[House Hearing, 115 Congress]
[From the U.S. Government Publishing Office]
OVERSIGHT OF THE SEC'S DIVISION
OF CORPORATION FINANCE
=======================================================================
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
SECOND SESSION
__________
APRIL 26, 2018
__________
Printed for the use of the Committee on Financial Services
Serial No. 115-89
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
______
U.S. GOVERNMENT PUBLISHING OFFICE
31-435 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
Shannon McGahn, 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
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Page
Hearing held on:
April 26, 2018............................................... 1
Appendix:
April 26, 2018............................................... 35
WITNESSES
Thursday, April 26, 2018
Hinman, William, Director, Division of Corporation Finance, U.S.
Securities and Exchange Commission............................. 5
APPENDIX
Prepared statements:
Hinman, William.............................................. 36
Additional Material Submitted for the Record
Maloney, Hon. Carolyn:
Letter from Rep. Maloney to Hon. Jay Clayton, Chairman, SEC.. 43
Response letter from Hon. Jay Clayton to Rep. Maloney........ 48
Response letter from Institutional Shareholder Services Inc.. 54
Letter from Institutional Shareholder Services Inc........... 61
Hinman, William:
Responses to questions for the record from Representatives
Hollingsworth and Hultgren................................. 66
OVERSIGHT OF THE SEC'S DIVISION
OF CORPORATION FINANCE
----------
Thursday, April 26, 2018
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 10:04 a.m., in
room 2128, Rayburn House Office Building, Hon. Bill Huizenga
[chairman of the subcommittee] presiding.
Present: Representatives Huizenga, Hultgren, Wagner,
Poliquin, Hill, Emmer, MacArthur, Davidson, Budd,
Hollingsworth, Maloney, Sherman, Lynch, Scott, Ellison, Foster,
Meeks, Sinema, Vargas, and Gottheimer.
Also present: Representatives Hensarling and Royce.
Chairman Huizenga. The committee will come to order.
Without objection, the Chair is authorized to declare a recess
of the committee at any time.
This hearing is entitled, ``Oversight of the SEC's Division
of Corporation Finance.'' We are very pleased to have Mr. Bill
Hinman here.
I do want to take a personal point of privilege, though,
here a moment. I know it is take your child to work day.
We have one special guest. One Mr. Donald, young master
Donald, over here. Donald McGahn is joining us, and he is going
to be heading over to the White House. So, if you have a
judicial appointment, this isn't the right Don McGahn you want
to get to. The one is--he will be--he will be with the other
one a little later.
I know from my own children over the years, it has always
been a great opportunity. So, we are glad that we can have this
day.
So, I am going to recognize myself now for 3 minutes to
give a quick opening statement. As we all know, the Securities
and Exchange Commission (SEC) has a three-part mission. Protect
investors, maintain fair, orderly and efficient markets, and to
facilitate capital formation.
Today's hearing will focus on the policies and procedures
of the SEC's Division of Corporation Finance. CorpFin, as the
office is better known, is responsible for ensuring that
investors are provided with materially complete and accurate
information in order to make informed voting and investment
decisions. This includes disclosure requirements when the
company initially offers its securities to the public and on a
continuing and periodic basis.
CorpFin also provides interpretive guidance to companies
regarding SEC rules and forms and makes recommendations to the
Commission on new rules and revisions to existing rules.
The Division of CorpFin's activities and responsibilities
include regularly monitoring and reviewing filings made under
the Securities Act of 1933 and the Securities Exchange Act of
1934 to ensure compliance with disclosure and accounting
requirements, conducting a comprehensive review of the SEC's
rules governing public company disclosure, completing
rulemakings to implement disclosure-related provisions of the
Dodd-Frank Act, and conducting oversight of the proxy process,
including the activities of proxy advisory firms.
One of my biggest concerns is the declining number of
public companies which has led to fewer investment
opportunities for main street investors. IPOs have historically
been one of the most meaningful steps in the life cycle of a
company.
Going public not only affords companies many benefits,
including access to the public capital markets, but IPOs are
important to the investment public as well.
Already, the recently enacted Tax Cuts and Jobs Act has
strengthened our economy at the local, regional, and national
level. By making our tax code more competitive, we have
signaled to the world that America is, again, open for
business, investment, and job creation.
To build on this success, we must continue with the pro-
growth reforms that ensure the United States has the strongest,
deepest, and most liquid markets in the world.
Unfortunately, from a regulatory standpoint, it has become
increasingly apparent that our capital markets are becoming
less and less attractive to growing businesses, due to the,
quote, unquote, ``one-size-fits-all securities regulations''
currently in place.
Let us work together to reverse this negative trend of
declining IPOs and focus on capital formation. Hard-working
families in West Michigan and across the nation rely on capital
markets to save for everything from college to retirement.
By making capital formation the priority, we can maximize
Mr. and Mrs. 401K's return on their investment, expand
opportunity, and increase job creation and grow our economy.
The Chair now recognizes the Ranking Member, the gentlelady
from New York, Mrs. Maloney, for 5 minutes for an opening
statement.
Mrs. Maloney. Thank you. Thank you so much and thank you
for holding this important hearing, Mr. Chairman.
The SEC's Division of Corporation Finance is hard to
believe the most important division in the SEC, because it is
responsible for ensuring that investors have access to all the
information they need to make informed investment decisions.
They review the financial statements and disclosures that
companies file and ensure that they are both complete and
accurate. This is critically important because investors simply
will not invest in a company unless they have confidence in the
company's financial statements, understand the business model,
and are aware of all the risks that the company faces.
The fact that investors all around the world are so eager
to invest in the public companies is a testament to the
confidence investors have in the disclosure framework that
Congress and the SEC have developed over the years.
In my personal view, we shouldn't make significant changes
to that disclosure framework lightly. When in doubt, we should
err on the side of more disclosure, not less.
But the Division of Corporation Finance has another role,
too. It also reviews the filings that companies make for their
IPOs, when they are offering securities to the public for the
very first time.
In these reviews, the SEC staff reviews the company's IPO
filings to ensure that the company is complying with the
Federal securities law.
One very important provision that public companies have to
comply with is the so-called, quote, ``anti-waiver provision''
which prohibits companies from waiving compliance with the
Federal securities law.
For example, a company can't require all its investors to
agree not to sue them for securities fraud, or to allow the
company to file their financial statements only once every 2
years, rather than every quarter.
The anti-waiver provision ensures that the basic investor
protections in the securities law, including the right to sue
companies for securities fraud, are guaranteed for all
investors.
So, I was troubled when I read an article in ``Bloomberg''
in January, that said the SEC staff was laying the groundwork
for a change that would allow public companies to strip
investors of their right to sue for securities fraud in court,
and instead force all of those claims into secret arbitration
proceedings.
Last month, I led a letter to SEC Chairman Clayton which
was signed by every single Democrat on the Financial Services
Committee.
The Senate has also sent over a letter strongly opposing
any effort to allow public companies to insert these forced
arbitration clauses into their corporate governing documents.
I ask unanimous consent to place in the record my letter,
Mr. Chairman.
Chairman Huizenga. Without objection.
Mrs. Maloney. Let us be clear about the stakes here. If the
SEC allows companies to use these forced arbitration clauses,
that would essentially be the end of any securities fraud cases
in public courts. It would definitely be the end of class
action lawsuits for securities fraud.
So, when the next Enron or WorldCom comes around,
shareholders who have been defrauded wouldn't be able to hold
these companies accountable in court at all.
The reason this issue is so important for this hearing is
simple. If a company that is preparing for an IPO tries to
insert the forced arbitration clause into its corporate
governing documents, it would be the staff in the Division of
Corporation Finance that would have to decide whether that
forced arbitration clause violates Federal securities laws.
For decades, the SEC's position has been that forced
arbitration clauses violate the anti-waiver provision of the
Exchange Act.
So, allowing companies to use these clauses would be an
enormous change in policy that would affect every single
investor in our markets.
So, I will be very interested to hear Mr. Hinman's thoughts
on this, and will expect to hear whether he supports any
efforts to reverse the SEC's long-standing position on the use
of forced arbitration clauses in the bylaws of public
companies.
I thank you, Mr. Chairman.
I yield my remaining seconds to my dear friend and
colleague. I just had to get that into the record, because I
feel it is important.
But he deserves a lot more time than what I am yielding on.
Mr. Sherman. Bitcoin is a security and it is an investment.
Investment protection is your business. Obviously, initial coin
offerings.
The tax bill, that the Chairman refers to, says you could
have a zero percent tax on the profit of your factory, but only
if you move that factory to a foreign country.
I yield back.
Chairman Huizenga. The gentlelady's time has expired.
If you would, actually, give me a copy of the letter. I
have not seen the letter. All right, that will be inserted in.
So, with that, Mr. Hinman, we welcome you here. I
appreciate your time and attention.
I am sorry I was being delinquent. I have 2 minutes
remaining in which I am going to be recognizing the Vice Chair
of the Capital Markets Committee, Mr. Hultgren, from Illinois
for 5 minutes.
Mr. Hultgren. Thanks, Chairman Huizenga.
Thank you for convening this hearing today. I have been
very pleased with the new leadership that we have seen at the
SEC under Chairman Clayton.
But I do value these opportunities to have the chance to
discuss the Commission's work to promote capital formation and
investor protection.
My constituents have been extremely happy with the strong
economic growth we have seen over the last year. I believe much
of the growth is attributable to tax reform. But the common
sense regulatory relief and reform across governments has also
been extremely important.
I am especially pleased that Chairman Clayton has
acknowledged the importance of reducing burdens on public
companies, in order to increase opportunities for all
investors.
One of the challenges I hear about most frequently, from
public companies or companies interested in going public, is
challenges with the shareholder proposal process.
This committee has spent a significant amount of time
exploring the damaging effects of activist investors using the
shareholder proposal process to achieve social change. But this
is at the detriment of investors who are simply seeking to
build wealth. These are many of my constituents who are seeking
to save for retirement.
