[House Hearing, 117 Congress]
[From the U.S. Government Publishing Office]
GOING PUBLIC: SPACS, DIRECT
LISTINGS, PUBLIC OFFERINGS, AND
THE NEED FOR INVESTOR PROTECTIONS
=======================================================================
VIRTUAL HEARING
BEFORE THE
SUBCOMMITTEE ON INVESTOR PROTECTION,
ENTREPRENEURSHIP, AND CAPITAL MARKETS
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED SEVENTEENTH CONGRESS
FIRST SESSION
__________
MAY 24, 2021
__________
Printed for the use of the Committee on Financial Services
Serial No. 117-26
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
______
U.S. GOVERNMENT PUBLISHING OFFICE
45-078 PDF WASHINGTON : 2021
HOUSE COMMITTEE ON FINANCIAL SERVICES
MAXINE WATERS, California, Chairwoman
CAROLYN B. MALONEY, New York PATRICK McHENRY, North Carolina,
NYDIA M. VELAZQUEZ, New York Ranking Member
BRAD SHERMAN, California FRANK D. LUCAS, Oklahoma
GREGORY W. MEEKS, New York BILL POSEY, Florida
DAVID SCOTT, Georgia BLAINE LUETKEMEYER, Missouri
AL GREEN, Texas BILL HUIZENGA, Michigan
EMANUEL CLEAVER, Missouri STEVE STIVERS, Ohio
ED PERLMUTTER, Colorado ANN WAGNER, Missouri
JIM A. HIMES, Connecticut ANDY BARR, Kentucky
BILL FOSTER, Illinois ROGER WILLIAMS, Texas
JOYCE BEATTY, Ohio FRENCH HILL, Arkansas
JUAN VARGAS, California TOM EMMER, Minnesota
JOSH GOTTHEIMER, New Jersey LEE M. ZELDIN, New York
VICENTE GONZALEZ, Texas BARRY LOUDERMILK, Georgia
AL LAWSON, Florida ALEXANDER X. MOONEY, West Virginia
MICHAEL SAN NICOLAS, Guam WARREN DAVIDSON, Ohio
CINDY AXNE, Iowa TED BUDD, North Carolina
SEAN CASTEN, Illinois DAVID KUSTOFF, Tennessee
AYANNA PRESSLEY, Massachusetts TREY HOLLINGSWORTH, Indiana
RITCHIE TORRES, New York ANTHONY GONZALEZ, Ohio
STEPHEN F. LYNCH, Massachusetts JOHN ROSE, Tennessee
ALMA ADAMS, North Carolina BRYAN STEIL, Wisconsin
RASHIDA TLAIB, Michigan LANCE GOODEN, Texas
MADELEINE DEAN, Pennsylvania WILLIAM TIMMONS, South Carolina
ALEXANDRIA OCASIO-CORTEZ, New York VAN TAYLOR, Texas
JESUS ``CHUY'' GARCIA, Illinois
SYLVIA GARCIA, Texas
NIKEMA WILLIAMS, Georgia
JAKE AUCHINCLOSS, Massachusetts
Charla Ouertatani, Staff Director
Subcommittee on Investor Protection, Entrepreneurship,
and Capital Markets
BRAD SHERMAN, California, Chairman
CAROLYN B. MALONEY, New York BILL HUIZENGA, Michigan, Ranking
DAVID SCOTT, Georgia Member
JIM A. HIMES, Connecticut STEVE STIVERS, Ohio
BILL FOSTER, Illinois ANN WAGNER, Missouri
GREGORY W. MEEKS, New York FRENCH HILL, Arkansas
JUAN VARGAS, California TOM EMMER, Minnesota
JOSH GOTTHEIMER. New Jersey ALEXANDER X. MOONEY, West Virginia
VICENTE GONZALEZ, Texas WARREN DAVIDSON, Ohio
MICHAEL SAN NICOLAS, Guam TREY HOLLINGSWORTH, Indiana, Vice
CINDY AXNE, Iowa Ranking Member
SEAN CASTEN, Illinois ANTHONY GONZALEZ, Ohio
EMANUEL CLEAVER, Missouri BRYAN STEIL, Wisconsin
C O N T E N T S
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Page
Hearing held on:
May 24, 2021................................................. 1
Appendix:
May 24, 2021................................................. 37
WITNESSES
Monday, May 24, 2021
Deane, Stephen, Senior Director, Legislative and Regulatory
Outreach, CFA Institute........................................ 5
Kupor, Scott, Managing Partner, Andreessen Horowitz.............. 10
Park, Andrew, Senior Policy Analyst, Americans for Financial
Reform......................................................... 6
Rodrigues, Usha R., Professor, and M.E. Kilpatrick Professor of
Corporate & Securities Law, University of Georgia School of Law 8
APPENDIX
Prepared statements:
Deane, Stephen............................................... 38
Kupor, Scott................................................. 47
Park, Andrew................................................. 61
Rodrigues, Usha R............................................ 66
Additional Material Submitted for the Record
Huizenga, Hon. Bill:
``IPOs, SPACs, and Direct Listings, Oh My!'' by Jennifer J.
Schulp..................................................... 77
GOING PUBLIC: SPACS, DIRECT
LISTINGS, PUBLIC OFFERINGS, AND
THE NEED FOR INVESTOR PROTECTIONS
----------
Monday, May 24, 2021
U.S. House of Representatives,
Subcommittee on Investor Protection,
Entrepreneurship, and Capital Markets,
Committee on Financial Services,
Washington, DC
The subcommittee met, pursuant to notice, at 12:01 p.m.,
via Webex, Hon. Brad Sherman [chairman of the subcommittee]
presiding.
Members present: Representatives Sherman, Scott, Himes,
Foster, Vargas, Gottheimer, San Nicolas, Casten, Cleaver;
Huizenga, Wagner, Hill, Emmer, Mooney, Davidson, Gonzalez of
Ohio, and Steil.
Ex officio present: Representatives Waters and McHenry.
Chairman Sherman. The Subcommittee on Investor Protection,
Entrepreneurship, and Capital Markets will come to order.
Without objection, the Chair is authorized to declare a
recess of the subcommittee at any time. Also, without
objection, members of the full Financial Services Committee who
are not members of this subcommittee are authorized to
participate in today's hearing.
As a reminder, I ask all Members to keep themselves muted
when they are not being recognized by the Chair. The staff is
instructed not to mute Members except where a Member is not
being recognized by the Chair and there is inadvertent
background noise.
Members are also reminded that they may only participate in
one remote proceeding at a time. If you are participating
today, please keep your camera on. And if you choose to attend
a different remote proceeding, please turn your camera off.
I want to commend Sean Casten for being the new Vice Chair
of this subcommittee, and I will endeavor to figure out ways to
transfer as many of the tedious and unpleasant duties of the
Chair to Sean, and we are now trying to think through exactly
what that would be.
Today's hearing is entitled, ``Going Public: SPACs, Direct
Listings, Public Offerings, and the Need for Investor
Protections.''
I now recognize myself for 4 minutes for an opening
statement.
Every year, there are hundreds of trillions of dollars in
securities transactions. But what matters not to investors, but
to the economy as a whole, to people who are just working for a
living, is when money flows into companies that they can use to
expand, provide jobs, and build factories. Of that money, $2.1
trillion is going into the issuance of corporate bonds, $312
billion going into companies that are selling stock who are
already public, and $132 billion for initial public offerings
(IPOs).
But this $132 billion, of the trillions of dollars of
securities transactions, is probably the most important for the
average American, because these are the companies that are
going to make our future in the second half of this century.
And that $132 billion is basically broken down between
traditional IPOs and Special Purpose Acquisition Companies
(SPACs).
In looking at these IPOs, there are three elements we need
to look at. The first is, how is the company treated, since our
goal is to get money into companies that can expand in the
future. Seven percent for smallish to medium-sized companies
goes to underwriting fees in a traditional IPO. A recent study
shows that 11 percent goes if it is a SPAC transaction. But
what I hear most from companies thinking about going public is
a concern about underpricing. That is to say, in addition to
the fee, they are selling all their shares for, say, $20 a
share, and wouldn't you know it, 2 days after the offering, the
shares are worth $30. Who gets that extra $10? Not the company.
So, the company is worth $30 a share but is getting only $20 a
share in the transaction.
The second issue is protecting the investor. We have strict
liability when a company first goes public in the traditional
system, strict liability for projections that are made about
the future. But if a company goes public through the SPAC
mechanism, we have a lower level of liability, unless Mr.
Coates is right and somehow it is a higher level of liability.
We don't know. It is up to Congress to clarify what level of
liability, what level of investor protection we have for IPOs,
and it should be the same whether it is done through the SPAC
mechanism or the regular mechanism. If we need to hold the
underwriters accountable for misstatements about the future
projections, then we need to do it for both. If we don't need
to do it, then we should do it for neither.
The second issue is the investor--as I was saying, I was
talking about protecting the investor. With SPACs, we see 70
percent of those who invest in SPACs take their money out
before the transaction goes forward, and then we see that those
who choose to remain see their investment diluted with the
Private Investment in Public Equity (PIPE), the investors who
come in afterwards.
Finally, there is the allocation of this great opportunity
to invest in the IPO, as most IPOs do go up on their first day,
in their first week, or in their first month. First, who gets
these good opportunities to invest in a new IPO, and are retail
investors missing out?
And second, do we have, in effect, a system of bribery
where an underwriter can go to someone with a fiduciary duty, a
CFO of a big corporation, the trustee of a large charitable
foundation, and give them for their own account a chance to buy
a $30 stock for $20, and then go back a month later and do
business not with the individual whom they have enriched but
with the big company or the big charitable trust that they
control?
So, we have a lot to cover in a limited amount of time. I
believe my time has expired.
The Chair now recognizes the Chair of the full Financial
Services Committee, the gentlewoman from California, Chairwoman
Waters, for a 1-minute opening statement.
Chairwoman Waters. Thank you very much, Chairman Sherman.
Special purpose acquisition companies, known as SPACs, are
blank check companies and have skyrocketed in popularity as a
way for private companies to go public and avoid the public
scrutiny of an initial public offering, or IPO, process.
In 2020, the amount of proceeds raised by SPACs jumped an
astounding 462 percent over the previous year. I have deep
concerns about the lack of transparency and accountability that
is a hallmark of the SPAC process, and it appears that SPAC
mergers are structured to ensure that Wall Street insiders
receive huge profits, and retail investors pay the cost.
I look forward to discussing with our witnesses what
Congress and the SEC can do to better protect investors and
ensure that our markets are fair.
I yield back the balance of my time.
Chairman Sherman. Thank you, Madam Chairwoman.
I now recognize the very patient ranking member of the
subcommittee, the gentleman from Michigan, Mr. Huizenga, for 4
minutes.
Mr. Huizenga. Thank you, Mr. Chairman.
In a challenging global economy, the strength of our
capital markets is vital to long-term economic growth, yet
regulatory burdens and bureaucracy are preventing small
businesses from thriving and hindering the United States'
ability to compete globally. Small businesses, which are the
fuel that powers our economic engine, make up 99 percent of all
enterprises in the United States and employ almost half of our
workforce.
Prior to the COVID-19 pandemic, roughly three-quarters of
all small businesses relied on financing in the last 12 months.
Nearly 70 percent of startups received less financing than they
initially requested, while 28 percent received no financing at
all. The fact is, most people don't realize it, but 80 percent
of business debt financing comes from investors in our capital
markets, not from banks.
