage.
        Mr. Himes. Great. Thank you. That was more to satisfy my
    own curiosity. So I appreciate the reflections, and yield back
    the balance of my time.
        Chairman Huizenga. The gentleman yields back.
        The Chair recognizes the gentleman from New Jersey, Mr.
    MacArthur, for 5 minutes.
        Mr. MacArthur. Well, thank you, Mr. Chair.
        Let me talk for one moment before I ask a question. Let me
    talk as a businessman, which I was for 30 years, instead of a
    Congressman, which I have only been for 3. I have lived in the
    world of depending on both BDCs and closed-end mutual funds. I
    bought my company with the help of a closed-end mutual fund
    that was trying to transform itself into an operating company.
    It would have been a lot easier had I been able to invest
    without what we had to go through. And at one point, the use of
    a BDC was really essential for me in growing the company. And
    that company, with one office and a hundred people, grew over
    15 years to 6,000 people and 100 offices. You can't do that
    without capital. Can't do it.
        And so I want to mention three things that I think are
    useful. One is just a reminder that business people rely on
    tranches of capital, both debt and equity capital, not one
    source. And so I think it is incumbent on us, with good public
    policy, to try to facilitate as many of those available
    tranches as possible.
        Second, companies evolve. And what I needed in an early
    stage small company was quite different than what I needed as a
    mid-market company.
        And, last, is there is simply no way for public
    policymakers and regulators to anticipate all of the things
    that business people can imagine. And so we should create the
    most flexibility, the most openness, and try to facilitate a
    good match-making environment where investors can make
    investments in all different kinds of opportunities, and
    business people can find all different kinds of credit--or
    capital, both through the credit markets and the equity market.
    So I support these reforms because I think they all tend toward
    that.
        My question is on one that is a little different, and Mr.
    Quaadman, it is for you. You mentioned in your written
    testimony that you supported an increase in Tier 2 reg A-plus
    offering limits. You supported something over the current $50
    million. And the Treasury Department recently published the
    report also recommending that we increase those limits. There
    was a provision of choice, which bumped it up to $75 million.
    And I think that is going to be coming back as a standalone.
        I just wanted to ask you how you thought that increase from
    $50 million to $75 million would help small businesses access
    capital and what the results might be, from your perspective?
        Mr. Quaadman. Thank you, Mr. MacArthur. And, also, I would
    also just add, in your preamble, I would also add in
    international operations as well also have a different capital
    structure that businesses would need.
        In terms of bumping up the reg A-plus, we were very
    supportive of the JOBS Act provision. We thought this is a way
    to help make it easier for small business to access capital to
    get deals done. To do that, I know, even with the bump up to
    $50 million, it has been--I think people are still finding
    their sea legs there. But, again, in terms of driving
    liquidity, we thought that the $75 million number was
    important.
        We did also participate with the Treasury Department on a
    specific roundtable on capital formation in the runup to that
    report. And this was a matter of discussion that we had as
    well. So this is an important way to help inject more liquidity
    and deal-making for small businesses to acquire the capital
    that they need to grow.
        Mr. MacArthur. I appreciate that. In the interest of giving
    another member a chance to weigh in, I will yield back my
    remaining time.
        Chairman Huizenga. The gentleman yields back.
        With that, the gentleman from Illinois, Mr. Foster, is
    recognized for 3 minutes.
        Mr. Foster. Yes. Thank you, Mr. Chairman. And I will try to
    be brief.
        Professor Bullard, would you be more inclined to support a
    bill that allowed closed-end funds to be treated as well-known
    seasoned issuers if they were also restricted to be reporting
    companies under the 1934 act?
        Mr. Bullard. Well, that is a great question because it
    really hits on my differences, I think, with Mr. Stevens. He
    noted properly that closed-end funds are heavily regulated
    under the Investment Company Act regulatory regime. It is not
    clear why, with respect to offering rules, he wants to take
    them out of that regime and to put them in a regime where they
    don't belong.
        For example, he made a comparison to closed-end funds
    filing quarterly reports as if they were similar to the 10-Qs
    filed by operating companies. Well, I would say if I--maybe if
    I sent a Christmas card to the SEC chairman every year, I might
    be considered to be filing annual reports, but I think that is
    about as close to filing a 10-K as a closed-end fund's
    quarterly report is to a real 10-Q.
