SEC CHAIRMAN WHITE'S ADDRESS AT SEC SPEAKS 2014

FROM:  SECURITIES AND EXCHANGE COMMISSION 
Chairman’s Address at SEC Speaks 2014
 Chair Mary Jo White
Washington, D.C.

Feb. 21, 2014

Good morning.  I am very honored to be giving the welcoming remarks and to offer a few perspectives from my first 10 months as Chair.  Looking back at remarks made by former Chairs at this event, the expectation seems to be for me to talk about the “State of the SEC.”  I will happily oblige on behalf of this great and critical agency.

In 1972, 42 years ago at the very first SEC Speaks, there were approximately 1,500 SEC employees charged with regulating the activities of 5,000 broker-dealers, 3,500 investment advisers, and 1,500 investment companies.

Today the markets have grown and changed dramatically, and the SEC has significantly expanded responsibilities.  There are now about 4,200 employees – not nearly enough to stretch across a landscape that requires us to regulate more than 25,000 market participants, including broker-dealers, investment advisers, mutual funds and exchange-traded funds, municipal advisors, clearing agents, transfer agents, and 18 exchanges.  We also oversee the important functions of self-regulatory organizations and boards such as FASB, FINRA, MSRB, PCAOB, and SIPC.  Only SIPC and FINRA’s predecessor, the NASD, even existed back in 1972.

Today the agency also faces an unprecedented rulemaking agenda.  Between the Dodd-Frank and JOBS Acts, the SEC was given nearly 100 new rulemaking mandates ranging from rules that govern the previously unregulated derivatives markets, impose proprietary trading restrictions on many financial institutions, increase transparency for hedge funds and private equity funds, give investors a say-on-executive pay, establish a new whistleblower program, lift the ban on general solicitation, reform and more intensely oversee credit rating agencies, and so many others.  These rulemakings, coupled with the implementation and oversight effort that each one brings, have added significantly to our already extensive responsibilities and challenge our limited resources.  These mandates also present the risk that they will crowd out or delay other pressing priorities.  But we must not let that happen.

All of this is upon us at a time when our funding falls significantly short of the level we need to fulfill our mission to investors, companies, and the markets.  As Chair, I owe a duty to Congress, the staff, and to the American people to use the funds we are appropriated prudently and effectively.  But it also is incumbent upon me to raise my voice when the SEC is not being provided with sufficient resources.  The SEC is deficit neutral.  Our appropriations are offset by modest transaction fees we collect from SROs.  What does that mean?  It means that if Congress provides us with increased funding, it will not increase the budget deficit or take resources from other programs or agencies, but it would go directly to protecting investors and strengthening our markets.  Given the critical role we play for investors and our expanded responsibilities, obtaining adequate funding for the SEC is and must be a top priority.

Fortunately, what has remained a constant over the years at the SEC is its magnificent and dedicated staff.  Indeed, it was the commitment, expertise, and moral, apolitical compass of the staff that led me here.  The SEC staff is a deep reservoir of extraordinary talent and expertise with a strong and enduring commitment to public service and independence.  And that is what has sustained the excellence of this agency since its founding.

Exercising my prerogative as Chair, I would now like to ask each SEC employee in the audience to stand and be recognized.  Please remain standing while I ask that everyone here today who once worked at the SEC to please also stand to be recognized.  In our most challenging moments, I urge all of us to think about the colleagues we just recognized, marvel at their public service and say thank you.

Back to the state of the SEC in 2014.

When I arrived at the SEC last April, I initially set three primary priorities: implementing the mandatory Congressional rulemakings of the Dodd-Frank and the JOBS Acts; intensifying the agency’s efforts to ensure that the U.S. equity markets are structured and operating to optimally serve the interests of all investors; and further strengthening our already robust enforcement program.  Ten months later, I am pleased with what we have accomplished.

Rulemaking
When I arrived, it was imperative to set an aggressive rulemaking agenda.  Congress had seen to that and our own core mission demanded it.  And, through the tireless work of the staff and my fellow Commissioners, we made significant progress.

