Congressional Hearings
LEGISLATIVE PROPOSALS TO INCREASE ACCESS TO CAPITAL
Congressional Hearings
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| AUTHORITYID | CHAMBER | TYPE | COMMITTEENAME |
|---|---|---|---|
| ssbk00 | S | S | Committee on Banking, Housing, and Urban Affairs |
[Senate Hearing 115-354]
[From the U.S. Government Publishing Office]
S. Hrg. 115-354
LEGISLATIVE PROPOSALS TO INCREASE ACCESS TO CAPITAL
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED FIFTEENTH CONGRESS
SECOND SESSION
ON
EXAMINING LEGISLATIVE PROPOSALS ON CAPITAL FORMATION
__________
JUNE 26, 2018
__________
Printed for the use of the Committee on Banking, Housing, and Urban
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
MIKE CRAPO, Idaho, Chairman
RICHARD C. SHELBY, Alabama SHERROD BROWN, Ohio
BOB CORKER, Tennessee JACK REED, Rhode Island
PATRICK J. TOOMEY, Pennsylvania ROBERT MENENDEZ, New Jersey
DEAN HELLER, Nevada JON TESTER, Montana
TIM SCOTT, South Carolina MARK R. WARNER, Virginia
BEN SASSE, Nebraska ELIZABETH WARREN, Massachusetts
TOM COTTON, Arkansas HEIDI HEITKAMP, North Dakota
MIKE ROUNDS, South Dakota JOE DONNELLY, Indiana
DAVID PERDUE, Georgia BRIAN SCHATZ, Hawaii
THOM TILLIS, North Carolina CHRIS VAN HOLLEN, Maryland
JOHN KENNEDY, Louisiana CATHERINE CORTEZ MASTO, Nevada
JERRY MORAN, Kansas DOUG JONES, Alabama
Gregg Richard, Staff Director
Mark Powden, Democratic Staff Director
Jonathan Gould, Deputy Chief Counsel
Elisha Tuku, Democratic Chief Counsel
Laura Swanson, Democratic Deputy Staff Director
Dawn Ratliff, Chief Clerk
Cameron Ricker, Deputy Clerk
James Guiliano, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
C O N T E N T S
----------
TUESDAY, JUNE 26, 2018
Page
Opening statement of Chairman Crapo.............................. 1
Prepared statement........................................... 31
Opening statements, comments, or prepared statements of:
Senator Brown................................................ 1
WITNESSES
Raymond J. Keating, Chief Economist, Small Business and
Entrepreneurship Council....................................... 3
Prepared statement........................................... 31
Responses to written questions of:
Senator Brown............................................ 73
Senator Sasse............................................ 74
Senator Cotton........................................... 77
Senator Rounds........................................... 78
Senator Cortez Masto..................................... 79
Mercer E. Bullard, Butler Snow Lecturer and Professor of Law,
University of Mississippi School of Law........................ 5
Prepared statement........................................... 40
Responses to written questions of:
Senator Brown............................................ 80
Senator Sasse............................................ 80
Senator Cotton........................................... 81
Senator Menendez......................................... 82
Senator Cortez Masto..................................... 83
Christopher H. Daniel, Chief Investment Officer, City of
Albuquerque, New Mexico, on behalf of the Government Finance
Officers Association........................................... 6
Prepared statement........................................... 71
Responses to written questions of:
Senate Banking Committee................................. 85
Additional Material Supplied for the Record
Letters and statements submitted by Chairman Crapo............... 150
Letters and statements submitted by Senator Brown................ 178
Letters submitted by Senator Toomey.............................. 344
Letters submitted by Senator Scott............................... 351
Letters submitted by Senator Cotton.............................. 355
Letters submitted by Senator Tillis.............................. 377
Letters submitted by Senator Menendez............................ 385
(iii)
LEGISLATIVE PROPOSALS TO INCREASE ACCESS TO CAPITAL
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TUESDAY, JUNE 26, 2018
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:02 a.m., in room SD-538, Dirksen
Senate Office Building, Hon. Mike Crapo, Chairman of the
Committee, presiding.
OPENING STATEMENT OF CHAIRMAN MIKE CRAPO
Chairman Crapo. The Committee will come to order.
Today's hearing will focus on several legislative proposals
that will encourage capital formation and reduce burdens for
smaller businesses and communities.
My goal is to work with Senator Brown and other Members on
this Committee to identify and move legislative proposals that
achieve these aims.
Senators Schatz, Toomey, Heitkamp, and Tillis, among
others, have cosponsored a bill that would make it easier for
startup companies to tap the expertise and capital of angel
investor groups.
Senators Toomey, Rounds, and Menendez, among others,
introduced a bill that would provide more financing options for
State and local governments seeking to raise money.
Senator Tillis has introduced a bipartisan bill that
exempts emerging growth companies from certain auditor
attestation requirements.
Senators Van Hollen and Tillis have cosponsored a bill that
would encourage more public offerings by allowing all companies
to ``test the waters'' prior to filing an IPO.
A bill introduced by Senators Kennedy and Jones would make
it easier for investment advisers to focus on rural business
investment companies.
Finally, Senators Cotton and Jones recently introduced a
bill that will cut audit costs for noncustodial brokers.
These bills will improve companies' access to our capital
markets and their ability to invest in the United States, in
turn growing and creating jobs.
I look forward to hearing from our witnesses on these
legislative proposals, and I now turn to Senator Brown.
OPENING STATEMENT OF SENATOR SHERROD BROWN
Senator Brown. Thank you, Mr. Chairman, and welcome to our
witnesses.
I want to thank the Chairman for holding today's hearing
and providing Members of this Committee the opportunity to
discuss legislation that a number of my colleagues have worked
on in this Congress.
Unfortunately, some of the bills we will discuss today, and
at Thursday's hearing, undermine investor protections and
transparency, and they potentially create risks to financial
stability.
The ink is barely dry on S. 2155, the bill that rolls back
many of the banking system protections developed following the
financial crisis. And while Congress was working on that bill,
the banking regulators, the newly installed banking regulators,
many of them coming from Wall Street, began several efforts to
weaken postcrisis safeguards. Now this Committee wants to work
on bills that will undercut investor protections and market
practices that have served to promote transparency. Lobbyists
in this town just never get enough.
Several of today's bills have their roots in the JOBS Act
and look to make changes that will supposedly increase capital
formation or balance the number of IPOS back to levels from the
1990s--I am sorry, to boost the number of IPOs back to levels
from the 1990s. I am concerned that more time is spent thinking
about a JOBS Act 2.0 or 3.0 and finding laws that should be
scaled back instead of trying to understand if the original
JOBS Act actually created jobs.
I am sure we will hear about how each of today's bills is
vital to help small companies grow and allow investors to
participate in that growth. What we should also talk about is
how Congress and the SEC can do more for investor protection
and for market stability.
We do not spend enough time working to increase the
public's trust in markets, but those efforts would benefit
small companies and the jobs they create.
Earlier this year we heard from the SEC and the CFTC that
keeping up with virtual currencies and related fraud was a tall
order. But we know that low-tech fraud still exists.
Just yesterday, the Wall Street Journal reported that
securities firms with high numbers of brokers with disciplinary
records are selling tens of billions of dollars in private
placements, specifically targeting seniors. We will hear more
on Thursday about customers who are defrauded by their brokers,
but the Journal's findings indicate a serious problem facing
savers: the allure of deals that are just too good to be true.
The SEC's recent settlement with Theranos shows how even
sophisticated investors can have wool pulled over their eyes
for years, and you read some of those names in the business
section of the Times and the Wall Street Journal or any other
papers, the Financial Times, and all over the last couple of
years.
While the SEC continues to pursue fraud cases, the fact is
enforcement cases and related penalties are down dramatically.
Last week I sent SEC Chair Clayton a letter expressing my
frustrations with the recent trends in enforcement. Yesterday's
article shows that risks to investors are increasing in these
good economic times.
The potential risks and potential negative consequences
arising from today's bills are easily predictable. For example,
a number of studies have shown that companies exempted from
accounting requirements and auditor oversight of internal
controls have higher rates of accounting restatements. It does
not take a lot of imagination as to how that happens.
Maybe if we focused on passing laws that enhance investor
confidence instead of undermining it, if we did that, this
would end up helping businesses, too. After all, the more
confident investors are, the easier it is for companies to
raise money.
I have said before that protecting investors and
strengthening the integrity of the markets is necessary for
successful capital formation. And yet here we continue to
consider bills that unwind many important safeguards, I think
another example of collective amnesia that set in to this
Congress. Slowly but surely, we will find that adding more
exemptions and more carveouts has not had the desired result of
more IPOs, but it has had a predictable result of denying
investors key protections and eroding trust in the markets.
I look forward to hearing from our witnesses.
Chairman Crapo. Thank you, Senator Brown.
Today's witnesses are Mr. Raymond J. Keating, chief
economist of the Small Business and Entrepreneurship Council;
Professor Mercer E. Bullard, Butler Snow Lecturer and professor
of law at the University of Mississippi School of Law; and Mr.
Chris Daniel, chief investment officer of the city of
Albuquerque, New Mexico, on behalf of the Government Finance
Officers Association.
We welcome all of you here. As I think you have been
advised, your written testimony has been entered into the
record, and we encourage you each to try to be very aware of
the clock that is in front of you. We ask you to keep your
initial remarks to 5 minutes, if you can, and then each of the
Senators will have a 5-minute opportunity to engage you with
questions. And at that point you can get out a lot that you did
not get out in your other statements.
Also, I would ask you to recognize that the clock also runs
on Senators, and when their questioning time is up, please try
to bring your responses to an end promptly so we can get to the
next Senator.
Mr. Keating, you may proceed.
STATEMENT OF RAYMOND J. KEATING, CHIEF ECONOMIST, SMALL
BUSINESS AND ENTREPRENEURSHIP COUNCIL
Mr. Keating. Chairman Crapo and Members of the Committee,
thank you for hosting this important hearing today on the issue
of access to capital. My name is Raymond Keating. I serve as
chief economist for the Small Business and Entrepreneurship
Council, a nonprofit, nonpartisan advocacy, research, and
education organization dedicated to protecting small business
and promoting entrepreneurship.
Throughout SBE Council's history, access to financial
capital has been a core issue as it stands out as a
foundational matter for entrepreneurs who are starting up,
operating, or expanding businesses. However, for many
entrepreneurs, gaining access to capital is a serious
challenge.
During the financial crisis, the Great Recession, and an
underperforming recovery, capital became difficult to access
from institutional banks and various capital market players.
And while matters have improved in recent years, many
entrepreneurs continue to face challenges. For example, while
growing since the recent low hit in 2013, the value of small
business loans outstanding remains below the high hit in 2008.
In effect, small business loan value has experienced no growth
for more than a decade.
A similar trend and shortfall is seen in the number of
small business loans with the level at the end of 2017 still
below the 2008 level.
On the equity side, angel investment stands out as a
critical source for funding startups in early stage businesses,
but here the numbers have been disappointing in recent years.
Postrecession growth was underwhelming, and since 2014, angel
investment has, in effect, stagnated. And while not an option
for most startups or very young firms, venture capital
investment is an important avenue for innovative firms to raise
capital for growth and expansion. The trend on the venture
capital front after the recession thankfully tends to show more
robust growth. Finally, there has been growth in online lending
and crowdfunding for entrepreneurs as well.
So long after the financial crisis hit in late 2008 and the
recession came to an official end in mid-2009, the financial
capital story for the small business community has been mixed.
While having recovered some, small business loans are still
well off from where they should be. Angel investment in recent
years largely seems stuck. Meanwhile, venture capital has
shown, again, solid growth, while online lending and
crowdfunding have opened new doors for many entrepreneurs
seeking funding.
Assorted factors contribute to these trends, including the
underperforming recovery--excuse me, underperforming economy
over a period of a decade and a general decline in
entrepreneurial activity.
Challenges among small community banks also have come into
play given the important role that these institutions play in
lending to small businesses. And community banking woes also
tie back to the state of the economy, but to Government
regulation as well, which always falls heaviest on small
businesses.
Reform and relief efforts to clear away obstacles and
reduce costs for lenders, investors, entrepreneurs and small
businesses on the financial capital front are most welcome. SBE
Council supports most of the measure being discussed today,
namely, the HALOS Act, the Fostering Innovation Act, the
Encouraging Public Offerings Act, the Small Business Audit
Correction Act, and RBIC Advisers Relief Act, along with a host
of other reform and relief measures mentioned in my written
testimony.
Finally, when it comes to boosting access to capital for
the entrepreneurial sector and thereby enhancing economic,
income, and employment growth, SBE Council also looks in other
areas such as taxation, and we favor, for example, reducing the
capital gains tax and indexing gains for inflation. These
measures, these other deregulation measures, enhance the
returns on and incentives for investment and entrepreneurship.
Thank you for your time and attention, and I look forward
to your questions and further discussion.
Chairman Crapo. Thank you.
Professor Bullard.
STATEMENT OF MERCER E. BULLARD, BUTLER SNOW LECTURER AND
PROFESSOR OF LAW, UNIVERSITY OF MISSISSIPPI SCHOOL OF LAW
Mr. Bullard. Thank you, Chairman Crapo, Ranking Member
Brown, and Members of the Committee. It is an honor and
privilege to appear before you again here today. I appreciate
the opportunity.
This hearing will address a number of bills. At the moment
I want to focus on those that relate to capital raising by U.S.
companies. I would like to first address the premises
underlying these bills and a fair amount of legislation over
the last few years.
Capital market reforms have repeatedly been posed as
solutions to the perceived problem of the decline in the number
of U.S. IPOs and the number of U.S. public companies, and
supporters often blame the decline on legislation that was
enacted following two of the three worst downturns in U.S.
markets since the Great Depression.
I have significant doubts about both premises. First, it is
not possible to make a statistically meaningful connection
between the Sarbanes-Oxley and Dodd-Frank Acts on the one hand
and changes in the number of IPOs in U.S. companies on the
other. The factors are too many and too diverse. Even if one
could establish a relationship, the relationship would
demonstrate that each act was followed by an increase in total
capital represented by U.S. listed companies. The gross
proceeds from IPOs during this century have substantially
exceeded the amount raised in preceding periods, and 2018 is on
pace to set a new record.
There is nothing inherently wrong with fewer IPOs and fewer
public companies. In my opinion, these are the wrong measures.
If Congress is concerned about the amount of capital raised in
U.S. public markets, then it should consider the amount of
capital raised in U.S. public markets, and in a century, the
amount of capital raised in U.S. public markets represented by
public companies has been a success story. The only short-term
downturns have followed the Internet bubble and the Enron-
WorldCom scandals and the financial crisis. The upward trend in
total capital restored after the Sarbanes-Oxley and Dodd-Frank
Acts became law. A U.S. listing is still the preferred
worldwide standard. Among non-U.S. companies that choose to
list outside their home country, U.S. exchanges are the
overwhelming favorite.
In my opinion, capitalism is about increasing capital, not
ensuring that regardless of the amount of capital raised, the
capital will be more widely distributed. Capitalism is about
the efficient allocation of capital, not ensuring that everyone
gets a share regardless of the value of their enterprise.
I am also concerned about the continuing salt on the
distinction between registered and unregistered offerings on
which the Securities Act is based. The HALOS Act would allow
virtually any type of public entity to advertise and host a
public event that can be attended by any person for the purpose
of any issuer pitching an unregistered securities offering. The
act would permit public notices that specifically advertise the
event as a forum for marketing securities. Congress calls this
a clarification of what does not constitute a general
solicitation, but a general solicitation is precisely what the
event would be.
The HALOS Act effectively repeals offering regulation in
the United States if that has not already occurred relative to
the JOBS Act's permitting general solicitation and advertising
in private offerings and $50 million Reg D offerings freed of
State oversight.
The effective recent legislation in bills pending today is
to make retail investors an informational underclass. Issuers
are allowed to file confidential registration statements while
distributing information to large investors in road shows for
months, with the initial public registration statement being
made available to retail investors just 15 days before the IPO.
Issuers can raise capital from retail investors through
crowdfunding, interstate, and Reg A offerings based on one set
of information while they provide additional nonpublic
information to wealthy investors under Reg D under terms that
may dilute retail investors' interests. If information can be
broadly and publicly disseminated to anyone and all offerings
are essentially public in nature, then the terms of all
offerings should be publicly available. If all offerings are to
be public, then all private issuers should be required to make
certain information publicly available on an ongoing basis,
such as the terms in which past and current offers are made to
investors and the amount of distributions made to investors.
Instead, issuers of unregistered securities routinely ignore
the minimal disclosure requirements to which they are subject.
Many if not most Reg D issuers do not file Form D, and even
that form is only a one-time filing that provides little useful
information.
If ultimately any investor will be able to buy any security
but only wealthy investors will be able to see confidential
information and have far longer to consider an investment's
prospects, Congress should consider what form of investor
protection will take the place of the protections that have
been and continue to be discarded.
I look forward to taking your questions.
Chairman Crapo. Thank you.
Mr. Daniel.
STATEMENT OF CHRISTOPHER H. DANIEL, CHIEF INVESTMENT OFFICER,
CITY OF ALBUQUERQUE, NEW MEXICO, ON BEHALF OF THE GOVERNMENT
FINANCE OFFICERS ASSOCIATION
Mr. Daniel. Chairman Crapo, Ranking Member Brown, and
distinguished Members of the Committee, I am honored to be here
today on behalf of the Government Finance Officers Association,
GFOA, to share with you our comments in support of S. 1117, the
Consumer Financial Choice and Capital Markets Protection Act of
2017, and its importance to public finance. My name is Chris
Daniel, and I am the chief investment officer for the city of
Albuquerque, New Mexico. I also serve on the Treasury and
Investment Management Committee of the GFOA.
