Senate Banking on Venture Exchanges and Small Capital Formation
Senate Banking Subcommittee on Securities, Insurance and Investment
“Venture Exchanges and Small-Cap Companies”
Tuesday, March 10, 2015
Key Topics & Takeaways
- Tick Size Pilot: Asked by Warner when the tick size pilot would be launched, Luparello said his Division in the SEC has received a significant number of comments that it intends to review, but that the statutory deadline for acting is early May and he has every intention of hitting that deadline.
- Venture Exchanges:. Farley said the possibility of venture exchanges is worthy of Congress’ attention and that it could be of value to smaller companies seeking capital. He cautioned, however, that the companies available for trading on such exchanges would have a higher rate of failure and could “shed a dark cloud” on the rest of U.S. public markets. For this reason, he suggested that companies listing on venture exchanges must have an appropriate level of financial disclosure. Further, he stated that broker-dealers and investment advisors should differentiate between a listed exchange securities from those that areventure exchange-traded.
- Regulatory Fixes: Crapo asked what could be done to “deal with the regulatory environment in general,” and specifically with the JOBS Act. Griggs said the most attractive provision of the JOBS Act is confidential filing, and said this should be expanded to more types of offerings. He also suggested reconsidering the “accredited investor” definition and transactions between them.
Speaker
- Stephen Luparello, Director of the Division of Trading and Markets, Securities and Exchange Commission
- Thomas Farley, President, NYSE Group
- Scott Kupor, Managing Partner and COO, Andreessen and Horowitz
- Nelson Griggs, Executive Vice President of Listing Services, NASDAQ OMX Group
Opening Statements
In his opening statement, Chairman Mike Crapo (R-Idaho) said that while U.S. capital markets have been and continue to be a “vibrant ecosystem fueling economic growth” providing financing to a wide array of businesses, smaller public companies have had difficulty sustaining strong secondary market liquidity and trading. He noted that the Securities and Exchange Commission’s (SEC) Advisory Committee on Small and Emerging Companies has said the current market does not provide sufficient liquidity for small company securities and that listing requirements can be too difficult, and also that even SEC Chair Mary Jo White has commented that markets should not be “one size fits all.”
Crapo said he agrees with this assessment, pointing out that metrics of market quality are less favorable for smaller companies and that the extent of the disparity highlights the need to consider improvements that would narrow the gap. He expressed interest in hearing whether a venture exchange could help narrow this gap, and learning more about what regulatory measures must be considered.
In his opening statement, Ranking Member Mark Warner (D-Va.) noted the importance of access to capital for small companies, saying that most job creation in the U.S. comes from startups. He commented that progress has been made in small business capital formation, notably through the bipartisan passage of the Jumpstart Our Business Startups (JOBS) Act, but that more must be done.
Warner added that he is interested in why the SEC’s tick size pilot is being delayed, and urged the Commission to move forward with Regulation A+ and the finalization of crowdfunding rules.
Testimony
Stephen Luparello, Director of the Division of Trading and Markets, Securities and Exchange Commission, said in his testimony that the SEC is considering innovative approaches that appropriately balance the needs of smaller companies against the need for investor protections. He commented that venture exchanges might be able to provide this balance by offering a transparent and regulated environment that offers enhanced liquidity and strong investor protections. He said such exchanges could operate nationally or in local and regional markets, with the inclusion of small businesses that may or may not have met the standards of larger exchanges.
Luparello acknowledged that liquidity and market quality metrics “decline rapidly” for smaller companies, but added that the SEC has been focused on smaller companies “for some time.” He noted that “among other things,” the SEC approved a venture exchange, the BX Venture Market, but that is has not been launched due to concerns about ensuring adequate liquidity. He stated that any new venture exchange might want to explore various initiatives to help promote liquidity, such as mechanisms to centralize liquidity across price and size or to attract liquidity providers to the exchange.
