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[Senate Hearing 112-482]
[From the U.S. Government Publishing Office]

                                                        S. Hrg. 112-482

                           INVESTORS--PART II



                               before the

                              COMMITTEE ON
                          UNITED STATES SENATE

                      ONE HUNDRED TWELFTH CONGRESS

                             SECOND SESSION




                             MARCH 6, 2012


  Printed for the use of the Committee on Banking, Housing, and Urban 


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                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York         MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii              JIM DeMINT, South Carolina
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin                 PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia             MARK KIRK, Illinois
JEFF MERKLEY, Oregon                 JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado          ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina

                     Dwight Fettig, Staff Director
              William D. Duhnke, Republican Staff Director
                     Dean Shahinian, Senior Counsel
                          Kara Stein, Counsel
                     Laura Swanson, Policy Director
                 Erin Barry, Professional Staff Member
                 Levon Bagramian, Legislative Assistant
                 Andrew Olmem, Republican Chief Counsel
                   Michelle Adams, Republican Counsel
                Mike Piwowar, Republican Chief Economist
          Gregg Richard, Republican Professional Staff Member
                       Dawn Ratliff, Chief Clerk
                     Riker Vermilye, Hearing Clerk
                      Shelvin Simmons, IT Director
                          Jim Crowell, Editor


                            C O N T E N T S


                         TUESDAY, MARCH 6, 2012


Opening statement of Senator Reed................................     1

Opening statements, comments, or prepared statements of:
    Chairman Johnson
        Prepared statement.......................................    34
    Senator Crapo................................................     2
    Senator Schumer..............................................     3
    Senator Moran................................................     5
    Senator Bennet...............................................     6


William D. Waddill, Senior Vice President and Chief Financial 
  Officer, OncoMed Pharmaceuticals, Inc., on behalf of the 
  Biotechnology Industry Organization............................     7
    Prepared statement...........................................    34
    Responses to written questions of:
        Chairman Johnson.........................................    70
Jay R. Ritter, Cordell Professor of Finance, Warrington College 
  of Business Administration, University of Florida..............     8
    Prepared statement...........................................    39
    Responses to written questions of:
        Chairman Johnson.........................................    71
Kathleen Shelton Smith, Co-Founder and Chairman, Renaissance 
  Capital, LLC...................................................    10
    Prepared statement...........................................    43
    Responses to written questions of:
        Chairman Johnson.........................................    72
Timothy Rowe, Founder and CEO, Cambridge Innovation Center.......    11
    Prepared statement...........................................    48
    Responses to written questions of:
        Chairman Johnson.........................................    79
Lynn E. Turner, Former Chief Accountant of the Securities and 
  Exchange Commission, and Managing Director, Litinomics, Inc....    13
    Prepared statement...........................................    56
    Responses to written questions of:
        Chairman Johnson.........................................    81

              Additional Material Supplied for the Record

Exhibits 1-10 submitted by Lynn E. Turner........................    82

                           INVESTORS--PART II


                         TUESDAY, MARCH 6, 2012

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:04 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Jack Reed, presiding.


    Senator Reed. Good morning. I call the hearing to order the 
hearing this morning, entitled ``Spurring Job Growth through 
Capital Formation while Protecting Investors, Part II.'' 
Unfortunately, Chairman Johnson had a prior commitment with the 
Energy Committee today and will not be able to attend. I 
understand also that Senator Shelby will not be able to attend. 
So Senator Crapo and I will do our best. We want to thank you 
all for the valuable time and valuable insights that you will 
provide us this morning.
    Senator Johnson also asked that I submit his statement for 
the record, and without objection, his statement and all the 
statements will be submitted for the record.
    Senator Reed. When I conclude my remarks, I will recognize 
Senator Crapo, then ask my colleagues if they have any opening 
remarks also.
    This is the fourth in a series of hearings by the Banking 
Committee on capital formation issues, including one held by 
Senator Tester in the Subcommittee on Economic Policy and one 
held by the Subcommittee that I chair on Securities, Insurance, 
and Investment.
    Job creation and revitalizing the growth of American 
businesses are two of the top issues facing our country right 
now. These are the issues that Americans are rightfully urging 
us to find ways to address. Entrepreneurial businesses need 
access to capital to fund the search for new ideas, the 
development of new products, and ultimately the hiring of new 
workers. At the same time, as we know from our country's own 
history, investors are more willing to invest when they are 
appropriately protected, so raising capital and assuring 
investors go hand in hand.
    This morning, we will focus on some of the legislative 
proposals introduced in this area, including creating an on-
ramp for emerging-growth companies, Regulation A and its 
offering limit, Regulation D and its requirements on 
solicitation, the 500 shareholders of record threshold for 
private banks and other companies to become public, and the 
issue of crowdfunding.
    The first Federal securities laws followed in the wake of 
the stock market crash of 1929, and the Securities Act of 1933, 
enacted as the ``Truth in Securities Act,'' required 
disclosures. As President Roosevelt stated at the time, ``This 
proposal adds to the ancient rule of `caveat emptor,' the 
further doctrine `let the seller also beware.' '' It puts the 
burden for telling the whole truth on the seller. It should 
give impetus to honest dealing in securities and thereby bring 
back public confidence.
    With the fragile economic recovery and continued high 
unemployment, directing the flow of capital to enterprises that 
would improve the economy is vital to putting people back to 
work. However, we must not forget that gaps in regulation and 
lack of transparency were contributing factors to the enormous 
losses suffered as a result of the financial crisis.
    As we consider these capital formation bills, we must be 
mindful to not re-create the very problems that we just tried 
to solve when we enacted the Dodd-Frank Wall Street Reform and 
Consumer Protection Act. Indeed, even with these steps, as we 
go forward, unfortunately, we are seeing incidents of market 
irregularities, from insider trading to micro stock capital 
fraud schemes. There remains the potential for investors to be 
harmed, and we have to recognize that potential.
    Today's hearing will continue the Banking Committee's 
examination of different proposals to update and streamline our 
capital-raising process. This process requires finding the 
right balance between ensuring entrepreneurial businesses have 
access to capital to fund new products and provide jobs while 
providing accurate information to investors so they have the 
opportunity to make sound investment choices. And I look 
forward to our witnesses' and to my colleagues' presentations.
    With that, let me recognize Senator Crapo.


    Senator Crapo. Thank you very much, Mr. Chairman. I 
appreciate the fact that we are holding this hearing, and I 
look forward to the information that our witnesses will provide 
to us, and I welcome the witnesses.
    As the December 1st and 14th hearings highlighted, we can 
do more to expand economic activity by removing unnecessary 
restrictions on capital formation to enhance access to capital 
for early stage startups as well as later-stage growth 
companies. Later this week, the House of Representatives is 
expected to pass a package of reforms that include increasing 
the 500-shareholder registration threshold, expanding the scope 
of Regulation A offerings to $50 million, permitting general 
solicitation of investors in Regulation D offerings, allowing 
small businesses and startups to raise capital from small-
dollar investors through crowdfunding, and, finally, providing 
an on-ramp that would provide emerging-growth companies up to 5 
years to scale up to IPO regulation and disclosure compliance.
    In the Securities Subcommittee hearing in December, Kate 
Mitchell of Scale Venture Partners talked about the fact that 
during the past 15 years, the number of emerging-growth 
companies entering capital markets through IPOs has plummeted 
relative to historical norms. From 1990 to 1996, 1,272 U.S. 
venture-backed companies went public on U.S. exchanges, yet 
from 2004 to 2010, there were just 324 of those offerings. This 
decline is troubling as more than 90 percent of company job 
growth occurs after an IPO.
    The IPO Task Force recommended providing an on-ramp that 
would provide emerging-growth companies up to 5 years to scale 
up to regulation and disclosure compliance. During this period 
emerging-growth companies could follow streamlined financial 
statement requirements and minimize compliance costs and be 
exempted from certain regulatory requirements imposed by 
Sarbanes-Oxley and Dodd-Frank.
    On December 8th, SBA Administrator Karen Mills and National 
Economic Council Director Gene Sperling posted a joint online 
statement about helping job creators get the capital they need 
by passing legislation relating to crowdfunding, Regulation A 
mini-offerings, and creating an on-ramp for emerging-growth 
companies. There is strong bipartisan support for these 
proposals, and I look forward to working together with my 
colleagues and others to enact necessary changes to promote 
investment and American job growth while protecting the 
    Again, Mr. Chairman, I appreciate the fact that we are 
holding this hearing. I look forward to the input that our 
witnesses will provide to us today.
    Senator Reed. Thank you very much, Senator Crapo.
    Following the early bird rule, let me ask if Senator Tester 
has an opening statement or any comments. No? Then, Senator 
Schumer, the next Democrat.


    Senator Schumer. I do. Thank you, Mr. Chairman. And I thank 
you for holding this hearing. It is the fourth time in recent 
months--and I thank Chairman Johnson as well, as well as 
Senator Shelby. It is the fourth time in recent months that 
this Committee or one of our Subcommittees has considered the 
issue of capital formation and the legislative proposals being 
discussed here today.
    This week, the House Republican leadership is scheduled to 
vote on a package of bills encouraging capital formation for 
growing companies. If the House package looks familiar, it is 
because it includes several proposals already advancing in the 
Senate. Speaking on behalf of some of us here in the Senate, we 
are glad to see the House endorsing a few of our ideas.
    The House package, for instance, borrows from a bill 
proposed by Senator Toomey and myself that would provide a 
transition period for emerging-growth companies to make it 
easier for these companies to go public. The House package also 
includes a measure to raise the offering limit under Regulation 
A from $5 million to $50 million, a proposal championed in the 
Senate by Senator Tester and supported by Senators Toomey and 
    In addition, Senators Warner and Toomey have joined Senator 
Carper on a bill that recognizes the reality that companies are 
taking longer to go public and would, therefore, help fast-
growing companies use stock to pay their employees without 
undergoing a cumbersome SEC registration process ordinarily 
designed for companies issuing stock to the general public. The 
proposal also made it into the House package being voted on 
this week. So the House package took a lot of bipartisan Senate 
proposals that had bipartisan support in the House and put it 
together, which is good.
    There is no reason why the Senate should not bundle these 
same proposals together, just like the House has, and we will. 
Leader Reid has already indicated the Senate will assemble a 
bipartisan package. The Senate version will probably go a 
little further than the House version, and I would hope that we 
would also take up some needed precautions on investor 
protection, which Senator Jack Reed and others have reminded us 
is important.
    Given the level of bipartisan support for many of these 
proposals, passage in the Senate appears not to be a question 
of if but of when. I expect a comprehensive Senate proposal 
could be announced in the coming days, and this is an important 
area for the Senate to address. Many recent IPOs and proposed 
IPOs--Zynga, Groupon, Facebook--have generated a lot of hype, 
but the actual numbers, if you are a small startup, not one of 
the ones that gets a lot of focus and glamour, that tells a 
different story. There have been ups and downs over the years, 
but the number of U.S. IPOs has actually drastically declined 
since the mid-1990s, and companies are taking almost twice as 
long to go public than they were then.
    I agree with some of today's witnesses who argue that there 
is not one simple reason for decline in U.S. IPOs, but I do 
think Congress has an ongoing obligation to ask whether the 
policy framework for public offerings is striking the right 
balance between facilitating capital formation on the one hand 
and attempting to protect investors on the other. That is 
always a needle we have to thread.
    If you ask the people running emerging-growth companies and 
looking to raise capital to build their businesses, they will 
tell you why our bill is important. In a recent survey, 79 
percent of those CEOs said the U.S. IPO market is not 
accessible for small companies, and 85 percent said going 
public is not as attractive today as it was in 1995. The 
primary reasons cited were regulatory and compliance burdens. 
This matters because a threat to the U.S. IPO market represents 
a direct threat to U.S. job creation. Historically, over 90 
percent of job creation at U.S. public companies has occurred 
post-IPO. And according to testimony we will hear from Mr. 
Rowe, ``Data show that companies that go public grow their 
headcount approximately 5-fold.''
    It is also important to point out that our IPO on-ramp is 
designed to be temporary, transitional, and limited. At any 
given time, only 11 to 15 percent of companies will qualify as 
emerging-growth companies, and those companies will only 
account for about 3 percent of market capitalization. Big-name 
companies who have gone public recently would not have 
qualified as emerging-growth companies. Neither Groupon nor 
Zynga would have qualified, and, of course, Facebook is not 
even in the ballpark.
    Finally, I should note that the IPO on-ramp we are 
proposing is not mandatory. If investors feel they require more 
protection, they would be free to request it from the issuer. 
Indeed, Carlyle recently filed to go public, and its 
registration statement included a provision that would have 
prevented investors from suing in court for securities fraud 
claims. Investors objected; Carlyle and its advisers amended 
the terms of the offering to remove the provision.
    In conclusion, Mr. Chairman, all of the bills we are 
considering today would advance the goal of capital formation 
and job creation. They all have bipartisan support from Members 
of this Committee. I see Michael Bennet has walked in, and he 
has another proposal that we are working on as well. Many have 
passed the House with over 400 votes, and I am glad to see our 
Committee devoting so much time to the issue of capital 
    I look forward to working with Chairman Johnson, Ranking 
Member Shelby, and the rest of my colleagues to see that the 
Senate passes a significant package of legislative proposals to 
help small companies raise capital and grow their businesses, 
and I am confident we will be successful.
    Thank you for the time, Mr. Chairman.
    Senator Reed. Senator Corker?
    Senator Corker. As is my custom, I think we benefit so much 
more listening to our witnesses than listening to us, so I look 
forward to that.
    Senator Reed. Senator Moran, do you have a comment?
    Senator Moran. While I agree with the Senator from 
Tennessee, I do have an opening statement.
    Senator Schumer. He was not directing it at you, Mr. Moran.


