[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]
THE SECs ROLE IN CAPITAL FORMATION:
HELP OR HINDRANCE?
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
OVERSIGHT AND INVESTIGATIONS
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED SEVENTH CONGRESS
FIRST SESSION
__________
JUNE 26, 2001
__________
Printed for the use of the Committee on Financial Services
Serial No. 107-29
U.S. GOVERNMENT PRINTING OFFICE
73-742 PS WASHINGTON : 2001
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; (202) 512-1800
Fax: (202) 512-2250 Mail: Stop SSOP, Washington, DC 20402-0001
HOUSE COMMITTEE ON FINANCIAL SERVICES
MICHAEL G. OXLEY, Ohio, Chairman
JAMES A. LEACH, Iowa JOHN J. LaFALCE, New York
MARGE ROUKEMA, New Jersey, Vice BARNEY FRANK, Massachusetts
Chair PAUL E. KANJORSKI, Pennsylvania
DOUG BEREUTER, Nebraska MAXINE WATERS, California
RICHARD H. BAKER, Louisiana CAROLYN B. MALONEY, New York
SPENCER BACHUS, Alabama LUIS V. GUTIERREZ, Illinois
MICHAEL N. CASTLE, Delaware NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California GARY L. ACKERMAN, New York
FRANK D. LUCAS, Oklahoma KEN BENTSEN, Texas
ROBERT W. NEY, Texas JAMES H. MALONEY, Connecticut
BOB BARR, Georgia DARLENE HOOLEY, Oregon
SUE W. KELLY, New York JULIA CARSON, Indiana
RON PAUL, Texas BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio MAX SANDLIN, Texas
CHRISTOPHER COX, California GREGORY W. MEEKS, New York
DAVE WELDON, Florida BARBARA LEE, California
JIM RYUN, Kansas FRANK MASCARA, Pennsylvania
BOB RILEY, Alabama JAY INSLEE, Washington
STEVEN C. LaTOURETTE, Ohio JANICE D. SCHAKOWSKY, Illinois
DONALD A. MANZULLO, Illinois DENNIS MOORE, Kansas
WALTER B. JONES, North Carolina CHARLES A. GONZALEZ, Texas
DOUG OSE, California STEPHANIE TUBBS JONES, Ohio
JUDY BIGGERT, Illinois MICHAEL E. CAPUANO, Massachusetts
MARK GREEN, Wisconsin HAROLD E. FORD Jr., Tennessee
PATRICK J. TOOMEY, Pennsylvania RUBEN HINOJOSA, Texas
CHRISTOPHER SHAYS, Connecticut KEN LUCAS, Kentucky
JOHN B. SHADEGG, Arizona RONNIE SHOWS, Mississippi
VITO FOSSELLA, New York JOSEPH CROWLEY, New York
GARY G. MILLER, California WILLIAM LACY CLAY, Missouri
ERIC CANTOR, Virginia STEVE ISRAEL, New York
FELIX J. GRUCCI, Jr., New York MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania
SHELLEY MOORE CAPITO, West Virginia BERNARD SANDERS, Vermont
MIKE FERGUSON, New Jersey
MIKE ROGERS, Michigan
PATRICK J. TIBERI, Ohio
Terry Haines, Chief Counsel and Staff Director
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Subcommittee on Oversight and Investigations
SUE W. KELLY, New York, Chair
RON PAUL, Ohio, Vice Chairman LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York JAY INSLEE, Washington
ROBERT W. NEY, Texas JANICE D. SCHAKOWSKY, Illinois
CHRISTOPHER COX, California DENNIS MOORE, Kansas
DAVE WELDON, Florida STEPHANIE TUBBS JONES, Ohio
WALTER B. JONES, North Carolina MICHAEL CAPUANO, Massachusetts
JOHN B. SHADEGG, Arizona RONNIE SHOWS, Mississippi
VITO FOSSELLA, New York JOSEPH CROWLEY, New York
ERIC CANTOR, Virginia WILLIAM LACY CLAY, Missouri
PATRICK J. TIBERI, Ohio
C O N T E N T S
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Page
Hearing held on:
June 26, 2001................................................ 1
Appendix:
June 26, 2001................................................ 27
WITNESSES
Tuesday, June 26, 2001
Devine, Hon. Donald J., Vice Chairman, American Conservative
Union.......................................................... 8
Halpern, Gregory, Chairman and CEO, Circle Group Internet, Inc.,
Mundelein, IL.................................................. 6
Steinkirchner, James A., Co-Chairman, National Small Public
Company Leadership Council, Washington, DC..................... 10
Sweeney, Joan, Chief Operating Officer, Allied Capital
Corporation,
Washington, DC................................................. 5
APPENDIX
Prepared statements:
Kelly, Hon. Sue W............................................ 28
Oxley, Hon. Michael G........................................ 30
Gutierrez, Hon. Luis V....................................... 32
Devine, Hon. Donald J........................................ 55
Halpern, Gregory............................................. 52
Steinkirchner, James A....................................... 69
Sweeney, Joan M.............................................. 40
Additional Material Submitted for the Record
Kelly, Hon. Sue W.:
``SEC Sleuths Beyond the Law?'', Washington Times, June 26,
2001....................................................... 29
Gutierrez, Hon. Luis V.:
Executive Summary of ``Modernizing the Regulation of Business
Development Companies''.................................... 34
Devine, Hon. Donald J.:
Written responses to questions from Hon. Sue W. Kelly........ 67
Sweeney, Joan M.:
Written responses to questions from Hon. Sue W. Kelly........ 49
THE SEC'S ROLE IN CAPITAL FORMATION:
HELP OR HINDRANCE?
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TUESDAY, JUNE 26, 2001
U.S. House of Representatives,
Subcommittee on Oversight and Investigations,
Committee on Financial Services,
Washington, DC.
The subcommittee met, pursuant to call, at 9:35 a.m., in
room 2128, Rayburn House Office Building, Hon. Sue W. Kelly,
[chairwoman of the subcommittee], presiding.
Present: Chairwoman Kelly; Representatives Cantor, Tiberi,
Gutierrez, Inslee, Moore, S. Jones of Ohio, and Shows.
Chairwoman Kelly. This hearing of the Subcommittee on
Oversight and Investigations will come to order. Without
objection, all Members' opening statements will be made part of
the record.
This morning, we are holding this subcommittee's first
hearings on the issue of capital formation. Capital formation
has been an implicit responsibility of the Securities and
Exchange Commission since it was first created. In 1996,
securities laws were amended by the National Securities Market
Improvement Act to explicitly state that capital formation is
an important responsibility of the Securities and Exchange
Commission. In 1995, in testimony before the former
Subcommittee on Finance and Hazardous Materials, former
Securities and Exchange Commission Chairman Arthur Levitt
stated, and I quote: ``Existing law already requires the agency
to give consideration to efficiency, competition and capital
formation concerns whenever the Commission is required to make
a public interest determination.''
Securities markets are the critical force behind our
Nation's economy. It has been one of my long-standing goals in
Congress to eliminate obstacles to capital formation in those
markets, especially for small businesses.
I am greatly distressed by the concerns that fundamental
regulatory obstacles are inhibiting the flow of capital to and
investor participation in the small and middle market business
sector. This hearing is the subcommittee's first step in
determining how we in Congress and the Commission can
effectively eliminate those obstacles for all participants in
our Nation's capital markets.
Capital is the life blood of business, and efficient access
to capital is a crucial ingredient to a strong, growing
economy. We have the responsibility to closely examine the
different structures the Securities and Exchange Commission has
crafted for businesses to access the markets and to determine
if these are practical and effective.
Businesses should be able to devote their energies toward
their customers and not be delayed by unnecessary requirements
that no longer reflect the realities of our new economy. In the
Securities and Exchange Commission's work to ensure investor
protection and efficient capital formation, I believe the best
service they can provide is to ensure transparency in
disclosures and ensure fair play through their enforcement
division.
A September 2000 General Accounting Office report found
that the estimated average total cost needed to conduct a small
business IPO during 1994 to 1999 was about 10 percent of the
total offering proceeds, while the average total cost for a
large business IPO was about 8 percent. The Securities and
Exchange Commission has a few different processes for smaller
businesses and smaller offerings which were designed to reduce
the regulatory burden for these issuers. We will examine the
effectiveness of some of these processes here today.
In addition, in 1996, the Securities and Exchange
Commission was given general exemptive authority to allow them
to waive specific requirements on a case-by-case basis in order
to give the Securities and Exchange Commission additional
flexibility in assisting businesses' access to the capital
markets. I intend for this subcommittee to take a close look at
how that authority is being used.
Before us today, we are honored to have a distinguished
panel of witnesses to share their thoughts and observations
with us on these issues. I thank all of you for taking the time
out of your busy schedules to spend some time discussing these
issues with us today, and I would let Members of the
subcommittee and staff know that it is my intention to enforce
the 5-minute rule, and I would appreciate their cooperation in
this.
