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House Financial Services Subcommittee Hearing on Barriers to IPOs and Retail Investment

House Financial Services Subcommittee on Investor Protection, Entrepreneurship and Capital Markets

“Examining Private Market Exemptions as a Barrier to IPOs and Retail Investment.”

Wednesday, September 11, 2019

 

Key Topics & Takeaways

  • Small Business Mergers, Acquisitions, Sales and Brokerage Simplification Act: Pieciak said the bill would codify the SEC no action relief letter and that the legislation does not cause a threat to small business. He recommended including language for a $25 million cap in the legislation. Ellenoff said that the SEC would maintain authority over state regulators. He said that codifying the SEC no action relief letter enshrines their rulings and guidance for not controlling other brokers.
  • Venture Exchanges: Pieciak said that the effort should not be for the private market to look like the public market, but rather incentivize the public markets. Ellenoff answered that the primary purpose of a venture exchange is to enable the resale of purchase, which creates liquidity. He said if legislation allows retail investors to participate, they would have the ability to purchase stocks earlier in the process through these exchanges.
  • Accredited Investors: The entire panel said retail investors have appropriate protections in private markets. Ellenoff added that expanding the definition of accredited investor is the correct approach. De Fontenay and Jones added that wealth does not equal knowledge, and suggested bright-line rules to balance investor interests.
  • Public Offerings: De Fontenay said that private and public market returns are converging, and the notion that private markets are the “promised land” is not all true. Ellenoff suggested all companies should have access to the public market, but not be forced to make the change if it does not make sense for them. He added that the JOBS Act helped reduce accounting requirements and legal costs for companies and suggested considering the venture exchange secondary market as a potential model for future public offerings.

Witnesses

  • Renee Jones, Associate Dean for Academic Affairs and Professor of Law, Boston College Law School
  • Elisabeth de Fontenay, Professor of Law, Duke University School of Law
  • Mike Pieciak, President, North American Securities Administrators Association, and Vermont Commissioner of Financial Regulation, Vermont Department of Financial Regulation
  • Dr. Andrew Lo, Professor, Massachusetts Institute of Technology Sloan School of Management
  • Douglas Ellenoff, Partner, Ellenoff Grossman & Schole LLP

Opening Statements

Chairwoman Carolyn B. Maloney (D-N.Y.)

In her opening statement, Maloney said that the subcommittee would focus on the “troubling” growth of private markets and why companies are remaining private longer at the expense of public markets. She noted that the size of the private markets has doubled over the last decade due to retail investors taking advantage of supposed “high growth” opportunities. Maloney expressed her desire to examine if the private markets genuinely are a better investment for retail investors and whether private markets are too deregulated. She asked the panel to provide feedback on legislation, specifically her bill the Family Office Technical Correction Act. Maloney also asked for feedback on H.R. 609, the Small Business Mergers, Acquisitions, Sales and Brokerage Simplification Act, introduced by Rep. Bill Huizenga (R-Mich.), and the Rare Diseases Act, introduced by Rep. Juan Vargas (D-Calif.).

Ranking Member Bill Huizenga (R-Mich.)

In his opening statement, Huizenga echoed many of Maloney’s points, emphasized the importance of initial public offerings (IPOs), and shared his concerns about the decrease of IPO’s in the U.S. relative to the growth of IPO’s in China. He expressed his desire to further the bi-partisan proposals under consideration, especially his legislation to simplify small brokerage mergers and acquisitions (M&A) systems. Huizenga stated that codifying the Securities and Exchange Commission’s (SEC) no action relief letter is necessary to provide relief and certainty to those small businesses. He also noted his appreciation for H.R. 2899, the Main Street Growth Act, introduced by Reps. Tom Emmer (R-Ind.) and Vincente Gonzalez (D-Texas), the Family Office Technical Correction Act, the Crowdfunding Amendments Act, and the Fair Investment Opportunities for Professional Experts Act, introduced by Rep. French Hill (R-Ark.).