According to proxy monitor in 2017, proposals related to
social or policy concerns, that did not relate to long-term
shareholder value, represented over half of the proposals.
This committee has advanced a number of legislative
proposals to address such issues, including a number of
provisions of the Financial Choice Act.
I am interested in hearing about how the Commission can use
its existing authority to revisit the shareholder resubmission
thresholds under Rule 14a-8.
Last March, under the leadership of acting Chairman
Piwowar, the Commission proposed a new rule to adopt inline
XBRL to merge traditional unstructured filing submitted by
public companies and mutual funds with standardized machine
readable XBRL formats into a single filing.
At the time, Ranking Member Maloney and I wrote the
Commission to encourage them to pursue this work to modernize
these filings. I believe this is important to both investors
and market surveillance by the Commission.
I hope we will be able to discuss this and that maybe you
can give us an update on this work.
Thank you, again, Chairman, for holding this hearing.
I yield back the balance of my time.
Chairman Huizenga. The gentleman's time has expired.
With that, today, we welcome the testimony of Mr. William,
Bill, Hinman, Director of the SEC's Division of Corporation
Finance.
Mr. Hinman, you will be recognized for 5 minutes to give an
oral presentation of your testimony, and, without objection,
your written statement will be added into the record.
So, with that, Mr. Hinman, you are recognized.
STATEMENT OF MR. WILLIAM HINMAN
Mr. Hinman. Thank you very much, Chairman Huizenga, Ranking
Member Maloney, and members of the subcommittee.
Thank you for inviting me to testify on behalf of the SEC's
Division of Corporation Finance.
Since arriving at the SEC in May 2017, I have felt very
privileged to work alongside the division's dedicated and
talented staff.
As you mentioned, Chairman, the mission of the SEC is to
protect investors, maintain fair, orderly, and efficient
markets, and facilitate capital formation. Our division
oversees the review of the disclosures of companies, and we
seek to ensure that investors have access to the important
information they need to make informed voting and investment
decisions.
In addition, the division provides interpretative advice
about securities laws and makes recommendations to the
Commission for rulemaking in areas of disclosure and securities
offerings. The division stands ready to collaborate with
companies in discussing how to comply with Federal securities
laws.
Our reviews of reporting companies monitor and enhance
compliance of the disclosure and accounting requirements we
enforce. The Sarbanes-Oxley Act requires us to review the
financial statements of reporting companies at least once every
3 years. In addition to these mandated reviews, the division
selectively reviews filings made for other offerings, business
combination transactions, and proxy solicitations.
Due to the declining number of U.S. public reporting
companies, the division has been considering ways to make the
public company alternative more attractive.
To the extent we are able to attract more companies to join
our reporting system and to do so at an earlier stage, it will
ultimately benefit those companies, our markets, and investors.
Companies that go through the evolution from a private
company to a public company emerge as stronger companies with
better disclosure.
Investors also benefit when there are more public companies
in which to invest. This is a high priority. We are taking
policy and rulemaking steps in this effort. For example, in
July 2017, the division expanded its non-public review process
for draft registration statements.
This expanded policy now applies to all IPOs for all
issuers, not just emerging growth companies (EGCs). It allows
follow-on offerings during that first year of being a public
company to be submitted on a draft basis.
Companies are taking advantage of that process. It saves
them money. It allows them to better access market windows.
Under this expanded process, we received draft submissions
for more than 20 IPOs, and from more than 50 follow-on
offerings from registrants that would not have qualified for
that review process under the old rules. We are hearing that
this is very helpful.
Through this process, companies can avoid preparing and
filing interim financial information for draft filings if that
information will be superseded by the time it is made public.
We still perform complete filing reviews. Investors still
continue to receive the full financial information and other
required disclosure at the time companies publicly file. We
have also been working to assist companies in their efforts to
comply with our rules in other areas.
Over the past months, the Commission or the division has
issued interpretations of the pay-ratio disclosure
requirements, the new tax reform law, and cyber security
disclosures.
The division has also been focusing attention on digital
assets and on initial coin offerings.
As this area continues to evolve, we are striving for a
balanced approach, one that encourages capital formation while
maintaining a strong focus on investor protection. We also are
keenly focused on the importance of capital formation by small
and emerging companies.
Congress and the Commission have taken steps, in recent
years, to provide additional capital-raising avenues through
Regulation A, securities-based crowdfunding, and Regulation D.
While at the same time we are doing this, we are
maintaining robust investor protections under those new
exemptions.
We continue to monitor the use of these exemptions, and we
engage with a wide range of interested parties at meetings and
at conferences around the United States to see how they are
being used.
We recognize that small companies and investors can also
benefit from reduced regulatory complexity. We are considering
ways to harmonize and streamline our exempt offering rules.
Further, the division continues to work on reforms to make
our disclosure regime more effective. Staff is working to
finalize a recommendation for the Commission to raise the
financial thresholds, under which more companies would qualify
for scaled disclosures as smaller reporting companies.
We are reviewing our disclosure requirements and
Regulations S-K and S-X, considering other ways to improve the
disclosure regime for both investors and companies.
In addition to our disclosure reform efforts, we are
looking to fulfill other rulemaking responsibilities, including
disclosure rules related to resource extraction, conflict
minerals, and executive compensation.
The division is also exploring where there are rules that
could encourage more companies to go through the IPO process.
We are thinking about extending the test the waters provision
that was enacted in the Jobs Act for emerging growth companies
to a wider range of participants.
Thank you very much for inviting me to discuss the
division's activities and responsibilities. I look forward to
answering your questions.
[The prepared statement of Mr. Hinman can be found on page
36 of the appendix.]
Chairman Huizenga. Thank you.
With that, I will recognize myself for 5 minutes of
questioning.
So, as you have talked about in this, and I can't stress
enough my concern about the number of IPOs that are happening
or, frankly, not happening. We have about half as many public
companies in the U.S. as we did 20 years ago.
I think that is detrimental to investors. The common
investors, not institutional investors. I am very pleased to
hear you say that the division is looking at ways to make the
IPO market more vibrant.
Can you elaborate a little more on the division's capital
formation agenda and discuss your priorities for enacting and
encouraging more companies to go and stay public?
Mr. Hinman. Sure. Thank you for that question.
We are doing a number of things. Some things require
rulemaking and that is a longer process, which is one of the
reasons we first did this broadening of the confidential review
process.
We have heard that companies find it much more useful to be
able to time the public announcement of their offering closer
to the time they actually expect to go to market. That gives
the company less exposure to market vagaries.
That also works in their first year as a public company
where prior to being S-3 eligible, companies would have to file
and wait, perhaps as much as a month before they could go to
market.
Now, with the confidential review process, that window is
much shorter and they have much less exposure to market
fluctuations during that period. That is helping people achieve
more liquidity sooner which is good for investors. That is one
area.
We have been trying to streamline our guidance and make it
more transparent to users. We have done things as simple as
putting more of our direct phone numbers in our manuals that
the public sees so that they can reach people more quickly on
issues.
Chairman Huizenga. Actual live people?
Mr. Hinman. Actual--
Chairman Huizenga. Not voice mail--
Mr. Hinman. It still may go to voice mail, but it goes at
least to the right office mailbox.
Chairman Huizenga. Right.
Mr. Hinman. Sometimes people pick up their line.
Chairman Huizenga. Yes.
Mr. Hinman. But we have, now, identified the people and the
phone numbers and the areas you might be interested in and made
that quite public.
There is an area in which we have had authority for a long
time, under Rule 3-13 of Regulation S-X, to provide waivers of
financial statement requirements, when those statements would
not serve investors but may be very burdensome to prepare. We
have reduced the amount of time it takes a company to go
through that process.
We have encouraged companies to come to us earlier in the
process and not wait and develop an expensive 30-page letter
explainging why they should receive a waiver, but to talk to us
earlier and find out where our head is on that, and see if we
can accommodate the request or not, but to save money in the
process.
Of course, on the rulemaking side, we are doing a number of
things which I can elaborate on if time permits.
Chairman Huizenga. Great. Well, in 2011, there was an IPO
task force that asked public company CEOs. It was 92 percent of
them said that the, quote, ``administrative burden of public
reporting was a significant challenge to completing an IPO.''
I appreciate that accumulative effect of those being looked
at.
My colleague brought up ICOs. I want to touch on those as
well.
Do you believe that ICOs could be a potential solution to
the declining number of IPOs? I want to have you touch on that.
You can hit on this if you would like, the differences between
an ICO and an IPO.
But do you believe that there are any circumstances,
instances where an initial coin offering should not be
regulated as an offering of securities?
Some have discussed the concept of a utility token. If you
could maybe take the next minute and a half and touch base.
Mr. Hinman. Sure. I think the Chairman has made a number of
statements around the use of this new technology. We very much
want to see our efforts not stifle innovation in that area.
We have developed working groups that cross the divisions,
my division and Trading and Markets, and Investment Management,
to work with issuers who are interested in complying with our
securities offering rules as they explore these new
technologies.
The issues around whether a particular coin offering may
involve an offering of a security are somewhat complex. But the
drafters of the 1933 Act were quite wise and added very
flexible provisions there.
An instrument that may be called a coin may still have the
hallmarks of a security and need to be regulated as such or be
offered on a registered basis or an exempt basis. We work with
issuers that are exploring those options.
Chairman Huizenga. Can you come up with an instance when
they wouldn't or shouldn't be viewed as securities?
Mr. Hinman. In theory, there is a time when a coin may
achieve a decentralized utility in the marketplace. There are
some coins where you wouldn't have an issuer to regulate. They
operate on their own.
Our rules, which look to protect investors by providing
disclosure, generally require some centralized authority to
make those disclosures.
In theory, there may be coins where that lack of central
actor would make it difficult to regulate at least the offering
as a securities offering.
Chairman Huizenga. OK.
