Capital Markets Subcommittee Hearing on Capital Formation Proposals, feat. SIFMA witness

House Financial Services Committee – Capital Markets Subcommittee

“Legislative Proposals to Help Fuel Capital and Growth on Main Street”

Wednesday, May 23, 2018

 

 

Key Topics & Takeaways

  • Public vs. Private Markets: There were numerous questions about the relative costs and benefits of public markets as compared to private capital markets, and how changing capital raising practices have affected entrepreneurship and investors. Much attention was paid to the decline in total number of public companies since 1996, and the sluggish initial public offering (IPO) market, as well as on ideas to improve the attractiveness of public capital markets for issuers. Brett Paschke, Head of Capital Markets at William Blair, testified on behalf of SIFMA at the hearing and called for extending the on-ramp for Emerging Growth Companies (EGCs) from five to ten years, and noted that investors reacted favorably to EGCs, even though they had lighter disclosure requirements.
  • Research Coverage of Issuers: Paschke spoke to the importance of research coverage to issuers and the relationship between research and capital formation. Paschke noted that smaller issuers usually have very little research coverage, so policymakers should try to encourage more research of smaller companies. Paschke also talked about how market changes and the EU’s new Markets in Financial Instruments Directive II (MiFID II) have affected research.
  • Venture Exchanges: There was discussion throughout the hearing on a legislative proposal to allow the creation of venture exchanges. Proponents argued that concentrated liquidity for small cap companies would make them more likely to go public, while opponents argued that the bill’s exemption for venture securities from state securities laws would draw bad actors to those exchanges.

Witness

  • Brett Paschke, Managing Director and Head of Capital Markets, William Blair, on behalf of the Securities Industry and Financial Markets Association (SIFMA)
  • Edward S. Knight, Executive Vice President, Global Chief Legal and Policy Officer, Nasdaq.
  • John C. Coffee Jr., Adolf A. Berle Professor of Law, Columbia University Law School
  • Brian Hahn, Chief Financial Officer, GlycoMimetics, Inc., on behalf of the Biotechnology Innovation Organization
  • Barry Eggers, Founding Partner, Lightspeed Venture Partners, on behalf of the National Venture Capital Association
  • Tyler Gellasch, Executive Director, Healthy Markets Association
  • Thomas Quaadman, Vice President, Center for Capital Markets Competitiveness, U.S. Chamber of Commerce

Opening Statements

Subcommittee Chairman Bill Huizenga (R-Mich.)
In his opening statement, Huizenga outlined the Jumpstart our Business Startups Act (“JOBS Act”) of 2012 and its creation of the Emerging Growth Company (EGC) status for certain issuers. Huizenga noted the bipartisan support for the legislation aimed at helping issuers raise capital and said that while the capital formation framework today is better than it was in the past, the last six years have shown the need for further changes. Huizenga the discussed the legislative proposals under consideration.

Subcommittee Ranking Member Carolyn Maloney (D-N.Y.)
In her opening statement, Maloney focused on a few of the legislative proposals that were the main topic of discussion for the hearing. Maloney was critical of H.R. 5054, which would exempt certain issuers from submitting forms to the Securities and Exchange Commission (SEC) using XBRL, and H.R. 5756, which would make it more difficult for shareholders to influence management. Maloney said that H.R. 5877, which would establish venture exchanges, was promising, but she questioned the need for a state securities law exemption for venture exchange-traded securities.

Testimony

Brett Paschke, Managing Director and Head of Capital Markets, William Blair, on behalf of the Securities Industry and Financial Markets Association (SIFMA)
In his testimony, Paschke outlined his experience as the head of Capital Markets at William Blair and his work on the original JOBS Act, as well as recent changes in the public capital markets (including the decline in total number of listed companies). Paschke noted that many start-ups are now being built to be sold, instead of as stand-alone companies, and that companies that stay private mean that wealth creation is not available for retail investors. Paschke praised the draft legislation that would extend the EGC “on-ramp” from five to ten years, and noted that investors reacted favorably to EGCs, even though they had lighter disclosure requirements. Paschke also called for changes to the provisioning of research that would encourage coverage of smaller issuers.

Edward S. Knight, Executive Vice President, Global Chief Legal and Policy Officer, Nasdaq
In his testimony, Knight outlined several recommendations for reforming public capital markets that are supported by Nasdaq, including establishing venture exchanges and 10-Q optionality. Knight defended the legislative proposals as “largely technical changes” that he thinks are non-controversial and said that it is necessary for securities laws to evolve to meet new challenges. Knight suggested that Congressional support for these measures would go a long way to encourage entrepreneurs to go public.

John C. Coffee Jr., Adolf A. Berle Professor of Law, Columbia University Law School
In his testimony, Coffee argued that the legislative proposals and the coalition IPO report are both unnecessary, that the dot-com collapse was a result of under-regulation (with the result being that retail investors fled the new-issue market) and that the JOBS Act did not solve the problem. Coffee also pointed to declining IPO volume in Canada, the EU, and Japan. Coffee argued that the decline is because of two factors – availability of private financing, and the alleged poor performance of small offerings.

Brian Hahn, Chief Financial Officer, GlycoMimetics, Inc., on behalf of the Biotechnology Innovation Organization
In his testimony, Hahn discussed the challenges facing new and small-cap issuers like GlycoMimetics, such as steep costs for audits, and how the JOBS Act helped those issuers go public through scaled disclosure requirements. Hahn also praised the draft legislation that expanded the definition of nonaccelerated filer, called for proxy advisory reform, changes to short position disclosure, and H.R. 5054, that would exempt small issuers from XBRL.

