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SEC’s Roisman on Encouraging Smaller Entrants to U.S. Capital Markets

Good afternoon. Thank you to everyone who hurried back from lunch to hear me speak. The pressure is on for me to make it worth your while. I never imagined that I would be standing at this podium, but I am excited to be here. I recognize that many of you are here today to get insight into what we are focusing on at the Commission. I would like to take this opportunity to let you know what you can expect to hear from me in the coming year.

I will note here that my views and remarks are my own and do not necessarily represent those of the SEC or the other Commissioners.

It is hard to describe what it is like to come to the SEC as a Commissioner, but the one thing that I think every Commissioner feels, even after a day, is: “Wow. This is different than I imagined.” While I had a sense of the issues on which I planned to focus before I was sworn in last September, I also knew it had been a few years since I worked in the building and I had some catching up to do. I have used the past seven months as an opportunity to engage with the staff and assess the issues on which I could be most helpful. I am now ready to discuss a few of my priorities.

First, encouraging and facilitating the entrance of companies, especially smaller companies, to our capital markets is incredibly important to me, and I feel fortunate that I came back to the SEC at a time when it is a priority for the Chairman as well. I will elaborate on this focus later, but let me first preview for you a few other areas I am interested in.

Second, I remain focused on market structure issues not only for the equities market, but for the fixed income and treasuries markets as well. The SEC is in a unique position to take a close look at how these markets work, to assess whether they work as intended, and to explore where there is room for improvement.

For the equities market, I would like to take a closer look at best execution requirements, especially in conjunction with the order protection rule (“OPR”). Having lived with Regulation NMS for more than a decade (a decade of incredible technological and operational change), we should consider whether tweaks, or more significant changes, are appropriate. For example, I would be interested in exploring a comprehensive and non-prescriptive interpretation of the regulatory requirement for broker-dealers and investment advisers to achieve “best execution” and assessing whether the OPR is still needed or if adjustments are warranted.

While our equities market receives the lion’s share of the SEC’s focus and resources, assets in the fixed income market are significantly greater. Chairman Clayton and the SEC staff have taken our responsibilities over these markets very seriously and have taken steps to promote a dialogue with market participants, including through the creation of the Fixed Income Market Structure Advisory Committee. I look forward to considering further improvements to these markets.

Third, the protection of investors is always front of mind for me, and I think we need to pay particular attention to our senior investors and others who may be especially vulnerable to fraud. Last fall, the Division of Trading and Markets hosted a roundtable on combating retail investor fraud.[1] Our Los Angeles and Philadelphia Regional Offices also recently hosted events focused on educating seniors, including on detecting and avoiding fraudulent schemes. I look forward to contributing to the Commission’s continued efforts in this area. In this regard, I am hopeful that we will be able to host follow up events that will focus on combatting senior investor fraud.

Finally, improving the proxy process is also incredibly important to me, and I thank Chairman Clayton for asking me to take the lead on the Commission’s review of the existing SEC rules that govern the proxy system. I spoke last month about my current thoughts on certain issues related to the proxy process, particularly those regarding asset manager voting practices, proxy advisory firms, proxy plumbing, and shareholder proposals. In those remarks, I extended an invitation to everyone who is interested to come talk to me or submit comments and share your views.[2] That invitation is still open. I am also sensitive to the challenges that funds, as issuers themselves, face when they are required to seek shareholder proxies on certain matters, including the costs involved. I would like to explore ways the Commission could help address those challenges, and I again encourage any interested parties to share your thoughts with me on this issue as well.

Today, though, I would like to talk to you about the first priority that I mentioned, capital formation.

The American Dream

Fifty-four out of the top 100 global companies by market capitalization are U.S. companies.[3] Our companies and markets are unique. As a former employee of an exchange, I remember starting most of my mornings on the floor observing the opening bell accompanied by the sound of people cheering and clapping. I can honestly tell you, it never got old and it never lost its meaning to me. I was inspired not only by the accomplishments of the hard-working business owners who were bringing their companies to market, but also by the knowledge that members of the public, with no particular ties to those companies, would be able to share in their continued growth and success.