On the day I was sworn in as Chair, we adopted identity theft rules requiring broker-dealers, mutual funds, investment advisers, and others regulated by us to adopt programs to detect red flags and prevent identity theft.[1]

A month later, we proposed rules to govern cross-border swap transactions in the multi-trillion dollar global over-the-counter derivatives markets.[2]

A month after that, we proposed rules to reform and strengthen the structure of money market funds. [3]

Last summer and fall, we made significant progress in implementing the reforms to the private offering market mandated by Congress in the JOBS Act.  We lifted the ban on general solicitation[4] and we proposed rules that would provide new investor protections and important data about this new market.[5]  We also proposed new rules that would permit securities-based crowdfunding and update and expand Regulation A.[6]

We adopted a Dodd-Frank Act rule disqualifying bad actors from certain private offerings.[7]

We adopted some of the most significant changes in years to the financial responsibility rules for broker-dealers.[8]

We adopted rules governing the registration and regulation of municipal advisors.[9]

We adopted rules removing references to credit agency ratings in certain broker-dealer and investment company regulations.[10]

In December, together with the banking regulators and the CFTC, we adopted regulations implementing the Volcker Rule.[11]

And, just last week we announced the selection of Rick Fleming, the deputy general counsel at the North American Securities Administrators Association, as the first Investor Advocate, a position established by Dodd-Frank.[12]

As even this partial list shows, we have made significant progress on our rulemakings, although more remains to be done.  But we must always keep the bigger picture in focus and not let the sheer number nor the sometimes controversial nature of the Congressional mandates distract us from other important rulemakings and initiatives that further our core mission as we set and carry out our priorities for the year ahead.

Other Critical Initiatives
To be more specific, in 2014, in addition to continuing to complete important rulemakings, we also will intensify our consideration of the question of the role and duties of investment advisers and broker dealers, with the goal of enhancing investor protection.  We will increase our focus on the fixed income markets and make further progress on credit rating agency reform.  We will also increase our oversight of broker-dealers with initiatives that will strengthen and enhance their capital and liquidity, as well as providing more robust protections and safeguards for customer assets.

We also will continue to engage with other domestic and international regulators to ensure that the systemic risks to our interconnected financial systems are identified and addressed – but addressed in a way that takes into account the differences between prudential risks and those that are not.  We want to avoid a rigidly uniform regulatory approach solely defined by the safety and soundness standard that may be more appropriate for banking institutions.

In 2014, we also will prioritize our review of equity market structure, focusing closely on how it impacts investors and companies of every size.  One near-term project that I will be pushing forward is the development and implementation of a tick-size pilot, along carefully defined parameters, that would widen the quoting and trading increments and test, among other things, whether a change like this improves liquidity and market quality.

In 2013, our Trading and Markets Division continued to develop the necessary empirical evidence to accurately assess our current equity market structure and to consider a range of possible changes.  Today we have better sources of data to inform our decisions.  For example, something we call MIDAS collects, nearly instantaneously, one billion trading data records every day from across the markets.  We have developed key metrics about the markets using MIDAS and placed them on our website last October so the public, academics, and all market participants could share, analyze, and react to the information that allows us to better test the various hypotheses about our markets to inform regulatory changes.[13]

The SEC, the SROs, and other market participants are also proceeding to implement the Consolidated Audit Trail Rule,[14] which when operational will further enhance the ability of regulators to monitor and analyze the equity markets on a more timely basis.  Indeed, it should result in a sea change in the data currently available, collecting in one place every order, cancellation, modification, and trade execution for all exchange-listed equities and equity options across all U.S. markets.  It is a difficult and complex undertaking, which must be accorded the highest priority by all to complete.

We also are very focused on ensuring the resilience of the systems used by the exchanges and other market participants.  It is critically important that the technology that connects market participants be deployed and used responsibly to reduce the risk of disruptions that can harm investors and undermine confidence in our markets.  A number of measures have already been taken and, in 2014, we will be focused on ensuring that more is done to address these vulnerabilities.  One significant vulnerability that must be comprehensively addressed across both the public and private sectors is the risk of cyber attacks.  To encourage a discussion and sharing of information and best practices, the SEC will be holding a cybersecurity roundtable in March.[15]

Enforcement
Let me turn to enforcement at the SEC in 2014 because vigorous and comprehensive enforcement of our securities laws must always be a very high priority at the SEC.  And it is.

