[Senate Hearing 116-90]
[From the U.S. Government Publishing Office]
S. Hrg. 116-90
LEGISLATIVE PROPOSALS ON CAPITAL
FORMATION AND CORPORATE GOVERNANCE
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HEARING
BEFORE THE
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED SIXTEENTH CONGRESS
FIRST SESSION
ON
EXAMINING LEGISLATIVE PROPOSALS ON CAPITAL FORMATION AND CORPORATE
GOVERNANCE
__________
FEBRUARY 28, 2019
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Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
Available at: https: //www.govinfo.gov /
__________
U.S. GOVERNMENT PUBLISHING OFFICE
38-477 PDF WASHINGTON : 2020
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
MIKE CRAPO, Idaho, Chairman
RICHARD C. SHELBY, Alabama SHERROD BROWN, Ohio
PATRICK J. TOOMEY, Pennsylvania JACK REED, Rhode Island
TIM SCOTT, South Carolina ROBERT MENENDEZ, New Jersey
BEN SASSE, Nebraska JON TESTER, Montana
TOM COTTON, Arkansas MARK R. WARNER, Virginia
MIKE ROUNDS, South Dakota ELIZABETH WARREN, Massachusetts
DAVID PERDUE, Georgia BRIAN SCHATZ, Hawaii
THOM TILLIS, North Carolina CHRIS VAN HOLLEN, Maryland
JOHN KENNEDY, Louisiana CATHERINE CORTEZ MASTO, Nevada
MARTHA McSALLY, Arizona DOUG JONES, Alabama
JERRY MORAN, Kansas TINA SMITH, Minnesota
KEVIN CRAMER, North Dakota KYRSTEN SINEMA, Arizona
Gregg Richard, Staff Director
Joe Carapiet, Chief Counsel
Jen Deci, Professional Staff Member
Laura Swanson, Democratic Deputy Staff Director
Elisha Tuku, Democratic Chief Counsel
Dawn Ratliff, Chief Clerk
Cameron Ricker, Deputy Chief Clerk
Shelvin Simmons, IT Director
Charles J. Moffat, Hearing Clerk
Jim Crowell, Editor
(ii)
C O N T E N T S
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THURSDAY, FEBRUARY 28, 2019
Page
Opening statement of Chairman Crapo.............................. 1
Prepared statement........................................... 31
Opening statements, comments, or prepared statements of:
Senator Brown................................................ 2
Prepared statement....................................... 31
WITNESSES
Catherine Mott, CEO, BlueTree Capital............................ 4
Prepared statement........................................... 33
Responses to written questions of:
Chairman Crapo........................................... 109
Senator Sinema........................................... 109
Thomas Quaadman, Executive Vice President, Center for Capital
Markets Competitiveness, U.S. Chamber of Commerce.............. 6
Prepared statement........................................... 36
Responses to written questions of:
Chairman Crapo........................................... 111
Senator Brown............................................ 113
Heather Slavkin Corzo, Director of Capital Markets Policy, AFL-
CIO, and Senior Fellow, Americans for Financial Reform......... 7
Prepared statement........................................... 66
Responses to written questions of:
Senator Brown............................................ 114
Additional Material Supplied for the Record
Letters and statements to the Committee submitted by Chairman
Crapo and Senator Brown........................................ 115
(iii)
LEGISLATIVE PROPOSALS ON CAPITAL FORMATION AND CORPORATE GOVERNANCE
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THURSDAY, FEBRUARY 28, 2019
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:03 a.m. in room SD-538, Dirksen
Senate Office Building, Hon. Mike Crapo, Chairman of the
Committee, presiding.
OPENING STATEMENT OF CHAIRMAN MIKE CRAPO
Chairman Crapo. This hearing will come to order.
Today's hearing will focus on a number of legislative
proposals that encourage capital formation and improve
corporate governance.
It is my intent to collaborate with Senator Brown and other
Senators on this Committee to identify and advance legislative
proposals that achieve these goals.
While there are bills for consideration today that I have
previously expressed concerns with, as well as a number that
Senator Brown has stated concerns with, I believe this is the
fairest way to consider all of these legislative proposals that
remain outstanding from last Congress.
Last year, the Committee held three hearings on legislative
proposals related to capital formation, corporate governance,
and the proxy process.
We are considering all of those bills again today, but in
the context of identifying areas where we can find bipartisan
consensus in the new Congress.
A number of the bills previously considered had strong
bipartisan support.
For example, the HALOS Act, which allows more startups to
access the capital and knowledge of angel investor groups that
they need to grow, had seven bipartisan cosponsors, including
Senators Schatz, Toomey, and Tillis.
The Fair Investment Opportunities for Professional Experts
Act, which expands the definition of an accredited investor for
the purposes of participating in private offerings, had six
bipartisan cosponsors, including Senators Tillis, Toomey, and
Cortez Masto.
Six Members of this Committee--three Republican and three
Democrats--worked together to introduce the Corporate
Governance Fairness Act, an important step in this Committee's
discussion on the proxy process.
Senators Toomey, Menendez, and Rounds introduced the
Consumer Financial Choice and Capital Markets Protection Act, a
bill that provides more financing options for State and local
governments seeking to raise money.
It is my hope that we can build off this type of previous
momentum as we consider legislative action in this Congress.
We will also consider a number of provisions included in
last Congress' JOBS 3.0 bill, which passed the House of
Representatives with over 400 votes. These nonprudential
provisions largely passed out of the House Financial Services
Committee and the House by voice vote, indicating their strong
bipartisan support.
Today's hearing provides the Committee with the opportunity
to publicly discuss many of these JOBS Act provisions for the
first time in the Senate.
For example, the Family Office Technical Corrections Act
passed the House with a voice vote. This bill provides that
family offices and their family clients meeting certain
thresholds can be considered accredited investors that qualify
for various exemptions under the securities rules.
Senators Rounds and Moran introduced a bipartisan Senate
companion to the Options Markets Stability Act, which amends
capital rules to more accurately reflect exposure for centrally
cleared exchange-listed derivatives.
These bills and their underlying aims of encouraging
capital formation and improving corporate governance require
collaboration between Congress and the SEC.
I commend the SEC and Chairman Clayton for their ongoing
work on a number of the issues we will discuss here today.
For example, last fall, the SEC conducted a staff
roundtable on the proxy process and rules, and I encourage them
to take action with the information they gathered.
It is time to re-examine the standards of inclusion of
proposals pursuing environmental, social, or political agendas
and ensure the fiduciary focus throughout the proxy process
reflects the economic interest of retail investors.
Last week, the SEC announced that it is considering
expanding its ``test-the-waters'' process beyond emerging
growth companies to all companies as they determine whether to
seek an IPO.
Senators Tillis and Van Hollen introduced the Encouraging
Public Offerings Act last Congress which requires the SEC to do
just that.
I share Chairman Clayton's goal of making it easier and
more appealing for companies to go public and will continue to
work with the SEC to advance this effort.
I look forward to hearing from our witnesses on these
legislative proposals and working with Members of the Committee
to identify areas where we can get bipartisan support.
Senator Brown.
OPENING STATEMENT OF SENATOR SHERROD BROWN
Senator Brown. Thank you, Mr. Chairman, and welcome to all
three of our witnesses. Thank you for joining us.
We are discussing legislation that a number of Members, as
Chairman Crapo said, worked on in the last Congress.
We need to look at these bills--and any bills that come
before this Committee--with one question in mind: Are they good
for workers? Do they contribute to the dignity of work? Or are
they just good for Wall Street?
Last year when we considered many of these bills, I asked
whether any of the previous efforts to roll back securities
laws had boosted investment in workers or created more jobs, if
our enforcement efforts were keeping up with fraud, and if
shareholders' ability to hold management accountable was under
attack. I still have those same questions.
When I look at the list of today's bills, I see a lot of
rollbacks and very little protection for ordinary investors.
When I hear some people say we need these bills to facilitate
capital formation, I am not really sure what problems they are
attempting to solve.
The capital markets worked pretty well last year: 2018 was
the best year for IPOs since 2014; biotech IPOs reached an all-
time record; venture capital investment also hit a record.
Market watchers expect 2019 to be even better. Household
names like Uber, Lyft, Pinterest, and AirBnB are planning to go
public.
Our time would be better spent making sure workers at
companies like Uber are getting the wages and the benefits they
have earned and are treated like real employees rather than
letting companies cut corners on their accounting controls.
And if we want to support American businesses, these
companies and the market overall would benefit more from
avoiding another Trump Government shutdown that closes the SEC
for a month than from passing all of these bills.
There are other bills that seek to make changes that
agencies are already working on. In one case, regulators
addressed the issue over 5 years ago.
A couple of the bills take controversial positions that
would undermine critical post-crisis reforms that keep our
financial system stable, and that would restrict the United
States' participation in international insurance regulation
discussions.
It is always the same story. Congress and the
Administration bend over backward to figure out how they can
make life just a little bit easier for Wall Street.
Instead, this Committee should look at how we can better
protect ordinary American investors who save for retirement. We
should be working on ideas to end Wall Street's shortsighted
obsession with short-term stock prices so that when companies
grow, their workers' wages actually grow along with them. A new
phenomenon, perhaps.
Earlier this month, 11 former SEC economists wrote to the
agency to say its proposed best interest rule, they said, had
``weak and incomplete'' economic analysis--that can have a real
impact on American families. That warning should be a red flag
for this Committee, and we should call on the SEC to explain.
Meanwhile, corporations announce more billion dollar stock
buybacks and cost-cutting that always have the same result:
more money for corporate executives, less money in workers'
paychecks--if they are lucky enough to keep their jobs at all.
Companies would rather engage in financial engineering than
they would investing in workers who make them successful.
Earlier this week, in this room in this Committee, Jay Powell,
the Chair of the Federal Reserve, told the Committee that
increasing investment in worker skills and training are vital
to our economy.
But what are corporations doing instead? Spending money on
buying their own stock back to line executives' pockets. The
Committee stands by and either does nothing, or some days we
make their work easier.
Some of the proposals we will discuss today, in fact, do
improve transparency. Senator Reed's bill would promote more
disclosure on cybersecurity. Senator Van Hollen's proposal
would require the SEC to consider ways to prevent trading
abuses by corporate insiders. These are improvements that help
investors and promote fairness--what this should be about.
I want to hear from our witnesses other areas where
transparency is possible, where we can do more to protect
consumers in an increasingly complex market, and hear what
risks are lurking out there that could cause another crisis and
cause more devastation for American families.
If we can focus on bills that make improvements in these
areas, workers will benefit, investors will help companies
grow, the financial system will be more stable, and the economy
will expand.
Thank you, Mr. Chairman.
Chairman Crapo. Thank you, Senator Brown.
Today's witnesses are: Ms. Catherine Mott, CEO of BlueTree
Capital and BlueTree Allied Angles; Mr. Thomas Quaadman,
Executive Vice President of the U.S. Chamber's Center for
Capital Markets Competitiveness; and Ms. Heather Slavkin Corzo,
Director of Capital Markets Policy of AFL-CIO and Senior Fellow
at Americans for Financial Reform.
To our witnesses, your written testimony has been entered
into the record, and we encourage you each to pay attention to
the 5-minute clock so we will have plenty of time for our
questions. And, again, I remind our Members on the Committee to
pay attention to your 5-minute clock as you do your questions.
With that, let us proceed and we will go in the order that
I introduced you.
STATEMENT OF CATHERINE MOTT, CEO, BlueTree CAPITAL
Ms. Mott. Good morning. Chairman Crapo, Ranking Member
Brown, and Members of the Committee, thank you for the
invitation to testify before you today. I am Catherine Mott,
Founder and CEO of BlueTree Capital and its affiliates BlueTree
Allied Angels and the BlueTree Venture Fund, all based in
Pittsburgh, Pennsylvania. I am past Chairman of the Angel
Capital Association, the Professional Association of Active
Accredited Investors Across North America.
I appreciate the opportunity to comment on legislative
proposals that would make it easier for entrepreneurs and
emerging companies to find the capital they need to maintain
their role as the engine of American economic growth. I applaud
the Committee for addressing these issues so early in this
Congress and for recognizing your critical role in increasing
economic growth.
Angel investors are accredited individuals who invest their
own money in early stage companies, helping them achieve
success. Angel investors support promising companies in every
State of the Nation. Angels invest approximately $25 billion
each year in more than 70,000 startups. Compared to venture
capitalists, angels invest in 15 times more businesses, albeit
smaller amounts across a greater number of companies.
Money, however, is not all angels invest. Angels provide
human capital. We invest our time, our expertise, mentorship,
and access to our networks.
The BlueTree entities have invested more than $50 million
in startup companies that meet our disciplined criteria.
BlueTree Allied Angels has 76 members, and we are currently
investing in a safety artificial intelligence company and a new
antibiotic company.
The Angel Capital Association represents more than 14,000
accredited angel investors like me and 260 angel groups,
individual angels, online platforms such as AngelList, and
family offices.
BlueTree and the other members of the Angel Capital
Association are glad to see the Committee return to two bills
that would clarify investment procedures and expand
opportunities for entrepreneurs and investors. These are the
Helping Angels Lead Our Startups Act and the Fair Investment
Opportunities for Professional Experts Act. Both are
bipartisan, commonsense proposals, and would produce immediate
benefits with no real risk to investors or the economy.