    Senator Moran. It did not seem like a very good segue.
    Mr. Chairman, thank you. It is a privilege to be here and 
to hear our witnesses, and I look forward to that moment. I 
just wanted to highlight legislation that I and Senator Warner, 
also a Member of this Committee, have introduced, which is 
called the Startup Act, and a significant component of the 
Startup Act is capital formation provisions. It also includes 
items related to regulatory balance, to employment of 
entrepreneurial and highly skilled talent, and promotion of 
commercialization for research done using Federal dollars.
    We are also working to bring in others with the ideas that 
Senator Schumer and others have mentioned in their opening 
remarks, provisions of Senator Tester's legislation, provisions 
that Senator Bennet supports, Senator Toomey, and Senator 
    We discovered in reviewing the research done by the 
Kauffman Foundation in Kansas City that startup companies that 
are less than 5-years old accounted for nearly all net jobs 
created in the United States from 1980 to 2005. And as we look 
at trying to balance our budget, grow our economy, and put 
people to work, the ability to create an environment in this 
country that is entrepreneurial is so critical. And so we look 
forward to working with the Majority Leader and others as they 
craft legislation that is designed to create opportunities for 
greater entrepreneurial efforts in the United States and try to 
create the opportunity for success.
    So we welcome the opportunity to work with the Senators I 
mentioned as well as those who are interested in this topic, 
and I appreciate the opportunity to be here to hear these 
witnesses that Senator Corker so appropriately indicated were 
more articulate and more highly educated and informing than the 
Senator from Kansas.
    Senator Reed. We thank the Senator from Kansas.
    Senator Bennet, do you have a comment?


    Senator Bennet. I am nowhere near as bold as the Senator 
from Kansas, so I am going to avoid the derision of the Senator 
from Tennessee and not make an opening statement. I do want to 
recognize Lynn Turner, who is here from the great State of 
Colorado--thank you very much for testifying--and simply say, 
Mr. Chairman, how important this discussion is for our economic 
    A lot of people do not know that our gross domestic product 
is actually higher today than it was before we went into this 
recession. The reason they do not know that is because we have 
become so productive as an economy that we are producing that 
economic output with a lot fewer people, and we are seeing 
median family income continue to decline in this country. That 
is a huge problem. And the only way it is going to be resolved, 
I think, is through the kind of initiatives that the Senator 
from Kansas has talked about and by educating our people. Those 
are the two things that we need to do in order to drive an 
economy that is actually creating jobs and lifting income in 
the United States.
    So I look forward to hearing the witnesses.
    Senator Reed. Thank you very much.
    Senator Reed. Let me now introduce the panel.
    Our first witness is Mr. William Waddill. He is the Senior 
Vice President and Chief Financial Officer of OncoMed 
Pharmaceuticals, Incorporated. It is a privately held company 
based in Redwood City, California. He has decades of experience 
in life science and public accounting and has helped startups 
grow. Thank you very much, sir.
    Our next witness is Professor Jay Ritter. Professor Ritter 
is the Cordell Professor of Finance at the University of 
Florida. Over the past 25 years, Professor Ritter has authored 
many articles and books on IPOs and is one of the most cited 
authorities on this subject. Thank you, sir.
    Our next witness is Ms. Kathleen Shelton Smith. She is the 
founder and principal of Renaissance Capital. Founded in 1991, 
her firm, which is headquartered in Greenwich, Connecticut, is 
a leader in providing institutional research and investment 
management services for newly public companies, and she has 
done a tremendous amount of data gathering and analysis related 
to IPOs, and we look forward to your testimony. Thank you.
    Our next witness is Mr. Tim Rowe. Mr. Rowe is the founder 
and Chief Executive Officer of Cambridge Innovation Center 
located in Cambridge, Massachusetts. Previously, he has served 
as a lecturer at the MIT Sloan School of Management, as a 
manager with the Boston Consulting Group, and has over a 
decade-long experience with startups and early stage venture 
capital. Thank you, Mr. Rowe.
    Our final witness is Mr. Lynn Turner, who is no stranger to 
this Committee. He is a former Chief Accountant of the 
Securities and Exchange Commission and is currently a Managing 
Director of LitiNomics, which has offices in Mountain View, 
Oakland, and Los Angeles, California. His expertise in issues 
related to accounting and investor protection has been helpful 
to the Committee in the past, and I look forward to his 
testimony. Thank you.
    I want to welcome all of you again. Thank you for your 
willingness and your insights today. Mr. Waddill, you may 
proceed with your testimony.


    Mr. Waddill. Thank you and good morning, Mr. Chairman, 
Members of the Committee, ladies and gentlemen. My name is Will 
Waddill. I am Senior Vice President of OncoMed Pharmaceuticals 
out in Redwood City, California. I want to thank you for the 
opportunity to speak with you today about unique hurdles of 
innovation companies like OncoMed that are facing and the 
opportunity that the Congress faces to try and get us past 
those hurdles.
    It takes decades and more than $1 billion to bring 
therapies to market in my sector of the world. In order to 
finance research and development, we must cultivate a wide 
range of public and private investors. Startup companies depend 
on venture capital in the early stages and later look to public 
markets to pay for the more expensive clinical trials as we 
develop our compounds.
    However, due to the current economic climate and economic 
realities that are hitting the venture capital community, 
public markets are both slow to recover, as has been noted this 
morning, which creates a barrier for us to progress our 
    The issue facing all of us across the board in the 
innovation sector really is the ability to access that capital, 
so I strongly support Senator Schumer and Senator Toomey in the 
effort to create an on-ramping for public market for emerging 
companies like mine.
    One of the key components of the on-ramp is the 5-year 
transition period to comply with Sarbanes-Oxley Section 404. 
That could have an immediate impact on capital that I will be 
able to divert more toward developing a product instead of 
paying for administrative costs in the company.
    Currently, these opportunity costs of compliance can be 
quite damaging and cause delays while I go out as a chief 
financial officer with other members of our management team to 
raise capital.
    Newly public companies have virtually no product revenue, 
so all operating capital must come from investors. Now, this is 
a key point to understand that when you are in an innovation 
stage, you are shooting for products, you are developing 
products, and you want to have all your capital go toward those 
products versus building infrastructure to comply with the 
    Because of this facing my company, which is a private 
company, we do fit into that 86 percent that looks at this and 
says, hey, you know, this is a cost burden for us and will 
cause us significant costs in the first few years of being a 
public company.
    So for companies that are still too small for the public 
markets, another portion of this legislation is Regulation A. 
And the current regulation, which was set in 1992, $5 million, 
the proposal is to raise that to $50 million, and this, again, 
will open up barriers in front of us to raise more capital. I 
support Senators Tester and Toomey's legislation to increase 
this to $50 million. This higher limit would raise Regulation A 
to match the realities of the current marketplace.
    Specific to my industry, it costs anywhere from $800 
million to $1.2 billion to get a product through clinical 
trials and onto the marketplace. It is an enormous sum of 
money, and it is an investment time that I talked about 
earlier, while you are in the innovation stage, that is 
critical that you have your focus on not only your people but 
also your capital in developing those products.
    Our hope would be to do that and get to the point where we 
could be a Genentech, where we could be a Gilead out in the 
world. And when you look across the bay in various sectors 
where we live, we would want to be a Hewlett-Packard. We want 
to have job creation that gets up to a 10,000-, 20,000-, 
30,000-person company. But we cannot do that unless we have 
early stage capital. So by creating this IPO on-ramp, reforming 
Regulation A, that is an opportunity for us to do exactly that.
    So with that, I would like to thank the Members for being 
here, and I am happy to answer questions when we get to them. 
Thank you.
    Senator Bennet. [Presiding.] Thank you for your testimony.
    Professor Ritter.


    Mr. Ritter. Thank you. My name is Jay Ritter. I am a 
Professor of Finance at the University of Florida, and I have 
studied initial public offerings for more than 30 years.
    I will first give some general remarks on the reasons for 
the low level of IPO activity this decade and the implications 
for job creation and economic growth and then a few suggestions 
on specific bills that the Senate is considering.
    First of all, there is no disagreement about the huge drop, 
prolonged drop in small-company IPOs that we have seen for 11 
years now. But there is disagreement about the reason for the 
prolonged decline, the implications for the economy, and what 
should be done, if anything, to rejuvenate the IPO market and 
spur capital formation.
    The conventional wisdom is that a combination of factors, 
including heavy-handed regulation such as Sarbanes-Oxley and a 
drop in analyst coverage of small companies, have discouraged 
companies, especially small companies, from going public. I 
agree with this conventional wisdom in terms of being causes of 
the decline in IPOs, but I think that this is only a minor 
cause for the huge and prolonged decline. I think the more 
general problem is the lack of profitability of small 
companies, and this is not so much a private versus public 
company issue as a big company versus small company issue.
    I think that there has been a long-term worldwide trend 
favoring big companies that can realize economies of scale, 
economies of scope, bring products to market more quickly. And 
this is one of the reasons for the increased right-skewness in 
the income distribution in the world, income distribution and 
wealth distribution, and I think the IPO market in the United 
States is just a microcosm, one of the trees in the big forest. 
And if this is the fundamental reason why very few small 
companies are going public, because small is not the optimal 
way of organizing a lot of businesses, but instead getting big 
fast has become more important than it used to be, then I think 
a lot of these proposed changes are going to have minimal 
effects on spurring small-company investing and rejuvenating 
the IPO market.
    Now, consistent with this idea that the problem is being 
small in many industries is a lot less advantageous than it 
used to be, there is a whole body of facts consistent with 
this. For one thing, small companies that are publicly traded 
have had a long-term down trend in their profitability. Indeed, 
of the small companies that have gone public since 2000, over 
the last 11 years, only 27 percent of them have had positive 
profits in one of the 3 years after going public.
    Investors have earned very low returns, way below investing 
in bigger companies, in the last decade, and that was true in 
the 1990s and the 1980s as well. And it is true not only in the 
United States, but it is true in Europe, that if you look at 
European markets for small companies, the returns that 
investors have earned have been far below the returns on 
bigger-company IPOs and more established companies.
    So investors have gotten burned way too many times on 
investing in small companies, and it is the lack of small 
companies that become successful big companies that is largely 
responsible for the lack of investor enthusiasm. They do not 
want to get burned time and time again.
    Now, that is not to say that Sarbanes-Oxley costs and other 
things have not had some effect on the profitability of small 
companies, but in work that I have done with co-authors, we 
have computed how many of them would have been profitable if 
they did not have the extra compliance costs. And we find that 
there would be some effect, but still that long-term down trend 
in profitability would still be there.
    Now, in terms of the implications for job growth, there 
have been a lot of numbers put out by Kate Mitchell before this 
Committee that have been repeated in the Wall Street Journal. 
One number that has been out there is 22 million jobs would 
have been created if IPO activity had just continued to be what 
it used to be. I have actually been doing some work currently 
for the Kauffman Foundation looking at the actual job growth of 
all the companies that have gone public since 1996, and the 
numbers we are coming up with are dramatically lower. Companies 
that have gone public in the late 1990s that have had 10 years 
of experience on average increased their post-IPO employment by 
60 percent, a compound growth rate of 4.8 percent per year.
    Now, the numbers are higher for venture-backed companies 
than, for instance, for older, more mature companies that have 
gone public. But I do not think increasing the number of IPOs 
is automatically going to spur an enormous amount of job 
growth. That said, I would like to see a healthy IPO market 
where good companies can get financing at terms that reflect 
their prospects and create wealth for society, investors, and 
spur employment.
    Senator Bennet. Thank you, Professor.
    Ms. Smith.