        So I think the place to do closed-end fund reform, and I
    would agree with many of the reforms that Mr. Stevens probably
    wants to accomplish, would be within that Investment Company
    Act regulation.
        Mr. Foster. Thank you.
        Now, Mr. Stevens, I am uncertain that the Investment
    Company Act disclosures adequately inform and update the
    markets to the point that they really justify a well-known
    seasoned issuer's status. Could you explain how current
    specific disclosures provide a continuous understanding of
    closed-end funds so that shelf-offering would be fully and
    adequately disclosed?
        Mr. Stevens. Well, I am astonished at Professor Bullard's
    comparison here. The SEC has developed reporting obligations
    based upon the nature of the activities of the reporter.
    Closed-end funds are investment pools. They are not operating
    companies. They don't have the kinds of activities, the range
    of activities, that an operating company would. So subjecting
    them to the same standards of an operating company is
    nonsensical. If there is a need for further reporting by
    closed-end funds or other registered investment companies, I am
    not aware of it, but the SEC can always enhance those reports.
        I think, frankly, there is no absence of information about
    closed-end funds or other registered investment companies in
    the United States that is desired by the market. And the only
    reason then to use the well-known seasoned issuer and the kind
    of streamlining that has been provided to public operating
    companies is that these closed-end funds are also subject to
    the Securities Act of 1933. So they are within that regime. In
    fact, we always say in my space, we are subject to every one of
    the Federal securities laws. Public operating companies are not
    subject to the 1940 Act.
        So I just think that the Chairman of the SEC, Mary Joe
    White, when she looked at this kind of treatment--in this case
    it was for the kind of closed-end fund that my colleague here,
    Mr. Gerber, is talking about, business development companies,
    but it could apply more broadly. She said making these changes,
    in her view, does not involve any compromise of investor
    protections. That is where we are.
        Mr. Foster. Thank you. My time is up, and I yield back.
        Chairman Huizenga. The gentleman's time has expired.
        The gentleman from Ohio, Mr. Davidson, is recognized for 3
    minutes.
        Mr. Davidson. Thank you, Chairman. Thank you all for your
    testimony.
        And, Mr. Quaadman, thank you for your advocacy across the
    country for small and medium businesses, and thanks for the
    focus on business development corporations.
        Mr. MacArthur addressed some of the same things I would say
    as a businessman, and the importance of options. One option is
    no option, when it comes to capital and lots of other things.
    But with limited time, I want to say, could you address the
    impact the Volcker Rule has had on venture capital investment
    in the middle of the country? And, in addition, do you see a
    significant public policy reason for prohibiting financial
    institution investment into venture capital?
        Mr. Quaadman. Yes. The Volcker Rule has caused a
    retrenchment of many different forms of capital formation that
    we would normally have expected to see financial institutions
    engaged in. It has made it much harder and more difficult for
    CFOs to access the debt and equity markets. So our hope is, as
    has been called for by the Treasury Department, that the
    regulatory agencies are going to take another look at the
    Volcker Rule.
        Venture capital has been under some stress from Volcker and
    from other areas as well. We believe that the capital formation
    report from the Treasury Department is actually putting forth
    some interesting recommendations for how to deal with this. We
    also have some concerns with some legislation that has been
    proposed in the past with beneficial ownership disclosure, that
    that is going to place another inhibitor on venture capital as
    well, which is one of the reasons why we have also opposed
    that.
        Mr. Davidson. Thank you. And I yield.
        Chairman Huizenga. I am sorry. I was managing the members.
        OK. I am sorry, did the gentleman yield back? The gentleman
    yielded back.
        All right. With that, the gentleman from Indiana, Mr.
    Hollingsworth, is recognized for up to 3 minutes.
        Mr. Hollingsworth. Well, good morning. I appreciate
    everybody being here, and I appreciate all the comments that
    were made early on, especially the compliments on the
    discussion draft that I am working on. I certainly won't take
    my full 3 minutes. I know much of this waterfront has been
    covered, especially by my partner in working in this, Mr.
    Foster, a few minutes ago.
        But I just wanted to hit, again, Mr. Stevens, if you
    wouldn't mind commenting on, is there anything about this
    particular piece of legislation that you feel greatly endangers
    investors or otherwise dramatically reduces the amount of
    disclosure burden that we are putting on closed-end funds
    currently as I have proposed it so far?