The HALOS Act would clarify that ``demo days'' are exempted
from the definition of ``general solicitation,'' eliminating
market confusion about these events and providing entrepreneurs
with better access to capital. While the JOBS Act created
general solicitation to allow entrepreneurs to raise capital
publicly for Reg D offerings--called ``506(c) offerings''--with
requirements for entrepreneurs to take additional steps to
verify that investors are accredited, the SEC did not modernize
its own definition of ``general solicitation.'' As a result,
that definition now effectively includes ``demo days,'' the
events in which entrepreneurs pitch their products and
companies to potential investors, local economic development
officials, academics, and other members of the startup
ecosystem.
The problem for entrepreneurs is that most accredited
investors are not interested in investing in generally
solicited offerings because the SEC ``safe harbors'' for
verification is a costly and onerous process. Consequently,
entrepreneurs are caught up in the legal conundrum,
inadvertently losing their opportunity to raise the capital
necessary to become a viable growing entity. Sophisticated
investors will not invest in 506(c) offerings.
On another note, the Fair Investment Opportunities for
Professional Experts Act would modernize the definition of
``accredited investor,'' which was last addressed in the Dodd-
Frank Act. The bill would codify the current income and net
worth thresholds for being considered an accredited investor,
eliminating regulatory discretion and providing much-needed
certainty to angel investors. The bill would also allow certain
people with other demonstrated expertise or credentials to
become accredited even if they do not meet the financial
thresholds.
These changes are commonsense ways to grow the pool of
accredited investors without risk or disruption. This is
especially important in Middle America--Pittsburgh, Ohio, Utah,
other areas--where the cost of living is lower and where
entrepreneurial activity is desperately needed for job creation
in areas devastated by losses in manufacturing.
Thank you again for taking up these legislative proposals.
Chairman Crapo. Thank you, Ms. Mott.
Mr. Quaadman.
STATEMENT OF THOMAS QUAADMAN, EXECUTIVE VICE PRESIDENT, CENTER
FOR CAPITAL MARKETS COMPETITIVENESS, U.S. CHAMBER OF COMMERCE
Mr. Quaadman. Thank you, Chairman Crapo, Ranking Member
Brown, Members of the Committee. Thank you for the opportunity
to testify before you today, and we appreciate the continued
bipartisan efforts of this Committee to address obstacles to
entrepreneurship and growth.
Business growth is a dynamic engine of American economic
prosperity and success. Launching a new business does not
guarantee an outcome, but it provides an owner, employees, and
their community with the chance to fulfill the American dream.
Laws, regulation, and oversight provide the certainty for
investors to provide the capital for those firms or, in other
words, the gas for that engine to operate.
If businesses are successful and can grow into a public
company, we all benefit. When a business goes public, it
reaches its apex for job creation, revenue growth, and wealth
distribution.
Of the 2,700 companies that went public between 1996 and
2010, they created 2.2 million jobs, and their revenue
increased by $1 trillion. Regional IPOs, which were predominant
in the 1980s and 1990s, those IPOs below $100 million,
distributed wealth to all the different pockets of our country.
Change is also dynamic for the companies who were in the
Fortune 500 in 2014--only 12 percent were listed there 50 years
earlier.
But, unfortunately, that engine is sputtering. Business
creation and destruction ratios inverted for the first time in
the 2008 financial crisis, stayed there for a protracted period
of time. While business creation has bumped back up, it is only
barely outpacing business destruction.
Fifty percent of the businesses created in the first part
of this decade were concentrated in 20 counties in the United
States, representing 17 percent of the population. Three-fifths
of the counties in the United States actually saw more
businesses go out of business than being created.
We have talked very often before about the fact that we
only have half the number of public companies today than we did
in 1996. The regional IPO does not exist anymore and, in fact,
the number of IPOs last year represented only half the historic
rate that we did in the 1980s and 1990s.
We need to have both strong private and public capital
markets in order to have our economy be successful, and they
need to have the policies to back them up. Proxy advisory firm
reform is needed so that investors have decision-useful
information grounded in economic return that will ultimately
benefit the American saver.
We appreciate the legislation introduced by Senators Reed,
Perdue, Tillis, Jones, and Kennedy. We have some suggested
changes with that, and we think we can work to make that bill
more effective.
The JOBS Act was important in arresting the decline of
public companies, but it has not produced a resurgence.
Legislation is needed to spark entrepreneurship. We need to be
able to tackle the continued vexing issues of limited liquidity
as well as a lack of public research. The lack of both of these
issues being addressed harms investment in emerging growth
companies.
We also agree that cybersecurity is a very important issue,
both for management and boards in public companies. We may
differ on some of the means in achieving that goal, but we look
forward to working with Senator Reed to find the common ground
to do just that.
Strong consumer protections are also needed. Unpaid FINRA
arbitration cases, while they are small in number, should be
addressed, and we think that SIPC is a better area to do that.
We also have concerns about insider trading. Insider
trading has no place in our capital markets. However, we are
concerned with a very broad remit to regulatory agencies to
address legal vagueness. We think that is actually a job for
Congress to tackle.
While competition was a good thing, we are losing our
ability to address these policy issues. Chinese venture capital
is now larger than American venture capital. The Hong Kong
Stock Exchange last year had more IPO activity than individual
U.S. exchanges. And, furthermore, the EU MiFID II rules have
now set the standard for research globally. In other words, our
international competitors are solving the issues of limited
liquidity as well as a lack of research.
In conclusion, let me just say that we need to address
these issues in order for our economy to be able to provide for
this and succeeding generations. The imperative to act is
critical now more than ever as we are losing the luxury of time
as well as a limiting of options to address these issues.
Thank you, and I am happy to take any questions you have.
Chairman Crapo. Thank you, Mr. Quaadman.
Ms. Slavkin Corzo.
STATEMENT OF HEATHER SLAVKIN CORZO, DIRECTOR OF CAPITAL MARKETS
POLICY, AFL-CIO, AND SENIOR FELLOW, AMERICANS FOR FINANCIAL
REFORM
Ms. Slavkin Corzo. Chairman Crapo, Ranking Member Brown,
and Members of the Committee, thank you for the opportunity to
testify today. My name is Heather Slavkin Corzo, and I am the
Director of Capital Markets Policy for the AFL-CIO and a Senior
Fellow at Americans for Financial Reform.
The AFL-CIO and AFR work on behalf of millions of people to
promote policies that create a safe, sound, and stable economy
that helps all Americans achieve economic stability.
Today the Committee will consider dozens of bills. It would
be impossible to discuss each one. Instead, I will say that, as
a general principle, public policy should promote fair,
transparent, and stable markets; facilitate regulatory
enforcement; and encourage shareholder engagement. One set of
bills being considered today moves away from that standard, a
few are neutral, and a handful are positive steps.
None of the pieces of legislation under consideration,
however, represents the type of material change that is needed
to create an economy that works for working people. This
Committee can move policies to end financial activities that
undermine the well-being of everyday Americans. Today I will
discuss a handful of opportunities.
Private equity. Working people are exposed to private
equity as employees, investors, and participants in the
American economy. PE-owned companies employ nearly 5 million
Americans. When these companies fail, workers often lose their
jobs, benefits, and retirement plans.
In addition, U.S. pension funds collectively have more than
$800 billion invested in private equity. Unfortunately, the
opacity, illiquidity, and high fees associated with PE add to
the risks of the investment and make it difficult to achieve
returns that justify those risks. The minimum reporting and
examination requirements instituted by Dodd-Frank revealed an
industry where abusive practices toward investors were
commonplace.
Finally, in the past 5 years, the value of outstanding
leverages loans has nearly doubled to $1.5 trillion. Regulators
in the United States and around the world have begun raising
alarms that the market could create systemic risk. The private
equity model exists and is remarkably profitable due to a
series of loopholes and carveouts in securities, bankruptcy,
and tax law. There is no public interest reason to provide
these benefits. In fact, I would argue that the public interest
demands that policymakers eliminate regulatory and legal
privileges that feed abusive LBOs and encouraged the Committee
to consider this set of issues.
Short-termism. Increasing public attention has focused on
how financial markets actors pressure businesses to focus on
short-term returns and financial engineering instead of long-
term competitiveness and contribution to the real economy.
Short-termism also disincentivizes attention to long-term but
potentially catastrophic implications of their activities such
as climate change and economic inequality which are, in fact,
key to long-term economic performance. Stock buybacks are a
prime example. The 2017 Tax Cuts and Jobs Act hyper-charged the
already worrisome practice of stock buybacks, and in 2018,
companies spent more than $1 trillion buying back their own
stock. Multiple policy changes have been put forward to limit
buybacks, and I encourage the Committee to dedicate more
attention to these issues.
And, finally, too big to fail. The largest banks in the
United States have gotten larger since the 2008 financial
crisis. Now these banks have a combined $10.6 trillion in
assets. Aspects of Dodd-Frank were aimed at limiting risks
within these institutions and preventing the need for future
bailouts. Unfortunately, it remains very difficult to envision
how one or more of these institutions could fail without
threatening U.S. and global economic stability. It does not
have to be this way. Congress must pass legislation to reduce
the size and complexity of our largest banks so that they could
fail without threatening economic stability.
In conclusion, I urge this Committee to advance policies
that will end financial activities that undermine the well-
being of working Americans, and to ensure sound implementation
of Congress' mandates, the Committee must fill the empty
commission slots at the SEC and other regulatory agencies to
bring credibility to the regulatory process. I encourage you
all to turn your attention to these priorities.
Thank you, and I look forward to questions.
Senator Brown. [Presiding.] Thank you, Ms. Slavkin Corzo.
Thank you to all three of you.
Ms. Slavkin Corzo, I would like to start with you. The Wall
Street Reform Act required private equity fund managers to
register with the SEC. The agency found widespread conflicts of
interest, excessive fees and other abuses. Companies and
workers clearly have paid the price.
The question is: What more can be done to increase
transparency into private equity funds and the companies they
own so that pension funds and other large investors and workers
in communities can better understand how funds and companies
are run and the risks that they pose?
Ms. Slavkin Corzo. Thank you, Senator. I agree it is a
travesty that there are private investment funds in this market
that control trillions of dollars in assets and employ millions
of workers, but there is no transparency into the activities
that would allow the investors and the employees to understand
the risks that they are exposed to as a result of this
strategy. I am really eager for the opportunity to talk to you
all in more detail about policies that could be promoted to
address these issues.
One thing that immediately comes to mind is currently
private equity funds, as you indicated, are required to
register with the Securities and Exchange Commission. There are
two types of disclosure that they provide on Form PF and
through the Form ADV. And the SEC has the opportunity to expand
those disclosure obligations in ways that would provide more
information to regulators and investors.
Senator Brown. Thank you. And if you would provide to the
Committee any other thoughts you have on supporting legislation
out there, ideas that you have on increasing transparency, in
writing to the Committee, if you could do that.
Another question for you. You mentioned stock buyback
announcements setting a record, exceeding $1 trillion. Bank of
America says this year companies are on track for another
record. Could you explain why companies choose buybacks instead
of investing in workers or investing in business expansion?
Ms. Slavkin Corzo. We have seen a move in our economy
toward an excessive focus on short-term financial performance
as opposed to long-term economic growth and growth of the
company. This has happened in concert with a dramatic increase
in the extent to which executive compensation is paid in the
form of stock. So there is certainly a personal interest on
behalf of the people who are making decisions to engage in
stock buybacks in creating short-term boosts in stock prices.
This is something that is a serious concern from the
investor perspective and from the worker perspective. If we
think about the typical investor, the typical retail investor
is someone who is saving for their retirement. We are
diversified, long-term investors who are not really invested in
the performance of a single company. We are invested in the
broader economy. And when we see individual companies engaging
in practices that undermine their ability to perform and create
products and services over the long term that will allow the
business and the economy to grow, we are undermining the
ability of investors to save for their retirement in a way that
will be able to achieve the returns that we need.
In addition to that, it has dramatic negative implications
for workers. One example of this is Walmart. There was an
analysis that if Walmart had dedicated the $10 million that it
had dedicated last year to stock buybacks instead to increases
in workers' wage, the typical Walmart worker would have made an
additional $5.66 an hour. So this is a direct negative impact
on the income of American workers.
Senator Brown. Five dollars and sixty-six an hour is the
equivalent of $10 billion in stock buybacks?
Ms. Slavkin Corzo. Ten billion, yes, spread evenly across
the company.
Senator Brown. Thank you.
Mr. Quaadman, do you think the Trump shutdown that closed
the SEC for 5 weeks was a negative for IPO markets?
Mr. Quaadman. Well, we were expecting a very active IPO
market this year. Obviously, those 30 days did not allow for
companies to get the regulatory certainty or questions answered
that they needed to, so that does create a little bit of a blip
in that IPO market, and I believe there were no IPOs in
January.
Senator Brown. So it sounds like a little more than a blip.
I mean, it clearly--Government doing that during the Trump
shutdown was bad for investor confidence and hurts enforcement
efforts. It should not put savers at risk. I think it also
speaks to the issue of how important it is to make the SEC and
the CFTC self-funded so that the watchdogs are always on the
job. Comments on that?