                    RENAISSANCE CAPITAL, LLC

    Ms. Smith. Thank you. Members of the Committee, thank you 
for inviting me to testify today. Capital formation, when 
accomplished through the IPO market, plays an important role in 
funding our best entrepreneurial companies. So it is no 
surprise that in looking to spur job growth, all eyes would 
turn to the IPO market--America's most admired system for 
funding entrepreneurs.
    We share the concerns of lawmakers about the IPO market and 
are honored to be asked for our thoughts. For over 20 years, 
Renaissance Capital has had a singular focus on the IPO market. 
We are involved in IPOs in three ways: we are an independent 
research firm providing institutional investors with analysis 
of IPOs; we are an indexing firm creating IPO indices that 
measure the investment returns of newly public companies; and 
we are an investor in newly public companies through a mutual 
fund and separately managed institutional accounts.
    I will start by examining the condition of the U.S. IPO 
market, including where we stand globally and the importance of 
investor returns in the equation. I will then make suggestions 
on the specific bills under consideration.
    IPO markets around the world were hurt by the 2008 U.S. 
financial crisis and the 2011 European sovereign debt crisis. 
And yet the United States accounted for 32 percent of global 
IPO proceeds during each of those years, larger than any other 
IPO market in the world. So despite what appears to be low IPO 
issuance levels in recent years, much of the U.S. IPO market is 
functioning quite well under challenging conditions.
    The IPO Task Force provided helpful data about large and 
small IPO issuance since 1991. This data, which is contained in 
my written testimony, shows that while smaller IPOs have 
disappeared, larger companies raising over $50 million in IPO 
proceeds continue to access the IPO market. We find little 
evidence that these larger issuers are deterred from wanting to 
tap the IPO market. Today we count over 200 companies in our 
U.S. IPO pipeline, 92 percent with deal sizes over $50 million. 
They are seeking to raise over $52 billion in total, the 
biggest we have seen in a decade. All these companies have 
undergone financial audits, implemented Sarbanes-Oxley 
policies, and filed full disclosure documents with the SEC.
    On the other hand, as the IPO Task Force concluded, 
smaller, sub-$50 million IPOs have practically disappeared from 
the market. Now, we can ease the path for IPO issuance for 
these smaller companies, but it only works if real investors 
are interested in buying these IPOs. At present, the trading 
market for IPOs is highly volatile with share turnover on the 
first day of trading at times exceeding the number of shares 
offered. This suggests that IPO shares are being placed with 
short-term trading clients of the IPO Underwriters. We urge 
policymakers to study ways to encourage IPO Underwriters to 
allocate IPOs to a broader base of long-term investors.
    But the most powerful way to fix the IPO market is to 
improve returns for IPO investors. There is a chart in my 
written testimony that shows how positive returns drive IPO 
issuance, and how poor returns shut down the market entirely. 
Unfortunately, there is very little policymakers can do about 
    The bursting of the Internet bubble over 10 years ago 
devastated IPO investors, far worse than the rest of the equity 
markets overall. Over 70 percent of those IPOs during that 
period were unprofitable companies whose offerings were 
promoted by the IPO Underwriters' research analysts. No wonder 
in the years following that disaster investors have avoided 
small IPOs.
    Our suggestions on the proposed bills include the 
    First, properly define ``emerging-growth company'' to 
target the really smaller issuers seeking to raise up to $50 
million who have disappeared from the IPO market.
    Second, strike the proposed informational rules in the 
bills that permit Underwriters' research analysts to promote 
offerings and obtain access to special information during the 
IPO process.
    And, third, the proposed private company bills should 
assist the smaller companies and add a market capitalization 
limit to prevent larger IPO-ready companies from enjoying an 
active trading market in their shares while avoiding public 
    To summarize, a well-functioning IPO market is based on the 
principle of full, transparent, and honest disclosure of 
company information available evenly to all public investors. 
The U.S. IPO market has been functioning well under the 
stressful conditions of a global financial crisis. While policy 
initiatives may help the most vulnerable, sub-$50 million 
issuers to enter the market, it is positive returns that will 
lead the way to a rising appetite by IPO investors for smaller 
IPOs. Waiving certain disclosure and stock promotion rules that 
result in misallocating capital to weak or fraudulent companies 
will only endanger the recovery of the IPO market.
    Thank you for inviting me to appear before you today.
    Senator Bennet. Thank you very much for your testimony.
    Mr. Rowe.

                       INNOVATION CENTER

    Mr. Rowe. Thank you very much, Chairman.
    Senator Bennet. I like the sound of that.
    Senator Bennet. It is fleeting, though.
    Mr. Rowe. Isn't everything?
    I want to thank Senator Bennet and Senator Merkley and 
Senator Brown, who is not on this Committee, for bringing 
forward crowdfunding proposals. I want to talk about that 
today. I think they are very exciting.
    First let me just briefly introduce myself. I am Tim Rowe. 
I run Cambridge Innovation Center. Cambridge Innovation Center 
is a facility in Kendall Square that sits next to MIT. We have 
about 450 startups going in this one office tower. We are told 
that we have more startups in one building at CIC than anywhere 
else in the world. And it is my background, having worked with 
these guys and, you know, about 1,000 startups overall over our 
history, that I bring to this discussion.
    What is exciting to me about the moment we are in is that 
we have the potential to really radically change the system by 
which we create new companies in this country. As Senator Moran 
raised when he quoted Kauffman Foundation data, we think now 
that most new jobs are coming from startups, companies 5-years 
old and younger. I was told I could not really show slides 
here, but I am going to cheat and turn my laptop around.
    Mr. Rowe. This is the Kauffman Foundation chart that I 
think you are all familiar with. You have probably seen it in 
other people's presentations. The blue is the jobs created by 
startups. The black is the jobs lost by existing companies, all 
companies 6-years old and older. This data has been pretty 
broadly vetted. Oh, it went dark. Did you see it before? All 
right. So it has been pretty broadly vetted, and what it says 
is that we need more startups.
    Now, we have got 80 percent of the world's venture capital 
in this country. We are awesome at this stuff. We are really 
good at innovation. This is where we are leading. 
Unfortunately, that venture capital only is good for the small 
percentage of companies that are very high growth companies, 
perhaps will be worth $1 billion. Most of the new companies in 
this country, as we all know, are local businesses. It may be a 
restaurant, somebody starting a construction company, somebody 
launching a plumbing business. These businesses are not going 
to be financed by venture capitalists, and for the large part, 
they are not going to be financed by angel investors. And, 
generally speaking, we have resorted to Government support 
through SBA loans and other programs like that.
    What we have in front of us is the possibility, through 
Senator Merkley's bill, through your bill, together with you, 
Senator Bennet, and Senator Brown's bill, to really change this 
and make it legal for people to help each other, for neighbors 
to help neighbors, people on your PTA committee, people in your 
Facebook friends circle, to help you start your business. This 
is a really healthy thing. We have seen this kind of thing 
happen in other countries. People talk about microfinance and 
so forth. It is just really exciting.
    I do not think there is really any disagreement that it is 
exciting. I think the disagreement or the concern--and it is 
well placed--is: Is there going to be fraud? Are bad people 
going to take advantage of good legislation to somehow, you 
know, screw us over? We have got to make sure that does not 
    So I have been on the phone with people from all over the 
country and around the world trying to learn about this. I am 
not a legislative guy. I am not an expert in this stuff. But I 
have been asking a lot of questions and pulling together data.
    It turns out there is a crowdfunding investing company that 
exists already. It is up and running; it is working. And the 
only reason it is legal is it is in the U.K. where they already 
have laws that permit this. And so they have a lot of data. 
They have only been up and running for about a year, but the 
data show, interestingly, that they have had zero claims of 
fraud so far through this system. What they are doing is very 
similar to what eBay does. When you go on there and you list 
something, they have systems to make sure that what is listed 
is true. They do background checks. They do make sure that the 
basic offering is OK.
    I thought, well, do we know any more? I looked at some U.S. 
companies that do crowdfunding lending. There is a company 
called Prosper that does. There is AngelList, which does 
Regulation D or accredited investor crowdfunding out of 
California. And there is a U.K. company that does micro 
lending. I went to all of them. They all said, ``We have had 
zero fraud.''
    So we can get more into the details of this, but the bottom 
line is it seems like these intermediaries, kind of like eBay, 
do make these things work. There are some specifics in my 
written testimony that I would like to refer people to about 
exactly how we do it, but I do not think that is the big point. 
The big point is let us get this done. Let us get a compromise 
that works for everybody and change the way the country works.
    Thank you very much for your time.
    Senator Bennet. Thank you very much for your testimony.
    Lynn welcome. We will hear your testimony now.

                        LITINOMICS, INC.