The U.S. continues to experience a slump in the number of
new businesses, which in 2016 hit a 40-year low. Last year
showed a spark in IPOs, which broke that disturbing trend.
Until 2020, our economy launched half the number of domestic
IPOs than it had 20 years ago.
At the same time, the U.S. doubled the regulatory
compliance costs that businesses incur, just one of the myriad
reasons why the decline in traditional IPOs is the cost of
going public. Costs associated with, ``going public'', are high
because investment bankers, lawyers, and auditors collectively
charge millions of dollars to prepare the lengthy registration
statement that is required to be filed with the SEC before any
shares can be sold.
Additionally, a series of regulatory burdens placed on
public companies only adds even more costs to these companies.
The SEC estimates the average cost of just achieving initial
regulatory compliance for going public in a traditional IPO is
$2.5 million, with an annual compliance cost averaging $1.5
million after that. These costs are prohibitive for small and
other emerging companies focused on growing their businesses.
As a result, more companies are opting for private
fundraising over the costly hassle of entering our public
markets. In 2016, private offerings in the U.S. raised nearly 5
times the equity as IPOs. In 1997, 8,884 companies were listed
on exchanges in the United States. Since then, the number of
companies on the exchanges has decreased by more than half,
which results in fewer investment choices for everyday Main
Street mom-and-pop investors.
In the U.S., there are 242 unicorns, startups with
valuations of more than a billion dollars, that were privately
financed as of November 2020. That is called a herd of
unicorns. Those aren't unicorns.
Conversely, as more businesses today remain privately
funded instead of going public, the number of publicly held
companies has declined to levels not seen since the 1980s. The
decline in IPOs only hurts everyday American consumers, as I
said, because there are fewer opportunities for them.
It is important to note that while the U.S. IPO market has
steadily decreased, until last year, foreign markets,
specifically China, were growing. China's annual GDP growth
remains approximately 6.2 percent despite the recent trade war.
Additionally, in 2020, mainland China was the only major
economy to achieve positive economic growth. China's IPO market
produced over one-third of the world's IPOs in 2020, reporting
536 out of the 1,363 IPOs across all global markets. Beijing's,
``Made in China'' 2025 agenda lays out its plan to dominate the
high-tech, biotech, and artificial intelligence industries
within the next 10 years. Additionally, experts predict more
IPO activity on mainland China's 14th 5-year plan, which is
designed to boost IPOs in specific sectors through direct
financing.
Increased pressure from foreign markets only heightens the
necessity for immediate action and reform. Republicans support
making our markets more attractive, but make no mistake: China
is aggressively pursuing policies that challenge us
economically. This includes the IPO space. Republicans and
Democrats must work together to continue to make our capital
markets the envy of the world.
Given the capital formation issues facing American
companies and the decline in IPOs over the last several
decades, this committee needs to be focused on legislative and
regulatory frameworks that make our public markets more
attractive and preserve various paths for companies to pursue
going public.
I look forward to hearing from our witnesses today, and I
yield back.
Chairman Sherman. Thank you very much.
I now recognize the ranking member of the Full Committee,
the gentleman from North Carolina, Ranking Member McHenry.
Mr. McHenry. Thank you. Look, if any one of my colleagues
wanted to discuss ways to make public companies more attractive
today, they would be disappointed. Today, committee Democrats
will push for more regulation, which ultimately will discourage
companies from going public. That is unfortunate.
What we should be discussing instead is Mr. Huizenga's
proposal to facilitate small business mergers and acquisitions
as an alternative to small business bankruptcy; Mr. Hill's bill
to expand investment opportunities for investors who know the
subject matter; Mrs. Wagner's proposal to provide investor-
friendly disclosure formatting and reduce disclosure costs for
public companies; Mr. Emmer's bill to facilitate trading in
smaller, early-stage companies to spur capital raises and
reward innovation; Mr. Steil's bill, his proposal to reduce
regulatory costs and streamline disclosures for small public
companies; and Mr. Loudermilk's bill to remove misguided
regulation and reduce costs for non-bank financial
institutions.
All of those bills I just mentioned would do more to help
investors and small businesses than the discussion we are
having today.
I yield back.
Chairman Sherman. Thank you.
Today, we welcome the testimony of our distinguished
witnesses: Stephen Deane, the senior director of legislative
and regulatory outreach at the CFA Institute; Andrew Park, a
senior policy analyst at Americans for Financial Reform; Usha
Rodrigues, professor, and M.E. Kilpatrick Professor of
Corporate & Securities Law at the University of Georgia School
of Law; and Scott Kupor, a managing partner at Andreessen
Horowitz.
Witnesses are reminded that their oral summary of their
testimony will be limited to 5 minutes. You will be able to see
the timer on your screen which will indicate how much time you
have left, and a chime will go off at the end of your time. I
would ask that you be mindful of the timer and wrap it up
quickly if you hear the chime. And without objection, your full
written statements will be made a part of the record.
Mr. Deane, you are now recognized for 5 minutes.
STATEMENT OF STEPHEN DEANE, SENIOR DIRECTOR, LEGISLATIVE AND
REGULATORY OUTREACH, CFA INSTITUTE
Mr. Deane. Chairman Sherman, Ranking Member Huizenga, and
members of the subcommittee, my name is Steve Deane, and I am
with the CFA Institute. It is an honor to be here.
I would like to focus on SPACs and investor protection. If
we look at the track record so far, we see two starkly
different worlds. On the one hand, we have big, sophisticated
investors such as hedge funds that invest at the IPO stage, and
then they exit when the SPAC announces a merger to take a
company private.
On the other hand, there are individual investors who buy
in the public markets, often at the time of the merger
announcement, and hold their shares in the post-merger period.
These two sets of investors face two starkly different
results. There are lucrative profits for the sponsors, as well
as the hedge funds who exit, but poor returns for ordinary
investors who stay on.
The question is, are there any design features of SPACs
that could explain this pattern, and I point to three. First,
dilution. The initial IPO investors, including hedge funds, buy
SPAC units which consist of shares and warrants, but those
warrants are detached after about 2 months. So later, in the
second phase, when these investors redeem their shares, and
most of these hedge funds do, they get their money back, plus
interest, but they get to keep their warrants.
One academic paper calls this a, ``default-free,
underpriced, convertible bond with extra warrants.'' In other
words, a free lunch. We know there is no such thing as a free
lunch. It comes at the expense of the investors who hold their
shares in the post-merger period, and that includes retail
investors. So, dilution is a handicap and it is one that the
record shows that SPACs to date have not overcome.
A second investor concern involves misaligned incentives.
For example, the sponsor has a strong financial incentive to
make a merger deal, even a bad one that may not be in the
interest of the other shareholders. In addition, the SPAC may
offer special inducements such as discounts to get still other
investors to invest in private deals called PIPEs. The details
of these side deals are not always disclosed.
The third area of concern involves forward-looking
statements. SPACs enjoy a safe harbor. At least, it has been
thought until now that they enjoy a safe harbor from private
litigation if they make a forward-looking statement or
projections about the future of the proposed merger. That is
different from a traditional IPO, which gets no safe harbor,
and therefore almost never offers forward-looking statements.
This heightened liability in IPOs is an important investor
protection, and the question is, why doesn't this same investor
protection apply to SPAC mergers?
So, where do we go from here? First, we have seen an
explosion of SPACs, and now they are facing heightened
scrutiny, including this hearing. That is a good thing. Public
education is an important component to help protect investors.
As SPACs evolve, we may see market solutions to address some of
these concerns.
But there is also a clear role for Congress and securities
regulators to remain vigilant to protect investors. As Congress
deliberates on possible actions it may take, we would welcome
the focus on investor protection and transparency. I would
specifically suggest focusing on dilution, misaligned
incentives, undisclosed side deals, and safe harbors to
forward-looking statements.
Thank you.
[The prepared statement of Mr. Deane can be found on page
38 of the appendix.]
Chairman Sherman. Thank you, Mr. Deane.
Mr. Park, you are now recognized for 5 minutes.
STATEMENT OF ANDREW PARK, SENIOR POLICY ANALYST, AMERICANS FOR
FINANCIAL REFORM
Mr. Park. Thank you. Chairman Sherman, Ranking Member
Huizenga, and members of the subcommittee, thank you for
inviting me this afternoon to share my views on the different
ways that private companies have been choosing to go public
outside of the traditional IPO process. My testimony today will
focus in particular on the rise of SPACs.
Over $100 billion worth have been issued so far this year,
or nearly 10 times the total that we saw in 2018. This
exponential growth is concerning because SPACs historically
have performed very poorly for retail investors, while the
issuers, advisors, and a select group of institutional
investors will still profit.
The SPAC surge appears to be driven in part by private
companies' desire to exploit the perceived speed, streamlined
disclosures, reduced liability, and reduced shareholder rights
that are offered by the SPAC process. Although many have just
started hearing about SPACs recently, SPACs are really far from
new. In fact, they actually date back to the 1980s, when they
were actually called blank check companies, and they were often
associated with scams, and in the process bilked unsuspecting
investors out of millions of dollars.
Fraud was, in fact, so pervasive in these blank check
companies that Congress back in 1990 had to pass the Penny
Stock Reform Act (PSRA) to address some of these problems. The
SEC followed shortly thereafter with Rule 419 that also
dictated blank check company rules.
Blank check company issuers, though, decided that they
would get around these rules and devised this modern-day SPAC
structure, reminding us that properly regulating new assets
requires both continuing attention and action, and there are
two main ways that SPACs escape from coverage from both the
PSRA and also Rule 419.
The first is this arbitrary $4-a-share threshold that
defines a penny stock; and the second is the extremely low
standard of $5 million in net tangible assets. None of those
conditions end up applying to SPACs, because everyone holds
more than $5 million in cash, and they are deliberately issued
at $10 a share to get around that $4 mark.
SPACs also rely on a safe harbor from being held
accountable to forward-looking statements under the Private
Securities Litigation Reform Act of 1995. Whereas with an IPO,
issuers and underwriters are liable for making false and
misleading forward-looking statements, SPACs are not subject to
that same standard. That has emboldened many pre-revenue
companies in highly speculative industries such as electric
vehicles, cryptocurrency, and space exploration to use what we
could generously call, ``rosy projections.''
Take, for example, nine electric vehicle companies that
have gone public through a SPAC in 2020. Their combined annual
revenue was $139 million that year. But between them, they
project to investors that by 2024, they will generate $26
billion in annual revenue. Or let's take a look at a space
exploration company, Holicity, which is proposing a merger with
Astra Space. They have disclosed to investors, for example,
that they have not yet launched any rockets, but by 2025, they
project that they will have daily rocket launches.
What is most concerning is that retail investors are buying
into this type of hype, and in some instances pouring a
significant portion of their savings into certain SPACs when
the data continue to show, time and time again, that they
perform poorly over the medium and long run. A large part of
that underperformance comes from the sizable up-front
compensation that goes to the sponsor who receives that 20
percent promote regardless of the quality of the acquisition.
As a result, when you look at the average SPAC that is
issued at $10 a share, after you pay the sponsor and you meet
the redemptions of the shareholders who want to cash out, that
SPAC only ends up with $6.67 in cash after the merger. Or put
another way, that would mean that the value of the company
would need to rise 50 percent just to get back to that $10, and
that leaves many of the retail investors who hold this post-
merger SPAC at a significant disadvantage.