Mr. Quaadman. We have concerns about self-funding. We do
agree that there should not have been a shutdown, and we do
believe that there should be increased funding for both of
those agencies as well.
Senator Brown. Well, one way to ensure that would be self-
funding.
Senator Toomey.
Senator Toomey. Thank you very much, Mr. Ranking Member.
Welcome, witnesses.
First, Mr. Quaadman, just a couple of thoughts on stock
buybacks. Isn't it true that in the last year or so, we have
seen an increase in stock buybacks, and we have also at the
same time seen a very big increase in capital expenditures by
business?
Mr. Quaadman. Capital expenditures have gone up. We are
seeing R&D spending last year being the highest that it had
ever been. Additionally, companies also gave workers bonuses as
well.
Senator Toomey. Right. And isn't it also true that while
stock buybacks have been occurring, we have seen an
acceleration in wage growth and that that acceleration in wage
growth has been more pronounced at the low end of the wage
spectrum than any other part of the wage spectrum?
Mr. Quaadman. That is correct. There are retailers,
including Walmart, that increased hourly wages for their
employees. And I would also just say, too, just in terms of
stock buybacks, if you do not like stock buybacks, you do not
like dividends. They are both providing return to their
investors.
Senator Toomey. Fundamentally, if a management team does
not believe it has attractive investment opportunities, doesn't
it have an obligation to return excess capital to the people
who own that company, who then typically invest in another
opportunity to grow the economy, to make more investments, to
hire more workers?
Mr. Quaadman. It provides for a more efficient allocation
of capital. That is correct.
Senator Toomey. Thank you.
I want to make a quick comment. First of all, I want to
thank the Chairman in absentia for having this hearing and for
working on a number of really constructive regulatory reform
measures, I think every one of which or certainly most of which
passed the House and were not even controversial. A bipartisan
bill that I have with Senators Menendez, Peters, and Rounds
from the last Congress that I intend to reintroduce deals with
the regulatory treatment of money market funds. I would just
remind my colleagues money market funds are a critical source
of short-term financing from municipalities, States, business,
attractive both to investors and borrowers.
The SEC imposed a very stringent wave of regulations in
2010, another entire wave of regulations in 2014, and one of
those regulations in 2014 is particularly problematic,
forbidding institutional prime and tax-exempt money market
funds from having a stable net asset value. So our bipartisan
legislation, which had companion legislation in the House,
would remedy that. We heard testimony at this Committee last
year from Christopher Daniel, the CIO of Albuquerque, New
Mexico, that tax-exempt money market fund assets are down
nearly 50 percent as a result of this regulation, and the
result of that is municipalities are forced to issue more
expensive debt. It has raised the cost of financing America's
municipalities.
So I am looking forward to working with my colleagues on
both sides of the aisle who have been supportive of this really
sensible regulatory reform.
I want to quickly mention an adverse effect of the SEC's
acquired fund fees expenses rule on BDCs. BDCs, of course, have
become a really important source of capital for small and
growing companies, and it is my view that the application of
the SEC's acquired fund fees has a particularly adverse impact
on BDCs that is inappropriate.
Mr. Quaadman, a quick question for you. The way that this
rule affects BDCs strikes me as inappropriate because the share
trading price of the BDC already reflects the expenses that are
paid. And it is my understanding that there has been a negative
implication on institutional ownership of BDCs as a result.
Is that your view? And do you think this is something we
should address?
Mr. Quaadman. Senator Toomey, we share your concerns and do
think that this needs to be addressed. BDCs primarily,
especially since the financial crisis, have become a very
important source of funding for new businesses as well as
existing businesses. The AFFE proposal we think is a good one,
but there has been a mismatch between--with BDCs not being
exempt from that rule because, as you said, there is already
transparency as to what those costs are.
This has actually also caused BDCs to be removed from some
indexes, which have actually hurt their ability to provide for
investors and to provide capital formation funding as well. So
we think this should be addressed by the SEC.
Senator Toomey. Thank you very much. I look forward to
working with you on that.
My last point is on the HALOS Act, again, bipartisan
legislation in the last Congress that I introduced with
Senators Murphy, Thune, Schatz, Heitkamp. I expect to introduce
it again. I look forward to working with Senator Sinema, who
was a champion of this legislation in the House.
I would like to pose a quick question to my constituent,
Ms. Mott. Welcome. Great to see you. I am so glad you could
join us. I just would like for you to clarify this, if you
could. Isn't it true that there is nothing in the HALOS Act
that would allow non-accredited investors to invest in
companies that participate in demo days? Isn't it true that you
would still have to be an accredited investor in order to make
an investment?
Ms. Mott. Thank you, Senator. Yes, it is true. And if I
have a minute here to talk as a practitioner that has been in
the market for about 15 years, prior to the JOBS Act and
506(c), demo days were an ordinary part of the ecosystem.
506(c) was created, and, you know, it became--a lot of
confusion occurred because of the term ``general
solicitation.'' And so to continue demo days, legal counsel
post-506(c) started advising entrepreneurs to register as
506(c) offering just to be safe, and that meant that, just in
case, because this may fall into general solicitation, this
will default to 506(c).
Sophisticated investors have trouble with that because
506(c) offerings require the entrepreneurs to confirm that the
investors are accredited, and it only lasts for 3 months.
Sophisticated angel investors are working on establishing a
portfolio of startup companies. All the principles you apply to
your public portfolio you apply to your private portfolio as
well. And so that would require sophisticated investors who are
looking at acquiring 18 to 36 companies in their portfolio to
go through this process four times a year for approximately 5
years.
So investors pulled back. When they did that, legal counsel
started advising demo days, saying, OK, do not talk about your
financials, do not talk about the financial terms, do not talk
about your financial strategy. Once again, entrepreneurs are
disadvantaged because investors are evaluating the business and
the growth strategy. And if they do not have the opportunity to
talk about the financials, there is no way that can be
assessed. So they have one arm tied behind their back. And this
becomes, you know, inefficient. And what the HALOS Act does is
it now makes the market an effective market, and they can still
raise money. But they are only going to raise money with people
who are accredited.
Senator Brown. OK. Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman. Thank you all
for your testimony.
Corporate America has a diversity problem. Boards and
executive offices across the United States do not look like the
people of this country. I have conducted four surveys focused
on Fortune 100 companies since 2010. My latest survey revealed
that, since 2010, women and people of color have only made
marginal gains in representation on corporate boards.
Women have made the greatest gains, but only by about a 5-
percent increase in the number of board seats they occupy. And
to put that in perspective, in 2017 I found that women
represented 24.5 percent of corporate board members, and yet
they are half of the population.
People of color represent fewer than 21 percent of
corporate directors, with women of color representing only 5.6
percent of those directors. This lack of representation is
simply unacceptable.
I was originally hopeful that the SEC would help address
this problem through its 2009 Diversity Disclosure Rule.
Unfortunately, the 2009 rule failed to even define diversity,
and it gives companies far too much discretion on what they
report.
That is why I am pleased to introduce a bill with
Representative Meeks to improve the SEC rule earlier this year.
My legislation, S. 360, the Improving Corporate Governance
through Diversity Act, requires public companies to disclose
specific information related to the racial, gender, ethnic
makeup, and veteran status of corporate boards and senior
management to the SEC. My bill will increase corporate
transparency, allow investors to gain better insight into board
makeup, and any policies in place to promote diversity among
the board and senior management.
Now, from my view, corporate diversity is not just morally
right. Corporate diversity makes financial sense. McKinsey &
Company studies have consistently found that greater diversity
on executive teams has led to greater profitability. The need
for increased corporate diversity is not an act of benevolence
but a necessity for businesses looking to compete in a diverse
21st century America.
So with that as a predicate, Ms. Slavkin Corzo, how does
disclosing specific details about corporate board diversity,
racial, gender, and otherwise, help investors in making
informed investment and voting decisions?
Ms. Slavkin Corzo. Thank you, Senator. You know, from an
investor perspective, we look at U.S. businesses, and we know
that they operate in complex and very diverse ecosystems. And
in order for senior management to be able to respond to
consumer demand and to manage their very diverse workforces,
they need to be led by people who understand the interests of
those populations.
And so from an investor perspective, when we see a lack of
diversity in the corporate boardroom, we understand that the
leadership is not bringing a complete understanding of the
markets in which they operate and the employees that they are
trying to manage into their day-to-day decisionmaking. And as
you referenced, there is emerging data that we are seeing come
out regularly that shows that more diversity actually
contributes to better investment performance. So it makes
financial sense.
Senator Menendez. Mr. Quaadman, I am pleased to have the
endorsement of the U.S. Chamber of Commerce on my legislation,
and that is maybe a first for me. But we are always happy to
find ways to work together on that 360.
Mr. Quaadman. Sure.
Senator Menendez. Can you talk about the benefits of--and I
know Senator Warner's ears perked up--enhanced transparency
regarding the specific makeup of corporate boards and how
companies select board members and senior management?
Mr. Quaadman. Sure. Thank you, Senator Menendez, for your
leadership on this issue, and we appreciate the bill and our
ability to work with you on that.
We believe it is very important for boards as well as
senior management to reflect their employee base, their
consumer base, and that it is also very important to have a
diversity of background and thought within the boardroom.
We do believe that business has been--some businesses have
done a very good job in addressing these issues. Others have
been very slow. We actually worked with Carolyn Maloney back in
2016 on her gender diversity bill and strongly supported that.
We also think that your bill in terms of collecting of best
practices as well as some of the transparency and disclosure
procedures not only will allow investors to better understand
what is going on but also to help ensure that other companies
that have been maybe a little slower in addressing these
problems can be put on a track to solving these issues.
Senator Menendez. Well, I appreciate that. Just taking one
dimension of this, with the Hispanic community the largest
minority in the Nation, a trillion-plus domestic marketplace
spending, younger by a decade than the rest of the American
population, more brand-loyal than any other group in America, I
would like to be on them like white on rice if I was selling a
product or a service, not because of my, you know, desires to
do the right thing, but it is just the right economic thing.
And you know how to penetrate those markets better when, in
fact, you have people diverse on the board who can give you
insights into that market.
Last, on a separate note, I would just like to briefly
state that I am concerned about one of the bills under
consideration today, H.R. 4537. The bill's language dilutes our
U.S. negotiators' ability to work in international settings to
support and defend our State-based system of regulation as
international insurance standards are being developed. We
should be at the negotiating table in as strong a stance as
possible, so I would not support language restricting any
leverage we might have without other international players.
Thank you, Mr. Chairman.
Senator Brown. Senator Rounds.
Senator Rounds. Thank you, sir.
First, I would like to acknowledge and thank the Chairman
for holding this hearing. I think it is critical for us to do
everything in our power to enable America's entrepreneurs and
job creators to succeed.
Before I begin my questions, I wanted to take a moment to
address two bills that I think would have been appropriate to
address at today's hearing but that are not on the agenda at
this time.
First is the Financial Stability Oversight Council
Improvement Act. I am proud to be reintroducing this
legislation today with Senators Jones, Sinema, and Tillis. It
makes a small addition to the SIFI designation process by
giving companies the opportunity to submit a written mitigation
plan before designation.
The second item is the Alleviating Stress Test Burdens to
Help Investors Act. This legislation would make commonsense
changes to the stress testing process for nonbank financial
companies. Last Congress, it received near unanimous support in
the House, with 395 votes, including the entire House
Democratic leadership.
With that said, I would like to turn to one of the current
bills under consideration: the Options Market Stability Act.
Mr. Quaadman, as you are aware, the goal of the legislation is
to promote liquidity in options markets by making capital
requirements risk-sensitive. Options are a critical tool used
to balance risk, and liquidity in option markets is an
important protection for all investors, particularly during
times of turbulence.
What are the drawbacks to not moving to a risk-weighted
system, in your opinion, sir?
Mr. Quaadman. Senator Rounds, first off, thank you for both
your leadership on the FSOC and stress test issues. Those are
very important for capital markets.
I would say that the options legislation is extremely
important. One is because it allows for netting, which will
actually provide for more transparency and insight as to the
positions of financial institutions with options and other
instruments. So we actually think that will provide investors
with a greater insight as to those positions and risks and to
be able to make better informed decisions on them.
Senator Rounds. Thank you.
Once again, Mr. Quaadman, unfortunately, my time is going
to be limited, so I am wondering if you could briefly address
four other bills that we sponsored: the Modernizing Disclosures
for Investors Act, the Developing and Empowering Our Aspiring
Leaders Act, the Improving Investment Research for Small and
Emerging Issuers Act, and the Investment Advisory Regulatory
Flexibility Improvement Act. Each of these bills would make a
small yet meaningful change in how the investors choose where
to allocate capital or how small companies raise money and
provide investment advice.
How important are the kinds of investors and institutions
that are impacted by each of these bills to our broader
economy? And how important is the relief that we are seeking to
provide to them?
Mr. Quaadman. So in the interest of time, let me treat them
globally. I think these are four bills that provide for tweaks
to different provisions that will effectively allow for more
efficient deployment of capital, allow for investors who can
invest--allow for more investors to invest in companies that
maybe they cannot do so far, and also allow for companies to
have a better way of interacting with their investors.
So each of these are very small tweaks. I think there has
been frustration in the past on some of these issues where the
SEC could have proactively addressed some of these issues. I
would actually say that Jay Clayton and his leadership of the
SEC has been very much in the forefront on this. But I do think
particularly here it is very important for Congress to set the
policy parameters and then have the SEC fill in the details
later on. So these are very important provisions.