    Mr. Turner. It is good that both of us are from God's 
    Mr. Rowe. Aren't we all from God's Country?
    Mr. Turner. I will leave that one alone. But it is good to 
be here. It is an honor to be here again.
    As some of you know, I have been a founder of a venture-
backed startup company that was highly successful, that did 
create jobs. I have been at the SEC. I now serve on the Board 
of Trustees and Investment Committee of a $40 billion fund that 
does invest in this market through investments in venture 
capitalists. So certainly important to all of us, and I think 
everyone in the room would agree that the more jobs we create, 
the better off we are.
    Having said that, though, I would like to talk about some 
of the things that bring us here, and I think some misnomers 
that in general the IPO market is off because of regulation, 
and let me quote from Goldman Sachs, which is in the written 
testimony. ``Legal and regulatory factors probably do matter, 
and policy reform might strengthen New York's competitiveness. 
Nonetheless, we do not see them as the critical drivers behind 
the shift in financial market intermediation, even in the 
aggregate. Quite simply, economic and geographic factors matter 
    I think that is borne out if you look at the charts on page 
3 and 4 of my written testimony. The IPO market has always 
tracked what is going on with the general economy. When the 
general economy is doing well, we have a good, vibrant IPO 
market. When the general economy is not doing so well, it has 
not done well. This includes at times in the 1970s, 1980s, and 
1990s, all before Sarbanes-Oxley was ever passed. So it 
certainly has nothing to do with the issue of SOX in that 
    In fact, if you look at the London AIM market that everyone 
mentions or points to, in Charts 5 and 6 and 7, you will see 
that in London they have had the same drop--in fact, their drop 
has even been more dramatic in London in the lightly regulated 
A market than it has been here in the United States. In fact, 
as we heard in the testimony from Renaissance Capital, the 
bottom line is people invest in IPOs when they think they can 
get a decent return. If you cannot get a decent return out of 
that company, people simply are not going to invest in them. 
Why should they?
    In fact, in the London AIM market, if you look at the 
statistics on page 7, you will see that since that market was 
created in 1995-96, if you put $1,000 in it at that point in 
time, you would have $700 to $800 of that left, while the other 
components, the more regulated components of the London market 
gave you 50 to 250 percent return.
    Perhaps more compelling is the chart on page 8, the venture 
capital returns. It highlights the great growth that came along 
with the IPO market in the 1990s, and keep in mind, the 1990s 
was a once-in-a-lifetime economic event. The economy has never 
done as well before, and it has certainly never done as well 
since the 1990s. And that IPO market during the 1990s is not 
necessarily something that in its entirety we want to 
replicate. In fact, when I was at the Commission, we had the 
leadership at the Business Roundtable come and meet with 
Chairman Levitt and myself at the time, and they were very 
highly critical of that IPO market because of misallocation of 
capital and losses that they thought it would bring and, in 
fact, did bring.
    What the chart on the venture capitalists shows is, quite 
frankly, our bigger problem, as Goldman suggests, is 
infrastructure. We have not invested in this country in the 
infrastructure that creates the opportunity for these small 
businesses to grow, become successful, then get capital, and 
then even grow further. Things such as the incubators--and I 
myself have served in two incubators--are very critical.
    Education, which I know is very near and dear to Senator 
Bennet's heart, as McKinsey said a year ago in a study, our 
investment in infrastructure which gives these companies the 
people they need is a serious shortcoming and has caused a real 
problem with these companies being able to get the talent and 
the issues we have in this country with the visas and being 
able to keep and retain really talented people who have come 
here and got their education, really hurts and impacts these 
companies as well, far more than the regulatory issues, just as 
Goldman Sachs mentioned.
    So, with that, let me just make a couple points on the 
    One, on page 13 it shows this bill will affect 98-plus 
percent of IPOs, so this is a fundamental shift in the 
regulation of IPOs. This is not for a portion. This is almost 
for all of them. It will be an impact for a long period of 
time. Five years is a very, very long period of time.
    The stuff on the control stuff, let me just close by saying 
good companies have good controls, and the stats, as the 
written testimony shows, it is very, very clear we get higher 
returns when we can invest in companies with good controls, not 
bad controls, and you are taking that transparency away from us 
as an investor.
    With that, thank you, Mr. Chairman.
    Senator Bennet. Thank you, Mr. Turner, and thank you to all 
the witnesses.
    I would ask the clerk to put 5 minutes on the clock, and 
with that, I will turn it over to Senator Reed.
    Senator Reed. [Presiding.] Thank you very much, Mr. 
Chairman, Mr. Chairman, Mr. Chairman.
    Senator Reed. Mr. Ranking Member, Mr. Ranking Member, Mr. 
Ranking Member.
    Senator Bennet. Your Excellency, Your Excellency.
    Senator Reed. Yes, yes.
    I apologize. I had to go down to the Armed Services 
Committee. General Mattis and Admiral McRaven are down there on 
another topic equally as challenging as crowdfunding and 
Regulation A.
    Professor Ritter, you have done a lot of work on IPOs, and 
the sense I had from reviewing your testimony is that there 
are, as you say, numerous factors to support the idea that 
small companies are not going public, being small is not best, 
whether private or public, particularly in this international 
marketplace. And it goes, I think, to some of the themes that 
my colleagues have spoken about with respect to even if we do 
make these changes--and many of them are very thoughtful--is 
that going to have the impact we desire because of these market 
structure issues? And you might elaborate on what these issues 
    Mr. Ritter. In terms of the market structure issues, are 
you including analyst coverage and smaller bid-ask spreads?
    Senator Reed. Analyst coverage, smaller bid-ask spreads, 
not having markets, secondary markets in some cases for the 
stock, employee stock. There are a whole bunch of issues, but 
you might be best to define what you think the most important 
ones are in commenting.
    Mr. Ritter. Yes. I think that there are a lot of tradeoffs, 
as the Committee is fully aware, between lowering the 
transaction costs, the compliance costs for companies, but 
still providing protection for investors. And as has been 
pointed out in the testimony of others here, having 
intermediaries who can do some vetting and potentially protect 
investors, protect investors from themselves, might be a good 
way of allowing some small companies to get access to capital 
without needing to go through formal angel investors, formal 
venture capital firms. When there are no protections for 
investors, it seems there are just too many con men and too 
many unsophisticated investors.
    But as the example of eBay has shown and crowdsourcing in 
the United Kingdom, sometimes intermediaries that do some of 
the vetting that have some things at stake can protect 
investors. So one possibility might be to put restrictions in 
some of the laws that require the use of certain intermediaries 
as a way of keeping out the fraudsters and possibly allowing a 
couple of years of experimenting to see does this work, and 
kind of go from there. Maybe it will not work, and hardly any 
capital will be raised. But maybe it will turn out to be a lot 
more successful than some people might expect.
    Senator Reed. I think your response raises three issues, 
and I will sort of put them on the table, and I might ask 
anyone else who wants to respond.
    One is that it presumes that the issuer is going to provide 
adequate disclosure to either the retail buyer or the 
    Second, if you have an intermediary structure, somehow it 
is going to have to police the intermediaries to ensure that 
they are really working on behalf of the investor and not on 
their own behalf.
    And then a lot of the issues we will talk about in the 
context of this legislation is, well, so what liabilities are 
on each of these different actors? Is it a very loose negligent 
standard, we tried our best, did not quite get it? Or is it 
much more significant? And those are some--and I have just 
seconds left, so, Mr. Rowe, could you respond? And then perhaps 
Lynn, but very quickly.
    Mr. Rowe. Just very quickly, I think Professor Ritter said 
it well. I think intermediaries should be required as I believe 
the Bennet, Merkley, and Brown bills do require, and I think 
that that has shown that it does block fraud.
    Senator Reed. Mr. Turner?
    Mr. Turner. Senator Reed, I would probably put a strict 
liability on that, and probably to establish accountability, I 
would put a fiduciary standard on that intermediary, a 
reasonable fiduciary standard. We do not want to go overboard 
here in that regard. In some of the information I provided the 
Committee, though, there is a paper by Professor Jay Brown from 
the University of Denver that gets into the issue of provisions 
for bad actors in the intermediary or one of the other roles. I 
would certainly turn around and take a look at that because I 
think that is one piece--there is some good stuff in these 
bills, but I think the lack of accountability is what is 
driving a lot of investors and consumers batty about these 
bills. They do not see it. So I think you have got to get the 
bad-actor provisions and you have got to get the liability and 
the fiduciary standard in there, or it will take us back to the 
bucket shops and penny stock frauds.
    Senator Reed. Thank you.
    Thank you, Mr. Chairman.
    Senator Warner. [Presiding.] Senator Corker.
    Senator Corker. Thank you, Mr. Chairman.
    Senator Warner. I know. I am not even going to get a couple 
comments in. Senator Corker.
    Senator Corker. If you would like to make comments----
    Senator Warner. No, no.
    Senator Corker.----in advance of a lowly minority Member, 
that would be fine.
    Listen, we thank all of you for your testimony today, and I 
think all of us care greatly about access to capital and 
ensuring that our economy flourishes, and I find this testimony 
today very interesting. I was most interested in the beginning 
on the scale issue that was brought up regarding larger 
companies having greater returns than smaller companies. Mr. 
Waddill, since you sort of represent the smaller-company issue 
now, and Professor Ritter was referring to that, do you have 
any comments regarding why that is the case?
    Mr. Waddill. It is probably tied to the fact that we all 
want to be bigger companies, right? I think what is really 
important to point out is access to capital. Without that 
access to capital you cannot be a big company. You cannot get 
through--and I certainly hope that the 1990s were not a once-
in-a-lifetime thing. I look back at the companies in my 
industry that were successful going through the 1990s, the 
biggest one being Genentech, a venture-backed company that got 
early access to capital, became one of the biggest biotech 
companies in the world.
    Senator Corker. And conditions have changed since that time 
so that Genentech could not have done that in 2012?
    Mr. Waddill. Certainly in the past 10 years, conditions 
have changed. Part of that, you know, you have to pay attention 
to--and I agree with what Lynn was saying--what happened in the 
economy. But what is another portion of this--and I can state 
as a CFO, an informed investor is a good investor. I want them 
to be informed because then they can get in lockstep with me 
and what I am trying to do. But I think there needs to be an 
appropriate balance in that.
    If we look at the past 10 years of the ups and downs in the 
economy, certainly IPOs have tracked along with that. But with 
this legislation, what is really being proposed is to unleash 
the access to capital. And as the economy comes back in an 
upswing right now in what clearly in my lifetime is the biggest 
financial crisis that I have seen, unless these burdens of 
compliances and these costs of compliances are loosened, you 
know, over, say, that 5-year period, this is going to be an 
anchor. It is going to be a negative factor, a negative 
multiplier that is going to prevent us from really growing jobs 
going forward in an appropriate way.
    Senator Corker. Mr. Ritter, U.S. PIRG, I guess, has 
mentioned that reducing compliance costs, meaning people not 
exactly knowing what they may be purchasing, will actually 
increase the cost of capital. I wonder if you might have any 
comments regarding that.
    Mr. Ritter. It is certainly possible that investors are 
going to demand higher promised returns if they have got 
greater concerns about having lack of transparency, having more 
bad apples in the barrel, that the good apples wind up 
subsidizing the bad apples. There are costs of compliance, and 
getting that balance exactly right in terms of imposing costs 
on all of the apples to reduce the number of bad apples does 
involve difficult balancing issues.
    Senator Corker. Mr. Turner, you mentioned the need right 
now for greater infrastructure. That is more important: 
incubators, education, visa issues, which I think many of us up 
here agree, especially on the visa issues.
    What was it about the 1990s that--I guess we were doing far 
less of that at the time. What was it about the 1990s, in your 
opinion, that caused IPOs and just the economy in general to 
flourish, whereas now we are looking at a lot of micro issues 
here to make that happen?
    Mr. Turner. Thank you, Senator. There were things going on. 
There was an increase in debt that was occurring over that 
period of time that was funding increases, if you go back and 
look at the issuances of debt and the debt that individuals, 
households, and companies were taking on, were financing a fair 
amount of that growth, even at a national level, as everyone 
knows these days, through an acquisition of debt; whereas, now 
we are in a more austere environment, if you will.
    There was probably also an environment, as you saw, the 
high-tech industry, which really only came about at about the 
end of the 1960s, early 1970s. You really saw the tech industry 
as an industry as a whole take hold and grow. We had a 
phenomenal amount of manufacturing still going on at that point 
in time, but as we reached toward the end of the 1990s, we 
started outsourcing. I was an executive in a large high-tech 
company at the time. Quite frankly, we started out first with 
much more manufacturing. We started to take a lot of our 
technology offshore as we came to the end of that decade. And 
as we did that and we stopped building the debt--or, you know, 
people started maxing out on debts, it has put us into the 
current economic situation we have now.
    So two vastly different economies, not only here, if we 
look around the rest of the globe, as the charts on London 
show, you had the same effect going on in other countries. And, 
of course, this decade has seen the growth of emerging markets 
like India and China. And some of that and the success of the 
markets is due to the fact that at the Commission we spent a 
lot of time, at the urging of this Committee and others, to go 
educate everyone else on how to build really good capital 
markets. And everyone else went and really built good capital 
markets. And if you have ever sold stock in a market, you know 
that it is best if you sell the stock in your home market with 
your home investors because that is where you get ultimately 
the greatest turnover in your stock and the greatest ownership. 
If you were doing a sale of stock in a U.S. company today and 
you went to the Japanese Mother market, 6 months later all 
those shares would be back trading in the United States, so why 
do it anyway? Well, it is the same thing for Chinese and Indian 
companies. When they list, they tend to list on their own 
markets. They have got good markets now that they did not have 
before. So there is a reason they go to those markets, and we 
have to be very particularly sure in that case, because of 
that, that we keep our market the most competitive, and that 
means it has to give the highest return to investors. In our 
$40 billion fund, we will put that money wherever we have got 
to go in the world to get the highest return for the half 
million people in Colorado because they depend on that money 
when it comes to retirement.
    And so if someone else is able to have more transparency 
and higher returns, we will go there, and we have gone there.