GFOA represents nearly 20,000 public finance officers from
State and local governments, schools, and special districts
throughout the United States. We appreciate this Committee's
continued support for efforts to strengthen the municipal bond
market, especially the recent enactment of legislation
designating municipal securities as high-quality liquid assets.
Such actions help States, local governments, and other
governmental entities maintain access to low-cost capital,
which is vital to infrastructure investment across the United
States and contributes to a healthy and vibrant economy.
Likewise, money market funds are used by Governments as our
leading vehicle for short-term investment of public funds. The
SEC's change of net asset value, or NAV, accounting methodology
from stable to floating negatively impacts our ability to use
them. S. 1117 would restore the ability of State and local
governments to safely invest in funds that meet the parameters
of investment policies as determined by our own State and local
elected officials, not by the SEC.
Let me provide the Committee with key concerns of
Government finance officers as you consider this legislation to
improve access to capital.
First, money market funds are used effectively to manage
safety and liquidity for public sector investments. According
to Federal Reserve data, State and local governments hold over
$190 billion of assets in money market funds. Traditionally,
Governments have used these funds to safely invest public
monies as dictated within an entity's own investment policy. It
is my experience that governing bodies approve a Government's
investment policy based on industry best practices such as the
GFOA's and the specific needs of the entity. Most Governments
have policies demanding that the products used in their short-
term investment portfolios have a stable NAV to maintain
adequate levels of liquidity and safety through principal
preservation. Requiring a floating NAV creates an unnecessary
obstacle that has steered State and local governments into very
low yielding U.S. Government-backed funds or other alternatives
from what was already a safe and highly liquid market.
Second, money market funds provide access to working
capital to fund public services and finance infrastructure
investment. Money market funds are key purchasers of municipal
securities. Historically, they have been the largest purchasers
of short-term tax-exempt debt. The original objectives of the
floating NAV rule change were to protect investors from runs on
money market funds, but those concerns were already effectively
addressed with the 2010 amendments to Rule 2a-7 following the
financial crisis. GFOA and other State and local government
issuer groups supported those amendments.
Despite the positive impact of the 2010 amendments, the SEC
moved forward in adopting additional amendments to the rule in
July 2014. Throughout that process, GFOA and public finance
officers all over the country submitted analysis showing that a
floating NAV would do little to deter heavy redemptions during
a financial crisis and would instead impose substantial costs
on State and local governments. That is exactly what happened.
Between January 2016 and April 2018, tax-exempt money market
fund assets under management fell by nearly 50 percent, from
$254 billion to $135 billion, a dramatic shrinking of an
important market for municipal debt. At the same time,
municipalities issuing variable rate demand notes saw their
borrowing costs increase significantly above the Federal
Reserve's rate increases over the same period. Many State and
local governments opted to issue higher-cost fixed-rate bonds
because issuing variable rate debt to money market funds has
become impractical. In both cases, higher costs are being
shouldered by taxpayers and ratepayers.
Public finance officers are encouraged by and support
initiatives like S. 1117 which allow us to better serve our
communities and provide important public services in a cost-
effective way.
Thank you for the opportunity to speak to you today. I will
be happy to answer any questions.
Chairman Crapo. Thank you, Mr. Daniel. And I will start
with you today.
Last week Ron Crane, who is Idaho's State treasurer, wrote
about the additional costs and reduced incomes that the SEC's
money market and mutual fund rule is imposing on State and
local governments. He notes that the SEC's rule has caused more
than $1 trillion of private sector liquidity to shift away from
funds that invest in the economic infrastructure of our
communities and into funds that invest strictly in the U.S.
Government debt.
First of all, could you confirm that? And, second, can you
talk about how S. 1117 will address those concerns?
Mr. Daniel. Mr. Chairman, I can confirm that. State and
local governments have a fiduciary obligation to taxpayers and
ratepayers to preserve the public fisc. Rule 2a-7 hit local
governments in two costly ways:
First, by floating the NAV, our statutes and policies
restrict investment in these instruments, and we were forced
out of the municipal money market and prime funds into very low
yielding U.S. Government funds.
Second, by depleting these funds, short-term borrowing
costs or rates on variable rate demand notes raised
dramatically. Municipal governments like Albuquerque were
forced into higher-cost fixed-rate debt in order to satisfy our
working capital requirements. This solution is simply
unsustainable.
S. 1117 will open back up the opportunity for investment in
these financing and investment instruments. It will put another
tool in the toolkit, if you will, for local governments to
invest in a safe and adequately yielding instrument while
providing a low-cost financing mechanism for short-term
borrowing needs. S. 1117 will permit local governments to have
the adequate and appropriate tools for local governments, both
and small communities alike, to invest in infrastructure and
maintain a healthy and vibrant economy.
Chairman Crapo. And do you think that the outcome will
increase risk in any aspect of this sector?
Mr. Daniel. Mr. Chairman, I do not. The 2010 amendments to
Rule 2a-7 dramatically increased the requirements for quality,
maturity, and the like for municipal money market funds. Since
2010 there have been no dislocations of the capital markets
until the SEC announced the 2014 amendments, which went into
effect in October 2016. At that time over $1 trillion shifted
out of prime- and tax-exempt funds to the Government funds.
This is a market dislocation, but more important to us as
medium and small local governments, it dried up access to
short-term capital and caused us as investment officers to
accept much lower return on our investments, as much as 30
basis points, which collectively amounts to $500 million in
investment income we had lost that could be reinvested in our
communities for public services.
Chairman Crapo. Well, I thank you for that.
Mr. Keating, in your testimony you discussed trends
regarding the availability of capital to small businesses. You
note that small business lending has not recovered from the
precrisis levels and angel investment has largely stagnated
while venture capital has increased. S. 2155's commonsense
reforms are intended to address some of this decline in small
business lending postcrisis. What feedback have you received
from your members about their access to capital and how it is
impacting their ability to hire, grow, and innovate?
Mr. Keating. Well, it depends on, again, the company, the
industry, geographic location, and so on. But I think from what
we have heard and from what you see in some of the polls,
certainly small businesses are in a better position now than
they were, say, you know, 4 or 5 years ago. However, there are
still difficulties, and we certainly hear from members that are
having problems in terms of getting small business loans, what
other avenues can they go, can they go online, et cetera, et
cetera.
So I think that, you know, the bill that you are talking
about that was passed and signed into law makes sense because
it deals with--when you are talking about community banks,
small community banks, roughly half of small business loans
come from those institutions. So when you look at the costs
that a whole host of--that these regulations have hit these
banks with--and I cite a couple of studies; I can give you
more--any movement toward reining back excessive regulatory
burdens and costs is not only good for those small banks, but
it is good for the small business community in general.
Chairman Crapo. Thank you.
Senator Brown.
Senator Brown. Thank you, Mr. Chairman.
I think it is important to point out that, you know, loans
were down from 10 years ago, but up from 9 years ago as the
economy climbed back. So it is not entirely intellectually
honest, I do not think, to only compare to what the economy
looked like 10 years ago, because we know we have been fighting
back. We also know we have had economic growth every quarter,
every month, job growth every month since the auto rescue in
2010, and even though we had fewer jobs created in the private
sector in 2017 than we did in previous Obama years, it is
important to note that, I think.
Professor Bullard, your testimony explains the incoherence
of the capital formation policies that Congress advanced in the
past and now seems to be considering. I would like to focus on
the risks to investors. What happens when companies use scaled-
back auditing procedures?
Mr. Bullard. Well, we have a lot literature on that, and it
shows what you would expect. Companies that do not have the
same level of auditing procedures have more restatements, but
they also pay for it in the form of less reliable earnings,
predictions, higher cost of private and public debt. There are
studies that show that they have--that the auditors develop
better information than management does internally. They also
impose a higher standard for significant deficiencies and a
higher standard for material misstatements. We know that the
rate of intentional misstatements is higher for those low audit
standards. And I think we would all understand intuitively
obviously when you have got a cop on the watch, you are going
to have better compliance going in, and you will detect a lot
more miscompliance going forward. And that is what the data has
pretty consistently shown.
Senator Brown. So what does that mean? What are the risks
of broadly advertising speculative early stage companies, as
contemplated in the HALOS Act?
Mr. Bullard. Well, we know very well not just from the Wall
Street Journal article that came out the other day that private
offerings have always been one of the favorites for brokers
looking to maximize their compensation and in some cases
committing fraud with respect to investors. And what we have
seen over the years is the class of so-called accredited
investors has increased exponentially. We have not really seen
any catching up, in fact, a restriction, if anything, on the
ability of States to enforce restrictions on offerings. And the
key structure in the Securities Act when it was formed back in
1933 was based on the idea of offers being regulated because,
as a practical matter, that is really the only way to regulate
securities offerings before they have already been sold and
investors have lost their money.
We have gone so far down the road through the JOBS Act that
there really is not much left of offering regulation in that
1930s sense, and I think that if Congress is going to continue
down that road, it really needs to think about a different way
of looking at securities offering regulation. If it is going to
be democratized in the sense of any issuer, any security, any
investor, then, you know, what I see is this growing
informational disadvantage that retail investors have, and that
what we need is to have broader publicization of offerings to
make them available at the retail----
Senator Brown. That informational disadvantage is growing,
and HALOS and other legislation Congress might be considering
and rules from the Administration would accelerate that?
Mr. Bullard. Yes. It is growing the private market because
you have Reg A filings and crowdfunding filings that are
publicly made and filed with the SEC. And then you have
contemporaneous Reg D offerings where the investors and the
crowdfunding and Reg A offerings, which are the retail
investors, have no access to that information, and particularly
do not have access to the terms being offered. So while in
crowdfunding, for example, the SEC is allowing issuers to sell
something that is called a ``SAFE,'' when I think everyone in
the rooms knows that crowdfunding securities are anything but
safe, at the same time that issuer can offer better terms, not
SAFEs, to Reg D investors.
On the public front, you really have a very extreme
informational disadvantage. We saw this in connection with the
Facebook offering when significant information came out 9 days
before their IPO, and broker-dealers reportedly saw their
institutional purchase base shrink as a result, and a bigger
piece of that pie was provided to retail investors. And what
Congress has done is essentially formalize that process by
allowing those institutional investors, the wealthy investors,
to receive information typically for months while the SEC
peruses a confidential registration statement, and then that is
put up on the SEC's site 15 days before the offering, and that
is the entire amount of time that retail investors have to
review it, which is pretty strikingly contrary to the
fundamental relationship between information and public
offerings in the Securities Act.
Senator Brown. Mr. Daniel, I want to ask you a question--
but my time has expired--about money market funds. I will
submit it, and I hope you will respond to it quickly.
Thank you.
Chairman Crapo. Thank you.
Senator Scott.
Senator Scott. Thank you, Mr. Chairman. Good morning to the
panel. Thank you all for taking your time and making the
investment to be here this morning.
In 1996, the American economy peaked with over 8,000
publicly traded company. As of today, that number is less than
4,300, about a 50 percent drop. In 2016, we saw just 112 public
offerings, the lowest number since the financial crisis.
Some have suggested there is no reason to be alarmed for
the demise of the IPO. These companies now tap private sources
of capital, and all is well that ends well. But that may not be
the case for those investors who are investing through their
401(k)s. Mr. and Mrs. 401(k) are the folks that I am thinking
about.
Think about the lost opportunities for everyday Americans
to create wealth if the next Boeing, Walmart, or Allstate do
not go public, or go public later in their life cycles than
they would have decades ago. The more expensive or burdensome
the Government makes it for a company to go public, the less we
will see folks take the risk. That has a negative impact on
individual investors, retirees, and those saving for a rainy
day.
Mr. Keating, how has the dramatic drop in companies going
public hurt Mr. and Mrs. 401(k)?
Mr. Keating. Well, I think you summarized it well in terms
of not having access to being able to invest in a whole host of
companies, especially earlier on in the process. And I think
when you look at--there are a whole host of things going on in
the economy that contribute to this, you know, a recession, a
poor recovery. We have grave concerns about the level of
entrepreneurship in this country and why it is off.
Senator Scott. Yes.
Mr. Keating. So these are all factors in the equation. But
I think also the regulatory costs, the signals, what it takes
to go public today is very different from not that long ago,
and I think those costs are real and significant. You know,
again, there are studies that will back that up, and I think
Economics 101 kind of backs it up.
Senator Scott. How will the HALOS Act and other bills we
are debating today reverse that trend?
Mr. Keating. Well, I think when you go down the list, these
are moves in a positive direction. In terms of--you know, the
problems with regulation are multiple. You know, these efforts
are trying to clarify regulations. They are trying to get more
resources toward innovation and investment rather than
unnecessary regulatory compliance, trying to streamline the
process, for example, in terms of IPOs, reduce unnecessary
costs, et cetera. So these are the types of move, while still
obviously protecting investors and consumers and so on, that
are needed to kind of bring some regulatory balance back into
the equation.
Senator Scott. Thank you. One last set of questions for
you, Mr. Keating. In tax reform, it included my signature
legislation, the Investing in Opportunity Act, the IIOA, that
has created the opportunity zones around the country that so
many folks were pretty excited about.
The good news is that this legislation was championed on
both sides of the aisle. So often we hear folks in Washington
and other countries talk about the fact that there is no
bipartisanship. I cannot say they are not always wrong.
However, the IIOA is truly a bipartisan effort where folks on
both sides of the aisle see the wisdom of bringing private
sector capital back into the distressed communities where more
than 50 million Americans live.
My question to you is: Can you expand on how the capital
gains tax deferral, which is the real motivating factor for
folks to take a second look at those opportunity zone areas,
how that deferral for investments made in opportunity zones
will jump-start capital formation where it is needed the most?
Mr. Keating. When you talk capital gains tax, you are
talking my language. And, also, opportunity zones are--you
know, I am an old disciple of Jack Kemp and Ronald Reagan, OK?
Senator Scott. Yes.
Mr. Keating. So I love the idea that the message here is
reduce these burdens, reduce these costs, and let the private
sector flourish. And when you are talking about capital gains,
what is a capital gains tax? It is a tax on the return on
entrepreneurship and investment. The more you tax it, the less
of it you get. Economics 101. So these types of efforts like
you are talking about with opportunity zones, other things that
we are advocating--we regret that the overall tax reform bill
did not reduce the capital gains tax rate. We are a big
advocate of that. So these types of measures I think are
crucial just to incentivize. I am economist. It is a bad
incentive, and you want incentives for entrepreneurship and
investment to flourish in these areas where it has not before.
Senator Scott. I just wish we had more time. Thank you, Mr.
Chairman.
Chairman Crapo. Thank you.
Senator Heitkamp.
Senator Heitkamp. Mr. Keating, just not to belabor the
point, there are two different perspectives on taxation of
capital gains.
Mr. Keating. Well, there are many perspectives.
Senator Heitkamp. Well, I think it is difficult for someone
like me to explain to a worker at Bobcat who puts on a shirt
every day and gets dirty that he pays more than people living
on trust funds. So I think it is important that we kind of talk
about who is that person who has made these investments and
what is their long-term contribution. I think we all want to
give contributions to people who are actually increasing the
productivity of this country. Unfortunately, in many cases
capital gains--the people who are wealthy enough to have
capital gains are the people who where the money makes the
money and not the productivity. You know, we can get into long
economic----
Mr. Keating. I would like to have a chat----
Senator Heitkamp. ----argument----
Mr. Keating. ----sit down in your office and have a good
chat.
Senator Heitkamp. I do not want to take up my time. I would
love to have that debate because I think that I do not disagree
with the conversation you just had with Senator Scott, that
there has got to be some way to incentivize investment and
entrepreneurship.
Mr. Keating. To get the productivity you are talking about.
Senator Heitkamp. I might argue that one of the reasons why
you see a decline is the increasing interest rates and burden
put on young entrepreneurs by the challenges that they have,
which includes student debt.
I want to know in your numbers, when you are looking at
investment, which is fascinating because I think it tells a
story that is not well understood in the American public, do we
have a differential--have you broken it out by rural
communities or rural counties versus urban counties?
Mr. Keating. I have not, but others have, and I can get you
that information.
Senator Heitkamp. That would be great.
Mr. Keating. The rural, that is where we are suffering in
terms of entrepreneurship and investment, without a doubt, and
certain inner-city communities. But those are the areas that
are being hit hardest that are still kind of, if you will,
stuck in the recession.
Senator Heitkamp. What I always tell people is--I do
something that a lot of people here do not do, which is
represent rural America, and I know Senator Rounds and I have
joined on a lot of this, but rural America is--if you want to
at rural poverty, if you want to look at stagnation in growth,
we can talk about why that is happening. But, obviously,
investment in rural America was a bit motivator for S. 2155. We
think that that may bring some investment back, but I think we
need to jump-start that investment. And so I am interested in
your perspectives, and maybe you can come in and just talk with
me. We will have a debate.
Mr. Keating. I would agree with that, and also things like
broadband in rural communities, these are all vital things that
we----
Senator Heitkamp. Right. We are going to debate a farm bill
that has rural economic development.
I want to turn to money market reforms in S. 1117. Mr.
