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House Financial Services Committee Meeting on Public Markets

House Committee on Financial Services

Subcommittee on Capital Markets

U.S. Public Markets Built for the 21st Century: Exploring Reforms to Make Our Public Markets Attractive for Small and Emerging Companies Raising Capital

Thursday, March 9, 2023

Topline

  • Republicans argued that the SEC has not focused on its mission to facilitate capital formation, and said unnecessary regulation makes U.S. capital markets less attractive.
  • Democrats focused on the need for investor protection and disclosures.

Witnesses

  • The Honorable Michael S. Piwowar, Executive Vice President of MI Finance, Milken Institute
  • Ms. Sue Washer, Former CEO, Applied Genetics Technology Corp
  • Ms. Anna T. Pinedo, Partner and Co-Leader of Global Capital Markets, Mayer Brown
  • Ms. Stacey Bowers, Professor of the Practice, University of Denver Sturm College of Law

Opening Statements

Chairman Ann Wagner (R-Mo.)

In her opening statement, Wagner said that U.S. public markets have long been recognized as the envy of the world, and it is the subcommittee’s responsibility to ensure that they continue to thrive. She added that the cost of entering these markets has doubled since the 1990s, and the number of public companies has drastically decreased. Specifically, she said IPO activity in the U.S. last year was the slowest it has been in a decade, but China saw more IPO activity than anyone else in the world. She also argued that the declining number of public companies and slow U.S. IPO activity limits opportunities for everyday investors to invest in the next generation of U.S. businesses, and there is a need for urgent action to outcompete global adversaries. Finally, Wagner said the SEC has neglected its mandate to facilitate capital formation. She recommended that the SEC work with Congress on proposals that encourage growth in our public markets.

Ranking Member Brad Sherman (D-Calif.)

In his opening statement, Sherman highlighted two things Congress should do, even though they are outside of the subcommittee’s jurisdiction: (1) allow credit unions to make more business loans by raising the cap; and (2) allow banks to make some loans at prime plus three and prime plus four without bank examiners regarding the loan as worthless. He also argued that his Access to Small Business Investor Capital Act will allow business development companies to provide capital to small businesses by making sure they are included in indexes and mutual funds. He noted that the JOBS Act made it too easy to stay private, and cited WorldCom and Enron as reasons for internal control audits. He also said that one bill being discussed today would prohibit the SEC from rationalizing how the number of investors in a company is counted. Finally, Sherman said new disclosures are needed for public companies, including ESGW, and he flagged his legislation to ensure that public companies identify their China risk.

Testimony

The Honorable Michael S. Piwowar, Executive Vice President of MI Finance, Milken Institute

In his testimony, Piwowar said that the JOBS Act provides a blueprint as this subcommittee looks at ways to improve access to capital. He said the law helped refocus the SEC on the third part of its mission, promoting capital formation, and there is a great opportunity to build on the success of the law, especially Title I. Finally, he said that hearings like this help ensure that our capital markets continue to run smoothly and remain the envy of the world, and will also support the subcommittee’s oversight role of the SEC.

Ms. Sue Washer, Former CEO, Applied Genetics Technology Corp

In her testimony, Washer said that broad, appropriate, and geographically widespread access to the public capital markets is needed. She said the JOBS Act paved the way for smaller, more geographically dispersed companies to access public markets in order to fund full development of new products in biotechnology. Additionally, she argued that recent constriction of the biotech market shows that the provisions of the JOBS Act remain vital, especially for smaller companies in areas outside of N.Y., Mass., and Calif. Washer also said that problems of access to capital are further compounded for minorities and women-led companies. She argued that flexibility afforded by the rules for emerging growth companies (EGCs) and smaller reporting companies, including exemptions, scaling, and phase-ins for new requirements, allows smaller companies to build their business and balance the needs of the company with the needs of investors. She also said extending EGC exemptions for another five years would enhance capital utilization. Finally, Washer said that in life sciences, the vast majority of small companies do not become ready for the public capital markets without substantial prior access to private funds, including seed funding and venture capital. She stressed the importance of promoting a diverse ecosystem of investors, including small, regional, and local funds and a do no harm approach to any changes in current Regulation D rules.