    Senator Corker. Mr. Chairman, thank you. I think you 
performed in an exemplary manner as Chairman, and I just want 
to say that I appreciate the efforts of so many on this 
Committee to create additional access to capital. But it seems 
to me the big issue that so many people, again, at this dais 
have worked on is getting the macro issues right, and if we 
could deal with some pro-growth tax reform and entitlement 
reform and deficit reduction, many of these issues that are 
being dealt with in a very micro-targeted way would go away, 
and that the market would function very, very well. And I 
appreciate your leadership in that regard, too.
    Senator Warner. Thank you, Senator Corker, and I am anxious 
to get to my time. I will call on Senator Tester next, but I 
would just make the comment that the appropriate role for 
intermediaries, but the intermediaries as trusted 
intermediaries in the late 1990s, I am not sure that that track 
record in terms of the ultimate result of a lot of those 
companies ended up being a great value-add for the investors.
    Senator Tester?
    Senator Tester. Yes, thank you, Mr. Chairman, and I 
appreciate that perspective. I also want to thank Senator 
Corker for his comments about the work that the Members of this 
Committee have done--I very much appreciate that, too--to craft 
proposals that really will, I think, help small businesses grow 
through access to capital.
    Let me say at the outset I am very pleased with Senator 
Reid's announcement about the consideration of a package of 
capital formation bills in the near future. I know you are 
working on one, too, Mr. Chairman, and hopefully we can get 
something to the floor that is going to work and get it passed 
in a bipartisan way.
    It is really an indication of the good work that is being 
done here on the Banking Committee, important legislation to 
open up markets for small businesses under the leadership of 
Senator Johnson and Senator Shelby.
    This Committee has seen some partisan battles in the recent 
past. We have been able to set those differences aside on 
several bipartisan bills that have the potential to become law, 
I think create jobs, and can happen this year, and I hope we 
will move forward and focus really on results instead of 
    Members of this Committee and Senators Reid and McConnell I 
looked forward to working with to put together a bill, passing 
it on the floor, and I am confident that with some strong 
leadership we can get a package of legislation signed by the 
    It is good to see Senator Toomey here. We have been working 
on legislation since July when I had an access-to-capital 
hearing in my Economic Policy Subcommittee. The key takeaway 
from that hearing was we need to ensure the capital markets 
within the reach of startups at various stages of their 
development, particularly in the stages before they are ready 
to go public.
    As a result of that hearing, we had a chance to take a 
closer look at updating Regulation A and better enable small 
businesses, including many of the innovative biotech firms in 
Montana and Pennsylvania and around the country, to raise 
capital through these public offerings. These capital-intensive 
firms face unique challenges in raising the significant amounts 
of money necessary to complete clinical trials and complete 
development of cutting-edge drugs. Mr. Waddill talked about 
that in his testimony, and I appreciate the partnership we have 
had working on this bill, a bill that passed the House 420-1. 
It makes a number of updates to Regulation A, increasing the 
amount of capital that can be raised through these offerings to 
$50 million, while providing a host of new additional investor 
protections that include a requirement of annual audited 
financial statements, and the bill provides the SEC with the 
ability to require issuers to provide additional information 
regarding the financial condition of businesses to prohibit bad 
actors from participating in such offerings.
    The bill maintains the most attractive elements of 
Regulation A, including the ability of issuers to test the 
waters before registering with the SEC, and preserves the 
nonrestrictive status of securities sold through Regulation A 
offerings, a bill that, along with many others, I hope we can 
get passed here in the U.S. Senate.
    My first question is for Mr. Waddill. In your testimony you 
talk about the opportunity that modifications to Regulation A 
present to startup biotech firms. Can you talk a little bit 
about how and at what stage of development a firm like yours 
might use Regulation A and what an adjustment of that cap from 
$5 million to $50 million might mean for your company?
    Mr. Waddill. Certainly. So OncoMed is a biotechnology 
company. We are doing discovery and development work on cancer 
therapies. We are currently in clinical trials. Clinical trials 
are extraordinary expensive. For every patient that is in a 
Phase I--and there are three phases of the clinical trial 
process. For every patient that is in Phase I is approximately 
$50,000. Get to Phase II, it gets to be about $75,000. So to 
access $50 million when I look at my company's plans, that 
would get me from discovery for a therapy to the end of Phase 
    Now, the end of Phase II is a very important marker, 
milestone, because that is when you reach what we call ``proof 
of concept,'' where you have shown that your drug has potential 
to move forward into Phase III, but the science that you have 
been working on for a number of years has gotten to that point.
    Now, in terms of would my company try to access $50 million 
time and time again, the answer is no because what I have to be 
cognizant of is when I raise $50 million, my previous 
shareholders are getting diluted a little bit. They own a 
little bit less of the company when I raise that money. So we 
try to be very strategic when trying to go for those sums of 
money and direct them specifically to what we think are the 
promising therapies within our pipeline.
    Senator Tester. I think your testimony also said it was 
1991 it was set at $5 million, and I do not know how long you 
have been in the business, pharmaceutical business, but----
    Mr. Waddill. Twenty years.
    Senator Tester. Well, we are there, then, 1992.
    Mr. Waddill. Yes.
    Senator Tester. How have the costs increased since then? In 
other words, $5 million I would imagine in 1992, as in 
agriculture, bought you a hell of a lot more than it is going 
to buy you today.
    Mr. Waddill. Yes, absolutely, the difference being--and 
this gets a little complex--that the recognition in the 
marketplace of what is valuable has changed.
    Senator Tester. Yes.
    Mr. Waddill. So back in the 1990s, when I first got into 
biotechnology, you could have $5 million, go for a couple of 
years, and shareholders would respond to the value you created 
with $5 million. That has changed dramatically in that you have 
to not go from just discovery but all the way to the end of 
Phase II before they will look at you.
    Senator Tester. Got you.
    Mr. Waddill. And that is a key understanding in all of 
this, that the data that flows through my financial statements 
talk about what is going on financially in the company. We 
disclose everything appropriately, but the science underlying 
it is really as important, if not more important.
    Senator Tester. Just a little liberty, Mr. Chairman.
    You can make this answer very, very concise, if you would. 
There is some anticipation that people would use this offering 
multiple times. Could you talk about that very briefly, if you 
see that as something that your company would do, or if it is 
something we need to be concerned about?
    Mr. Waddill. No, that would be dilutive to my current 
shareholders, and I would not have a job.
    Senator Tester. Got you. Thank you very much.
    Thank you, Mr. Chairman.
    Senator Warner. Thank you, Senator Tester, and thank you 
for your leadership on this issue. It seems to me--now when I 
get to my turn, I will speak a little bit about the fact that 
there is a lot of commonality amongst a number of these bills. 
I know Senator Toomey has been very active on a series of them, 
and this sure ought to be one where we could find some common 
ground and a broad bipartisan bill as opposed to a Democrat and 
Republican alternative.
    Senator Toomey?
    Senator Toomey. Thanks, Mr. Chairman, and I do appreciate 
your interest and leadership in this, as well as that of 
Senator Tester. You know, when we go back home to our 
respective States, I am sure we all hear the vocal complaints, 
legitimate complaints, from our constituents about how little 
is getting done, how little we work together, how this place 
has devolved into this partisan battling that has been 
downright counterproductive for our economy and for our 
    I really believe that we are on a topic here today that is 
a complete exception to this entire idea. And since I got to 
the Senate a year ago, I have been delighted to work with 
colleagues on the other side of the aisle to advance bills that 
are very broadly, almost universally supported, and I think it 
is time we move on this. I am, frankly, delighted that we have 
got a strong interest in the House to move a series of bills. I 
am delighted that there is interest here.
    If ever there was an opportunity to do something that is 
unambiguously constructive for the economy, pro-growth, good 
for job creation, this is it. And an awful lot of the heavy 
lifting has already been done.
    So, really, I am glad we are having this hearing. I hope 
this is to drive home this message that now is the time to 
    Senator Tester referred to a bill that he and I have 
together that passed the House 421-1. We have many cosponsors 
on both sides of the aisle. I have a bill with Carper--it is 
known as the ``shareholder bill''--that would limit the 
permissible cap on the number of shareholders. It passed the 
House Financial Services Committee, which is a big committee, 
by a voice vote in October of last year. It is my understanding 
some version of that will be included in the House package.
    Then there is the bill S. 1933 that I have done with 
Senator Schumer, which the nickname for this is the ``on-ramp 
bill.'' This one, of course, would facilitate an IPO by 
diminishing some of the burdens of registration that currently 
attends to an IPO. This bill passed the House Financial 
Services 54-1. These bills, if not every one of them certainly 
the first and the last, are supported by the President in part 
of the Startup America Plan. So I hope we will move on this 
very soon.
    My quick question for Mr. Waddill: One of the things that 
has been stressed to me by some of the folks in the life 
sciences in Pennsylvania is how critical the multiple stages of 
capital raising is, from infancy right through IPO, and there 
are a lot of pieces, a lot of steps along the way.
    It seems to me that if you facilitate access to capital at 
any step along the way, let us say even the IPO, you increase 
the opportunity and the chances and the ability to raise money 
at the earlier stages because one stage in many ways depends on 
subsequent stages.
    So could you comment on whether you agree with that, 
whether that is, in fact--and, in other words, if you 
facilitate raising capital at one stage, are you really helping 
that company out throughout its entire life cycle?
    Mr. Waddill. Oh, there is no doubt about it. I can tell you 
10 of my 20 years in the industry was spent consulting and help 
start 34 different companies, some of those in Massachusetts, 
some of them in California. And predominantly they were the 
early stage companies, predominantly venture capital-backed. 
And those early stages, to raise $5, $10, or $15 million to 
establish a lab in biotechnology was just absolutely key. You 
cannot progress the science forward unless you set up that 
    So it is remarkably important, and you can connect the dots 
between the later-stage raise and the earlier-stage raise. And 
if you get a high-quality investor in that process, they will 
stay with the company for a period of time because they will 
believe and understand what you are doing.
    Senator Toomey. So would it be your judgment that if we 
passed some package of these bills, that could actually 
facilitate angel investment, early venture capital, even in 
respects that are not directly addressed by the bills?
    Mr. Waddill. Yes. So when you look at venture capital 
investing, part of their collective problem right now is they 
have no exit for their investment. They cannot cash out. And 
that is due to economic climate and the barrier to go and be a 
public company. Part of that barrier is the cost of compliance. 
I am a numbers guy, so I can share some numbers with you. For 
my company to try and prepare for it Sarbanes-Oxley compliance 
would be somewhere between $3 to $3.5 million. On an ongoing 
basis, if we use the SEC study that came out, the medium cost 
to comply with 404 is in the $400,000 to $450,000 per year 
range. So an easy way to think about that, for every $1 million 
of compliance, I am prohibited, because I do not have the 
funds, to hire 15 to 20 scientists--those 15 to 20 scientists 
will be key in developing the science further--and, more 
importantly, another 15 or 20 patients that I cannot treat in 
the clinic. For us to be successful in our sector, we have to 
be treating patients to progress forward.
    Senator Toomey. Mr. Chairman, if you would just indulge me 
for 1 second, I notice Mr. Rowe seemed to have something to 
indicate. If you want to respond to this question, I would 
appreciate it.
    Mr. Rowe. Yes, I do. I spent part of my time with New 
Atlantic Ventures, which is an early stage venture capital 
firm. One of the things that we're seeing is that the exits 
that are prevalent today are primarily acquisition as opposed 
to IPOs. There is much less upside for a venture capitalist if 
you go down the actual path. And, incidentally, unlike in IPOs 
where it is somewhere between a 60-percent increase and a 5-
fold increase, depending on whose data you look at in jobs, 
typically after acquisition you let go people because there are 
redundancies. So this is very important to the venture capital 
    Senator Toomey. Thank you very much, Mr. Chairman. Thanks 
to the witnesses.
    Senator Warner. And thank you for your leadership on these 
    Senator Menendez?
    Senator Menendez. Thank you, Mr. Chairman, and thank you 
all for your testimony. I had two lines of questioning I wanted 
to ask.
    One, how should we address the counting of beneficial 
owners of stock rather than owners of record? In my own view, I 
think it makes sense that we should be counting beneficial 
owners and raising the threshold to a higher number, and not 
necessarily be counting a broker of record that has stock from 
many shareholders as a shareholder. But I would be interested 
in hearing some of your views.
    Mr. Waddill. It is a cumulative number. I agree with you 
that the number needs to be raised. I am not sure what that 
number is. I can tell you that one of the predominant issues in 
my industry is that we compensate employees with stock options. 
We do that from the president of the company down to the glass 
washer in the lab. And over the course of time, a lot of shares 
will be issued to a number of people. So that is another 
cumulative set that needs to be added to what you are 
    Mr. Ritter. Senator Menendez, I am in complete agreement 
with you that the regulations do need to be changed given that 
the concept of shareholders of record is dramatically different 
now than it used to be because individuals for public companies 
are holding stock in street name. Now if you have got a company 
that before going public might have had 1,000 beneficial 
shareholders and after going public has 2,000 beneficial 
shareholders, the shareholders of record might have only 
increased by 10 people. So the regulations do need to be 
changed to reflect stock being held in street name.
    Senator Menendez. Anyone else? Ms. Smith.
    Ms. Smith. Yes, I would add to that that I think that the 
ability to do online activities has helped us so much, for 
example, with disclosure. EDGAR enables information to reach 
the hands of investors so elegantly and has made such a big 
impact on transparency.
    However, when it comes to the private placement market, the 
issues that we have, even with the 500-shareholder rule, 
actually developed because of the ability to connect online 
with investors of all kinds, and hopefully they are all 
qualified. We have had a situation where Facebook, for example, 
even under the 500-shareholder rule, has benefited from a 
lively trading market in its stock at prices that have valued 
the company before they filed for the IPO, something over $80 
to $100 billion, the size of McDonald's. A major company that 
can then have the benefit of this lively trading market beyond 
any of their existing employees but involving outside 