Daniel, I was taken by your analysis of what the SEC rules have
cost State and local entities that live off investment income,
and, you know, obviously the SEC has disagreed. That has long
been the debate here. And I am wondering, when the SEC adopted
the floating NAV rule in 2014, their analysis suggested that
the impact on the market would be minimal. They just did not
see that that would have a big impact. And I think you are
arguing the market has moved since implementation of this rule
and left some people behind that they did not think would be
left behind, right?
Mr. Daniel. Senator Heitkamp, that is correct. At the city
of Albuquerque, like many of our medium- and small-size peers,
we provide a plethora of services. We provide airport services,
refuse, transit, cultural services, family and community
services, and a host of other things, and some of our peers
provide even more than that. We as finance officers consider
ourselves enablers of those types of services.
With capital being limited, it is vital for us to be able
to gain as much safe investment income and to be able to
finance through short-term debt offerings at as low a rate as
possible to help finance these services. What has happened is
that the decreased income from us having to shift into
Government funds for investments by 25 basis points or more and
the increased cost of us having to move to fixed-rate debt has
squeezed our ability to fund these types of services.
Senator Heitkamp. Are there other factors in this shift
when you analyze what that--when you look at it, obviously,
there is a concern that we have in this Committee or we would
not be hearing this bill, to analyze this. But have you seen
other factors that may have driven that shift like tax reform,
like----
Mr. Daniel. Senator Heitkamp, from my perspective the cause
is primarily from the floating NAV rule. The 2010 amendments to
Rule 2a-7, as stated previously, provided higher quality, lower
maturity, and the ability to stabilize money market funds. From
2008 until 2016, when these amendments went into effect, the
industry was very stable. The prime funds which we were
investing in, we consider a very safe vehicle for public funds
investment. And so with us not having access to those, it has
really squeezed our ability to provide public services and
infrastructure.
Senator Heitkamp. Obviously, we want to be good partners
with State and local government, want to better understand this
issue, and so thank you so much for your testimony, thank you
all for appearing on these bills.
And thank you, Mr. Chairman and Ranking Member, for holding
this hearing.
Senator Brown [presiding]. Senator Kennedy.
Senator Kennedy. Thank you, Mr. Chairman. I want to thank
Senator Rounds and Senator Toomey for letting me jump the line
here. I have got to go preside.
Professor Bullard, I listened to your testimony very
carefully and was very impressed. Let me ask you sort of a
30,000-foot question. Do you think most Americans who work in
the financial services industry cheat their customers?
Mr. Bullard. No, I do not think so.
Senator Kennedy. But some do?
Mr. Bullard. Absolutely.
Senator Kennedy. So our job is to try to draft legislation
to catch the cheaters and prohibit them from cheating while at
the same time not undermining the work that the honest people
do in financial services which is vital to our free enterprise
system. Is that about it?
Mr. Bullard. I agree.
Senator Kennedy. OK. Mr. Keating, let me ask you a quick
question about SBICs and rural investment companies. You know
what an SBIC is, obviously.
Mr. Keating. Yes.
Senator Kennedy. It provides capital to small businesses,
often in suburban and rural areas, regulated by SBA. We also
have an investment vehicle called ``rural business investment
companies,'' do we not?
Mr. Keating. Yes.
Senator Kennedy. Regulated by USDA.
Mr. Keating. I believe so, yes.
Senator Kennedy. Dodd-Frank Act regulated both SBICs and
RBICs. Is that right?
Mr. Keating. Yeah.
Senator Kennedy. In 2015, Senator Kirk and Senator Manchin,
with President Obama's support, passed a law by the name of--
well, I do not have it here now, but it is--here it is--no, it
is not. Its purpose was to give some relief to the SBIC
advisers, right?
Mr. Keating. Yes.
Senator Kennedy. But they did not include RBICs. Why was
that?
Mr. Keating. I do not know because it would seem like it
would be a natural coupling.
Senator Kennedy. Well, Senator Jones and I have a bill. It
is called the ``Rural Business Investment Company Advisers
Relief Act of 2018'', and basically it would say that we are
going to treat advisers to SBICs, which were given some relief
by President Obama in 2015, the same as the financial advisers
to these RBICs because both advisers are kind of small-time.
What do you think about that bill?
Mr. Keating. This is one of the bills that we support here.
The SBE Council has stated its support, and it makes perfect
sense in terms of providing basic relief from unnecessary costs
and burdens that these regulations should not apply to these
small folks.
Senator Kennedy. And I want to thank Senator Jones for all
his hard work on this bill. If our bill passes, it is not going
to do anything to preclude or prohibit the requirement of
registration by most advisers to private equity funds, is it?
Mr. Keating. As far as I know, no.
Senator Kennedy. OK. We are just carving a little bitty
small niche for advisers to these rural investment funds, and
we are treating them the same way that President Obama and
Senator Manchin and Senator Kirk and the entire U.S. Congress
treated the advisers to the SBICs in 2015. Is that right?
Mr. Keating. Correct.
Senator Kennedy. OK. Have you got any other thoughts about
this wonderful piece of legislation?
[Laughter.]
Mr. Keating. Well, I would echo that it is a wonderful
piece of legislation. It goes along with what our emphasis at
SBE Council is; let us make regulation rational across the
board, and let us not place excessive undue burdens on small
businesses, including rural investment advisers.
Senator Kennedy. And I agree with you, but it is also about
equal treatment, is it not?
Mr. Keating. Yeah, well, I mean, that is----
Senator Kennedy. If you and I are in similarly situated
circumstances, the law ought to treat us the same.
Mr. Keating. You are absolutely right, and that is one of
those unfortunate things when you get into regulation and
politics, that you and I might sit here and say, well, why was
the rural community left out here, and, you know, that is one
of those things that we economists would go back to public
choice theory and say, well, who was lobbying and who was doing
this and who was doing that, unfortunately. So I think equal
treatment across the board where it makes sense here is
perfectly logical.
Senator Kennedy. OK. I found the name of the bill. It is
called the ``SBIC Advisers Relief Act''. My staff had it right
here all the time.
Thank you, Mr. Chairman.
Senator Brown. Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman.
As a former mayor, one of my primary concerns on this
Committee has been ensuring access to capital for New Jersey's
towns and cities, particularly to ensure that there are liquid
capital markets to help finance infrastructure and economic
development projects all across the State. And when communities
in New Jersey thrive, the Nation thrives. New Jersey and other
States in the Northeast corridor contribute nearly $4 trillion,
or 20 percent of the entire Nation's GDP. Over the last several
years, I have heard from officials all across New Jersey with
concerns about their access to capital, funding that they
depend on to get the lowest-cost financing for public
infrastructure projects, affordable housing properties,
schools, hospitals.
Money market funds are important to municipal governments
for two primary reasons: one, they serve as a major source of
investment in municipal debt, helping to finance key projects;
and, second, local governments utilize money market funds
themselves as both an investment and cash management option
because of their safety and simplicity.
The SEC's new rules requiring certain money market funds to
change the way in which they report their net asset value has
led to both a decreased demand for municipal debt by certain
funds and in turn higher borrowing costs, as well as serving to
limit the utility of a key investment vehicle for State and
local governments. And in response to the concerns that I have
heard from New Jersey's Association of County Administrators,
the mayors, for example, of my State's two biggest cities,
Newark and Jersey City, among others, I cosponsored Senator
Toomey's legislation. Our legislation would both preserve money
market funds as a source of liquidity and capital to meet the
public infrastructure and investment needs of New Jersey's
communities, and it will preserve money market funds as an
important cash management tool for State and local officials.
So that is the focus in which I come to this particular
legislation with.
So let me ask, Mr. Daniel, can you walk us through how the
SEC's new rule has increased municipal borrowing costs and how
those increased costs affect local government public
infrastructure, housing, education, health projects, for
example?
Mr. Daniel. Senator Menendez, I would be happy to. The new
rule has shifted investment in money market funds to Government
funds and away from prime- and tax-exempt funds. This decreased
demand for tax-exempt floating rate debt has forced Governments
to either increase rates on these debt offerings, which still
may not attract demand due to the floating NAV, or try to
access higher-cost alternative financing. In either case, cost
to taxpayers and ratepayers increases because expenditures in
infrastructure, housing, education, and health projects may
suffer diminishment.
Senator Menendez. Let me ask you this: Do those increased
borrowing costs remain even when controlling for the current
interest rate environment?
Mr. Daniel. Senator Menendez, yes, increases in the Fed
funds rate and other money market rates necessarily rise
concurrently, although not in tandem. Nonetheless, capital will
still flow from floating NAV instruments, causing Government
borrowers like ourselves to raise our issuance yields and
borrowing costs or seek out other higher-cost financing.
Senator Menendez. For those municipal borrowers who can no
longer rely on money market funds as a stable source of
capital, where are they going to fund their projects?
Mr. Daniel. Senator Menendez, we will be forced either to
issue higher fixed-cost bonds, which creates an asset/liability
imbalance, or access bank capital. The problem with that is
that we are often crowded out of low-cost bank financing. So it
is vital that this floating NAV rule be reversed so that we can
invest our funds at higher rates and have access to the tax-
exempt floating rate debt market.
Senator Menendez. From a New Jersey perspective, according
to one estimate, we have lost $2.7 billion in financing from
certain money market funds. Financing infrastructure projects
in New Jersey is a top priority, and this is one of our
challenges.
Do you think that investors who have left the municipal
money market funds would come back to the funds if those funds
were able to again report a fixed net asset value?
Mr. Daniel. Senator Menendez, absolutely. Over $1.2
trillion float out of prime- and tax-exempt funds to Government
funds, beginning with the announcement of the 2014 amendments
to Rule 2a-7, even before it went into effect in October 2016.
And most of that money has not come back.
As an investment officer for a medium-size public entity, I
feel absolutely that investment will come back to prime funds
because we consider them a safe vehicle for investment and tax-
exempt funds because we would consider ourselves investors in
public infrastructure and public services.
Senator Menendez. All right. Thank you very much.
Senator Brown. Senator Toomey.
Senator Toomey. Thank you, Mr. Chairman--well, Mr. Ranking
Member. I am glad we are having this hearing today. This is an
important opportunity to continue the work this Committee has
been doing, and I want to specifically encourage support for
two bills that I have introduced with colleagues here. One is
the HALOS Act, which is S. 588, and the other is the Consumer
Financial Choice and Capital Markets Protection Act, which we
have been discussing.
Very briefly, on the HALOS Act, I would just stress this is
a bipartisan bill. Senators Murphy, Thune, Schatz, and Heitkamp
as well as myself are cosponsor of this bill. It is a narrow
fix related to the demo days and their treatment under the JOBS
Act. Demo days, as I think we all understand, these are events
that are sponsored often by universities or economic
development officials, often to which angel investors are
invited. Entrepreneurs make a broad pitch about an idea or a
company, and these demo days existed for decades prior to the
passage of the JOBS Act, and they were never considered general
solicitations. It was only after the JOBS Act that the SEC
decided to treat demo days as general solicitations. So this is
a very narrowly tailored bill. It makes it clear that demo days
should not be considered general solicitations. It would not
allow nonaccredited investors to invest in nonpublic offerings,
but what I think it would do is help entrepreneurs access
capital and help promising businesses to grow.
I want to spend most of my time on the Consumer Financial
Choice and Capital Markets Protection Act. This is another
bipartisan bill. As Senator Menendez pointed out, he and I have
introduced this legislation together with Senators Peters and
Rounds, and as we have discussed, it deals with the regulatory
treatment of money market funds.
We have heard once again what I think we all know to be
true: Money market funds have been a critical source of short-
term financing for businesses, for States, for municipalities.
It is attractive to issuers. But it is also attractive as a
place to manage surplus cash for municipalities and others.
You know, the 2008 financial crisis obviously put enormous
stress on our financial system. Hundreds of banks failed. Money
market funds experienced some stress, yet only one broke the
buck, and even then investors received 99 cents on every
dollar. And despite that, in 2010 the SEC implemented major new
regulations meant to enhance the safety and security of money
market funds. There were stringent liquidity requirements,
shorter maturity requirements, and then 2014 came along, and
with no evidence that the 2010 reforms were somehow
inadequate--there had been no problems in the interim--
nevertheless, there was yet another wave of new regulations
imposed on these instruments that had exhibited no problems
whatsoever--more stress testing, diversification requirements,
additional disclosures, and most problematic, as we have
discussed, one category of money market funds, the
institutional prime- and tax-exempt funds, were required for
the first time to have what we call a ``floating net asset
value'' to abandon the practice of over 40 years and that all
other money market funds continue, which is to have a stable
net asset value.
As we have discussed, exactly as some of us predicted, well
over $1 trillion promptly left the prime- and tax-exempt money
market funds. The funds largely shifted to Government and
agency funds. And the result of that, as Mr. Daniel has very
persuasively argued, is higher cost of funds for municipalities
and corporate borrowers, lower return on surplus cash that
municipalities invest, and no persuasive evidence at all that
anything has been accomplished by way of safety and soundness.
So what our bill does is it simply allows all money market
funds to elect to operate with a stable net asset value, as
most can today. It would not be required, but that option would
be available. And it waives the mandatory liquidity fee. This
is essentially a withholding on withdrawn money that went into
effect in 2014. All the other myriad and very extensive
regulations imposed in 2010 and in 2014 would remain in place.
They would still be very, very heavily regulated, but there
would be this important change that would allow these funds to
go back to the way things had been for 40 years.
Mr. Daniel, here is my question for you. We have discussed
various aspects of this. Could you just explain to us why
having a stable net asset value is so important and why that is
so much preferred by investors such as yourself and your
colleagues over the floating net asset value?
Mr. Daniel. Senator Toomey, our statutes and investment
policies as public investment officers prohibit us from
investing in floating NAV vehicles. They also prohibit us from
investing in a vehicle that would have a liquidity fee
associated with it. Therefore, we are being forced into these
Government funds as investments.
Would you repeat the last part of your question, please?
Senator Toomey. That was the main gist of it. I wanted to
understand why you find a stable NAV more appealing, and I
think your answer is you just do not have any choice in the
matter, right? You are restricted and required to invest in
something that does not have a liquidity fee and something that
has a stable net asset value.
Mr. Daniel. Senator Toomey, that is correct. And, of
course, we are more inclined to invest in prime funds rather
than Government funds because of the higher yield, and we
consider those prime funds to be very safe vehicles for
investment.
Senator Toomey. Thanks very much. I see my time has
expired, Mr. Chairman. I would just remind my colleagues we
have seen what has happened as a result of this misguided
policy. Over $1 trillion have left the nongovernment money
funds. Borrowing costs are higher. Returns on surplus cash are
lower. The time has come to pass this legislation.
Thanks, Mr. Chairman.
Chairman Crapo [presiding]. Thank you.
Senator Jones.
Senator Jones. Thank you, Mr. Chairman, and thank you to
the witnesses for your attendance here today.
I want to kind of go back to a bill that Senator Kennedy
talked about. Briefly, it is one that Senator Cotton and I have
introduced concerning the small business--you know, it is the
Small Business Audit Correction Act, and I think it is pretty
clear that everyone on both sides of the aisle in Congress
always take investor protection very seriously, and we should
never take it lightly. But I also recognize that sometimes
rules can kind of spread and have meanings that catch up small
businesses when they were not intended. I think our bill is a
perfect example of trying to give some relief to small
businesses, small firms which are privately held, noncustodial
broker-dealers who do not handle client funds, and that are in
good standing, and going to exempt those firms from the
rigorous PCOAB audits.
So, first, I would like to ask you, Mr. Keating, it
sometimes can seem like a small issue, but can you just give us
a sense of what regulatory costs like that can mean for a small
firm, especially, you know, a noncustodial type business?
Mr. Keating. Well, I think in general, you are right, it
can seem small, but when you look at this type of requirement
and you look at other regulations, this is one of the things
that we have to fight on a constant basis, because it is not
just the additional costs of this regulation, but it is on top
of everything else along the way.
So when you look at small firms, again, they do not have,
you know, the legal department down the hall to handle these
types of things. You are right, they often serve as a surprise
because that legal department is not down the hall. So there
are a whole host of things here. It is uncertainty, it is
costs, and ultimately it is what would you be doing with those
resources otherwise.
Senator Jones. Right, and it is important to note, again,
that these are noncustodial. They do not handle client money,
so they are not auditing any kind of money coming through like
that.
Mr. Keating. What is nice about all these bills that we are
talking about that we support today is they are commonsense
carveouts. That is why I think they are bipartisan, which is,
again, a wonderful thing. Somebody mentioned before we do not
see too much bipartisanship, but they are commonsense carveouts
that small businesses certainly would----
Senator Jones. All right. Mr. Bullard, I would like to
follow that up with you, though, and especially in light of
earlier comments to Ranking Member Brown about the need for
audits, and sometimes the problems that we see when we exempt
and carve out industries and companies from having those. I
recognize that. As a lawyer, I have seen that all too many
times.
I also know that the Accounting Institute, American
Institute of CPAs, has kind of consistently said that this
might not be needed for these firms, but I would like to get
your thoughts on this particular bill if you are familiar with
it and what you think about it.
Mr. Bullard. This is the exemption for broker without
custody?
Senator Jones. Yes.
Mr. Bullard. I think that there may be other reasons--there
are a lot of reasons why an entity might be subject to public
accountant oversight. But if they do not have custody, that
resolves the securities law issue. And I agree that unless
there is some other public policy concern, there is no reason
to require that they have a public accountant.