Ms. Anna T. Pinedo, Partner and Co-Leader of Global Capital Markets, Mayer Brown

In her testimony, Pinedo said that while an IPO was once a signifier of success and an important milestone for a company, most companies that pursue IPOs now have other reasons for doing so (usually providing liquidity for existing security holders). She also noted that exempt and hybrid offerings have become more commonplace, largely due to the proliferation of private capital sources, and the shift away from IPOs and public markets can be attributed to an increase in regulation from Sarbanes-Oxley and Dodd-Frank. Pinedo said that there is nothing wrong with having vibrant public markets and fostering the private markets, and she argued that the way to increase the attractiveness of public markets is not by imposing regulation designed for public companies on the private markets. She stated that smaller companies face disproportionately high regulatory costs, limited equity research coverage, lack of liquidity in the market for their securities, a higher cost of capital, and limited financing alternatives even once public. Finally, Washer said the extension of the well-known seasoned issuer status is the most important among the bills being considered today.

Ms. Stacey Bowers, Professor of the Practice, University of Denver Sturm College of Law

In her testimony, Bowers said that strong capital markets are the bedrock of a healthy economy, but few seem to recognize that they are also the product of federal securities laws designed to ensure all investors have the information needed to make informed decisions. She added that decades of deregulation, coupled with the expansion of exemption from registration, have resulted in the majority of capital in the U.S. being raised through private markets. Bowers also said that none of the bills noticed today would entice her clients to forgo a private offering for a public offering, when they can raise from hundreds of thousands of investors with limited requirements. She argued that efforts to restore the public markets should focus on the investors who are providing the capital, but the bills today will reduce investor confidence, interest, and trust in our markets. As an example, Bowers noted that China has recently strengthened its disclosure requirements and appears to be seeing results from doing so. Reducing disclosures and transparency, in her view, will only benefit companies who take advantage of reduced disclosures and potentially waste investors’ capital. She recommended that the committee consider other avenues of change, including raising the bar for companies in the private markets and requiring public companies to provide basic disclosures at a minimum. She also flagged the practice of underwriters charging issuers unreasonable fees as something the committee could address.

Question & Answer

The Securities and Exchange Commission

Wagner asked Piwowar to explain the problem with SEC Chair Gary Gensler’s approach to the issue of capital markets and why the committee should focus on making capital markets more attractive. He replied that the accumulation of the many rules the SEC is trying to move forward will impact U.S. markets, and there is no way for them to look at the cumulative effect.

Sherman said he is concerned about codifying a practice of the SEC if it is a stupid practice. Specifically, he asked if it is true that a company could have many thousands of beneficial owners, but under current SEC rules only have 2,000 shareholders of record. Bowers said yes, and explained that when counting the ownership to determine if a company should register as public, the SEC looks to record holders versus beneficial owners, so as a result many private “unicorns” have many more than 2,000 shareholders. Sherman said that these unicorns are worth over a billion dollars, and this counting enables them to avoid making the disclosures required of public companies.

Rep. Pete Sessions (R-Texas) said that he plans to introduce a bill to codify an SEC no action letter that allows broker dealers to continue accepting cash or hard dollar payments for research reports in order to comply with the EU directive. He added that if no action on this is taken by July, the SEC Investment Management Division Director has said that he will simply allow it to fade away. Pinedo said that it would be difficult to overstate the importance of research for vibrant capital markets. She said that codifying the SEC’s no action letter relief for MiFID II is extremely important, as broker dealers in the U.S. are struggling with the sunsetting of the relief, and this affects investment managers located in the EU, UK, and elsewhere. She added that if nothing is done, it may subject broker dealers to regulation under the Investment Advisers Act, which is completely different than the regulation by FINRA and the SEC.

Sessions continued by saying that this keeps companies that could utilize the data out of the regulatory environment and puts them at a disadvantage. Pinedo agreed, and added that additional time is necessary for a framework to be devised that is appropriate and would allow for research to continue. She said there has been a reduction in the availability of research since this was announced, and any diminution in research is bad for capital markets. Piwowar also stated that he finds it unconscionable that the SEC would not extend this, especially since the Europeans are finally thinking about walking back that requirement. He said that codifying it would be the right thing to do.

Rep. Bill Huizenga (R-Mich.) discussed his Improving Disclosure for Investors Act, which he introduced last year to direct the SEC to engage in rulemaking that would allow registered investment companies to deliver documents to investors using electronic means. He noted that the SEC has not comprehensively updated the framework in over 20 years. Furthermore, Huizenga said his legislation promotes positive investor engagement by making it easier for investors to find information most relevant to them. He added that he worked with Rep. Jake Auchincloss (D-Mass.) to provide safeguards allowing investors to receive paper statements. Finally, he entered into the record a letter from SIFMA that had survey results of its members.

Rep. Zach Nunn (R-Iowa) asked if the magnitude of SEC rules will raise costs in a way that makes public markets less effective for those interested in raising capital. Piwowar agreed, and said that the pace of rulemaking right now is unprecedented. Nunn asked what Congress could do to address this. Piwowar said that the bills being considered could help the SEC refocus on its mission to facilitate the formation of capital, as the JOBS Act did.