To me, the American Dream is not just the ability for entrepreneurs to turn an idea into something larger than life. It is also the ability for those who may not have their own million-dollar-idea but who have the ability to recognize one when they see it, to participate in a company’s success by helping that company raise money or providing liquidity for that company’s shares. Main Street investors’ participation is a necessary component of successful capital markets and one that has been a hallmark of the U.S. markets since their inception. It is also a reason that countless Americans have been able to save for retirement, pay for school, and deal with unexpected financial inflection points.

Road Blocks for Small Public Companies

In this context, I think often of the story of Apple’s initial public offering (“IPO”) in 1980. Massachusetts and several other states declared the IPO “too risky” for state residents and barred the sale of shares to individual investors.[4] I will note that the SEC is purposefully not a merit regulator and, of course, an investor always assumes the risk that the stock he or she purchased will not return a profit. That said, we all know where Apple is today.

Unfortunately, there are fewer opportunities for retail investors to invest in a company like Apple at such an early stage of growth and more generally in smaller IPOs.[5] While it is not common for state regulators to ban their citizens from participating in early-stage IPOs, there are other barriers to small business capital formation that I think the Commission should understand and address.

It is no secret that the owners of private companies struggle with the decision of whether to enter our public markets given the costs and challenges that come with it. In explaining his decision to sell a majority stake in Blue Bottle Coffee to Nestlé rather than taking the company public, the founder stated of the option to become a public company, “Everything that I’ve seen and read, it seems like a way of living in hell without dying.”[6] I take that statement to heart. If business owners feel that way and are motivated to keep their companies private, retail investors have fewer options and opportunities to grow their wealth. I believe it is critical for the SEC to scrutinize whether its rules and regulations have contributed to this decreasing public company environment.

In addition to regulatory burdens, I am aware that high costs related to litigation are another deterrent from raising capital in the public markets. The risk of shareholder litigation has always been a cost that public companies have to anticipate. However, today such litigation is less of a risk and more of a certainty. I have heard that since the Supreme Court’s Cyan[7] ruling last spring, shareholder litigation surrounding initial public offerings has become even more top of mind for companies considering going public. In addition to costs directly related to defending against shareholder complaints, I have heard that acquiring director and officer liability insurance has become more expensive and harder to come by for companies wishing to enter our capital markets and for newly public companies.[8] Of course, I believe that there are shareholders who bring cases that have merit to address legitimate complaints involving companies in which they invest. That said, the legal process can be abused and, oftentimes, is mainly lucrative for plaintiffs’ attorneys who can take the chance that a company will decide to settle rather than waste shareholder money defending even a frivolous class action lawsuit. Ultimately, those who lose out are not only the public companies that spend millions on litigation and insurance (and, importantly, their shareholders), but also prospective investors who lose investing opportunities as private companies delay their entry into the public markets because of these types of disincentives.

Additionally, smaller companies often have challenges once they are public with secondary market liquidity. This can have a profound effect on companies’ abilities to grow. The SEC acknowledged this concern and held a roundtable to discuss ways to improve the markets with respect to thinly traded securities.[9] If companies do not have robust secondary market liquidity, it places burdens on them, including potentially making it harder to get favorable terms for secondary and shelf offerings.[10] As one of the panelists at the roundtable noted: “[C]apital formation is inextricably linked to trading volume.”[11] When you talk to a CEO, especially one that is at a public company, he or she will tell you that the journey of the company does not end with an IPO; in fact, it is only the beginning.

The SEC’s Role

Recent SEC Action

Now that I have laid out what I view to be some of the reasons companies are reluctant to enter our public markets, I want to give you my thoughts on how I think we can help.

As a general principle, it is the SEC’s responsibility to constantly engage with those who participate in, or want to participate in, our markets and to help facilitate capital formation. I think of the entrepreneurs wondering how to raise money to grow their businesses. I want those people to know that we are doing our best to ensure that that the capital markets are accessible to them.

We have taken steps since I joined the Commission to promote capital formation and I want to highlight some recent SEC action.

For instance, in late December of last year, we issued a request for comment on quarterly reports and earnings releases. The request for comment asks a lot of questions about how the Commission can reduce burdens associated with quarterly reporting while maintaining investor protections. It also asks for comments on how the existing periodic reporting system, earnings releases, and earnings guidance may foster an overly short-term focus by managers and other market participants. I look forward to hearing from the Division of Corporation Finance on their proposals based on the feedback we received from the comment file.