When I arrived in April, I found what I expected to find – a very strong enforcement program.  Through extraordinary hard work and dedication, the Commission’s Enforcement Division achieved an unparalleled record of successful cases arising out of the financial crisis.  To date, we have charged 169 individuals or entities with wrongdoing stemming from the financial crisis – 70 of whom were CEOs, CFOs, or other senior executives.  At the same time, the Commission also brought landmark insider trading cases and created specialized units that pursued complex cases against investment advisers, broker dealers and exchanges, as well as cases involving FCPA violations, municipal bonds and state pension funds.  In 2013 alone, Enforcement’s labors yielded orders to return $3.4 billion in disgorgement and civil penalties, the highest amount in the agency’s history.  But there is always more to do.

Admissions
Last year, we modified the SEC’s longstanding no admit/no deny settlement protocol to require admissions in a broader range of cases.  As I have said before,[16] admissions are important because they achieve a greater measure of public accountability, which, in turn, can bolster the public’s confidence in the strength and credibility of law enforcement, and the safety of our markets.

When we first announced this change, we said that we would consider requiring admissions in certain types of cases, including those involving particularly egregious conduct, where a large numbers of investors were harmed, where the markets or investors were placed at significant risk, where the conduct undermines or obstructs our investigative processes, where an admission can send a particularly important message to the markets or where the wrongdoer poses a particular future threat to investors or the markets.  And now that we have resolved a number of cases with admissions, you have specific examples of where we think it is appropriate to require admissions as a condition of settlement.[17]  My expectation is that there will be more such cases in 2014 as the new protocol continues to evolve and be applied.

Financial Fraud Task Force
Last year, the Enforcement Division also increased its focus on accounting fraud through the creation of a new task force.[18]  The Division formed the Financial Reporting and Audit Task Force to look at trends or patterns of conduct that are risk indicators for financial fraud, including in areas like revenue recognition, asset valuations, and management estimates.  The task force draws on resources across the agency, including accountants in the Division of Corporation Finance and the Office of the Chief Accountant and our very talented economists in the Division of Economic Risk and Analysis (DERA).  The task force is focused on more quickly identifying potential material misstatements in financial statements and disclosures.  The program has already generated several significant investigations and more are expected to follow.

In addition to the new admissions protocol and the Financial Fraud Task Force, the Enforcement Division also has other exciting new initiatives including a new Microcap Task Force[19] and a renewed focus on those who serve as gatekeepers in our financial system, just to name a few.

* * *

We have talked about our rulemaking agenda, some of our ongoing market structure initiatives, and a bit about what is new and developing in Enforcement.  But what else lies ahead?

Corporation Finance: JOBS Act and Disclosure Reform
As we move to complete our rulemakings in the private offering arena, it is important for the SEC to keep focused on the public markets as well.  Our JOBS Act related-rulemaking will provide companies with a number of different alternatives to raise capital in the private markets.  Some have even suggested that if the private markets develop sufficient liquidity, there may not be any reason for a company to go public or become a public company in the way we think of it now.  That would not be the best result for all investors.

While the JOBS Act provides additional avenues for raising capital in the private markets and may allow companies to stay private longer, the public markets in the United States also continue to offer very attractive opportunities for capital.  They offer the transparency and liquidity that investors need and, at the same time, provide access to the breadth of sources of capital necessary to support significant growth and innovation.  For our part, we must consider how the SEC’s rules governing public offerings and public company reporting and disclosure may negatively impact liquidity in our markets and how they can be improved and streamlined, while maintaining strong investor protections.

Last year, I spoke about disclosure reform[20] and in December the staff issued a report that contains the staff’s preliminary conclusions and recommendations as to how to update our disclosure rules.[21]

What is next?

This year, the Corp Fin staff will focus on making specific recommendations for updating the rules that govern public company disclosure.  As part of this effort, Corp Fin will be broadly seeking input from companies and investors about how we can make our disclosure rules work better, and, specifically, investors will be asked what type of information they want, when do they want it and how companies can most meaningfully present that information.

Investment Management: Enhanced Asset Manager Risk Monitoring
The SEC of 2014 is an agency that increasingly relies on technology and specialized expertise.  This is particularly evident in the SEC’s new risk monitoring and data analytics activities.  One important example is the SEC’s new focus on risk monitoring of asset managers and funds.

Last year featured a very concrete success from these risk monitoring efforts when the SEC brought an enforcement case against a money market fund firm charging that it failed to comply with the risk limiting conditions of our rules.[22]

In the past year, the SEC has established a dedicated group of professionals to monitor large-firm asset managers.  These professionals who include former portfolio managers, investment analysts, and examiners track investment trends, review emerging market developments, and identify outlier funds.

