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Senate Banking Hearing on Capital Formation and Corporate Governance

Senate Banking Committee

“Legislative Proposals on Capital Formation and Corporate Governance”

Thursday, February 28, 2019

Key Topics & Takeaways

  • S. 2756, Fair Investment Opportunities for Professional Experts Act: Mott said this bill impacts middle America more than coasts, helps start-ups receive funding from angel investors, helps bridge equivalence of differing markets and profit gains, and helps amend criteria for accredited investors and raising capital.
  • S. 1744, Brokaw Act : Quaadman stated short sale disclosures have costs that will outweigh benefits, especially with naked short sales. He said short sales are an important part of an efficient market and that Brokaw doesn’t allow for an understanding of the intent of short sales. Quaadman suggested the SEC should conduct a study on the implications of short sales.
  • S. 3283, Options Markets Stability Act:. Quaadman said this legislation allows for netting and provides more transparency for institutions, providing investors with greater insights of risks to make better decisions.
  • S. 2347, Encouraging Public Offerings Act: Quaadman stated it is important to allow more business capital opportunities. He said it is a small tweak, but beneficial. He also recommended setting policy parameters to codify and create direction for the SEC moving forward.

Witnesses

Opening Statements

Sen. Mike Crapo (R-Idaho), Chairman

In his opening statement, Crapo said the hearing would address a number of legislative proposals to encourage capital formation and improve corporate governance. He referenced a handful of bills, including the S. 588, Helping Angels Lead Our Startups (HALOS) Act, S. 2756, the Fair Investment opportunities for Professional Experts Act, S. 3614, the Corporate Governance Fairness Act, S.1117, the Consumer Financial Choice and Capital Markets Protection Act, all focused on capital formation, corporate governance and proxy advisors. Crapo also spoke about the JOBS 3.0 provisions up for consideration including non-prudential provisions, H.R. 3972, the Family Office Technical Correction Act, S. 3283, the Options Markets Stability Act, targeting accredited investing, exchange listed derivatives, and increased collaboration between Congress and the Securities and Exchange Commission (SEC). Crapo referenced the S. 2347, Encouraging Public Offerings Act and to continue building upon prior work alongside SEC Chairman Clayton in expanding its “test the waters” process in emerging growth in IPO’s.

Sen. Sherrod Brown (D-Ohio), Ranking Member

In his opening statement, Brown said he wants the committee to consider the numerous bills while bearing in mind whether they are “good for workers or just good for Wall Street.” He noted the lack of positive progress, as well as increased stock buybacks and initial public offerings (IPOs). Brown expressed his desire for workers to be treated equally, with wage increase and benefit protections as companies continue to grow. He stated his support for Sen. Jack Reed’s (D-R.I) bill S. 536, Cybersecurity Disclosure Act, Sen. Chris Van Hollen’s (D-Md.) concerns addressing insider trading. Brown claimed the SEC’s Regulation Best Interest (Reg BI) rule has had “weak and incomplete” economic analysis, and the SEC should testify before Congress to explain. Brown called on the committee to support legislation focused on improvements to benefit workers, investors, and expand the economy.

Testimony

Catherine Mott, CEO, Blue Tree Capital and Blue Tree Allied Angels

In her testimony, Mott discussed the critical role private investments play in capital formation. She testified to the impact angel investors have had, providing billions of dollars investment to support thousands of startups across the nation, especially for “middle America.” Mott spoke to the mentorship, support, safety and guidance angel investors provide to many startups. She expressed her support for two specific bills, S. 588, the HALOS Act, and S. 2756, the Fair Investment Opportunities for Professional Experts Act, stating both bills would produce immediate benefit and no real risk to investors or the economy. Mott said the S. 588 would help to clarify “demo days” exemptions from general solicitation and help to provide better access to capital, by addressing provisions in the JOBS Act under 506c offerings regarding accredited investment verification. She stated S. 2756 would modernize the definition of accredited investor, last addressed in the Dodd-Frank Act, and grow the capital available for new businesses, equaling the playing field for “middle America” compared to the coasts.

Thomas Quaadman, Executive Vice President, U.S. Chamber of Commerce Center for Capital Markets Competitiveness

In his testimony, Quaadman said that new business growth allows for job creation and wealth distribution as businesses grow to their apex. He discussed the significant increase in IPO’s since 2014 and how beneficial this is for the U.S. economy, however, Quaadman noted that business creation is barely outpacing business destruction and despite recent growth, since 1996 only half of public companies go public. He recommended the committee address proxy advisor reform, limited liquidity and lack of public research, investment incentives to remain globally competitive, cybersecurity, using CFIX to tackle unfair arbitration, and providing a narrow legal clarification to insider trading, saying the “window” to address these issues is closing.

Heather Slavkin Corzo, Head of Capital Markets Policy, AFL-CIO

In her testimony, Corzo called for policies that promote transparent and stable markets, encourage shareholder engagement, and facilitate regulatory enforcement. She said that none of the bills address or support the needs of working individuals. Corzo stated that as private equities fail, they are leaving workers exposed to threats, costing them jobs, benefits, and pensions. She noted that private equities increase risks on liquidities, and are increasing leveraged loans and unfair and abusive practices toward investors. She touched on the need to eliminate regularity and legal privileges to cut loopholes and leveraged buyout (LBO’s) for private equities. Corzo expressed the need for policies addressing long term competitiveness, and concerns over the rise in stock buybacks and increases to bank size and complexity.