Mr. Hinman. That said, if someone is raising money and they
have a stake in that, and they are promoting that, that is
usually the central authority we are looking to for disclosing
it.
Chairman Huizenga. My time has expired.
With that, I recognize the gentlelady from New York for 5
minutes.
Mrs. Maloney. Thank you.
Mr. Hinman, as I mentioned in my opening statement, I led a
letter to Chairman Clayton that every single Democrat signed,
in strongly opposing any effort to allow public companies to
use forced arbitration clauses on their own shareholders.
If the SEC allowed this, it would, essentially, be the end
of securities fraud cases in Federal court. It would deprive
shareholders of their ability to hold companies accountable for
fraud. I think we can all agree that this would be an absurd
and wrong result.
Chairman Clayton sent us a response on Tuesday which
included an analysis by your division at the SEC.
While I appreciate Chairman Clayton's and your detailed
response and how seriously both of you looked at our letter, I
do have a question for you.
If it was actually reported earlier this year by Bloomberg
that the SEC staff was, quote, ``laying the groundwork to start
allowing these forced arbitration provisions.''
I want to ask you, are you or any of the staff in the
department of the division at the SEC actively encouraging
companies to submit registration statements with forced
arbitration provisions in them?
Mr. Hinman. So, I think that the letter that you
referenced, in response to your inquiry and the other committee
members' inquiry, covers that point. This is something that we
are not actively looking at, in terms of trying to bring
something in and address this issue.
It is a complex issue. It involves our laws and
regulations. It involves other Federal laws, such as the
Federal Arbitration Act and State laws.
As the Chairman's correspondence noted, if this issue were
to come over to my division in the context you mentioned, of an
IPO of a U.S. company, we would not be declaring that
registration statement effective at the division level.
We recognize that this is an important issue, that is in
the correspondence. We would defer to the entire Commission.
Mrs. Maloney. Then, where did this report in Bloomberg come
from, that the SEC was actively pursuing this course?
Mr. Hinman. I hate to speculate where the press gets some
ideas.
I do know that it correlated to a conference that was held
in California. The SEC was not in attendance because the
Government was shut down.
I think panel members there were speculating and I think it
got translated into the article you read.
Mrs. Maloney. OK, thank you.
Last year, this committee marked up the Republicans Choice
Act which made sweeping changes to the securities law. One
provision of the act that got a lot of attention would have
raised the threshold for shareholders who were allowed to put
proposals on the public company's ballot.
Currently, a shareholder can submit a proposal, as long as
he or she has held either $2,000 or 1 percent of the company's
stock for at least 1 year.
The Choice Act would have eliminated the $2,000 threshold
and would also have lengthened the holding period from 1 year
to 3 years. Which means that in order to submit a proposal,
shareholders would need to own at least 1 percent of the
company's stock for 3 years.
This would make it virtually impossible for ordinary
shareholders to submit proposals at the largest companies. For
example, under the Choice Act, for a shareholder to submit a
proposal at Wells Fargo, he or she would have to own $2.7
billion worth of Wells Fargo stock and hold it for 3 years.
So, my question is, do you believe that only shareholders
who own more than 1 percent of very large companies, like Wells
Fargo, should be able to submit shareholder proposals to get
voted on at annual meetings? Or do you believe that would
unfairly restrict the ability of small shareholders to
participate and try to influence the companies that they own?
Mr. Hinman. In the shareholder proposal area, in general,
we don't have a rule proposal moving forward, at this time.
The proposal thresholds that you had mentioned are the
current rules that we are operating under. Those are somewhat
aged. They haven't been looked at in, I think, over 20 years,
in terms of either adjusting those for inflation or otherwise.
There have, from time to time, been discussions around what
would the right threshold be? If we were to engage in
rulemaking there, we would receive comments from a wide range
of people and consider all of them.
We do see the value of the shareholder proposal process and
giving shareholders access to the proxy to express their
opinions.
So, we would be mindful of that as we develop whatever new
or updated rule in this area we would come up with.
Mrs. Maloney. Thank you.
My time has expired. Thank you.
Chairman Huizenga. The gentlelady's time has expired.
The gentleman from Illinois, Mr. Hultgren, for 5 minutes.
Mr. Hultgren. Thank you, Chairman. Thank you, Director.
Appreciate you being here.
As a proponent of seeing all aspects of our Government
innovate with technology, I have been closely following the way
the Division of Corporation Finance has been trying to
implement the use of machine readable, searchable, structured
data formats in its operations.
To that end, what efficiencies and productivity gains has
the division been able to realize in analyzing filings as it
has continued to innovate with standardized data?
Mr. Hinman. The XBRL tagging of information does assist us,
as we try to review companies. We now have more modern tools to
use some of those items to screen for certain characteristics
of a financial statement.
So, we have found them to be of value.
Mr. Hultgren. Great.
On March 1st of last year, 2017, Commissioners Piwowar and
Stein proposed a new rule to adopt inline XBRL to merge the
traditional unstructured filings with the standardized machine
readable XBRL formats into a single filing.
I authored a letter to the Commission, with Ranking Member
Maloney and Representative Issa, with whom I had championed the
Financial Transparency Act to encourage the Commission to
continue this work.
I wonder if you could give us an update on where this
proposed inline XBRL reform stands?
Mr. Hinman. It is something we are actively working on. I
do expect to get something out in the next 12 months, in that
area.
Mr. Hultgren. Great, thank you.
Chairman Clayton has indicated that on the Commission's
longer-term agenda is reviewing shareholder engagement in the
proxy process. This is something that we have touched on a
little bit already, but I want to go into a little bit
different direction.
The House has passed legislation sponsored by Chairman
Duffy, that brings long-overdue transparency, supervision, and
accountability to proxy advisory firms.
In November, Chairman Clayton stated that the Commission
should be, and I quote, ``lifting the hood and taking a hard
look at whether the needs of shareholders and companies are
being met,'' end quote.
I have heard from a number of companies and shareholders
that feel their current needs are certainly not being met.
There is particular concern regarding proxy advisory firms in
the outsized influence they seem to have in the market, yet
they are subject to a little oversight and are susceptible to
conflicts of interest.
I was particularly concerned, when I was advised of a
filing earlier this month from one pharmaceutical company,
Abbott Labs. That proxy advisory firm they engaged with was,
and I quote, ``aware of the flaws and inaccuracies of its
report and has disregarded our attempts to correct them and
proceeded to publish a flawed and inaccurate report,'' end
quote.
I wonder if you have any updates for the committee
regarding when the Commission will be addressing issues like
this? Will the Commission reopen the comment file of the 2010
proxy plumbing concept release?
Mr. Hinman. As you mentioned, this is an area of interest
for the Chairman. He and I meet periodically with investor
groups, the funds and the advisory firms themselves, to talk
this through.
We are still gathering information. The Chairman has
indicated in some of the speeches informally that proxy
plumbing is a topic of interest for developing some ideas, in
terms of what comments to ask for in that area. This is
certainly on the list of things that we are considering.
In the meantime, we are applying our 2014 guidance which
does apply more rigor to the process in watching for compliance
in that area.
Mr. Hultgren. Great, thanks.
SEC's Rule 14a-8 provides an opportunity for a shareholder
owning a small a relatively amount of the company's securities
to have his or her proposal placed alongside management's
proposals in that company's proxy material for presentation to
a vote at an annual or special meeting of shareholders.
The rule generally requires the company to include the
proposal, unless the shareholder has not complied with the
rule's procedural requirements or the proposal falls within one
of the Rule's 13 substantive bases for exclusion.
On September 22, 2016, the Capital Markets Subcommittee
held a hearing entitled, ``Corporate Governance, Fostering a
System That Promotes Capital Formation and Maximizes
Shareholder Value.'' Where witnesses from the Society of
Corporate Secretaries and the Business Roundtable provided
compelling testimony for making updates in order to reduce
unnecessary regulatory burdens.
The Financial Choice Act that has been discussed, proposed
a number of changes to Rule 14a-8, that I think would be
valuable for public companies, investors, and our markets.
I wonder, does the Commission plan to revisit Rule 14a-8?
Specifically, what are your views on increasing the
resubmission threshold under 14a-8?
Mr. Hinman. To the extent that we would open 14a-8, which I
mentioned, that would probably happen in the context of this
request for more comment on the wide range of proxy issues.
In terms of the thresholds, we would look at where they
are. Both the initial submission threshold and the recent
submission thresholds, where once a proposal has been voted
down, can it be submitted again? Those two have not been looked
at for some time.
So, we would be very interested in public comment on those
provisions.
In the meantime, one of the things that we are doing is
trying to get more input from the companies' boards on these
topics.
So, we put out a staff legal bulletin this past year,
asking for the board's more in-depth analysis. That has created
more engagement between boards and shareholders.
Some of these proposals go away after that engagement
happens. But it allows us to make rulings on whether it is
something that can be excluded or not, more effectively.
Mr. Hultgren. Thanks, Director. I know my time has expired.
Chairman Huizenga. The gentleman's time has expired.
The gentleman from California is recognized for 5 minutes.
Mr. Sherman. I would like to talk about parity between
disclosing long positions versus short positions.
Securities law requires investors or certain investors to
disclose their long positions 45 days after the end of each
quarter. It would require institutions to make disclosures
within 10 days after their position reaches 5 percent of a
company's outstanding shares.
But there is nothing corresponding for those taking short
positions. I am not criticizing short positions, however there
is an asymmetry of information.
It is my understanding that several European countries
require the disclosure of short positions.
Here, in the United States, the principles that underlie
Section 13 disclosure requirements, applicable investors with
long positions, transparency, fairness and efficiency apply
equally to investors with significant short positions.
Moreover, investors with short positions can pursue
strategies designed to invisibly drive down share prices or
rely on regulatory processes to challenge the intellectual
company--property of a company intending to profit from the
uncertainty created.