The tools they use include analytics of data we receive, high-level engagement with asset manager executives and mutual fund boards, data-driven, risk-focused examinations, and with respect to money market funds certain stress testing results.

What is next?

I asked the IM staff for an “action plan” to enhance our asset manager risk management oversight program.  Among the initiatives under near-term consideration are expanded stress testing, more robust data reporting, and increased oversight of the largest asset management firms.  To be an effective 21st century regulator, the SEC is using 21st century tools to address the range of 21st century risks.

OCIE: Innovation in Exam Planning
We also are using powerful new data analytics and technology tools in our National Exam Program to conduct more effective and efficient risk-based examinations of our registrants.

OCIE’s Office of Risk Assessment and Surveillance aggregates and analyzes a broad band of data to identify potentially problematic behavior.  In addition to scouring the data that we collect directly from registrants, we look at data from outside the Commission, including information from public records, data collected by other regulators, SROs and exchanges, and information that our registrants provide to data vendors.  This expanded data collection and analysis not only enhances OCIE’s ability to identify risks more efficiently, but it also helps our examiners better understand the contours of a firm’s business activities prior to conducting an examination.

What is next?

The Office of Risk Assessment and Surveillance is developing exciting new technologies – text analytics, visualization, search, and predictive analytics – to cull additional red flags from internal and external data and information sources.  These tools will help our examiners be even more efficient and effective in analyzing massive amounts of data to more quickly and accurately hone in on areas that pose the greatest risks and warrant further investigation.  In an era of limited resources and expanding responsibilities, it is essential to identify and target these risks more systematically.  And we are doing that.

Conclusion
Let me stop here.  Hopefully, I have at least given you a window into the strong, busy, and proactive state of the SEC in 2014.  More importantly, throughout the next two days, you will hear directly from our staff about the many ways we are meeting the current challenges that we all face in our complex and rapidly changing markets and how we are preparing for tomorrow’s challenges.

This year as in every year, we look forward to hearing your ideas and input on our rulemakings and other initiatives.  Your views are very important to us and assist us to implement regulations that are true to our mission, effective, and workable.

Thank you and enjoy the conference.


[1] See Identity Theft Red Flags Rule Release No. 34-69359, (Apr. 10, 2013), available at http://www.sec.gov/rules/final/2013/34-69359.pdf.

[2] See Title VII of the Dodd-Frank Act and Cross-Border Security-Based Swap Activities; Re-Proposal of Regulation SBSR and Certain Rules and Forms Relating to the Registration of Security-Based Swap Dealers and Major Security-Based Swap Participants Release No. 34-69490, (May 1, 2013), available at http://www.sec.gov/rules/proposed/2013/34-69490.pdf.

[3] See Money Market Fund Reform; Amendments to Form PF Release No. 33-9408, (Jun. 5, 2013), available at http://www.sec.gov/rules/proposed/2013/33-9408.pdf.

[4] See Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, Release No. 33-9415 (Jul. 10, 2013), available at http://www.sec.gov/rules/final/2013/33-9415.pdf.

[5] See Release No. 33-9416, Amendments to Regulation D, Form D and Rule 156 (Jul. 10, 2013).

[6] See Crowdfunding, Release No. 33-9470 (Oct. 23, 2013), available at http://www.sec.gov/rules/proposed/2013/33-9470.pdf and Proposed Rule Amendments for Small and Additional Issues Exemptions Under Section 3(b) of the Securities Act, Release No. 33-9497 (Dec. 18, 2013), available at http://www.sec.gov/rules/proposed/2013/33-9497.pdf.

[7] See Release No. 33-9414, Disqualification of Felons and Other “Bad Actors” (Jul. 10, 2013), available at http://www.sec.gov/rules/final/2013/33.9414.pdf.

[8] See Release No. 34-70072, Financial Responsibility Rules for Broker-Dealers (Jul. 30, 2013), available at http://www.sec.gov/rules/final/2013/34-70072.pdf.

[9] See Release No. 34-70462, Registration of Municipal Advisors (Sep. 20, 2013), available at http://www.sec.gov/rules/final/2013/34-70462.pdf.

