June 22, 2017

Securities and Exchange Commission: Investor Advisory Committee Meeting

Key Topics & Takeaways

• Chairman Clayton Remarks: Clayton stated that he believed the FINRA’s and the MSRB’s new mark-up/mark-down disclosure rules are an important step toward creating more transparent bond markets that will provide substantial benefit to retail investors.
• MiFID II: Solomon highlighted the need to focus on MiFID II and the impact it will have on capital formation in the U.S.
• Small Company Capital Formation: Solomon stated that regulators need to consider revisions to certain compliance rules, as well as continue to look at market structure, and create incentives to provide research analysts for small companies to assess the risks of a potential of IPO.

Morning Session: Discussion Regarding Capital Formation, Smaller Companies, and the Declining Number of Initial Public Offerings

• Jim Brau, Joel C. Peterson Professor of Finance, Marriott School, Brigham Young University
• Elisabeth de Fontenay, Associate Professor, Duke University School of Law
  • Article by Elisabeth de Fontenay
• Jackie Kelley, Americas IPO Markets Leader, E&Y
  • Report by E&Y
• Scott Kupor, Managing Partner, Andreesen Horowitz
• Jeffrey M. Solomon, President of Cowen Inc. and CEO of Cowen and Company
  • Slides by Jeffrey M. Solomon

Afternoon Session: Overview of Certain Provisions of the Financial CHOICE Act of 2017 Relating to the SEC

• Joseph Brady, Executive Director, North American Securities Administrators Association (“NASAA”)
• John C. Coffee Jr., Adolf A Berle Professor of Law and Director of the Center on Corporate Governance, Colombia Law School
  • Remarks by John C. Coffee, Jr.
• Paul G. Mahoney, David and Mary Harrison Distinguished Professor, University of Virginia School of Law

Opening Remarks

In his opening remarks, Chairman Jay Clayton said that he was interested in promoting transparency for retail investors in our fixed income markets. Furthermore, he noted that the Commission approved rules by FINRA and the MSRB that will require disclosure to retail customers of mark-ups and mark-downs for certain transactions in fixed income markets. Clayton stated the he believed that this is an important step toward creating more transparent bond markets, and that it will provide substantial benefit to retail investors. Additionally, he added that there are still discussions to be had around pre-trade price transparency and that he looked forward to engaging on that and other issues related to our fixed income markets.

Clayton stated that the substantial decline in the number of U.S. IPOs and publicly listed companies in recent years is of great concern. He added that some companies have shifted capital raising activities to the private markets, where many retail investors have limited access. Clayton stated that under his direction, SEC staff is actively exploring ways in which the SEC can improve the attractiveness of listing on our public market, while maintaining important investor protections.

Discussion Regarding Capital Formation, Smaller Companies and the Declining Number of Initial Public Offerings

Jackie Kelly opened by discussing a recent E&Y study on the decline in IPOs in U.S. capital markets. The study found that the U.S. public markets have changed dramatically over the past two decades with more financially stable companies entering the public markets and significantly lower delisting rates compared to the period immediately following the dot-com boom. Additionally, the study highlighted a decline in the number of public companies from 8,000 publicly listed companies at the dot-com peak compared to approximately 4,000 companies today.

Kelly discussed the private markets and how capital access is easier than ever before as a result of market forces, lower interest rates, and strong demand for innovation. She suggested that policymakers interested in changing policy while keeping prosperous growth on an upward trend should address the following questions:

• Where should the U.S. investment dollar go, private, public or agnostic?
• If more retail investment is desired in private markets, are there more protections that are needed to be contemplated?
• If more IPOs are desired and one policy pushes into another, will investors understand the risks of IPOs and that there are more failures than successes?

In his remarks, Jim Brau stressed the importance of IPOs and the difficulty in determining the optimal number of IPOs in order to promote healthy financial markets. He argued that regulations have taken a significant toll on small IPOs in different ways. Brau recommended that a study be conducted on the optimal number of IPOs necessary to promote a healthy and well-functioning markets, but agreed that it would be hard to distinguish the optimal amount due to changes in market structure.