Senator Jones. All right. Great. Well, thank you for that,
and I appreciate Senator Cotton's work with me on that. And so
let us go back to the one that Senator Kennedy talked about a
little bit, Mr. Keating, you know, the bill on the RBIC
Advisers Relief Act. Can you just kind of comment a little bit
more broadly on the policy challenges for rural businesses
looking for their capital to grow?
Mr. Keating. Well, I cannot--yes and no. I mean, in terms
of rural businesses in general, when you are talking about
access to capital, which is what this is ultimately for, there
are just far fewer options. When you look at--you know, we
talked about banks briefly--the dropoff, dramatic, in the
number of community banks, that has hit rural America very,
very hard. And it is not just the dropoff in the number of
existing banks, but there are very few banks coming in; new
banks are not being developed.
So all of these things come into play, and I think the
rural community is just limited in terms of the realities of
rural America, so why would we want to, you know, treat this
particular issue differently in the rural community and leave
those additional costs and burdens when we have dealt with it
on other fronts?
Senator Jones. Right. That is great. Well, thank you both
for those answers. And, Mr. Chairman, I appreciate everyone
being here. Thank you.
Chairman Crapo. Senator Rounds.
Senator Rounds. Thank you, Mr. Chairman. First of all, let
me say thank you to you for holding this meeting today. I think
it is very important as we have a number of different ideas
being discussed, that we have a public discussion like this and
really vet it.
I think there is an agreement among at least two of you,
Mr. Keating and Mr. Daniel, as to the acceptability of the
Consumer Financial Choice and Capital Markets Protection Act
that Senator Toomey is sponsoring and I am a cosponsor of.
Mr. Bullard, in reading your testimony, you identified
first that when the original changes to this which was made
back in--right after the recession, you had indicated that you
thought that it was a mistake to have made the changes and the
further regulations which restricted or made it more difficult
for municipals to actually be able to access the money markets.
But then you went through an analysis of the concerns that you
had right now, and I think in all fairness, we have not really
heard about those. I think this is a move in the right
direction.
But you had some suggestions out there about concerns that
you felt were appropriate to lay out. Can you talk a little bit
about these limitations or restrictions that you fear the bank
regulators would put on that we should be aware of or that
might very well be areas that should be addressed as well in
other legislation? Then I am going to ask our other two members
here their thoughts about other items that should also be
addressed besides the bills that are here in front of us today,
other ideas that you have that you are wondering either why we
have not done it or that we should modify within the existing
bills. Mr. Bullard, would you like to just talk about that for
a minute.
Mr. Bullard. Sure. That is correct that I testified against
the SEC rules primarily because money market funds had
demonstrated an astonishing level of safety, especially having
had two break a dollar, one not even a retail fund, over about
40 years, at the same time thousands of banks failed. But I
think one of the concerns Vanguard and BlackRock have and one
reason they are probably opposing this is, of course, that
these rules were adopted in response to the Dodd-Frank Act,
which gave banking regulators, in my view, far too much
authority over what I would call risk-based markets. Banking
regulation and banks are designed with the socialization of
risk in mind, and when you put them in charge and the SEC
realizes that FSOC is controlled by banking regulators, they
will bend to banking regulators' will. So I cannot even fully
blame them for what happened. But it was, I think, inevitable
that there would be massive dislocation and expense. That has
already occurred. Since then I think that there have been
mitigating effects on the municipal business, but I think that
is probably a close call. But I am concerned about that
BlackRock-Vanguard concern, which is if you reintroduce
floating rate NAV funds, frankly Federated will roll out a lot
of funds. That will be a competitive disadvantage for the large
money market fund managers. They will have to go back into the
business, and then the next time a money market fund breaks,
the banking regulators will have a lot less power to save the
industry and, frankly, I would expect Congress to go back and
end up maybe taking the same steps that dislocates the industry
again.
I think the interesting point of view is we have been
through this once. We do not want to go through it again. Just
leave us alone.
But, you know, the free market guy in me says there is more
capital that is out there looking for purchasers in a
demonstrated, successful way to create essentially a cash
vehicle for retail investors, and that should be an available
option.
Another concern is really a specific SEC concern. One
reason the Reserve Fund failed is the SEC was not monitoring
the funds that had the greatest risk of failing. It also had
this no-action process whereby a fund that was about to break a
dollar, which had happened hundreds of times previously, was to
call up an office in the SEC, and a guy picks up the phone and
says, ``OK, you are fine,'' and because that process was
fumbled by the staff, in my opinion, and because it was such an
ad hoc system in the first place, that contributed to the
Reserve Fund failure. It was a primary element of their defense
when the founders were sued, and I think that has to be
corrected.
And then, finally, I think that it is a mistake--as much as
you can tell, I am probably not the biggest friend of banking
regulators--to overly hamstring their Depression era authority
to emergency situations, use their lending authority for
nonbanks. I think that this bill would further hamstring them,
and I think that is a mistake.
Senator Rounds. Thank you. And I am out of time, Mr.
Chairman. I would just ask for the record if I could ask each
of our other two gentlemen to respond. You have heard the
discussion here on the part of Mr. Bullard, but I most
certainly think it would be fair to ask you to respond to that
and to point out your differing points of view to the argument
that he has made.
Thank you, Mr. Chairman.
Chairman Crapo. Thank you. And as I will explain to the
witnesses at the end of the hearing, there will be follow-on
questions, and we ask you to respond to those, and you are
welcome at that time to respond to this one and others.
Senator Warner.
Senator Warner. Thank you, Mr. Chairman. And thank you for
holding this hearing.
I want to talk a little bit about the HALOS Act that I know
that a number of my colleagues have cosponsored. I am taken by
some of Mr. Bullard's comments. As a former venture capitalist,
I have thought of a lot of events that right now that have been
prohibited that I did not feel at all fell into kind of the
normal solicitation category. I even think about the fact that
I think the effect of some of the regulations now--sitting on
the Intelligence Committee, I look at the enormous threats we
face in the cyberdomain and we are technically even holding
hack-a-thons now where we try to explore different, better
techniques on providing cybersolutions that could fall astray.
And so what I am wondering--and this is directed to you,
Mr. Bullard, and you, Mr. Keating, if you would like--is that
there have been a couple of amendments added in the House,
because I am not looking at something here to try to give an
unfair advantage to one set of investors over retail investors.
But there were two amendments added, one that would have
required that attendees of demo days receive an SEC-prescribed
risk disclosure that clarified that simply attending a demo day
would not put them into that--would not mean that they passed
the preexisting relationship test, that would still stand in
terms of their ability to look at any of the companies or ideas
that were put up; the other would have prohibited those who
sponsor these so-called demo days from compensating companies
and investors that were participating and making sure that none
of the companies that were participating--making sure that all
the companies that were participating were operating companies,
that none of them were bankruptcy. Knowing your reluctance in
this area, did that move it in the right direction? Are there
other things that could be done? And I would like to hear from
you as well on this, Mr. Keating.
Mr. Bullard. As I noted earlier, if we are going to move in
that direction--and I think the JOBS Act already put us well
down that path; the HALOS Act frankly simply extends that
further--then we need to rethink what is the substitute for
that central regulation of offerings that was really the basis
of the Securities Act. And the obvious substitute would be
something like you describe, which is if you are going to go
out publicly and talk about raising capital, you need to make
basic information available. And the first step would be what
you describe, which is: Is this really an operating company?
Does it have some kind of financial statement? And to make
that, speaking partly as a researcher, publicly available in
what I would hope would be a very efficient, cheap filing
system so that we could get that data, and I----
Senator Warner. So it is not giving the attendee some
advantage over other potential investors.
Mr. Bullard. That is also part of the reason. The big
informational disadvantage is, I think, more in the public
market where you have got months-long road shows going on with
institutional investors and mutual funds, and then 2 weeks
before an offering, the retail investors get their first look
at an IPO registration statement, and the SEC continues to let
them make material amendments. I think they would let them do
it up to the day before the offering. And we saw what happened
with the Facebook fiasco, and I think that, you know, we need
to think about how we are going to resolve that issue. But,
again, that is assuming that we have moved to a different
model, which I think we have done, but we continued to impose
an irrational way of describing the model, which is clarifying
general solicitation as opposed to recognizing that general
solicitation is what we have allowed, and to think about what
the substitute would be.
Senator Warner. Mr. Keating.
Mr. Keating. I would have to take a closer look at those
amendments, but in general, I would not have a problem with
them. What we are talking about here is going to angel
investors. I mean, that is in the title of the legislation. So
I think when we are talking about understanding who we are
going to and what the purpose of these demos are, I think it
makes---I think the legislation makes perfect sense.
Senator Warner. And as somebody who has been very active in
trying to set up angel investor networks, particularly in rural
and more disadvantaged communities, I think there is an
enormous value there. I do think we need to consider some of
Mr. Bullard's concerns. I would point you to both of those
amendments in the House that were included, and I would also
make the point that I think no one would want to restrict, for
example, the ability to have hack-a-thons that are advancing
that may have as a secondary value some opportunity into
investment.
I have got 20 seconds left, and I just want to make this on
a pitch basis. You know, Senator Heitkamp raised about capital
gains. I would argue that some of the greatest abuses in our
Tax Code are people converting ordinary income into capital
gains on a short-term basis and that one of the greatest
challenges that modern American capitalism faces right now is
this enormous focus on short-term over long-term value
creation. And I would hope, Mr. Chairman, we could come back at
some point and hold a hearing that would examine a differential
capital gains rate for longer-term holds that would look at
different countries, their long-term stock exchanges, even look
at additional voting power based upon holding shares, different
reporting standards. I think this quest for short-term
quarterly based profits will ultimately destroy the kind of
great American business paradigm that was created post- World
War II. As a matter of fact, I would argue that we would not be
able to create the same kind of economic growth engine in
today's market, and the examples of tech companies that still
are able to do that are because there is a different class of
stock for the founders that allow them not to have the
pressures put on that are put on other corporate enterprises.
Thank you for letting me go a little extra. Thank you, Mr.
Chairman.
Chairman Crapo. Thank you, Senator Warner. And I am aware
of your work on the short-termism issues. I think it is a
critical issue that we do need to pay more attention to.
Senator Cotton.
Senator Cotton. Thank you, Mr. Chairman. Thank you,
gentlemen, for your appearance today.
I would like to say a few words about the topic Senator
Jones addressed, the bill that we have introduced, the Small
Business Audit Correction Act. The bill would correct one of
the unintended consequences of Dodd-Frank, specifically the
massive increase in audit costs for small noncustodial broker-
dealers. This is a big problem.
In hindsight, I think it is clear that Congress overshot
the mark trying to prevent another Bernie Madoff-style scandal
when it extended the Public Company Accounting Oversight Board
audit requirements to these small noncustodial broker-dealers.
As a result, public company audit rules for gigantic firms now
apply to firms that do not hold customer assets and could not
even pull off a Madoff scam if they wanted to in the first
place.
Now, this requirement might seem harmless or obscure, but,
in fact, it has increased costs for small broker-dealers a lot.
One Arkansas broker told me that his audit costs have gone from
$6,000 to $30,000, and he has only five employees, and his
offices are much smaller than the room in which we now sit.
That is not an isolated incident to Arkansas either. I
would venture that every Member of the Banking Committee has
constituents just like mine. And when you think about it, this
is a classic square peg into a round hole problem. As one
Board-registered audit firm wrote in a letter, ``The Board
audit requirement makes sense for public companies like Apple
and broker-dealers that carry customer funds or securities like
Morgan Stanley because the investing public and markets are
potentially at much greater risk from these companies.
Conversely, the Board requirements make no sense for privately
held, small noncustodial firms that do not carry customer funds
or securities, companies like mine. Currently a three-person
small business is held to the same standards are Merrill Lynch.
This is not right, fair, or reasonable.''
As he wrote, ``In other words, it is the big guys, the
custodial firms that should be receiving the Public Company
Accounting Board audit, not these little guys.''
Both the SEC and the Board have said that they have no data
to suggest that this requirement has created a healthier or
safer investment environment. In fact, even Board-registered
audit firms whom you would think would be in favor of this
requirement are speaking out against it. But it should not be a
surprise they are losing business as small brokers die out.
That is why my legislation with Senator Jones would make a
simple change. It would exempt the small privately held,
noncustodial firms in good standing from this Board requirement
and allow them to file their financial statements according to
GAAS standards they used just a few years ago.
It is true regulators like the SEC and FINRA could relieve
some of this compliance burden themselves, but they could also
reverse that decision later on. I think our small broker-
dealers deserve the regulatory certainty that will only come
from a change in the law.
I think this is simply common sense, and I know it has
widespread support. We have heard from many organizations who
have sent letters of support, and as far as I know, there are
no organized groups opposed.
So, to sum up, I believe these unnecessary regulations are
crushing our small broker-dealers and holding back economic
growth, particularly in States like Arkansas. If we pass our
bill, we can help lighten the load a little bit and allow more
Americans to invest their money with small local broker-dealers
if that is their choice.
I address the question first to you, Mr. Keating. Do you
feel that these small noncustodial firms, perhaps more
importantly their customers, would benefit from returning to
this kind of rightsized audit standard?
Mr. Keating. Yeah, I would agree with you 100 percent. I
think you laid it out very well, and I think this legislation
makes sense, and I think any kind of scaling to fit the size of
the business has to be thought about when we are moving ahead
with legislation and when folks like the SEC are moving ahead
with what they are--you know, in terms of the regulatory
burdens they put on things. And that speaks of just a larger
regulatory issue of can we--you know, we need some
institutional reforms in addition to fixes like this so we do
not have to come back and keep doing this, you know, cost-
benefit analysis. There is a bill in the House, 78, where the
SEC would be required to do cost-benefit analysis and look at
the impact on small businesses and market liquidity and so on.
So I think this makes perfect sense, and I think we need
tot make the next step and say how do we stop the overshooting
that you talk about.
Senator Cotton. And, Professor Bullard, do you share that
opinion?
Mr. Bullard. I share the opinion on the bill, yes.
Senator Cotton. Thank you. My time has nearly expired. I do
hope this Committee can mark up our legislation and then move
it to the floor for a vote, as well as some of the other
meritorious bills we have passed. As our witnesses have made
clear today, too, I think this is another good example of
working together in a bipartisan fashion. I know we do not have
unanimous support for this legislation, but that is pretty rare
around here. But we do have healthy support from both Democrats
and Republicans, and I want to thank the Chairman and the
Ranking Member for trying to move ahead with additional and
important legislation in this Congress.
Chairman Crapo. Thank you.
Senator Schatz.
Senator Schatz. Thank you, Mr. Chairman. Thank you for
having this bipartisan hearing. I want to thank you for the way
you conduct all of your hearings. You are a model for the
regular order, and we really appreciate it. I will just add
gently that we look forward to our hearing on credit bureaus
and credit reporting agencies. Senator Kennedy and a number of
Senators on both sides of this dais are anxious to dig into
this issue, so we have several more months of legislative work
to do, including during August. That would be an appropriate
time to consider those issues.
Mr. Keating, you know that startups have created around 20
percent of total job creation every year, and these demo days
are really a critical aspect of it. There is some confusion in
terms of how to maintain compliance, especially as you get
further and further from centers where venture capital exists.
Can you talk about the role of demo days for startups in
terms of surviving their earliest moments?
Mr. Keating. Well, yes, in the sense that specifically I
can talk about the importance of angel investment. You know,
when you look at the stages of a startup, you are going to your
own savings first. Then you go to family and friends, and the
natural next step are angel investors. Who are angel investors?
Well, there are networks of them, of course, that have
developed especially recently, which are wonderful, but they
are usually, you know, professional people that are looking for
investment opportunities. Perhaps they have started up their
own businesses and are looking to help others as an investor-
mentor scenario. This is not unusual in the angel community.
And when you look at the numbers, they are a vital source, you
know, because there are a whole host of companies that cannot
go to banks. I taught MBA students entrepreneurship and
innovation for 10 years, and you can talk about what you take
to the bank. But you know what? More often than not, you have
to be a little more established to get that bank loan. So angel
investors are critical there, and any kind of ability to reach
out and simply communicate to them--and, again, with all the
safeguards in place, and I think Senator Toomey laid it out
pretty well, that, you know, it is not like we are reinventing
something new here with this legislation; we are going back to
the way it was before--makes perfect sense.
Senator Schatz. Can you just talk about the--it seems to me
that part of the problem is this operational difficulty. If you
are trying to set up a demo day or if you are trying to
participate in a demo day, the SEC says that they will evaluate
each one on a case-by-case basis, and that is difficult if you
are a three-person startup because you have got to lawyer up
and interact with the Securities and Exchange Commission when
you are still sort of scaling your tech, figuring out your
pitch, and all the rest of it.
So can you talk about the importance of going away from a
case-by-case analysis and to a sort of statutory framework that
allows everybody to comply and to have confidence in the
system, but not to disadvantage especially rural or sort of
nontech hubs?
Mr. Keating. Well, maybe the others can put some meat on
the bone, but you put it well in terms of when you are
developing your business, the idea that you are going to go to
a regulatory agency and it is going to be a case-by-case basis,
you know, really? So the idea that you have a statutory set way
of doing this obviously is preferable.
Senator Schatz. Professor Bullard.
Mr. Bullard. I would like to correct one thing. This is not
a traditional practice by any means whatsoever. You are not
permitted, except under the already approved general
solicitation private offering rule, to go do these offers of
securities, to do a pitch, giving terms and price and number.