Senator Rounds. Thank you.
Can you also speak to the costs and benefits associated
with modifying short-selling regulations if legislation like
the Brokaw Act was to be signed into law?
Mr. Quaadman. We have some very significant concerns there
that the costs could actually outweigh the benefits. We have
strongly supported disclosures around short selling,
particularly with naked short selling that the SEC moved on in
2010. However, we also have to understand, too, that short
selling is a very important part of an efficient capital
market. You can take a short position because you think a
company is not doing well. You can take a short position in
order to hedge a long position. But there are some who actually
take a short position then to also engage in distortion to
drive the company to the place where they want to.
What I think the Brokaw Act does, which I think is well
intentioned, is it does not allow for an understanding of what
the intent is of that short seller, so that it can actually
create dislocations in the market that can be helpful to the
overall investor community.
So we think that it is probably better off if the SEC were
to do a study of what some of the problems are, report back to
Congress, and then we can see moving forward what the right
solutions are to those problems.
Senator Rounds. Thank you.
Thank you, Mr. Chairman.
Chairman Crapo. [Presiding.] Thank you, Senator Rounds. And
before I go to Senator Cortez Masto, I want to just explain to
the witnesses. I apologize. I had to step out. I had a critical
vote in the Judiciary Committee that I had to be there for, so
I apologize I missed some of your--the finish of your
testimony, Ms. Slavkin Corzo, and then some of the answers to
the questions.
Senator Cortez Masto.
Senator Cortez Masto. Thank you. Thank you, Mr. Chair.
Thank you all for being here. I really appreciate the
conversation this morning.
Let me start with Ms. Corzo because I am hoping you are
going to help me clarify this. I, too, have concerns about
private equity firm acquisitions by utilizing LBOs and what we
are seeing in the increase of that debt. But you make this
statement that these private equity firms employ millions of
workers. Let us put that in perspective, because I know in
Nevada we have lost a number of businesses from leveraged
buyout. That is Mervyn's, Toys ``R'' Us. You talked a little
bit about Toys ``R'' Us in your statement. If you could help
us, put that in perspective what that means when there is high
debt, a leveraged buyout comes out. What does that mean for
workers? And how do workers potentially lose their jobs? And we
are talking about the workers at these companies, not workers
that actually work for the private equity firm, but we are
talking about workers at Toys ``R'' Us or Mervyn's where these
companies are acquired by the private equity firm. So do you
mind kind of talking about those concerns?
Ms. Slavkin Corzo. Sure, thank you. So the way that private
equity firms typically operate is that they have money that
they raise from outside investors, and they collect money that
is pooled to be the fund, the ``dry powder,'' as it is
sometimes called. And then once that money is raised, they go
out and identify portfolio companies which are operating
companies that have millions, 5 million employees aggregated
throughout the economy.
The way that the leveraged buyout then works is they use a
little bit of cash that comes from investors and an even
smaller amount, on average 1 to 3 percent, from the general
partners to purchase a company, and then a bunch of debt, up to
70 percent, sometimes higher, that sits on the books of the
operating company, the portfolio company.
So with Toys ``R'' Us as an example, the company was bought
using a little bit of outside money and then debt that Toys
``R'' Us was responsible for servicing, for paying back over
time.
Senator Cortez Masto. So its typical--and in your
statement, you talk about this excessive leverage. Its typical
buyout, around 30 percent of the purchase price is paid as
equity or cash and 70 percent is debt financing, right?
Ms. Slavkin Corzo. Yes.
Senator Cortez Masto. And so then that company, say Toys
``R'' Us, is now responsible for starting to pay down that
debt. The private equity company does not have to worry about
it. Now the burden is on the company. And does that then start
a cycle of now that money going toward debt, a decrease in
maybe wages to employees to pay for it, a decrease now in money
coming in for profit to allow the company to continue to
operate, and now we are looking toward potential bankruptcy for
that company.
Ms. Slavkin Corzo. Exactly.
Senator Cortez Masto. Now, is that consistent, is that what
you are seeing more of in the marketplace now?
Ms. Slavkin Corzo. That is what we are seeing, and, you
know, we are in a relatively easy credit environment right now.
One of the things that my testimony does talk about is some
analysis that has been done that is specific to the supermarket
industry, where they found that, I believe it was, seven
supermarket chains that have failed in the last few years, all
of them private equity owned. And when you compare that to the
performance of nonprivate-equity-owned businesses, they tend to
be doing quite a bit better.
We are, though, as I said, in a pretty easy credit market,
and so one of the things that we are starting to see regulators
around the world--and Janet Yellen was actually quoted last
fall talking about this--is this concern that while--as is the
case with all businesses, it is a lot easier to maintain your
debt payments when the economy is doing well. But if we see an
economic downturn happen, it becomes much more difficult, and
now you have got $1.15 trillion in outstanding leveraged loan
that can go back, causing potentially systemic consequences.
And then from the perspective of the employees of the
individual business, if your employer goes bankrupt, you are
out of work.
Senator Cortez Masto. Right.
Ms. Slavkin Corzo. And we often see employers using that
bankruptcy process as a way to shed pension liabilities and
other benefits that the workers had counted on and put in many
years of service in order to earn.
Senator Cortez Masto. Do any of the bills that are before
us today address this issue and bring transparency or
accountability or disclosure of what is going on here?
Ms. Slavkin Corzo. They do not.
Senator Cortez Masto. And to that matter, should the SEC
require disclosure of all fees that are paid to private equity
firms that are by the firms--by the firms that the PE owns? In
other words, private equity firms own some companies, and some
of those fees are being paid out to those companies owned by
the PEs, and investors do not even know about that. Is that
correct?
Ms. Slavkin Corzo. Yeah, there is a large array of
transparency failures that exist within the private equity
market, and particularly in terms of fees and expenses that are
paid by the portfolio companies to the management companies,
and also by the investors to the general partners. And so one
of the things that is extremely challenging for investors is
that, first of all, there is not adequate disclosure of fees.
It is not being disclosed in a uniform format so they are able
to compare it. And the same goes for the performance of the
fund. And so it is very difficult to get clear, accurate data
on what the performance is net of fees, which is something that
an investor needs in order to make an informed investment
decision.
Senator Cortez Masto. Thank you. I notice my time is up.
Thank you all for being here.
Chairman Crapo. Thank you.
Senator Tillis.
Senator Tillis. Thank you, Mr. Chairman. Thank you all for
being here.
Mr. Quaadman, I want to actually start with something
that--we have put forth a bill--or there was a bill put forth
last year, the Corporate Governance Fairness Act, that did not
make it into law, but we took action within our office on some
of the no-action letters with the SEC. I know that you have
written about that. Why do you think that was a good idea?
Mr. Quaadman. So, first, the SEC historically has not
provided any oversight over proxy advisory firms. They did
issue guidance in 2014. The withdrawal of the no-action letters
was important because those two no-action letters which date
back to 2005 effectively did two things. One is they told the
proxy advisory firms, ``You do not have to disclose any
conflicts of interest to your clients.'' The second letter
effectively said to the clients, ``You do not have to ask about
conflicts of interest, and you can really on that advice
anyway.''
Senator Tillis. What would be the case for allowing that?
We just thought it did not make any sense. That is why we took
action with the SEC. But what would be the rational basis for
the no-action letters?
Mr. Quaadman. We agree with your position that it does not
make sense. However, the thinking was----
Senator Tillis. I am trying to figure out what the argument
would be for the other side, how you would get there.
Mr. Quaadman. The argument for the other side was that you
have--you only have effectively two advisory firms, but you
have institutional investors that are invested in thousands of
companies and, therefore, they are really going to have to rely
on the advisory firms to do so.
Now, if you take a look at Vanguard, BlackRock, et cetera,
they actually have independent analyses units that do that, but
some of the smaller ones do not. And that has actually provided
a portal for those smaller institutional investors just to do
what is known as robo-voting, which they just follow blindly
what ISS and Glass Lewis come up with.
Senator Tillis. Just briefly, I know that the legislative
fix, the Corporate Governance Fairness Act, you did express
some concern--you like the direction, but I believe you
expressed some concern over changes that you would suggest. Can
you briefly describe those? Then I want to go to Ms. Mott.
Mr. Quaadman. Yeah, very quickly, we think that there
should be some language in there specifically about regulation
of conflicts. We also think that there should be some
recognition of linking the fiduciary duty--the advice to the
fiduciary duty of the investors as well, as well as a process
to allow for not only companies but others to be able to have
some transparency as to how the recommendations are made.
Senator Tillis. Thank you.
Ms. Mott, we had the bill Fair Investment Opportunities for
Professional Experts Act in the last Congress, and we are
trying to work to get bipartisan support to reintroduce that
bill. Can you briefly explain to me why you think that is a
good idea?
Ms. Mott. Thank you, Senator, for asking that. I guess
primarily because this impacts Middle America more than it does
the west coast or the east coast, there is plentiful money in
the Silicon Valley and Boston and New York. Primarily startups
are being funded by angel investors, and an angel investor
making $200,000 a year, which is the current standard, is
equivalent to making 450 in New York. If your net worth is a
million in Middle America, it is probably 2.3 or 3 million in
New York or Boston. So raising the accreditation standards or
the accredited criteria only hurts Middle America where we need
the jobs the most. It is a lower cost of living so our money
goes further. We can withstand the losses, so it only makes
common sense, let us not hurt Middle America where we need the
jobs the most.
Senator Tillis. Thank you.
Mr. Quaadman, in my remaining time, first, I want to thank
Senator Van Hollen for going on the Encouraging Public
Offerings Act. I appreciated it the last Congress and re-upping
this Congress. I would like in my remaining time and within the
time limits with respect to the Chair, give me an idea why you
think that is a good idea.
Mr. Quaadman. We think that is important legislation, that
it will allow for businesses to have more opportunities to
attract capital. We think that--again, as I was mentioning with
Senator Rounds, I think it is one of those that it is a very
small tweak but I think a very beneficial tweak to achieve that
goal. And I think it is important, again, for the Senate and
for Congress to set that policy parameter to also ensure,
number one, that it is codified; but, number two, to give clear
direction to the SEC to move forward.
Senator Tillis. Thank you. I yield back my 3 seconds.
Chairman Crapo. Duly noted. Thank you.
Senator Warner.
Senator Warner. Thank you, Mr. Chairman. And thank you for
holding these hearings. I think this is an area where there is
a lot of fertile ground for improvement.
I want to step back on a slightly broader topic for a
moment. You know, one of the things I have been looking at a
lot is the fundamental change between the 20th century and the
21st century. I would argue the 20th century we had a shortage
of capital and an abundance of labor. The 21st century, we have
got capital floating all over, but we have got a shortage of
qualified labor. And I have heard companies and some estimates
say as much as 70 percent of a company's assets may be in their
workforce, the intellectual property they handle or they have.
And yet, candidly, nothing in our Tax Code, nothing in our
public reporting system, nothing in our accounting system
reflects that value on human capital and the folks who make up
companies.
I have got legislation, for example, that would take one of
the most effective tools, I think, post-World War II that we
created in the Tax Code, an R&D tax credit, and create the
equivalent for a human growth tax credit so that, again, I
would argue, businesses more often than government have the
notion of where we ought to be doing some of this training,
because currently you make that--you spend $10,000 on a piece
of equipment that gets an R&D tax credit, you have got an asset
you can put on a balance sheet, you spend $10,000 on your
workforce training and human investment, you get a deduction.
But there is no place to reflect that on your balance sheet or
in your accounting system.
So one of the areas that I think SEC Chairman Jay Clayton
has been, I think, very good at, he has been working with us
and others about should there be--if we can take out some of
the perhaps existing non-essential traditional reporting
requirements, can we increase or could we put in place a
reporting requirement for public companies to indicate that
investment in human capital? Right now a public company
reflects the number of employees, median pay, compensation, but
actually the training or upscaling or nature of their workforce
is not reflected in any way. And I think this would not add a
new burden. Harvard Law School has indicated a majority of
companies have already put in place these metrics.
So, Ms. Slavkin Corzo, I would like to start with you
because I know you have been doing some work in this area, and
I would like to hear from the other panelists as well. Do you
think giving some guidance to public companies about human
capital investment training, upscaling, would be valuable for
the investing public and, frankly, valuable in terms of how we
assess the value of these companies?
Ms. Slavkin Corzo. Thank you, Senator. I think you raise a
really important question. From an investor perspective, we
hear management and senior executives say all the time things
like, ``Our workforce is our most valuable asset.'' Yet we get
no information or almost no information in financial reports
about what the businesses are doing to cultivate those assets.
And so I think it would be extremely valuable for public
companies to be required to disclose additional information
about what they are doing to invest in their workforce and to
make sure that they are developing a workforce that can be
competitive in the 21st century.
Senator Warner. Others on the panel?
Mr. Quaadman. Senator Warner, first off, the only other
thing I would add to your analysis is, unlike the 20th century,
capital is also now global. It can move in any direction.