To provide transparency to other investors in affected
companies, would you support extending the existing disclosure
requirements for long investors, such as those on forms 13-F,
Schedule 13-D, and Schedule 13-G, to persons with short
positions, including any agreements or understandings that
allow an investor to profit from a loss in the value of a
security?
Mr. Hinman. Thank you for the question.
There has been some experimentation in the disclosures
around short positions post-financial crisis. Certain
institutions were required to disclose, in real time, their
short positions. DERA, our economic analysis division, had an
opportunity to look at the cost benefits there.
Mr. Sherman. I know you have looked at it. Where do you
stand?
Mr. Hinman. In that provision, I think they concluded that
there was not a good return cost benefit for real time
reporting of all transactions.
Mr. Sherman. This--well, long positions aren't, for the
most part, real time. Why not throw away the disclosure of long
position? Why require one without a cost-benefit analysis and
then say to the other, oh, we have decided it isn't worth
doing?
Mr. Hinman. I--again, I think this is something that DERA
would need to look at before we did it, because it would have
market effects. I haven't done that work myself.
Mr. Sherman. Let me shift to another issue.
The Chairman says that the decline in IPOs might be
replaced by an increase in ICOs initial coin offerings. I think
we missed the mark in this meeting because we think that the
reason for security markets is to let people issue and trade
and be securities lawyers and be government bureau executives,
et cetera.
The reason for security markets is to provide jobs in the
real economy. An IPO does that.
An ICO does the opposite. It takes money out of the real
economy. It takes people willing to invest in risk and says,
don't use that ability to risk. Don't use those animal spirits
to help create a job for a person who needs one, let alone
build a factory for thousands. Sit there and trade back and
forth in the ICO.
Now, it is--these are investments. They are--I think it was
you that said a balanced approach.
The balance we have in the real economy is, on the one
hand, we want people to invest in new companies and factories
and provide jobs. But on the other hand, we want to protect the
investors. So, we have a lot of burdens on somebody who wants
to build a new factory.
But with the coins, there is no factory. There are no jobs.
We have no burden on the invest--no investor protection.
It is--when you strike a balance between those who are
trying to create a new currency to facilitate drugs, tax
evasion, to deprive the fed of its ability to market our
securities and return a hundred billion dollars or so to the
U.S. Treasury, all the balances are for total investor
protection which could be achieved by totally banning.
Why aren't you stopping all the ICOs which are clearly
unregulated investments?
Mr. Hinman. So, when I talked about taking a balanced
approach, what we are trying to do is recognize that this new
technology, specifically the blockchain technology that
underlies it, may have some promise.
Mr. Sherman. Oh, I am not saying ban blockchain. Just ban
the ICOs.
Mr. Hinman. OK. Some folks are finding that the ICO
instrument allows for a different type of enterprise. One that
is more decentralized in which they think has some value. We
are--
Mr. Sherman. Charlatans and scammers have always favored
decentralized new enterprises.
Chairman Huizenga. The gentleman's time has expired.
Mr. Sherman. I yield back.
Chairman Huizenga. The gentleman's time has expired.
With that, the Chair recognizes the gentlelady from
Missouri, Mrs. Wagner, for 5 minutes.
Mrs. Wagner. Thank you, Chairman Huizenga.
Director Hinman, as you noted in your written testimony,
your role is to support the SEC's mission to protect investors
as well as to maintain fair, orderly, and efficient markets.
To follow up on my colleague, Representative Hultgren's,
questioning, there are some red flags when it come to the--in
particular, to the two largest proxy advisor firms who,
together, seem to control at least 97 percent of the proxy
advisory industry.
Director Hinman, what are the main factors hindering
greater competition in the proxy advisory industry, do you
think?
Mr. Hinman. I am not an economist, so it is hard for me to
know exactly what would hinder more competition there.
I do know that the service they provide is basically
collecting all of the proxies that are out there, looking
through, and thinking about how a particular matter should be
voted on. Once someone does all that work and there are one or
two people supplying that, it is hard for a new entrant to come
in.
Mrs. Wagner. What steps is the division taking to ensure
that all proxy advisory firm conflicts of interest are properly
disclosed?
Mr. Hinman. That was something that we emphasized strongly
in our legal bulletin that came out in 2014. We, through our
Office of Inspections, continue to look at how that is being
complied with.
We are seeing better disclosure than what predated that
guidance.
Mrs. Wagner. What steps is the division taking to ensure
that public companies have sufficient time to respond to errors
or flaws that are made in proxy advisory firm recommendations?
Mr. Hinman. As I mentioned earlier, we do meet with these
firms. We have provided feedback around the kinds of concerns
you are raising. We have seen an increase in the level of some
responsiveness.
We are still monitoring it, but we do think encouraging the
firms that are providing these services to listen more actively
is something we can do and are doing.
Mrs. Wagner. Switching topics. I wanted to spend some time
talking about cyber-security attacks.
On February 21, 2018, the SEC voted unanimously to approve
updated interpretive guidance to assist public companies in
preparing disclosures about cyber-security risks and incidents.
How does this guidance expand upon the guidance issued in
2011?
Mr. Hinman. One of the basic differences is where it was
issued. The original guidance was issued in my division. The
updated guidance was approved by the full Commission and,
therefore, has more weight.
But, in terms of the substance, there were maybe three or
four areas that we concentrated on and brought attention to.
One was disclosure controls. We reminded companies it is
very important for them to take cyber risk into account when
they are looking at their disclosure controls, so that if an
attack happens and when someone in the front line sees that,
they raise it to the company's disclosure experts and more
consideration is given to timely disclosure.
But we also reminded companies that as that happens, to
enforce their insider trading policies. So, now that they have
a better sense of what is going on at the higher level, they
are more apt to apply their insider trading policies.
Mrs. Wagner. Given the increasing number of cyber security
breaches, such as the Equifax breach, how does this guidance
help to ensure that companies have the appropriate procedures
in place to both prevent and respond to cyber-security
incidents?
Mr. Hinman. What we were trying to do was to emphasize this
disclosure point.
We also--one of the other items that is a little different
than the old guidance was that we said, when a company has
cyber risk as a material risk that they face, we expect to see
disclosures of how their board is overseeing that risk.
So, board oversight, better controls, and more compliance
on the insider trader policies.
Mrs. Wagner. To that point, can you walk me through more of
the steps you believe that companies should take after they
have discovered material cyber-security event has occurred?
Mr. Hinman. Sure. After it has been discovered and you have
determined it is material, and that may take a little time
because these companies are attacked daily. One of the reasons
we wanted this to be elevated was to make that materiality
decision that you are referencing.
Once that decision has been made, insiders with knowledge
of that should not trade. The company, we would expect, would
be moving to formulating appropriate disclosures.
Mrs. Wagner. What disclosure forms do you think they should
be using, in the event that they have an event related to the
cyber security breach?
Mr. Hinman. Sure. There are a number of ways. The most
common we see is Form 8-K. That is something that is not just
done quarterly or annually, but can be done at the time an
event is occurring.
Mrs. Wagner. My time has expired.
Chairman Huizenga. The gentlelady's time has expired.
The gentleman from Massachusetts is recognized for 5
minutes.
Mr. Lynch. Thank you, Mr. Chairman.
If we could, I would like to stay right on the same topic
that the gentlelady from Missouri was talking about.
So, last year, we had an increase of about 80 percent in
the number of cyber-attacks.
As the gentlelady pointed out, we haven't updated this
guidance on cyber-security protocol since 2011. So,
exponentially increased on the number of attacks.
But last year, if you sort out the significant cyber-
attacks on publicly traded companies, it was about 82 of those
companies that publicly traded that had major cyber-attacks on
their systems. Only 3 percent, only 3 percent, filed an 8-K to
inform the shareholders that their systems have been hacked.
So, you have 97 percent of the companies that have been
hacked failed to file an 8-K to let their shareholders know
that there had been a significant event.
The problem seems to be on the definition of materiality.
The legal counsel within the company is nervous about
disclosing the hack, because share price will drop and there is
vulnerability. That is an issue.
But on the other hand, shareholders have a right to know.
Also, if we don't do anything about that, I think this trend
will continue.
The companies will not improve their--there is no price to
pay. There is no accountability. The companies will not improve
their cyber protections, and we will just keep seeing the
volume of these hacks continue.
How do we get at that decisionmaking being made at the
corporate level to encourage--you don't want to punish a
company that is a victim of a cyber-attack. I understand that.
But you do want to encourage them to disclose. That is
basically the mission of the SEC.
How do we get these companies to come forward so that we
will know about the attacks in a timely fashion and protect the
shareholders and also the entire system because everything is
so interconnected?
Mr. Hinman. Thank you for the question.
We agree that this is an important disclosure issue and
that the materiality judgment can be a difficult one. But we do
expect more.
As you mentioned, the 2011 guidance has actually been
updated at the beginning of this year by the full Commission.
It highlights some of the items I had mentioned.
Beyond that, we conduct our reviews of companies. This is
an item of review priority for us. We look at those each year.
This is one that clearly we are looking at.
Then, moreover, when we see a hack occur, we will often
pick up the phone--our review teams that are familiar with that
particular company may pick up the phone, talk to counsel, and
ask to be walked through. Is this something that is material?
You will see things, sometimes, reported in the press. The
company has decided it is not material. We sometimes will ask
them to walk us through that analysis.
Mr. Lynch. Yes, it is still--it is still fairly
discretionary, however. Timing is important.
Where--what we are seeing right now is, like I have said
before, 97 percent not filing an 8-K. Not telling people.
There needs to be some consequences. I was hopeful that the
new guidance would get at that issue. I am not sure if a
legislative solution is the best way to go here. I would rather
have the SEC do it themselves. It is not happening fast enough,
in my opinion.
But I appreciate your willingness to come here before the
committee and help us with our work. I yield back the balance
of my time.
Thank you.
Chairman Huizenga. The gentleman yields back.
With that, the gentleman from Minnesota is recognized for 5
minutes.
Mr. Emmer. Thank you, Mr. Chair.
