June 26, 2018

Senate Banking, Housing, and Urban Affairs Committee “Legislative Proposals to Increase Access to Capital”

Key Topics & Takeaways

  • S.1117, the Consumer Financial Choice and Capital Markets Protection Act: Throughout the hearing, numerous Senators spoke in favor of S.1117, the Consumer Financial Choice and Capital Markets Protection Act, which would allow institutional prime and tax-exempt money market funds to use a stable net asset value (NAV) instead of the floating NAV that the Securities and Exchange Commission (SEC) required them to use in their 2014 Amendments to Rule 2a-7. GFOA’s Chris Daniel focused his written and oral testimony on this bill and argued that the floating NAV hurts the ability of municipal governments to raise funds and manage their cash.
  • Capital Formation: There was also discussion throughout the hearing on capital formation generally. Chairman Mike Crapo (R-Ind.) asked SBE Council’s Raymond Keating to describe the feedback his members have given him since the passage of S.2155, the Economic Growth, Regulatory Relief, and Consumer Protection Act. Keating said that there is more optimism among small businesses, but that many still have trouble getting bank loans.
  • S.3004, the Small Business Audit Correction Act: Sen. Doug Jones (D-Ala.) asked about a bill he and Sen. Tom Cotton (R-Ark.) introduced, S.3004, the Small Business Audit Correction Act, that would exempt small, non-custodial brokers from needing to hire a Public Company Accounting and Oversight Board (PCAOB)-registered audit firm. Cotton also discussed the bill, arguing that the same audit requirements should not apply to large custodial brokers and small, non-custodial brokers. 

Witnesses

  • Raymond Keating, Chief Economist, Small Business & Entrepreneurship Council
  • Mercer Bullard, Professor, University of Mississippi
  • Chris Daniel, Chief Investment Officer of Albuquerque, on behalf of the Government Finance Officers Association 

Opening Statements

Chairman Mike Crapo (R-Idaho), Senate Banking Committee

In his opening statement, Crapo stated that the hearing would focus on several legislative proposals to encourage capital formation by small businesses. Crapo discussed several of the bills specifically, including S. 588, the Helping Angels Lead our Startups (HALOS) Act, S.1117, the Consumer Financial Choice and Capital Markets Protection Act, and S. 3004, the Small Business Audit Correction Act, among others. Crapo stated that the legislation would collectively help entrepreneurs access capital.

Ranking Member Sherrod Brown (D-Ohio), Senate Banking Committee

In his opening statement, Brown stated that some of the proposed bills undermine investor protections and transparency while creating risks to financial stability. Brown expressed his concern that Congress is working too hard on a “JOBS Act 3.0” instead of trying to understand if the original Jumpstart Our Business Startups Act of 2012 created jobs. Brown suggested that Committee members discuss how Congress and the SEC could do more for investment protection and market stability and noted a recent Wall Street Journal about disreputable brokers. Brown stated that risks to investors are increasing in today’s economic time. Instead, Brown suggested that the committee should focus on enhancing investor confidence rather than undermining protections. 

Testimony

Raymond Keating, Chief Economist, Small Business & Entrepreneurship Council

In his testimony, Keating stated that throughout Small Business & Entrepreneurship Council’s (SBE Council’s) history, access to capital has been a core issue for its members. Keating stated that while matters have improved in recent years, many entrepreneurs continue to struggle with accessing the capital they need to compete and grow. Keating followed by discussing the value of small business loans and their lack of growth in the past decade. Keating also noted that angel investments have stagnated since 2014, though he noted that venture capital has shown solid growth in recent years. Keating reiterated that government regulation falls heaviest on small businesses and outlined in his written testimony legislative proposals that the SBE Council supported.

Mercer Bullard, Professor, University of Mississippi

In his testimony, Mercer argued that a core premise of the JOBS Act and some of the bills under consideration at the hearing – that excessive regulation wrought by the Sarbanes-Oxley and Dodd-Frank Acts damaged U.S. capital markets by causing a dramatic decline in the number of U.S. initial public offerings (IPOs) – is false.  Bullard stated that there is nothing inherently wrong with fewer IPOs but believed that that total IPOs is a faulty metric for measuring the health of capital markets. Bullard then stated that capitalism is more about increasing capital broadly and Congress should refocus on that. Bullard followed by arguing that the HALOs Act effectively repeals offering regulation in the United States.

Chris Daniel, Chief Investment Officer of Albuquerque, on behalf of the Government Finance Officers Association (GFOA)

In his testimony, Daniel focused on S.1117, and the impact that the SEC’s 2014 Amendments to Rule 2a-7 have had on municipal governments’ ability to finance their operations through short-term debt. Daniel noted that variable-rate debt is a low-cost method of financing for municipalities, especially when compared to fixed-rate bonds, but that the 2014 Amendments pushed municipal issuers to issue more fixed-rate bonds because of new requirements on money market fund NAVs. Daniel noted that tax-exempt money market funds’ assets under management fell by half from January 2016 and April 2018. Daniel noted that money market funds are key purchasers of investment grade short-term municipal debt. Daniel said the GFOA supported S.1117 because it would allow institutional, non-government money market funds to price their shares with a fixed NAV instead of using a floating NAV and by extension, would help municipal governments raise money.