I am now going to recognize my friend from Chicago, Mr.
Gutierrez, distinguished Ranking Member for this subcommittee,
for his opening statement.
Mr. Gutierrez.
[The prepared statement of Hon. Sue W. Kelly can be found
on page 28 in the appendix.]
Mr. Gutierrez. Well, good morning, Chairwoman Kelly, and
thank you for holding this hearing. I would like to welcome all
of the panelists who have come here today to share their views
on the important issue of capital formation.
The mission of the U.S. Securities and Exchange Commission
is to protect investors and promote efficient capital
formation. Challenges facing the Commission in accomplishing
its mission are no different today than the challenges that
existed in 1933 when the U.S. Federal Government first began
regulating the issuance of securities. The premise of the 1933
Act is that full and fair disclosure would most effectively
promote efficient and fair functioning in the process of
capital formation.
We are here today to study and discuss possible changes to
the existing regulatory structure to facilitate capital
formation for small businesses and all market participants.
Small businesses are an important source of economic growth and
creation; they account for 50 percent of the gross domestic
product and the majority of new jobs.
Access to capital is a critical issue for small businesses.
Without sufficient capital, small businesses are unable to
develop new products and services or grow to meet new demands.
Insufficient liquidity is frequently cited as a cause of small
business failure. Small firms are heavily dependent on bank
float, trade credit and informal sources of financing such as
personal savings, credit cards, home equity loans and loans
from family and friends.
Steps have been taken by both the Federal securities
regulators and State governments in an attempt to reduce some
of the regulatory burden and costs for small businesses seeking
equity capital financing in the regulated securities market.
One of the steps taken by the Federal securities regulators has
been simplifying Federal registration of securities offerings
and exempting certain small businesses' securities offerings
from several requirements, Regulation D, in an attempt to
reduce the regulatory burden and the cost for small businesses
in equity capital formation.
One of these exceptions, Rule 504 under Regulation D, is
intended to allow companies to raise seed capital. A company
may privately sell up to $1 million in securities in a 12-month
period to any investor without registration as long as there is
no public solicitation or advertising or resale of the share;
and resale of the share is restricted. A company may sell the
same amount of securities using public solicitation if it has
registered the securities in a State that requires: one, public
filing of a registration statement with the State and; two, the
delivery of disclosure documents to investors.
From 1992 to 1999, the Securities and Exchange Commission
dropped the State registration requirement from Rule 504. They
then experienced a substantial increase in the number of
complaints they received from investors who have been defrauded
by operations selling shares under Rule 504. The Securities and
Exchange Commission found that fraudulent operations had
developed that would go to States that had no substantive
registration requirements and sell securities to residents in
those States. This resulted in substantial incidence of
fraudulent sales to the general public of securities for which
no information was publicly available.
Another step taken by the Securities and Exchange
Commission to minimize the regulatory costs of raising equity
capital has been permitting small businesses' issuers to use
simplified, small business forms, so-called SB-1 and SB-2, in
filing registration. Small business issuers are those with less
than $25 million in revenue in the last fiscal year and
outstanding stock of $25 million or less. Even though these
forms save an issuer up to approximately $125,000 an average
offering, small business issues are viewed unfavorably by many
investment bankers because they are too small in size to be
profitable. Also, small offerings are commonly distributed by
small investment banks that lack the market recognition which
can be an impediment to attracting investors.
These problems show that even though many positive steps
have been taken to help small businesses gain access to equity
capital, more needs to be done. By passing the capital
promotion tools in the National Securities Market Improvement
Act in 1996, we sought to enhance the Commission's role in
promoting capital formation and efficiency with the appropriate
investor protections. It is crucial then that the Securities
and Exchange Commission balance the burden placed on small
businesses against the purposes of investor protections under
the securities law.
I look forward to hearing all of the testimonies and thank
you, Madam Chairwoman, once again.
[The prepared statement of Hon. Luis V. Gutierrez can be
found on page 32 in the appendix.]
Chairwoman Kelly. Thank you very much, Mr. Gutierrez.
Mr. Cantor, have you an opening statement?
Mr. Cantor. No, Madam Chairwoman.
Chairwoman Kelly. Mr. Tiberi.
Mr. Tiberi. No.
Chairwoman Kelly. Thank you.
Well, then, if there are no more opening statements, we
will begin with our first panel. Before us today we have Ms.
Joan M. Sweeney, the Managing Director and Chief Operating
Officer for Allied Capital. Before her work with Allied
Capital, Ms. Sweeney was an accountant with the Securities and
Exchange Commission's Enforcement Division.
Next, we have Gregory Halpern, the Chairman and CEO for
Circle Group Internet Incorporated. In 1998, Mr. Halpern
distinguished Circle Group Internet by raising $2.5 million as
the first and only company to orchestrate a complete end-to-end
Regulation A offering over the internet without the assistance
of outside brokerage.
In addition, we have Mr. Donald J. Devine, the Vice
Chairman of the American Conservative Union, who is the former
Director of the U.S. Office of Personnel Management, Grewcock
Professor of American Values at Bellevue University, a
Washington Times columnist, a writer, and an Adjunct Scholar at
the Heritage Foundation. And if you don't mind, Mr. Devine, we
are all enjoying this column of yours that appeared in the
newspaper today. And I am going to, with your permission, sir,
and the permission of the subcommittee, I am going to include
this in the record. If anybody hasn't read this, you should get
the Washington Times, take a look at it.
Mr. Devine. Well, thank you.
Chairwoman Kelly. If you don't have enough time today, at
least this clarifies your position, along with a very good
cartoon.
[The article referred to can be found on page 29 in the
appendix.]
Finally, we have Mr. James A. Steinkirchner, the Co-
Chairman of the National Small Public Company Leadership
Council. Mr. Steinkirchner is listed as an NSAD trader since
1996 and is currently the Vice President of McGinn, Smith &
Company of Atlanta, Georgia.
We thank you all for joining us here today to share your
thoughts on these issues. Without objection, your written
statements will be made part of the record, and you will each
be recognized now for a 5-minute summary of your testimony, and
I would like to begin with you, Ms. Sweeney.
STATEMENT OF JOAN M. SWEENEY, CHIEF OPERATING OFFICER, ALLIED
CAPITAL CORPORATION
Ms. Sweeney. Thank you, Madam Chairwoman. Members of the
subcommittee, my name is Joan Sweeney, and I am the Chief
Operating Officer of Allied Capital, a public business
development company. Today, I am pleased to share our thoughts
about improvements to the Federal securities regulatory
framework as it impacts capital formation.
Allied Capital has invested in growing businesses for over
40 years. We operate the oldest SBIC license and we have
financed thousands of small businesses. We provide mezzanine
debt and equity capital, and our portfolio today is just shy of
$2 billion.
We constantly see challenges faced by companies seeking
capital. As a business development company, we are a successful
conduit for bringing public investment dollars to small
businesses, but we too are burdened with a cumbersome
regulatory regime. I was a member of the Securities and
Exchange Commission's Division of Enforcement, and I fully
support the Securities and Exchange Commission's role as ``cop
on the street.'' However, the authority and activities of the
Securities and Exchange Commission staff need a fresh look if
the goal is to encourage capital formation as well.
There are three areas I would like to discuss related to
improving capital access. First, it is time to embrace the
internet. Financial markets are moving at the speed of light
and financial information is only a click away. The fact that
the Securities and Exchange Commission does not consider
information to be publicly disclosed when it is presented on a
company's website seems out of touch with the realities of the
millennium. This is especially true when online disclosure is
required through EDGAR filings. We need to think outside the
box and outside the four corners of the prospectus to come to a
virtual prospectus that incorporates a company's website.
Second, the Securities and Exchange Commission needs to
challenge low value-add activity. Under a 70-year-old system,
too much of the Securities and Exchange Commission's activity
centers around the review of registration statements. This is
cumbersome and low value-added. The law is the law, and the
registrant and their lawyers and the registrant's underwriters
and their lawyers all know the law, are responsible for it and
are liable with respect to compliance with the law. Why, then,
is a 30-day review period, often undertaken by an unseasoned
examiner, necessary? Legal fees mount, often in response to
questions raised only from a lack of experience. More
seriously, the delay of this process can result in a missed
market window.
The reality is, public offerings are not sold off
registration statements. Plain English improves disclosure, but
prospectuses are still not read. The majority of public
securities are sold to mutual funds, and fund managers research
far beyond the registration statement, ironically, using the
registrant's website and the internet. To further the irony,
individual investors use websites and internet chat boards to
get the real plain-English scoop. Why not focus staff time on
regulating information in channels that investors really use,
rather than allocating limited resources to the review of
outdated registration forms?