We wouldn't want people's 401(k)s to be used at the
blackjack table, given how the game is mathematically stacked
against them. But unfortunately, investing in SPACs in their
current form is not too different. I will end my remarks with
these figures that show just how clearly the house always wins.
The average SPAC sponsor between 2019 and 2021 saw returns
of 958 percent. The average institutional investor who is doing
this arbitrage trade, which I can later elaborate on, averages
a 40-percent return. But now, retail investors who chase these
SPACs with high hopes are losing. So if we look at between 2010
and 2018, the average one-year return of SPACs following a
merger was negative 15.6 percent. Even more recently, Goldman
Sachs found that 200 SPACs in April lost around 17 percent
compared to a 10 percent return.
Given these dramatically misaligned incentives that
characterize these deals and their extremely poor performance,
we urge the committee to take action. We urge you to amend the
Exchange Act to align the rules that govern forward-looking
projections in SPACs with those of IPOs and to broaden the
definition of blank check companies to better protect Main
Street investors.
I thank you for your time, and I look forward to answering
your questions.
[The prepared statement of Mr. Park can be found on page 61
of the appendix.]
Chairman Sherman. Thank you.
Professor Rodrigues, you are now recognized for 5 minutes.
STATEMENT OF USHA R. RODRIGUES, PROFESSOR, AND M.E. KILPATRICK
PROFESSOR OF CORPORATE & SECURITIES LAW, UNIVERSITY OF GEORGIA
SCHOOL OF LAW
Ms. Rodrigues. Chairman Sherman, Ranking Member Huizenga,
and members of the subcommittee, it is an honor to participate
in today's hearing. Because my time is limited, I am going to
highlight just two aspects of my written testimony. I will use
a somewhat offbeat metaphor, and then an analogy that I think
might hit home.
First, the metaphor. The subject of this hearing is going
public, and I am going to propose to you that you think of the
traditional IPO process like a traditional wedding. Most of us
have attended many weddings: the couple picks out the date
months in advance; there is an announcement; there are elegant
invitations; the venue is selected with care, and so are the
flowers, the photographer, the caterer, and the dresses. The
couple's families will meet and perhaps help with planning the
ceremony. It is quite a process.
Well, how is an IPO like a wedding? An IPO also starts out
months ahead of time. The CEO, the CFO, and the General Counsel
have likely been dreaming for years of the day when they can
take their company public. Once they decide they are ready to
embark, they interview a series of investment banks and select
the right one to lead the offering. The lead underwriting bank
then shepherds the company through the process. It works for
the company to draft the registration statement, which it files
confidentially with the SEC. The SEC comments on the draft, the
company responds, and they go back and forth several times.
Finally, the company files its first public registration
statement.
But that isn't the end of the story. The banks and the
company then launch a road show in which they try to explain
the company's business to interested investors and convince
them to invest in the IPO. The SEC continues to comment, asking
for clarification or adjustments in wording. Finally, the SEC
signals that it has no more comments, and the bank is
comfortable that it can sell the offering and the prospectus is
free of material misstatements.
Then, and only then, will the offering price and the IPO
commence.
Now, if an IPO is like a traditional wedding, then an SPAC
is more like a Vegas wedding. It just doesn't have the same
level of preparation and vetting that a traditional IPO does.
But here is the point: It is still a legal wedding. Whether it
is Vegas or traditional, at the end of the day, you still have
a lawfully married couple, and that is just like whether a
company goes public via an SPAC or via a traditional IPO. At
the end of the day, it is a publicly traded company.
But these are the products of two very different processes.
And it is misleading to try to equate the two. That is why I
support prohibiting forward-looking statements in the De-SPAC,
and extending Section 11 liability, underwriter liability, to
include the De-SPAC disclosures. These reforms will help to
equalize the process.
Okay, that is my offbeat metaphor. Here is my analogy. As I
described in my written testimony, SPACs used to allow a vote
in the De-SPAC so that SPAC shareholders got a say in whether
or not to make the acquisition. And if enough of them said they
wanted their money back, 20 percent to be precise, then the
deal wouldn't close. After all, the SPAC needed the money from
the trust account to fund the acquisition.
The rules changed, and I don't have time here to get into
why, but they did, and now just a majority vote is required,
except sometimes a vote isn't required at all. And what
actually troubles me isn't the elimination of the vote; it is
how meaningless the vote is when it does occur. And that is
because SPACs allow shareholders to vote for the acquisition
and still redeem their shares.
As a SPAC shareholder, you can basically say, sure, I think
we should acquire this company and take it public, but I don't
want any part of it; give me my money back.
And that takes me to my analogy. This is like a U.S.
citizen voting in an election, say a congressional election,
except this citizen is in the process of renouncing their
citizenship while they are voting. They vote, but they have no
interest in the outcome.
I suggest that this decoupling of voting and economic
interest is a real problem that you should consider.
This concludes my remarks. Thank you again. I look forward
to your questions.
[The prepared statement of Ms. Rodrigues can be found on
page 66 of the appendix.]
Chairman Sherman. That is perhaps the most interesting
presentation I have heard in a while.
And Mr. Kupor, you are now recognized for 5 minutes.
STATEMENT OF SCOTT KUPOR, MANAGING PARTNER, ANDREESSEN HOROWITZ
Mr. Kupor. Thank you, Chairman Sherman, Ranking Member
Huizenga, and members of the subcommittee. Thank you for the
opportunity to talk about this very important topic.
Before I give you some perspectives on potential reforms to
consider in order to enhance capital formation and access to
investment opportunities for all Americans, I will briefly
summarize a few trends that haven't yet been touched on in this
setting.
First, I think we shouldn't lose sight of the fact that the
raw number of IPOs has declined significantly. From 1980 to
2000, we used to do about 300 IPOs per year. From 2001 to 2016,
that number fell to about 108.
Second, companies are staying private longer, roughly
double the time period they used to, and therefore we have more
mature and obviously higher valuation companies at the time of
the IPO.
Now, I think it is a reasonable question to ask, why should
we care about any of this? First, the number of publicly listed
companies in the U.S. has declined by 50 percent, which reduces
competitiveness and overall consumer choice.
Second, we know publicly traded companies drive employment
growth and are the key to expanding geographic access to
economic opportunity.
And third, and I think very importantly, the vast majority
of appreciation of high-worth companies is now accruing to
institutions, pension funds, and wealthy individuals who can
invest in the private markets, while retail investors are
largely relegated to the public markets. This two-tiered market
structure has significant implications for income and wealth
inequality.
There is some good news, which is we have seen some
positive developments. The number of IPOs has been steadily
increasing in the last few years, and no doubt, some of this is
due to the work that many of you were instrumental in as part
of the passage of the JOBS Act. So we appreciate that, and
thank you for your efforts.
We also now have choice, which is really important.
Traditional IPOs now compete alongside direct listings and
SPACs for quality issuers. And choice is good. It drives
competition, it reduces expenses, and it enables more companies
to seek capital to grow their business.
However, to ensure that choice and competition thrive, and
that all investors have access to growth opportunities, and
that the U.S. continues to create new jobs and economic growth,
and that the U.S. remains the best place for company formation
and growth, there are a number of things that I believe
legislators and regulators should consider.
First of all, we should consider, how can we make it easier
for companies to go public and to do so at earlier stages of
maturity? Expanding the current JOBS Act emerging growth
company (EGC) eligibility criteria for issuers from 5 years to
10 years, as noted in the Helping Startups Continue to Grow
Act, would help smaller-cap companies on-ramp into the public
markets; and providing a transition period of one year for EGCs
could trigger the large accelerated status when public flow
exceeds $700 million for the first time, which would also help.
Second, we have to be mindful of the fact that very low-
volume small-cap stocks are especially vulnerable to short
activity, and so this body should consider short positions
closure similar to what exists for materially long positions to
support innovative small capitalization companies.
Another way to enhance liquidity would be to look at the
opportunity for EGCs to opt out of unlisted trading privileges
and therefore select the venues on which they want to trade
their securities and consolidate trading volume.
We ought to ensure that the choices exist for going public
and that they engender fair competition, and enhance price
discovery and broader retail participation.
With respect to direct listings, one of the very important
things for clarification is around the tracing rules and
Section 11 liability. There is some uncertainty around this for
selling shareholders, and this is potentially preventing direct
listings from achieving their full potential.
You have heard a lot already about SPACs, so I won't
comment on that, but I think, Chairman Sherman, you noted the
most important thing, which is that we should have a level
playing field. Whatever this body determines, it should not be
the case that there are different regulatory regimes for
traditional IPOs relative to SPACs.
While enhancing the public market, I think we also need to
look at ways to enhance access to the private markets for non-
institutional investors, obviously with appropriate oversight
and investor suitability. While the SEC has taken some initial
steps towards amending the credit investor definition, I think
there are more ways that we should expand that to materially
increase the number of individuals who qualify.
We might also consider making it easier for retail
investors to access private fund investments. Models such as
that proposed by Representative Gonzalez could enhance retail
access to private growth companies.
And finally, there is another area of capital formation
that hasn't been touched on here, which is around blockchain
crypto industries. In many ways, a healthy blockchain ecosystem
not only creates economic growth and technological development
for the U.S., but it is also an opportunity for anyone who
desires to be part of a project and benefit from the success of
that endeavor. Unfortunately, to date, the SEC has not provided
clear regulatory guidance for how tokens will be treated under
existing regulatory rules.
This is important, because we need to differentiate between
good-faith technology entrepreneurs and get-rich-quick schemes,
and make sure that this is very clear to others.
I appreciate the opportunity to be here, and I look forward
to your questions.
[The prepared statement of Mr. Kupor can be found on page
47 of the appendix.]
Chairman Sherman. Thank you. I want to thank all of our
witnesses for their presentations. I now recognize myself for 5
minutes for questions.
I am going to be interested in all of our witnesses
presenting for the record their ideas on how we can reduce the
cost of the companies' base because we need more companies to
decide to go public for all of the reasons that have been
outlined. And when I talk about cost, it is not just the
commission that is shown but also underpricing or anything else
that prevents the company from benefitting from all the dollars
invested.
I want to thank our last witness for recognizing that we
ought to have the same liability system, whether you choose the
SPAC route or the IPO route. Either we want to encourage
companies to speculate about the future so that we at least get
some information or some speculation and tell them they are
free to do so without strict liability, or we want to tell all
investors that you are protected and that any forward-facing
statement will be subject to all of the protections of Section
11 liability.
I want to focus on the use of the IPO as a way, in effect,
to bribe those with fiduciary duties. A public (inaudible)
spends a lot of attention making sure that Members of Congress
who owe a fiduciary duty to our constituents and the people
aren't taking gifts. And yet, there is also the private sector,
where every corporate officer owes a fiduciary duty to the
corporation.
We have charitable trusts; we have pension trusts. And it
occurs to me that if I was in the investment banking business,
I would love to do business with a $100 billion pension trust.
And if I were to go into the trustee's office with $100,000 in
a briefcase and say, ``I will be bringing you similar
briefcases from time to time, no quid pro quo, I just like
bringing you briefcases full of money,'' my guess is that I and
the trustee would go to jail.
But if instead, I call the trustee and say, ``Look, for
your own account, you may want to invest in this hot IPO. I
won't make it available to any but my best friends, and no quid
pro quo, it is just that every month I am going to give you
another IPO and you will make about $100,000 from the shares I
allocate to you. And, oh, by the way, I would like to, in some
other conversation, talk to you about your $100 billion fund
and how we can be of service.''