And you are not allowed to publicly advertise it. I mean, let
us be honest. That is a huge change in the law. But the JOBS
Act went a long way down that road.
Also, I hear references to HALOS, but there is nothing in
the bill that prevents anyone from attending, and based on my
experience at the University of Mississippi, they are attended
by anyone who wants to. So there is no restriction to HALOS.
This is not the HALOS Act. This is being able to have, you
know, public demonstrations regarding both the operations of
the business and its securities offerings.
Senator Schatz. Well, I will offer a thought, and then I
will end with Mr. Daniel's comments. You know, it is not just
the ability to track investment, but if you are--say the island
of Maui, right, the majority of the population in the State of
Hawaii is in Honolulu, but Maui has a thriving tech community.
But part of the reason that they would want to do something
like a demo day is not just to officially solicit investment,
but also to find partnerships, to find new business
opportunities that sort of are outside of the Securities and
Exchange Commission purview, and also just to communicate to
the broader public that there are some pretty exciting things
happening on Maui. So part of it is just give a permission
structure to economic development organizations, universities,
you know, dual-use companies to kind of get into this without
thinking to themselves, ``I am going to get sideways with the
SEC before I even have a going concern.''
Mr. Daniel.
Mr. Daniel. Senator Schatz, one of our critical missions at
the city of Albuquerque is providing economic development for
our community and our State without having to have taxpayers
and ratepayers shoulder that additional economic development.
That is why it is so key that we reverse the 2014 Rule 2a-7
reforms and return to a stable net asset value investment
opportunity for prime- and tax-exempt money market funds.
Senator Schatz. Thank you.
Chairman Crapo. Thank you.
Senator Tillis.
Senator Tillis. Thank you, Mr. Chairman. Thank you for
holding this hearing. And I think if you listen to the comments
of colleagues on both sides of the aisle, you have done a good
job of putting together for consideration measures that
generally have support from both Republicans and Democrats.
I became a partner at Pricewaterhouse in 1996, and in 1996
we saw explosive growth because of Y2K. The world was going to
end. You needed to prepare your systems and processes to deal
with Y2K.
And then came Enron and Sarbanes-Oxley, and I saw explosive
growth again. Because of the additional audit requirements, the
Big Four firms that I was with at the time, all the other
accountancies, just exploded. On the one hand, that sounds good
if you are a partner. But on the other hand, you know that is
an expense of using other service areas within Pricewaterhouse
who really want to invest in projects to grow improved
productivity. So you are moving--if you are in the health care
or sciences field, you go from science to compliance, moving
money away from building the future value of your company, and
to just making sure you do not get penalties.
The banking reform act that the Chair did such a great job
of getting through this Committee and getting to the
President's desk I think provided much-needed relief for the
lower base of what I call the ``banking ecosystem,'' the
community banks, the smaller regional banks.
I think what we are trying to talk about today are what I
would consider to be modest proposals to take regulatory
burdens off of some of the newer companies, the smaller
entities. That is why I have sponsored the Encouraging Public
Offerings Act and the Fostering Innovation Act that are being
discussed today, having discussed today. And, Mr. Chair,
without objection I would like to submit letters of support on
the Fostering Innovation Act from organizations representing
virtually everybody on this Committee.
Chairman Crapo. Without objection.
Senator Tillis. And we have bipartisan support for the
bill.
This is, I think, a fairly straightforward bill which
provides a very narrowly tailored exemption for SOX 404(b) for
emerging growth companies that are now in their 6- to 10-year
phase.
Mr. Keating, I do not know if you have had an opportunity
to take a look at the bill, but do you have any concerns or
comments you would like to make with respect to that bill?
Mr. Keating. Just simply that I think there is a certain--
you know, when you are talking about the limited aspect of
this, it does not surprise--limited aspect but limited market
that we are talking about here, it makes perfect sense. So I
think the exemption makes sense. I think, again, you are
talking about--what did you use, compliance rather than
science? I am going to steal that if that is OK. I am sure it
has been around.
Senator Tillis. I stole it from my staff.
Mr. Keating. But the idea that, you know, we want these
resources for innovation and growth. We do not want them for
unnecessary----
Senator Tillis. Well, you see it in the biotech industry,
and it is one that is growing nationwide. In North Carolina, we
clearly have a critical mass there. It does not make sense to
me. And I think that the way we have drafted the bill that it
is tailored in a way that we are just simply removing a
regulatory burden, but we have clear insights in what is going
on with the companies, and hopefully we are going to get
support from that. I do appreciate Members on both sides of the
aisle.
On the Encouraging Public Offerings, that is actually two
pieces. One is just codifying some of the administrative
changes the SEC made last year, and then providing some other
options for trying to--now I am going to the ecosystem. We do
not have a very healthy flow of public offerings in the United
States, and it is really counter to what we are seeing in most
other, what we would consider to peer or near-peer economies.
Do you believe that there is something beyond just the
regulatory hurdles that are doing that? Or are their economic
underpinnings that would make some countries doing relatively
better with IPOs than what we are seeing in the United States?
Mr. Daniel.
Mr. Daniel. Senator Tillis, I am not prepared to comment on
that particular issue, but on behalf of GFOA, we will certainly
get back to you with our response.
Senator Tillis. That is OK. I just want to give everybody a
chance to talk at least once.
[Laughter.]
Senator Tillis. Mr. Bullard.
Mr. Bullard. I guess I would take a different view that I
articulated earlier, which is not only has there been steady
and enormous growth in the amount of capital in our public
markets, the proceeds raised in IPOs have zigzagged essentially
the same way since the mid-1990s, before which gross proceeds
were very low. And I also note that if you look at the growth
of capital among U.S.-listed companies, we have grown
substantially more and been far more resilient since the crisis
than the best comparison, which would be European markets.
Senator Tillis. So you think that it is structurally--the
current state is structurally sound?
Mr. Bullard. I do. I think we have vibrant markets that are
still the envy of the world.
Senator Tillis. I wonder why--or how does that square--and
this is my final comment, but it may be Congress needs to be
better educated. But if I am not mistaken, this bill got passed
out of the House 60-0 in Committee and 419-0 in the House. So
maybe we need to dig into that and understand why that looks
like there is fairly broad--nothing gets passed out with a 0 on
the other end of the vote. So it would be very interesting to
maybe dig down on that, and we could possibly submit some
questions for the record to get your insights on that.
Thank you, Mr. Chair.
Chairman Crapo. Thank you, Senator Tillis.
That concludes the questioning here today, and the hearing
will come to a conclusion. I want to again thank our witnesses
for bringing us your expertise and being willing to share it
with us. As the discussion here showed today, there is a lot of
intense interest in these issues.
For Senators who wish to submit questions for the record,
those questions are due on Tuesday, July 3, and I encourage the
witnesses, if you receive questions, to please respond as
promptly as you can.
Again, I thank you all very much for being here. This
hearing is adjourned.
[Whereupon, at 11:34 a.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF CHAIRMAN MIKE CRAPO
Today's hearing will focus on several legislative proposals that
will encourage capital formation and reduce burdens for smaller
businesses and communities.
My goal is to work with Ranking Member Brown and other Senators on
this Committee to identify and move legislative proposals that achieve
these aims.
Many of the bills we will discuss in today's hearing have been
considered in the House of Representatives earlier this Congress.
Of those that the House has considered to date, all have passed the
House Financial Services Committee with bipartisan support and some
have passed the full House, including one with a vote of 419 to 0.
Many of my colleagues on this Committee are also interested in
these issues and have introduced Senate companions to many of these
bills as well as taking the lead in introducing bipartisan bills in the
Senate.
Senators Schatz, Toomey, Heitkamp, and Tillis, among others, have
cosponsored a bill that would make it easier for start-up companies to
tap the expertise and capital of angel investor groups.
Senators Toomey, Rounds, and Menendez, among others, introduced a
bill that would provide more financing options for State and local
governments seeking to raise money.
Senator Tillis has introduced a bipartisan bill that exempts
emerging growth companies from certain auditor attestation
requirements.
Senators Van Hollen and Tillis have cosponsored a bill that would
encourage more public offerings by allowing all companies to ``test the
waters'' prior to fling an IPO.
A bill introduced by Senators Kennedy and Jones would make it
easier for investment advisers to focus on rural business investment
companies.
Finally, Senators Cotton and Jones recently introduced a bill that
will cut audit costs for noncustodial brokers.
These bills will improve companies' access to our capital markets
and their ability to invest in the United States, in turn growing and
creating jobs.
I look forward to hearing from our witnesses on these legislative
proposals.
______
PREPARED STATEMENT OF RAYMOND J. KEATING
Chief Economist, Small Business and Entrepreneurship Council
June 26, 2018
Chairman Crapo and Members of the Committee, thank you for hosting
this important hearing today on the issue of access to capital. The
Small Business and Entrepreneurship Council (SBE Council) is pleased to
submit this testimony.
My name is Raymond Keating and I serve as chief economist for the
Small Business and Entrepreneurship Council (SBE Council), a nonprofit,
nonpartisan advocacy, research, and education organization dedicated to
protecting small business and promoting entrepreneurship. For nearly 25
years, SBE Council has worked on a range of private sector and public
policy initiatives to strengthen the ecosystem for healthy startup
activity and small business growth.
Small Business and Access to Financial Capital
Throughout SBE Council's history, access to capital has been a core
issue. Of course, financial capital--whether equity or debt--stands out
as a foundational matter for entrepreneurs who are starting up,
operating or expanding businesses. However, for many entrepreneurs,
gaining access to capital has long been a challenge.
During the financial crisis, the Great Recession and an
underperforming recovery, capital became increasingly hard to access
from institutional banks and various capital market players. And while
matters have improved in recent years, many entrepreneurs continue to
struggle with accessing the capital they need to compete and grow.
Small Business Loans. Consider the trends in bank small business
loans (less than $1 million) over the past decade or so, as displayed
in Charts 1 and 2.
Chart 1 shows that the value of small business loans outstanding
hit a high of $711.5 billion in 2008, and subsequently fell for 5
straight years. Growth resumed in 2014, and has continued since. But
recovery to the 2008 high is yet to occur, never mind factoring in any
additional growth. In fact, the 2017 level of $623.1 billion came in at
less than the 2006 level. So, small business loan value has experienced
no growth for more than a decade, and consider that these numbers are
nominal, so inflation is not even factored in, which would make the
picture bleaker.
The small business share of commercial and industrial loan value
outstanding registered, for example, 33 percent in 1995, 35 percent in
2004, 30 percent in 2007, and in early 2010, it registered 31 percent.
However, the subsequent decline has been rather stark, falling to 20
percent by mid-2015 and remaining at that level since. Looking at
nonfarm nonresidential loans, the small business share came in at 52
percent in 1995, and had declined to 39 percent in 2007. And at the end
of 2017, the small business share further declined to 20 percent.
As for the number of small business loans, these rose steadily up
to 2008 (hitting 27.1 million in 2008 compared to 6.3 million in 1995),
and subsequently declined into early 2011 (coming in at 21.3 million)
and then working to recover, climbing back to 26.4 million in mid-2017.
However, there was a falloff in the second half of 2017, retreating to
just below 26 million. Again, the level at the end of 2017 remained
below the 2008 level.
Angel Investment. On the equity side, angel investment stands out
as a critical source of funding for start-ups and early-stage
businesses. But here, the numbers have been disappointing in recent
years.
According to numbers from the Center for Venture Research at the
University of New Hampshire (as seen in Chart 3), moving past a big
drop in angel investment in 2002, coinciding with the aftermath of the
2001 recession (as well as the post- ``tech bubble''), growth resumed
from 2003 through 2007, with angel investments increasing from $15.7
billion in 2002 to $26 billion in 2007. Subsequently, though, there was
a large decline in 2008 and 2009 during the recession. Postrecession
growth was underwhelming, growing from $17.6 billion in 2009 to $24.8
billion in 2013. Since then, however, angel investment has stagnated--
in fact, actually declining some, coming in at $23.9 billion in 2017.
As for the number of deals (again, according to the Center for
Venture Research at the University of New Hampshire), they grew from
36,000 in 2002 to 57,120 in 2007. After a brief falloff in 2008, growth
then resumed, eventually rising to 73,400 in 2014. So, while total
angel investment dollars declined and then recovered some from 2007 to
2014, the number of deals grew robustly, pointing to angel investors
being active in more deals at lower investment levels. Unfortunately,
over the last 2 years--during 2016 and 2017--angel investment dollars
declined slightly, and over the last 3 years--2015, 2016, and 2017--the
number of deals dropped notably, from 73,400 in 2014 to 61,560 in 2017.
The 2017 deal level of 61,560 came in at about the same level as in
2010 (61,900 deals).
Venture Capital. While not an option for most start-ups or very
young firms, venture capital investment is an important avenue for
innovative firms to raise capital for growth and expansion. The trend
on the venture capital front after the Great Recession tends to show
more robust growth, even with a decline from the second quarter of 2015
to the fourth quarter of 2016. Since then venture capital investment
has bounced back nicely, and over the longer run, growth has been solid
since the end of the recession--moving from $4.8 billion in the second
quarter of 2009 to $21.2 billion in the first quarter of 2018.
Online Lending and Crowdfunding. Finally, the growth of online
lending and crowdfunding for entrepreneurs must be highlighted. SBE
Council President and CEO Karen Kerrigan noted the following in her
recent testimony (June 21, 2018) before the U.S. House of
Representative's Committee on Financial Services:
There's been improvement in the online lending space as some of
the Nation's largest ``FinTech'' small business lending
platforms are quietly helping many entrepreneurs with their
capital needs. A May 31, 2018, study, ``The Economic Benefits
of Online Lending to Small Businesses and the U.S. Economy''
reported that just five of the largest lending platforms funded
nearly $10 billion in online loans from 2015 to 2017,
generating $37.7 billion in gross output, creating 358,911 jobs
and $12.6 billion in wages in U.S. communities. The study found
that 24 percent of these borrowers are microbusinesses with
less than $100,000 in annual sales and two-thirds have less
than $500,000 in annual sales. So online lenders are definitely
filling an important niche, and small business borrowers are
becoming better educated about this type of financing.
The Jumpstart Our Businesses Startup Act (JOBS Act) included
solid reforms that have helped boost Initial Public Offerings
(IPOs) and deliver many startups the funding they need through
regulated crowdfunding (Title III crowdfunding). It took the
Securities and Exchange Commission (SEC) four long years to
develop and implement the rules around regulated crowdfunding,
which is why it has taken longer than expected to get traction
through this promising funding approach. Regulation
crowdfunding is quietly funding companies and doing what its
supporters, like us, hoped it would. To date, there are nearly
1,000 active campaigns (about 600 of those are fully funded),
where $132 million has been committed from 133,883 backers
(investors). The average raise is $247,456. A wide array of
sectors are represented, with application software companies
leading the pack followed by beverages (alcoholic), computer
hardware, entertainment, and the auto industry.
To sum up, long after the financial crisis hit in late 2008 and the
Great Recession came to an official end in mid-2009, the financial
capital story for the small business community has been mixed. While
having recovered some, small business loans are still well off from
where they should be. Angel investment has largely stagnated.
Meanwhile, venture capital has shown solid growth, while online lending
and crowdfunding have opened new doors for many entrepreneurs seeking
funding.
Regulatory Burdens
Regarding the trends noted above, assorted factors have come into
play, including the underperforming economy over a period of a decade
and a decline in entrepreneurial activity. Challenges among small
community banks also come into play given the important role these
institutions play in lending to small businesses. And community banking
woes also tie back to the state of the economy, but to Government
regulation as well, which, again, always falls heaviest on small
businesses, including small banks.
In a May 2016 analysis, I noted the following:
Consider key points from two recent reports on the state of
community banks. A study published in February 2015 by the
Harvard Kennedy School's Mossavar-Rahmani Center for Business
and Government, titled The State and Fate of Community Banking
and authored by Marshall Lux and Robert Greene, looked at the
role of community banking in the marketplace, as well as the
impact of Dodd-Frank financial regulation law on these small
banks.
The authors note that ``community banks provide 51 percent of
small business loans,'' and quote William Grant, then chairman
of the Community Bankers Council of the American Bankers
Association, pointing out, ``The cost of regulatory compliance
as a share of operating expenses is two-and-a-half times
greater for small banks than for large banks.''
As for the Dodd-Frank impact, the authors note, ``Community
banks (defined as banks with less than $10 billion in assets)
withstood the financial crisis of 2008--with sizeable but not
major losses in market share--shedding 6 percent of their share
of U.S. banking assets between the second quarter of 2006 and
mid-2010 . . . But since the second quarter of 2010, around the
time of the Dodd-Frank Wall Street Reform and Consumer
Protection Act's passage, we found community banks' share of
assets has shrunk drastically--over 12 percent.'' They go on to
observe: ``Interestingly, community banks' vitality has been
challenged more in the years after Dodd-Frank than in the years
during the crisis.''
And at another point, they state: ``[C]ommunity bank
consolidation trends have almost doubled since the passage of
Dodd-Frank, relative to the Q2 2006 and Q2 2010 time frame,
which includes the crisis period.'' The authors added: ``As the
GAO reports, regulators, industry participants, and Fed studies
all find that consolidation is likely driven by regulatory
economies of scale--larger banks are better suited to handle
heightened regulatory burdens than are smaller banks, causing
the average costs of community banks to be higher.''