Third, there needs to be more staff time allocated to
exemptive orders and new rulemaking. There are many
inefficiencies in the system that could be readily fixed if the
staff had the time and authority.
For instance, you may not be familiar with BDCs, such as
Allied Capital, and our role in capital formation. BDCs were
created by Congress 20 years ago to encourage the flow of
public capital to small, private companies. Yet today, the BDC
industry is still barely visible. I believe this is largely
because operating within the cumbersome yoke of the 1940 Act
discourages new entrants.
For example, efficient access to the public markets through
integrated disclosure is not available to BDCs. Unlike other
public companies, we cannot use our Forms 10-K and 10-Q to
update our shelf registration statements. This situation is
time consuming and costly and, we believe, results from a mere
oversight in the law that could be easily remedied.
We submitted a letter to the staff in July of 1998 to
address our integrated disclosure issue by requesting a no-
action position. After 3 years of waiting for their answer,
last week we were told that under the current regulatory
framework, the staff could not grant the relief we were
seeking. Instead, we were told to pursue rulemaking, with no
guarantee of immediate attention. We essentially waited 3 years
to learn we must pursue a different bureaucratic process. This
is clearly inefficient.
The staff needs to allocate its resources to foster capital
formation through interpretive positions, exemptive orders and
rulemaking. I am certain that if they had the time and
authority to act, we would not have waited 3 years to find
ourselves back at square one.
I believe the changes that I have suggested would improve
capital formation as well as enhance investor protection.
Thank you.
[The prepared statement of Joan M. Sweeney can be found on
page 40 in the appendix.]
Chairwoman Kelly. I thank you very much Ms. Sweeney. I
really appreciated reading your testimony last night as well.
So we will get into that more.
Now we move on to Mr. Halpern.
STATEMENT OF GREGORY HALPERN, CHAIRMAN AND CEO, CIRCLE GROUP
INTERNET, INC.
Mr. Halpern. Madam Chairwoman, Members of the subcommittee,
thank you for inviting me to this hearing. I am Greg Halpern,
founder and CEO of Circle Group Internet. We are a funding and
consulting source for emerging technology companies, based in
Mundelein, Illinois.
Now, I represent 21 million small business professionals
who create half the jobs in America who are not here today,
because today is a work day and for them, every day is a work
day. My written testimony is going to address most of my issues
in detail, but let me summarize.
Small businesses like ours produce more than half of
America's private gross domestic product. As you know, by 2005,
we will create 60 percent of the new jobs in this country, and
these figures are provided by the United States Government so
they are not rhetoric, they are reality.
Small businesses struggle to succeed despite often
unreasonable and misguided regulations, taxes and very little
representation. We face regulations that make raising capital
difficult, if not impossible. At today's hearing our concern is
with the Securities and Exchange Commission.
Now, the Great Depression, as we know, created the need for
the Securities and Exchange Commission, and it has served its
purpose. Nearly a century later, however, the Securities and
Exchange Commission has failed to keep pace as markets and the
global economy have evolved. Now, I am not here to propose
increased limitations on the Securities and Exchange
Commission's power. Let's help the Securities and Exchange
Commission continue its mission and at the same time assist
small business.
Today, the process to register with the Securities and
Exchange Commission is so time consuming, expensive and
subjective that many small businesses either drop out during
registration or avoid it altogether. The Securities and
Exchange Commission regularly fails to comply with the Act of
the Congress, which we have talked about, known as the National
Securities Market Improvement Act of 1996, which concerns
competition, efficiency and capital formation in the Securities
and Exchange Commission's rulemaking activities.
Hundreds of companies retired from the Securities and
Exchange Commission's registration process in 2000. The
opportunities missed by just these companies represented
billions and billions of dollars that could have gone toward
jobs, the economy and tax dollars to the Treasury. Was the next
Home Depot, Dell, or Yahoo among them? We will never know.
Small businesses register their securities under Regulation
SB. The SB, as you know, stands for ``small business,'' and it
is supposed to mean a much simpler and friendlier way to enter
the capital market based on objective criteria. In reality,
though, SB often predisposes the staff against the very
companies it is supposed to be serving.
The Securities and Exchange Commission often mistakenly
loses sight of its simple, objective mission, which is to
ensure full disclosure and then send the companies off to
market. Instead, many companies are drained needlessly of time,
money and resources, answering endless rounds of questions and
waiting for the slow process to resolve itself.
Another issue that affects many small businesses is the
Investment Act of 1940, which requires public companies to hold
no more than 40 percent of their value in securities of other
companies. This hurts firms like ours, because as we fund other
emerging companies and their securities increase in value, we
find ourselves out of compliance. This means we are becoming
victims of our own success.
At the end of the day, this is not about the 1940 Act or
Regulation SB, though; it is quite simply about the larger
issues of the Securities and Exchange Commission's role in
capital formation. The Securities and Exchange Commission was
told in the last century to support capital formation, and it
really needs to learn how to work with small businesses in this
new century.
Small businesses need relief now. The processes are
actually in place; the Securities and Exchange Commission just
needs to let them work.
Additionally, I am proposing the creation of a department
in the Securities and Exchange Commission to be known as the
Small Business Advocacy and Liaison Office. This office should
serve small business ventures that require special assistance
in reaching the capital markets. It would fall under the
Division of Corporate Finance and represent the nineteenth
office in the Commission.
The office would advise small businesses how to meet the
regulations and requirements of the Securities and Exchange
Commission. It would monitor processing of applications and
provide quick, reasonable responses. The office would establish
a schedule to better prepare businesses for their Securities
and Exchange Commission experience, and it would also respond
with clear and concise information regarding any difficulties
or irregularities with its constituent applicant companies.
And finally, the Small Business Advocacy and Liaison Office
would provide an annual review of the Securities and Exchange
Commission rules and regulations related to all small business
entities and make recommendations to Congress for changes in
those policies that may unfairly encumber small businesses.
I thank you, Madam Chairwoman and the rest of the
subcommittee, for the opportunity to take a day off and come to
Washington to discuss the concerns of 21 million of my fellow
small business professionals. I know there is a genuine
willingness on your part to help and together we can solve
these problems and get on with the task of building our
businesses, and the Nation as well.
Thank you.
[The prepared statement of Gregory Halpern can be found on
page 52 in the appendix.]
Chairwoman Kelly. Thank you very much, Mr. Halpern.
I am very sorry, having read your testimony, that your
company has had such a problem in dealing with simple things
like phone calls not even being returned by any kind of a
Federal Government agency.
Now, we turn to you, Mr. Devine.
STATEMENT OF HON. DONALD J. DEVINE, VICE CHAIRMAN, AMERICAN
CONSERVATIVE UNION
Mr. Devine. Thank you very much, and I would like to thank
you very much for holding this hearing.
I think it is a critical question as to whether the
agencies and the bureaucracy--and I used to be the chief
bureaucrat for 4 years as Director of the Office of Personnel
Management--that they actually follow the law. This
subcommittee and its predecessor have gone through an enormous
amount of activity to try to get the Securities and Exchange
Commission to follow the law.
I think when the former Chairman and Mr. Oxley wrote the
Securities and Exchange Commission and got its reply, the reply
clearly showed that the Securities and Exchange Commission did
not understand what it was supposed to do under the law--in
order to take into account its other obligations, other than
fighting fraud, which is certainly a very important obligation.
But that is not the only obligation under the very law under
which they operate.
I think we saw this very clearly when they amended Rule
504, under which small companies secured small amounts of
capital. It was a critical element in their raising capital.
Effectively, the Securities and Exchange Commission took public
companies out of the regulated market so that they could raise
small amounts of capital with limited bureaucratic review. In
my opinion, it is a sad situation, a public scandal really,
that this critical legal avenue is not open to small business
anymore.
Several tables are in the formal testimony, but I have a
larger version here. You see what happened when the Securities
and Exchange Commission adopted Rule 504. The market went up
and up and up, for years in fact. This is, in fact, the plot
from one of these automatic computer programs for it. I didn't
fit it in that line.
Now other things were happening. There were tax cuts and
things. I am not saying it is the only thing, but clearly that
is what happened after those initial Rule 504 reforms.
Now we see in a second chart what happened after the
Securities and Exchange Commission made the 1999 change. And
this one really amazed me when I looked at it, and again, the
computer fitted the lines. It is almost as if there is a
perfect correlation. As a former Professor at the University of
Maryland and now at Bellevue University, I know this doesn't
happen very often. I was just bowled over by it.
But the fact of the matter is that when the Securities and
Exchange Commission rule went into effect on April 7th, 1999,
the market dropped. It was unstable during the whole period of
the OTC registration process. When the OTC registration process
ended, it dropped again enormously; and, at the same time, the
regular market kept going up. I had that on there too, but it
is too confusing to add it.