Director Hinman, welcome to the committee and
congratulations on your new position.
You touched on it briefly during your testimony, however
can you give more detail as to why it is so important for the
SEC to encourage more small companies to go public and not just
the big ones?
Mr. Hinman. We think capital formation at all levels, and
the small levels, is important for job creation, number one. We
think it obviously is good for the economy.
We are very interested in looking at our rules. Over the
years there has been more and more added to the disclosure
requirements. We do want to look at the scaling of those
requirements for smaller companies.
We do have a rule actively being considered right now. It
has been proposed and we will try to finalize it for lifting
the limits for who qualifies for that scaled reporting.
Mr. Emmer. When Chairman Clayton came before this committee
in the fall, I asked him about the concept of venture exchanges
and whether or not the creation of a lower-tier equity market
to facilitate the secondary trading of shares of smaller
companies, where liquidity challenged securities would entice
more early stage IPOs.
Do you have any thoughts on this matter?
Mr. Hinman. Sure. I am not the trading and markets expert.
Our colleagues in the Division of Trading and Markets actually
are focused on the issue. In fact, they had a roundtable
earlier this week, I believe, to discuss some of the issues
smaller companies face in terms of developing liquidity in
their shares and in smaller company trading.
Venture exchanges, ideas like that where liquidity is
enhanced and an exchange is used to do that certainly would
provide more liquidity.
I think, again, the Trading and Markets folks are very
interested in exploring those ideas and that is why they are
holding these roundtables.
Mr. Emmer. Wonderful.
I want to change gears just a little bit. I find that
people tend to fear what they don't know. If people who started
sailing the oceans at the time of Columbus would have believed
that the world was flat, we never would have had the great
discoveries of the new world.
The typical attitude, too, that I get from so many elected
officials who have no idea what they are talking about--they
are ignorant on a topic--is that everyone who is involved in
the area that they maintain their greatest ignorance. That
everyone who is participating in that area is either bad or
dishonest. Therefore, the elected official must rush in and
help people from these.
I find this a lot when we talk about initial coin
offerings. We are talking about blockchain technology. There is
a lot of ignorance about how special this area is.
Given your division's jurisdiction, as it relates to crypto
currencies and initial coin offerings, do you have any
circumstances that come to mind that might render a token sale
as something other than a securities offering?
Mr. Hinman. The initial sale--it is quite hard to have an
initial sale without having a securities offering which is why
the Chairman has noted that the initial sale of these may
require compliance or exemptions.
Mr. Emmer. Let me ask you a question about that. Is it
possible that a utility token would not be a security, because
it is not done for capital formation?
Mr. Hinman. It is certainly possible that there are tokens
that would not have the hallmarks of a security.
Over time, many of these fundraisings are intended to
develop networks where a token may be used to buy a good or
service.
That is its only use. It doesn't have much utility--
Mr. Emmer. No, I understand. But there is a difference.
Mr. Hinman. There are other senses.
Mr. Emmer. If you can just--this is the difference. I get
this all the time. People are suggesting that everything that
is done in this area involves a currency or something like a
currency or security.
But, in fact, a security--or a utility token is nothing
more than a card, if you would, that would allow you access to
a certain platform so that you can participate.
Is it possible, in your jurisdiction, that that may not
qualify as something that is a security offering?
Mr. Hinman. We certainly can imagine a token where the
holder is buying it for its utility and not as an investment.
In those cases, especially if it is a decentralized network in
which it is used and there are not central actors that would
have information asymmetries where they know more than the
investors in those tokens.
Mr. Emmer. Can I--I have to get this in before my time runs
out.
You have stated that, quote, ``sponsors of offerings
conducted through the use of a distributed ledger or blockchain
technology must comply with the securities law,'' close quote.
You also stated, quote, ``Investors need the essential facts
behind any investment opportunity, so they can make fully
informed decisions.''
How can we improve the regulatory clarity for entrepreneurs
here in the United States so that their contribution to
something that may not be a security will not see enforcement
actions by the SEC?
Chairman Huizenga. I will allow a quick reply.
Mr. Hinman. One of the things we are doing is meeting with
the participants who have these ideas, that think that they may
have a token that shouldn't be regulated as a security, to work
through with them how that may be structured.
Mr. Emmer. Wonderful. I will follow up in writing. I have a
bunch of other questions.
Thank you for your patience, Mr. Chair.
Mr. Hinman. The gentleman's time has expired.
With that, the gentleman from Georgia, Mr. Scott, is
recognized for 5 minutes.
Mr. Scott. Thank you, Chairman Huizenga.
I am very, very pleased to have Mr. Hinman here, because
you are in the crucible of what we really refer to as wealth
building in this country. You are the SEC Director of the
Division of Corporation Finance and capital formation and
public offerings.
There are basically three ways we build wealth, meaning
financial security, and stability, and that is either through a
job, your business, but most acutely through investments.
I want to talk to you about the fact that we have some
alarming news. My excellent staff has done some research that I
want to bring to your attention. Important research. One, they
have informed me that during the past 20 years, the number of
new companies deciding not to go public has increased
dramatically.
As a matter of fact, they inform me that in 1997, we had
474 companies that went public, while only 108 went public in
2017. That is astounding. So, with this in mind, I wanted to
ask you about this expanded use of nonregistered offering
exemptions.
Because I truly believe that it makes sense to expand our
security laws to make it easier for our businesses, especially
our startups, that we rely on. Small business startups are
still the driving force.
From that comes the necessary resources to make those
investments through the public and private offering. One other
thing I want to tell you is that I agree with you, when you
said this in your testimony. You said, it is far more efficient
for retail investors to invest in companies through our public
markets rather than our private markets.
Now, that, to me, is very profound. As a matter of fact, I
think it gives us a nobility of purpose why you are here.
You went further. You said, the SEC is conducting a look-
back review of the impact Regulation Crowdfunding and
Regulation A on capital formation and investment protection.
So, my question is this. I am very interested to know,
first of all, what you think about the points I have made.
Also, how this look-back is going with you.
I am curious to know if the SEC is including in its look-
back a measure of whether our capital markets are operating
efficiently, from the standpoint of retail investors.
Mr. Hinman. Thank you for the question and the comment on
your observations around the decline in numbers of public
companies or companies deciding to do IPOs. We share that
concern.
We do think, as you mentioned I said in my testimony, that
public companies are terrific vehicles for the smaller investor
to invest in. There is more liquidity because of our
regulations. There is more transparency.
So, we do share a concern that those numbers are declining,
in terms of the number of investment options retail investors,
in particular, may have.
In terms of the various ways that our rules are working
together to, hopefully, encourage people to join the public
reporting system, you mentioned crowdfunding and Regulation A.
I think Regulation A, at the time it was expanded by
Congress, the thought was, this is perhaps, a bit of a roadmap
to becoming public. It's still very early days, in terms of
experience of Regulation A.
We have seen some Regulation A issuers get used to the idea
of providing disclosure and having it reviewed by the SEC. Some
of those issuers have matured to the point where they have been
listed.
Not all those are great successes in the same way. Not all
IPOs are great successes. We are monitoring the developments
under Regulation A carefully. Same with crowdfunding. With
crowdfunding, we see a lot of activity on the coasts. We see
less in the middle of the country. We think it would be
terrific to have more activity there.
We are looking at ways to stimulate portals interest in
folks across the country, not just on the coast.
Mr. Scott. Thank you very much, Mr. Chairman and Mr.
Hinman.
Chairman Huizenga. The gentleman's time has expired.
The gentleman from New Jersey, Mr. MacArthur, is recognized
for 5 minutes.
Mr. MacArthur. Thank you, Chairman.
Director, thank you for being here.
Forgive me if I work on fields that have already been
plowed. But I had to step out for a few minutes, so I don't
know what you have been talking about.
In the Chairman's opening remarks, he mentioned that
primary goals are protecting investors, facilitating orderly
markets, encouraging capital formation.
One of the concerns I have is we have a lot fewer initial
public offerings than we used to. We have to consider, why is
there less interest in the public markets?
One of the things I have observed is that companies engaged
in interstate commerce, that are traded on public exchanges,
have a very difficult situation in both State and Federal
actions that target them for civil fraud. Not criminal fraud
but civil fraud.
So, for example, an overzealous State attorney general
might not have a case that rises to the burden of proof to
prove civil fraud. They will accuse a company anyway and that
company can get raked over the coals for something that doesn't
even have any intent.
This is not unique to one State alone. It is not even
unique just to the States.
For example, CFPB raked their company, in my district, over
the coals and ended up losing their actions. But the company
lost a billion dollars in market value which hurt all of their
main street investors.
States like New York, California, Connecticut have gone
after companies and decimated share-holder value.
That hurts main street investors. It is hard for those
companies to recover. The moment there is an accusation of
anything, they have to disclose it because they are publicly
traded companies.
So, I just wanted to ask you if you could comment on the
problem. How you see it. The fact that these publicly traded
companies engaged in interstate commerce all across the country
are subjected to 50 different standards on civil fraud.
Could you talk about the problem from your perspective? Do
you see any solutions? I would be happy to hear those, too.
Mr. Hinman. Sure. So, to go to the broader point of fewer
public companies, one of the reasons--this is one of them. I
think there are a number of reasons why fewer companies are
choosing to go public.
There is the Federal regulatory burden. There are the State
regulatory burdens. There is simply more money available in the
private sector right now as well. So, the need to seek public
funding is lower than it would have been in the past.
So, there are all these different factors going on all at
the same time. So, to pick one out and to try and weigh it in
the equation is difficult.
The point you are raising is not something I have a view on
as a Federal regulator. The ability to change that landscape
would be one of Federal statute. That is a Federal preemption
question, really, that you are getting to, if you were trying
to make a more uniform anti-fraud landscape for public
companies.
Mr. MacArthur. Do you see it as a problem?
Mr. Hinman. I certainly--
Mr. MacArthur. As part of the--as part of the issue.