Thomas Farley, President, NYSE Group, said in his testimony that there have been many efforts in the U.S. to address the needs of smaller companies, and specifically pointed to NYSE’s recent announcement of a mid-day auction for less liquid securities that it intends to launch later this summer pending SEC approval. He said he was discouraged that companies are spending more time as private companies due to increased regulatory hurdles in applying and becoming publicly traded and because of a lack of liquidity once they do become listed. Farley said the possibility of venture exchanges is worthy of Congress’ attention and that it could be of value to smaller companies seeking capital. He cautioned, however, that the companies available for trading on such exchanges would have a higher rate of failure and could “shed a dark cloud” on the rest of U.S. public markets. For this reason, he suggested that companies listing on venture exchanges should have an appropriate level of financial disclosure, and that broker-dealers and investment advisors should differentiate listed securities from those that are venture exchange-traded.
Scott Kupor, Managing Partner and COO, Andreessen and Horowitz, said in his testimony that the underlying issues that are forcing companies to stay private longer must be addressed. He said there are economic costs of listing that the JOBS Act has “done a very good job” of lessening, but that the most significant impediment today is the after-market environment in which these smaller companies will have to function as public entities. He said that market capitalization and liquidity are serious concerns. Kupor said the move to decimalization is one of the reasons for low liquidity, and that for this reason his firm has advocated for a robust tick size pilot program. He added that empirical data is required to demonstrate that clustering trades at fewer price increments will enhance liquidity.
Kupor said a successful venture exchange would need to employ a regulatory framework that at a minimum would incorporate the JOBS Act’s regulatory requirements, but if the goal is to enable a significant number of sub-$50 million initial public offerings (IPOs), then this would require a framework that scales down to Regulation A+-like regulations for smaller companies. For the after-market environment, he said the exchange would need to set an appropriate minimum tick size to foster liquidity.
Kupor expressed two concerns about the creation of venture exchanges. First, he said the most attractive companies would still continue to raise capital through other means while only the weakest companies would use the venture exchanges. He said this would lead to a problem of “adverse selection.” Second, he warned that separating out the venture exchange could actually lead to less liquidity for small caps as institutional investors opt to wait for companies to “graduate” to traditional exchanges.
Nelson Griggs, Executive Vice President of Listing Services, NASDAQ OMX Group, said in his testimony that changes in the regulatory landscape over the years have reduced the abilities of NASDAQ and other exchanges to facilitate stably, reliable and cost-effective capital formation for many emerging companies, and that the “one size fits all” approach has had serious negative consequences. He said the JOBS Act eased some burdens, but that extent of that relief has not reached venture-size companies. This has created a sense that there is a need for venture exchanges, Griggs said, but from NASDAQ’s view this notion is “somewhat misplaced” and that instead two paths of reforms are needed to make the market structure attractive for growth companies again: 1) changing certain trading rules and listing requirements to encouraged and facilitate the raising of capital on public markets, including allowing exchanges to evaluate and adjust their own listing standards; and 2) further leveraging the JOBS Act for companies wishing to stay private.
To reinvigorate capital formation to support small companies, Griggs offered a number of recommendations: 1) exempting certain companies from the tick price provision of Regulation NMS and delegate authority to the listed exchanges to set tick sizes; 2) modifying the definition of “penny stock,” which has inhibited innovation in listing requirements for the past decade; 3) expanding the availability of confidential filings; 4) adopting limited short-selling regulations to prevent aggressive short-selling of smaller companies; 5) allowing issuer choice to suspend unlisted trading privileges for certain growth companies to allow for focusing competition among orders on a single platform; 6) permitting market maker support programs, which have been successfully used in Europe for several decades; and 7) eliminating certain requirements for shareholder approval for smaller companies which can delay many transactions.
Griggs also offered some improvements to be made for private companies. He said the JOBS Act includes several provisions allowing companies to stay private for longer, but that private markets such as NASDAQ’s own need assistance to be made robust. He noted that companies are currently allowed to sell shares to “accredited investors” who may not need the protections of registration requirements, but that the subsequent sale of shares from an existing shareholder to an accredited investors does not enjoy the same legal status. He explained that his puts unnecessary legal and regulatory costs on companies and investors.
Question and Answer
Crapo asked about the SEC’s tick size pilot and its benefits. Luparello explained that the SEC has demonstrated a desire to explore widening tick sizes for certain securities to improve liquidity, and that he expects to act of the proposal very soon. He added that this is the “first way to look” at whether anything can be done to attract liquidity for issuers already in the market.