I have all of the details in my formal testimony here. But,
to me, that is the proof. The Securities and Exchange
Commission is supposed to pay attention to capital formation. I
think their former response to this subcommittee shows they do
not.
As I tried to outline in detail in my testimony, the Rule
504 process did not find them taking capital formation into
consideration. The only specific amount they mentioned was a
$30,000 registration fee, which is a very small part of costs.
I estimate that cost alone is about 10 percent, or $250,000, of
an offering of about a million dollars. I presented some GAO
figures for higher offerings in my formal testimony.
So I just can't say how pleased I am that the subcommittee
is looking into this, that they are going to presumably
question the Securities and Exchange Commission and ask them
why they aren't following the law. I recommend that you also
apply consideration of capital formation to their rule for
oversight of private exchanges, that the Securities and
Exchange Commission try to find a new way for public companies
to use Rule 504 or a different rule. It doesn't matter what
rule it is, but some way to raise capital. Also, I would
encourage giving more control to stockholders. They are the
ones that really can keep fraud from happening.
And that is my time. Thanks for having me.
[The prepared statement of Hon. Donald J. Devine can be
found on page 55 in the appendix.]
Chairwoman Kelly. Thank you very much, Donald Devine. We
appreciate very much hearing from you.
Next we have some more testimony that I read last night
from Mr. Steinkirchner. Mr. Steinkirchner, thank you so much
for your testimony; and thank you for appearing here today.
Please proceed.
STATEMENT OF JAMES A. STEINKIRCHNER, CO-CHAIRMAN, NATIONAL
SMALL PUBLIC COMPANY LEADERSHIP COUNCIL
Mr. Steinkirchner. I would like to thank Madam Chairwoman
Kelly and Ranking Member Gutierrez and other Members of the
subcommittee for the opportunity to testify on critical issues
facing small business.
I am testifying today as the Co-Chairman of the National
Small Public Company Leadership Council and on behalf of the
small business marketplace we represent.
The Leadership Council, based in Washington, DC., seeks to
educate and inform Members of Congress about the economic
contributions of small emerging growth companies. Although the
Government has made great strides in the right direction, the
Leadership Council believes that more cost-benefit analysis
needs to be conducted on how it affects small business before
laws and regulations are passed.
In my written testimony, I address 10 key issues affecting
small business. Today, I will address four.
In 1982, Mr. Devine covered the Rule 504-C exemption. In
1999, the Government amended Rule 504 to a point where nobody
would really want to use it. Also, the Securities and Exchange
Commission and the press have created a stigma relating Rule
504 to fraud. I doubt very seriously if it ever will be used
again in its current form.
Instead, my proposal would be to create a new Rule 509
offering. It is kind of like a quasi-public offering. It would
be available to both public and private companies, be able to
raise up to $10 million.
Some key points to address. Investor protections, I would
mandate that an NASD underwriter would have to be used in this
type of offering, can advertise the offering, can use only line
road shows, use the modernization that Ms. Sweeney addressed
earlier in her testimony.
Abuses of the current short sale rules are depriving
individual investors of essential investor protections. They
also are making it more expensive for companies to raise
capital.
Some possible solutions to the illegal short-selling abuses
are: apply the uptick rule to both the NASDAQ small cap and the
bulletin board issues; develop a mechanism for tracking short
sales; identify 5 percent or more holders of the outstanding
stock or 10 percent of the public float; and create a new Rule
13S which would be filed with the Securities and Exchange
Commission. Those that have beneficial ownership must currently
use a 13D if they earn over 5 percent. Why not make those
holding substantial short positions report also?
Some other issues I would like to address are: one, minimum
stock price listing requirements for some of the exchanges.
When a company stock price approaches or drops below minimum
listing requirements, it actually fosters fraud and unethical
practices by imposing an artificial guideline in a free market
mechanism. A company's management has limited options to keep
itself from being delisted. It could create artificial demand
by issuing press releases, hiring promoters or reverse
splitting its stock. All these efforts are usually offset or
exceeded by the short sellers.
Another problem that we have in our industry right now is
what is called a ``toxic convertible'' or a ``death spiral
convertible.'' These instruments have exploded over the last 5
years from $274 million to $3.2 billion last year. Private
Investment in Public Equity, or another name it is called,
PIPE, deals have become a major source of capital for public
companies. PIPE deals do have their place in the markets, but
it is their offspring, the ``toxic convertible,'' that needs to
be regulated. In simple terms, the ``toxic convertible'' is a
private placement that enables investors to convert their
securities at a discount to the current market price usually
with no floor as to how low the conversion can go.
An investor who buys common stock of an issuer in a toxic
convertible loses, on average, 34 percent of his investment 1
year after a toxic convertible is issued. In the year 2000,
there were 220 toxic convertibles done, and only five were at a
higher price than before the offering. It is obvious the common
stock investor is getting burned by these convertibles.
Thank you. I would like to go into a little more. I guess I
ran out of time. I would like to thank the Leadership Council
and thank you.
Chairwoman Kelly. We thank you, Mr. Steinkirchner. You have
a little more time because we will ask you questions.
[The prepared statement of James A. Steinkirchner can be
found on page 69 in the appendix.]
Chairwoman Kelly. I would like to begin the questioning by
asking all of you one general question, and I want a very
succinct answer, please, because I, too, have a time limit.
My question is, I want to know how you think that we can
use, or you can use, the internet more effectively to get
information there to the Securities and Exchange Commission and
to make the disclosures. You have all mentioned the internet.
There is a reason that I am sure you want to do that. So, very
quickly, if you could all just chime in here. Thank you.
Ms. Sweeney. I guess I will start.
I think the thing that we see, we invest in companies every
day, so we are an investor ourselves, is that you can use a
company's website to do everything a registration statement
does and in a much more plain English, dynamic disclosure
means. So why not set out what are the disclosure requirements
that the Securities and Exchange Commission and the law
requires and ask companies to comply with them by keeping that
information updated on a quarterly basis right on their own
website?
I don't know if you have pulled down information from EDGAR
recently, but EDGAR is a very, very cumbersome system. There
are a lot of private sector systems like 10-K Wizard, and other
things that do a lot of things better than does EDGAR, but
companies on their own website are really the best at telling
their own story. So I think you use the website as the virtual
prospectus.
Chairwoman Kelly. Thank you, Ms. Sweeney.
As you were talking about that, you brought up the issue of
registration. I just want to quickly ask you one question about
that. Since you worked over there, is the registration process
used by the staff to leverage extract concessions from a
registrant like on a related or an unrelated matter? Is that
part of what is happening with the registration process?
Ms. Sweeney. I don't think so. I think what it just simply
is, is cumbersome. I brought, just so you could see, Allied
Capital's registration statement. This is our Form N-2, OK? No
one reads this. It is impossible. Look at the depth of the
print. I mean, what individual shareholder is going to pore
through this? They are not going to.
What is the problem in the registration statement process,
is that it is an outdated medium of communication. Plain
English, didn't really do anything. It made it so you could
maybe read it, but still there are tables in here that defy the
average shareholder to understand. I mean, it doesn't make any
sense. So I think that is the real problem. I don't think
necessarily that even the staff understands what is required in
a registration statement.
Chairwoman Kelly. Thank you. I want to go on and ask my
first question on down, but thank you very much.
I have more questions, but we have been called to a vote. I
am going to finish my questions, then I am going to take a
break, and with the subcommittee's indulgence we will be back
here--can I give everybody just 10 minutes to come back, or do
you want a standard 15? We will be back in 10 minutes, but
please answer the question.
Mr. Halpern. The current question?
Chairwoman Kelly. The first question.
Mr. Halpern. Sure. Certainly, I would second everything Ms.
Sweeney said, and I would add a couple of fundamental things.
As you had said, we had the distinction of doing the first
end-to-end stock offering on the internet, and I actually
thought that it was quite a novel approach, we worked closely
with the staff of the Securities and Exchange Commission to
clear it and we thought it could be an outstanding model for
companies to use in the future.
What we did was, we had the risk disclosure shown first;
and it was a simple two pages of risk disclosure that the user
could read. After that, they were forwarded on to the
downloading of the prospectus; and, finally, if they passed
through that, they could see the marketing material and then
subscribe online. It was done quite efficiently, in a matter of
a week's time we raiseed several million dollars. I thought it
would be a great opportunity for small businesses to have
access to capital markets.
But the other caveat that I would put in there, which camps
on to what was just said, is that if people were to read the
registration statements cover to cover and really understand
it, they probably wouldn't invest in anything. So that is the
reality of it. I think that the idea of full disclosure is an
important one, because it basically says, if we have junk, we
are telling you we have junk, and you can make a decision if
you like junk and you want to invest in it. But, beyond that,
the process becomes entirely subjective. Because if somebody
doesn't like any aspect of the business, then it becomes a
subjective process, and that can go on for some extended period
of time.
Chairwoman Kelly. Thank you.