Jeff Solomon discussed the significant changes in the IPO market (slides here) and the factors that impact decision to go public or not. Solomon stressed that individual investors are increasingly choosing to enter the market through institutional players. He stated that the current market structure is completely different from the 1990s, so some of the conclusions of the E&Y study were not completely relevant. Solomon highlighted the need to focus on MiFID II and the impact it will have on capital formation in the U.S. Additionally, he said that regulators need to consider revisions to certain compliance rules, as well as continue to look at market structure, and create incentives to provide research analysts for small companies to assess the risks of a potential of IPO. He stressed the importance of pre-IPO research.

Elisabeth de Fontenay discussed the causes and consequences to the decline of IPOs, such as the informational effects of securities regulations, which have had an impact of both IPO supply and demand. De Fontenay said that private companies benefit from and can more easily raise private capital based upon information collected from public companies’ mandatory disclosure and stock trading prices which essentially amounts to a subsidy. She added that deregulation has historically incentivized companies to go public in the first place. De Fontenay argued that the decline in public companies shouldn’t be a surprise given the way the regulatory regime is currently structured, and that the trend may continue.

Scott Kupor argued that small companies are disincentivized enter public capital markets, and that the costs of being a public company are material, agreeing with Solomon. Kupor further agreed with Solomon that the combination of the material costs of being public and the disproportionate effects of the regulatory regime on a small-cap company vs. large-cap makes the decision to go public difficult. He suggested that increasing institutional support and secondary market liquidity for small-cap companies would be an important step towards promoting capital formation.

Overview of Certain Provisions of the Financial CHOICE Act of 2017 Relating to the SEC

In his opening remarks, John Coates described the Financial CHOICE Act as a gigantic buffet covering many different aspects of securities regulation. He stated that the bill cuts the SEC budget, imposes cost-benefit requirements, and forbids the SEC from rulemaking if the quantified costs of the rule exceed the quantified benefits.

Mahoney referenced the morning session, which focused on IPOs, and said that Title IV of the CHOICE Act would assist in promoting capital formation. He said that there will be some skepticism regarding the cost-benefit analysis provision, and it’s notable that the requirement was not a feature of federal securities laws from the very beginning. Mahoney argued that the cost-benefit principles are not followed by government agencies since there are no incentives to prioritize regulations with an emphasis on defined social benefits. He stated that a focus on high net social value proposals will allow the Commission to exercise more control over proposals that it receives from its staff.

Joseph Brady discussed enforcement and regulatory elements of the CHOICE Act. He referenced Section 391, which requires agencies to implement policies and procedures to do the following:

• Minimize duplication of efforts with other Federal or State authorities when bringing an administrative or judicial action against an individual or entity;
• Establish when joint investigations, administrative actions, or judicial actions or the coordination of law enforcement activities are necessary and appropriate and in the public interest; and
• While in the course of a joint investigation, administrative action, or judicial action, establish a lead agency to avoid duplication of efforts and unnecessary burdens and to ensure consistent enforcement, as necessary and appropriate in the public interest.

He voiced support for the provision adding that he was pleased that the final version of the bill included a statutory instruction clarifying that nothing in Section 391 shall be construed to require coordination. Brady further argued that the current system of collaboration between state securities regulators and the SEC is the best approach. Additionally, he discussed the Senior Safe provision and said that NASAA adopted a similar provision in January 2016. Lastly, Brady voiced support for Section 466 (Private Placement Improvement Act) which would revise certain filing requirements under Regulation D. He added that NASAA agreed with the SEC’s proposed amendments and IAC’s recommendations and continued to believe that these changes will benefit investors in private placements.

John Coffee discussed provisions of the CHOICE Act addressing SEC administrative enforcement. He described Section 823, which entitles any defendant sued in an administrative proceeding to opt out and compel the Commission to seek sanction by filing civil action in court. Coffee said that he believed a majority of people will choose to exercise this option which poses a problem due to the SEC’s resource constraints. He added that this may increase cost for the SEC and decrease the number of cases brought via SEC administrative proceedings. Additionally, Coffee discussed Section 824, which requires the SEC to make two findings before it can approve civil money penalties against issuers: (1) whether the alleged violation resulted in direct economic benefit to the issuer and (2) whether the penalty will harm shareholders. He argued that the provision doesn’t require an affirmative finding but rather requires an analysis be conducted by the Division of Economic and Risk Analysis which is certified by the Chief Economist.

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