shareholders and yet not take on the responsibility of full 
    So with these rules on the numbers, it appears to us that 
it is not the number that--with technology, 500 may even look 
like a big number because we can move information around very 
quickly among a lot of people. That the real issue is to target 
the smaller companies and to put some kind of a market cap 
limit. For example, if the company's market valuation is below 
$300 million, and below $300 million in total valuation, and it 
gets to 500 shareholders, fine, we can have this market. But if 
it goes beyond that, we then do not want to establish what I 
would call a shadow IPO market of major companies that should 
be disclosing and yet accepting the ability to have a lively 
trading market in their stock. A shadow IPO market is probably 
not in the best interest of promoting a strong IPO market here 
in the United States.
    Senator Menendez. And a final question, Mr. Waddill. You 
mentioned in your testimony a number of avenues where financing 
could be potentially raised by small private and public 
companies, and in 2010, Congress passed my therapeutic 
discovery project tax credit. My understanding is your firm was 
awarded credits through the program.
    From your experience, can you talk about whether you found 
this program beneficial, for example, small biotech capital 
formation? And do you believe that an extension of the credit 
would help other small innovative biotech firms as they compete 
against competitors around the world?
    Mr. Waddill. Absolutely. So we applied for five, we got 
five. That equated to $1.2 million into my company. And I can 
specifically tell you that we had--we did not have funds to 
progress one of our therapeutic areas, and that $1.2 million 
provided that. So as I sit here today, that for us is a major 
initiative in the company which just would not have happened. 
And it was one of several areas. So if you equate that to a 
smaller company than mine, certainly it would have been 
beneficial to advance the technology, so it was a tremendous 
    Senator Menendez. Thank you, Mr. Chairman.
    Senator Warner. Senator Bennet.
    Senator Bennet. Thank you, Mr. Chairman. Thank you so much 
for holding this hearing. I wanted to associate myself with 
Senator Toomey's remarks. This is a place, I think, where there 
is very broad bipartisan support and that we ought to figure 
out how to advance these bills in a bipartisan way. So much of 
the debate that we have around this place is this left-right 
discussion that no one at home really understands and, frankly, 
find meaningless. And we are at a position now, I think, where 
as a Congress we can actually support what is the most 
innovative economy in the world still and drive this innovation 
in a way that actually is promoting job growth here in this 
country and promoting wage growth in the country, the two 
biggest issues that the people that I represent face, frankly. 
And as the testimony pointed out, we are at a moment in the 
economy where the productivity increases, the productivity 
gains that legacy firms have achieved, which is great, are not 
driving the job growth that we need, and it is going to be the 
company that is founded tomorrow and next week and the week 
after that that is actually going to drive job growth.
    The other point I want to make before asking one question 
is the critical importance that education plays in all of this. 
You know, the worse the unemployment rate ever got for people 
with a college degree in the worst recession since the Great 
Depression, the recession we just went through, was 4.5 
percent, and there is a reason for that. And if we are not 
educating the people in this country to be able to do these 
jobs, the capital formation that we are all talking about here 
is going to go someplace else to find human capital that 
actually can drive these new businesses. So that is not within 
the jurisdiction of this Committee, but it is a very important 
part of what we are dealing with.
    Mr. Rowe, I appreciated very much your comments about 
crowdfunding, the bill that Senator Merkley and I and Senator 
Brown have been working on. I wonder if you could talk a little 
bit about what kind of businesses you would expect to take 
advantage of crowdfunding if we were able to pass this. Is it 
just somebody who has got an initial idea, existing small 
businesses, someone who has got the need for additional 
capital? And then, finally, as we look to formulate a consensus 
bill on crowdfunding, which I believe we can do, you know, what 
thoughts do you have about the lessons that we can learn from 
existing Web sites like Kickstarter, which you mentioned in 
your testimony, which has enabled individuals to donate to film 
production and the arts? So run with it.
    Mr. Rowe. Thank you, Senator Bennet. I really appreciate 
your question and the whole Committee's time again.
    Let us put sort of the potential of this in a little bit of 
perspective. Apparently, Americans save in long-term savings 
about $30 trillion. This is 401(k)s, you know, pension funds, 
IRAs and so forth. Author Amy Cortese framed this by saying if 
Americans took 1 percent of their saving and put them into--
instead of saving it in a 401(k), invested it with another 
business somewhere in their town, just 1 percent of their 
money, that would create a pool of money 10 times bigger than 
all the venture capital that we invest every year in this 
country. It would create a pool of capital that is half as big 
as all outstanding small business loans.
    So the size of this, just first of all, is simply huge, and 
the Kickstarter analogy--this came out I think in Talking 
Points Memo recently, and there was some debate about the 
accuracy of the figures, but I think they really nailed it now. 
They found that Kickstarter, which is one crowdfunding site 
that instead of investing, you get a thing, to kind of work 
around the laws today you get an item from the person you are 
investing in, you do not get equity. Kickstarter raised for the 
arts alone half as much as the NEA, the National Endowment for 
the Arts, raised for arts last year in 2011. And they are 
predicting that in 2012 it will tie the NEA in money raised for 
the arts. This is everything from video games to film to 
paintings and so forth. So the impact of this, just the scale, 
is huge.
    I predict that this is going to be your everyday business. 
I think that you are going to have somebody in your community 
who starts a catering business, and they are going to go on 
Facebook, and this is the general solicitation part. This is 
why that is important, because if you post on Facebook that is 
a solicitation and it would be illegal today. They are going to 
go on Facebook, and they are saying, ``I am starting a catering 
business.'' They are going to go to their friends from college 
and say, ``Would you back me? Would you put 500 bucks or 250 
bucks in to help me get this thing going? I need to buy an 
oven.'' That is the kind of business that I think this is going 
to really--this is where it is really going to hit the ground 
running. And where it really is different from what, you know, 
for instance, happened in the late 1990s with the IPO boom and 
the venture capital, that happened in a very small part of the 
country, in a very small type of business. The rest of the 
country did not see those benefits. I think we are talking 
about something which is timeless and which is growing. So that 
is the first part.
    If you are interested, I do have some very concrete 
suggestions, having talked to dozens of people about your bill 
and other bills. I think there is a potential for a compromise 
bill here that is 99 percent what is already in all the bills, 
and there are a couple little tweaks that people would like to 
see, or we can come back to that afterwards.
    Senator Bennet. Great. My time is up, but I for one would 
love to hear those suggestions, and I am sure that Senator 
Merkley would as well.
    I just think the last point is so important. These 
initiatives will inject capital throughout the country, 
throughout the entire geography of the country, in a way that 
we have not seen before. This really is about Main Street, and 
we need to do everything we can do to make sure we protect the 
investors that will come. But I think the potential here is 
just enormous, so thank you, Mr. Chairman.
    Senator Warner. Thank you, Senator Bennet.
    Senator Merkley?
    Senator Merkley. Well, thank you very much, Mr. Chair, and 
I will follow up by saying I had highlighted in your testimony, 
Mr. Rowe, the comment about the $30 trillion. So I think it is 
a reminder of the potential, and that is just retirement 
    As we wrestle with the crowdfunding platform, the goal that 
I brought to this, and my colleagues who have joined me in the 
bill, is to establish a successful system, because if it gains 
a taint of fraud on the front end, it will be very hard to 
improve on that in the future. And one philosophy we brought to 
that was portal neutrality, so the portal itself is not 
involved in any sort of pump scheme that might discredit its 
    A second was accountability for accuracy among the officers 
and directors, and I know you have made the point in your 
testimony that maybe that is going too far. I think that is an 
important conversation for us to have, at least at the startup 
of this, and as we search for a way to try to give folks 
confidence that what they are reading is accurate.
    And the third was having statements reviewed under 500K and 
audited over 500K as three of these approaches.
    But I thought I would just invite you to share your concern 
that the accountability for accuracy might be going too far. 
And, Mr. Turner, I think if you would like to follow up on 
that, I would appreciate it.
    Mr. Rowe. Thank you. So on the accountability, I think we 
are very close. I think the definition you used in your bill is 
almost identical to the--and I am not an expert in this, but 
the SEC Rule 10b-5, which Lynn probably authored, which defines 
the accountability for fraud in private exempt offerings of 
securities today under the SEC. It is identical to yours with 
one exception. They do not hold the officers liable if there 
was no intent of malfeasance or negligence. So in the basic 
standard in the bill today, it just says if you misstate 
something, then you are liable. And we are concerned that if 
you have got 100 investors and one of them gets made at you 
because of, you know, maybe a personal dispute or something, 
they sue you ad you are liable because you accidentally 
misstated something, we are hoping that would not be included. 
The standard SEC fraud clause works fine. It just says you are 
liable as long as you did not--as long as there was 
malfeasance, or I think they call it--you are probably going to 
be able to do a better job with this.
    On the other bits, I think that reporting is great. There 
was some suggestion that maybe reporting should be quarterly. 
Again, for these small businesses it would be really great if 
that could be annual. I mean, this is a catering business. They 
do not do quarterly accounting typically, and it is an extra 
cost. It is that kind of level of tweak that we are really 
talking about. I do not think we are in disagreement at the 
overall level.
    Senator Merkley. Thank you very much. I think it is very 
helpful to chew on these things.
    Mr. Turner, do you want to make a comment on that?
    Mr. Turner. Thank you, Senator Merkley. In general, I like 
the notion in your legislation that there is a degree of 
accountability. I think it needs to be more than just an 
intent-based thing. If, in fact, you go out and mislead people, 
you ought to be held accountable. And on the flip side of that, 
if you are the intermediary representing someone trying to 
raise the money, then I think you ought to have a fiduciary 
standard to that investor that you are held to. And I think it 
goes beyond just being something with scienter or fraud. I 
think that if people recklessly go out there and exhibit gross 
negligence in doing this and misrepresent things, certainly 
those people should be held accountable. If it is merely an 
oversight, you know, I do not think an oversight, but, 
nonetheless, there is a danger to the system here. We have a 
very good history with these types of situations in the past, 
as recent as Congress did the penny stock fraud reform act in 
this building.
    So we have a history that when people are out attracting 
this type of money, unless you have a fair degree of 
accountability so that investor can go recover, you turn around 
and create a situation where there will be damage done and 
people withdraw from doing these. Rather than increasing them, 
you are going to decrease them if we go back to the whole penny 
stock frauds or bucket shop days that we have had a couple 
times. We have tried this a couple times, and it never worked. 
So if we are going to try it a third time, you have got to 
build in transparency, you have got to build in full disclosure 
of conflicts, and you have got to put in a decent level of 
liability if you take people's money and misappropriate it or 
mislead them on it.
    Senator Merkley. So, Mr. Turner, I am running out of time, 
but I will look forward to following up with you on this issue 
of platform fiduciary responsibility, because I think we had 
really worked to frame this as a facilitator rather than a 
vetter, and I think a couple alternative perspectives are being 
presented here to chew on.
    Mr. Chair, can I extend for a moment here? Yes, Mr. Rowe?
    Mr. Rowe. Yes, I think that probably the word ``vet'' is 
the problem because it could mean different things to different 
people. What seems to be working well is where the facilitator 
does background checks, makes sure that the offering 
descriptions are very complete, does a bunch of other stuff to 
make sure that these are not fraudsters; but does not try to 
say this is a good catering business or a bad catering 
business. That is the line that I think they should not cross. 
And I think that is also what you are saying as a facilitator.
    If you look at AngelList, which is working very successful 
now under Regulation D for just accredited investors, they 
describe the offerings. They also do clever things. They 
describe well-known people who are investing in these things, 
well-known people in the community that have already privately 
vetted them, and they say, you know, if Mitch Kapor wants to 
invest in this--they do not say this overtly. They say, ``Here 
are the people who are investing. You draw your own 
    So there are very clever ways that they can get the 
intermediary without actually directly vetting can facilitate 
and prevent fraud.
    Senator Merkley. Mr. Chair, I have two more questions, if 
we have time.
    I want to throw both of these out there at once. One is 
that another challenge for small investors--because they are 
looking at the front end, and they figuring in a couple years 
this company is going to sell out or be purchased or is going 
to merge. How do you ensure that there is some protection for 
the small investor who is so key in the success on the front 
end, but the deals struck by management when they sell the 
company might basically undermine any return to that small 
investor. So that is one question.
    A second is: Should there be the possibility for 
intermediary funds? For example, let us say I think it would be 
quite interesting to put 1 percent of my retirement funds into 
small companies, but I have no time or desire to vet those 
companies. Should I be able to put 1 percent of my money into 
basically an intermediary fund that would then invest in 
    So I will throw those two questions out for any thoughts or 
insights you might have. And, Mr. Ritter, I think that you 
might want to start, or if you would like to start, related to 
this issue of protecting the small investor when M&As come up.
    Mr. Ritter. Right. In regard to your first issue, with a 
lot of startup businesses, they fail, and investors, I think, 
will certainly be aware that there is a possibility of failure. 
But there is also an issue, what if the company is very 
    One possible thing that could go on is the small investors 
wind up ex post being diluted out. For instance, the first-
round financing might be Class A shares, and then later on some 
venture capitalist or brother-in-law of the entrepreneur comes 
in and is issued Class B shares that have conversion rights of 
100:1 into Class A shares. So the company is very successful, 
but the original Class A investors wind up owning 0.1 percent 
of the company and they do not get to share much in that upside 
    I think that, you know, angels, venture capitalists, are 
aware of these possibilities. They insist on fine-print anti-
dilution rights. A lot of individual investors are not going to 
be thinking about all of these concerns, and if they are 
talking about investing $1,000 in a company, it is certainly 