Crapo asked if the panelists all agreed that focusing on tick size if a way to achieve progress. All the panelists agreed, and Farley added that NYSE is working diligently with the SEC to construct a reasonable proposal. He then said he wanted to “highlight one nuance,” that about 50 trading venues exist in the U.S. but that only about a dozen are “fully-regulated” exchanges, and the tick size pilot will only impact roughly 20 percent of the market. He encouraged recognition that a significant part of the market is not fully regulated and recommended that the pilot should be done on a market-wide basis.
Asked by Warner when the tick size pilot would be launched, Luparello said his Division in the SEC has received a significant number of comments that it intends to review, but that the statutory deadline for acting is early May and he has every intention of hitting that deadline.
Crapo asked if NYSE would be interested in creating a venture exchange of its own. Farley answered that NYSE does not believe in “one size fits all” and is committed to bringing additional capital formation for less-liquid securities, including through the creation of a venture exchange.
Warner asked Griggs to comment on why NASDAQ has not launched the BX Venture Market despite approval in 2011. Griggs responded that it is his belief that the best way forward is to first address the problems facing companies that are already public, and then letting these fixes take hold for new companies.
Crapo asked what could be done to “deal with the regulatory environment in general,” and specifically with the JOBS Act. Griggs said the most attractive provision of the JOBS Act is confidential filing, and said this should be expanded to more types of offerings. He also suggested reconsidering the “accredited investor” definition and transactions between them.
Farley said that for smaller companies that are relatively illiquid, unlisted trading privileges can fragment liquidity. He said this issue would require an act of Congress. Luparello commented that whether or not legislation is needed in this space, it is being studied by SEC staff.
Warner lamented that the JOBS Act was passed nearly four years ago and yet the SEC has yet to finalize crowdfunding rules or to take action on Regulation A+. Luparello noted that Chair White has said these are both “among her highest priorities for this year,” but Warner countered that she said the same last year.
For more information on this hearing, please click here.
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Senate Banking Subcommittee on Securities, Insurance and Investment
“Venture Exchanges and Small-Cap Companies”
Tuesday, March 10, 2015
Key Topics & Takeaways
- Tick Size Pilot: Asked by Warner when the tick size pilot would be launched, Luparello said his Division in the SEC has received a significant number of comments that it intends to review, but that the statutory deadline for acting is early May and he has every intention of hitting that deadline.
- Venture Exchanges:. Farley said the possibility of venture exchanges is worthy of Congress’ attention and that it could be of value to smaller companies seeking capital. He cautioned, however, that the companies available for trading on such exchanges would have a higher rate of failure and could “shed a dark cloud” on the rest of U.S. public markets. For this reason, he suggested that companies listing on venture exchanges must have an appropriate level of financial disclosure. Further, he stated that broker-dealers and investment advisors should differentiate between a listed exchange securities from those that areventure exchange-traded.
- Regulatory Fixes: Crapo asked what could be done to “deal with the regulatory environment in general,” and specifically with the JOBS Act. Griggs said the most attractive provision of the JOBS Act is confidential filing, and said this should be expanded to more types of offerings. He also suggested reconsidering the “accredited investor” definition and transactions between them.
Speaker
- Stephen Luparello, Director of the Division of Trading and Markets, Securities and Exchange Commission
- Thomas Farley, President, NYSE Group
- Scott Kupor, Managing Partner and COO, Andreessen and Horowitz
- Nelson Griggs, Executive Vice President of Listing Services, NASDAQ OMX Group
Opening Statements
In his opening statement, Chairman Mike Crapo (R-Idaho) said that while U.S. capital markets have been and continue to be a “vibrant ecosystem fueling economic growth” providing financing to a wide array of businesses, smaller public companies have had difficulty sustaining strong secondary market liquidity and trading. He noted that the Securities and Exchange Commission’s (SEC) Advisory Committee on Small and Emerging Companies has said the current market does not provide sufficient liquidity for small company securities and that listing requirements can be too difficult, and also that even SEC Chair Mary Jo White has commented that markets should not be “one size fits all.”