Professor Rodrigues, does that work? Is that legal?
Ms. Rodrigues. It is a practice called IPO spinning, and it
is not legal. The allocation of IPO shares from the syndicate
to investors is a really opaque one. I was looking on--
Chairman Sherman. If I can interrupt, Professor--
Ms. Rodrigues. Yes, of course.
Chairman Sherman. --it is kind of known that the
underwriter can make this opportunity available to their best
customers.
Ms. Rodrigues. Yes.
Chairman Sherman. And the best customer is the one with a
$5 million account. But if you have a person who only has a
$50,000 account, but they happen to be the trustee of a big
charitable trust, can you treat them as one of your good
customers?
Ms. Rodrigues. I was looking on the Fidelity website, and
it says, ``Customers who want to participate in an IPO offering
are evaluated and ranked based on their assets and the revenue
they generate for their brokerage firm.'' So, it is clearly a
system where--
Chairman Sherman. Okay, so that is a system whereby it is
just what you generate for the firm. Would it be illegal to
say, or what you generate for this firm through the accounts
you control? I don't think Fidelity does it that way, and I
would put it in writing if I did. But would it be illegal for
them to say, you generate a lot of money for our firm because
you are the trustee for the big trust?
Ms. Rodrigues. I think it would. It certainly is an
ethically questionable practice.
Chairman Sherman. I look forward to trying to draft
legislation to make sure that not only is it illegal to bring
the fiduciary a briefcase with $100,000 in cash, it is also
illegal to bring a fiduciary a chance to make $100,000 profit
that is not available to the other customers of the brokerage.
And with that, I will call on our next questioner, who, of
course, is the ranking member of the subcommittee, Mr.
Huizenga.
Mr. Huizenga. Thank you, Mr. Chairman.
First of all, I would like to ask unanimous consent to
enter into the record an article written by Jennifer Schulp
entitled, ``IPOs, SPACs, and Direct Listings, Oh My!''
Chairman Sherman. Without objection, it is so ordered.
Mr. Huizenga. Thank you.
Mr. Kupor, today's hearing is focused on three primary
pathways for going public: traditional IPOs; SPACs; and direct
listings. Will you please discuss each of these three pathways
to go public, and why one may be more attractive or
advantageous over another, depending on a company's specific
circumstances and needs at the time?
Mr. Kupor. Yes, sure. Thank you very much for that
question. In general, let me take them one by one. The promise
of SPACs is that the process typically can be faster for
companies because you already obviously have a public vehicle,
and there is more certainty around the initial pricing because
you pre-negotiate, obviously, through the merger and the De-
SPAC agreement, as well as a PIPE, what the valuation is. That
has been the promise.
I would say so far, if you look at the data, that has
generally been true, which is the timeframe has been faster. I
will note, and I mentioned this in my written testimony, that
of late, we have seen things slowing down at the SEC, just
given the volume of SPACs, and that has created more
uncertainty around market timing. We have also seen the PIPE
market be very, very different in terms of being much less
robust than it was even just a couple of months ago. So, that
timing question kind of remains to be seen.
Direct listing today is most relevant for companies that do
not have to raise primary capital. Now, there is, as you know,
the opportunity for companies to raise primary capital, but to
date we have only seen secondary offerings. The direct listing
tends to be most attractive for companies where they don't need
access to primary capital, and in general, where there is
enough what I would call awareness and brand of the company so
that they can effectively be able to become public through a
lesser marketing process.
And the traditional IPO is, again, mostly today being taken
advantage of by companies who need access to primary capital.
That is really the main reason. It is obviously a heavier-
weight process from a regulatory perspective. It certainly
takes typically more time. But it does have that effect.
I think what is important in this discussion, which I don't
think we should lose sight of, is that this choice really
matters because it is very important, and we are already seeing
market responses to these choices being available.
Mr. Huizenga. Expand on that. It is my understanding that
you have helped bring a number of companies public?
Mr. Kupor. Yes.
Mr. Huizenga. So, talk a little bit about why do some of
them want to go public, and why are some of them choosing to
not go public? We talked about these unicorns. I always say if
you have 240-some-odd unicorns, they are not unicorns; that is
a herd. And there is a reason why they are doing that, and we
can't seem to come to an agreement on both sides of the aisle
as to these massive costs or what it is that is keeping that.
But let me ask this last part, if you can touch on that.
What kind of concerns do you have about the SEC or Congress
making it more difficult or less attractive for companies to go
public via these three pathways?
Mr. Kupor. I have a lot of concerns, because I think it is
really important for us to have more public companies.
To give you just a few specific thoughts, one of the
reasons that companies are staying private longer is because it
is very difficult to be a small-cap company today in the public
markets. You don't have research coverage. You tend not to have
sales and training activity happening at the banks. You
obviously do have regulatory burdens, but I would say the
regulatory burdens are a little bit of an up-front cost often.
But the real question is, once you are a public company,
what is it like to be a public company? It can be very lonely
to have a very low float, not well-followed stock.
So some of the things, as I mentioned in my testimony, we
can do is to think about how do you increase liquidity and
volume of activity for small cap stocks in particular? I think
that is one really important area.
Second, we do want to have more public companies. One of
the beauties of this country has been that the capital markets
here are the envy of many across the world. And if you look,
quite frankly, at what we have seen even in this horrible
crisis of COVID, companies like Moderna--the reason we have
vaccines is because companies like Moderna were able to both
tap private capital, and then, quite frankly, tap public
capital in a way that gave them access to tremendous research
and development dollars that has now resulted in what is today
a medical miracle, and there is a whole host of companies doing
that.
So, the most important thing that I would ask this body to
think about is, before we introduce additional regulation, I
think I would ask: first, does that regulation help or hinder
access to capital markets for companies; and second, does it
help or hinder access for retail investors to be able to
actually access these opportunities?
Mr. Huizenga. In my closing seconds, I know that these are
the questions that we have. We need to pursue these and make
sure that we remove those barriers, not put more up.
With that, I yield back.
Chairman Sherman. Thank you.
I now recognize the Chair of our Full Committee, Chairwoman
Waters.
[pause]
Chairman Sherman. Chairwoman Waters?
[pause]
Chairman Sherman. I don't know if Chairwoman Waters is
available.
I am going to go to Mr. Himes, and we will come back to
Chairwoman Waters later.
Mr. Himes. Thank you, Mr. Chairman. Thank you for holding
the hearing.
And thank you to our witnesses.
We have been talking a lot about investor protection in the
context of Robinhood. There is a dispiriting dialogue on this
committee where the Republicans accuse the Democrats of wanting
more regulation. When that dispiriting dialogue happens, we
forget to focus on something that I think is particularly
important in this realm, which is remarkable rent-seeking
behavior. By rent-seeking, of course, I mean taking advantage
of oligopolistic situations or information asymmetries or
dislocations in markets to make money which you wouldn't
otherwise make in a competitive scenario.
I do think that an awful lot of investors--as Warren Buffet
says, you don't know who is swimming naked until the tide goes
out. The tide really hasn't gone out much in the last couple of
years, and I do think that investors at some point are going to
get a very expensive education in the fact that equity markets
don't go to the sky, but I don't think that, absent shining a
light on or considering regulatory behavior, we are going to
see a decline in the amount of rent-seeking.
It hasn't been mentioned, but for a long time I have been
banging the drum on the fact that if you do an IPO between
roughly $30 million and $150 million in proceeds, the mint
market IPO, you always get to pay a 7 percent gross spread.
That has never felt to me like competitive activity.
There is another area that has been mentioned this morning,
and I would like to highlight it for a minute or two, maybe
starting with Mr. Deane, and that is IPO pricing. I used to do
IPOs for many, many years, and we always used to celebrate when
you were 10 times oversubscribed and priced the IPO at exactly
half or one-third of what the value was on the second day of
trading. It always struck me that that was a way to leave an
immense amount of value, value that might have otherwise gone
to the limited partners at Mr. Kupor's organization or to the
company itself.
So, Mr. Deane, talk to me a little bit about pricing
behavior and who benefits when IPOs are underpriced. And I will
open this up, once you are done, to anybody on the panel.
Is there any long-term fundamental value in having a big
IPO pop, long-term fundamental value? Mr. Deane?
Mr. Deane. Thank you, Mr. Himes. Actually, Commissioner
Jackson, Professor Jackson has often made the same points that
you have about the 7 percent tax and competitiveness.
I guess first, I would say that on the one hand, IPOs offer
tremendous strengths in investor protections, including Section
11 strict liability. On the other hand, they just don't seem to
be perfect, and you have identified one of the big issues,
which is, are the issuers leaving money on the table for the
pop, the extra price that the shares trade at on the first day,
and also a seemingly uniform 7-percent cost for the IPO?
It does seem to me that some of these other things we are
seeing, like SPACs and direct listings, maybe they are
identifying some underlying problems, even if the SPACs
themselves have flaws, even if they are not the perfect
answers. Maybe we also have to ask, what are they telling us
about the market that could be improved?
So again, on the one hand, I think, yes, these are
problems--in my opinion, these are problems with IPOs. The
issuers are leaving money on the table. On the other hand, I
would reiterate that they also come with some great strengths
in investor protection.
Mr. Himes. Thank you, Mr. Deane.
Professor Rodrigues, I saw you nodding away there. Give me
30 seconds, because I do have a question for Mr. Kupor. Give me
30 seconds on the value of a very substantial IPO pop. Who gets
that value?
Ms. Rodrigues. The investors, right? The investors in that
initial IPO get a huge bump. They get a huge rise in value on
one day.
Mr. Himes. To go with your metaphor, the investors are the
guests at your wedding. Does every guest at that wedding get an
equal chance to see that Day-1 doubling in value?
Ms. Rodrigues. Let's beat this metaphor. So, no.
Mr. Himes. Let me put it this way, some people weren't
invited to the wedding, right?
Ms. Rodrigues. Yes.
Mr. Himes. Lots of people weren't invited to the wedding,
and I will leave the witness here by saying usually those are
the retail investors, right?
Ms. Rodrigues. Right. So, the syndicate, the banks, get the
value of having their customers be happy with them because they
have gotten this initial first-day pop. Those are the winners,
and then the losers are everybody who has to buy at the real
market price.
Mr. Himes. Which is generally retail investors investing a
couple of weeks after you have seen that pop, and an awful lot
of institutions have actually made an awful lot of money,
correct?
Ms. Rodrigues. That is exactly right.
Mr. Himes. Thank you.
Mr. Kupor, I'm sorry I don't have time to go to you. My
time has expired, and I yield back.
Chairman Sherman. I would point out the company might also
be losing if they underprice the shares.
Mrs. Wagner is now recognized for 5 minutes.
Mrs. Wagner. Thank you, Mr. Chairman.
Mr. Kupor, I will go to you. Would you agree that being a
public company comes with additional disclosure and filing
requirements that can often deter a private company from going
public?
Mr. Kupor. Yes, I think that is a fair statement.
Mrs. Wagner. In your experience, and I know your experience
is vast in this, from taking private companies public, what are
some of the specific overly burdensome regulatory requirements,
specifically filings and disclosures, that you believe make
going public less attractive to a private company?
Mr. Kupor. Yes, some of the things that were identified in
the JOBS Act, the EGC status of being able to defer some of the
Sarbanes-Oxley requirements, obviously, is very helpful and
valuable, and those things can be burdensome, particularly for
small-cap companies where you are really trading off regulatory
dollars versus R&D dollars.