not worth their while to go out and hire a securities lawyer 
before they decide to invest this $1,000, to put the $1,000 in.
    So one possibility might be to craft the legislation to 
have certain defaults, anti-dilution provisions or something as 
the base case that these Class A shareholders would have to 
vote to override if they are overridden.
    Mr. Rowe. If I may, I do think it is a very valid concern, 
and I would say there are other concerns, similar concerns, 
such as if it does very well, what if it just does not sell the 
stock for a long time, does not make dividends. You know, when 
does this investor get out, for instance?
    So this is why I believe that you should require 
intermediaries, and I know you do in your bill. The 
intermediaries will compete to be attractive to these small 
investors. What is already happening in England is that they 
are looking at--the intermediaries are looking at putting in 
just such these provisions themselves in order to be more 
competitive to draw small investors. I think this actually is 
an area where we can leave the intermediaries to figure out 
what is the best deal. How can we structure this with standard 
docs and standard provisions that will be attractive to these 
small investors? The intermediary who loses all the investments 
or whose investors hate it because they lost all their money 
will go out of business very quickly and I do not think 
realistically will set up in the first place.
    Senator Merkley. Thank you. And I am way over my time, so I 
am going to return it to the Chair.
    Senator Warner. Thank you, Senator Merkley. And I want to 
also thank all the witnesses and all the good work of the folks 
on the Committee. This was my business for 20 years in the 
venture business, and I believe there is enormous opportunity 
here to jump-start capital access, because, frankly, our recent 
efforts in terms of the small business bill and some of the 
other capital access bills have not been very successful.
    I am very intrigued with the crowdfunding notions. I do 
think these questions around--having been that, you know, bad 
venture capitalist coming in at times, you know, there are real 
concerns about dilution interests, trying to protect those 
early stage investors. But the flip side is if the company is 
not doing well, the market drives some of this. So the question 
of how you get the intermediary right is, I think, an important 
one. I know Senator Merkley has been working on this.
    Clearly, the intermediary in and of itself, though, we had 
very ``trusted'' intermediaries in the late 1990s, I am not 
sure all the products that were put out in the marketplace, you 
know, their performance record was obviously not that good. I 
still recall a number of companies I had that had, you know, 
momentary billion-dollar caps that went to zero as the tech 
bubble burst.
    One of the things that I am--and I have great respect for 
Lynn Turner, but I do believe that the regulatory burdens of 
Sarbanes-Oxley, 404 and others, are stopping companies from 
choosing to pursue that route. And I think some of the bills 
that I've been working with Senator Toomey and Senator Schumer 
on, on the on-ramp approach, make some sense.
    I would argue that one of the things that is different than 
the bucket shop era is that the power of the Internet bringing 
more and more transparency and being able to more quickly 
identify bad actors through this tool I think is something that 
might preclude some of this bad behavior, and I would just be 
curious to hear folks' comments on that. And, Lynn, I would 
love to have your rebuttal as well to that presumption.
    Mr. Waddill. Well, I can tell you from our company's point 
of view, when we look at the use of capital, it clearly comes 
into the equation. Do we want to spend $3 million ramping up 
into Sarbanes-Oxley compliance? Do we want to spend $2 million 
over the next 5 years, $1 million plus? Do I need to hire a 
couple more staff to support this internally? It comes up, 
because every dollar is precious.
    One thing that is just fundamentally different than the 
crowdfunding--crowdfunding, they have a product. I am in an 
innovation stage where I am shooting for a product, and this is 
something that is interesting to cut across industries that 
when you are in that zone, when you are spending your capital 
to get to the point where you can make hopefully millions and 
tens of millions of dollars and build a company, that is when 
the funds are really critical.
    Ms. Smith. Just to comment on the power of the Internet and 
having a IPO market perspective, we can do much more. It may be 
outside of these bills, but we are not using the power of the 
Internet enough to help the IPO market, which is ultimately the 
end game for so many of these companies.
    For example, in early IPO trading, we know very little 
about who owns the shares as soon as they are allocated and 
during the first days they trade. The transparency of our 
trading markets is extremely poor, which hurts and scares a lot 
of investors in the market. They do not understand the trading 
volatility. And I think we can use more transparency.
    The ease of information when a stock ownership gets to be 
over 5 percent is poor. We should not have to wait for days to 
find out who owns that stock. So there is a whole lot we can do 
to make our IPO market better. And that is regarding the 
    When it comes to information, I mentioned how important 
EDGAR Online has been to the market. There is so much more that 
we can do. We file registration statements that are lengthy, 
and when they are updated, we do not know--we are not given a 
red line as to what the update is online. Companies' talk at 
road shows, why aren't they transcribed? Information is there, 
and it does not cost much to get it out to investors. And I 
believe that if we could add that kind of attention, it would 
help. The market is what it is--we are not going to be able to 
change too much. It is about returns. But the more information 
that we can give investors would help the IPO market that these 
smaller companies are trying to address.
    Senator Warner. Lynn?
    Mr. Turner. Senator Warner, we do totally agree that the 
Internet is bringing out more of the bad actors. The problem 
is, as we have seen it with the Chinese companies--and keep in 
mind, all these bills are applicable to the Chinese companies--
is that the Internet is getting it out after the fact. So while 
it is good it is getting out earlier before losses can get as 
big as perhaps they might have been in the past, it is still 
water over the dam, and the money is gone. And so while it gets 
out sooner, it ultimately does not prevent the losses. So from 
that, it is not a workable thing. And as we have seen with the 
Chinese companies, that IPO market has totally dried up, and 
people went away from it because they do not trust it. No one 
is going to play at a Vegas casino, which is what that IPO 
market was.
    As far as the SOX 404 stuff, yes, we would probably 
respectfully disagree on that point. SOX 404, I went through 
two companies, including a fairly new software company that had 
done it. I actually found that in the long run--one was Sun 
Microsystems. We found that we actually had tremendous savings 
from getting the company run the way it should be and the way 
it controls when we put that in. As the data in the testimony 
shows, companies that do not have those controls way 
underperformed the market, way underperformed their peers. And 
yet this year--I got an email just yesterday from a service 
that tracks this. They said something like 22 percent of the 
2011 filers so far have reported problems with their controls, 
and there are a number of studies now underway to look at these 
IPO companies and see how long it is between the IPO and when 
we are all of a sudden seeing this, because you actually trade 
in the market. What we have found is you can make money, good 
money, as a trader in the market by trading against the 
companies that have the poor controls because they underperform 
versus the companies with good controls. So when I was at Glass 
Lewis, when we put out this type of research, we actually found 
funds trading on the data and making good money just by 
identifying the companies with poor controls. They do 
    So if a company goes public with poor controls, sooner or 
later it is going to impact on the stock. There has also been 
research that shows that that has a contagion effect now. It 
not only impacts that company, but it impacts the stock price 
of other companies in the trading, especially with all the 
trading and all that is going on today. And so especially given 
the fact--you cannot say SOX 404 cost you that much at IPO 
because it is not until the second annual report 2 years later 
that you are doing your first SOX 404.
    We also know that a high percentage of these companies in 
terms relative, you know, are still not getting that fixed, so 
it is having an impact on them, and it is having an impact on 
the investors in those companies. And why is it that you are 
going to take that away? Why are you all of a sudden going to 
say in a situation where before you would have told me they had 
bad controls, now you are going to let them hide it for 5 
    Senator Warner. I would take issue. I do not think that the 
on-ramp proposals that we are laying out allow you to hide it. 
I think there are appropriate balance controls for these 
companies to ramp up. I do think having been on boards and 
investors in many of these entities, it is a burden and hurdle 
that slows the IPO market.
    That brings me to my next question, which is, you know--and 
I would like anybody's comments on this. One of the challenges 
with a much more limited IPO market is not only the fact that 
less companies get access to that capital, but I think there is 
a competitive price our overall economy pays when companies are 
forced through their only virtual exit to be a merger and 
application. I can tell you in the telcom business, you know, 
the ability of the big guys to take over the innovative guys 
and a way to stifle innovation, to continue to control the 
market, to not have as competitive of a landscape, I think does 
damage to our economy. And I would just be curious--we have 
talked a lot about the capital part, but more on the macro 
standpoint here of, you know, having companies only having kind 
of an M&A exit strategy, whether any of you agree that that 
also has a negative effect on overall innovation growth in our 
economy. Mr. Rowe?
    Mr. Rowe. Yes, just very briefly, and in my experience 
sitting on boards in the venture capital context, we see--and I 
will not name names, but over and over again the companies that 
are acquired very frequently end up dying. The buying company 
may pay a high price, but they do not really have the spirit or 
the passion that the entrepreneur had. The entrepreneur cashes 
out and leaves. And I do not know. Maybe there is some research 
on this. I would love to see it. But I see this in practice all 
the time. And if these companies can instead go public and that 
entrepreneur becomes the next Bill Gates running that company 
for another decade or two, that is where you see real impact on 
this country.
    You know, Harvard Business School's Bill Sahlman said this 
nicely yesterday at a forum on crowdfunding. He said, you know, 
we should distinguish between fraud, which is illegal and we 
should clamp down on that and make sure it does not happen and 
enforce it, and failure. He said failure has been the thing 
that has made this country great. The fact that we are willing 
to take risks, the fact that we are willing to start companies 
and try to be Apple, try to be Microsoft, try to be Zynga or 
Facebook, that is what is great about this country, and if we 
try to legislate out failure, we are making a great mistake.
    Mr. Waddill. I can tell you that my last company, we did 
sell the company. It was a great transaction. It was great for 
investors. The company got sold to Amgen, another U.S.-based 
company, and the result of that was people were rewarded, but 
the employees that were there that were incented to get to the 
point where they could sell the company are starting another 
company and continue on in the same vein.
    So certainly out in the Bay Area, once you get the bug, you 
just keep on doing it. It is an avenue for exit, and there is 
some chance that the technology is going to go away. But the 
incentives are in place in the capitalist society to perpetuate 
    Senator Warner. Although one of the things by having a 
broader-based IPO market, you know, my hope would be we would 
have this innovation not just taking place in the valley or 
Northern Virginia, but around----
    Mr. Waddill. Sure.
    Senator Warner. And I think, again, some of the 
opportunities. We have got to get this balance right on 
crowdfunding and crowdsourcing. You know, that does open up 
enormous, enormous opportunities elsewhere.
    I will just simply close, and I want to again thank the 
panel for their good work and good comments. This is an area 
where a group of us on this Committee and others are looking at 
combining a series of these bills and launching a bipartisan 
effort. It would be, I think, great for startup companies, but 
it would also be great in terms of sending a message that there 
are actually issues that Democrats and Republicans can work 
together on, get done, and end up jump-starting greater job 
growth in our economy.
    Again, my thanks to the panel, and with that the hearing is 
    [Whereupon, at 11:53 a.m., the Committee was adjourned.]
    [Prepared statements, responses to written questions and 
additional material supplied for the record follow:]
    Today we will have our second full Committee hearing on ``Spurring 
Job Growth through Capital Formation While Protecting Investors.'' It 
is our fourth hearing overall on capital formation, following Senators 
Reed and Crapo's Securities Subcommittee hearing on ``Examining 
Investor Risks in Capital Raising'' and Senators Tester and Vitter's 
Economic Policy Subcommittee hearing on, ``Access to Capital: Fostering 
Job Creation and Innovation Through High Growth Startups.''
    Growing small businesses is critical to building a stronger 
American economy, and today we meet to consider how to help small 
business and entrepreneurs access the capital they need through stock 
markets. The intent is to help them grow and create new jobs, while 
having suitable protections so investors are assured they will not be 
taken advantage of if they put their money at risk.
    Businesses may attempt to raise more capital if the process of 
selling stock is made easier and less costly. At the same time, 
investors are more likely to buy stock when they have adequate reliable 
information and fair trading markets. Last week in the Committee, in 
response to my question, Fed Chairman Bernanke said, ``Startup 
companies--companies under 5-years old--create a very substantial part 
of jobs added to the economy'' and he encouraged assisting startups. 
SEC Chairman Schapiro has said, ``companies seeking access to capital 
should not be overburdened by unnecessary or superfluous regulations At 
the same time, . . . we must balance that responsibility with our 
obligation to protect investors and our markets.''
    In previous hearings, witnesses have discussed how public markets 
allocate capital and help create jobs, SEC requirements for a company 
to go public, why some firms prefer to remain private, how investors 
may be solicited to buy stock, how institutional investors decide 
whether to buy a company's IPO shares, the importance of liquidity in 
the secondary markets, the importance of investor protections, measures 
to reduce the cost of selling stock and their potential impact on the 
cost of capital and other considerations.
    Today, we will hear testimony from experts analyzing the history 
and state of the IPO market, the needs of startup and small businesses, 
why investors buy IPOs, the role of accounting and other disclosures, 
analyst conflicts of interest and other matters.
    Members of this Committee on both sides of the aisle including 
Senators Schumer, Crapo, Tester, Reed, Vitter, Merkley, Toomey, Bennet 
and Johanns have been working hard on bipartisan proposals and I 
welcome our witness to provide their insights on these measures and 
others on the topic.
    I look forward to working with the entire Committee and with Senate 
Leadership to quickly move bipartisan legislation forward.
           Senior Vice President and Chief Financial Officer,
              OncoMed Pharmaceuticals, Inc., on behalf of
                the Biotechnology Industry Organization
                             March 6, 2012
Executive Summary
    The Biotechnology Industry Organization (BIO) represents 
        more than 1,100 innovative biotechnology companies, along with 
        academic institutions, State biotechnology centers, and related 
        organizations in all 50 States.

