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SEC Chair Speaks Before Small Business Capital Formation and Asset Management Advisory Committees

Thank you, Carla [Garrett]. It’s good to be with this Committee again. I’d like to thank the members for their time and willingness to represent the interests of America’s small businesses. As is customary, I’d like to note I’m not speaking on behalf of the Commission or the SEC staff.

I look forward to your readouts from today’s discussion on late-stage, private rounds of financing, as well as the pathways to our public markets.

Last time we gathered, I spoke about my father, Sam Gensler, a small business owner who never had more than a few dozen employees. He didn’t tap the capital markets like many small business owners today.

As a society, the U.S. is blessed with the largest, most sophisticated, and most innovative capital markets in the world. Our companies, including small businesses, rely on our capital markets more than companies in other countries do.

Consider this: The U.S. capital markets represent 38 percent of the globe’s capital markets.[1] This exceeds even our impact on the world’s gross domestic product, where we hold a 24 percent share.[2]

Furthermore, corporate bonds, a $10 trillion market,[3] is about the same size of commercial bank lending in this country.[4]

Broadly speaking, as small businesses grow, they often migrate from borrowing in bank markets to borrowing in capital markets. Having that breadth and depth in our markets facilitates capital formation. That’s why we want to make them as efficient as possible.

In that context, I’d like to touch on one topic this Committee will discuss today: special purpose acquisition companies (SPACs).
This year, there has been an unprecedented surge in SPACs, which provide an alternative to traditional initial public offerings (IPOs). As technology and markets evolve to challenge existing business models, it is important to think about how we protect investors and facilitate capital formation.

With SPACs, there are a lot of costs in between the companies and their investors. I think enhanced disclosures and other provisions can increase competition in this market.

SPACs are shell companies that raise cash from the public through what I call “blank-check IPOs.” They generally have two years to find and merge with a target company.

SPAC sponsors generally receive 20 percent of shares of ownership up front — but only if they actually do a deal later. The first-stage investors can redeem when they find the target, leaving the non-redeeming and later investors to bear the brunt of that dilution.

Once they find a target company, SPACs often raise more capital through transactions known as private investments in public equity (PIPEs). These deals give new investors — mostly big institutions — an opportunity to put money into the target IPO.

These PIPE investors often can buy shares at a discount to what the share price will be after the target IPO, or receive other benefits or payments that are not available to ordinary investors.

The result? PIPE investors often get a better deal than retail investors, whose investment may be further diluted.

There are lots of costs that this structure is bearing — whether sponsor fees, dilution from the PIPE investors, and fees for investment banks or financial advisers. These costs are borne by companies trying to access markets and by regular investors. It may be that those fees are coming out of the retail public’s investment dollars.

I think for small businesses considering going public via SPACs, it is important to consider these costs as well, and whether it is the best approach for the target company.

I’ve asked staff for recommendations about how we might update our rules so that investors are better informed about the fees, costs, and conflicts that may exist with SPACs.

I do think, however, that it is worth considering what we have learned from SPACs and direct listings, and whether there are any changes that might be appropriate for traditional IPOs.

I look forward to hearing from the public — including from this Committee — on these topics.

Thank you.

ENDNOTES

[1] See Securities Industry and Financial Markets Association, “2021 SIFMA Capital Markets Fact Book,” available at https://www.sifma.org/wp-content/uploads/2021/07/CM-Fact-Book-2021-SIFMA.pdf.

[3] Statistics from Securities Industry and Financial Markets Association: https://www.sifma.org/resources/archive/research/statistics/

[4] See Federal Reserve, “Assets and Liabilities of Commercial Banks in the United States,” available at https://www.federalreserve.gov/releases/h8/current/default.htm.

Asset Management Advisory Committee Remarks

Thank you, Ed [Bernard]. I’m glad to be with the Asset Management Advisory Committee again. I appreciate the members’ time and willingness to give us advice, and I look forward to hearing the readouts from today’s discussions. As is customary, I’d like to note I’m not speaking on behalf of the Commission or the SEC staff.

Today, I’d like to speak about a topic that I know your Evolution of Advice Subcommittee regularly takes up: the way rapidly changing technology is changing user experiences and marketing, providing the ability to give individuals personalized advice and client service.

I’d like to discuss something underlying all of this: predictive data analytics.

We are living in a transformational time, perhaps as transformational as the internet itself. Artificial intelligence, predictive data analytics, and machine learning are shaping and will continue to reshape many parts of our economy.

To take just one example, I believe we’re in an early stage of a transition toward driverless cars. Policymakers already are thinking through how to keep passengers and pedestrians safe, if and when these changes take hold.

Finance is not immune to these developments. Here, too, policymakers must consider what rules of the road we need for modern capital markets and for the use of predictive data analytics.

You see, new platforms can collect boundless amounts of data — from customers or from the world around them. With that data — say, the steps we’ve taken wearing our fitness bands, or the days of the week we buy pet food online — they can tune their marketing to each of us differently.

Therefore, fintech platforms have new capabilities to tailor marketing and products to individual investors, using predictive data analytics and other digital engagement practices (DEPs).

These technologies can bring increased efficiencies and greater access in finance. In many cases too, though, these individualized features may encourage investors to invest in different products or change their investment strategy.

Thus, in the case of robo-advisers or investment advisers, I question what are they doing within the predictive data analytics algorithms — if, statistically speaking, they are maximizing for our returns as investors, or, say, the revenues of the platforms.

In essence, predictive data analytics and other DEPs, including behavioral prompts and differential marketing, often are designed, in part, to increase platform revenues, data collection, and customer engagement.

This raises some key questions:

How are investors protected in light of the potential conflicts of interest that may exist when DEPs optimize for revenues, data collection, or investor behaviors?

There’s a related policy question: if DEPs are affecting investors’ behavior, when is that a recommendation or investment advice?

How do these new business models ensure for fairness of access and pricing? More specifically, this question arises when the underlying data used in the analytic models reflects society’s data, with historical biases that may be proxies for protected characteristics, like race and gender.[1]

Advances in predictive data analytics also could raise some system-wide issues when we apply new models and artificial intelligence across our capital markets. This could lead to greater concentration of data sources, herding, and interconnectedness, and potentially increase systemic risk.

We’re taking a look at these issues as part of a broader examination of predictive data analytics and the intersection between finance and technology.

In late August, the Commission published a request for public comment on the use of new and emerging technologies by financial industry firms.[2] I encourage investors in your funds to weigh in by Oct. 1.

Separately, I have asked SEC staff to develop proposals for the Commission’s consideration on cybersecurity risk governance — both on the issuers’ side and on the funds’ side. These could address issues such as cyber hygiene and incident reporting.

I look forward to your thoughts on all these topics.

Thank you.

ENDNOTES

[1] See Gary Gensler and Lily Bailey, “Deep Learning and Financial Stability,” available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3723132.

[2] See https://www.sec.gov/rules/other/2021/34-92766.pdf.

These remarks were delivered on September 27, 2021, by Gary Gensler, chairman of the U.S. Securities and Exchange Committee, before, separately, the SEC’s Asset Management Advisory Committee and Small Business Capital Formation Advisory Committee.

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