Mr. Devine.
Mr. Devine. Well, these people in Government deal much more
in this on a practical level. In my experience in the
Government, it is very hard for the bureaucracy to do anything
new to keep up. That is why, in general, the fewer regulations
the better. And certainly it just makes fundamental sense to
bring the Securities and Exchange Commission into the 21st
century here and use the internet. It is just so elemental,
common sense.
Chairwoman Kelly. Mr. Steinkirchner.
Mr. Steinkirchner. The Securities and Exchange Commission
has already issued quite a few no-action letters; and Mr.
Halpern, I believe, received one relating to the internet. The
problem here is it has taken so much time to get the Securities
and Exchange Commission no-action letters, and basically what
they do is they test the waters with these Securities and
Exchange Commission no-action letters. This started way back in
1995, and we are already in the year 2001, and we still don't
have a general ruling on internet road shows, things of this
nature, offering prospectuses online, signature requirements
online. You could go on and on.
I believe right now that in the public arena you will find
that probably 90-something percent have a website right now. So
it is not like people don't have access to these companies.
I think you could get the private market to embrace the
internet also by providing financials, and Mr. Devine says I
would like to see them get into the 21st century.
Chairwoman Kelly. Good. That is wonderful. Thank you very
much for answering and being, all of you, all four of you,
being very clear about it.
We are going to take a break so that everyone can go to the
floor and vote, and we will see you back here in 10 minutes.
[Recess.]
Chairwoman Kelly. Mr. Gutierrez.
Mr. Gutierrez. Thank you very much.
Professor Devine, the dramatic growth of the internet has
provided a new medium for fraudulent operators to reach a much
larger audience than was ever possible over the telephone. Mr.
Devine, you obviously disagree with the approach that the
Securities and Exchange Commission has taken to prevent fraud
and ensure that adequate public information is available to
investors about small business insurers of securities. What
would you do to protect investors from fraud in these markets?
Mr. Devine. Well, it is not so much me that thinks that. It
was Congress in 1996 that passed the law saying that beside
taking into account questions of fraud, that the Securities and
Exchange Commission should also consider efficiency,
competition, and capital effects. And that is what I think they
need to do to make a balanced judgment, as the law requires
them to do. I am not sure that the internet does, in fact, open
things up to more people than the telephone. I would suspect
more people have a telephone than have a computer or are hooked
up to the internet. So, I don't think it's a question of
broader opportunities for fraud. I think, in their rulemaking,
as opposed to their enforcement action, they need to take into
account these other activities.
The Securities and Exchange Commission has had--and they
haven't asked for any major changes in the fraud statutes and
regulations themselves--they have sufficient powers to pursue
fraud. So I don't think it is a question of neglecting fraud.
When it happens, they should go after it and prosecute it, and
they do and they should continue to do that. I just think it is
a question in their rulemaking. They should consider these
other important things, and not so much because I say it--
although I happen to agree with it--but it also happens to be
the law.
Mr. Gutierrez. Mr. Halpern, if you could just follow up on
what Mr. Devine just said and answer the question. And also,
your company has successfully raised capital over the internet
in 1998, but dropped out of the registration process in the
year 2000. Could you tell us a bit more about how you were
successful in 1998 and why you dropped out in the year 2000 and
what has changed and maybe talk a little bit concerning the
question I raised with Mr. Devine?
Mr. Halpern. Yes, sir. Well, to follow on to what Mr.
Devine, I think, put well, there are many good rules already to
protect investors. Yet many investors still lose most, if not
all their investments. I mean, we legalize gambling, for
example, and let people go lose all of their money. And in
essence, you know, investing in the market is a form of
legalized gambling. But again, there are many good rules to
protect the investors. What I am calling for in that score is
if we want to protect investors, then let's protect all
investors, including those who have already invested in small
business. You see, there is this space in small business where
a lot of people don't want to invest because it is risky. And
most of these newer businesses, these emerging businesses get
their humble beginning from anywhere from credit card financing
to their friends and family to get started. Well, after that it
is hard for a lot of investors to want to participate, because
they don't see where the liquidity is going to come from.
One of the ways, a tremendous stimulation to the economy,
is to give investors a greater degree of confidence in these
emerging companies, which is--our acronym is advanced small
business. It is a business which is growing much faster than
businesses used to. In other words, in 3 to 5 years the company
is going to hit $100 million. It couldn't do that, you know, 10
years ago. It could only hope a much smaller fraction of that.
So I am saying let's protect all investors.
In my case, I already had almost 500 investors in the
Regulation A offer I conducted successfully online, and I
thought--I think you might have just stepped out when I started
to say that I thought that was a very novel process. I was very
proud of fact that we had done it online because it worked so
well. And I thought, wouldn't this be novel in a lot of small
businesses that have a difficult time in getting access to the
capital markets. And with Rule 504 and all the OTC things that
you hear that are so negative, wouldn't it be great if they had
a novel process the way Ms. Sweeney said, to use the internet
to produce commerce and investment capital in their business at
a minimal amount of effort and a minimal amount of cost. We
could essentially create a lot more opportunity for our
society. But, you know if we will give investors the confidence
to invest in early stages that they are going to achieve
liquidity, I believe we are going to dramatically stimulate the
economy, and I think new investment capital in that space is
sadly lacking.
So the other thing I wanted to say about any negativity
about protecting the investor, there are a lot of investor
protections. But we must remember that while we can't legislate
risk out of existence, we can legislate the future of small
business out of existence. And in my own process, all that
really happened, Congressman Gutierrez, was that when we did
the Reg A we said this is very novel. And by that time the
Securities and Exchange Commission was looking at a lot of
companies raising money online and saying ``this is making us
nervous.'' We didn't see that it would really work. And so when
we went back in the process with another self-underwriting,
which was the SB2, the small business regulation, I firmly
believe, although again I don't blame anybody. I feel that it
would almost be a relief for the Securities and Exchange
Commission if it had an easier way to cope with small emerging
businesses. I don't believe they have a way to cope with it. So
they have to move you from point A to point B until someone
else says, well, you release it. Well, no I don't want to. You
do it. And I think that is a huge problem.
Mr. Gutierrez. Well, following up on that, I would like
Ms. Joan Sweeney to wrap up, because I am over my time. We have
an Executive Summary of ``Modernizing the Regulation of
Business Development Companies.'' I would like to ask that this
be entered into the record of this hearing and ask Ms. Sweeney
when she thinks the report will be done.
[The information can be found on page 34 in the appendix.]
Chairwoman Kelly. Without objection.
Mr. Gutierrez. And give us just a brief overview of the
report and when you think it will be done.
Ms. Sweeney. Sure. We, Allied Capital, are a member of
something we call the Committee for Modernization of BDC
Regulation. And there are a handful of BDCs out there who also
share our views that it is just very difficult to operate
within the 1940 Act. I don't know how much time any of you have
spent with the 1940 Act, but it is a very cumbersome piece of
legislation. The subcommittee is now circulating a report
within the committee to make sure that everyone agrees that
these are the issues, things that need to be done, very, very
simple things to modernize BDC regulation. I touched on one in
my testimony, which is integrated disclosure.
I mean, that is somewhat of a no-brainer when you get down
to it. That is just simply allowing us to do what other
companies can do on their Form S-3 registration statement. The
other things that we are looking to do is, for instance, break
down some of the barriers with respect to affiliated
transactions.
The Investment Company Act of 1940 is set up to prevent bad
external managers from doing bad things to shareholders of
mutual funds. That is a noble purpose and there are bad fund
managers. For instance, if you know, the management company is
external; it could have cross purposes with the fund. A
business development company is usually internally managed.
There is no way the business development company is going to
disadvantage itself dealing with itself. It is the same entity.
And there is a whole cadre of rules within Section 57 of
the Investment Company Act of 1940 that is set up to
essentially prevent an activity that really wouldn't happen in
any operating company. So there are various things like that
that are really simple fixes to the operation that we think
could encourage the flow of public company capital to small
businesses.
You know, the hardest thing about investing in a small
business--Mr. Halpern touched on it--isn't even necessarily the
risk, it is the liquidity. You are a company with a market cap
of less than $100 million. People will not invest in you simply
because you are illiquid. You know getting in and getting out
of the stock can cause problems. BDC has fixed that. If you
look at Allied Capital, we are about a $2.2 billion market cap
BDC. We have huge liquidity. People can invest in Allied
Capital, get a nice 8 percent dividend because we pass our
earnings to our shareholders. Come in and out of us, while we
put money into illiquid companies. Our portfolio to date is
about 125 companies that have gotten their investment capital
from public investors, but in a liquid format. So we think BDCs
are a great thing that should be really studied and embraced.
Mr. Gutierrez. Thank you. Thank you very much.
Chairwoman Kelly. We turn now to Mr. Shows.
Mr. Shows. No.