Barry Eggers, Founding Partner, Lightspeed Venture Partners, on behalf of the National Venture Capital Association
In his testimony, Eggers discussed the importance of IPOs to venture capital firms (VCs) as an exit strategy. Eggers noted that many companies today are waiting longer to go public, and he cited the increased regulatory costs associated with being public as a reason for this. Eggers identified two consequences to fewer IPOs – less job creation and fewer opportunities for retail investors. Eggers also praised a draft bill that would revise the definition of a qualifying portfolio company to include an emerging growth company.

Tyler Gellasch, Executive Director, Healthy Markets Association
In his testimony, Gellasch criticized the legislative proposals at the hearing as bad for investors and said they would increase risks to investors, increase costs of trading, divert investment opportunities by easing limits on trading private exchanges, and reducing shareholder influence in corporate decision. Gellasch said the proposals “offer nothing” to induce investors to participate in public markets. Gellasch said preserving public markets is important due to liquidity and valuation improvements, compared to private markets, and that this could be done through improving the provisioning of research and other reforms not related to the draft bills.

Thomas Quaadman, Vice President, Center for Capital Markets Competitiveness, U.S. Chamber of Commerce
In his testimony, Quaadman praised the JOBS Act and follow-on legislation, along with S.2155, that have helped small businesses access financing, but said that more needs to be done. Quaadman said that the bills under consideration were “a good step forward” that would “remove obstacles to growth.”

Question and Answer

Public vs. Private Capital Markets
There were numerous questions about the relative costs and benefits of public markets as compared to private capital markets, and how changing capital raising practices have affected entrepreneurship and investors. Huizenga led off by asking if the JOBS Act had truly helped public markets and issuers of public securities, and Hahn argued that the audit exemptions for EGCs are crucial for companies like his, that are developing pharmaceutical products but that presently lack a major revenue stream. Paschke argued that the success of the five-year on-ramp is a sign that the JOBS Act benefited investors, and that the popularity of EGC IPOs is evidence that the scaled disclosure did not dampen investor interest in these securities.

Rep. Tom Emmer (R-Minn.) asked if retail investors were “missing out” on wealth creation due to the decline in public companies. Paschke agreed, saying that many retail investors, including retail investors that invest through mutual funds, are restricted from investing in many private securities, and mutual funds are upset that they are missing out on the wealth creation occurring in private markets. Gellasch said that while many mutual funds are able to invest in private companies, they choose not to because of the risks associated with private securities.

Research Coverage of Issuers
Paschke spoke several times about the importance of research coverage to issuers and the relationship between research and capital formation. Paschke noted that William Blair provides research coverage on more than 600 issuers, many of them small-and mid-cap companies. In response to a question from Rep. French Hill (R-Ark.) Paschke noted that many smaller issuers have only a handful (sometimes three or fewer) research analysts covering their stocks, and so if one researcher stops covering the issuer, that issuer loses a large percent of their research coverage. Paschke also talked about how market changes and the EU’s new Markets in Financial Instruments Directive II (MiFID II) has hurt the ability of issuers to receive research coverage, points that were echoed by Quaadman.

Venture Exchanges
H.R. 5877, the Main Street Growth Act, would allow for the creation of Venture Exchanges for small-cap securities to trade on one exchange only. Maloney asked Coffee for his views on the bill, and Coffee said that he opposes bills that preempt state securities laws, and that the generally efficient trading of over-the-counter (OTC) securities on Alternative Trading Systems (ATSs) is evidence that those preemptions are unnecessary. Coffee also argued that the bill could attract disreputable actors to build and operate venture exchanges. Witnesses from the Chamber and Nasdaq expressed support for establishing venture exchanges.

Listed Options
Rep. Randy Hultgren (R-Ill.) used the hearing as an opportunity to ask witnesses for his thoughts on his bill, H.R. 5749, the Options Markets Stability Act. The bill would require bank regulators to account for the netting of market maker positions across the options market when calculating capital requirements for those positions. Knight said he believes the bill would improve liquidity in the listed options market and help end-users hedge their risks in the options market.

Initial Public Offering Spreads
Rep. Jim Himes (D-Conn.) used his allotted time to discuss the “7% spread” that he has observed across the market for launching IPOs. Himes said he believes the uniformity in fees for IPOs is a sign of an uncompetitive market. Himes asked Eggers and Hahn if they and their organizations would support Congress and the SEC “taking a look” at the consistency of prices for IPOs. Eggers pointed out that many companies want to be taken public by a major investment bank and that there is “less competition” in the market today. Himes also drew attention to SEC Commissioner Robert Jackson’s recent remarks on the topic.

Draft Legislation on Quarterly Reporting
The draft legislation considered at the hearing that would replace the 10-Q with a “shortened form” or “press release” received attention from both proponents and opponents. Rep. Ann Wagner (R-Mo.) asked Knight to describe some of the redundancies in 10-Q / 8-K reporting. Knight argued that the 8-K causes a large impact on trading in a reporting company and is more valuable than the quarterly report, and Quaadman argued that very few investors utilize disclosed 10-Qs. The proposal drew sharp criticism from Gellasch and Coffee, who argued that eliminating mandatory quarterly disclosure forms, or allowing issuers to simply release press releases with material information, would harm investors by severely limiting the amount of information available about issuers, and would discourage investment in public capital markets.

Shareholder Submissions
H.R. 5756, which was a topic of discussion at the hearing, would amend the shareholder resubmission thresholds from 3%/6%/10% to 6%/15%/30% for proposals submitted one, two, or three or more times in the prior five years. Coffee argued that the bill was unnecessary to encourage capital formation, and Rep. Brad Sherman (D-Calif.) argued that start-ups do not shun the public markets over worries about shareholder submissions, and that this measure would harm shareholders by limiting their ability to push changes at companies.

 

For more information on this hearing, please click here.