What I would say, too, is last year we did a very deep dive
on a lot of these issues and talked with people all over the
world for about 6 months. I think that is an appropriate way to
look at it. We need to look at those issues which are linked to
the return and success of a company. What is sometimes
happening when we talk about this very broad ESG discussion is
we get involved in a lot of extraneous issues that really are
not linked with return.
So during one of the conversations we had during this
discussion, an institutional investor, who is extremely
involved in these issues, said, ``Look, let us understand one
thing. We are not an NGO, and those that we invest in are not
NGO's.'' So I think when you take a look at human capital or
human talent, depending on the industry or the business, it can
be a very critical issue.
So I think we need to really think through those issues. We
have been doing a lot of thinking on them. I should also say,
too, 85 percent of the S&P 500 do some form of an extra report
or extra reporting.
The other issue I would just put on the other side of that
equation, too, is we also have to think as to who the recipient
of that information is, because under our current system, our
securities laws have a very clear, defined channel for how we
are communicating with investors, but some of this information
is also being used to communicate to employees, consumer base,
it is used for vendor management and others. So I think we also
need to think through some of those ramifications as well, but
we would love to have further discussions with you on it.
Senator Warner. Ms. Mott, if you want to add anything,
because I would like to get, Mr. Chairman, 10 seconds for a
closing comment.
Well, I think it is critically important, because if you
look particularly in terms of business investment in workforce
training for low- and moderate-skilled people, it is a steady
decline. And, frankly, I do not agree with that as a
policymaker, but I agree with that from a business--I
understand why from a business standpoint, because those are
the jobs that are most subject to automation, and that is even
before we get to AI. Those are the jobs that are most subject
to the ability to be moved abroad. Those are the jobs that are
most subject to, you know, if you invest in that individual,
low- and moderate-skilled, they may become more valuable and
could move around. And I just think from a fundamental basis in
this world--and, Mr. Quaadman, I am interested in the ESG
stuff, but I think there are some things that are extraneous. I
think that is why if we focus on workforce, we can make a more
targeted investment. And my fear is that, you know, from kind
of a macro standpoint, we ought to at least treat investing in
people as valuable on a tax and accounting system and reporting
system as investment in tangible items.
This is not going to reverse the move toward AI and robots,
but it might at least slightly rebalance where I think the 21st
century economy is at, because the rules we had for the 20th
century economy might have worked then, but we have a very,
very different mix and match between human capital and
traditional capital in this 21st century.
Thank you for giving me the extra time, Mr. Chairman.
Chairman Crapo. Thank you.
Senator Kennedy.
Senator Kennedy. Thank you, Mr. Chairman.
I want to take advantage of your experience and expertise
to ask you a few general questions, if I could. Before the
meltdown in 2008, did you think community banks--I am defining
a community bank as $10 billion or less. Did you think
community banks were overregulated, underregulated, or just
about right? I need just kind of quick answers.
Mr. Quaadman. Community banks probably had an appropriate
level of regulation. What we did after the financial crisis is
we started to impose larger bank regulations on----
Senator Kennedy. Right. I am sorry for interrupting, but I
have just got 5 minutes. Do you all agree with that?
Ms. Slavkin Corzo. I have not spent much time thinking
about community bank regulation.
Senator Kennedy. OK.
Ms. Mott. I am also not familiar with the community banking
regulations.
Senator Kennedy. Well, you are capital experts, aren't you?
Ms. Mott. I am a practitioner investing my own money in
startup companies, but I am not a banker, and I do not----
Senator Kennedy. That is OK. I am not a banker either. It
just seems to me our businesswomen and businessmen need
capital, right? We can agree on that. One place to start is
community banks.
Now, I know community banks, by their definition, they are
not going to finance some of the sophisticated deals. But they
provide capital, and one of the problems with Dodd-Frank was
that they made the community banks spend all their money on
compliance. They were hiring compliance officers instead of
loan officers. So it would just seem to me that before we get
all fancy here, we ought to at least talk about saying Dodd-
Frank does not apply to community banks. I mean, if a $10
billion bank goes under, it is not going to take the U.S.
economy with it, is it?
Mr. Quaadman. No. And, Senator, I would also state, too,
2155 is a very important step in that direction. We had also
hoped that the regulators--they are getting there, but we would
hope that they would be quicker in implementing some of that as
well.
Senator Kennedy. Sorry, I am really not trying to be rude,
but we only have 5 minutes. Look, honestly, I mean, I try to
see this from both sides. I just do not see why Dodd-Frank
needs to apply to community banks.
Now, on the other hand, I read where five of our largest
financial institutions have about 50 percent of the banking
assets. Does that sound about right to you all? This is not a
test.
Mr. Quaadman. Give or take. It is probably somewhere around
there.
Senator Kennedy. All right. If one of them called the
Secretary of Treasury tomorrow and said, ``Look, I hate to tell
you this, but I am about to go belly up,'' do you think
Congress would bail them out?
Mr. Quaadman. Senator, Title II of Dodd-Frank creates the
liquidation authority to deal with that. It has been used
actually in Europe, a very similar system, to handle some of
the Italian banking issues. So we do think----
Senator Kennedy. Yes, but here is another way to ask this:
Do you think our banks are still too big to fail, five of them?
Ms. Slavkin Corzo. I certainly do.
Senator Kennedy. Do you? OK.
How about you, sir?
Mr. Quaadman. No, sir.
Senator Kennedy. Ma'am?
Ms. Mott. I am not familiar enough to comment.
Senator Kennedy. OK. Let me ask you this about FINRA. Gosh,
this time goes so fast. A lot of awards by FINRA--you know what
FINRA is, right? OK. The brokers regulate themselves. It is
supposed to be a level playing field. A lot of the awards,
arbitration awards, when they actually find in favor of an
investor, go unpaid. About 25 percent, I think. Are you
familiar with that? I do not want to ask----
Mr. Quaadman. I believe it is actually around 2 percent.
Senator Kennedy. No, I think it is more than that. I mean,
you might be right, but I do not think you are.
Do you have any thoughts about what we ought to do about
that?
Mr. Quaadman. Senator, as we put in our testimony, for the
unpaid arbitration awards with FINRA, we think that SIPC should
be used as a way to help compensate with that. We think that
some of the legislation that is before us today could create a
situation where the good actors in the industry are subsidizing
the bad actors, and that the bad actors then are not going to
have to pay a price for that. But we do think that those unpaid
awards need to be paid, and SIPC might be the right mechanism
to do that.
Senator Kennedy. Yeah. SIPC is not getting the job done.
Otherwise, we would not have so many unpaid claims.
Ms. Slavkin Corzo. We support the legislation on the agenda
today. We think it is critically important to make investors
whole when they lose out as a result of fraud.
Senator Kennedy. Can I ask one more quickly? Teeny-weeny.
Chairman Crapo. And quick answers, too.
Senator Kennedy. Do you think it is right to have just two
proxy advisory firms dictating corporate governance in America?
Mr. Quaadman. No, but I think there are others that have
tried such as PGI and Proxy Mosaic, and there have been
barriers to entry. And, therefore, as we have done in other
areas such as credit reporting agencies, if there are not going
to be more that are going to be entering there, that field,
then there should be a level of oversight to make sure that
there is a level playing field and proper rules for the road.
Senator Kennedy. Thank you, Mr. Chairman.
Chairman Crapo. All right. Thank you.
Senator Van Hollen.
Senator Van Hollen. Thank you, Mr. Chairman. I thank all of
you for your testimony today.
Senator Tillis mentioned a piece of legislation that we
have introduced, the Encouraging Public Offerings Act
legislation. Mr. Quaadman, thank you for your testimony on
that. And, Ms. Slavkin Corzo, I understand that we addressed
some of the early concerns that you and others may have had
with that bill and you do not object to that piece of
legislation. Am I right about that?
Ms. Slavkin Corzo. I would need to go back and look at my
notes and confirm.
Senator Van Hollen. OK. That was my understanding. It ended
up passing the House with a big vote, and a big bipartisan vote
as well.
Another bill that was just introduced on a bipartisan basis
was one I joined with Senator Fischer to introduce yesterday
called the ``Promoting Transparent Standards for Corporate
Insiders Act.'' We all know that 10b-5 trading plans are
designed to make sure that folks inside the company can trade
and do so without trading on inside information.
There has also been a lot of evidence recently that some
folks who are using those trading plans are using them in very
creative ways and are trading on insider information. And so
the purpose of the legislation is to ask the SEC to take a look
at it and then move forward on rules.
If you could talk, Ms. Slavkin Corzo, briefly about that
legislation, whether you support it, and if so, why.
Ms. Slavkin Corzo. Sure. Thank you. Yes, we definitely
support that legislation. I think that insider trading is a
serious concern from an investor perspective. Capital
formation, investor protection relies on a sense that the
markets are fair, and when insiders have the ability to profit
off of inside information that investors do not have access to,
then it undermines investor protection, investor confidence,
and capital formation.
Senator Van Hollen. Thank you. And could you mention some
of the examples that we have seen recently that may point to
abuse in this area?
Ms. Slavkin Corzo. There was a Wall Street Journal study, I
believe, a few years ago that discussed it, and there was some
recent analysis from some Harvard economists that found that
when they looked at the trading that was conducted under 10b5-1
plans, there was outperformance that seemed fishy.
Senator Van Hollen. So, Mr. Quaadman, I see the statement
that you and the Chamber have made on this piece of
legislation, raising some concerns, and also indicating that
you are open to engaging with Members of the Committee to
address the alternatives.
One issue you raise is that we are asking the SEC to look
into this issue and at the same time asking them--or giving
them the authority to promulgate regulations. If we were to
amend that slightly to indicate that if their study found and
there was evidence that the 10b-5 trading plans were not
working as intended and that, indeed, needed to be--we needed
to close some of the loopholes to make sure they were working
as intended, meaning that people are not cheating, if we made
that link in the legislation between a finding of evidence of
wrongdoing or abuse and linking the authority to that, would
you have any objection?
Mr. Quaadman. No, I would look forward to having a further
discussion with you on that because I think we can find common
ground. 10b-5 plans should be blind. There should not be
anything there.
One of the concerns that we had--and this is maybe where we
should also have a further discussion--is with insider trading,
there have been a lot of concerns about some of the vagueness--
and this has been expressed by courts as well on that. And so
some of the issues we think ultimately need to be addressed by
Congress rather than a regulatory agency because of the
criminal penalties that can attach to them.
Senator Van Hollen. Well, I am happy to work with you on
refining that together because we all agree on the premise and
the goal here, right? Which is to make sure that folks who are
on the inside, when they engage in trading, that they are not
taking advantage of inside information, right? I mean, that is
the key thing to making sure we have a transparent and honest
system. Right?
Mr. Quaadman. Insider trading hurts everybody.
Senator Van Hollen. So I would just, Mr. Chairman, point to
the fact--and Ms. Slavkin Corzo mentioned some of the studies
that have been done. There have also been some very visible
examples where it appears that people made very creative use of
their ability to amend their 10b-5 trading plans just in time
to take advantage of inside information that only they had
access to. So I look forward to working with all of you, and I
hope this is something--it passed the House by something like
400-3, or something. So I gather, Mr. Quaadman, that--did you
raise concerns about this bill in the House?
Mr. Quaadman. We did not send a letter to the House or the
Committee on that, but as this has been moving forward in the
process, we have taken a closer look at it, and that is why we
thought there were a couple things there we had some concerns
with, which we would like to engage on.
Senator Van Hollen. OK. Thank you.
Thank you, Mr. Chairman.
Chairman Crapo. Thank you.
Senator Reed.
Senator Reed. Well, thank you very much, Mr. Chairman. I
want to thank you for holding the hearing today. There are two
pieces of legislation which you have allowed to be brought
forward today for discussion: the Corporate Governance Fairness
Act, which I have sponsored along with Senators Perdue, Jones,
Tillis, and Kennedy; and S. 592, which was just introduced
today, the Cybersecurity Disclosure Act, with Senators Collins,
Warner, Kennedy, and Jones. And I want to thank the witnesses
for being here.
I am just going to make a few comments about Senate bill
592 and then yield back to the Chairman for his questions. But
592 is designed to confront what I am hearing from most
business people is one of the most serious problems they face
every day, and that is cybersecurity. Financial institutions,
and seemingly every enterprise in the United States, is
worrying more and more about being hacked, having their data
stolen, having their intellectual property stolen. And I see
this from a perspective not only as a Banking Committee Member
but as the ranking Democrat on the Armed Services Committee.
One point I want to make about the bill is there has been
some kind of response that it is overbearing in some respects,
and Professor John Coates of Harvard Law School points out very
clearly that the bill simply asks for a publicly held company
to either have a cybersecurity expert on the board or indicate
why that is not necessary, that there is no requirement for a
cybersecurity expert on the board. We are trying not to dictate
the composition of publicly held boards.
And I think it is critical because, again, I come at it
from the perspective not only of financial institutions. And,
again, as I speak to leaders, particularly major firms, they
are spending hundreds of millions of dollars a year on
cybersecurity, and they are just trying to stay one step ahead
of an increasingly dangerous risk.
But what was particularly disturbing to me is, in my armed
forces capacity, listening to the former head of the
Transportation Command, General Darren McDew, talk about his
challenges. In order for us to confront any threat across the
globe, we have to project power from the United States. We can
only do it with civilian aircraft, civilian ships, et cetera.