There are other things like say on pay and other disclosure
items that I think are challenging as well, particularly for
some of these smaller cap companies. But as these companies get
much larger, many of those things are much more manageable.
Mrs. Wagner. There certainly is more work that this
committee should be doing to make our public markets more
attractive to increase the number of companies going public
while also, very importantly, preserving investor protection.
Mr. Kupor. Absolutely.
Mrs. Wagner. One way to help increase IPOs is by
simplifying the quarterly financial reporting burden on
companies. In recent years, quarterly reporting requirements
have grown in size and complexity, making it much more
difficult for investors to determine, I think, relevant
information, often leaving them overwhelmed and unable to make
sound investment decisions.
Furthermore, some companies believe that current reporting
requirements have become a barrier to registering as a publicly
traded company, as noted in a report by the IPO Task Force. The
report, which was promoted by the JOBS Act that you mentioned
of 2012, found that 92 percent of public company CEOs said that
the administrative burden of public reporting was a significant
challenge to completing an IPO and becoming a public company.
It is time, past time, to move away from this one-size-
fits-all approach to corporate disclosure and focus on
transparency through new technologies and the flexibilities
that I think new technologies have allowed us. The current
disclosure rules were written before the advent of websites and
social media and direct connection to investors that comes from
the ubiquitous access of even just smart phones.
I believe that you can reform disclosure requirements
without depriving investors of any critical information that
they may need or that they absolutely deserve. That is why I
have introduced the Modernizing Disclosures for Investors Act,
which would require the SEC to implement rules simplifying the
quarterly reporting regime for SEC registrants. My legislation
would allow issuers of securities traded on a national
securities exchange to disclose quarterly financial information
in a much more simplified manner and reduce some of the
administrative costs that are deterring small and mid-sized
companies from going public, and I would certainly urge my
colleagues, especially here on the Capital Markets
Subcommittee, to co-sponsor this legislation.
Mr. Kupor, in the limited time I have left, is it
beneficial for businesses to have multiple pathways of going
public? And why?
Mr. Kupor. Yes, it absolutely is, and the good news, as I
mentioned in my testimony, is that we are seeing that now.
There are some issues that many of the panelists have raised
here around SPACs, and I think those are worthy of discussion.
But the idea that we now have SPACs, we now have direct
listings, and we have traditional IPOs really is helping from a
market perspective. So even in some of the comments that were
mentioned earlier by some of the Members here, things like IPO
pricing has actually improved. If you are concerned about pops,
those pops have actually gone down as a result of greater
competition. We are getting better price discovery in these
mechanisms.
And so to me, the most important thing to preserve is
competition and choice, and if we do that alongside, as you
mentioned, Mrs. Wagner, investor protection, then I think we
have a very good shot at remaining a very important capital
market center.
Mrs. Wagner. Great. Thank you very, very much. I appreciate
it.
Mr. Chairman, I yield back.
Chairman Sherman. Thank you. I thank the witness for
mentioning direct listing, and I am hoping that the questioning
will focus more on that.
And I now recognize the Chair of the Full Committee,
Chairwoman Waters.
Chairwoman Waters. Thank you very much, Mr. Chairman.
Mr. Park, in a letter sent to the House Financial Services
Committee, the Consumer Federation of America and Americans for
Financial Reform noted that initial SPAC sponsors and hedge
funds that are granted exclusive access to the early investor
pool are granted, ``attractive investment returns on an
essentially risk-free investment while avoiding the disclosure
obligations and liability risk associated with the typical
IPO.''
The letter noted that these initial investors who sell or
redeem their shares before the SPAC merger received, on
average, an 11.6-percent rate of return, while the SPAC
sponsors themselves, ``performed even better, earning a mean
return of 32 percent in the 12-month period post-merger.''
However, unsurprisingly, retail investors in the rest of
the market appear to have a much different experience. Reports
show that 90 percent of SPACs that announced this year are
lagging the S&P 500 based on when they began trading. According
to a Reuters analysis, ``The median performance of a SPAC from
the day it announces what company it will merge with is 6
percent.''
Why is it that, once again, it appears that Wall Street and
hedge funds are profiting while retail investors are left
bearing the cost? A lot has been said about this already, but
what I would really like, instead of answering that question, I
would like to know, can you explain the protections and
safeguards that are part of the traditional IPO process that
are absolutely absent from the SPACs and how this may affect
investors, particularly retail investors? What is it that
investors have access to with the IPO that they don't have with
the SPACs?
Mr. Park. Thank you for that question, Chairwoman Waters. I
would say, first off, that the key critical component that is
missing is information. When investors are buying into these
SPACs at the initial offering, they don't have any insight as
to the financials, nor really necessarily what the business is
going to be. So what they are doing is they are putting their
faith in the sponsor to be able to find a good deal for them,
or ultimately a good company with which to merge.
Now, the problem here is that when it comes to the process
where the SPAC has finally identified a company to merge with,
there wouldn't be a vote in place. But what we find is that a
lot of the initial investors are more interested in voting for
the merger and then selling their shares because they know that
they can still profit. They can do so because when you
originally buy into a SPAC, as Mr. Deane was saying in his
testimony, you get both the shares and you get these warrants.
So, if you sell the shares and you still vote for the merger,
you can still hold onto these warrants. What happens with the
warrants is that if the stock were to go above $11.50, you can
still make money, even though you don't still own the shares.
But at the same time, you still voted for the merger.
That conflict right there seems to be very odd. And keep in
mind, too, with the compensation structure of these SPACs, as I
was stating in my testimony, the sponsor, upon completing a
deal, gets 20 percent. They are not evaluating necessarily on
whether it is a good deal but whether it gets completed. They
collect that, right?
And there are also these other sets of investors that come
in later called the PIPE investors. They have a different set
of securities that they are investing in, and they have a
different set of interests.
So all throughout the whole SPAC process, everyone has
their own set of incentives where they can make money.
Chairwoman Waters. Okay. Let me just ask you before my time
is up, Mr. Sherman has legislation dealing with precisely what
we are discussing, making sure that more information is
available, et cetera. Have you seen the legislation, and do you
think it is what we need? Do we need to make it tougher? Do we
need to add to it? Have you examined that legislation of Mr.
Sherman's?
Mr. Park. Yes, I have, Madam Chairwoman.
Chairwoman Waters. What do you think?
Mr. Park. It is certainly a step in the right direction. We
are really going after these forward-looking projections that
are being abused. That is the core component of the difference
between an IPO and a SPAC. And on top of that, I will add the
fact that there are reasons why Rule 419, which dictates blank
check companies, was put into place, again, to protect
investors. And we are asking the committee to also consider
aligning SPACs with blank check company rules.
Chairwoman Waters. Thank you, and I thank all of our
witnesses who are here today. I yield back the balance of my
time.
Chairman Sherman. Thank you.
I now recognize Mr. Hill.
Mr. Hill. Thank you, Mr. Chairman, and I appreciate you
holding this hearing. It is, of course, I think, no surprise to
any of the Members that with interest rates at negative returns
due to artificially keeping our interest rates too low and
fueling a major fiscal injection into our economy, and the GDP
at the growth rate that it is projected to be this year, and
our bit companies announcing outstanding earnings, I think it
is no surprise that over the last 5 months, we have
concentrated on some of the excesses that we have seen out in
the capital markets and people taking advantage of this
unprecedented expansion in the capital markets due to, I think,
the monetary policy.
So with that, I do share Mr. Huizenga's goal that we need
to be thinking long term, which is, how do we bring down that
marginal cost of going public and staying public? Of course, we
want that going public to be done in a fair and transparent
way, but the real issue is that ongoing cost of being public
and continuing to stay public, and try to lower that as much as
we can consistent with our obligations to the investing public.
So, I appreciate Ranking Member Huizenga raising that
point. I think, long run, we need to get that ecosystem of both
private company capital formation and public capital formation
really looked at closely so that we encourage the U.S. to be
the preeminent capital market.
One thing I wanted to concentrate on in this hearing today
is a bill that I have introduced with my friend, Mr. Schweikert
of Arizona. I have introduced this bill during my time in
Congress, and it has gotten a good report in the past in
previous Congresses, and it speaks to expanding the access to
investors by expanding the definition of an accredited investor
to include professional expertise. We introduced that in the
114th Congress, and it was passed favorably by the committee
with strong bipartisan support, and received a 347-8 vote on
the House Floor. It also received strong support in the
committee during the 115th Congress, and a voice vote on the
House Floor. But with the change in the Majority in the 116th
Congress, this bill did not receive Floor consideration, and I
hope, Mr. Chairman, we can do that.
Mr. Kupor, I believe you have had a chance to review the
legislation. You and I have talked about the importance of an
accredited investor definition before. I wonder if you would
reflect on what the Commission has done, and do you think the
bill that Mr. Schweikert and I are proposing would aid
investors that have the professional qualifications and
knowledge to be a bigger participant in that accredited
investor rule in a private placement?
Mr. Kupor. Thank you, Mr. Hill. Yes, I have reviewed it,
and I agree with your general proposition, which is in addition
to figuring out how we have more companies going public, we
also need to figure out how we actually increase private access
participation from more investors, and I do think expanding the
definition of accredited investors would be very helpful.
One of the things that also could be considered is that in
the crowdfunding legislation that was part of the JOBS Act,
this Congress decided that there were certain dollar limits,
for example, that they were comfortable with, even unaccredited
investors investing in that market. So, another potential way
to expand that access to investors in the private markets would
be to adopt that language and give people, for example, a set
number of dollars that even unaccredited investors could invest
in the private markets.
And then finally, I think we have discussed this as well,
the other way to help increase private market access for
unaccredited or even accredited investors under a new
definition would be to look at expanding fund-level investment
opportunities by giving people the benefit of professionally
managed funds and revisiting, for example, the 3(c)(1)
limitations on the number of accredited investors that are
currently limited to 100 in those funds. Those I think would
expand access, as well.
Mr. Hill. That is helpful, because I think we want to do
both. I think we want to make sure that our public investors,
through 401(k)s and through their IRAs and through their
company pension plans have more opportunities, as you have
outlined, to invest in public companies. The number of public
companies has been cut in half over my business career. But we
also want to safely give them opportunity to participate in a
private market if, in fact, as you argue, companies are staying
private longer.
Give me one thing that would lower that marginal cost of
being public so that a small or mid-cap company might be
inclined not to wait until it is huge to go public? What would
be the top thing for you?
Mr. Kupor. To me, I think the framework that this Congress
laid out on the EGCs is the right framework. So if you could
extend the time period under which those issuers could take
advantage of the lighter regulatory environment for EGCs that
exists today, I think that would be very meaningful.
Mr. Hill. Good. Thank you so much.
I yield back, Mr. Chairman.
Chairman Sherman. Thank you.
I now recognize Mr. Foster for 5 minutes.
Mr. Foster. Thank you, Mr. Chairman. First, just two quick
comments on the thing that we have been struggling with on this
committee for quite some years, which is, who is going to pay
for the research on a small-cap firm at the edge of going
public? There is an asymmetry because wealthy private equity
investors have the wherewithal to look into details. If they
are talking about investing in a potential unicorn, they can
look and ask if the intellectual property is sound and
defensible in court. That is never going to be cheap or easy or
transparent, but it is a real cost, and someone ought to do it
at the point that the issue goes public, because the retail
investor is not going to have the wherewithal to do that kind
of due diligence.