[10] See Release No. 34-71194, Removal of Certain References to Credit Ratings Under the Securities Exchange Act of 1934 (Dec. 27, 2013), available at http://www.sec.gov/rules/final/2013/34-71194.pdf; Release No. 33-9506, Removal of Certain References to Credit Ratings Under the Investment Company Act (Dec. 27, 2013), available at http://www.sec.gov/rules/final/2013/33-9506.pdf.

[11] See Release No. BHCA-1, Prohibitions and Restrictions on Proprietary Trading and Certain Interests In, and Relationships With, Hedge Funds and Private Equity Funds Bank Holding Company Act (Dec. 10, 2013), available at http://www.sec.gov/rules/final/2013/bhca-1.pdf.

[12] See Press Release No. 2014-27, SEC Names Rick Fleming as Investor Advocate (Feb. 12, 2014), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540780377.

[13] The MIDAS web site and interactive tools are available at http://www.sec.gov/marketstructure.

[14] See Release No. 34-67457, Consolidated Audit Trail (Jul. 18, 2012), available at http://www.sec.gov/rules/final/2012/34-67457.pdf.

[15] See Press Release No. 2014-32, SEC to Hold Cybersecurity Roundtable (Feb. 14, 2014), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540793626.

[16] The Importance of Trials to the Law and Public Accountability, remarks at the 5th Annual Judge Thomas A. Flannery Lecture (Nov. 14, 2013), available at http://www.sec.gov/News/Speech/Detail/Speech/1370540374908.

[17] See Press Release No. 2013-159, Philip Falcone and Harbinger Capital Agree to Settlement (Aug. 19, 2013), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370539780222; Press Release No. 2013-187, JPMorgan Chase Agrees to Pay $200 Million and Admits Wrongdoing to Settle SEC Charges (Sep. 19, 2013), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370539819965; Press Release No. 2013-266, SEC Charges ConvergEx Subsidiaries With Fraud for Deceiving Customers About Commissions (Dec. 18, 2013), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540521484; Press Release No. 2014-17, Scottrade Agrees to Pay $2.5 Million and Admits Providing Flawed ‘Blue Sheet’ Trading Data (Jan. 29, 2014), available at http://www.sec.gov/News/PressRelease/Detail/PressRelease/1370540696906.

[18] See SEC Spotlight on the Financial Reporting and Audit Task Force, available at https://www.sec.gov/spotlight/finreporting-audittaskforce.shtml.

[19] See SEC Spotlight on Microcap Fraud, available at http://www.sec.gov/spotlight/microcap-fraud.shtml.

[20] The Path Forward on Disclosure, remarks at the National Association of Corporate Directors Leadership Conference 2013 (Oct. 15, 2013), available at http://www.sec.gov/News/Speech/Detail/Speech/1370539878806.  See also The SEC in 2014, remarks at the 41st Annual Securities Regulation Institute (Jan. 27, 2014), available at http://www.sec.gov/News/Speech/Detail/Speech/1370540677500.

[21] Report on Review of Disclosure Requirements in Regulation S-K (Dec. 2013), available at http://www.sec.gov/news/studies/2013/reg-sk-disclosure-requirements-review.pdf.

[22] In the Matter of Ambassador Capital Management, LLC, and Derek H. Oglesby, Admin. Proc. File No. 3-15625 (2013), available at http://www.sec.gov/litigation/admin/2013/ia-3725.pdf.

SEC COMMISSIONER LUIS A. AGUILAR ON INVESTOR PROTECTION

The following excerpt is from the SEC website:
Investor Protection is Needed for True Capital Formation
By Commissioner Luis A. Aguilar
U.S. Securities and Exchange Commission
March 16, 2012
Last week, the House of Representatives passed H.R. 3606, the “Jumpstart Our Business Startups Act.” It is clear to me that H.R. 3606 in its current form weakens or eliminates many regulations designed to safeguard investors. I must voice my concerns because as an SEC Commissioner, I cannot sit idly by when I see potential legislation that could harm investors. This bill seems to impose tremendous costs and potential harm on investors with little to nocorresponding benefit.

H.R. 3606 concerns me for two important reasons. First, the bill would seriously hurt investors by reducing transparency and investor protection and, in turn, make securities law enforcement more difficult. That is bad for ordinary Americans and bad for the American economy. Investors are the source of capital needed to create jobs and expand businesses. True capital formation and economic growth require investors to have both confidence in the capital markets and access to the information needed to make good investment decisions.