He is trying to organize this, and he said, In his view:
Cyber is the number one threat to U.S. Transportation Command,
but I believe it is the number one threat to the Nation . . .
in our headquarters, cyber is the commander's business, but not
everywhere across our country is cyber a CEO's business. In our
cyber roundtables, which is one of the things we are doing to
raise our level of awareness, some of the CEOs' chief security
officers cannot . . . even get to see the board, they cannot
even see the CEO. So that is a problem.
So we have a situation now where in private companies, from
the perspective of this very astute observer, it is not a
priority. And what we want to do in this legislation is make it
a priority by forcing the companies, publicly held companies,
each year to say either we have someone on the board
responsible or we do not need it because we have outside
experts, we have annual review with scrutiny. That is all
appropriate. And, again, my concern is--and it is the concern
particularly of all my dealings with anyone connected to the
military--that we have a lot of companies, private companies
particularly, that are vulnerable today, that already probably
have been intruded upon and waiting literally for the flag to
go up and they will see the consequence of that.
That is why I thank the Chairman for holding the hearing,
and that is why I hope we can move forward this year and get
what I think is just a commonsense piece of legislation
completed that will help everyone.
Thank you, Mr. Chairman.
Chairman Crapo. Thank you, Senator Reed. We look forward to
working with you on these and some of the other bills in this
package to make sure we can get a good wholesome and beneficial
package put together.
Senator Reed. Thank you.
Chairman Crapo. Well, I had to leave the hearing earlier,
but now I have the dais all to myself. But I am going to try to
stick to my 5 minutes, too, and, again, I appreciate the
witnesses being here. I said I am going to try to stick to my 5
minutes. I do have a number of questions, and I know I will not
get through those, so I will submit to you in writing for your
response.
The first thing I wanted to get at is in the hearing today
some issues have been raised about whether the legislation we
have, particularly the capital formation legislation that we
have put forward, is beneficial or whether it is just a nod to
Wall Street or what have you.
It seems to me that safe access to capital is a critical
benefit to our economy and to workers for their jobs and the
wages and benefits, as well as to retail investors. So I do not
see the issue there.
Now, if the issue is with some piece of the legislation in
terms of whether it really does facilitate safe access to
capital, I understand that. But just on the broader question of
whether this Committee's focus on increasing access to safe
capital in this country is a bad thing, could I ask each of you
to just quickly respond to that? Ms. Mott.
Ms. Mott. Thank you. I am so glad you asked that, Senator.
First of all, the SBA Business Dynamics Statistics Report last
demonstrated I think the data since 1980, that all net new jobs
come from companies 5 years old or less, and the people funding
those companies and that are taking the risk on those companies
are early stage investors. Friends and family, angel investors,
they are taking the first step.
The other thing is they are investing in their backyard.
This is Middle America. You are investing in your town. You are
creating the jobs, and nothing makes you feel better than to
drive by and see a company that started out with 5 people now
has 150 people employed.
Now, that is a do-good in your neighborhood. That is a
byproduct, I know. But at the end of the day, we take our
money, once we get a liquidity event, and we put it right back
to work.
So there is a circular system, and nothing benefits more
than your local economies, and particularly as you heard my
passionate voice today about Middle America.
Chairman Crapo. Middle America.
Ms. Mott. We are overlooked. There is lots of money on the
coasts, but not in the middle of America, and it relies on us.
And a lot of times we are investing companies' first round,
second round, third round. We are continuing to give them a
lifeline, and to a point where they get handed off to a venture
capital firm or, fortunately, if we are lucky enough, the
company gets acquired or--you know, we do not see IPOs. There
is a liquidity but we do not----
Chairman Crapo. Let me follow up with you quickly before I
go on to the other two witnesses. But there was a point made by
one of the Senators earlier today, I believe, that our capital
system is working fine, there is not a problem. Is access to
capital just fine in America? Or do we have some issues there
where we need to make improvements?
Ms. Mott. I do not have the data in front of me. I wish I
had that. But we are seeing a decline, and perhaps Tom has, a
decline in business startups in the United States. And, you
know, I live in that world, and, again, I am co-investing with
my colleagues in Cleveland, Columbus, Indianapolis. You know,
we are all putting our money together to syndicate, to make
these things happen.
You know, without us, I will tell you, there would be
negative, very, very negative job creation without us.
Chairman Crapo. Thank you.
Mr. Quaadman?
Mr. Quaadman. I would just add quickly, Mr. Chairman, 80
percent of business financing in the United States is nonbank.
So what we also have to recognize as well is that while we
still have the deepest, most liquid markets in the world, we
are now competing with Hong Kong and Singapore and Dubai and
other places around the world where capital can now go. So we
are seeing where investors are willing to deploy capital
outside the United States, and, consequently, we are also
seeing a decline in the number of startups, and it is more
difficult--primarily where businesses are going to be more
dependent on private financing, it is more difficult for
businesses to grow because they do not necessarily have that
availability of capital. And I think the package of bills here
allows for tweaks. This is not a rollback or anything like
that. This allows for tweaks to, one, address a changing
ecosystem; and, number two, it is going to make our businesses
and our financial systems competitive in that global
environment.
Chairman Crapo. Thank you. And, again, I want to follow up
with you, Mr. Quaadman, before I go on to Ms. Slavkin Corzo. I
think it was you, but one of you mentioned earlier that China
is attracting more capital in certain parts of its economy than
we are.
Mr. Quaadman. Yeah.
Chairman Crapo. And I would like you to comment on that
because it seems to me that one of the issues that we face--and
this is not all just because of access to capital. It is our
immigration laws and other things like that. But
entrepreneurial activity is being pushed offshore from the
United States because of a number of our policies, and it seems
to me that increasing access to capital for entrepreneurs here
in the United States could address that trend. But, anyway,
would you comment on that?
Mr. Quaadman. I did raise that point earlier, and I also
mentioned the Hong Kong Stock Exchange being the leader in IPOs
last year. So we are pushing--those activities are being pushed
offshore, and, frankly, our international competitors are more
than happy to take that activity on board.
I would also think, too, that as Brexit comes online,
London is going to try and position itself to be an
entrepreneurial center. So we have greater headwinds coming,
and we have a chance, we still have a chance to correct the
situation. But the time window is narrowing.
Chairman Crapo. And just to make sure that this point is
made, if we push an entrepreneur to London or to Hong Kong,
then the business that that entrepreneur creates is going to be
in London or Hong Kong.
Mr. Quaadman. That is correct, and we are actually seeing
that with both FinTech and blockchain, where London is trying
to create the regulatory structure to provide the certainty;
they have the funding to do it. And to your point, you have
American businesses now saying, ``We want to be in the United
States, but if they win that race, we are going to have to go
over there.''
Chairman Crapo. Yeah, all right.
Ms. Slavkin Corzo, would you please comment on all of this
issue we have been talking about?
Ms. Slavkin Corzo. Sure. So, clearly, capital formation is
extremely important for outcome economy. To the extent that I
have raised concerns about the legislation that is being
presented today, it is because I am concerned about investor
protection and systemic economic stability.
Chairman Crapo. OK.
Ms. Slavkin Corzo. What we have seen is that we had a move
toward additional regulation after Dodd-Frank, and pretty much
immediately after that, there was a shift in attention on
Capitol toward tweaks; and tweaks built upon tweaks and built
upon tweaks, until we end up in a situation where we have large
gaping loopholes in our financial regulatory system that come
to light when we have an economic downturn.
And so right now our stock market is doing fantastic, and
people think that--they forget what we have seen so many times
in the past during a downturn, that the loopholes or the tweaks
that we thought were minor are oftentimes the causes of that
crisis that we could have prevented had we left the regulatory
system in place.
Chairman Crapo. All right. Thank you. And the message I
take from what you have said is that the notion of trying to
increase safe access to capital is not a bad notion and not an
improper thing for this Committee to be focused on, but that we
have got to be sure that it is safe.
Ms. Slavkin Corzo. Exactly.
Chairman Crapo. That we do not create risk either to our
economy overall or to investors or to employees as we move
forward. And I agree with that, too.
I will submit the rest of my questions to you. I had
questions on the proxy system and on a number of other things,
so I will submit those questions to you.
Chairman Crapo. I really do appreciate the attention that
you have brought, the help that you have brought to us here on
these issues. I hope that you will work with us to help address
concerns that are there in this legislation and then to promote
and support this legislation moving forward into law. I think
it is a big deal for the country.
With that, let me just say that other Senators will have
questions to submit, too, and for those Senators, the questions
are due to our witnesses by Thursday, March 7th, and I ask you
to please respond to those questions as quickly as you can so
that we can get the maximum information into the Committee as
we possibly can.
Again, thank you all for taking the time and making the
effort to present us your views and to help us gain your
insight and expertise in this hearing.
With that, this hearing is concluded.
[Whereupon, at 11:34 a.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF CHAIRMAN MIKE CRAPO
Today's hearing will focus on a number of legislative proposals
that encourage capital formation and improve corporate governance.
It is my intent to collaborate with Senator Brown and other
Senators on this Committee to identify and advance legislative
proposals that achieve these goals.
While there are bills for consideration today that I have
previously expressed concerns with, as well as a number that Senator
Brown has stated concerns with, I believe this is the fairest way to
consider all of the legislative proposals that remain outstanding from
last Congress.
Last year, the Committee held three hearings on legislative
proposals related to capital formation, corporate governance and the
proxy process.
We are considering all of those bills again today, in the context
of identifying areas where we can find bipartisan consensus in the new
Congress.
A number of the bills previously considered had strong bipartisan
support.
For example, the HALOS Act, which would allow more startups to
access the capital and knowledge of angel investor groups that they
need to grow, had seven bipartisan cosponsors, including Senators
Schatz, Toomey, and Tillis.
The Fair Investment Opportunities for Professional Experts Act,
which expands the definition of an accredited investor for the purposes
of participating in private offerings, had six bipartisan co-sponsors,
including Senators Tillis, Toomey, and Cortez Masto.
Six Members of this Committee--three Republican and three
Democrats--worked together to introduce the Corporate Governance
Fairness Act, an important step in this Committee's discussion on the
proxy process.
Senators Toomey, Menendez, and Rounds introduced the Consumer
Financial Choice and Capital Markets Protection Act, a bill that would
provide more financing options for State and local governments seeking
to raise money.
It is my hope that we can build off this previous momentum as we
consider legislative action this Congress.
We will also consider a number of provisions included in last
Congress' JOBS 3.0 bill, which passed the House of Representatives with
over 400 votes.
These nonprudential provisions largely passed out of the House
Financial Services Committee and the House by voice vote, indicating
their strong bipartisan support.
Today's hearing provides the Committee with the opportunity to
publicly discuss many of these JOBS Act provisions for the first time
in the Senate.
For example, the Family Office Technical Correction Act passed the
House by voice vote. This bill provides that family offices and their
family clients meeting certain thresholds can be considered accredited
investors that qualify for various exemptions under Federal securities
rules.
Senators Rounds and Moran introduced a bipartisan Senate companion
to the Options Markets Stability Act, which amends capital rules to
more accurately reflect exposure for centrally cleared exchange-listed
derivatives.
These bills and their underlying aims of encouraging capital
formation and improving corporate governance require collaboration
between Congress and the SEC.
I commend the SEC and Chairman Clayton for their ongoing work on a
number of the issues we will discuss today.
For example, last fall, the SEC conducted a staff roundtable on the
proxy process and rules, and I encourage them to take action with the
information they gathered.
It is time to re-examine the standards of inclusion of proposals
pursuing environmental, social or political agendas and ensure the
fiduciary focus throughout the proxy process reflects the economic
interest of the retail investors.
Last week, the SEC announced that it is considering expanding its
``test-the-waters'' process beyond emerging growth companies to all
companies as they determine whether to seek an IPO.
Senators Tillis and Van Hollen introduced the Encouraging Public
Offerings Act last Congress which requires the SEC to do just that.
I share Chairman Clayton's goal of making it easier and more
appealing for companies to go public and will continue to work with the
SEC to advance this effort.
I look forward to hearing from our witnesses on these legislative
proposals and working with Members of the Committee to identify bills
with bipartisan support.
______
PREPARED STATEMENT OF SENATOR SHERROD BROWN
Thank you Chairman Crapo, and welcome to our witnesses.
Today's hearing allows Committee Members to discuss legislation
they worked on in the last Congress.
We need to look at these bills--and any bills that come before this
Committee--with one question in mind: are they good for workers, or
just good for Wall Street?
Last year when we considered many of these bills, I asked whether
any of the previous efforts to roll back securities laws had boosted
investment in workers or created more jobs, if our enforcement efforts
were keeping up with fraud, and if shareholders' ability to hold
management accountable was under attack. I still have those questions.
When I look at the list of today's bill, I see a lot of roll backs
and very little protection for ordinary investors. In fact, when I hear
some people say we need these bills to facilitate capital formation,
I'm not sure what problem they are trying to solve.
The capital markets seemed to work just fine last year----
2018 was the best year for IPOs since 2014;
Biotech IPOs reached an all-time record; and
Venture capital investment also hit a record.
Market watchers expect 2019 to be even better. Household names like
Uber, Lyft, Pinterest, and AirBnB, just to name a few, are planning to
go public.