Mr. Hinman. I certainly see that some companies bear that
in mind as they decide to go public. It is not a positive
factor.
Mr. MacArthur. I agree with you that it is not the only
issue. I didn't mean to imply that it was.
But I know, as a former businessman, it certainly weighed
into my mind. Just the difficulty of the environment.
You mentioned there is more capital available in other
mechanisms, like private equity and such.
But there is a reason more capital is being attracted into
that space, too. It is because the public markets are less
attractive.
Mr. Chairman, I am happy to yield my remaining time to you,
if you have any other comments or questions.
Chairman Huizenga. Thank you. Yes, I will take that.
We are going to go on a slightly different direction from
what you were having.
I want to touch base on something that Chair Clayton and
CFTC Chairman Giancarlo stated. That they, along with their
counterparts at the Department of Treasury and Federal Reserve,
may come to Congress in the coming months, regarding ICOs.
I am curious what you believe the role for Congress might
be in that? Is there concern that the Congressional regulatory
intervention will chill the ICO market?
Mr. Hinman. In terms of what is going on in the landscape
right now, I think Treasury, through the FSOC committee, is
trying to gather views from the various regulators, CFTC and us
principally. But also the banking regulators, everyone that
participates in FSOC.
People that have your customer concerns, anti-money
laundering concerns, our securities law concerns, commodities
concerns, to look at the overall regulatory touch here. To see
if there are gaps and to see if there are ways to improve the
environment.
One thing we are trying to do is provide as much guidance
as we can to the marketplace, so we don't have a chilling
effect.
But it is still something that is being worked on by all
the agencies, and we are trying to coordinate to make sure we
don't stifle innovation.
Chairman Huizenga. All right. Thank you. Time has expired.
With that, the gentleman from North Carolina, Mr. Budd, is
recognized for 5 minutes.
Mr. Budd. Thank you, Mr. Chairman. Thank you, Director
Hinman, for your service. The first time out, you are doing a
good job.
Chairman Huizenga. Thank you.
Mr. Budd. So, thank you.
I want to talk this morning about SEC efforts to facilitate
capital formation and efforts to increase investment
opportunities here at home.
Obviously, this is an issue of importance to me. I have led
H.R. 3903, the Encouraging Public Offerings Act, along with my
friend, Representative Meeks from New York. That would expand
testing the waters.
So, a lot of us on the committee were pleased to see the
SEC expand the use submitting of confidential draft filings of
last year, just from emerging growth companies to all
companies.
In that vein, do you plan on extending the use of testing
the waters from these emerging growth companies to all
companies as well? What steps are the division taking to help
facilitate pre-IPO communications between businesses and
investors?
Mr. Hinman. Thank you for that question.
As you point out, the test the waters exemptions from
Section 5 have been available for the emerging growth
companies. We have put on our agenda expanding that. It seems
to be working well.
There are parameters in which those test the waters
activities take place. We think investors are protected by
those. As I said in my opening remarks, this is something that
we think could make a difference, and we will explore it very
carefully.
Mr. Budd. So, just to clarify, you said it is on your
agenda. Is there any timeline for expanding that?
Mr. Hinman. I don't think we have it on a specific timeline
right now. But it is something that we would like to move
forward.
I don't think it will take an inordinate amount of time to
duplicate what we have done for the EGCs for a broader group of
folks.
Mr. Budd. Very good.
So, in a speech earlier this year, you stated that your
intent is to put emerging growth companies and non-EGCs on as
level a playing as possible. Can you please elaborate on this
and how the division aims to ensure that this is a level-
playing field?
Mr. Hinman. One of the primary things would be looking at
the EGC opportunity to test the waters and broadening that.
There had been, prior to the revisions we made in the
policies, certain advantages the EGCs had, in terms of
confidential filings, which we have spoken about, that has been
extended to all.
Then, as we expanded confidential filings, beyond what the
EGCs had available, we made sure that both the EGC group and
others were allowed to file confidentially for their first
year. So, we kept them on the same level playing field.
Mr. Budd. Very good. I appreciate your time. Chairman, I
yield back.
Chairman Huizenga. The gentleman from North Carolina yields
back.
The gentleman from New York, Mr. Meeks, is recognized for 5
minutes.
Mr. Meeks. Thank you, Mr. Chairman.
Let me ask you a question, Mr. Hinman. Over the years, we
have seen an increase in the amount of public companies with
dual-class share structures, including many of the largest tech
companies in Silicon Valley, like Google, Facebook, Snapchat.
These structures can create benefits for a company by
allowing founders to guide a company's success after going
public. But substructures also pose a risk for shareholders who
are less able to hold boards and CEOs accountable for their
failures.
The SEC's Investor Advisory Committee recently proposed
ways of improving disclosures related to dual-class shares.
So, my question to you is, what is your personal opinion of
those recommendations and the risk associated with dual-class
share structures?
Mr. Hinman. Thanks for the question.
You are right, the Advisory Committee did ask us to look at
those disclosures. I had independently talked with our
disclosure teams about the disclosures that we are able to
receive, when a company has a dual-class or a unique structure.
We are looking for robust disclosure there, so investors
understand not just the voting ratios, but things like the life
of the arrangement, whether it has a sunset. We are looking for
disclosure of those provisions.
The Advisory Committee did not ask us to ban those, in part
because the SEC really doesn't have jurisdiction on this topic,
to ban or allow. We are a disclosure agency.
State law generally governs whether a dual class is allowed
or not or how it may be limited. We look to the State law to
see whether these are allowed.
But if they are allowed, we are then focused on disclosure.
Our jurisdiction in this area has been limited by case law and
by the statutory structure.
Mr. Meeks. So, you don't believe that the SEC has any plans
for considering and/or adopting the recommendations?
Mr. Hinman. Again, what we can do is focus on the
disclosure. Because it is case law, that has limited our
ability to legislate one share one vote. That was done many
years ago in a business roundtable case which the SEC did not
prevail on.
We see our focus now as one of disclosure.
Mr. Meeks. Let me jump to the other issue in my last 2
minutes.
Earlier this year, New York's controller announced that the
State's pension fund would oppose reelection of all directors
of boards that lacked women representation.
New York was unable to make a similar action with respect
to boards that lacked racial or ethnic diversity, because the
SEC's board diversity rule has not yielded robust disclosures.
This has been a constant problem and complaint of my office and
investors that we have talked to nationwide.
In October, when Chairman Clayton was here, we asked
whether or not the agency would adopt the proposal from the
SEC's Advisory Committee on small and emerging companies that
requires companies to specifically list their race, gender, and
ethnicity of their board members.
Chairman Clayton made no commitments to adopt these
recommendations. Merely stated that the Division of Corporation
Finance, your division, will monitor compliance with the
current rules.
So, what has been your division's assessment of compliance
with the agency's board diversity rule? Have diversity
disclosures been adequate, considering shareholder demands for
more information? Will the Division of Corporation Finance
eventually provide a public recommendation to the SEC on
whether it should adopt proposals to improve the rule?
Mr. Hinman. To start with your last question, the answer
would be, yes, we will. It is on the Chairman's rulemaking
agenda. This is a topic that both he and I view as highly
important.
The old policy in this space has been subject to some
criticism that it doesn't get enough useful disclosure. Our
division has been looking at how that policy has been complied
with.
Some companies, notwithstanding the fact that the
disclosure doesn't require specific items, such as gender,
race, or ethnicity, to be disclosed, had been providing that
disclosure. Sometimes in graphic forms, tables.
We have been looking at how people are approaching the
issue. We have talked to some of those issuers to find out what
has their experience been in preparing those kinds of
disclosures?
One thing that we have discovered is that there is some
sensitivity to their board members' privacy issues, in terms of
self-identifying on some of these topics. So, we would want to
take that into account as we develop any new rules here.
But we are gathering information on this. It is on the
rulemaking agenda. It is important to both myself and the
Chairman.
Mr. Meeks. Thank you very much.
Chairman Huizenga. The gentleman's time has expired.
With that, the gentleman from Maine, Mr. Poliquin, is
recognized for 5 minutes.
Mr. Poliquin. Thank you, Mr. Chairman, very much. Thank you
very much, Mr. Hinman, for being here.
I represent rural Maine. We have a huge Congressional
district geographically with lots of hard-working folks and
small savers with 401Ks and IRAs and 529 plans for their kids
to go to school and to plan for their own retirement.
So, I am very concerned about small savers and small
investors in Maine and throughout America, Mr. Hinman.
Now, there is a bill that I originated called--well it is
1312, H.R. 1312, which deals with the annual government
business forum that you folks host every year.
You get together and you get all these great ideas from
folks on the public side and the private side, to see if there
are ways that we can improve the enhancement of capital
formation in our economy.
The bill, sir, which is included in Mr. Crapo's bill over
in the Senate, simply requires the SEC to make sure they take a
look at every recommendation, evaluate them and act upon them.
Are you familiar with that bill, sir?
Mr. Hinman. I have heard of it, yes.
Mr. Poliquin. OK. Do you, right now, go through the process
of making sure the recommendations from that annual business
forum are evaluated by the SEC?
Mr. Hinman. Certainly. I personally participated in that
forum in Texas this year. We see the reports, my staff in the
small business office receives that and helps compile it and
helps to get it out. We take all the recommendations under
consideration. We are always looking for good ideas.
Mr. Poliquin. That is great.
Since you have personal knowledge of this, Mr. Hinman, I
appreciate that very much.
We just want to make sure that folks that go through the
effort, like you in your former life, do not let these
recommendations which could help our economy grow and thrive
and companies raise more capital.
They just don't sit on the shelf somewhere, but they are
actually evaluated and looked at. Make sure that that
information is useful to everybody.
OK. I would like to move on a little bit to data security
here, sir.
On Tuesday, the former Yahoo company paid about $35 million
in a penalty because you folks determined they misled
investors, when it comes to a hacking that took place that
disclosed the personal data of hundreds of millions of accounts
around the world.