Crapo said he agrees with this assessment, pointing out that metrics of market quality are less favorable for smaller companies and that the extent of the disparity highlights the need to consider improvements that would narrow the gap. He expressed interest in hearing whether a venture exchange could help narrow this gap, and learning more about what regulatory measures must be considered.
In his opening statement, Ranking Member Mark Warner (D-Va.) noted the importance of access to capital for small companies, saying that most job creation in the U.S. comes from startups. He commented that progress has been made in small business capital formation, notably through the bipartisan passage of the Jumpstart Our Business Startups (JOBS) Act, but that more must be done.
Warner added that he is interested in why the SEC’s tick size pilot is being delayed, and urged the Commission to move forward with Regulation A+ and the finalization of crowdfunding rules.
Testimony
Stephen Luparello, Director of the Division of Trading and Markets, Securities and Exchange Commission, said in his testimony that the SEC is considering innovative approaches that appropriately balance the needs of smaller companies against the need for investor protections. He commented that venture exchanges might be able to provide this balance by offering a transparent and regulated environment that offers enhanced liquidity and strong investor protections. He said such exchanges could operate nationally or in local and regional markets, with the inclusion of small businesses that may or may not have met the standards of larger exchanges.
Luparello acknowledged that liquidity and market quality metrics “decline rapidly” for smaller companies, but added that the SEC has been focused on smaller companies “for some time.” He noted that “among other things,” the SEC approved a venture exchange, the BX Venture Market, but that is has not been launched due to concerns about ensuring adequate liquidity. He stated that any new venture exchange might want to explore various initiatives to help promote liquidity, such as mechanisms to centralize liquidity across price and size or to attract liquidity providers to the exchange.
Thomas Farley, President, NYSE Group, said in his testimony that there have been many efforts in the U.S. to address the needs of smaller companies, and specifically pointed to NYSE’s recent announcement of a mid-day auction for less liquid securities that it intends to launch later this summer pending SEC approval. He said he was discouraged that companies are spending more time as private companies due to increased regulatory hurdles in applying and becoming publicly traded and because of a lack of liquidity once they do become listed. Farley said the possibility of venture exchanges is worthy of Congress’ attention and that it could be of value to smaller companies seeking capital. He cautioned, however, that the companies available for trading on such exchanges would have a higher rate of failure and could “shed a dark cloud” on the rest of U.S. public markets. For this reason, he suggested that companies listing on venture exchanges should have an appropriate level of financial disclosure, and that broker-dealers and investment advisors should differentiate listed securities from those that are venture exchange-traded.
Scott Kupor, Managing Partner and COO, Andreessen and Horowitz, said in his testimony that the underlying issues that are forcing companies to stay private longer must be addressed. He said there are economic costs of listing that the JOBS Act has “done a very good job” of lessening, but that the most significant impediment today is the after-market environment in which these smaller companies will have to function as public entities. He said that market capitalization and liquidity are serious concerns. Kupor said the move to decimalization is one of the reasons for low liquidity, and that for this reason his firm has advocated for a robust tick size pilot program. He added that empirical data is required to demonstrate that clustering trades at fewer price increments will enhance liquidity.
Kupor said a successful venture exchange would need to employ a regulatory framework that at a minimum would incorporate the JOBS Act’s regulatory requirements, but if the goal is to enable a significant number of sub-$50 million initial public offerings (IPOs), then this would require a framework that scales down to Regulation A+-like regulations for smaller companies. For the after-market environment, he said the exchange would need to set an appropriate minimum tick size to foster liquidity.
Kupor expressed two concerns about the creation of venture exchanges. First, he said the most attractive companies would still continue to raise capital through other means while only the weakest companies would use the venture exchanges. He said this would lead to a problem of “adverse selection.” Second, he warned that separating out the venture exchange could actually lead to less liquidity for small caps as institutional investors opt to wait for companies to “graduate” to traditional exchanges.