Our time would be better spent making sure the workers at companies
like Uber are getting the wages and benefits they've earned and are
treated like real employees, rather than letting companies cut corners
on their accounting controls.
And if we want to support American businesses, those companies and
the market overall would benefit more from avoiding another Trump
shutdown that closes the SEC for a month than from passing all of these
bills.
There are other bills that seek to make changes that agencies are
already working on. In one case, regulators addressed the issue over 5
years ago.
A couple of the bills take controversial positions that would
undermine critical post-crisis reforms that keep our financial system
stable, and that would restrict the United State's participation in
international insurance regulation discussions.
It's always the same story--Congress and this Administration
bending over backward to figure out how they can make life a little
easier for Wall Street.
Instead, this Committee should look at how we can better protect
ordinary American investors who are saving for retirement. We should be
working on ideas to end Wall Street's shortsighted obsession with
short-term stock prices, so that when companies grow, their workers'
wages actually grow along with them.
Earlier this month, 11 former senior SEC economists wrote to the
agency to say its proposed best interest rule had ``weak and
incomplete'' economic analysis--that can have a real impact on American
families. That warning should be a red flag for this Committee, and we
should call on the SEC to explain.
Meanwhile, corporations announce more billion dollar stock buybacks
and cost-cutting that always have the same result--more money for
corporate executives, less money in workers' paychecks--if they're
lucky enough to keep their jobs.
Companies would rather engage in financial engineering than
investing in the workers who make them successful. Earlier this week,
Fed Chair Powell told this Committee that increasing investment in
worker skills and training are vital to our economy.
But what are corporations doing instead? Spending money on buying
back their own stock to line executives' pockets. And the Committee
stands by and either does nothing, or makes their work easier.
Some of the proposals we will discuss today improve transparency.
Senator Reed's bill would promote more disclosure on cybersecurity.
Senator Van Hollen's proposal would require the SEC to consider ways to
prevent trading abuses by corporate insiders. These are improvements
that help investors and promote fairness.
I want to hear from our witnesses other areas where transparency is
possible, where we can do more to protect consumers in an increasingly
complex market, and what risks are lurking out there that could cause
another crisis or devastate working families.
If we can focus on bills that make improvements in those areas,
workers will benefit, investors will help companies grow, and the
economy will expand.
Thank you, Mr. Chairman.
______
PREPARED STATEMENT OF CATHERINE MOTT
CEO, BlueTree Capital
February 28, 2019
Chairman Crapo, Ranking Member Brown, and Members of the Committee,
thank you for the invitation to testify before you today. I am
Catherine Mott, founder and CEO of BlueTree Capital and its affiliates,
BlueTree Allied Angels and the BlueTree Venture Fund, all based in
Pittsburgh, Pennsylvania. I am past Chairman of the Angel Capital
Association (ACA), the professional association of active accredited
investors across North America.
I appreciate the opportunity to comment on legislative proposals
that would make it easier for entrepreneurs and emerging companies to
find the capital they need to maintain their role as the engine of
American economic growth. I applaud the Committee for addressing these
issues so early in this Congress, and for recognizing its critical role
in increasing economic growth by removing barriers to capital
formation.
The Role of Angel Investors
``Angel'' investors are accredited individuals who invest their own
money in early stage companies, helping them achieve success. Angel
investors support promising companies in every State of the union.
Angels invest approximately $25 billion each year in more than 70,000
startups. Compared to venture capitalists, angels invest in 15 times
more businesses, albeit smaller amounts across a greater number of
companies.
Angel investors are private individuals writing personal checks.
After friends and family, they are the primary source of equity capital
for most startup companies, supplying critical funding to companies
that are too early and too risky for bank loans, and too small or new
for venture capital firms. Without angel funding, these businesses
would never get off the ground.
The median angel investment in a startup company is about $850,000,
but investments range from $50,000 to $2,000,000. In most cases,
multiple angels participate in these investments, with each angel
contributing between $5,000 and $50,000.
Money, however, is not all angels invest. Angels provide not only
financial capital but human capital--time, expertise, mentorship, and
access to our networks of experts, service providers, and potential
customers. We tend to invest in companies based in or near our own
communities, to support local economic development and make the best
use of our specific resources.
Startup companies typically go through several levels of private
equity funding. The first layer is ``bootstrapping,'' or the investment
of the entrepreneur's own money. The second is capital from friends and
family. Angels and angel groups follow (often in multiple rounds of
funding), and if the business succeeds, the next stage is venture
capital. Angels are often the bridge to venture capital, and angels may
build relationships with venture capital firms to help with this
transition.
Angel investing is not a low-risk activity. Looking at a typical
set of 10 angel investments, three to four break even, five may fail,
and one--just one--delivers high-yield results. It is worthwhile,
however, because of the opportunities these investments provide for
mentoring and making a difference at the ground level of the American
economy.
The BlueTree entities have invested more than $50 million in
startup companies that meet a list of 10 criteria, including an
experienced and talented management team; a clear path to cash-flow
breakeven; a clear strategy for exiting angel funding; and primary
operations in targeted, high-growth industries. Our BlueTree Allied
Angels network is a group of accredited investors that meets regularly
in Pittsburgh to evaluate potential investments. BlueTree Allied Angels
has 76 member investors, and we are currently accepting new investors.
The Angel Capital Association, our national trade support
organization, comprises more than 14,000 accredited angel investors
like me, and 260 angel groups, individual angels, online platforms for
accredited investors such as AngelList, and family offices. Our
investment portfolios include more than 20,000 entrepreneurial
companies, including some of the most iconic names in America, which
got their initial startup funding from angel investors. Even
Pittsburgh-based Alcoa owes its start to two angel investors, back in
1888. I have attached a short list of successful companies BlueTree
angels have helped to fund, to give you some idea of the range of these
businesses and industries.
Legislative Proposals to Promote Capital Formation
BlueTree and the other members of the Angel Capital Association are
glad to see the Committee return to two bills considered in the last
Congress that would clarify investment procedures and expand
opportunities for entrepreneurs and investors. These are the Helping
Angels Lead Our Startups Act, or HALOS Act, and the Fair Investment
Opportunities for Professional Experts Act. Both are bipartisan,
commonsense proposals that should not be controversial, and would
produce immediate benefits with no real risk to investors or the
economy.
Senator Sinema has been a champion of the HALOS Act during her
service in the House, and ACA looks forward to working with her and
Senator Toomey in this Congress to see it become law.
The HALOS Act would clarify that ``demo days'' are exempted from
the definition of ``general solicitation,'' eliminating market
confusion about these events and providing entrepreneurs with better
access to capital. While the JOBS Act created general solicitation to
allow entrepreneurs to raise capital publicly for Regulation D
offerings (called 506(c) offerings), with requirements for issuers to
take additional steps to verify that investors are accredited, the SEC
did not change or modernize its own definition of general solicitation.
As a result, that definition now effectively includes ``demo days,''
the events in which entrepreneurs pitch their products and companies to
potential investors, local economic development officials, academics
and other members of the startup ecosystem.
The problem for entrepreneurs is that most accredited investors are
not interested in investing in generally solicited offerings because
the SEC ``safe harbors'' for verification require certifications from
third parties such as CPAs that are costly, and these certifications
last only for 3 months. Because angels build portfolios for
diversification, they would have to be certified 4x a year every year.
Accredited investors prefer to avoid this additional burden and instead
invest in private (506(b)) offerings that allow them to self-certify
their accredited investor status in significant legal documents.
Demo days have been an essential part of America's startup culture
for more than 30 years with thousands of events every year without
problem. Some current name brand companies, such as Airbnb and Dropbox,
started their journeys in accelerators that hold demo days at the end
of their programs. These events have always included the full spectrum
of the innovation ecosystem, from university students to seasoned angel
investors, venture capitalists, accelerators and incubators, government
economic development agencies, and professionals who support
entrepreneurs. Demo days have traditionally offered valuable education
in entrepreneurship to students, would-be entrepreneurs, new investors
and economic development leaders. Entrepreneurs pitch their ideas to a
general audience, but engage in capital raising only with accredited
investors. The SEC's rules on general solicitation have had the
unintended consequence of creating confusion among investors, potential
legal liability for entrepreneurs, and a reduction in funding
opportunities for startups.
I receive hundreds of invitations for demo days in Pennsylvania
every year, and work with my BlueTree colleagues to assign someone to
attend as many as possible. Many Pennsylvania demo days have followed
local legal advice to remove not only information about the offering,
but also descriptions of the companies' business models from pitches.
This reduces educational effectiveness--as most investors evaluate
companies on how they will create, build and capture value--and it also
makes it more difficult for entrepreneurs to get their best information
to potential investors.
The Fair Investment Opportunities for Professional Experts Act
would modernize the definition of ``accredited investor,'' which was
last addressed in the Dodd-Frank Act. ACA applauds the work of Senators
Tillis and Cortez Masto in building bipartisan consensus to grow the
pool of capital available for new businesses. The bill would codify the
current income ($200,000 for an individual/$300,000 for a couple) and
net worth ($1,000,000 excluding the primary residence) thresholds for
being considered an accredited investor, eliminating regulatory
discretion and providing much-needed certainty to angel investors. The
bill would also allow certain people with other demonstrated expertise
or credentials, such as demonstrated financial sophistication via
education or experience of profit and loss responsibility in
businesses, to become accredited even if they do not meet these
financial minimum
requirements.
These changes are commonsense ways to grow the pool of accredited
investors without excessive risk or disruption. This is especially
important in Middle America, where the cost of living is lower and
where entrepreneurial activity is desperately needed in areas
devastated by losses in manufacturing jobs.
The bill's proposal to index the numerical thresholds for
accredited investor status to inflation, with adjustments every 3
years, raises some concerns. While we recognize the intent to protect
accredited investors against potential losses, we fear that raising
these thresholds too quickly or too often may shrink the pool of
capital available to startup companies. If Congress decides to add
these inflationary increases to the financial thresholds, the Committee
may want to ensure that any changes allow accredited investors to
retain their accreditation through a hold-harmless or
``grandfathering'' provision. The risk is that the higher thresholds
may push accredited investors out of the income or asset minimums,
stripping their accredited status and preventing them from continuing
to invest in the high-growth startup companies that create innovation
and jobs in the United States--and that could help boost investors'
returns.
I also see people who are financially sophisticated but don't meet
the wealth or income thresholds, who could help new businesses start
and grow. Some of the young attorneys who develop the deal terms and
investment documents for Pittsburgh angels, for example, are not
currently accredited investors but know a lot about the companies and
investment opportunities. Enhancing the pool of angel investors by a
sophistication criteria (i.e., education or profession) can help fund
many more companies that are left behind but, given a financial life-
line, could deliver meaningful results for the American economy.
Thank you again for taking up these legislative proposals. Your
bipartisan commitment to improving access to capital for early stage
startup companies will produce long-term benefits to our economy at
both local and national levels. The members of the Angel Capital
Association support these efforts and stands ready to provide
assistance and expertise as needed toward our common goals of economic
opportunity and job creation. Please call on me as a resource as you
continue this work.
I would be happy to answer any questions the Committee may have.
Successful Angel Funded Companies
Pittsburgh:
Wombat Security (acquired by Proofpoint Systems, Inc.--remains in
Pittsburgh)
Shoefitr (acquired by Amazon)
Fore Systems (IPO, then acquired by Marconi, Inc.--remains in
Pittsburgh)
GiftCards.com (acquired by BlackHawk Network Holdings, Inc.)
DuoLingo (Unicorn Status)
Pineapple Payments, Inc.
Older and notable:
Free Markets (IPO, then acquired by Ariba, Inc.)
Alcoa, Inc.
Others around the country:
Home Depot
RedHat (acquired by IBM)
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
RESPONSE TO WRITTEN QUESTION OF CHAIRMAN CRAPO FROM CATHERINE
MOTT
Q.1. Ms. Mott, angel investor groups provide much needed
capital to startups that may not otherwise be able to obtain
the funding they need to grow their ideas into successful
businesses.
Do you believe that the HALOS Act and the Fair Investment
Opportunities for Professional Experts Act will be helpful
tools to create additional opportunities for startups to access
capital?
A.1. Yes, indeed I do. The resulting split of Reg D between
506(c) and 506(b) offerings has created market confusion. This
confusion around the definition of ``general solicitation'' has
hampered ``demo days,'' which in turn cripples entrepreneurs'
ability to raise significant capital. Demo days are a mainstay
of the ecosystem; this is an introductory process between
investors and entrepreneurs. To avoid defaulting to 506(c),
entrepreneurs have been advised to withhold financial terms,
financial projections, and go to market strategies. Without the
ability to clearly communicate how a company builds value for
customers and how the company communicates its own enterprise
value, investors will pass on investing.
We know that America is falling behind China in startup
creation. This is not a time to limit the ability of
entrepreneurs to raise capital; we should be supporting startup
companies with capital formation and drive our economy to
``raise up'' our leadership in new company creation and
meaningful new job creation. Most of the startups are ``tech
related' and the resulting job creation leans toward higher
paying jobs that drive greater tax revenue, a by-product of
such activity.