Testimony

Renee Jones, Associate Dean for Academic Affairs and Professor of Law, Boston College Law School

In her testimony, Jones highlighted the risks private companies pose to society and mentioned “unicorn” startups as a significant concern to the markets due to their operations. She said that the trend of public companies decreasing and private companies increasing corresponds to securities laws and rules introduced by Congress and the SEC. Jones highlighted changes to the standards of securities resales under SEC Rule 144, and the general solicitation ban on 506 transactions that limit accredited investors as causes to the facilitation of private offerings for startups. Jones added that this led to the emergence of unicorns and startup founders’ ability to maintain control of their boards, in the absence of corporate governance structures in the private market. She recommended Congress reform the requirement for the SEC to study the trend of dual-class and to reverse Section 12-G of the Securities Exchange Act of 1934.

Elisabeth de Fontenay, Professor of Law, Duke University School of Law

In her testimony, De Fontenay stated that the growth of private companies is no “accident” and that the growth has occurred due to deregulation and lack of public material disclosure requirements, as well as companies’ ability to remain private indefinitely. She applauded the goals of the SEC to remedy perceived inequality for retail investors and to encourage capital raising. However, she said the SEC has failed to achieve both goals due to the lack of data. De Fontenay said private markets give insiders and institutional investors more bargaining power and access to information and do not benefit smaller firms’ access to investment. She recommended using the example of low-cost index funds for retirement savings to encourage “healthy” public market investment. De Fontenay said that private markets play an essential role in the U.S. but can substantially reduce liquidity and that public markets level the playing field.

Mike Pieciak, President, North American Securities Administrators Association, and Vermont Commissioner of Financial Regulation, Vermont Department of Financial Regulation

In his testimony, Pieciak said that his previous work as president of the North American Securities Administrators Association (NASAA) helped provide financial safeguards to local businesses raising capital and the futures of hardworking Americans. He said that this experience provided him insight into how state regulators work to achieve the balance between investor protection and capital formation. Pieciak said that overly stringent standards could limit investor opportunity, while too much deregulation can harm people, and added that the balance is currently out of alignment. Pieciak said that public markets lack material information to properly function, which has led to the growth of private markets. He expressed his support for the Private Securities Transparency and Reform Act, as well as the legislation that would require the SEC to study private securities offerings’ impact on the marketplace.

Dr. Andrew Lo, Professor, Massachusetts Institute of Technology Sloan School of Management

In his testimony, Lo said the legislative proposals are important to improve access to capital and lower the cost of innovation. He expressed full support for the legislative proposals, particularly the Rare Diseases Act. Lo added that “better” access to capital does not always mean there is “more” access to capital. He recommended Congress strike a balance between capital and mechanisms to identify potential unintended consequences.

Douglas Ellenoff, Partner, Ellenoff Grossman & Schole LLP

In his testimony, Ellenoff stated that crowdfunding regulations have led to an increase in capital and jobs for entrepreneurs. He mentioned entrepreneurs’ preference for private markets due to companies being free from regulatory burden and expense. Ellenoff said Congress must be cognizant of how public and private markets interact while ensuring optimal operations and regulations for both markets. He recommended including prudential professionals in the definition of accredited investors, offered support for the Small Business Mergers, Acquisitions, Sales and Brokerage Simplification Act and the Main Street Growth Act, and disproved of the legislation to require the SEC to study private securities offerings.

Question & Answer

Private Markets

Reps. Katie Porter (D-Calif.) and Alexandria Ocasio-Cortez (D-N.Y.) asked about threats posed by private markets. Jones said the valuation process and lack of audit requirements can breed the possibility of fraud in private markets. Ellenoff suggested that the concern is not about public versus private, but rather it is a corporate governance structure issue. De Fontenay added that private markets increase the bargaining power for certain investors, as well as for startup founders.

Maloney asked Jones what led to the growth of the private markets. She responded that policy changes to Rule 12 G of the Securities Exchange Act of 1934, and SEC Rule 144.