Nelson Griggs, Executive Vice President of Listing Services, NASDAQ OMX Group, said in his testimony that changes in the regulatory landscape over the years have reduced the abilities of NASDAQ and other exchanges to facilitate stably, reliable and cost-effective capital formation for many emerging companies, and that the “one size fits all” approach has had serious negative consequences. He said the JOBS Act eased some burdens, but that extent of that relief has not reached venture-size companies. This has created a sense that there is a need for venture exchanges, Griggs said, but from NASDAQ’s view this notion is “somewhat misplaced” and that instead two paths of reforms are needed to make the market structure attractive for growth companies again: 1) changing certain trading rules and listing requirements to encouraged and facilitate the raising of capital on public markets, including allowing exchanges to evaluate and adjust their own listing standards; and 2) further leveraging the JOBS Act for companies wishing to stay private.
To reinvigorate capital formation to support small companies, Griggs offered a number of recommendations: 1) exempting certain companies from the tick price provision of Regulation NMS and delegate authority to the listed exchanges to set tick sizes; 2) modifying the definition of “penny stock,” which has inhibited innovation in listing requirements for the past decade; 3) expanding the availability of confidential filings; 4) adopting limited short-selling regulations to prevent aggressive short-selling of smaller companies; 5) allowing issuer choice to suspend unlisted trading privileges for certain growth companies to allow for focusing competition among orders on a single platform; 6) permitting market maker support programs, which have been successfully used in Europe for several decades; and 7) eliminating certain requirements for shareholder approval for smaller companies which can delay many transactions.
Griggs also offered some improvements to be made for private companies. He said the JOBS Act includes several provisions allowing companies to stay private for longer, but that private markets such as NASDAQ’s own need assistance to be made robust. He noted that companies are currently allowed to sell shares to “accredited investors” who may not need the protections of registration requirements, but that the subsequent sale of shares from an existing shareholder to an accredited investors does not enjoy the same legal status. He explained that his puts unnecessary legal and regulatory costs on companies and investors.
Question and Answer
Crapo asked about the SEC’s tick size pilot and its benefits. Luparello explained that the SEC has demonstrated a desire to explore widening tick sizes for certain securities to improve liquidity, and that he expects to act of the proposal very soon. He added that this is the “first way to look” at whether anything can be done to attract liquidity for issuers already in the market.
Crapo asked if the panelists all agreed that focusing on tick size if a way to achieve progress. All the panelists agreed, and Farley added that NYSE is working diligently with the SEC to construct a reasonable proposal. He then said he wanted to “highlight one nuance,” that about 50 trading venues exist in the U.S. but that only about a dozen are “fully-regulated” exchanges, and the tick size pilot will only impact roughly 20 percent of the market. He encouraged recognition that a significant part of the market is not fully regulated and recommended that the pilot should be done on a market-wide basis.
Asked by Warner when the tick size pilot would be launched, Luparello said his Division in the SEC has received a significant number of comments that it intends to review, but that the statutory deadline for acting is early May and he has every intention of hitting that deadline.
Crapo asked if NYSE would be interested in creating a venture exchange of its own. Farley answered that NYSE does not believe in “one size fits all” and is committed to bringing additional capital formation for less-liquid securities, including through the creation of a venture exchange.
Warner asked Griggs to comment on why NASDAQ has not launched the BX Venture Market despite approval in 2011. Griggs responded that it is his belief that the best way forward is to first address the problems facing companies that are already public, and then letting these fixes take hold for new companies.
Crapo asked what could be done to “deal with the regulatory environment in general,” and specifically with the JOBS Act. Griggs said the most attractive provision of the JOBS Act is confidential filing, and said this should be expanded to more types of offerings. He also suggested reconsidering the “accredited investor” definition and transactions between them.
Farley said that for smaller companies that are relatively illiquid, unlisted trading privileges can fragment liquidity. He said this issue would require an act of Congress. Luparello commented that whether or not legislation is needed in this space, it is being studied by SEC staff.
Warner lamented that the JOBS Act was passed nearly four years ago and yet the SEC has yet to finalize crowdfunding rules or to take action on Regulation A+. Luparello noted that Chair White has said these are both “among her highest priorities for this year,” but Warner countered that she said the same last year.
For more information on this hearing, please click here.