Chairwoman Kelly. No questions?
Mr. Shows. No.
Chairwoman Kelly. All right. Since there seems to be a bit
more to be discussed here I think we will go into--with the
indulgence of the panel--a second round of questioning, if that
is all right.
Ms. Sweeney, you had mentioned a couple of things that I--
one thing in particular I would like to ask you about. I would
like to know how the regulatory process can be used to impose
unduly burdensome requirements on a company. Can you give us
some examples of that?
Ms. Sweeney. Sure. You know, I think, as I say, there are
some pretty simple things and probably the most burdensome
process any public company can undertake, whether it is in the
initial public offering or in registering securities a second
time, third time, fourth time around, is the registration
process. That is probably where the average public company
touches the Securities and Exchange Commission most frequently.
That process is so antiquated and outdated, and it causes huge
delays. This is where you will get questions on whether we
should be using the word ``such'' items versus ``certain''
items. OK, that is a comment. To spend the legal time
addressing that comment adds little value, if any, to the
registration process.
I don't know if any of you have spent an all-nighter at a
financial printer with an army of lawyers responding to a
litany of staff questions, largely in plain English. But I can
tell you it adds a lot of cost and burden to the process.
The other thing is, I don't think necessarily the level of
examiner you get within the Division of Corporation Finance, or
other divisions within the Securities and Exchange Commission,
really have the business savvy to understand the magnitude of
some of their information requests. For instance, we took a
company private in the fourth quarter of 2000. This was a
company that really couldn't access the public markets,
unloved, low market cap. It is our job as a BDC to fund these
companies. We took it private and we had to do it through a
merger. We actually issued Allied Capital stock to complete the
transaction, a very innovative way of using a BDC capital to do
something good for another public company. In that process we
were floored to find out that, because it was a merger in form
and a going private transaction, that there was a requirement
in the rules that we had to actually file and disclose board
presentations that were done to effect the merger. We are
talking about a company's trade secrets, the internal works of
the board of directors, as they evaluated why the merger was
good, taking their projections and filing it with the public.
Now, that is kind of stepping over the bounds of disclosing
trade secrets that most likely really wasn't necessary for
those shareholders to make an educated decision on the proxy
that they were being presented to decide, whether or not they
were getting an adequate premium over their market price. There
is fairness opinions done by the investment banks. Shareholders
can make their own decisions. Shareholders can call management.
Understand this: There is no need to take the inner workings,
you know, that is pretty confidential information of the board
of directors, and file it. So those are the types of things
that are just huge, time consumers and also maybe overreaching
in terms of disclosure through kind of a registration process.
Chairwoman Kelly. I thank you very much, Ms. Sweeney. One
other question that I had was the question about the shelf
registration. You mentioned in your testimony that there is a
question in my mind about the fact that you can't use
information that is already provided to the public through the
different forms, the 10-Ks and the 10-Qs. Could you speak about
that just a little bit, please?
Ms. Sweeney. Yes. This is what we think is pretty much an
oversight for BDCs. BDCs are required to file 1940 Act forms.
So we re-file our registration statement on a Form N-2 every
time we post new quarterly information. So, once a quarter we
have to update this thing, and fully, all the way through, and
refile it and subject ourselves to staff review, once a
quarter. If we were Coca-Cola, any other company out there,
public company, that doesn't file under the 1940 Act, that
files their shelf on something called an S-3, which most
companies file, they don't have to do that. They put their S-3
up at the Securities and Exchange Commission and they are
allowed to have integrated disclosure. Form 10-Qs and Form 10-
Ks update their shelf registration statements. So we have a
kind of mechanism that doesn't work, where companies that file
on N Forms aren't allowed to do that. Companies that file on S
Forms are. A very simple fix would allow those on N Forms to do
the same thing.
So this is the thing we have been waiting on for about 3
years to try to solve.
Chairwoman Kelly. Well, good. I am glad we at least had a
chance to discuss it. Thank you.
Mr. Steinkirchner, I wanted to just quickly ask you one
question, and if you would just fill me in on your thoughts and
the new Rule 509 legislation that you had proposed. Could you,
sir, please pull the microphone closer to your mouth so we can
all hear you? Thanks.
Mr. Steinkirchner. OK. Rule 509 is actually a rebirth of
Rule 504 almost. But it adds some more investor protections in
there. And basically what I wanted to do with Rule 509 is
create a modernization type instrument where you could use
online road shows, put your financials up on the site, offer a
prospectus all online, because using the internet is cost
effective. I mean, it is just much less costly to use the
internet. So the Securities and Exchange Commission has allowed
it in certain circumstances and it has all worked out
relatively well. They haven't revoked anybody's Securities and
Exchange Commission no-action letter, so I would say that the
online no-action letters that have been approved to date have
been working quite effectively.
But I also wanted to create a new investor class that could
get involved in private offerings. Currently, the Securities
and Exchange Commission segregates investors into two classes,
nonaccredited and accredited, and what I wanted to do is create
a semi-accredited. It is an investor class that is in between
these two. Last year, there were five million Americans that
qualified as credited investors. Out of that five million,
250,000 contributed about $60 billion to the private
marketplace to fund small businesses. And if we could create a
new investor class that has the financial sophistication--I
mean, I deal with these people on a day-to-day basis. They want
to get involved in these private transactions, but are
restricted under these requirements. And by adding a layer of
protection by making sure that an NASD member underwriter is
the only type of underwriter that can underwrite this type of
security, what you are doing is you are effective putting the
investor under all the NASD scrutiny that both the broker
dealers and the issuers have to deal with. So I am kind of
covering the investor protection rule there and making sure
that the client is suitable for the investment.
Some other issues are I would like to put a cap on it of
$10 million, but I also wanted to have a minimum contingency of
$2 million, and that the money had to be escrowed in an escrow
account. Although this is a little more costly, I think it will
protect the investor a lot more. More importantly, by putting a
minimum contingency, this will ensure, hopefully, in a lot of
cases, that there is enough money for the business to progress.
And I could go over numerous other examples, but the bottom
line, Rule 509 is kind of like a quasi-public offering. What
you have right now is you have public offerings that are doing
private offerings, which are called pipe deals, and we are
talking hundreds of billions of dollars have been done in these
pipe deals. It is a quick, effective way for public companies
to raise money. And now, by using the internet, you have
private companies offering over the internet. So effectively
they are becoming public offerings. So instead of having two
separate classes, why don't we just put it right in the middle?
In a way, it is like a quasi-public/private offering. But it
would open it up to another 12.8 million Americans, would
afford them investor protection. It would give small business
an instrument that is cost effective.
I will give you an example. In the State of Georgia, where
I reside, over the last 5 years there were roughly 200-and-
something, low 200s, Rule 504 offerings filed with the
Secretary of State. There were only 32 offerings that were
completely subscribed, and out of that 32, 80 percent of them
used an underwriter. The bottom line is that even if you do get
through and you put a registration statement together using
Rule 504 and you are a private company and you submit it with
your State regulator and they approve it, these aren't people
where their profession is raising capital. And the problem is
they get through this whole process and at the end of the day,
they find that they haven't raised the money. And I think in
order for small business to have a way of raising capital, I
think they need to use a professional.
Thank you.
Chairwoman Kelly. Thank you very much.
Mr. Gutierrez.
Mr. Gutierrez. Thank you very much. You just, real quickly,
commented that, well, there probably are more phones than
people hooked up to the internet. The fact is that people are
using the internet a lot more than phones, especially to make
investments. Senior citizens are a growing group of people that
are using the internet.
So while you might have more phones than internet, the
internet is the vehicle of use for making investments. All you
have to do is turn on the TV to see all the different companies
who are making offerings and competing with one another for
$9.95 a trade, $19.95 a trade. It is an explosion, and it is
all on the internet. They don't say ``call this phone number.''
They say ``get on the internet and make these trades.'' It is
the quick way to do it. And especially senior citizens we have
noticed have an increased--and I am surprised, because I am 47,
so I am hoping the next 20 years go quickly so I can become an
internet user, too, given that at the age of 47 it appears that
older folks and younger folks than me, I think it is the people
in the middle that don't know how to use the computer. If you
are young or if you are older, it seems like that is what you
are doing.
So that was kind of where I was going with my questions.
But I thank you, Doctor, for your answer and for the security
questions. I do want to ask a couple of questions, another one
of Mr. Devine.
During the period before Rule 504 was--I am sorry. I need
to also get glasses--was put into law, how many companies took
advantage of it and how much money was raised?
Mr. Devine. I don't think anybody really knows the answer
to that question. At least I haven't been able to find it. The
anecdotal assumption is that a very large proportion of the
capital for small public firms was raised through Rule 504.
Since these were only required to be listed in States--and in
New York didn't have to be listed at all, and I think the
Securities and Exchange Commission correctly got rid of that
exemption--nobody really knows. But, at least anecdotally, it
was a very large proportion of the funding of small public
companies.