And a second general comment on it, I think it is very
often pointed out that maybe one of the drivers of wealth
inequality is the asymmetric access. I think it may actually be
the other way around, that when you have an increasing
concentration of wealth at the top, then those are the people
who can realistically make private equity-type investments,
which are the high-risk, high-reward investments. So the
problem is at least feeding on itself, and we should look at it
from both sides of that coin.
Okay. I really appreciate the argument about the benefits
of competition between IPOs, direct listings, and SPACs. That
has to be part of a good solution to this. But the question I
have is, do we know enough at this point to define what a safe,
sound, and economically efficient SPAC looks like? In an effort
to at least carve out a subset of SPACs that are really
reasonable things to invest in, can we define those? This huge
boom in SPAC listings has given us a lot of data. So, do we
know enough?
Does anyone want to grab that and try to say what are the
essential things that we could do, and is it a wise thing to
try to split off part of the SPAC market into well-regulated,
responsibly-run entities?
Let's start with weddings. How do you make weddings less
likely to end in divorce?
Ms. Rodrigues. I am studying SPACs right now. I am studying
the current crop of SPACs right now. I will have better answers
when that study is concluded. I will say that I think all of
the witnesses are in agreement that we need to equalize the
regulations so there isn't this regulatory arbitrage. It
shouldn't be that it is easier, that the liability is
different, or the disclosure level is different in one versus
the other.
So once that is done, I think a lot more disclosure--I will
tell you, I am looking at these disclosures around the mergers
right now, and they are incredibly complex. I can't really
understand them, and this is what I am doing every day. They
are opaque, and I am not exactly sure whose money is coming in
and what their interests are. So, standardizing disclosure.
And then, the final thing that I think would make SPACs
safer is to make it a real vote, to have there be a real vote
from the market so that if 50 percent--and this was the
intention at the outset of the form--of the SPAC shareholders
want their money back, then it is not a good acquisition and it
shouldn't go forward. But if more than 50 percent are willing
to stay in, that is a market test.
Again, I am looking at the empirics, but that is where I am
right now.
Mr. Foster. Any other comments or suggestions?
Mr. Kupor. Mr. Foster, if I could comment on your earlier
comment, you mentioned two things that I think were very
important. One was you mentioned who will pay for research for
these small-cap companies, because it is very critical, and I
do think fundamentally this goes back to, is there an economic
incentive for this through making sure that these stocks trade
and they have appropriate volume and liquidity. So, some of the
suggestions that I brought up around UTB suspension, and also
looking at the global research settlement and making sure that
there aren't impediments to research covers that may still be
stemming from that.
And then, if I could just also comment on the second thing
you mentioned, which is wealthy individuals being able to
access private markets, I 100 percent agree with you that is a
real issue, and I think that is why, again, this body should
consider how you could improve retail access to the private
markets in addition to all of the good work you are doing
around IPOs. So, thank you for bringing this up.
Mr. Foster. Does anyone else have a suggestion?
Mr. Deane. I would just also speak--when you ask about how
we can identify better SPACs, they are evolving. I talked
earlier about the dilution, the misaligned incentives.
I see the time is up. I would just say the current designs
that they have are not locked in stone, and there could be
changes. But I see my time is up.
Mr. Foster. Thank you, and I was just suggesting that maybe
we can carve out a set of responsibly run SPACs and let the
market, let the Wild West try to develop more efficient models.
My time is up, and I yield back.
Chairman Sherman. I believe next in seniority order is Mr.
Davidson.
Mr. Davidson. I thank Chairman Sherman for this hearing. I
really appreciate our witnesses highlighting this important
topic, and I have enjoyed the discussion thus far.
Ms. Rodrigues, in your testimony you stated that you do not
believe there is anything fundamentally wrong with the current
IPO process. But in Mr. Kupor's testimony, he eloquently
pointed out that small IPOs, companies with less than $50
million in annual revenue at the time of their IPO, have
declined from more than 50 percent of all IPOs in the 1980 to
2000 timeframe, to about 25 percent of IPOs over the past 15
years. Additionally, he points out that companies are trying to
stay private much longer. The median time to IPO from founding
hovered around 6\1/2\ years from 1980 to 2000, but now
companies are staying private for 10 years or more.
Ms. Rodrigues, when you look at these facts, how can you
say that there is nothing fundamentally wrong with the IPO
process?
Ms. Rodrigues. Thank you for that question. I will say,
one, I want to be more precise. I think there is nothing wrong
with the basic IPO process from a regulatory perspective. I
think that the move to direct listings and SPACs is, in part, a
function of companies' dissatisfaction with phenomenon like
underpricing and the fact that there is a lot of uncertainty
surrounding that traditional system, wanting to get more
control over it, which they can get from a direct listing or
from a SPAC.
I would echo what Mr. Kupor said about how it is pretty
unattractive to be a small-cap publicly traded company, that
there isn't that coverage, there isn't the trading volume. So,
that is one explanation.
Another explanation is it is pretty darn easy to be
private. There has been so much money sloshing around private
equity firms. Venture capital firms are throwing money at these
private companies--
Mr. Davidson. Thank you for that reference to the private
market. I think that would be a great hearing, as well.
When you talk about public markets, there are really
important things. Mr. Deane highlighted some good topics on
dilution. My colleague, Mr. Hill, who has a bill that I am a
co-sponsor of, highlighted one of the barriers to participation
in our markets with accredited investor rules. Frankly, Mr.
Himes did a nice job talking about reference price, which you
alluded to here, all a big deal in terms of affecting value for
not just the companies that launch but the people who invest in
them, and so broadly, access to capital.
But when you look at the things that are broken, the SPAC
market and the volatility in it, is coming in after the IPO
market. If you look back a few years ago, the initial corn
offering market was in a kind of meltdown, and you saw some
fraud.
Mr. Kupor, I appreciate you for highlighting that issue,
because it is heavily dominated in the crypto space. For the
structure of our market, the SEC failed to provide regulatory
clarity, and that has kept your average investor from being
able to hold these in retirement accounts. What has that meant
for people, and what needs to happen in that space?
Mr. Kupor. Mr. Davidson, as you mentioned, I think this is
another example where I think we just have very significant
disparity between, let's call it institutional or high-net-
worth individuals versus traditional retail investors, which is
for the former category people can afford to spend a lot of
money on legal counsel and understand exactly what is the
nature of these tokens, are they securities, are they not, what
the SEC is likely to do. But for ordinary folks without that
clarity from the SEC, it really does mean that they are missing
out on what at least we do believe is a really important growth
opportunity.
Mr. Davidson. Yes, thanks for that. For example, because of
that lack of regulatory clarity, there is no Bitcoin exchange-
traded fund (ETF), though many have tried and are lingering in
never-never land with some hope that there will be some
clarity. Maybe with new Chairman Gensler, we will get there.
But you can get a SPAC ETF. You can still buy those.
All of these highlight voids in the fundamental IPO market,
and I really think that the market is trying to tell us the IPO
market is not healthy, it is not fundamentally sound, it is
broken, and everyone is trying to find a path around that.
Lastly, I want to thank Ranking Member McHenry for his bill
on Regulation Crowdfunding (Reg CF). I think just the promise
that has offered for crowdfunding should be looked at as a
model, though we could expand to provide broader access and
more democratic access to capital.
The last thing--and I am running low on time--is direct
listings. I think Coinbase's direct listing highlights that it
can be a viable model and all important areas, and I thank
everyone for helping us get to this point in the hearing, and I
yield back.
Chairman Sherman. Okay. We have five more questioners. We
will be done in less than 30 minutes, unless there is a general
consensus to do a second round of 2\1/2\ minutes per Member. So
if you have a view on that, please text me.
Mr. Vargas is now recognized for 5 minutes.
Mr. Vargas. Thank you very much, Mr. Chairman, for holding
this hearing. And I especially want to thank the witnesses
today. I think the most important question that came up today
was, what about weddings and marriages?
I am going to give you the answer right now, very clearly.
It doesn't matter if it is a wedding in Vegas or a traditional
wedding. If you want to make the marriage work, if you love
your spouse, you don't cheat on them. I have been married for
30 years; it works great, okay? There. That one has been asked
and answered.
So now, we move to this. The way that traditionally we hold
a hearing is that whatever party is in power has two or three
or four witnesses, and then the party in the Minority has one
witness. Normally, they don't agree on things. That is why you
have the disparity, which is fine.
But I think we may have found something that everyone
agrees on today, and that is why I want to pursue this line of
questioning, and that is the issue of liability. I think Mr.
Kupor said we should have the same liability system for all of
these.
Section 11, as I understand it, is a strict liability
regime. Issuers are made strictly liable for registration
statements that contain an untrue statement of a material fact,
or that they omit one. So, you don't have to prove causation or
reliance on the misstatements. It is a strict liability statute
and regime.
Now, did I understand correctly, Mr. Kupor, that you agree
that an IPO should have the same--that the playing field should
be the same for a SPAC and for an IPO, or am I misstating what
you said?
Mr. Kupor. No, Mr. Vargas. Yes, I agree that this Congress
should determine--I am not taking a position on what the
appropriate liability regime should be, but I absolutely agree
with your position that we should have a level playing field
and we should not have regulatory arbitrage that determines
which path makes most sense for companies.
Mr. Vargas. To me, that seems like a very big deal. I am
going to ask Professor Rodrigues, that seems to me a huge issue
with these forward-looking statements, do you agree?
Ms. Rodrigues. Yes, absolutely.
Mr. Vargas. Could you expound on that?
Ms. Rodrigues. Sure. So, information is valuable. That is
why issuers disclose it on their own, and that is why we
require disclosure under the securities laws. If you are
interested in a company, you are interested in what happened in
the past, but you are probably as or more interested in what
should happen in the future, what the CEO and the CFO think the
prospects of the business are. That is why Congress, in 1995,
said, okay, under the Private Securities Litigation Reform Act,
you have a safe harbor and we can protect you if you want to
say, hey, here is what we think is going to happen down the
road.
But that is not for IPOs, because IPOs are a special world
where the company is first coming out into the public markets,
and so we have really strict liability standards. We want to
make sure that everything there is accurate, that there isn't
any material misstatement.
Mr. Vargas. And do SPACs have that today?
Ms. Rodrigues. They do, because when they go public they
are just an empty shell. What you really care about is when
they find that private target and they are acquiring it. That
acquisition is effectively an IPO. But in that, the Vegas
wedding IPO, then they get to say whatever they want about the
company's prospects in a way that a traditional IPO can't, and
that is just not fair, right? There is a different standard
depending on which way you take to--
Mr. Vargas. I agree with that.
Does anyone disagree with that?
Mr. Park, do you disagree with that?
Mr. Park. No, I don't. In fact, I think this whole notion
of forward-looking statements and the accuracy of that is very
important, and the way that we know that is because if we look
back most recently to COVID, actually, the strength and the
certainty of these forward-looking statements are very
important to make sure that not only do investors have
protections, but also other business owners who rely on what
some of these other businesses are doing.
For example, the SEC, back in April 2020, had to give
guidance to a lot of executives on how to handle a very
unprecedented and uncertain time as it pertains to how COVID
affects their business models, and that shows how strong the
protections are for public companies right now.
If you also think about this from another point of view, if
I am a travel agency and I need to look at airlines and hotels
and what they are doing, I need to trust their forward-looking
statements as well.