As noted in a March 2015 report from the Federal Reserve Bank
of Richmond, the sizeable decline in the number of community
banks from 2007 to 2013--shrinking by 41 percent--was not only
about community bank failures, but about ``an unprecedented
collapse in new bank entry.''
It is noted: ``This collapse in new bank entry has no precedent
during the past 50 years, and it could have significant
economic repercussions. In particular, the decline in new bank
entry disproportionately decreases the number of community
banks because most new banks start small. Since small banks
have a comparative advantage in lending to small businesses,
their declining number could affect the allocation of credit to
different sectors in the economy.''
Potential issues include the state of the economy and Federal
Reserve policymaking: ``An important factor in bank
profitability is the net interest margin, or the spread between
deposit rates and lending rates. The Fed's policy of keeping
the Federal funds rate near zero since 2008 has pushed lending
rates down, which has kept the net interest margin relatively
small. Adams and Gramlich [of the Federal Reserve Board of
Governors] estimate that this low interest rate environment
coupled with weak demand for banking services accounts for as
much as 80 percent of the decline in bank entry in recent
years. However, a literal interpretation of their model would
predict that even if the net interest margin and economic
conditions recovered to 2006 levels, there still would be
almost no new bank entry, suggesting that other factors are
also important for explaining the recent decline.''
The authors write: ``Banking scholars also have found that new
entries are more likely when there are fewer regulatory
restrictions. After the financial crisis, the number of new
banking regulations increased with the passage of legislation
such as the Dodd-Frank Act. Such regulations may be
particularly burdensome for small banks that are just getting
started.''
The Richmond Fed report concludes: ``If de novos [i.e., newly
formed banks] are absent due to the low interest rate
environment and weak economic recovery, then entry should
increase as the economy improves and the Fed raises interest
rates. If regulatory costs are the driving force behind low
entry rates, then future entry will depend on how those costs
change over time.''
Writing in the American Banker in October 2017, Camden R. Fine,
then-president and CEO of the Independent Community Bankers of America,
echoed some of these points. He explained:
Community banks are highly capitalized, so they're better
prepared than their larger competitors for economic crises. And
as local institutions, they reinvest in their communities and
channel loans to their depositors' neighborhoods . . .
promoting localized growth that radiates out to the broader
economy. Community banks have been instrumental in helping the
Nation recover from the financial crisis and economic downturn,
yet their numbers continue to dwindle, declining by roughly
1,500 since 2009. As the only physical banking presence in
nearly one in five of the Nation's 3,000 counties, this
lifeline to many American families is at risk.
The mere trickle of de novo banks entering the market
exacerbates the problem. The number of bank applications has
plummeted from more than 100 per year before the crisis to just
a handful since 2009 . . . posing tangible risks to financial
services access and economic growth in communities overlooked
by larger institutions.
Regulatory burden plays no small part in the growing
consolidation. A new survey from the Federal Reserve and
Conference of State Bank Supervisors found that community bank
compliance costs have increased by nearly $1 billion in the
past 2 years to roughly $5.4 billion, or 24 percent of
community bank net income. Of the respondents who said they
considered an acquisition offer in the past year, virtually all
(96.7 percent) said regulatory costs were a very important,
important or moderately important reason. Further, the Federal
Reserve Bank of Richmond has found that regulatory costs play a
key role in the recent dearth of applications to form new
community banks.
Efforts To Expand Access to Financial Capital
Reform and relief efforts to clear away obstacles and reduce costs
for lenders, investors, entrepreneurs and small businesses on the
financial capital front are most welcome. For example, SBE Council
supports the following bills being discussed today:
S. 588 Helping Angels Lead Our Startups Act or the HALOS Act--This
bill clarifies that startups and entrepreneurs can showcase their ideas
and businesses at events designed to connect them with potential
investors. It clarifies the rules about ``demo days'' and similar
events hosted by universities, Government, accelerators and other
entities that help entrepreneurs network, make connections, and
identify funding for their enterprises. As noted in the joint statement
released by the Senate bill's sponsors: ``In order for startups to
secure capital and grow their businesses, entrepreneurs often attend
`demo days.' or conferences to showcase their business model in front
of investors like `angel investors' and venture capitalists. It is
estimated that angel investors provide 90 percent of outside equity to
help grow these young businesses. Unfortunately, recent regulations now
require excessive hurdles for angel investors, deterring them from
participating in demo days. The HALOS Act would preserve important
investor vetting processes without forcing startups to jump through
unnecessary hoops to get the investments they need to grow and create
new jobs.'' U.S. Senator Chris Murphy (D-CT) stated, ``I'm
reintroducing the HALOS Act because the most important thing we can do
to help local entrepreneurs is knock down road blocks and make it
easier for angel investors to put capital behind them.''
S. 2126 Fostering Innovation Act of 2017--Sensibly extends an
exemption allowed for in the JOBS Act to growing companies whose
business models require more regulatory flexibility, and thus will
enable greater success. Extends the JOBS Act's SOX 404(b) exemption for
an additional 5 years for former emerging growth companies (EGCs) that
maintain a public float below $700 million and average annual revenues
below $50 million. As Senator Gary Peters (D-MI) has observed, ``This
bipartisan, commonsense legislation would cut red tape for emerging
biotechnology companies so they can focus their resources on the
critical research and development that will provide innovative
treatments and save lives.''
S. 2347 Encouraging Public Offerings Act of 2018--As U.S. Chris Van
Hollen (D-MD) has pointed out, ``Many emerging businesses find that the
process of going public is too complex and expensive.'' Given that
reality, this bill would streamline the process by allowing an issuer
communicate with potential investors to ``test the waters'' in terms of
gauging interest in a contemplated securities offering, either before
or after the filing of a registration statement, and allowing an issuer
to submit a confidential draft registration statement to the Securities
and Exchange Commission for review prior to public filing or within one
year after the initial public offering or registration. U.S. Senator
Thom Tillis (R-NC) correctly observed, ``IPOs give companies crucial
access to our capital markets, and yield the potential to create
thousands of jobs. When private companies consider going public, we
should be doing everything possible to make this process easy and to
encourage it, without jeopardizing investor protections.''
S. 3004 Small Business Audit Correction Act of 2018--As is clear
from the data and a wide array of studies, regulatory burdens fall
heaviest and with greatest consequence on small businesses. This
legislation would redress the Dodd-Frank requirement that all
investment brokers and dealers, no matter their size, must hire a
Public Company Accounting Oversight Board (PCAOB)-registered audit firm
to conduct audits that use complex guidelines designed for larger,
public companies. As noted in the statement from Senators Tom Cotton
(R-AR) and Doug Jones (D-AL), ``This requirement is devastating for
small investment firms . . . These firms are closing at an alarming
rate, in part due to skyrocketing audit costs required by a rule that
is illogical for firms that don't hold customer assets. The Small
Business Audit Correction Act would exempt privately held, small
noncustodial brokers and dealers in good standing from the requirement
to hire a Public Company Accounting Oversight Board (PCAOB)-registered
audit firm to meet their annual SEA Rule 17a-5 reporting obligation and
would instead reinstate the previous regulatory audit requirements.''
S. 2765 RBIC Advisers Relief Act of 2018--This bill would reduce
unnecessary costs by amending the Investment Advisers Act of 1940 to
exempt investment advisers who solely advise certain rural business
investment companies.
In addition to these pieces of legislation, several other measures
would expand access to capital for entrepreneurs and small businesses.
In SBE Council's ``2018 Policy Agenda for Entrepreneurs and Small
Businesses--Issue Two: Access to Capital'', assorted additional pro-
small-business measures were highlighted, including:
H.R. 477 Small Business Mergers, Acquisitions, Sales and Brokerage
Simplification Act of 2017--H.R. 477 reduces regulatory costs
associated with the sale and purchase of small, privately held
companies. Current law forces broker dealers to register with the
Security and Exchange Commission (SEC), the Financial Industry
Regulatory Authority (FINRA), and one or more States at substantial
costs. This results in higher transaction costs for many entrepreneurs
who want or need to sell their business.
H.R. 2201 Micro Offering Safe Harbor Act--H.R. 2201 would exempt
from registration requirements with the Securities and Exchange
Commission (SEC) offerings made only to the entrepreneur's friends and
family, to less than 35 purchasers, and when $500,000 or less is
raised. The offering would be exempt from State registration and
qualification rules, thus reducing costs and complexity. H.R. 2201
would appropriately scale SEC rules and regulatory compliance for our
Nation's small businesses, which in turn will provide another practical
option for entrepreneurs to raise the capital they need to start or
grow their firms.
H.R. 78 SEC Regulatory Accountability Act--H.R. 78 requires the SEC
to assess the costs and benefits of regulatory actions and the impacts
on small businesses, investor choice, and market liquidity. The bill
also requires an exploration of regulatory alternatives, including the
option of not regulating, to maximize the net benefits of SEC
rulemakings. Having SEC periodically review its regulations is
critically important as cumulative and outdated regulation put U.S.
capital markets at a competitive disadvantage.
Other Bipartisan Proposals on the Move--There is movement in the
U.S. House on several bipartisan bills that are also strongly supported
by SBE Council. For example, the ``Main Street Growth Act'', H.R. 5877,
would allow for the creation of venture exchanges, which would provide
a tailored trading platform for small issuers and emerging growth
companies (EGCs). The ``Modernizing Disclosures for Investors Act'',
H.R. 5970, requires the SEC to provide a report to Congress with a
cost-benefit analysis of EGCs' use of SEC Form 10-Q and recommendations
for decreasing costs, increasing transparency, and increasing
efficiency of quarterly financial reporting by emerging growth
companies. Both of these bills advanced out of the Financial Services
Committee unanimously. Another bill also recently reported out of the
committee, the ``Helping Startups Continue to Grow Act'', H.R. 6130,
would provide for a 5-year extension of certain Security Exchange Act
exemptions and reduced disclosure requirements for companies designated
as EGCs and will continue to remain as such but for the 5-year
restriction on EGCs. Under Title I of the JOBS Act, the IPO ``on-ramp''
for EGCs provides exemptions and provisions that make sense given the
size and development of these small firms. The scaling of rules and
exemptions from certain disclosure requirements for EGCs have reduced
compliance and regulatory burdens, which have benefited these promising
small firms. Each of these bills work to modernize and streamline
rules, or make important fixes, which will make the capital markets
work better for small businesses and improve U.S. capital formation.
Mobilizing More Capital to Startups and Small Businesses--As noted
in my testimony, regulated (Title III) crowdfunding is beginning to
gain traction in the marketplace. Refining some of rules would help
many entrepreneurs tap into this promising funding option. Some of the
reforms supported by SBE Council include raising the amount that can be
raised (which is currently $1 million), allowing issuers to ``test the
waters,'' allowing for special (or single) purpose vehicles, providing
simplified rules for advertising, legal clarity for platforms, and
removing the caps for accredited investors, among other changes.
Congress is updating thresholds across many areas of the law, and
the same needs to be done with Section 1224 Small Business Stock, which
allows investors to deduct losses taken on investments in C Corp
startups. Qualified Small Business tax (loss) treatment under Section
1244 of the I.R.S. code (QSB 1244) was passed as part of the Small
Business Investment Company Act of 1958, the spirit of which was to
mobilize more capital into innovate startups. The current thresholds
were last updated in 1978, which are: the first $1,000,000 of outside,
individual taxpayer(s) (angel investors) capital receives 1244
treatment; $100,000 per year of 1244 losses deductible against ordinary
income (for joint tax returns); $50,000 per year of 1244 losses
deductible against ordinary income (for single filers). The Consumer
Price Index has risen 363 percent since 1978. If the above thresholds
were inflation adjusted, the levels would be: $3,630,000 of outside
investors' capital would qualify for de-risking under 1244; $363,000
per year of 1244 losses could be deductible for joint filers: $181,500
per year for single filers. These changes would be consistent with the
laudable changes recently made to the QSB 1202 laws, which now provide
for the first $10M of profits that qualify under 1202 to be excluded
from taxes.
This change can help up-and-coming entrepreneurial ecosystems
outside Silicon Valley as well as Opportunity Zones where many new
investors and family offices are interested in impact investing.
Capital Gains Tax Relief. Finally, it must be noted that capital
gains tax relief is needed to boost access to capital for the
entrepreneurial sector of our economy, and further enhance economic,
income, and employment growth. One key measure would be reducing the
capital gains tax rate--such as from the current rate on individuals of
23.8 percent to 10 percent or 15 percent--while also indexing gains for
inflation so that the real capital gains tax rate does not climb higher
than the stated nominal rate. In the end, the capital gains tax raises
diminishes the returns on and disincentivizes investment and
entrepreneurship. Reduce the capital gains tax substantially, and that
would be good news for the risk taking that drives the economy forward.
Thank you for your time and attention. I look forward to your
questions and further discussion.
______
PREPARED STATEMENT OF MERCER E. BULLARD
Butler Snow Lecturer and Professor of Law, University of Mississippi
School of Law
June 26, 2018
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
PREPARED STATEMENT OF CHRISTOPHER H. DANIEL
Chief Investment Officer, City of Albuquerque, New Mexico, on behalf of
the Government Finance Officers Association
June 26, 2018
Chairman Crapo, Ranking Member Brown, and distinguished Members of
the Committee on Banking, Housing, and Urban Affairs, thank you for
holding today's hearing on legislative proposals to increase access to
capital. My name is Chris Daniel and I serve as the Chief Investment
Officer for the City of Albuquerque, New Mexico. My remarks here today
are in my capacity as a representative of the membership of the
Government Finance Officers Association (GFOA). GFOA represents nearly
20,000 public finance officers from State and local governments,
schools, and special districts throughout the United States.
GFOA is dedicated to the professional management of governmental
financial resources by advancing fiscal strategies, policies and
practices for the public benefit, including issues related to issuing
tax exempt bonds and investing public funds. We appreciate this
Committee's continued support for efforts to strengthen the municipal
bond market, especially the recent enactment of legislation designating
municipal securities as high-quality liquid assets. Such actions help
States, local governments and other governmental entities maintain
access to low-cost capital, which is vital to infrastructure investment
across the United States and contributes to a healthy and vibrant
economy. On behalf of the GFOA and its members, I appreciate the
opportunity to provide comments at this hearing in support of S. 1117,
the Consumer Financial Choice and Capital Markets Protection Act of
2017.
This morning I will describe how money market funds have been
utilized effectively to both manage liquidity for public sector
investments and provide a reliable source of working capital to fund
public services and finance infrastructure investment and economic
development. I will also describe the impact of the U.S. Security and
Exchange Commission's (SEC) change of net-asset-value (NAV) accounting
methodology for money market mutual funds (MMMF) from stable to
floating.
State and local governments access the capital markets and issue
short term debt for a variety of reasons. This important legislation
would allow State and local governments to continue this access and
investor appetite for short term debt issuance without increasing costs
for taxpayers or creating risks to the financial system For Governments
like the City of Albuquerque, variable-rate debt has been a very low-
cost method of financing as compared to issuing fixed-rate bonds. GFOA
has published best practice guidance on the use of variable rate debt
by Government issuers to ensure that it is used appropriately. Also,
variable rate debt issued by State and local governments has
historically been a reliable low risk investment type for money market
fund sponsors. Money market funds themselves are key purchasers of
municipal securities--historically, they have been the largest
purchasers of short-term tax exempt debt. Therefore, the impact of SEC
Rule 2a-7 of the Investment Company Act of 1940, as amended in 2010 and
2014, on Governments is real and it affects not only large governmental
entities, but also small communities throughout the country.
Additionally, money market funds are a widely used cash management
and investment tool for State and local governments. According to
Federal Reserve data, State and local governments hold over $190
billion of assets in money market funds. \1\
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\1\ See https://www.federalreserve.gov/releases/z1/20180607/
z1.pdf, p. 84.
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While we have supported and continue to support initiatives that
both strengthen money market funds and ensure that investors are
investing in high-quality securities, we applaud Senators Toomey,
Manchin, Rounds, and Menendez for introducing legislation which focuses
on addressing the unintended consequences of the SEC's 2014 Amendments
to Rule 2a-7 that require institutional, nongovernment MMFs to price
their shares at a floating net asset value (NAV), by allowing those
funds to return to a fixed NAV.
The original objectives of the floating NAV rule were to protect
investors in money market funds by preventing runs that hamper access
to short-term capital, shield taxpayers from future financial bailouts,
and promote general market stability. Those objectives were effectively
addressed in the 2010 Amendments to Rule 2a-7. GFOA supported those
amendments which dramatically increased the credit quality of the
assets held in MMFs, required money market funds to have a minimum
percentage of their assets in highly liquid securities so that those
assets can be readily converted to cash to pay redeeming shareholders,
and increased transparency by requiring funds to regularly calculate
their portfolios' per-share values at market prices.
Despite the success of the 2010 reforms, the SEC adopted additional
amendments to Rule 2a-7 in July 2014. Among other things, those
amendments require institutional prime- and tax-exempt funds to use a
floating NAV. The SEC's reasoning for the 2014 Amendments was that a
floating NAV would provide investors with a more frequent and accurate
assessment of the value of a fund's assets. Under previous rules,
institutional prime- and tax-exempt MMFs were allowed to round their
share price to $1.00, so long as the actual value of a share does not
fall below $0.9950 (``known as breaking the buck''). The SEC's change
from fixed to floating was predicated on the belief that investor
awareness of the actual value of the fund's assets will make investors
less likely to redeem shares in times of economic distress.