Additionally, I believe that the Fair Investment
Opportunities for Professional Experts Act starts an important
discussion about how to ensure that most current angel
investors remain accredited and safely and responsibly bring
more investors into the angel space. It is important that the
current pool of early stage capital remains available to
startups by implementing inflationary increases to financial
thresholds only going forward. The numeric thresholds currently
in place in SEC regulations are not the only way to judge
whether someone has the expertise or resources to help support
our startup ecosystem. The Fair Investment Opportunities for
Professional Experts Act will open the door to other types of
sophisticated investors, which is critically important in
Middle America where net worth and incomes may not be as high,
while also putting the existing numeric thresholds in statute
to reduce regulatory risk.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SINEMA FROM CATHERINE
MOTT
Q.1. As you know, we've worked for years to champion the HALOS
Act, a bipartisan proposal which provides commonsense
regulatory clarity and improves access to capital for startups,
universities, and the broader innovation economy.
In addition to growing Arizona's economy, university-hosted
``demo days'' allow students to see entrepreneurs pitch ideas
to investors. Given your experience with demo days, can you
elaborate more on the educational value these events offer
students who are looking to turn a great idea into an
innovative startup?
A.1. Thank you for asking this question--and thank you for your
previous work on the HALOS Act. Prior to the confusion about
the definition of general solicitation, demo days were well-
attended by more than investors. Academics, university students
(aspiring entrepreneurs), and economic development
professionals would be in the audience.
For the aspiring entrepreneurs, observing good pitches and
bad pitches--and the questions the companies are asked--are the
best lesson for preparing to succeed. A pitch is limited in
time and in order to attract capital, the entrepreneur must
communicate the ``business'' (not just the unique technology)
and how it creates market value and how it appeals to
customers. This is no easy task when one is limited to
typically less than 15-20 minutes.
For academics who are teaching entrepreneurship (many of
whom never ran a business), they are seeing how the real world
operates. Business books often don't cover the practical points
of raising capital and particularly how to communicate business
value in less than 20 minutes.
For economic development professionals, this is an
introduction to the real world of trying to raise capital and
like investors, they are evaluating the ``business''
opportunity to consider how to assist the companies and drive
job creation.
If we can no longer include the students, professors, and
economic development professionals, we limit the market of
``net new job creation'' for America. As I mentioned in my
response to Senator Crapo, this is not a time to continue
falling behind China.
Q.2.a. Your testimony alludes to local legal advice in
Pennsylvania that pushes demo days to reduce information about
offerings, which makes it difficult to get the best information
to potential investors.
Will passing the HALOS Act and the Fair Investment
Opportunities for Professional Experts Act, both of which we
have supported, fully ensure that demo days can get the best
information possible to potential investors?
A.2.a. Yes, indeed. The HALOS Act will eliminate confusion and
avoid causing an entrepreneur to default to a 506(c) offering.
Sophisticated investors (sophisticated angels and VCs) will not
invest in 506(c) offerings. It's too onerous to comply over the
5-10 years' timeframe for which investors are creating a
portfolio of 18-36 companies.
The Fair Investment Opportunities for Professional Experts
is so very important for Middle America. (As opposed to
California, Boston, and NYC that are rich in a plethora of risk
capital.) Regions in between the coasts and in the south rely
on angel investors to fund their startups; there is not a
plethora of VCs or PE firms in Middle America. Job creation in
Middle America is even more
critical; these areas are still trying to recover from the loss
of manufacturing since the mid-80s. One only needs to drive
across the center of America to observe; and we see how the
hopelessness of the lack of meaningful employment has fueled
the opioid crisis. Angel investors have been filling the risk-
capital void in Middle America investing in multiple rounds to
help extend the runway for startup companies.
The Dodd-Frank Act had the GAO study the impact of raising
financial thresholds for inflation going back to 1982 would
have when it first considered raising the criteria for
accredited investors. Close to 60 percent of accredited
investors would have been eliminated if the criteria for
accredited investors was raised. The Angel Capital Association
did another study and found that 30 percent of its existing
check-writing members would no longer qualify, mostly due to
increased net worth criteria. Of course, there would have been
less impact in NYC or San Francisco, but it would have
decimated the number of active investors in Middle America.
Another point to consider: The cost of living is much lower
in Middle America; earning $200,000 annually is like earning
$450-$500,000 in NYC, LA, San Francisco, and Boston. And a
million-dollar net worth outside the coasts and the poorer
areas of the south, is equivalent to $2.5 million on the
coasts. One size does not fit all.
Q.2.b. If not, what other recommendations would you make to
ensure a regulatory climate that better facilitates angel
investment?
A.2.b. Middle America would be well-served if the criteria for
accredited investors could be expanded to include a
``sophistication'' standard to include Registered Investment
Brokers, CPA's, Attorneys, and MBA's. This would expand the
pool of investors who understand the nuances of business and
key financial terms, and the importance of a ``portfolio
strategy'' for private stock.
Also: Many angel groups raise small funds because we need
to support the runway of many companies in our portfolio. We
typically are challenged when we need to invest more capital in
3 to 5 follow-on rounds. This could be more easily accomplished
by raising small angel funds. The increase to 249 investors
passed by the last Congress is great in terms of increasing the
number of investors in small funds, but it would be helpful if
the rules also increased the capacity to raise meaningful
funds. The amount these funds can raise is capped at
$10,000,000. Later rounds of investment capital require much
larger dollar sizes ($3-$5 million per company); in order to
have meaningful impact for scaling a company, a fund size of
$50,000,000 would have a much greater impact; it would allow
for larger rounds across 15-20 companies.
------
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN CRAPO FROM THOMAS
QUAADMAN
Q.1. Mr. Quaadman, as I mentioned in my opening statement, last
Congress the SEC and this Committee discussed the need for
reforms to the proxy process. Senators Reed, Purdue, Tillis,
Jones and Kennedy introduced S. 3614, the Corporate Governance
Fairness Act which I see as an encouraging bipartisan first
step in the direction of making these much needed changes.
As the Committee looks to move beyond consideration and
toward action in this Congress, what changes to the existing
proxy process do your members believe are necessary in order to
ensure that the process and voting decisions of fiduciaries
reflect the clear economic interests of the retail investors?
A.1. We believe that reforms and greater oversight of the proxy
process are needed to ensure that voting recommendations
reflect the economic interest of retail and long-term
shareholders. As Chairman Clayton has iterated, voting advice
and research should be company and industry-specific and not
one-size-fits-all. Additionally, conflicts of interest of proxy
advisory firms should be at the least disclosed, such as when a
shareholder proponent is a proxy advisor firm client, and where
possible mitigated. Also, in order to ensure that voting
recommendations are based on accurate information, proxy
advisory firms should consult with issuers and provide an
opportunity for feedback on recommendations.
Q.2. Mr. Quaadman, the Compensation for Cheated Investors Act
requires FINRA to create a relief fund which would be funded
first by penalties paid by brokers and then from sources
determined by FINRA. While I am sympathetic to finding remedies
for unpaid arbitration, this approach requires the entire
industry to bear the burden of bad actors.
Does the Chamber believe that the Compensation for Cheated
Investors Act is the correct approach to addressing arbitration
awards? If not, are there approaches that the Chamber believes
will be effective in remedying unpaid arbitration awards more
fairly?
A.2. We do not believe that the Compensation for Cheated
Investors Act is the correct approach, as it would effectively
allow FINRA to assess firms that have done nothing wrong in
order to pay out arbitration awards that have been awarded due
to the
activities of bad actors. The legislation would also empower
bad actors by providing a backstop in place for them, paid for
by somebody else, to compensate investors they have cheated.
FINRA's customer code also states that unless a brokerage firm
has a bona fide reason for nonpayment of an arbitration award,
the firm must pay the award within 30 days. Firms that do not
pay within 30 days risk being penalized or suspended by FINRA.
Given the existing protections in place and the likelihood that
the Compensation for Cheated Investors Act would embolden bad
actors, we think that policymakers should contemplate and take
into account the existing Securities Investor Protection
Corporation (SIPC) regime that was created to compensate
investors in the event of a broker liquidation.
Q.3. John Bogle, the creator of the index fund, warned last
year that ``if historical trends continue, a handful of giant
institutional investors will one day hold voting control of
virtually every large U.S. corporation.'' Chairman Clayton has
also expressed concerns that the ``voices of long-term retail
investors may be underrepresented or selectively represented in
corporate governance.''
What is the best way to make sure that the voting decisions
of fiduciaries reflect the clear economic interests of the
retail investors on whose behalf these institutional investors
engage?
A.3. In addition to reforms and changes to proxy advisory firms
and the way they produce voting recommendations, the SEC should
also clarify how investment advisers can satisfy their
fiduciary duty in voting proxy decisions, particularly
following the withdrawal of the 2004 no-action letters. Staff
Legal Bulletin 20 went a long way in articulating that an
investment adviser must exercise proper oversight over a proxy
advisory firm when an adviser uses such firm's recommendations
in deciding how to vote. Further issues regarding investment
adviser compliance could be clarified, such as whether it is
necessary to vote every proxy in order to satisfy an adviser's
fiduciary duty, and providing further guidance around the
definition of an ``independent'' third party, such as a proxy
advisory firm.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN FROM THOMAS
QUAADMAN
Q.1. At the hearing, in response to a question, you stated,
``We are seeing R&D spending last year being the highest that
it has ever been.''
Please compare 2018 R&D spending by public companies to
stock buybacks.
A.1. While stock buybacks overall have seen a recent spike
following the passage of the tax cut bill, S&P 500 firms have
increased their spending on both R&D and capital expenditures
as a percentage of revenue over recent years, and R&D spending
in fact is at a record high.\1\ We believe the idea that stock
buybacks precludes spending on R&D and other reinvestments in
the company is misguided. Businesses make the most productive
decisions they can based on the capital they have. For those
businesses that decide stock buybacks are the most productive
decision, that returned capital can then be redeployed
throughout the economy in innovative public and private
companies that need the funding in order to grow their business
and expand their operations.
---------------------------------------------------------------------------
\1\ https://taxfoundation.org/economics-stock-buybacks/
?utm_source=Corporate&utm_cam-
paign=2c6c9faa58-EMAIL_CAMPAIGN_2018_08_16_01_36_COPY_01&utm_medium
=email&utm_term=0_94e6588ff2-2c6c9faa58-
429053753&mc_cid=2c6c9faa58&mc_eid=70da
02528d.
Q.2. At the hearing, in response to a question, you stated, ``I
also mentioned the Hong Kong Stock Exchange being the leader in
IPOs last year.''
Please compare 2018 IPOs, both by proceeds and number of
offerings, between the (i) Hong Kong Stock Exchange and (ii)
the New York Stock Exchange and Nasdaq.
A.2. In 2018, Hong Kong led the number of IPOs with 197,
compared to 142 by Nasdaq and 63 by NYSE. By proceeds, Hong
Kong again led with $35.4 billion, compared to $29.7 billion by
NYSE and $23.1 billion by Nasdaq.\2\ Listing reforms that Hong
Kong has recently implemented such as allowing dual-class
shares and pre-revenue biotech firms to list have made their
exchange much more competitive in the global IPO landscape.
That is why it is critical for the SEC and Congress to continue
to advocate for capital formation reforms to make it easier for
companies to go public and continue to make the U.S. capital
markets an attractive destination to list.
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\2\ https://www.ey.com/Publication/vwLUAssets/ey-global-ipo-trends-
report-q4-2018/$FILE/ey-global-ipo-trends-report-q4-2018.pdf.
---------------------------------------------------------------------------
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN FROM HEATHER
SLAVKIN CORZO
Q.1. At the hearing, in response to a question, Mr. Quaadman
stated, ``We are seeing R&D spending last year being the
highest that it has ever been.''
Please compare 2018 R&D spending by public companies to
stock buybacks.
A.1. Response not received in time for publication.
Q.2. At the hearing, in response to a question, Mr. Quaadman
stated, ``I also mentioned the Hong Kong Stock Exchange being
the leader in IPOs last year.''
Please compare 2018 IPOs, both by proceeds and number of
offerings, between the (i) Hong Kong Stock Exchange and (ii)
the New York Stock Exchange and Nasdaq.
A.2. Response not received in time for publication.
Q.3. At the hearing, in response to a question, Mr. Quaadman
discussed the SEC's repeal of the two proxy advisor no-action
letters and the content of the letters. He stated the
following:
``The withdrawal of the no-action letters was important
because those two no-action letters which date back to 2005
effectively did two things. One is they told the proxy advisory
firms, ``You do not have to disclose any conflicts of interest
to your clients.'' The second letter effectively said to the
clients, ``You do not have to ask about conflicts of interest,
and you can really on that advice anyway.''
LDo you agree with his characterization of the
letters?
LDo you have any concerns with the SEC's withdrawal
of the no-action letters without providing comparable
guidance?
A.3. Response not received in time for publication.
Q.4. In discussing stock buybacks with Mr. Quaadman, Senator
Toomey stated:
if a management team does not believe it has attractive
investment opportunities, doesn't it have an obligation
to return excess capital to the people who own that
company, who then typically invest in another
opportunity to grow the economy, to make more
investments, to hire more workers?
To which Mr. Quaadman responded, ``It provides for a more
efficient allocation of capital. That is correct.''
Do you agree with the characterization of options available
to management? In addition, do stock buybacks provide
shareholders with a ``return of excess capital'' that is
directly investable elsewhere?
A.4. Response not received in time for publication.
Additional Material Supplied for the Record
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