        Mr. Stevens. To your first question, does it pose risks for
    investors? We would not be supporting it at the ICI if we
    believed that it was posing additional risk for investors, so
    no.
        Mr. Hollingsworth. I was operating under the--I am asking
    the question I know the answer to philosophy.
        Mr. Stevens. I am sorry?
        Mr. Hollingsworth. I said I am operating under the old
    lawyer--I am asking a question I know the answer to philosophy.
        Mr. Stevens. All right. And your second question is what
    benefits does it provide?
        Mr. Hollingsworth. Yes.
        Mr. Stevens. It streamlines the issuance process. It allows
    closed-end funds to get to market more promptly in response to
    market conditions.
        Mr. Hollingsworth. Right.
        Mr. Stevens. It facilitates their ability to communicate
    with the marketplace and with the investing public.
        Mr. Hollingsworth. Right.
        Mr. Stevens. And hopefully, find a greater interest in the
    investment opportunities it is bringing to the market.
        Mr. Hollingsworth. Right.
        Mr. Stevens. And I think those are all very favorable from
    the point of view of investors.
        Mr. Hollingsworth. Yes.
        Mr. Stevens. And from the point of view, ultimately, of
    getting capital to work in our economy, creating jobs and
    economic growth.
        Mr. Hollingsworth. Absolutely. And I think that is exactly
    the push that I have been making, right. The world is certainly
    not slowing down, opportunities come up and go away very, very
    quickly. I want these closed-end funds to be able to capture
    those opportunities.
        And as for what was said before about whether closed-end
    funds are an appropriate vehicle or not for individual
    investors, I leave it up to those investors to make those
    decisions versus bureaucrats in D.C., or even legislators in
    D.C., deciding for people all the way across this country that
    might use these vehicles for specific purposes in fulfilling
    their financial needs.
        And with that, I will yield back, Mr. Chairman.
        Chairman Huizenga. The gentleman yields back.
        With that, the gentleman from Ohio, Mr. Stivers, is
    recognized for 3 minutes.
        Mr. Stivers. Thank you, Mr. Chairman. And I will be fairly
    brief too, because I know Mr. Rothfus wants to go.
        My question is for Mr. Gerber. Mr. Gerber, can you explain
    why leverage is important and how you will use that to get more
    capital to businesses that want to expand, as well as to make
    better returns for your investors? And if you want to also talk
    about why--reenforce, again, how financial service firms allow
    you to help businesses that are below--help BDCs, help firms
    that are below their threshold for lending to get capital to
    smaller business, that would be great.
        Mr. Gerber. Sure. So I will take those in order. And thank
    you, Congressman, not only for the question, but for your work
    on this bill.
        In terms of the role that BDCs play in the capital markets,
    I mentioned in my testimony that most BDCs are deploying
    capital in the middle market, and that is a fast growing
    sector, very important from a job creation perspective. As I
    mentioned, from 2011 to 2017, more than 100 percent growth in
    job creation. So that is a very important role that BDCs play.
    And as my colleague, Mr. Quaadman, mentioned in his testimony,
    we are doing it at a time where other capital providers are
    not. So I think from a capital markets perspective, BDCs play
    an increasingly important role.
        In terms of what we can do for our investors, again, as I
    mentioned earlier, it is an opportunity for us to deploy
    capital in ways that other investment vehicles do not, thereby
    giving investors an opportunity to invest differently and to
    build a more diversified portfolio with exposure to assets that
    aren't as correlated to the market as, say, a mutual fund would
    be.
        To your question around how we can help smaller financial
    companies. I mentioned, in response to a question from the
    gentleman from Connecticut, there are portfolio companies
    within BDC portfolios that are able to lend to smaller
    businesses. We have them in our portfolio. And so as you scale
    as a BDC, it is harder to do smaller deals. It is just an issue
    of resources. And so larger BDCs tend to do larger deals. But
    if we can invest in portfolio companies that have the ability
    to do smaller deals or lend in ways that we don't lend, it is
    an opportunity for us to fund companies that are, in and of
    themselves, performing an important role in the capital
    markets.
        Mr. Stivers. Thank you very much.
        And with my remaining 14 seconds, I will just say that Mr.