Mr. Gutierrez. OK. I have a question, another question,
for my fellow Illinoisan. You expressed in your testimony
another issue that affects particularly advanced small
businesses such as yours in the Investment Act of 1940, which
requires public companies to hold up to a maximum of 40 percent
of their values in the securities of other companies. How do
you think this law can be amended and/or improved to better
serve the current needs of companies such as yours?
Mr. Halpern. Well I think that is an excellent question,
and Ms. Sweeney, I think, made a good point about the
Investment Act. And just really the purpose of the Investment
Act was to manage and regulate the mutual fund industry. And we
clearly are an advanced small business, as we had said earlier.
I mean, these are companies that have grown much quicker and
are trying to help companies in a much earlier stage and have
very little to do with public investing and mutual funds. I
think that the Investment Act of 1940--not the Investment Act,
but the NMSIA, the 1996 National Market Securities Improvement
Act, clearly gives some latitude. It gives latitude to allow
companies to be exempt from some of those processes, and when
we go through that department, what happens is they really
don't know what to do with us. I get that feeling. I don't get
the feeling that there is somebody there that is antagonistic.
They are just saying ``How do we fit you into that mold from
1940?'' And since they can't figure it out, every time we
reinvent ourselves to try to suit it they say, ``Well, gee,
then you have a problem with accounting.'' And if we change the
accounting by restating financial statements, then they say,
``Well, then you have a problem with the Investment Act.'' And
then, if you have a problem with the Investment Act, but you
are operating as an Investment Act company, and you do that for
an extended period of time, then you have to go the enforcement
department and have an enforcement action because you are out
of compliance.
So these processes are neither effective or economical for
anybody in the Government. And I generally--if I were--I am
trying to put myself in a staff member's shoes and say, well,
if I was them looking at me I would say all I have got is
oranges and apples in my bowl and you are a kiwi. Well, there
are a lot of kiwis now and they need a bowl.
And I don't know if this helps you, but I think something
that is a very good point here is, I think this subcommittee
and the Securities and Exchange Commission have an opportunity
to do for the Securities and Exchange Commission and to do for
small business what was done a few years back for the IRS,
where if you think about it, you know, if you are already
collecting upward of 40 percent of someone's hard-earned income
and in addition you are taking 20 percent of their after-tax
family budget in hidden regulatory costs, you would think that
it pays to be very nice to those people, because they are
working hard so the money can be distributed, so the Government
can proliferate and do a good job managing its interests.
But I think that in the case of the Securities and Exchange
Commission, it is like an accident out on the highway. Two cars
crash, nobody knows whose fault it was--and I am not here to
say it is anybody's fault, because I don't think there is any
fault. I just think we have a process which clearly doesn't
work. And if you ask me to summarize, what I would tell you is,
it could work, but somebody there at the staff has to let it
work. They don't know it is OK to let it work.
No-action letters? Well, those are irrelevant, because
everyone has a disclaimer at the bottom that says ``By the way,
if we change our mind later, then this doesn't apply any
more.'' And those disclaimers are continuously put into every
single process at the staff. I don't think it is from the
intent to harm small business, I think it is the reality of the
regulatory machine that has built itself up into a corner and
put a lot of tape around it. And so they can't see a clear way
to do this.
But I clearly represent the 21 million small business
professionals who have businesses, and many of them avoid
altogether, or once in the process, drop out because it is too
costly, it is too time-consuming, it doesn't produce the
desired result. So I am calling for a process to assist the
Securities and Exchange Commission in continuing on with its
mission to protect investors.
I think Mr. Steinkirchner made some excellent points about
how investors could be protected in the smaller markets, but
give more stimulation. And I think what you get then is like we
said with the IRS. Now if you call the IRS, you get a friendly
process. A few years ago that wasn't the case. I think there
should be a spirit of cooperation and a friendly process that
we can participate in and grow these economies of scale and
produce, as was mentioned earlier, a transparent process using
what the other panelists have quite accurately said, the
internet process.
Mr. Gutierrez. I think that we will be delving into that
issue. Let me say the only Federal regulator I have to deal
with is the Federal Election Commission in terms of keeping my
reports, and we have gone online. And since we have gone online
it certainly has helped us and everybody gets to know what I am
doing and the information, and it has worked pretty well. But
they are not--they haven't been particularly cumbersome over
there. I mean, if they raise a question about a $10,000
contribution to the Democratic Party of the State of Illinois,
we kind of write them back. But that is where I spend my money,
my legal money, dealing with the--unfortunately I have to spend
money, because they raise an issue and, of course you don't
want your opponent to raise it later on and you want to be
within the law--only to find out that they were wrong, that I
could indeed give that $10,000 to the State Democratic Party
and that they made a big thing. But in this particular case,
don't worry. All the Democrats in Illinois gave the same
$10,000. So we all got the same letter. So we figured if we are
in trouble we are all in trouble together.
But it does cause anxiety. I mean, the anxiety that it
causes is something that I want to relieve for investors out
there that are developing businesses that I don't--it causes--
you know, your lawyer calls you, ``call your lawyer.'' It is
like everybody is in a panic that you have done something wrong
and illegal, and I want to make sure that we can get through
that process in a manner in which investors can--especially
that are trying to run companies, especially small businesses.
They have got a lot of other things to deal with than a lawyer
calling them panicked that they are out of regulation, that
somebody is going to come down hard on them.
And so, thank you so much to all the panelists for coming
here on behalf of the minority. Thank you very much.
Chairwoman Kelly. Mr. Shows.
Mr. Shows. Thank you, Madam Chairwoman.
Mr. Halpern, I was reading your testimony, and Mississippi
has a lot of startup small businesses going even though we are
a small State. And one of the questions I would like to ask you
in your statement, and I will read the question first, is what
do you think the main factor affecting the responsiveness of
the Securities and Exchange Commission to the needs of small
business--this probably is outdated laws, and maybe
undertrained personnel or disorganized regulatory structure or
maybe a tracking system. But your statement says here, when you
were trying to get your money and raise capital, you said
``staff members continue to contact our service, saying they
still do not understand the nature of our business.'' I find
that true in dealing with reporters sometimes, in that when you
try to explain--as a Highway Commissioner back in Mississippi,
I tried to explain a project to a reporter, who may be a young
reporter, who didn't really understand what I was trying to
tell them and I didn't know how to break it down where you
didn't make them feel bad about asking that question. And I
know that is probably the same problem that you have.
How do you explain to the Securities and Exchange
Commission what you are trying to do and yet get it to where
they can understand where they can write the guidelines for you
to perform like you would want to? And that is what I am
interested in, is trying to let small business be able to come
in and work with the Securities and Exchange Commission and so
we still have the--and I guess what everybody else is talking
about--you know, simplify it enough so that the company doesn't
get like you did, so disheartened with the system that you
almost throw the paper up and walk out the door. And we need to
turn that around. And what would you say would be the thing
that we need to do to the Securities and Exchange Commission to
help them to help small business?
Mr. Halpern. Well, I think that is an excellent point
that you are raising, and it brings back to mind two of the
different approaches that we have discussed here. One is that
in the short term I would like to see the processes that are in
place be used the way I believe that they were intended to be
used. In other words, in the National Market Security
Improvement Act of 1996, clearly that is an act of Congress
which said the Securities and Exchange Commission will consider
efficient competition and capital formation in its rulemaking
activities. But I don't think there is any spirit of
cooperation there, because as the internet evolved there became
a sort of fanaticism within the staff that there must be a lot
of scams there. In fact, I attended one of these Securities and
Exchange Commission meetings, an enforcement meeting in New
York early-on, about 2 years ago, and one of the marketing
people from the staff got up and said, ``Well, you know, people
think that you know we are not on it. We don't have enough
people to keep track of all the scams out there. But actually
we are way ahead of it. We have hired hundreds and hundreds of
new people, and we are on it all the time.'' And what I think
it became was a fishing expedition. And again, you know, not
with the intent, but the idea that, well, with the internet
evolving there must be all these scams. And sure, there are
scams. But as I said before, and I want to reestablish this
point, you cannot legislate risk out of existence. But you can
legislate the future of small business out.
So that was the first point. The point was let the systems
that are in place do what they were intended to do. First, you
need a person in there that says, ``Now wait a minute, we have
a process that could work.''
Regulation SB was designed, and it was released in 1992,
because in the late 1980s, banks started tying up the coffers
on lending to small, new, emerging companies. And you have seen
this. So they said we are not going to lend. So in response,
Congress said let's do Regulation SB. And so SB was designed
for small business to have an easier and friendlier process.