Additionally, earlier this year, we proposed extending the availability of test-the-waters communications to all issuers, regardless of size. Currently, this accommodation is only available to emerging growth companies. Our hope is that extending the test-the-waters reform to a broader range of issuers will encourage issuers to conduct registered public offerings and lower their cost of capital, which will provide investors with more opportunities.

Most recently, we adopted amendments to implement the FAST Act, which will modernize and simplify the SEC’s disclosure requirements in a manner that we anticipate will result in significant savings of time and money for registrants without reducing the amount of material information provided to investors.

In addition to rulemaking efforts, I would like to commend the SEC staff for working closely with issuers who express a wish to enter the public markets through paths less traveled. For instance, we have seen companies pursue direct listings instead of initial public offerings, where they have amassed enough private capital to allow them to do that. We have also seen recent examples of IPOs from companies with dual class share structures. In these instances, investors are provided with robust disclosures of their rights and choose to buy shares with differing or no voting rights attached. This is certainly an appropriate investment for those who want to own a piece of a company and trust management to continue making the types of decisions that have made the company a success so far. If investors decide at a point in the future that they no longer agree with management, there is a market where they can sell their shares and part ways with the company. I think it is important for the SEC to allow for flexibility in corporate governance structures. We are not a merit regulator. Our job is to evaluate whether an issuer has provided proper disclosures to potential investors, and then let the market decide its share value. While the Commission is charged with protecting investors, investor protection does not necessarily mean limiting options for investors. Rather, our job is to ensure people have an array of investment choices with the relevant material information for them to consider in decision-making.

Proposed SEC Action

While we have made progress, there is more that we can do to promote capital formation, especially for small businesses.

I look forward to the SEC taking steps to harmonize the maze of regulations that comprise the exempt offering framework. My hope is that more entrepreneurs will feel empowered to conduct securities offerings at earlier growth stages, potentially leading to them conducting registered, public offerings at earlier stages as well.[12]

While we are on the topic of private issuers who wish to raise capital, I would like to express my hope that the SEC will address the topic of “finders,” who introduce companies to prospective investors, typically for compensation. Sometimes the finder merely introduces the investor to the issuer. In other arrangements, the finder may take on a greater role in the negotiations and eventual consummation of the transaction. Questions have existed for decades regarding whether these finders are acting as broker-dealers under Section 15 of the Securities Exchange Act of 1934, and, if so, whether they must register as such and comply with applicable requirements. I would like the SEC to provide clear guidance on the activity of finders in the context of our securities laws, including whether that activity implicates broker-dealer status. I look forward to future dialogue with the SEC staff and my fellow Commissioners on this topic, and I welcome input from the public.

I also look forward to the Commission revisiting the application of Section 404(b) of the Sarbanes-Oxley Act (“404(b)”)[13] as we consider changes to the definition of “accelerated filer.” In my time both at the SEC and in the Senate, I have heard from more companies than I can count that compliance with 404(b) is an enormous undertaking. We must think about the reasons we require companies to obtain this attestation and identify where burdens may be outweighing benefits to investors.[14]

In addition to rulemaking, I believe the SEC can take proactive steps to encourage entrepreneurs to take advantage of the federal securities laws drafted with them in mind. I want to share an idea I heard from panelists at last year’s SEC Government-Business Forum on Small Business Capital Formation (the “SEC’s Small Business Forum”). One panelist explained that in his experience, a lot of entrepreneurs are hesitant to take advantage of capital raising options like crowdfunding because they do not really understand what they involve or whether they are right for them or their businesses. A consensus seemed to form on the panel that the SEC should step in to educate entrepreneurs about their options for raising capital. This is something that I want to explore and I hope you will engage with me and provide suggestions for how the SEC can be more helpful to entrepreneurs.

Speaking of the SEC’s Small Business Forum, I would like to take a moment to express how excited I am to have Martha Legg Miller, the SEC’s first Small Business Advocate, planning this year’s Forum. I am so impressed with the work Martha has done in the few short months that she has been in her new role, and I cannot wait to see what she does next.