Throughout the rulemaking process, GFOA and public finance officers
throughout the country submitted analysis showing that a floating NAV
would do little to deter heavy redemptions during a financial crisis
but would, instead, impose substantial costs on State and local
governments. That is exactly what has come to fruition.
The 2014 Amendments have dramatically shrunk an important market
for municipal debt. Between January 2016 and April 2018, tax exempt
MMFs assets under management fell by nearly 50 percent, from $254
billion to $135 billion, \2\ as MMF investors, including Government
investors, preferred or were required to hold stable-NAV Government
MMF's comprised of Treasury and/or U.S. Agency securities. The lack of
investor appetite for floating-NAV tax-exempt MMMF's resulted in
municipalities issuing variable rate demand bonds seeing their
borrowing costs nearly double the Federal Reserve's rate increases over
the same period. Many State and local governments determined that
issuing variable rate debt to MMFs was excessively costly, and opted to
issue higher cost fixed-rate bonds. These increased costs are
shouldered by taxpayers and ratepayers.
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\2\ https://www.sec.gov/divisions/investment/mmf-statistics/mmf-
statistics-2018-04.pdf, p. 4.
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In addition to the impact that the 2014 Amendments had on
Governments finding investors for their short-term debt issuances,
there are also implications for the investments that State and local
governments use to protect public funds. Many Governments have specific
State or local statutes and policies that require them to invest in
financial products with a stable NAV. The policy reason for this is to
ensure that public funds are appropriately safeguarded.
It is important to emphasize that MMFs with a stable NAV,
particular prime MMFs, are required to meet the highest liquidity and
credit quality standards, which is why they are a commonly used vehicle
by State and local governments for managing operating cash. This
important legislation would lift an unnecessary obstacle that has
steered State and local entities into very low yielding U.S. Government
backed funds or other alternatives from what was already one of the
safest sources for earning market returns on the management of cash,
short of FDIC-insured bank accounts.
By allowing all MMFs--prime, tax-exempt and Government funds
accessible to both retail and institutional investors--to offer a
stable NAV, S. 1117 would allow State and local governments to once
again utilize suitable investments as defined by State and local
elected officials, rather than by the SEC. The disruptions to the
short-term capital markets caused by the SEC's floating-NAV rule are
real and irrevocable short of restoring the stable NAV. The legislation
fixes that problem, and does so without undermining the other important
reforms that have made MMFs resilient to the kind of market disruptions
that occurred in 2008. GFOA is working with a coalition of stakeholders
to advance S. 1117 and we have submitted our most recent letter of
support for the record. Thank you again for considering this important
legislation. We look forward to working with you and supporting your
efforts to help State and local governments on this and other
regulatory and financial matters of mutual interest.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN
FROM RAYMOND J. KEATING
Q.1. In response to questions on the Helping Angels Lead Our
Startups (HALOS) Act, S. 588, you stated that, ``[w]hat we are
talking about here is going to angel investors. I mean, that is
in the title of the legislation. So I think when we are talking
about understanding who we are going to and what the purpose of
these demos are, I think it makes--I think the legislation
makes perfect sense.''
Please explain how the limitation you described, ``[w]hat
we are talking about here is going to angel investors'', is
required under the bill. In addition, please explain if you
believe there is any stated requirement that the event sponsors
outlined in section 3(a)(2)(A) of the bill must verify any
information with respect to an attendee at an event that would
be covered by the bill.
A.1. This legislation would revise Regulation D, as noted in
the CRS summary of S. 588, as pertaining ``to events with
specified kinds of sponsors, including `angel investor groups'
unconnected to broker-dealers or investment advisers,'' in
cases where, in part, ``the sponsor does not provide investment
recommendation or advice to attendees, engage in investment
negotiations with attendees, charge certain fees, or receive
certain compensation.'' In the end, it is critical to keep in
mind that these events, often referred to as ``demo days,'' are
geared toward the ``accredited investors'' who can purchase
securities under the Section 506 exemption. However, at the
same time, these events allow entrepreneurs and startups to
interact with accredited investors, such as angel investors,
while not soliciting investors to purchase an equity stake.
Given these straightforward cases and limitations, this
legislation lifts unwarranted burdens and costs placed on
entrepreneurs and startups regarding ``demo days.''
Q.2. The Small Business Audit Correction Act, S. 3004, would
allow certain brokers or dealers defined under the bill to use
auditors that are exempt from Public Company Accounting
Oversight Board registration and supervision.
How many brokers or dealers do you believe would be covered
by the definition in the bill?
Does that definition in the bill capture brokers or dealers
in one or more of the following categories: active high-
frequency trading or principal trading firms, sophisticated
market-maker firms, private placement brokers, dealers in the
to-be-announced (TBA) for mortgage-backed securities market,
and alternative trading system routing brokers, in addition to
retail customer facing brokers or dealers?
A.2. As noted in my testimony, ``This legislation would redress
the Dodd-Frank requirement that all investment brokers and
dealers, no matter their size, must hire a Public Company
Accounting Oversight Board (PCAOB)-registered audit firm to
conduct audits that use complex guidelines designed for larger,
public companies.'' S. 3004 would provide relief to small
investment firms overburdened by this requirement. As for the
questions about coverage and definition, the Financial Services
Institute in its letter of support for S. 3004 noted the
following points:
``Currently, the Dodd-Frank Act requires all investment
brokers and dealers, irrespective of size, to hire a
PCAOB-registered audit firm to conduct audits using
significantly more complex guidelines designed for
larger, public companies. We believe this legislation
will provide much-needed regulatory relief to small
broker-dealers by exempting them from the most onerous
audit requirements.''
``The broker-dealer community in the financial services
industry consists of large companies, midsized firms,
and small businesses. As of November 2017, the small
business community consisted of 3,425 firms all
employing 150 registered reps or fewer. Ten years ago,
there were approximately 1,000 more of these small
businesses in our industry than there are today, but
the crush of regulatory burdens, including the PCAOB-
registered audit firm requirement, has led to their
demise. The remaining small firms are feeling this
impact especially hard as fees rise due to the smaller
pool of audit firms. The impact is felt throughout the
country as these Main Street businesses struggle to
remain viable.''
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SASSE
FROM RAYMOND J. KEATING
Q.1. As policymakers how should we strike the right balance
between encouraging firms to go public and improving the
private capital markets?
Are the private capital markets currently high-functioning?
If not, where are the biggest potential areas for improvement?
I'm concerned about the increasingly uneven geographic
distribution of growth. As the Economic Innovation Group has
found, economic growth is largely clustered in the most
prosperous areas, instead of evenly distributed across areas
like the Great Plains and the Midwest. Would increasing access
to equity and crowdfunded debt improve the geographic
distribution of new firms?
When do new and smaller firms tend to rely upon access to
equity or crowdfunded debt instead of a traditional bank loan?
For example, some have suggested that technology-based firms
rely more upon equity while main street companies like
restaurants more rely upon bank loans. What are the biggest
hurdles new and smaller firms have--regulatorily or otherwise--
in accessing equity and crowdfunded debt?
Is there currently sufficient clarity about the conditions
under which an offering by a small business issuer would
qualify as a ``transactions by an issuer not involving any
public offering'' under Section 4(a)(2) of the Securities Act?
Are small businesses able to acquire such clarity without
paying a meaningful amount in legal fees?
Representative Emmer's bill, H.R. 2201, the Micro-Offering
Safe Harbor Act would ``exempt certain micro-offerings from:
(1) State regulation of securities offerings, and (2) Federal
prohibitions related to interstate solicitation.'' Such
offerings could be worth up to $500,000, have 35 participants,
and involve and instance where the ``purchaser has a
substantive preexisting relationship with the issuer.'' How
would you evaluate this legislation? If you have concerns with
this legislation, how would you ideally address them?
How viable is conducting an offering under the SEC's
Regulation Crowdfunding, particularly for new and smaller
businesses? What about for businesses that are not located in
the top five largest cities? What about for smaller offering
sizes? If smaller offering sizes tend to be less viable, how
large must an offering be to be viable?
Would there be merit to increasing the offering limit for
Regulation Crowdfunding issuers, from $1 million? Why or why
not? If so, what should the limit be? For example, the 2017 SEC
Government-Business Forum on Small Business Capital Formation
recommended raising the limit to $5 million.
A.1. In the following, I hope to at least provide a few
thoughts of value on your various questions.
First, regarding how should ``strike the right balance
between encouraging firms to go public and improving the
private capital markets,'' in the end, it's not an either/or.
Nor should it be that policymakers ``encourage'' firms to go
public. Instead, policymaking should be focused on establishing
the best possible policy climates for public and private
capital markets to flourish, and thereby allowing entrepreneurs
and investors to make decisions about, for example, staying
private or going public, based on economic, business, industry
and market assessment, rather than according to costs imposed
by Government.
Second, I think it is fair to say that the U.S. has among
the most high-functioning private capital markets across the
global economy. Impediments largely come from outdated or
intrusive governmental policies, including unnecessary and
costly regulations, such as via various aspects of Sarbanes-
Oxley and Dodd-Frank, and areas of high and/or multiple layers
of taxation. On July 17, the U.S. House passed the JOBS and
Investor Confidence Act (JOBS Act 3.0), which is a solid
package of reforms to modernize some securities laws, and
improve capital access and capital formation, particularly for
entrepreneurs and small businesses. The biggest potential areas
of improvement at this point are areas where there is a
bipartisan consensus to make changes, and those reforms and
solutions are represented within JOBS Act 3.0. Hopefully, the
Senate will also act, and then we can build on JOBS Act 3.0
improvements from there.
Third, the geographic challenges in terms of growth are
quite troubling. A variety of factors can come into play,
including shifts in views on entrepreneurship; State and local
government costs, impediments and obstacles to risk taking
(please see SBE Council's Small Business Policy Index and Small
Business Tax Index, which break out dozens of measures and
rankings by State); access to markets; as well as access to
capital issues, including the decline in small community
banking, as noted in my testimony. I would very much agree that
increasing access to crowdfunded equity and debt would improve
the geographic distribution of new firms, though understanding,
again, that other factors also are in play. These other factors
include access to broadband and migration patterns. SBE Council
is working on many fronts--including education and boosting
entrepreneurship among the general population, as new business
formation remains weak--to improve opportunities and appeal
within rural areas that have been ``left behind'' by the
recovery.
Fourth, I think, in general, it is a fair assessment that
technology firms tend to rely on equity financing more so than
do certain Main Street businesses like restaurants, and that
largely would be due to the fact that equity investors
generally have a better chance to make a notable return in
tech, justifying the risk involved, as opposed to restaurants
and similar business with traditionally tighter margins and
bank loans (or debt-based crowdfunding) tending to make a
better fit. As for the development of crowdfunding equity and
debt markets, again, these are clear plusses for firms seeking
either equity or debt financing. In fact, a review of the firms
that have used Title III equity crowdfunding to date shows that
firms of all types are using Regulation Crowdfunding, and doing
so successfully.
Because it took the SEC 4 years to write the rules around
Title III crowdfunding, this approach to raising capital is
still fairly new. However, early adopters across industries
have been successful in raising funds. For example, according
to Crowdfund Capital Advisors, 715 firms have successfully
raised a combined $137,565,606 from 133,006 investors. The
average amount raised is $238,534. That might not sound like
much compared to the millions of dollars that early stage
companies often raise, but for the small businesses that need
this capital to grow, it is very important indeed. The top
industries that have successfully tapped into regulated
crowdfunding include: applications software (132 firms),
beverages (81 firms), entertainment (70 firms), personal
services (67), consumer products (60), computer hardware (50),
retail (50), restaurants (49 firms), autos (37), baking (31),
and advertising (28). There are more regulatory complexities
involved with equity vs. debt-based crowdfunding. As noted
below, there are various reforms that will help more
entrepreneurs and startups leverage crowdfunding if these costs
are lowered, which would improve the appeal of equity
crowdfunding as significant time and resources by the issuer is
put into a campaign and they cannot access those funds if the
target amount or goal is not reached. One of the biggest
hurdles at this point is education--that is educating both
small businesses and investors about this opportunity. In this
regard, SBE Council has been at the forefront of small business
education. For example, we recently teamed up with SCORE to
host a webinar about how to raise capital via regulated
crowdfunding and more than 2,000 individuals registered for the
event. So there is great interest, across industries and in
every corner of the U.S., and SBE Council believes that we are
in the very early stages of what will become a mainstream
method for raising capital, including in rural areas where new
Opportunity Zones will hopefully play a big role in mobilizing
capital to these areas and crowdfunding can be used as an
efficient conduit for doing so.
SBE Council supports H.R. 2201, the Micro Offering Safe
Harbor Act: ``H.R. 2201 would exempt from registration
requirements with the Securities and Exchange Commission (SEC)
offerings made only to the entrepreneur's friends and family,
to less than 35 purchasers, and when $500,000 or less is
raised. The offering would be exempt from State registration
and qualification rules, thus reducing costs and complexity.
H.R. 2201 would appropriately scale SEC rules and regulatory
compliance for our Nation's small businesses, which in turn
will provide another practical option for entrepreneurs to
raise the capital they need to start or grow their firms.'' At
this point we do not have any major suggestions regarding H.R.
2201, except perhaps to strengthen transparency via simple
reporting and compliance.
Sixth, and finally, again as detailed in my written
testimony: ``[R]egulated (Title III) crowdfunding is beginning
to gain traction in the marketplace. Refining some of rules
would help many entrepreneurs tap into this promising funding
option. Some of the reforms supported by SBE Council include
raising the amount that can be raised (which is currently $1
million), allowing issuers to `test the waters,' allowing for
special (or single) purpose vehicles, providing simplified
rules for advertising, legal clarity for platforms, and
removing the caps for accredited investors, among other
changes.'' SBE Council fully supports lifting the amount of
capital that can be raised. The current limit, $1.07 million in
a 12-month period, is restricting the use of regulated
crowdfunding (Title III) although there has been the successful
use of parallel offerings via Title III and Title II
crowdfunding. SBE Council is currently working with all the
major crowdfunding platforms on this very issue and we feel
that the limit should be raised to $20 million. To date, there
has been no fraud associated with regulated crowdfunding and
the $20 million limit would fill a big void in the marketplace
for small businesses and promising firms that require larger
amounts of financing to scale or for expansion projects.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR COTTON
FROM RAYMOND J. KEATING
Q.1. Regarding S. 3004, one possible objection is that, in the
5 years since noncustodial broker-dealers have been required to
use a PCAOB-registered auditor, the PCAOB has consistently
found those audits to have high levels of ``deficiencies.'' The
deficiencies are with the expensive PCAOB auditors, not with
the broker-dealers. Some feel the deficiencies are an argument
in favor of S. 3004, since it illustrates the ``square peg,
round hole'' problem of applying PCAOB audit requirements
rather than the AICPA's GAAS standards that these brokers used
to use. So currently these small, privately held noncustodial
brokers are being forced to choose an auditor from the PCAOB's
list, firms that charge much higher prices, and the end product
often has deficiencies that are (perhaps) due to the type of
auditing standards being applied. The audits of the
noncustodial brokers may have even higher rates of
deficiencies, and these broker-dealers tend to be much smaller
than custodial brokers, and thus (perhaps) even less suited to
the PCAOB requirements.
Are the deficiencies in these PCAOB audits evidence in
favor of keeping the law as it is, or in favor of passing S.
3004? What of the fact that audits of noncustodial brokers are
even higher than for custodial firms?
Attached is a letter from one of those approximately 480
PCAOB-registered firms, a firm that in theory should benefit
from the status quo, but it illustrates the issue from the
auditor's perspective. The link below talks about the PCAOB's
2017 report.
A.1. While circumstances and results certainly can be unique to
each case, the costs and general results related to PCAOB
audits of small, privately held noncustodial brokers indicate
that the law and standards do not properly fit these entities.
As noted in the April 2017 Wall Street Journal article you
referenced: ``The Public Company Accounting Oversight Board
found deficiencies in 83 percent of the broker-dealer audits it
inspected in 2016, up from 77 percent in 2015, the board said
in its annual report on its broker-dealer audit-inspection
program. As has been the case in the past, nearly all of the
audit firms conducting the audits, 97 percent, had deficiencies
in one or more of their audits, the PCAOB said. The findings
don't mean that the broker-dealers themselves have any
operational problems, just that the PCAOB believes that most of
the audits that assessed them were flawed or inadequate.''
Again, as stated in my testimony, SBE Council supports S. 3004
and its focus on properly aligning regulation with the
realities of small businesses.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR ROUNDS
FROM RAYMOND J. KEATING
Q.1. During the Banking Committee's hearing on Legislative
Proposals to Increase Access to Capital, Professor Mercer
Bullard from the University of Mississippi School of Law
expressed the following view on S. 1117, the Consumer Financial
Choice and Capital Markets Protection Act of 2017. Could each
of you please comment on Mr. Bullard's views?
Mr. Bullard. Sure. That is correct that I testified
against the SEC rules primarily because money market
funds had demonstrated an astonishing level of safety,
especially having had two break a dollar, one not even
a retail fund, over about 40 years, at the same time
thousands of banks failed. But I think one of the
concerns Vanguard and BlackRock have and one reason
they are probably opposing this is, of course, that
these rules were adopted in response to the Dodd-Frank
Act, which gave banking regulators, in my view, far too
much authority over what I would call risk-based
markets. Banking regulation and banks are designed with
the socialization of risk in mind, and when you put
them in charge and the SEC realizes that FSOC is
controlled by banking regulators, they will bend to
banking regulators' will. So I cannot even fully blame
them for what happened. But it was, I think, inevitable
that there would be massive dislocation and expense.