    Rothfus, who is about to ask questions, has done great work on
    H.R. 2319 that will help get--help allow a stable net asset
    value for a lot of folks who need that in their investment
    requirements.
        I yield back the balance.
        Chairman Huizenga. The gentleman's time has expired.
        With that, our guest today, Mr. Rothfus, is recognized for
    3 minutes.
        Mr. Rothfus. Thank you, Mr. Chairman. And thank you for
    allowing me to participate in today's hearing.
        I would like to just take a couple of minutes here and talk
    about my bill, H.R. 2319, the Consumer Financial Choice and
    Capital Markets Protection Act of 2017. And I would note the
    broad-based support we have gotten from across the country with
    over 200 groups and community leaders in support of this
    legislation.
        I would like to offer for the record two letters, November
    2, 2017, one from the Association for Financial Professionals,
    the other from the Association of School Business Officials
    International, to the committee.
        Chairman Huizenga. Without objection.
        Mr. Rothfus. Also, an October 3, 2012 article by Mr.
    Bullard on money market funds and life on support. I would like
    to offer that to the record as well.
        Chairman Huizenga. Without objection.
        Mr. Rothfus. Real quick, Mr. McCoy, to your earlier point
    whether we need to study this issue and the impact of this rule
    any further. We know what happened, right? $1.2 trillion has
    moved out of the private and mutual fund sector into the
    treasuries?
        Mr. McCoy. That is correct. Yes. We have seen investors
    vote with their money and leave, yes.
        Mr. Rothfus. There are cost benefits to any regulatory
    change, Mr. McCoy. Have the costs of this rule been justified?
        Mr. McCoy. I certainly believe so. It is an interesting
    question. I haven't totally focused on that, but I believe so.
        Mr. Rothfus. In what sense? You are seeing an increase in
    borrowing rates for municipalities.
        Mr. McCoy. We absolutely are. We are seeing an increase--
    increased costs to issue variable rate debt into the money
    market funds, and that is filtered through our ability, State
    and local government's ability, to finance infrastructure at
    the lowest possible costs.
        Mr. Rothfus. And, again, where has this money gone, out of
    the muni funds and out of the corp funds, where has it gone to?
        Mr. McCoy. Typically, it has gone into fixed rate bonds or,
    as I noted, there is an alternative product out there, a
    floating rate note, that is not eligible to be invested by 2a-7
    funds, but that particular product does allow municipalities to
    participate at the short end of the yield curve where we get
    the best cost of funds.
        Mr. Rothfus. Do you know whether money market funds that
    hold treasuries are immune to fluctuations and principal value?
        Mr. McCoy. I do not.
        Mr. Rothfus. Mr. Quaadman, would they be--if you have a
    money market mutual fund holding just treasuries--let's say
    there is a fund out there that has a million dollars in
    treasuries and somebody goes out, buys a million treasuries,
    starts to do this fund. Interest rate today is 1.43 percent,
    and the interest rate goes up tomorrow, what happens to the
    principal value in that money fund?
        Mr. Quaadman. I would have to consult with some of our
    members and get back to you. I had not thought through that
    question. But let me do that and let me get back to you, if you
    want to--
        Mr. Rothfus. Well, it makes sense that the principal value
    is going to fluctuate and it is going to go down. And while
    that Treasury bill a year from now, if it is a 1-year bill, is
    going to be worth a thousand bucks a bill, it is going to be
    stable in that sense, but it is going to change in principal
    value--
        Mr. Quaadman. Yes.
        Mr. Rothfus. --because of the fluctuation.
        Mr. Chairman--
        Chairman Huizenga. The gentleman's time has expired. And we
    are going to miss a vote here if we don't move quick.
        So I would like to thank our witnesses for their testimony
    today.
        Without objection, I would like to submit the following
    letter from Government Finance Officers Association and a
    number of others in support of Mr. Rothfus' bill.
        Chairman Huizenga. Without objection, all members will have
    5 legislative days within which to submit additional written
    questions for the witnesses to the Chair, which will be
    forwarded to the witness for their responses. I ask you all to
    please respond as quickly as you are able.
        And, without objection, all members will have 5 legislative
    days within which to submit extraneous materials for the Chair
    for inclusion in the record.
        This hearing is adjourned.
        [Whereupon, at 10:53 a.m., the subcommittee was adjourned.]

                                A P P E N D I X

                                November 3, 2017

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