Rep. French Hill (R-Ark.) said that the SEC’s rulemaking has done nothing but hamper capital formation. He said that Gensler should make it easier for companies to enter the public markets, not harder.

Capital Formation vs. Investor Protection

Wagner also asked how the policies being considered today would work together to facilitate capital formation without compromising investor protection. Pinedo said that it would be incorrect to say that these measures would reduce information available for investors. She added that providing certainty to all market participants is important and does not reduce the mix of information that is available.

Regulation, Internal Control Audits, and EGCs

Rep. Maxine Waters (D-Calif.) asked how deregulation could push investors to other countries or markets with stronger protections. Bowers said that investors need information to make decisions because they have the potential to lose their money. She expressed concern that emerging growth companies do not need to have an auditor attestation report on their internal controls, which helps to protect against and prevent fraud. She stated that if investors cannot trust the U.S. markets are transparent, they are likely to take funding elsewhere or put it in safer avenues, and other countries are increasing their transparency.

Rep. Bryan Steil (R-Wis.) said that the JOBS Act created emerging growth companies to give smaller companies an ability to navigate a regulatory framework, and asked if it is working. Piwowar said he absolutely thinks it is working. Steil also asked about the challenges, and if companies are falling out of the EGC definition too soon. Washer said companies are falling out too soon, especially in the biotechnology space. Pinedo added that the bill to allow companies to remain EGCs if they fit other prongs of the definition, regardless of the five-year period, would help with this issue.

Sherman said that internal control audits are necessary for a huge chunk of our economy. He said they are not needed everywhere, but finding political slogans to justify less auditing is something to be skeptical of.

Rep. Dan Meuser (R-Pa.) said that markets in the U.S. have become over-regulated and too expensive. He asked about the cost of regulation and litigation and the risk of disclosure. Piwowar replied that regulatory burdens fall hardest on the small companies. He added that they might be appropriate for large, complex companies, but when looking at the cost/benefits for smaller companies the costs are much higher. He noted that dealing on a cost/benefit analysis leads one to potentially scale disclosures or exempt them. Meuser asked about solutions, and Piwowar said that the EGC status in Title I is a great blueprint, but tweaks or additions to that are totally appropriate eleven years later.

Rep. Andrew Garbarino (R-N.Y.) asked about the role that regulatory costs play in decisions to go public. Pinedo said that they play an essential role. She said low revenue companies should continue to be able to go public, and the U.S. should continue to right size/phase in regulation and also extend EGC status for a longer time period. She recommended exploring ways to encourage smaller companies to go public.

Rep. Mike Lawler (R-N.Y.) asked what actions would be key to addressing unnecessary regulatory burdens or compliance costs. Pinedo reiterated that the proposed measures would not significantly reduce the amount of information available to investors. She said that all of the changes are incremental, and many are codifications of existing SEC policy. Additionally, she noted that investors have lived with the existing mix of information that EGCs provide for many years, and these changes would help companies that are considering the path to an IPO, particularly through ability to preserve EGC status if they do not become large accelerated filers and do not cross the revenue threshold.

ESG Disclosures

Rep. Juan Vargas (D-Calif.) asked about ESG disclosures. Bowers said that investors want ESG disclosures to make informed decisions and that is what matters. Piwowar said that the SEC is charged with implementing the federal securities laws, and under those laws information has to be disclosed to investors if it is material that meets the standard determined by the Supreme Court. He said there is a balance between providing helpful information and not overloading investors with an avalanche of information. Finally, he noted that for some companies, climate risk is very material, but for others it may not be.

Private vs. Public Markets

Rep. Sean Casten (D-Ill.) asked if some of the declining participation in public markets is actually just a reflection of the successful growth of private markets. Bowers said that private markets have drawn people away from public markets. She added that access to capital allows companies to grow in the private markets and avoid disclosure requirements.

Casten also asked if the committee should be concerned about the rise in access to larger pools of less sophisticated capital in private markets. Bowers responded that private markets have created a situation where billions are being invested with little disclosure, and added that institutions in private markets are getting access to information but retail investors on the fringe of accredited investor status do not have the same power to demand information. She said that is frightening.

The Debt Limit

Rep. Wiley Nickel (D-N.C.) asked how defaulting on the debt would impact U.S. capital markets. Bowers said if the U.S. defaults on its debt limit, the trickle down into public markets will have a drastic impact. She noted that stock prices will continue to decline, which will push EGCs to the brink and result in billions of dollars being lost by investors.

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For an archive of past SIFMA hearing coverage, please click here.