Question & Answer

S.2756, Fair Investment Opportunities for Professional Experts Act

Sen. Thom Tillis (R-N.C.) asked is why this bill is a good idea, to which Mott responded it impacts middle America more than coasts, helps start-ups receive funding from angel investors, helps bridge equivalence of differing markets and profit gains, and helps amend criteria for accredited investors and raising capital.

S.1744, Brokaw Act

Sen. Mike Rounds (R-N.D.) asked if the benefits of modifying short sale disclosures will outweigh costs. Quaadman responded that costs will outweigh benefits, especially with naked short sales. He said short sales are an important part of an efficient market and that Brokaw doesn’t allow for an understanding of the intent of short sales. Quaadman suggested the SEC should conduct a study on the implications of short sales.

S.1117, Consumer Financial Choice and Capital Markets Protection Act  

Sen. Pat Toomey (R-Pa.) asked how SEC acquired fund fees from Business Development Company (BDC’s) have an adverse impact on tax-exempt money markets and the cost for state and municipal financing and how to address the problems. Quaadman responded that BDC’s have become an important source for business and BDC should be exempt, and that certain criteria from indexes should be removed because they are hurting capital formation.

S.2347, Encouraging Public Offerings Act

Sens. Chris Van Hollen (D-Md.) and Tillis asked for feedback on this legislation. Quaadman stated it is important to allow more business capital opportunities. He said it is a small tweak, but beneficial. He also recommended setting policy parameters to codify and create direction for the SEC moving forward.

S.588, Helping Angels Lead Our Startups Act

Sens. Mike Crapo (R-Idaho) and Toomey asked how to focus on accredited investment and create policies to increase participation. Mott responded to both saying and under Dodd-Frank, 506c general solicitation has caused confusion. She noted the need to reform definitions under 506c’s and demo days, to allow more accredited investment for companies to raise capital. Mott added that early stage investors and angel investors are investing in these companies and start small, and that liquidity events create circular systems and benefits to the economy and that middle America relies on these investments.

S.3614, Corporate Governance Fairness Act

In response to Tillis asking why this is a good bill, Quaadman responded that SEC rules removed requirements for proxy advisors to report conflict of interests, preventing further action on these issues. He recommended regulating conflicts and linking fiduciary duty advice to investors for companies.

Sen. John Kennedy (R-La.) asked what to do about currently only having two Proxy advisory firms in America, to which Quaadman suggested a need for better oversight over these advisors.

S.3283, Options Markets Stability Act

Rounds asked about the drawbacks of not having a risk weighted system. Quaadman said it allows for netting and provides more transparency for institutions, providing investors with greater insights of risks to make better decisions.

H.R. 6320, Promoting Transparent Standards for Corporate Insiders Act 

Van Hollen asked about preventing insider trading to which Corzo responded support and relying on fair markets for equal information protects investors, referencing prior “fishy” reports of insider trading occurring within corporations in the past without oversight. Quaadman suggested the 10b5 plan should be blind, and that current insider trading terms are too vague. He said Congress should address this concern, as well as create regulations to enforce criminal penalties for insider trading.

Global

Sens. Bob Menendez (D-N.J.) and Crapo noted their support for policies to remain globally competitive and maintain international relationships. Quaadman responded saying China is leading in IPO’s and with Brexit, we will have big headwinds coming. He said the timeline is narrowing for us to correct the global competitiveness and that using regulation structures with regards to fintech/blockchain will prevent U.S. companies from going overseas to London and beyond.

S.536 Cybersecurity Disclosure Act

Sen. Jack Reed (D-R.I) briefly recommended to the committee and panel to address growing concerns over domestic and global cybersecurity, seeking support for legislation.

Stock Buybacks

Brown and Toomey asked about how stock buybacks are impacting wage growth and capital expenditure. Corzo said there has been a dramatic negative impact on income equality. Quaadman said capital expenditures have increased, Research and Development as increased, workers have seen bonuses and wages have increased, especially on lower end of pay scales. He said buybacks provide for more efficient of allocation of capital.

IPO’s

Brown asked if the shutdown hurt IPO’s. Quaadman said the “blip” was small because there wasn’t much of an expectation for action.

SEC and Private Equities

Brown asked if the SEC and Commodity Futures Trading Commission (CFTC) should be self-funded, to which Quaadman said funding should be increased funding for each of agency, but there are concerns about self-funding.

Sen. Catherine Cortez Masto (D-Nev.) and Brown asked what steps should be taken by the SEC and Congress to create disclosure requirements and promote transparency of private equities. Corzo said there is a large array of transparency due to no uniform format or performance standard, to provide clear accurate data to investors. She said there needs to be an understanding from employees of the risks of these practices. Corzo also said that leveraged lending and buyout is piling up, putting more burden on companies and less on private equities. She continued that this in turn falls on workers and the practice should be stopped to better maintain debt payments.

Diversity

Menendez asked how to increase transparency and lack of diversity in corporate governance and investment. Corzo responded by saying companies need to be led by more diverse leadership. She said the lack of diverse leadership and employees is preventing proper regulations to be implemented. Quaadman said it is important to have diversity of thought in boardrooms, and transparency procedures in hiring practices could put companies on track on governance and investing.

Capital

Sens. Mark Warner (D-Va.), Crapo, and Rounds asked questions about the effects of not addressing capital, whether through human capital, to which Quaadman supported linking return to investment for human capital, Corzo suggested closing loopholes to protect investment protections and stabilities, and Mott touched on the decline in business startups in the U.S., leading to a loss in job creation. Quaadman added the need for Congress to set policy parameters for the SEC on capital formation.

For more information about this hearing, click here.