That has already occurred. Since then I think that
there have been mitigating effects on the municipal
business, but I think that is probably a close call.
But I am concerned about that BlackRock-Vanguard
concern, which is if you reintroduce floating rate NAV
funds, frankly Federated will roll out a lot of funds.
That will be a competitive disadvantage for the large
money market fund managers. They will have to go back
into the business, and then the next time a money
market fund breaks, the banking regulators will have a
lot less power to save the industry and, frankly, I
would expect Congress to go back and end up maybe
taking the same steps that dislocates the industry
again.
I think the interesting point of view is we have been
through this once. We do not want to go through it
again. Just leave us alone.
But, you know, the free market guy in me says there is
more capital that is out there looking for purchasers
in a demonstrated, successful way to create essentially
a cash vehicle for retail investors, and that should be
an available option.
Another concern is really a specific SEC concern. One
reason the Reserve Fund failed is the SEC was not
monitoring the funds that had the greatest risk of
failing. It also had this no-action process whereby a
fund that was about to break a dollar, which had
happened hundreds of times previously, was to call up
an office in the SEC, and a guy picks up the phone and
says, ``Okay, you are fine,'' and because that process
was fumbled by the staff, in my opinion, and because it
was such an ad hoc system in the first place, that
contributed to the Reserve Fund failure. It was a
primary element of their defense when the founders were
sued, and I think that has to be corrected.
And then, finally, I think that it is a mistake--as
much as you can tell, I am probably not the biggest
friend of banking regulators--to overly hamstring their
Depression era authority to emergency situations, use
their lending authority for nonbanks. I think that this
bill would further hamstring them, and I think that is
a mistake.
A.1. SBE Council has not taken a position on S. 1117, so I
would be unable to answer this question--at least at this point
in time.
------
RESPONSES TO WRITTEN QUESTIONS OF
SENATOR CORTEZ MASTO FROM RAYMOND J. KEATING
Q.1. In the past year, we have had two high-profile chronic
liars that defrauded investors. Elizabeth Holmes from Theranos
sold a false blood testing system and raised $700 million from
wealthy investors. Martin Shkreli is serving a 7-year prison
sentence for lying about returns to his investors. Shkreli
specialized in buying drugs, like Daraprim, a 62-year-old life-
saving drug that helps newborns and people with HIV, and then
raising the price from $13.50 to $750 a pill. Both Holmes and
Shkreli ran private companies. As private firms, they did not
have strong oversight from State regulators or from the
Securities and Exchange Commission. Elizabeth Holmes' firm,
Theranos, bilked investors of more than $700 million dollars.
Martin Shkreli was sentenced to 7 years in prison for lying to
his investors.
Of the six capital formation bills we considered which of
these are going to help investors distinguish good-faith pipe
dreams from fraudsters like Elizabeth Holmes and Martin
Shkreli?
Which bills do you think would make it easier for
fraudsters to rip off investors?
A.1. The capital formation bills under consideration during the
hearing entitled ``Legislative Proposals to Increase Access to
Capital'' were meant to redress unwarranted burdens and costs
facing entrepreneurs and small businesses seeking to raise
financial capital in order to grow by better serving customers,
and thereby also aiding economic, income and employment growth.
There is nothing in these bills that would further open the
door to fraud. The bills provide commonsense relief while still
protecting investors. In the end, of course, private markets
and assorted laws provide various means to protect investors
and consumers from fraud, and where fraud is perpetrated,
lawbreakers are pursued by the proper authorities, with the
expectation of being caught and prosecuted accordingly.
Unfortunately, there will always be some people who attempt to
defraud or rip off others. Thankfully, technology has helped to
boost transparency, as well as communications between investors
and the public so that schemes are uncovered and put to an end
more quickly.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR BROWN
FROM MERCER E. BULLARD
Q.1. Your testimony discussed the Fostering Innovation Act, S.
2126 and raised concerns with exempting additional companies
from the requirements of section 404(b) of the Sarbanes-Oxley
Act (SOX).
Last week, the SEC approved its final rule on the smaller
reporting company definition, which also impacts the
application of SOX section 404(b).
Are you concerned that the SEC rule change expands the
number of companies exempt from SOX section 404(b)? Given the
rule is S. 2126 still necessary?
A.1. Response not received in time for publication.
Q.2. Does the Helping Angels Lead Our Startups (HALOS) Act, S.
588, propose any limits on the type of investors or persons
that may attend a ``demo day''?
In addition, please describe any requirements to evaluate
attendees that would be imposed on entities that could serve as
an event sponsors, as outlined in the section 3(a)(2)(A) of the
bill.
A.2. Response not received in time for publication.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SASSE
FROM MERCER E. BULLARD
Q.1. As policymakers, how should we strike the right balance
between encouraging firms to go public and improving the
private capital markets?
Are the private capital markets currently high-functioning?
If not, where are the biggest potential areas for improvement?
I'm concerned about the increasingly uneven geographic
distribution of growth. As the Economic Innovation Group has
found, economic growth is largely clustered in the most
prosperous areas, instead of evenly distributed across areas
like the Great Plains and the Midwest. Would increasing access
to equity and crowdfunded debt improve the geographic
distribution of new firms?
When do new and smaller firms tend to rely upon access to
equity or crowdfunded debt instead of a traditional bank loan?
For example, some have suggested that technology-based firms
rely more upon equity while main street companies like
restaurants more rely upon bank loans. What are the biggest
hurdles new and smaller firms have--regulatorily or otherwise--
in accessing equity and crowdfunded debt?
Is there currently sufficient clarity about the conditions
under which an offering by a small business issuer would
qualify as a ``transactions by an issuer not involving any
public offering'' under Section 4(a)(2) of the Securities Act?
Are small businesses able to acquire such clarity without
paying a meaningful amount in legal fees?
Representative Emmer's bill, H.R. 2201, the Micro Offering
Safe Harbor Act would ``exempt certain micro-offerings from:
(1) State regulation of securities offerings, and (2) Federal
prohibitions related to interstate solicitation.'' \1\ Such
offerings could be worth up to $500,000, have 35 participants,
and involve and instance where the ``purchaser has a
substantive preexisting relationship with the issuer. . . . ''
\2\ How would you evaluate this legislation? If you have
concerns with this legislation, how would you ideally address
them?
---------------------------------------------------------------------------
\1\ https://www.congress.gov/bill/115th-congress/house-bill/2201
\2\ https://www.congress.gov/bill/115th-congress/house-bill/2201
---------------------------------------------------------------------------
How viable is conducting an offering under the SEC's
Regulation Crowdfunding, particularly for new and smaller
businesses? What about for businesses that are not located in
the top five largest cities? What about for smaller offering
sizes? If smaller offering sizes tend to be less viable, how
large must an offering be to be viable?
Would there be merit to increasing the offering limit for
Regulation Crowdfunding issuers, from $1 million? Why or why
not? If so, what should the limit be? For example, the 2017 SEC
Government-Business Forum on Small Business Capital Formation
recommended raising the limit to $5 million.
A.1. Responses not received in time for publication.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR COTTON
FROM MERCER E. BULLARD
Q.1. Regarding S. 3004, one possible objection is that, in the
5 years since noncustodial brokerdealers have been required to
use a PCAOB-registered auditor, the PCAOB has consistently
found those audits to have high levels of ``deficiencies.'' The
deficiencies are with the expensive PCAOB auditors, not with
the broker-dealers. Some feel the deficiencies are an argument
in favor of S. 3004, since it illustrates the ``square peg,
round hole'' problem of applying PCAOB audit requirements
rather than the AICPA's GAAS standards that these brokers used
to use. So currently these small, privately held noncustodial
brokers are being forced to choose an auditor from the PCAOB's
list, firms that charge much higher prices, and the end product
often has deficiencies that are (perhaps) due to the type of
auditing standards being applied. The audits of the
noncustodial brokers may have even higher rates of
deficiencies, and these broker-dealers tend to be much smaller
than custodial brokers, and thus (perhaps) even less suited to
the PCAOB requirements.
Are the deficiencies in these PCAOB audits evidence in
favor of keeping the law as it is, or in favor of passing S.
3004? What of the fact that audits of noncustodial brokers are
even higher than for custodial firms?
Attached is a letter from one of those--480 PCAOB-
registered firms, a firm that in theory should benefit from the
status quo, but it illustrates the issue from the auditor's
perspective. The link below talks about the PCAOB's 2017 report
(https://www.wsj.com/articles/inspectors-again-find-problems-
in-how-broker-dealers-are-auditedpcaob-says-1503074899).
A.1. Response not received in time for publication.
------
RESPONSES TO WRITTEN QUESTIONS OF
SENATOR MENENDEZ FROM MERCER E. BULLARD
Q.1. Do money market funds benefit the public by providing an
efficient means of intermediating short-term cash investments
with short-term financing needs of State and local governments
and businesses?
In your testimony, you state, ``[t]he counterargument that
the MMF rules are needed to reduce systemic risk has never had
a sound factual basis.'' Can you explain this statement?
In your testimony, you state, ``I do not have faith in the
SEC's ability to manage money market fund risk,'' however, you
also recommend that the SEC should conduct an analysis on the
impacts of the legislation before it is enacted. If you do not
have faith in the SEC's ability tomanage money market fund
risk, why do you believe the agency is equipped to conduct an
empirical analysis of the legislation's impact?
During the hearing, in response to a question from Senator
Rounds, you said, ``I think one of the concerns Vanguard and
BlackRock have and one reason there [sic] probably opposing
this is of course, these rules were adopted in response to the
Dodd-Frank Act which gave banking regulators in my view, far
too much authority over what I would call risk-based markets.''
\1\
---------------------------------------------------------------------------
\1\ https://plus.cq.com/doc/congressionaltranscripts-534822773
---------------------------------------------------------------------------
In fact, a memorandum written by the Investment Company
Institute (ICI) states, ``Although FSOC's recommendations
regarding money market funds and SIFI designation do not appear
to be an active threat under the Trump administration, some ICI
members have raised concerns that overturning the SEC's reforms
by legislation may reenergize bank regulators and financial
reform activists. These members wish to avoid spurring FSOC-
under a future administration to return to its examination of
the industry and possibly to seek to apply ill-suited, bank-
oriented measures to money market funds, other regulated funds,
or fund advisors.'' \2\
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\2\ ICI Memo, January 5, 2018.
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Is it your opinion that if S. 1117 is enacted, large asset
managers such as Vanguard and BlackRock will be more vulnerable
to designation as nonbank systemically important financial
institutions by future administrations?
A.1. Responses not received in time for publication.
------
RESPONSES TO WRITTEN QUESTIONS OF
SENATOR CORTEZ MASTO FROM MERCER E. BULLARD
Q.1. In the past year, we have had two high-profile chronic
liars that defrauded investors. Elizabeth Holmes from Theranos
sold a false blood testing system and raised $700 million from
wealthy investors. Martin Shkreli is serving a 7-year prison
sentence for lying about returns to his investors. Shkreli
specialized in buying drugs, like Daraprim, a 62-year-old life-
saving drug that helps newborns and people with HIV, and then
raising the price from $13.50 to $750 a pill. Both Holmes and
Shkreli ran private companies. As private firms, they did not
have strong oversight from State regulators or from the
Securities and Exchange Commission. Elizabeth Holmes' firm,
Theranos, bilked investors of more than $700 million dollars.
Martin Shkreli was sentenced to 7 years in prison for lying to
his investors.
Of the six capital formation bills we considered which of
these are going to help investors distinguish good-faith pipe
dreams from fraudsters like Elizabeth Holmes and Martin
Shkreli?
Which bills do you think would make it easier for
fraudsters to rip off investors?
Some say start up culture encourages a ``fake it till you
make it'' hustle when pitching investors.
Do you see Elizabeth Holmes and Martin Shrkeli as
indicative of the perils of this ``fake it till you make it''
ethos that makes investing in start-ups risky or are they just
unique and terrible exceptions?
Professor Bullard, in 2012, Congress passed the JOBS Act
into law. It made it easier for companies to raise capital.
Do you have any concern that these one-off bills represent
a piecemeal approach that may interact with one another in
unforeseen ways?
Rather than the piecemeal approach taken with these bills,
might a comprehensive review of the requirements of, and
interactions between, the Securities Act of 1933 and the
Securities Exchange Act of 1934 be more desirable?
Professor Bullard, on May 3, the United States Court of
Appeals for the Second Circuit in Manhattan overturned for the
second time the conviction of Jesse C. Litvak, a former trader
at Jefferies & Co., for misstating the price at which his firm
had acquired residential mortgage backed securities and then
resold them to investors.
The appeals court said Mr. Litvak had no duty to the firm's
customers, who were all sophisticated investors, to provide
truthful information. The court said that sophisticated
investors should not rely on statements from traders.
In two other cases--U.S. vs. Weimert in Chicago and a case
against David Demos, former managing director at Cantor
Fitzgerald--financial services employees who misled investors
by providing false information were not convicted because the
judges found that misleading other parties about prices and
terms is not criminal.
What is the impact for prosecutors when judges refuse to
hold financial executives accountable for misstatements to
sophisticated investors?
The Murdoch's, DeVos's, and other millionaires lost a
hundred million dollars or more when they invested in Theranos.
Should wealthy people follow the ``buyer beware'' approach when
they invest in start ups? Can ``sophisticated investors'' be
defrauded?
The accredited investor criteria was set in 1982: a million
in wealth or $300,000 in couple income. It has not been
increased since then. What level do you think the wealth and
income level should be increased to? Do you think having a
wealth and income threshold as the test is appropriate? Should
there be some kind of test or access for knowledgeable experts
who might have less wealth/income?
A.1. Responses not received in time for publication.
RESPONSES TO WRITTEN QUESTIONS OF THE SENATE BANKING COMMITTEE
FROM CHRISTOPHER H. DANIEL
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
Additional Material Supplied for the Record
LETTERS AND STATEMENTS SUBMITTED BY CHAIRMAN CRAPO
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
LETTERS AND STATEMENTS SUBMITTED BY SENATOR BROWN
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
LETTERS SUBMITTED BY SENATOR SCOTT
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
LETTERS SUBMITTED BY SENATOR COTTON
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
LETTERS SUBMITTED BY SENATOR TILLIS
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
LETTERS SUBMITTED BY SENATOR MENENDEZ
[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]
[all]
| MEMBERNAME | BIOGUIDEID | GPOID | CHAMBER | PARTY | ROLE | STATE | CONGRESS | AUTHORITYID |
|---|---|---|---|---|---|---|---|---|
| Shelby, Richard C. | S000320 | 8277 | S | R | COMMMEMBER | AL | 115 | 1049 |
| Brown, Sherrod | B000944 | 8309 | S | D | COMMMEMBER | OH | 115 | 136 |
| Moran, Jerry | M000934 | 8307 | S | R | COMMMEMBER | KS | 115 | 1507 |
| Toomey, Pat | T000461 | S | R | COMMMEMBER | PA | 115 | 1594 | |
| Van Hollen, Chris | V000128 | 7983 | S | D | COMMMEMBER | MD | 115 | 1729 |
| Corker, Bob | C001071 | 8294 | S | R | COMMMEMBER | TN | 115 | 1825 |
| Tester, Jon | T000464 | 8258 | S | D | COMMMEMBER | MT | 115 | 1829 |
| Donnelly, Joe | D000607 | 7941 | S | D | COMMMEMBER | IN | 115 | 1850 |
| Heller, Dean | H001041 | 8060 | S | R | COMMMEMBER | NV | 115 | 1863 |
| Warner, Mark R. | W000805 | 8269 | S | D | COMMMEMBER | VA | 115 | 1897 |
| Scott, Tim | S001184 | 8141 | S | R | COMMMEMBER | SC | 115 | 2056 |
| Cotton, Tom | C001095 | S | R | COMMMEMBER | AR | 115 | 2098 | |
| Schatz, Brian | S001194 | S | D | COMMMEMBER | HI | 115 | 2173 | |
| Heitkamp, Heidi | H001069 | S | D | COMMMEMBER | ND | 115 | 2174 | |
| Warren, Elizabeth | W000817 | S | D | COMMMEMBER | MA | 115 | 2182 | |
| Perdue, David | P000612 | S | R | COMMMEMBER | GA | 115 | 2286 | |
| Rounds, Mike | R000605 | S | R | COMMMEMBER | SD | 115 | 2288 | |
| Sasse, Ben | S001197 | S | R | COMMMEMBER | NE | 115 | 2289 | |
| Tillis, Thom | T000476 | S | R | COMMMEMBER | NC | 115 | 2291 | |
| Cortez Masto, Catherine | C001113 | S | D | COMMMEMBER | NV | 115 | 2299 | |
| Kennedy, John | K000393 | S | R | COMMMEMBER | LA | 115 | 2303 | |
| Jones, Doug | J000300 | S | D | COMMMEMBER | AL | 115 | 2364 | |
| Crapo, Mike | C000880 | 8289 | S | R | COMMMEMBER | ID | 115 | 250 |
| Menendez, Robert | M000639 | 8239 | S | D | COMMMEMBER | NJ | 115 | 791 |
| Reed, Jack | R000122 | 8272 | S | D | COMMMEMBER | RI | 115 | 949 |
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