Second, I share the concerns expressed by many others that the bill rests on faulty premises. 1 Supporters claim that the bill would improve capital formation in the United States by reducing the regulatory burden on capital raising. However, there is significant research to support the conclusion that disclosure requirements and other capital markets regulations enhance, rather than impede, capital formation, 2 and that regulatory compliance costs are not a principal cause of the decline in IPO activity over the past decade. 3Moreover, nothing in the bill requires or even incentivizes issuers to use any capital that may be raised to expand their businesses or create jobs in the U.S.

Professor John Coates of Harvard Law School has testified that proposals of the type incorporated into H.R. 3606 could actually hurt job growth:

While [the proposals] have been characterized as promoting jobs and economic growth by reducing regulatory burdens and costs, it is better to understand them as changing … the balance that existing securities laws and regulations have struck between the transaction costs of raising capital, on the one hand, and the combined costs of fraud risk and asymmetric and unverifiable information, on the other hand. Importantly, fraud and asymmetric information not only have effects on fraud victims, but also on the cost of capital itself. Investors rationally increase the price they charge for capital if they anticipate fraud risk or do not have or cannot verify relevant information. Anti-fraud laws and disclosure and compliance obligations coupled with enforcement mechanisms reduce the cost of capital.

… Whether the proposals will in fact increase job growth depends on how intensively they will lower offer costs, how extensively new offerings will take advantage of the new means of raising capital, how much more often fraud can be expected to occur as a result of the changes, how serious the fraud will be, and how much the reduction in information verifiability will be as a result of the changes.
Thus, the proposals could not only generate front-page scandals, but reduce the very thing they are being promoted to increase: job growth.

4 Similarly, Professor Jay Ritter of the University of Florida has testified before the Senate banking committee that such proposals could in fact reduce capital formation:

In thinking about the bills, one should keep in mind that the law of unintended consequences will never be repealed. It is possible that, by making it easier to raise money privately, creating some liquidity without being public, restricting the information that stockholders have access to, restricting the ability of public market shareholders to constrain managers after investors contribute capital, and driving out independent research, the net effects of these bills might be to reduce capital formation and/or the number of small [emerging growth company] IPOs.

 5 As drafted, H.R. 3606 would have significant detrimental impacts on the U.S. securities regulatory regime, including the following:

First, the bill will reduce publicly available information by exempting “emerging growth companies” from certain disclosure and other requirements currently required under the Federal securities laws. The bill’s definition of “emerging growth company” would include every issuer with less than $1 billion in annual revenues (other than large accelerated filers and companies that have issued over $1 billion in debt over a three year period) for five years after the company’s first registered public offering. 6 It is estimated that this threshold would pick up 98% of IPOs and a large majority of U.S. public companies for that five year period.

 7An emerging growth company would only have to provide two years (rather than three years) of audited financial statements, and would not have to provide selected financial data for any period prior to the earliest audited period presented in connection with its initial public offering. It would also be exempt from the requirements for “Say-on-Pay” voting and certain compensation-related disclosure. Such reduced financial disclosure may make it harder for investors to evaluate companies in this category by obscuring the issuer’s track record and material trends.

“Emerging growth companies” would also be exempt from complying with any new or revised financial accounting standards (other than accounting standards that apply equally to private companies), and from some new standards that may be adopted by the PCAOB. Such wholesale exemptions may result in inconsistent accounting rules that could damage financial transparency, making it difficult for investors to compare emerging companies with other companies in their industry. This could harm investors and, arguably, impede access to capital for emerging companies, as capital providers may not be confident that they have access to all the information they need to make good investment decisions about such companies.
Second, the bill would greatly increase the number of record holders a company may have, before it is required to publish annual and quarterly reports. Currently, companies with more than 500 shareholders of record are required to register with the SEC pursuant to Section 12(g) of the Securities Exchange Act and provide investors with regular financial reports. H.R. 3606 would expand that threshold to 2000 record holders (provided that, in the case of any issuer other than a community bank, the threshold would also be triggered by 500 non-accredited investors). Moreover, the bill would exclude from such counts any shareholders that acquire securities through crowdfunding initiatives and those that acquire securities as eligible employee compensation. Thus, a company could have a virtually unlimited number of record stockholders, without being subject to the disclosure rules applicable to public companies. 8 This effect is magnified by the fact that the reporting threshold only counts records holders, excluding the potentially unlimited number of beneficial owners who hold their shares in “street name” with banks and brokerage companies, and thus are not considered record holders.