Conclusion

I am glad that I had the opportunity to highlight for you what I will be focused on as a Commissioner and to share my thoughts on capital formation. I am sure that many of you have your own ideas, based on practical experience, that could help inform my views going forward. I encourage you to reach out if you want to engage in a discussion. I want to thank you for listening to me today. Enjoy the next panel and the rest of the afternoon.

ENDNOTES

[1] Materials for the equity market structure roundtables the SEC hosted in 2018 are available at https://www.sec.gov/spotlight/equity-market-structure-roundtables.

[2] Commissioner Elad L. Roisman, “Keynote Remarks: ICI Mutual Funds and Investment Management Conference” (Mar. 18, 2019), https://www.sec.gov/news/speech/speech-roisman-031819.

[3] See “Global Top 100 companies by market capitalisation” by PricewaterhouseCoopers LLP (2018), https://www.pwc.com/gx/en/audit-services/assets/pdf/global-top-100-companies-2018- report.pdf.

[4] See “Apple Computer Set to Go Public Today; Massachusetts Bars Sale of Stock as Risky” by Richard E. Rustin and Mitchell C. Lynch of The Wall Street Journal (Dec. 12, 1980).

[5] See Chairman Jay Clayton, “Remarks on Capital Formation at the Nashville 36|86 Entrepreneurship Festival” (Aug. 29, 2018) available at https://www.sec.gov/news/speech/speech-clayton-082918; see also “Hunting High and Low: The Decline of the Small IPO and What to Do About It” by Marshall Lux and Jack Pead (April 2018) https://www.hks.harvard.edu/sites/default/files/centers/mrcbg/working.papers/86_final.pdf.

[6] See “Nestlé Targets High-End Coffee by Taking Majority Stake in Blue Bottle” by Michael J. de la Merced and Oliver Strand of The New York Times (Sept. 14, 2017).

[7] Cyan, Inc. v. Beaver County Employees Retirement Fund, 138 S. Ct. 1061 (2018) (affirming the jurisdiction of state courts to adjudicate class actions alleging only violations of the Securities Act of 1933).

[8] See “Year-Old Cyan Ruling Still A Touchy Subject For Attorneys” by Rachel Graf and Jon Hill of Law360 (Mar. 22, 2019).

[9] See “Transcript of Roundtable on Market Structure for Thinly-Traded Securities” (Apr. 23, 2018) (the “Roundtable Transcript”), at 21-22 https://www.sec.gov/spotlight/equity-market-structure-roundtables/thinly-traded-securities-rountable-042318-transcript.txt. (Adam Epstein, Third Creek Advisors LLC, stated: “As a result of my firm’s work with dozens of exchange listed small cap companies over the last eight years, I see what I would characterize as the insidious nature of illiquidity on a day to day basis. And I use the word insidious because small cap trading illiquidity affects considerably more than capital formation. Trading illiquidity gravely impacts the ability for small cap companies to garner and retain research coverage. Trading illiquidity gravely impacts mergers and acquisitions in the small cap ecosystem. Trading illiquidity gravely impacts the ability for small cap companies to hire and actually retain great employees.”)

[10] Id. at 51-52. (Adam Epstein, Third Creek Advisors LLC, also stated: “[W]hat really matters, and what really happens out there to these issuers, is that if you trade a million dollars a day, you can go out and probably do a shelf takedown or do a follow on offering with no warrants and price somewhere around 15 percent off. If you’re the company that trades $50,000 a day, what you’re looking at is perhaps some type of restricted stock deal. You may be looking at something that’s hyperstructured with pretty austere warrant coverage. And to be able to dig your way out of that operationally is really challenging.”)

[11] See Roundtable Transcript, at 21-22.

[12] The Reg Flex agenda for 2019 rulemaking was published in the Federal Register on August 7, 2018, https://www.reginfo.gov/public/do/eAgendaMain?operation=OPERATION_GET_AGENCY_RULE_LIST&currentPub=true&agencyCode=&showStage=active&agencyCd=3235.

[13] Pub. L. 107-204, Sec. 404(b) 116 Stat. 745 (2002).

[14] Supra, note 12.

These remarks were delivered by Elad L. Roisman, commissioner of the U.S. Securities and Exchange Commission, on April 8, 2019, at the SEC Speaks conference.