Question & Answer

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

Throughout the hearing, numerous Senators spoke in favor of S.1117, the Consumer Financial Choice and Capital Markets Protection Act, which would allow institutional prime and tax-exempt money market funds to use a stable NAV instead of the floating NAV that the SEC required them to use in their 2014 Amendments to Rule 2a-7. GFOA’s Chris Daniel focused his written and oral testimony on this bill and argued that the floating NAV hurts the ability of municipal governments to raise funds and manage their cash.

Crapo asked Daniel if it was true that $1 trillion in private sector liquidity shifted away from institutional prime funds to U.S. government-backed funds, and Daniel said that this is true. Daniel also noted that municipal governments have been pushed into higher fixed-rate bonds from variable rate demand notes due to decreased demand for those products since the 2014 Amendments passed. Daniel described this throughout the hearing as a “market dislocation.” Sen. Pat Toomey (R-Pa.) a sponsor of S.1117, also asked witnesses about the bill during the hearing, specifically why a stable NAV is important for municipal investors. Daniel said that municipal governments are generally prevented by statute from investing in vehicles with a liquidity fee, so they are forced to rely on government funds for cash management despite preferring to invest in institutional prime funds with a higher yield. Toomey also argued that the SEC’s 2014 Amendments were unnecessary and that they were promulgated despite no evidence that a floating NAV is necessary for stability.

Sen. Heidi Heitkamp (D-N.D.) noted that the SEC argued their 2014 Amendments to Rule 2a-7 would have a limited impact on the market. Daniel replied that the dislocations caused by the Amendments have hurt municipal government finances, and that the 2010 Amendments to the Rule made important reforms to money market funds without harming local government finances. Sen. Bob Menendez (D-N.J.) said he has heard from local New Jersey officials about higher borrowing costs, decreased demand for municipal debt, and an inability to invest cash in institutional prime money market funds. Daniel replied that the 2014 Amendments pushed investors in money market funds toward government funds, decreasing demand for floating rate demand notes and into higher rate fixed-cost bonds for their financing needs.

Capital Formation

There was also discussion throughout the hearing on capital formation generally. Crapo asked Keating to describe the feedback his members have given him since the passage of S.2155, the Economic Growth, Regulatory Relief, and Consumer Protection Act. Keating said that there is more optimism among small businesses, but that many still have trouble getting bank loans.  Sen. Tim Scott (R-S.C.) asked Keating if he thought the legislation under consideration would improve capital formation and grant retail investors more investment opportunities, and Keating praised some of the bills for streamlining processes and reducing costs for IPOs while maintaining investor protections.

Brown asked Bullard to describe the risks investors could face if Congress made it easier for brokers and issuers to advertise private securities, especially for early-stage companies. Bullard noted the same Wall Street Journal article that found disreputable practices in the market for private securities and argued that the expansion of the accredited investor definition in the JOBS Act increased the number of people who could be targeted in frauds. Bullard also noted that issuers can use JOBS Act offering tools, like Regulation A and Regulation D, simultaneously, allowing them to offer different securities with different disclosures to different investors. Bullard also criticized current disclosure requirements that allow retail investors only 15 days to review offering documents, while institutional and private investors can have months to review documents during the SEC’s confidential filing review period.

S.3004, the Small Business Audit Correction Act

Sen. Doug Jones (D-Ala.) asked about a bill he and Sen. Tom Cotton (R-Ark.) introduced, S.3004, the Small Business Audit Correction Act, which would exempt small, non-custodial brokers from needing to hire a Public Company Accounting and Oversight Board (PCAOB)-registered audit firm. Jones asked Keating to describe the regulatory costs of a PCAOB audit on small brokers and dealers, and Keating said that in addition to the higher dollar amount (which can be difficult for small brokers to pay) there are uncertainty and resource costs. Cotton also discussed the bill, arguing that the same audit requirements should not apply to large custodial brokers and small, non-custodial brokers. Cotton noted that this requirement grew out of Sarbanes-Oxley and asked Keating if the pre-Sarbanes-Oxley requirements should be recreated. Keating argued that they should, and said that regulations should be tailored to firms of different sizes.

Issuer Audit Requirements

Brown noted that there is a push by some members of Congress to reduce audit requirements on certain public issuers, and asked Bullard what the impact would be of lighter audit requirements on issuers. Bullard argued that in addition to those issuers having a higher cost of financing, issuers with lighter audit requirements have more restatements of earnings and more intentional misstatements. Bullard argued that audits are necessary to protect investors and described the data on this point as “pretty consistent.”

Sen. Thom Tillis (R-N.C.) asked about S. 2126, the Fostering Innovation Act , which would exempt certain issuers from the auditor attestation requirements of Sarbanes- Oxley Sec. 404(b). Keating said he believed the exemption made sense for the companies covered by the bill.

For more information on this hearing, please click here.