Mr. Vargas. Yes. My time has expired, but I am glad that we
may have agreed on something here.
Thank you. I yield back.
Chairman Sherman. Thank you. And I would add one more thing
for a happy marriage: Do not undervalue your spouse, or
underprice in this world.
The gentleman from Ohio, Mr. Gonzalez, is now recognized
for 5 minutes.
Mr. Gonzalez of Ohio. Thank you, Mr. Chairman, for holding
today's hearing, and thank you to our witnesses for being with
us today, and thank you to Mr. Vargas for preaching a little
bit; I enjoyed that.
In any event, over the last year we have seen significant
changes in the way that retail investors of all stripes are
engaged in our capital market system, and personally, I am
encouraged to see more and more retail investors invested in
the market in an effort to better their lives and build a more
prosperous future for their families.
Of course, that is not without risk. That is how markets
work. And in this case I do think it is important that we take
a step back and recognize that whether we are talking about the
crypto or NFT markets or SPACs, the proliferation of riskier
investments has been driven by a zero-interest-rate world,
which has resulted in a fully valued stock market and investors
moving further and further out on the risk curve. I don't think
we have mentioned that, but I do think it is important to keep
that in mind as we debate what is happening in our markets.
So rather than doing what I fear my colleagues on the other
side are doing, which is trying to turn off options at times
for retail investors to put their capital to work and to make
it harder for companies to raise capital, I do think we need to
recognize the uniqueness of the moment and try to find ways to
improve the efficiency and the strength of our capital markets
for all participants.
Mr. Kupor, in your testimony you talk about the two-tiered
capital market structure where, because more companies are
willing to go public later, a disproportionate amount of value
is created in the private markets, which structurally lock out
retail investors. I completely agree. You also correctly point
out that having multiple avenues to go public is a good thing
from a competitive standpoint.
And we haven't talked much about direct listings, and I
want to hear from you from the perspective of the entrepreneur
or the founder. When it comes to a direct listing, what is the
benefit specifically of a company looking at that as a vehicle
to go public? And if you could also touch on the projections
that are made in that process, because I see projections when I
look at the YouTube videos and things like that, but I would
love for you to just sound off on that, if you could.
Mr. Kupor. Sure. Thank you, Mr. Gonzalez.
So, yes, with respect to direct listings, as mentioned
before, typically the companies that are choosing this route
are ones that don't have a need for primary capital. So they
are able, again, to avoid the dilution, quite frankly, that you
would have in the IPO process, and that is very positive.
The second benefit to direct listings is they utilize what
I would call more of an auction mechanism to actually try to
derive the opening price for the stock. We see a little bit of
advancement here in the traditional IPO markets. There are some
banks trying to do a modified auction process, but the kind of
process that goes into a direct listing is still a much more
robust process. Therefore, for people who are concerned about
potential underpricing or things of that sort, there is
probably a closer market price and a better way to discern that
market price that happens there.
So, it has been very positive. As I said, the reality is we
have had very few. We have had about six of them in the
technology market, so I think there is a lot of work to be done
there. But it also has the positive effect, as you mentioned,
from a competitive perspective. It has forced traditional
underwriters and IPOs to kind of tighten their pricing windows,
which I think has been positive, and it has forced people to
think about things like lockups, for example, which can create
distortions based on supply and demand in the market.
I think making sure direct listings stay as a viable option
will also actually address some of the challenges that many of
you have mentioned around traditional IPOs.
Mr. Gonzalez of Ohio. Thank you.
Mr. Deane, one thing that you talked a lot about on the
SPAC side with respect to disclosures and subsequently
incentive alignment--and I think that is right in many ways. I
am personally somebody who wants to be able to take risk. I
just want those things disclosed so I can understand them. And
more or less, I do think you can figure out what the promote
structure is in a SPAC if you go through the listings. Yes, it
is hard, but I think you can do it.
One thing you didn't touch on, which sort of surprised me,
is with respect to the syndication of the risk capital at the
pre-IPO stage, if you will. So in essence, if you are
purchasing pre-merger shares in a SPAC, you are really just
buying a sponsor. But is it possible today for someone to know
who owns the sponsor, or can the sponsor syndicate the risk
capital such that you don't actually know?
Mr. Deane. To be honest, I am not certain what your
question is about. You are asking who actually stands behind
the sponsor?
Mr. Gonzalez of Ohio. Yes. The sponsor has to put up risk
capital. Can the sponsor syndicate that, sell it off, and not
disclose it?
Mr. Deane. In the pre-IPO, I would question that. But to be
honest, I would like to look at it further and get back to you.
Mr. Gonzalez of Ohio. Sure.
Mr. Kupor, do you know how to answer that?
Mr. Kupor. I believe that is correct.
Mr. Gonzalez of Ohio. So, the answer is yes. I think that
is another area where I think from a disclosure standpoint we
probably need to do a little bit better work.
I have run out of time, but thanks again for the hearing.
With that, I yield back, and thanks for the marriage advice.
Chairman Sherman. Thank you.
Good news for our witnesses. Our friends on the other side
of the aisle did not want an abbreviated second round, so we
will be done in around 20 or 25 minutes. That puts a special
onus on the remaining questioners to ask brilliant and incisive
questions, which is why I now recognize Mr. San Nicolas.
Mr. San Nicolas. Thank you, Mr. Chairman, for the
introduction. That is very kind of you.
I wanted to address my question to Professor Rodrigues. As
I am listening to this whole conversation about SPACs, I am
brought back to the old days when I was in the investment
industry and we had to learn about the different types of
management companies, and I wanted to see if you could really
help us to understand the difference between a SPAC as we are
discussing it today, and a closed end equity fund that would
typically be somewhat similar in its function of pulling
together investors and making specific investments or
acquisitions.
Ms. Rodrigues. Well, I don't know that I can. I think a
closed end equity--if you could describe a closed end equity
fund a little more to me, then I can probably take it from
there. But thank you for the question very much.
Mr. San Nicolas. I just wanted to put it out there. Maybe
Mr. Deane can elaborate, perhaps, on what the differences are
between a closed end equity fund and a SPAC.
Mr. Deane. Again, I am not--as I understand it, there are
closed end mutual funds. I am not quite sure. But if that is
what you are asking, they would own assets. They would buy--
they would invest in different things. It would be closed end,
but it would still be--other than that, it would be like a
mutual fund, and it would have diversity. It would probably
have a diversified portfolio, and you could look at it and see
what those assets are.
Now, in a SPAC, it is different because first, at the very
beginning of the IPO, the SPAC is just saying, we are out
there, give us some money, and we are going to go find a great
deal, trust us. There are no assets other than the money that
comes in.
And a second point, they do find a merger market, but at
that point it is just one company, a private company that they
are taking public. It is not a diversified portfolio. It is
just a risk on one company.
That is really the best I can do to respond.
Mr. San Nicolas. When a SPAC is being formed, do the
investors in the SPAC know what company is being targeted for
acquisition?
Mr. Deane. No, Congressman, they do not. A SPAC might say,
we are going to look at EV, electric vehicles, or we are going
to do something in the tech space or biotechnology. So, you
might have an idea of what sector it is. But if the question is
do they identify a specific company that they plan to take
public, the answer is no.
Mr. San Nicolas. So why would an investor invest in a SPAC
prior to its IPO if they have no idea what they are investing
in?
Mr. Deane. That is a great question.
Mr. San Nicolas. The reason I am asking is that there are
really only one of two answers. Either, one, they do know what
they are going to invest in, and then we are talking about some
serious potential insider trading; or they don't know what they
are going to invest in, but they are investing because of the
management team of the company, but then we are talking about
open-ended or closed-ended management companies that really
should be under the regulation of the Investment Company Act of
1940.
So, I am sitting back and I am looking at SPACs, and it
doesn't really make any sense to me as to why they would be
treated as a typical IPO, a typical company that is being
formed under the equity markets. They really sound like they
are forming under the status of management companies and trying
to skirt around the Investment Company Act of 1940; or two,
they actually know what they want to invest in, in advance, and
then we are talking about insider trading and a bunch of
investors knowing what they are going to go after and kind of
structuring the entire acquisition in a manner that is going to
guarantee that all the players are going to make a certain
amount of margin at the expense of retail investors.
Professor Rodrigues, do you have anything that you perhaps
would like to add to that analysis?
Ms. Rodrigues. Yes, that was very helpful. Thank you to Mr.
Deane and to you.
The idea, in theory, is that it is a bet on management,
that the management either has this experience in private
equity that makes it able to identify some attractive target or
it has public company operating experience that can help
shepherd the company once it is identified.
I will say that in the study I am doing right now,
sometimes there are multiple targets that wind up being
acquired. It isn't just one company. It is two or even three
that are sometimes related and sometimes not.
Mr. San Nicolas. And just to close, because my time has
expired, Mr. Chairman, perhaps we need to regulate SPACs as
management companies and not as equity IPOs.
Thank you, Mr. Chairman. I yield back.
Chairman Sherman. The Chair will advise Members that if I
cannot see your face on screen, I cannot call on you when your
turn arrives. But Mr. Emmer's face is definitely on screen and
he is now recognized.
Mr. Emmer. Thank you, Mr. Chairman.
Participation in the IPO process has significantly slowed
over several years. The number of IPOs declined more than 63
percent in the 1990s to the 2000s, and then it stayed flat up
until 2020.
What is interesting is that at the same time, the United
States has doubled the regulatory compliance costs a business
has to take on for going public in a traditional IPO. It costs,
on average, $2.5 million for a company to achieve initial
regulatory compliance for going public, and an additional $1.5
million annually thereafter. These are the SEC estimates.
This is just not feasible for our small and emerging growth
companies. These businesses are turning to more streamlined
approaches to access capital like SPACs, direct listings, or
even staying private. An overly burdensome IPO process hurts
American consumers by eliminating their access to the markets
and ensuring that only institutional investors can invest in
these innovative emerging growth companies. It is critical that
our capital market structure meets the needs of American
companies regardless of their size or type.
I am excited that we are going to reintroduce my bill, the
Main Street Growth Act, which passed out of the House in the
115th Congress, and passed out of this committee unanimously
thanks to my colleagues on the other side of the aisle, many of
whom are present with us today. This bill will allow the SEC to
provide for the creation of venture exchanges. These
specialized securities exchanges offer streamlined regulation
and strong investor protections which will help small and
emerging growth companies gain access to capital, create jobs,
and help the economy rebound.
Mr. Kupor, in your testimony you note that fewer small
companies than ever are going public. But the good news for
capital formation is that there are now multiple choices for
companies that are considering going public--traditional IPOs,
direct listings, and SPACs. Given the current landscape and the
importance of having new companies join the marketplace, can
the creation of venture exchanges help incentivize more
emerging growth companies to go public?
Mr. Kupor. Thank you, Mr. Emmer. I appreciate that. You and
I have discussed this a little bit before.
The concept of a venture exchange, I think is a very good
concept, the basic idea being how can we address from a
regulatory perspective, and then, importantly, from an after-
market perspective things like liquidity and volume of trading
that impacts small-cap stocks. So, the concept makes a lot of
sense to me. I think the devil is in the details, as you and I
have discussed.
We want to make sure that we don't create kind of adverse
selection risks associated with companies that might choose to
list on a venture exchange relative to the traditional market,
and again these are issues that you and I have talked about
before. Some of the experience, for example, in the A markets
in the U.K. have exposed some of those challenges. So making
sure that the venture exchanges don't create that and that
there is a seamless opportunity for companies to effectively
graduate over time from a venture exchange into a more
traditional national market exchange, as we have today, I think
would be important to ensure high-quality issuances in those
markets.