Are you comfortable that the SEC has the metrics in place
such that public companies know, in fact, when they should
disclose material events like this?
Mr. Hinman. We do think we have given very good guidance in
this space. We don't use bright line metrics, in part because
those bright lines sometimes will result in over-inclusive
disclosures or under-inclusive.
If someone is on one side, it still might be material to an
investor. But they would say, oh, we didn't have to disclose
because we didn't meet the metric. We don't want to flood the
market with things that are just noise.
So, the bright line tests don't seem to work that well in
this space. We have used, basically, principle based guidance
and have elaborated on that in a 30-page Commission-level
guidance document most recently.
Mr. Poliquin. I just want to make sure that you folks are
giving every due consideration for investors, small investors,
who have taken a position in a company.
Then, at the same time, making sure that you don't overly
burden companies with this. So, it seems like you are moving
down that path.
On a third issue, quickly, sir, if I may, is that there
seems to be, over the years, the threshold for small groups of
political activists to take $2,000 positions in companies in
order to push a specific agenda at a shareholder annual
meeting, is something that is a concern to companies that are
thinking about going public.
I wonder if you have any input on that. I know the number
of companies that have gone public over the years has dropped
precipitously.
Also, I notice that Mr. Clayton, in his speech last
November, said he had a concern about this threshold.
Do you have any feelings at the SEC where those thresholds
may or may not be adjusted to make sure folks do have a voice,
if they own part of a public company? But, at the same time, is
not so disruptive and costly for the company, that they hurt
small investors who actually bought shares in the company also.
Mr. Hinman. We are certainly looking at the right balance
there. You point out the issues in terms of that you want to
make sure that shareholders still are able to have a voice, and
you don't want to overburden a company with trivia.
Those thresholds haven't been looked at in quite some time.
I mentioned earlier today that we do have an interest in
looking at that.
The Chairman is going to be seeking more comment in the
space. He has, as he mentioned in the speech, expressed
interest here. I expect that will continue.
Mr. Poliquin. Great, thank you.
With indulgence, Mr. Chairman, please.
The State of Maine, Mr. Hinman, has a 2.6 percent
unemployment rate. I think it is the lowest in the country.
Clearly, lower taxes for our families and small businesses. It
is having a dramatic effect.
I know you folks are responsible for making sure public
companies disclose this good news of more growth and more
hiring and for their companies.
Are you comfortable where there is a right balance between
making sure they report this great news to their shareholders,
but, at the same time, not overburdening them with the more
costly regulations that would be hurtful?
Mr. Hinman. We are very focused on that.
Mr. Poliquin. Thank you, sir. Thank you, Mr. Chairman.
Chairman Huizenga. The gentleman's time has expired.
The gentleman from Minnesota, Mr. Ellison, is recognized
for 5 minutes.
Mr. Ellison. Thank you, sir.
Director Hinman, when do you expect to finalize the
Executive Compensation Rule, Section 953(a), which requires
companies to detail the relationship between CEO pay and
profits?
Mr. Hinman. That rule is on the Chairman's agenda. We don't
have a date certain. There isn't in the statute, unlike some of
the other Dodd-Frank provisions, a mandated date.
He has indicated he wants to go through all the executive
compensation rules of Dodd-Frank in order. That is one we will
get to. But he hasn't set a date for us, yet.
Mr. Ellison. When do you expect to finalize the clawback
rule so that CEOs who jack up their incentive pay to increase
profits only to have those profits paying, have their incentive
pay clawback?
Mr. Hinman. That is part of that package, so it would be
the same approach.
Mr. Ellison. Any date on that? You can give us a range,
like next year, like next month? I understand you may not know
the exact date. But if you can give us some sense because the
public would like to know, my constituents want to know.
Mr. Hinman. Right. I would say it would not be in this
fiscal year. The short-term agenda is pretty packed. We are
trying to achieve everything that is on there.
I would think it would be some time after this fiscal year.
Mr. Ellison. When do you think you will finalize the
incentive-based compensation guidelines for our large financial
institutions?
Mr. Hinman. That is part of that package of three
compensation-related initiatives. It fits into that same
category. I think the Chairman wants to look at those together
and take them in order.
Mr. Ellison. OK. Do you think they will come all out
together at the same time or you don't know?
Mr. Hinman. I think he will likely ask us to do these in
sequential order.
Mr. Ellison. OK.
Mr. Hinman. That is up to the Chairman. I haven't heard
what the order would be or whether there would be a possibility
of soliciting comment collectively.
Mr. Ellison. All right.
I just want to give you a little context for my question.
One of the lessons that I think we have learned from the great
recession just 10 years ago, which I still remember very well,
is that CEO pay incentives were actually encouraging--CEOs to
encourage, engage in activity, I think put a premium on risk-
taking.
If we had a better incentive structure, more risk
assessment, create an oversight at the corporate level, we may
not have engaged in some of the things that really hit our
economy hard.
So, when pay is tied to short-term profits, CEOs will take
risks that prioritize quick returns. When Congress rolled Dodd-
Frank, Congress included a number of provisions to ensure CEO
pay was no longer promoting excessive risk-taking.
The SEC is charged with propagating the rules here. It has
been 8 years since Dodd-Frank, and we still have the final
rules.
I am not blaming you, personally. But I think that it has
been plenty enough time. I am disappointed to hear that we are
not going to be having those rules in this fiscal year. I think
that there has been more than ample time.
By the way, the delay has been costly. We have seen some
serious banking crises that could have been avoided, in part
with better CEO pay regulations.
Look at Wells Fargo, for example. They were trying to pump
up profits every quarter by creating fake accounts. I know a
lot of workers got fired by the people who directed and
designed the program. I think the CEO got away with a $173
million severance package or something like that.
Anyway, New York State controller, Thomas DiNapoli, sent a
letter to Wells Fargo shareholders last week, in advance of
their annual meeting, asking for Wells to disclose their
payments in the policies.
I will tell you what he said in that letter. He said,
incentive pay practices have been identified as contributing to
the multiple crises at Wells Fargo.
Investors need to know whether the company is taking steps
to identify employees' incentive-based compensation. It could
spur conduct. It puts the bank, its customers, and investors at
risk.
I will say, the economy, if widespread enough. I don't
believe in beating up our witnesses unless they have it coming.
I don't think you do.
But I will say, I hope you take back to the people you work
with that 8 years is plenty enough. This is a serious thing. It
is the law. It has to get handled quickly.
I don't think the American people can afford to wait much
longer. I think, until these rules are finalized, CEOs are
still getting pay packages that misalign their shareholders
with their own compensation. I don't think that is right.
So, thank you.
Chairman Huizenga. The gentleman's time has expired.
The gentleman from Indiana, Mr. Hollingsworth, is
recognized for 5 minutes.
Mr. Hollingsworth. Good morning. I really appreciate you
being here.
I will be brief. I want to focus on a very narrow topic
that is really important to me, and important to constituents
back home, and, frankly, important to America as a whole.
It really has to do with some of our emerging growth
companies, and specifically those involved in biotech. The
economists can tongue in cheek remark that all is required for
one to get a drug approved in this country is superhuman
persistence over 10 years and $2 billion.
Many of these companies are very early stage. Many of these
companies are very small, in terms of the number of employees,
even if their market cap is relatively large. Just waiting on
approval of drugs, waiting on approvals to be able to get
through the process.
One of the things I continue to hear from them is concern
about 404(b) compliance and the cost of 404(b) compliance.
We have heard testimony in this very room about companies
that are on the cutting edge of new technology. Cutting edge of
new biology and be able to finally cure diseases that ail
millions of Americans. But are spending more and more of those
dollars that they have raised on compliance instead of the
search for cures.
I know that a 2011 SEC study noted that those companies
with a public float between 75 million and 250 million, spend
on average, $840,000 a year on compliance with 404.
Really, what I wanted to ask you was if there is any look
at the cost of 404(b) on very, very small companies that are
public, and the benefits of 404(b) for those very small
companies that are public. Whether we can better align those
two to ensure that we are enabling and empowering them to do
more of what they do best, serve their customers research
technology development products instead of more and more
compliance.
Mr. Hinman. Thank you for the question.
We are looking at that very carefully. As I think you
probably know, today, we draw the line at $75 million market
cap, right below that 404(b) attestation is not required.
We are doing some things, scaling disclosures up to the
$250 million market cap. That is something where the SEC, in a
proposed rule, decided we would not move the 404(b). We
suggested we would not move the 404(b) threshold along with the
rest of those requirements.
We are taking a fresh look at that. The life science
industry, as you mentioned, makes a fair point that this is
costly for them. They have lots of terrific ways to spend
money.
At the same time, we want to protect investors. We want to
have, perhaps, a more sophisticated test in this area. So, we
want to adjust that market cap.
We also might look at revenues. If you are a low-revenue
company but a higher-market cap, you probably have some
promising product in the pipeline. You don't have the revenues,
but people value you highly.
You probably also have a simpler set of financial
statements. Where the requirement is to do a full attestation,
maybe that is not money well spent.
We haven't analyzed that yet. In terms of looking--having
DERA look at it. Is there a better way to draw the lines here?
That is something we are quite interested in doing. Your life
science industry colleagues have suggested that we do that, and
I think that is a good idea.
Mr. Hollingsworth. Mr. Hinman, you have stolen all of my
thunder because that is exactly where I was going, in the hope
that we would have a more sophisticated test.
Some of these biotech companies have a billion dollars in
float, but they have seven employees and they are outsourcing
their drug trial process. This is expensive to go through.
We heard some testimony from individuals that were in that
same camp. We earn $10 million a year from licensing a few
things. But we have a billion-dollar float while we wait to go
through this process.
We certainly don't believe that we should be held to the
same levels as a larger, more operating entity with many more
employees, many more moving parts, many more subsidiaries, et
cetera.
So, I really appreciate the fact that you brought that up
and want to look at a more sophisticated and thorough test to
better understand what companies can benefit.