The problem is, it is not an easier and friendlier process. In
fact, if you go in and say ``I am a small business,'' they say,
``Ooh, I don't know what that means to me, other than I don't
have a bowl to put you in.'' So you will have to go around and
around the staff. In our case, the first registration process
was successful, but the second one wasn't because it took too
long to get through. And by that time, most of my competitors
had lost 98 percent of their initial value of a year earlier.
Now, we had the distinction of funding 10 companies in that
process. And today our 10 companies stand tall, have strong
beating hearts and have grown and thrived in a down market,
which I think says something about we are more of a traditional
style of business rather than the dot.com that, you know,
selling buzzwords such as B2B, B2C infrastructure. But with
your small businesses that are in your home State I think it is
critically important that they have a process.
Maybe the Rule 509 prepared by my collegue would be an
earlier stage process. They must be inspired though, no matter
what the process, to follow the process that should work. And
when the company gets in the process, I think they should be
embraced. If you come here to Washington to the Securities and
Exchange Commission and you say ``I am a small business,'' I
think you should have a red carpet thrown out and say, ``You
are going to create more jobs and more money for our staff to
run itself and take care of real problems. So therefore, we
embrace you.''
But it is really not that way. It is more of a mean-
spirited approach, saying ``We don't really understand,
therefore we will shuffle you around and see what happens.''
And you know, I survived it. OK. I am here on my dime to come
here because you were willing to take your time and listen. But
I think it is a critically important issue. And I think, step
one, let's make the processes that are already in place work.
They have latitude. Let's give latitude. Let's get rid of these
things. Let's give latitude to this BDC. Let's give latitude to
investors and let's make them work. My second phase will give
the Small Business Advocacy and Liaison Office, the 19th office
in the Commission, a long-term latitude, a long-term
communication process that would allow us to keep track of what
is going on and make sure that there is a special interest
group within the staff that always says no matter what rules
are going on, you know, we have a process to help the small
business get through so it can become a big business some day
and create more jobs and more economy and more value.
Mr. Shows. But don't you think that is the intent of
Congress, but the mindset of some of the Securities and
Exchange Commission is still set this way and not initially the
intent of Congress? We would like for it to work. Like you
said, it is in place. Now, why isn't it working? Is it because
some of the people have been there so long their mindset is set
in that fashion?
Mr. Halpern. Yes.
Mr. Shows. And they are locked in and they don't feel like
they are going anywhere?
Mr. Halpern. Yes. I think it is as frustrating for the
staff as it is for us out here. You know, they may not be aware
of it, because they will go home and come back every day, you
know, going to the same job, not being concerned in the least
with what the outcome is. But we are concerned because it is
our business. I think this is an issue where we all can say
yes, we get it. We have to figure out a way to help small
business and achieve the desired result. And I think given that
opportunity the staff would say, ``OK, give us some clear
instructions on how to handle these other entities and we will
do it.''
Mr. Shows. Thank you.
I appreciate it, Madam Chairwoman.
Chairwoman Kelly. Thank you, Mr. Shows.
Mrs. Jones, have you questions?
Mrs. Jones. Yes.
Good morning. I missed some of your presentation and I am
trying to quickly read through your statements to kind of catch
up here. I also sit on the Small Business Committee, so the
combination of these two works very well. I am trying to, in my
second term in Congress, improve. I come from the City of
Cleveland and we are always looking for more capital investment
in Cleveland. So if you don't have any investment in
Cleveland--I don't have a company, but please come on in and do
some work because we need it.
Let me also say, I think that small businesses are key to
creating stronger communities throughout this country. We have
had great success in building new homes in Cleveland in many
communities, but we need some businesses to go with those new
homes to really create a community.
Ms. Sweeney, I am looking at your statement, and you speak
about not being able to use an integrated disclosure for
purposes of your shelf registration statement and other things.
Are there other examples of improvements that you can suggest
that the Securities and Exchange Commission could do in order
to assist small business in working its way through the
process?
Ms. Sweeney. Yes. I will answer that and also follow up on
some of the points Mr. Halpern made.
Mrs. Jones. No problem.
Ms. Sweeney. I have kind of got an interesting background
myself, because I was with the staff of the Securities and
Exchange Commission.
Mrs. Jones. I read that.
Ms. Sweeney. In the Enforcement Division, and I have got to
tell you, there are lot of bad people out there and there does
need to be a very strong Securities and Exchange Commission
that does protect the widows and orphans, because there are a
lot of scam artists out there. So regulation, I think, is a
good thing.
What I think has happened to our Securities and Exchange
Commission, and I think it has happened more in the decade of
the 1990s than you saw in the 1980s, is there has been a
misplacement of emphasis and a misplacement of leadership at
the core of the Securities and Exchange Commission to focus
time on interpretive positions, rulemaking, and exemptive
orders, because we are dealing with a body of law that is 70
years old. The capital markets move. Law can't possibly keep
pace with the speed of the capital markets. Death spiral
preferred is a classic example. This is a preferred stock
instrument that is killing common shareholders. How can people
at the Securities and Exchange Commission stay on top of that
if their time is spent in low value-add activities like
reviewing registration statements?
There is a ton of very, very talented staff members at the
Securities and Exchange Commission that have the capabilities
to spend their time thinking of interpretive positions,
rulemaking and ways to increase access to capital. But when
their hours, their daily work hour is spent pouring through
these--do you know I have to file one of these every quarter
and someone has to review it? I mean, when that time is spent
doing that, how can they have time to think of the bigger
picture and think about how to push access?
So it really is a very simple change. It is a change in
emphasis from low value-add to maximum value-add, and that is
really all that needs to happen.
Mrs. Jones. OK.
Mr. Devine, or Mr.--want to pronounce that for me?
Mr. Steinkirchner. Steinkirchner.
Mrs. Jones. Steinkirchner. Would either of you like to add
anything based on what we have discussed before my time is up?
Mr. Devine. On the question of the Securities and Exchange
Commission itself, I will speak as somebody with some
background in Federal personnel, being in charge of it at one
time. Bureaucracies aren't known for quick response. I mean,
that is kind of the nature of bureaucracy. And the Securities
and Exchange Commission is no better or no worse than probably
any other bureaucracy, maybe a little better than most. But the
problem is that changing ways of thinking in a bureaucracy is
enormously difficult. And I think the history of the 1996 Act,
in Chairman Oxley, and former Chairman Bliley's attempt to get
the Securities and Exchange Commission to respond, in the kind
of response that in my opinion was enormously inadequate, you
can see right there reading it--that they are not responding--
or in reading the cost-benefits section of the change to Rule
504. I mean, you can see they just don't get it. And I don't
think it is necessarily a bad spirit; but they just don't get
it. And that is why these hearings, to me, are so important.
The Congressman from Mississippi--I am afraid, unlike Mr.
Gutierrez, I am already old, so I can't read his name. I
apologize.
Mrs. Jones. Shows. Ronnie Shows.
Mr. Devine. He asked, ``Congress didn't intend.'' And that
is very clear. Congress intended the Securities and Exchange
Commission to look at the broader picture. And in my experience
in this business, the only way you can do it is you keep going
back and telling them again and again. That is why my every
other word is thanking you for having this hearing.
Mrs. Jones. Do I have a moment to allow the last gentleman
to respond?
Chairwoman Kelly. Of course.
Mr. Steinkirchner. Thank you. Well, I will give you two
conviction solutions, one a standardization of the offerings.
The reason why that book is as big as it is is because the
Securities and Exchange Commission asks you to put what is
pertinent that investors should know. But that is all they say.
They don't tell you exactly what is needed to be put in that
document. And I think if they found what was necessary for
investor protection to put into a document of that nature, that
would go down dramatically, and I think Ms. Sweeney would
probably agree with me.
Two, education. If we want people to stop getting burned
over the internet or through whatever, we need to educate the
public a lot more about private and public offerings, and that
is the number one way. I mean, we have been harping for--I
don't know, 20 or 30 years, to use seatbelts and now people are
using seatbelts. And I think if we harp on them that, ``Hey, I
think you should get a registration document, here are 10
things that you should look at before you place money in a
private company,'' or a public company or whatever, and harp
this continually, I think you will cut down the amount of scams
and frauds that are occurring over the internet, through the
mails, and over the telephone.
Mrs. Jones. Thank you.
Chairwoman Kelly. Thank you very much, Mrs. Jones.
If there are no more questions I am going to note that some
Members may have additional questions and they may wish to
submit them in writing. So without objection, the hearing
record is going to remain open for 30 days for Members to
submit written questions to these witnesses and to place their
responses in the record.
I really thank this panel. You have been extraordinarily
patient with us. We do have more questions I am sure. You have
also been very interesting in your responses, and we do thank
you for your indulgence in allowing us a second round of
questions here.
This panel is excused with our great thanks, the
subcommittee's great thanks, and appreciation for your time.
This hearing is adjourned.
[Whereupon, at 11:15 a.m., the hearing was adjourned.]
A P P E N D I X
June 26, 2001
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