Mr. Emmer. Just following up on that, can you elaborate a
little bit more and speak to the importance of facilitating a
competitive marketplace where small and medium-sized companies
can be attractive to investors, since that marketplace is
currently dominated by larger-cap companies?
Mr. Kupor. Yes, it is really important, and I think the
issue goes back to something one of your colleagues mentioned,
which is that we have taken a bit of a one-size-fits-all
approach to regulating companies. Many things that have worked
well for large companies just don't work well for small
companies, so we really need to do that.
And look, to me, competition is great. I mentioned before
that we are already seeing changes in how underwriters are
doing pricings in traditional IPOs as a result of direct
listings and SPACs being viable alternatives. We are seeing
reforms around how people think about lockups, which also, as I
mentioned, create strange trading dynamics in these companies.
And you would expect that also may impact pricing, quite
frankly, and the fee structure, which I know many people have
talked about on this committee.
So, I think the last thing we want to do is restrict
choice. Clearly, we should make sure that things are
regulatory-compliant and are available to others. But if we do
something that kind of constricts the choice for issuers, I
think we will lose on a lot of these great opportunities.
Mr. Emmer. I appreciate that.
Mr. Chairman, I yield back the balance of my time.
Chairman Sherman. Thank you.
I now recognize the new Vice Chair of our subcommittee, who
brings tremendous business and financial experience to that
role, for his first questions as Vice Chair, Mr. Casten.
Mr. Casten. Thank you so much, Mr. Chairman. I am looking
forward to the responsibilities you will be assigning me.
It strikes me that on this subcommittee, we talk about
trends in capital markets as if the investors were static and
they only reflect changes in companies' access to capital. We
all know that is not true. In the last 3 decades, we have seen
transformative changes in the institutional sector, the pension
funds, the endowments, which used to have all of their capital
in Treasuries and utility stocks and have now created these
whole investor classes, alternative investment classes and real
estate investment trusts (REITs) and private equity and
venture, and that is awesome. It has completely changed the
market. It has created opportunities where companies, like the
company I used to run, that were really too small to go after
private markets, still had access to capital, and that is a
good thing.
It has also created an entirely new class of actors in our
financial markets. They used to be owners of wealth and people
who needed wealth, and now we have custodians of wealth in the
middle, and some of them have done a great job. Some of them
haven't, but it has changed the dynamics. There is nothing
wrong with that.
I sort of view SPACs and PIPEs as things that live in that
continuum, right? Because every company that has a single,
large, sophisticated investor would love to still have the
access to capital with the less sophisticated investor. It
makes your life easier as a manager. And I think the challenge
of regulation is always trying to figure out how to ensure that
access to capital survives, while at the same time, not taking
advantage of unsophisticated investors.
So my first question for you, Mr. Park, is you mentioned
that the challenge with SPACs is that they are putting their
trust in a sponsor rather than the company. Isn't that
essentially the same thing that happens when investors invest
in a private equity fund? Is there any fundamental difference
there?
Mr. Park. Representative Casten, the major difference
between the SPAC and a private equity fund is that, again, with
the private equity fund there is going to be a debt investment
where the investor has some security that they have, versus in
a SPAC they are the junior most if there is other debt type of
investor there.
I should also point out that there are some significant
differences between how SPACs work and also some of these
private equity funds. Again, part of the business model for a
lot of these SPACs is that you need a lot of marketing and a
lot of hype around them in order to attract investors. That is
why you see the SEC warning a number of investors, don't just
buy a SPAC just because they hire a celebrity to go and promote
them, right? That is a major concern there.
Mr. Casten. Sure, and I take your point. I am really just
talking about the equity investors in both, that if you view it
as along a continuum, the equity investor is taking a bet on
the sponsor in both cases. I take your point, and I don't mean
to criticize. I just want to run through some other questions.
Mr. Deane, you mentioned in your testimony that there is
pressure to deploy capital in a SPAC before the window closes.
Is that fundamentally different from a private equity fund that
is nearing the end of its lockup period, that has committed
capital that is still undeployed?
Mr. Deane. I would say it is the same, except that maybe a
private equity (PE) firm might have more years. Maybe it will
have 7 years, or 5 years to do it. The SPAC is usually either
18 months or 2 years.
The other difference, if I could, is that a PE firm will
often have a diversity of targets, a diverse portfolio, whereas
the SPAC is usually, if not always, one firm, one target.
Mr. Casten. Okay. And I want to be clear that I am in no
way meaning my questions to be leading and saying one way or
the other. But we have all seen the statistics that the
overwhelming majority of returns in the alternative asset class
base is driven by a tiny number of firms, and there are
actually a lot of people who are thought of as sophisticated
investors, who are losing their shirt on that side.
I guess I will start with you, Mr. Deane, because I still
have you on the screen. But capital markets are going to
continue to evolve. They will evolve in response to what we do
from a regulatory perspective. And if the issues are the
compensation structure and the incentives, let's make sure we
think about where those guardrails should be. If the issue is
that there is a specific class of investment that we want to
prohibit, okay, then let's do that. I just want to make sure
that in thinking about the compensation structure of SPACs, the
lockup period, the deployment, I want to make sure we are
focusing on the right issues.
So if you were looking at the broader space of money going
into somewhat less conventional structures, are there
guardrails that cross that whole continuum we should be
thinking about, or is this just a SPAC issue?
And I see I am out of time, so perhaps we will have to take
that offline, but I would appreciate any of your thoughts in
writing after the hearing is over on that question.
Mr. Deane. Saved by the bell. But I would be happy to
respond afterwards.
Mr. Casten. Thank you.
Chairman Sherman. We look forward to your written response
to that question, and we all look forward to the questions of
Mr. Steil, who is now recognized for 5 minutes.
Mr. Steil. Thank you. I appreciate you holding this
hearing, Mr. Chairman.
Mr. Kupor, as you know, most venture startups are emerging
growth companies. Can you walk us through your analysis of some
of the benefits of EGC status?
Mr. Kupor. Yes. Thank you, Mr. Steil. There are several
things.
Number one, which we have now extended more broadly, is the
idea of confidential filings and the idea of test-the-waters
are very, very important, because this really gives the
companies an opportunity to talk to investors before they have
to kind of make a final determination, quite frankly, of what
the right path is, and it really is beneficial.
Number two is, as we have talked about before, the idea of
reduced regulatory burdens, the ability to have different
Sarbanes-Oxley-related requirements and other things that are
generally geared towards smaller companies. So, effectively,
think of it as an on-ramp to becoming a public company. If we
make that on-ramp a little bit easier, we are more likely to
see public companies go out.
Mr. Steil. And maybe you could comment about bringing more
companies into the public markets, how that EGC structure
assists companies in accessing capital? Can you comment on
that?
Mr. Kupor. Yes. At the end of the day, what it means is
that if you are an investor, it just means that there is more
money that the company is going to have access to on their
balance sheet that can go towards research and development or
other important initiatives they are doing, versus that amount
of money being diverted towards regulatory expenses. It has
been very beneficial--particularly, you see this in the biotech
market, which has been very robust over the last several years.
That tends to be a bit of a smaller-cap market, at least
relative to the IT markets, and I think those companies have
substantially benefitted from the ability to deploy capital in
the most promising areas versus on regulatory structure.
Mr. Steil. We are talking about how companies enter. How
about companies that are already in EGC status, and
particularly those that have either already lapsed through the
5 years or that are approaching that lapse, what are the
implications of losing EGC status for some of those key
companies?
Mr. Kupor. Yes. I think it is really the same. If we could
extend that time period from 5 years to 10 years, or whatever
this body thinks is appropriate, I think it has the same
beneficial impact. Think of it as you have a fixed pot of money
on your balance sheet, and the question is, where are you
deploying those resources? The more we can divert those towards
productive research and development-related expenses, I think
that is beneficial for the economy, and it is beneficial for
those issuers, as well.
Mr. Steil. So in your view, if we extend the EGC status,
there are going to be benefits not only to the companies but
really to the R&D ecosystem, to employees, and all the way down
that entire pipeline for those EGC companies and their
stakeholders?
Mr. Kupor. Yes, I do believe that, Mr. Steil.
Mr. Steil. I appreciate it. And I appreciate you joining us
today.
And I appreciate you, Mr. Chairman, for holding today's
hearing. With that, I will yield back.
Chairman Sherman. Thank you.
We now turn to the distinguished gentleman from Missouri,
Mr. Cleaver, who is also the Chair of our Housing, Community
Development, and Insurance Subcommittee, for 5 minutes.
Mr. Cleaver. Thank you, Mr. Chairman.
I just have one question. I think most of the issues that I
was concerned about have been raised by the members of the
intelligentsia of your committee.
What I wanted to just say is that I am amazed by the
notoriety of our celebrity culture in this country. It is just
absolutely amazing. Shaq played basketball, and now he is in
the middle of giving financial advice to folks. He made a lot
of money, so maybe he learned a lot about money.
But back in March, the SEC issued an investor alert
regarding celebrity involvement in SPACs. In the notice, the
SEC warned individuals never to invest in a SPAC based solely
on a celebrity's involvement.
I don't know if that will stop anybody from doing it, but,
Mr. Park, would you agree that this trend reinforces the fact
that SPACs generally represent a very speculative investment?
Mr. Park. Absolutely, Congressman Cleaver, and that is a
great point that you raise. What I find really noteworthy about
how SPAC sponsors are relying on celebrities to promote
themselves is that they are implicitly saying that by doing so,
they think that they can attract retail investors to invest in
their SPACs just merely by the association alone rather than on
their business model, their financial statements, or really
looking at it in any kind of substantive way.
What is kind of notable about this too is that hiring
celebrities really isn't a new strategy. We have seen
celebrities being used time and time again to promote different
types of financial products, whether it is reverse mortgages,
annuities, and lately different cryptocurrencies too, right?
So, I think that is very noteworthy.
What I would also point out is that sometimes the issuers
can also have a bit of a celebrity status of their own, and
that can also lead to some poor investments that way.
I think that for SPACs, the perfect type of investment that
goes wrong is that a company is very heavily hyped, you have a
compelling narrative around the founder, and it also really
appeals to our desires for a product or a company that will
really improve the world. But the problem is that sometimes we
can find that it is fraud. The example that comes to mind for
that is Theranos, which kind of meets all of the criteria of
that, and unfortunately just bilked a bunch of different
investors, some of whom were more sophisticated than your
average retail investor.
Mr. Cleaver. Thank you very much. This is an all-day
conversation, at least for me, because I am just amazed at what
goes on. I am not sure that the statement issued by the SEC is
going to do anything in and of itself. We are almost worshipful
when it comes to celebrities in this country.
Anyway, thank you very much, Mr. Park.
And I yield back, Mr. Chairman.
Chairman Sherman. I want to thank all of my colleagues for
participating in this hearing, particularly those who were here
at the very end. And I want to thank our witnesses for their
testimony.
The Chair notes that some Members may have additional
questions for this panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to these witnesses and to place their responses in the record.
Also, without objection, Members will have 5 legislative days
to submit extraneous materials to the Chair for inclusion in
the record.
With that the hearing is adjourned. Thank you.
[Whereupon, at 1:53 p.m., the hearing was adjourned.]
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