AT TODAY’S SENATE BANKING COMMITTEE HEARING, lawmakers heard from a panel of industry stakeholders and academics on legislative measures to spur job growth and capital formation. Much of the discussion was directed toward bipartisan legislation that members on both sides of the aisle hoped would be considered by the full Senate in the coming weeks. In his opening remarks, Sen. Charles Schumer (D-N.Y.) said passage of the bills in the Senate is “not a question of ‘if’ but ‘when’.”
The bills include: S.1933, Reopening American Capital Markets to Emerging Growth Companies Act, offered by Sens. Schumer and Pat Toomey (R-Pa.), which would create an initial public offering (IPO) on-ramp for companies designated as “emerging growth;” S. 1544, the Small Company Capital Formation Act, offered by Sens. Jon Tester (D-Mont.) and Mike Crapo (R-Idaho), which would increase the Securities and Exchange Commission’s (SEC) Regulation A threshold from $5 million to $50 million; S. 1824, the Private Company Flexibility and Growth Act, offered by Sens. Toomey and Mark Warner (D-Va.), which would increase the limit regarding shareholder registration requirements from 500 to 2000 shareholders; and S. 1831, Access to Capital for Job Creators Act, offered by Sen. John Thune (R-S.D.), which would require the SEC to allow for general solicitation in public offerings.
Legislation similar to the Senate bills have been approved by the House Financial Services Committee and have been bundled into H.R. 3606, the Jumpstart Our Business Startups Act, which will be considered by the full House this week. The President’s Startup America initiative, released at the beginning of the year, also includes crowdfunding and IPO on-ramp measures.
William Waddill, who spoke on behalf of the Biotechnology Industry Organization (BIO), discussed the lack of venture capital fundraising for biotechnology firms and cited the weak demand for public offerings of smaller companies as working to restrict access to capital. Waddill said more efforts must be made to increase smaller initial public offering (IPO) on-ramp for companies designated as “emerging growth;” S. 1544, the Small Company Capital Formation Act, offered by Sens. Jon Tester (D-Mont.) and Mike Crapo (R-Idaho), which would increase the Securities and Exchange Commission’s (SEC) Regulation A threshold from $5 million to $50 million; S. 1824, the Private Company Flexibility and Growth Act, offered by Sens. Toomey and Mark Warner (D-Va.), which would increase the limit regarding shareholder registration requirements from 500 to 2000 shareholders; and S. 1831, Access to Capital for Job Creators Act, offered by Sen. John Thune (R-S.D.), which would require the SEC to allow for general solicitation in public offerings.
Jay Ritter, Professor at the University of Florida, said the decline of IPOs are related to the declining profitability of small firms. He discussed how venture capital-backed firms have been merging with other entities rather than going public because small stand-alone businesses are less profitable relative to their value as part of a larger organization. Ritter also suggested that over the last decade there has been no deterioration in analyst coverage for companies that do go public. In terms of the proposed legislation, Ritter recommended that the shareholder registration limit remain at 500 while excluding current and former employees from the count and adding a public float requirement. Ritter also said provisions in S. 1933 regarding quiet periods related to research coverage would have the effect of crowding out unbiased independent research.
Kathleen Shelton Smith, Principal at Renaissance Capital, said the best way to help small issuers accomplish an IPO would be to improve returns for IPO investors. Shelton also recommended improvements to the legislation discussed, including properly defining “emerging growth companies” as smaller issuers seeking to raise up to $50 million; striking the proposed information rules in S. 1933 Section 6 that permit IPO underwriters and issuing companies to promote offerings; and encouraging large private companies to file public disclosure when active trading markets develop in its shares by adding a public float requirement to S. 1824.
Lynn Turner, Managing Director at LitiNomics, Inc. and former SEC official, provided an overview of IPO activity over the past two decades and raised concerns with a number of the bills discussed at the hearing. Turner said many of the bills would reduce the level of transparency and the amount of information investors receive as well as reduce the credibility of information given to investors. Turner stated “if ill-conceived amendments regulating the cost benefit analysis the SEC would have to perform, that were adopted in the U.S. House of Representatives, I suspect investors would be well served to understand that handcuffs had been put on the SEC, rather than bad actors.” Turner specifically raised concern with S. 1933, in particular Section 6’s research provisions, which he said would establish a process “whereby analysts can once again engage in issuing conflicted reports and avoid accountability for their actions.”
Tim Rowe, Founder and CEO of Cambridge Innovation Center, recommended a number of measures to improve proposed crowdfunding legislation, including requiring the use of SEC-licensed intermediaries that would have the discretion to develop mechanisms to reduce fraud; setting a higher limit or no limit on the amount accredited investors can invest under crowdfunding legislation; and ensuring issuers are not subject to the possibility for individual rights of action.
Question and Answer
Sen. Jack Reed (D-R.I.) asked the panelists whether the regulatory changes called for by the proposed legislation will have the effect of spurring capital formation and job growth. Jay Ritter said the bills would entail a lot of trade-offs and recommended the use of intermediaries to mitigate the risk of fraud.
Reed followed up on his questioning and asked whether the use of intermediaries would be based on the presumption that issuers would provide adequate disclosure to those entities and investors, and what standards of liability intermediaries would be held to. Lynn Turner, Managing Director at LitiNomics, Inc., suggested that the intermediaries be held to a “reasonable” fiduciary standard.
Sen. Tester referred to his bill to increase the Regulation A threshold to $50 million and asked if people would be expected to use this offering more than once. William Waddill, Senior Vice President and CFO for OncoMed Pharmaceuticals, Inc., said he would not use the offering more than once because doing so would dilute his current shareholders.
Sen. Michael Bennet (D-Colo.) asked what kind of businesses would be expected to take advantage of the crowdfunding measure. Rowe said ‘everyday businesses’ would utilize general solicitations to raise start-up capital.
Sen. Jeff Merkley (D-Ore.) followed up on the issue of crowdfunding, noting that he is working to craft a measure that mitigates the risk of fraud. He specifically noted that he is working on portal neutrality measures to ensure portals are not individually involved in any ‘pump and dump’ schemes. He said it was important for there to be some accountability for accuracy and stated his belief that disclosure requirements are needed least in the initial phase of any crowdfunding measure. Merkley said he would follow up with Turner on the idea of intermediaries being held to a fiduciary standard.
Merkley also raised crowdfunding concerns regarding the possibility of small investors becoming diluted ex post. Ritter suggested that any legislative measure include anti-dilution provisions where Class A shareholders would have to vote to override certain provisions.
Sen. Warner said he was “intrigued” with the crowdfunding notions but emphasized the importance of crafting an effective intermediary that is held to the appropriate standards.
For testimony and a webcast of the hearing, please click here.
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