Just one last point, since you stole most of my thunder in
the middle here, is nothing that you would do, I imagine, would
say you are absolutely barred and restricted from getting any
404(b) to any of these companies.
If they elected to say, look, it lowers our equity cost of
capital, if we underwent a 404(b) audit attestation. They could
still pursue that if they wanted to at any level.
Mr. Hinman. You are absolutely right and some companies do
that.
Mr. Hollingsworth. The reality is they can make that as a
business decision.
As you well said, and have said on many occasions,
disclosure can benefit companies as well and ensuring investors
feel more comfortable with the asset that they own and lowering
their equity cost of capital.
I don't think anything I propose, anything that this
committee has voted on, anything that I have heard from other
testimonies says, we should bar companies from doing this at
any size.
But, instead, let us make it up to those companies to
determine whether it is in their best interest, their
investors' best interest, their products best interest to do
this or whether it is not at a certain level or not.
So, thank you for being here. Thank you for your testimony
today.
Mr. Hinman. Thank you.
Chairman Huizenga. The gentleman yields back.
With that, the Chair recognizes the gentleman from Ohio,
Mr. Davidson, for 5 minutes.
Mr. Davidson. Thank you, Chairman. Mr. Hinman, Director
Hinman, thank you for your testimony today.
I want to return to the topic of initial coin offerings. I
want to focus particularly on the Howey Test.
The Howey Test is used to determine whether an asset is
classified as a security and, therefore, subject to Federal
securities laws. The test was developed by the 1946 Supreme
Court case SEC versus W.J. Howey Company.
Do you believe the Howey Test should be--is it adequate for
application for crypto currencies?
Mr. Hinman. I think the principles annunciated there are
still solid principles, in terms of the factors one would weigh
to see if an investment contract could be viewed as a security.
Mr. Davidson. Do you believe that it should be updated or
changed to better incorporate what is, in fact, a security?
Mr. Hinman. Again, I do think the basic principles there
are the investor giving money or some consideration to a third
party to have an enterprise take that money and generate a
return? That feels, to me, like those are pretty flexible and
sound hallmarks of how to judge whether an instrument is a
security.
Mr. Davidson. As you were speaking with Chairman Huizenga
earlier, you know, a little concerned by the idea that the SEC
would inherently be involved in an ICO. But you left some
latitude to say that, perhaps, it wouldn't meet.
When you look at the criteria. There is an investment of
money. There is an expectation of profits. The investment of
money is in a common enterprise and any profits come from the
efforts of a promoter or third party.
Some of those offerings of coins, as disclosed currently in
white papers, are, really, almost like prepaid cards. They are
not really securities.
In some cases, they are assets for sure. But is it a
security? Is it a commodity? As some migrate, is it, really,
even a currency?
I am encouraged by the work of FSOC to try to bridge that
understanding. Our office is working to help provide clarity as
to where those lines should be drawn. Because there isn't
clarity in law or it has certainly been tested.
In one of the ways it has been tested is with SAFTs which
is--let me get the correct piece of this acronym. Are you
familiar with this acronym?
Mr. Hinman. I am, a Simple Agreement for a Future Token.
Mr. Davidson. Right, there you go. So, this is a--because
there is no guarantee that there are future profits to the
holder of the token. The token would simply be able to be
traded at some point.
Currently, the investment wouldn't necessarily have a lot
of value. But at some point it may and then, therefore the
token, even in the early stages, would be able to be exchanged.
What is your assessment of the path on SAFT?
Mr. Hinman. The number of folks who have tried to raise
funds through the SAFT technique have an interesting idea. They
say that they will eventually have a network on which this
token may be used. If that network is developed, the token may
have more value than it does on day 1.
People who are buying into those agreements are hoping that
that happens, that those developers and other parties are
actually able to do that.
So, you have all the hallmarks there. You have, I am
getting money to the person who is getting me the SAFT. I hope
that they will develop this network and that it will have more
value and give me a return.
So, in early days, before that network exists and before
that token has real utility, it probably is a security.
In theory, there may be a time when the people, the
developers go away. What you have is a token that can be used.
To use your Howey analogy.
In the Howey case, you had a developer putting together
this orange grove, tending to it and making it work and selling
interest in it.
The court viewed that as an investment contract, because
this developer knew how this was going to progress. He had more
information about it than the people he was selling the
contract to.
Someday, in theory, he could have gone away. People could
have come in and tended to their groves themselves or parties
that participate in these decentralized networks, their
equivalent could have tended to the grove and those oranges
probably wouldn't be securities.
I think that analogy somewhat works to say, at some point,
you may have a token that doesn't represent investment in the
efforts of others. In this case, the Howey Hill Service--
Mr. Davidson. Thank you.
As my time winds down, I would just say there is a clear
distinction there between jurisdiction in the SEC and the
commodities future trading Commission, I am glad FSOC is paying
attention to it as is our office. As you can tell, as is our
committee.
So, I look forward to future collaboration.
My time has expired and I yield.
Chairman Huizenga. The gentleman's time has expired.
Seeing now there are members on the other side, we will go
to Mr. Hill of Arkansas for 5 minutes.
Mr. Hill. Thank you, Chairman. I appreciate you testifying
today. Glad to have you before the panel and also glad that you
bring your years of private-sector experience and transactions
to the division. That is an important skillset. So, I
appreciate your public service.
In my nonpublic service, a lot of that time was spent
raising money for startup businesses and growth enterprises.
Frequently, that used the Reg D exemption for raising those
dollars.
A couple of things. On the issue of the definition of
accredited investor, I see in your testimony, the division is
considering recommending to the Commission proposed amendments
to expand the definition of accredited investor. So, I commend
you for that.
One of the most frequent frustrations, I think, in normal
506 Reg D-type offerings was that you could offer it to the
accredited investors and no more than 30, or whatever the
number was, nonaccredited investors.
But in point of fact, due to potential liability, very few
lawyers would allow their client to offer to so many
nonaccredited investors.
What I found time and time again, it is the inventor. It is
the scientist. It is the person with the PhD. It is a CPA. It
is somebody with a CFA. It is somebody who is a registered
broker dealer. Who wants to participate in the Reg D offering.
They certainly have the knowledge to do that, but they are
excluded due to the net worth test or income test.
So, is one of the things you are considering expanding the
definition for professional qualifications or expertise in a
particular area?
Mr. Hinman. It is. That expansion of the accredited
investor definition, updating it to include folks who may be
sophisticated but not meet financial tests. It is certainly
under consideration as one of the items that the Small Business
Forum observed as well.
As I mentioned earlier, we take those comments seriously.
Mr. Hill. Right.
Mr. Hinman. That is something we will be considering.
Mr. Hill. We have a lot of bipartisan support for that. I
appreciate Mr. Schweikert of Arizona being one of the leaders
in the House on that topic.
My colleague from Indiana was talking about 404, and I
really encourage you to--after the decade or so post-Sarbanes-
Oxley.
But, really, the Commission thinks differently about it. We
impose this internal control or regime that only maybe a
financial institution would have on every public enterprise,
regardless of business model and regardless of size with the
small cap exemption that you noted.
Really, I would love to see an economic cost benefit
analysis of who has benefited from that.
The purpose of it was that Arthur Andersen and Enron were
running a black box. The transparent internal control process
was bypassed and the shareholders couldn't determine what was
happening.
And, yet, 404 was fully present during AIG, I am sure. Some
would argue AIG was a black box.
So, I really think we ought to step back and see what is
the real benefit of this and how can it be customized by
industry or by size of business. Because I think it has
probably far exceeded its benefits and burdened, particularly,
our small-cap companies.
So, I do support expanding of the size exempt from 404.
I think another one of our industries that has perpetually
come to the Commission for an exemption is the small broker
dealer industry under 404 for a separate audit.
I wonder your views on if you would be supportive? That is
more of a regulatory issue for the Commission, but are you
supportive of some industries that are heavily regulated, like
a small B.D., small broker dealer, overseen by--of the
Commission from being exempt from 404? Permanently, although it
has been waived many times over the last decade.
Mr. Hinman. The application of some of these rules to the
broker dealer community is something that the Division of
Trading and Markets would be better suited to address.
So, I wouldn't want to jump into their space and I hope
they don't jump into mine.
Mr. Hill. Thank you for that.
You have also talked in your testimony about materiality.
It seems like there has been real mission creep out in public
reporting, and that we are getting beyond a materiality
standard.
Do you, as a--having practiced law for all these years and
helped many, many companies navigate the public process, do you
support a materiality standard for our public disclosures and
not going beyond that, unless a company wants to go beyond
that?
Mr. Hinman. If I understand your question correctly, I
think you are saying companies just need to disclose what is
material and that is it.
We do think that a number of the specific requirements that
are qualified by materiality, but which remind registrants to
describe parts of their business, to do certain disclosures
with respect to their results of operations, the MD&A, all,
again, qualified by materiality are helpful.
We think the issuers find that helpful to have the guidance
that gives them the sense of what are we, as the securities
laws experts, saying might be material.
But we do, in general, think that a materiality standard
should be applied to disclosures generally. We have a rule that
says even if we haven't hit something in our overall
requirements, please tell us what is material. In practice, I
always focus--
Mr. Hill. Thank you.
I yield back.
Chairman Huizenga. The gentleman's time has expired.
I see no further questions. I would like to thank our
witness today for your time and your expertise and your
attention to this.
The Chair notes that some Members may have additional
questions for this panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to these witnesses and to place their responses in the record.
Also, without objection, Members will have 5 legislative days
to submit extraneous materials to the Chair for inclusion in
the record.
I ask our witness to please respond as promptly as able. I
know I will be sending in a question regarding--plus. I will
just put you on notice on that one.
Again, thank you for your time, Mr. Hinman. We appreciate
it.
The hearing is adjourned.
[Whereupon, at 11:46 a.m., the subcommittee was adjourned.]
A P P E N D I X
April 26, 2018
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