This provision of the bill raises concerns because it could significantly reduce the number of companies required to file financial and other information. 9Such information is critical to investors in determining how to value securities in our markets. Regular financial reporting enhances the allocation of capital to productive companies in our economy.

 10 Third, the bill would exempt “emerging growth companies” from Section 404(b) of the Sarbanes-Oxley Act, which requires the independent audit of a company’s internal financial controls. Section 404(b) currently applies only to companies with a market capitalization above $75 million; companies below that threshold have never been subject to the internal controls audit requirement and were exempted from such requirement in the Dodd-Frank Act. The internal controls audit was established following the accounting scandals at Enron, WorldCom and other companies, and is intended to make financial reporting more reliable. Indeed, a report last year by Audit Analytics noted that the larger public companies, known as accelerated filers, that are subject to Section 404(b), experienced a 5.1% decline in financial statement restatements from 2009 to 2010; while non-accelerated filers, that are not subject to Section 404(b), experienced a 13.8% increase in such restatements. 11 A study by the SEC’s Office of the Chief Accountant recommended that existing investor protections within Section 404(b) be retained for issuers with a market capitalization above $75 million. 12 With the passage of H.R. 3606, an important mechanism for enhancing the reliability of financial statements would be lost for most public companies, during the first five years of public trading.

Fourth, the bill would benefit Wall Street, at the expense of Main Street, by overriding protections that currently require a separation between research analysts and investment bankers who work in the same firm and impose a quiet period on analyst reports by the underwriters of an IPO. These rules are designed to protect investors from potential conflicts of interests. The research scandals of the dot-com era and the collapse of the dot-com bubble buried the IPO market for years. Investors won’t return to the IPO market, if they don’t believe they can trust it.
Fifth, H.R. 3606 would fundamentally change U.S. securities law, by permitting unlimited offers and sales of securities under Rule 506 of Regulation D (which exempts certain non-public offerings from registration under the Securities Act), provided only that all purchasers are “accredited investors”. The bill would specifically permit general solicitation and general advertising in connection with such offerings, obliterating the distinction between public and private offerings.

This provision may be unnecessary. A recent report by the SEC’s Division of Risk, Strategy and Financial Innovation confirms that Regulation D has been effective in meeting the capital formation needs of small businesses, with a median offering size of $1,000,000 and at least 37,000 unique offerings since 2009. 13 Regulation D offerings surpassed $900 billion in 2010. The data does not indicate that users of Regulation D have been seriously hampered by the prohibition on general solicitation and advertising.

I share the concerns expressed by many that this provision of H.R. 3606 would be a boon to boiler room operators, Ponzi schemers, bucket shops, and garden variety fraudsters, by enabling them to cast a wider net, and making securities law enforcement much more difficult. Currently, the SEC and other regulators may be put on notice of potential frauds by advertisements and Internet sites promoting “investment opportunities.” H.R. 3606 would put an end to that tool. Moreover, since it is easier to establish a violation of the registration and prospectus requirements of the Securities Act than it is to prove fraud, such scams can often be shut down relatively quickly. H.R. 3606 would make it almost impossible to do so before the damage has been done and the money lost.
In addition others have noted that the current definition of “accredited investor” may not be adequate and that the requirement that purchasers be accredited investors would provide limited protection. 14 For example, an “accredited investor” retiree with $1 million in savings, who depends on that money for income in retirement, may easily fall prey for a “hot” offering that is continually hyped via the internet or late night commercials.

These are just a few observations regarding H.R. 3606. It also includes other provisions that require substantial further analysis and review, including among other things the so-called crowdfunding provisions.

15 The removal of investor protections in this bill are among the factors that have prompted serious concerns from the Council of Institutional Investors, AARP, the North American Securities Administrators Association, the Consumer Federation of America, and Americans for Financial Reform, among others. 16
Questions Re: H.R. 3606
As H.R. 3606 is considered, the following is a non-exhaustive list of questions that should be addressed:
1. The bill would define “emerging growth company” as any company, within 5 years of its IPO, with less than $1 billion in annual revenue, other than a large accelerated filer or a company that has issued $1 billion in debt over a three-year period.
What is the basis for the $1 billion revenue trigger?