Maloney asked de Fontenay if the market would be corrected if rates were to increase. She responded that there are clear signs of the market overheating and there would be a natural correction from rate increases, but not back to numbers from the 1980s. De Fontenay added that overheating has led to problems in underwriting, corporate governance and valuation in private markets.

Reps. Patrick McHenry (R-N.C.), Ann Wagner (R-Mo.) and Warren Davidson (R-Ohio) asked about retail investors’ access to private markets and their benefits. Ellenoff said the benefits include job creation, share earnings, visibility of results, and a range of other benefits. He added that retail investors have a limited exposure for private securities and have benefited from the Jumpstart Our Business Startups (JOBS) Act. Lo responded that with the development of new technology, investors’ ability to gather capital has become difficult, though mechanisms to protect investors would be welcomed.

Public Offerings

Reps. David Scott (D-Ga.), Jim Himes (D-Conn.), Trey Hollingsworth (R-Ind.), Steve Stivers (R-Ohio), Hill, Maloney and Huizenga asked about the benefits of a company going public and if the approaches to IPOs were correct. Pieciak said that public markets provide retail investors more opportunities. De Fontenay said that private and public market returns are converging, and the notion that private markets are the “promised land” is not all true. She added that public shareholders are willing to tolerate long-term planning due to the discipline of public markets relative to private markets. Ellenoff suggested all companies should have access to the public market, but not be forced to make the change if it does not make sense for them. He added that the JOBS Act helped reduce accounting requirements and legal costs for companies and suggested considering the venture exchange secondary market as a potential model for future public offerings. Jones stated that it is important for investors to have a basis for the value of an investment, which is not available in private markets.

Rep. Brad Sherman (D-Calif.) asked about the possibility of lifting targeted fund liquidity caps. De Fontenay suggested there is a possibility to modify target fund caps for liquidity purposes but that it would be difficult.

Small Business Mergers, Acquisitions, Sales and Brokerage Simplification Act

Huizenga asked how the SEC’s authority would be affected, as well as anti-fraud and investor protections, and why there is the need for legislation. Pieciak said the bill would codify the SEC no action relief letter and that the legislation does not cause a threat to small business. He recommended including language for a $25 million cap in the legislation. Ellenoff said that the SEC would maintain authority over state regulators. He said that codifying the SEC no action relief letter enshrines their rulings and guidance for not controlling other brokers.

Venture Exchanges

Gonzalez and Sherman asked how venture exchanges could increase market liquidity and affect other exchanges’ ability to compete. Pieciak said that the effort should not be for the private market to look like the public market, but rather incentivize the public markets. Ellenoff answered that the primary purpose of a venture exchange is to enable the resale of purchase, which creates liquidity. He said if legislation allows retail investors to participate, they would have the ability to purchase stocks earlier in the process through these exchanges. Ellenoff recommended watching out for exchange operations, regulations, and vetting investors, amongst other variables when implementing venture exchanges.

Crowdfunding

McHenry asked about the appetite for more crowdfunding investment and limits to small-dollar offerings. Ellenoff stated the SEC filing burdens, costs, and length of the procedure deter companies from the process. Lo answered that crowdfunding is one way to increase capital, but suggested that Congress should ensure there are no unintended consequences.

Accredited Investors

Stivers and Hill asked how to define an accredited investor while maintaining investor protections. The entire panel said retail investors have appropriate protections in private markets. Ellenoff added that expanding the definition of accredited investor is the correct approach. De Fontenay and Jones added that wealth does not equal knowledge, and suggested bright-line rules to balance investor interests.

Studies

Rep. Bill Foster (D-Ill.) asked if there have been any studies on wealth disparity as a reason for the shift to private markets. Pieciak responded that this circles back to his point about the lack of data about the private marketplace, and reiterated his support for transparency and accountability for the private markets.

Wagner asked if the legislation that would require the SEC to study private securities offerings would hinder the SEC’s ability to modernize its framework. Ellenoff said it would, and that putting up barriers for the SEC at this time is not the right approach.

For more information about this hearing, click here.