Why is revenue the right test? Why is $1 billion the right level?

It has been estimated that this definition would include 98% of all IPOs, and a large majority of all public companies within the 5-year window. Was such a broad scope intended?
2. As provided in the bill, financial accounting standards, auditing and reporting standards, disclosure requirements, and the period for which historical financial statements is required, could all differ as between “emerging growth companies” and all other public companies – including all companies that went public before December 8, 2011.
How will these differences affect the comparability of financial reporting for these two classes of issuers?

Will reduced transparency, or lack of comparability, affect the liquidity of emerging growth companies?

Will reduced transparency or reduced liquidity affect the cost of capital for emerging growth companies? Will investors demand a “discounted price” to offset any perceived higher risk resulting from reduced disclosures and protections?

Will emerging growth companies be required to include risk factors or other disclosure in their registration statements and other filings, regarding transparency, comparability and any potential effects thereof?
3. The bill would expand the threshold for the number of shareholders an issuer may have, before it is required to file annual and other reports under Section 12(g) of the Exchange Act, from 500 to 2000 (of which no more than 500 may be non-accredited investors, for issuers other than community banks), and would exclude from such counts shareholders that acquire securities through crowdfunding initiatives and those that acquire securities as eligible employee compensation.
How was the new threshold of 2000 holders determined?

Is that the right threshold for determining whether the public interest in such securities justifies regulatory oversight?

How many companies would be exempted from registration and reporting by the bill?

When shares are held in “street name” the number of beneficial owners may greatly exceed the number of record holders. How will the new threshold of 2000 record holders be applied in such cases?17

How would the exclusion of employees and crowdfunding purchasers be applied, if such holders transfer their shares to other investors? How would this be tracked?
4. To the extent the bill results in reduced transparency and/or reduced liquidity for emerging growth companies, or for companies exempted from Exchange Act reporting by the new thresholds under Section 12(g), such results may impact investment decisions by institutional investors.
How would mutual fund managers, pension fund administrators, and other investors with fiduciary duties address such reduced transparency or lack of liquidity in making investment decisions?

Could reduced transparency or reduced liquidity impact the ability of fund managers to meet applicable diversification requirements?

Could such effects cause managers to increase concentration into fewer US reporting companies? How would such concentration affect market risk? Would the bill result in investor funds being redirected to companies overseas?
5. The bill is being promoted as a jobs measure, on the grounds that reducing regulation will improve access to capital for small and emerging businesses, allowing them to grow and add employees.
What is the evidence that regulatory oversight unduly impedes access to capital?

What is the evidence that companies that are otherwise prepared to grow (that is, they have the appropriate business model, management team, and aspirations) are prevented from growing by an inherent lack of access to potential sources of capital?

I understand that the costs of complying with regulatory requirements are a factor underpinning H.R. 3606. How do such costs compare to other costs of raising capital, such as investment banking fees? How do such costs compare to other administrative costs? If reduced transparency, lack of comparability, and other consequences of the bill result in a higher cost of capital for emerging growth companies, will the money saved on compliance be worth it?
6. Evidence shows that the public companies that are currently exempt from internal controls audit requirements have a higher incidence of financial reporting restatements, and that companies that have restated their financial results produce substantially lower returns for investors. 18
How do any perceived benefits from H.R. 3606’s exemption of emerging growth companies from the audit of internal controls compare to the likelihood of increased restatements? Would an increase in restatements hamper capital formation?

Will the lack of an internal controls audit result in greater financial and accounting fraud?

7. The bill requires the Commission to revise its rules to provide that the prohibition against general solicitation or general advertising contained in Regulation D shall not apply to offers and sales of securities pursuant to Rule 506, provided that all purchasers are accredited investors.
Given the success of Regulation D as a capital raising mechanism, including its successful use by small and emerging companies,19 is there any evidence that general solicitation and general advertising are necessary for capital formation?

Given the current definition of “accredited investor”, is that the right test for determining who issuers may target, in offers made by general solicitation or advertising?

Conclusion
H.R. 3606 would have a significant impact on the capital markets and raises many questions that have yet to be satisfactorily resolved. I have yet to see credible evidence that justifies the extensive costs and potential harm to investors this bill may impose.
I urge Congress to undertake the review necessary to resolve these questions, and to ensure that investors, as the providers of the capital that companies need to grow and create jobs, have the protections they need and deserve.