    It can take over a decade and more than $1 billion to 
        develop a single biotechnology therapy. Venture capital 
        fundraising is stagnant and the IPO market is largely closed, 
        forcing innovative companies to delay research on promising 
        scientific breakthroughs.

    BIO supports S. 1933, the Reopening American Capital 
        Markets to Emerging Growth Companies Act, which would create an 
        ``on-ramp'' to the public market for ``emerging growth 
        companies.'' Most newly public biotech companies have no 
        product revenue, so the 5-year transition period into 
        compliance with Sarbanes-Oxley (SOX) Section 404(b) and certain 
        accounting and disclosure requirements would allow growing 
        biotechs to focus on the search for cures and treatments rather 
        than costly regulations.

    BIO supports S. 1544, the Small Company Capital Formation 
        Act, which would reform SEC Regulation A by expanding its 
        eligibility requirements to include companies conducting direct 
        public offerings of up to $50 million, an increase from the 
        current threshold of $5 million. This increase would provide a 
        valuable funding alternative for small biotech startups, giving 
        them access to the market at an earlier stage in their growth 
        cycle and allowing them to raise valuable innovation capital.

    BIO supports S. 1824, the Private Company Flexibility and 
        Growth Act, which would increase the limit that requires 
        private companies to register with the SEC from 500 to 2,000 
        shareholders, giving growing biotech companies more investor 
        options to finance their early stage research. The bill would 
        also exempt employees from the shareholder count, allowing 
        biotech companies to attract and hire the most qualified 
        researchers and scientists.

    BIO supports S. 1831, the Access to Capital for Job 
        Creators Act, which would require the SEC to revise Rule 506 of 
        Regulation D to permit general solicitation in direct public 
        offerings, broadening the investor base.

                                      * * * * *

    Good morning Chairman Johnson, Ranking Member Shelby, Members of 
the Committee, ladies, and gentlemen. My name is William Waddill, and I 
am the Senior Vice President and Chief Financial Officer of OncoMed 
Pharmaceuticals in Redwood City, California. I am also the Co-chairman 
of the Finance and Tax Committee at the Biotechnology Industry 
Organization (BIO). I want to thank you for the opportunity to speak 
with you today about the unique hurdles that innovative biotechnology 
companies face as they work toward developing cures and breakthrough 
medicines to treat crippling illnesses that affect families across the 
    Biotechnology has incredible potential to unlock the secrets to 
curing devastating disease and helping people to live longer, 
healthier, and more productive lives. My company, OncoMed 
Pharmaceuticals, is working at the cutting edge of oncology research, 
focusing on a specific set of cells within tumors that drives the 
growth of the tumor and can morph into various cell types within the 
tumor. We have developed the ability to isolate and monitor these tumor 
initiating cells, and our studies have shown that they are more 
resistant to standard chemotherapy agents. Some current treatments may 
succeed at initially decreasing the size of a cancer, but leave behind 
an increased proportion of these most malignant cells. We have 
developed a portfolio of antibodies that target biologic pathways 
critical for survival of tumor initiating cells, with the goal being to 
stop those cells from replicating. We believe these models are more 
representative of the effects of these treatments in cancer patients 
than traditional models using cancer cell lines, which may no longer 
accurately reflect the properties of the original tumor. Currently we 
have three antibodies that target tumor initiating cells in Phase I and 
are developing other promising therapeutic candidates.
    BIO represents more than 1,100 innovative companies like mine, 
along with academic institutions, State biotechnology centers, and 
related organizations in all 50 States. Entrepreneurs across the 
biotech industry are conducting groundbreaking science like ours, and 
are deeply invested in treating the severe illnesses that families 
around the Nation and world face. At the same time, biotech leaders 
must deal with the day-to-day challenges of running a small business. 
Of great import in the biotechnology industry is the constant struggle 
to find working capital. It takes 8 to 12 years for a breakthrough 
company to bring a new medicine from discovery through Phase I, Phase 
II, and Phase III clinical trials and on to FDA approval of a product. 
The entire endeavor costs between $800 million and $1.2 billion. For 
the majority of biotechnology companies that are without any product 
revenue, the significant capital requirements necessitate fundraising 
through any source available, particularly venture capital firms. 
Later, we must turn to the public markets in the final stages of 
research to fund large-scale and expensive clinical trials.
    Startup companies depend on venture capital fundraising to finance 
the early stages of research and development. In fact, many companies, 
including mine, rely on venture financing to fund even middle- and 
late-stage clinical trials. However, the current venture landscape has 
made this type of funding difficult. In 2011, we saw only 98 first 
round venture deals with biotechnology companies, a significant drop 
from the industry's peak of 141 in 2007. Last year was only the third 
time since 2000 that the number of deals dropped below 100. Small, 
startup companies are the innovative heart of our industry, but 
depressed financing means that potential cures and treatments are often 
left on the laboratory shelf.
    Further, venture capitalists expect this downward trend to 
continue. A recent survey conducted by the National Venture Capital 
Association (NVCA) found that 41 percent of venture capital firms have 
decreased their investments in the biopharmaceutical sector in the past 
3 years. Additionally, 40 percent of venture capitalists reported that 
they expect to further decrease biopharmaceutical investments over the 
next 3 years. Therapeutic areas that affect millions of Americans will 
be hit by this change in investment strategy, including cardiovascular 
disease, diabetes, and cancer.
    A significant reason for reluctance in venture investing has been 
the inaccessibility of the public markets. Venture capital investors 
need to know that they will have an exit through which they can get a 
return on their investment; often, they look for this exit when a 
company enters the public market. Unfortunately, due to the current 
economic climate, it is becoming harder for biotech companies to go 
public. As a result, venture capital firms are turning elsewhere to 
make their investments, leading to a dearth of innovation capital for 
    Despite the desire on the part of companies and private investors 
for a clear path to a public offering, public markets remain 
essentially closed to growing biotech companies. There was only $1 
billion in public financing for biotechnology last year, just a third 
of the total from 2007. Though funding totals are slowly climbing back 
toward pre-recession levels, this progress has been made almost 
entirely by larger, more mature companies. These more established 
companies are getting better deals and emerging companies making their 
first forays onto the public market are getting squeezed out. The weak 
demand for public offerings for smaller companies is restricting access 
to capital. This then hampers critical research, forces companies to 
stay private for longer, and depresses valuations of later-stage 
venture rounds. Although the industry is slowly recovering from its 
recession-induced nadir (in 2008 there was only one biotechnology IPO), 
this progress is not fast enough for struggling biotechs that need 
funding to innovate or patients waiting for breakthrough medicines.
    These disturbing investment trends could be ameliorated by allowing 
emerging growth companies increased access to the public markets. In a 
recent survey conducted by NASDAQ and the NVCA, 86 percent of chief 
executive officers cited ``accounting and compliance costs'' and 80 
percent cited ``regulatory risks'' as key concerns about going public. 
If burdens on public financing were removed, private investors would 
have greater certainty that they would have an avenue to exit, leading 
to augmented venture capital investment, the lifeblood of the 
biotechnology industry. Additionally, companies on the cusp of a public 
offering would have the confidence that a successful IPO could fund 
their late-stage trials and push therapies to patients who desperately 
need them.
Public Market On-Ramp
    Senators Schumer and Toomey have introduced S. 1933, the Reopening 
American Capital Markets to Emerging Growth Companies Act. This bill 
would create a new category of issuers, called ``emerging growth 
companies,'' and ease their transition onto the public market. The 
legislation would give newly public companies much-needed relief by 
allowing them to transition into full regulatory compliance over time 
as they grow. This transitional ``on-ramp'' will encourage 
biotechnology companies and other small businesses on the cusp of going 
public to venture onto the public market.
    One of the key components of the on-ramp is the 5-year transition 
period before emerging growth companies are subject to full Sarbanes-
Oxley (SOX) Section 404(b) compliance. While we can all agree that 
investors benefit from greater transparency, the unintended consequence 
of the regulations found in Section 404(b) is the diversion of precious 
invested capital away from innovative product development and job 
growth to onerous, costly compliance with little to no benefit to 
investors or the general public. The opportunity cost of this 
compliance can prove damaging, resulting in delays to developing cures 
and treatments during a necessary and often prolonged search for 
investment capital.
    SEC studies have shown that SOX compliance can cost companies more 
than $2 million per year. The biotechnology sector is especially 
disadvantaged by this burden due to the unique nature of our industry. 
Newly public biotech companies have little to no product revenue, so 
they are essentially asking investors to pay for SOX reporting rather 
than research and development. The compliance costs are fixed and 
ongoing, and have a severe impact on the long-term investing of 
microcap and small cap companies at the forefront of developing new 
treatments for severe diseases. Companies are the most vulnerable 
during their first few years on the public market, yet they are forced 
to shift funds from core research functions to compliance costs. This 
can lead to research programs being shelved or slowed as compliance 
takes precedence.
    Further, the true value of biotech companies is found in scientific 
milestones and clinical trial advancement toward FDA approvals rather 
than financial disclosures of losses incurred during protracted 
development terms. Investors often make decisions based on these 
development milestones rather than the financial statements mandated by 
Section 404(b). Thus, the financial statements required do not provide 
much insight for potential investors, meaning that the high costs of 
compliance far outweigh its benefits.
    In 2010, Congress made the important acknowledgement that SOX 
Section 404(b) is not an appropriate requirement for many small 
reporting companies. The Dodd-Frank Wall Street Reform and Consumer 
Protection Act sets a permanent exemption from Section 404(b) for 
companies with a public float below $75 million. Additionally, the SEC 
Small Business Advisory Board in 2006 recommended that the permanent 
exemption be extended to companies with public floats of less than $700 
    Similarly, the Reopening American Capital Markets to Emerging 
Growth Companies Act would allow emerging growth companies time to find 
their footing on the public market without diverting precious funds to 
onerous SOX reporting. I support giving these companies 5 years to 
transition onto the public market, providing them with time to create 
jobs and continue research before entering full regulatory compliance.
    Additionally, an on-ramp transition period would allow emerging 
growth companies to provide only 2 years of previous audited financial 
statements prior to going public rather than the 3 years currently 
required. Similar to the transition into SOX compliance, this change 
would save emerging biotech companies valuable innovation capital that 
could be used for important research and development. I fully 
appreciate and agree that strong auditing standards can enhance 
investor protection and confidence and I support this goal. However, 
overly burdensome auditing standards impose a significant cost burden 
on emerging growth companies without providing much pertinent 
information to their investors. By allowing for limits on the look-back 
requirements for audited financial statements, a public market on-ramp 
would balance the goals of cost-efficient auditing standards and 
investor protection. Two years of audited financials is sufficient for 
investors to gather information about companies going public. Further, 
most biotech investors look to scientific and development information 
when making investment decisions, so the extra year of audited 
financials imposes costs without providing benefit. Requiring just 2 
years of audited financial statements would continue to protect 
investors but would allow emerging growth companies to expend more of 
their capital on the search for breakthrough medicines.
    An on-ramp approach would also exempt emerging growth companies 
from certain rules issued by the Public Company Accounting Oversight 
Board (PCAOB), particularly a proposal being considered regarding 
mandatory audit firm rotation.
    Audit fees would most certainly increase with the implementation of 
audit firm rotation. There would be a steep learning curve for any new 
audit firm, and the additional resources necessary to educate the audit 
firm about business and operations would raise audit fees. Companies 
might even need to hire more compliance personnel to avoid disruption 
of day-to-day operations, further increasing the cost burden. Audit 
firms have also suggested that audit firm rotation could increase the 
challenges and costs to maintain high-quality personnel. The cost 
associated with these scenarios would be transferred to the company 
while making relationships between the audit firm and the company more 
difficult to establish. Each new cost burden would require funds to be 
diverted from research and development to the transition between audit 
firms, slowing the progress of cures and treatments for which patients 
are waiting.
    I support the ongoing efforts to incentivize emerging growth 
companies to go public and make their transition smoother while 
continuing to protect investors. Easier access to the public market 
will improve the health and stability of the biotechnology industry, 
both for companies considering an IPO and for those which are still 
seeking private investment.
Financial Services Capital Formation Proposals
    While easing entry onto the public market is a key component of 
capital formation for growing companies, there are several proposals 
being considered that would benefit companies that are not yet suited 
to enter the public markets but face their own unique burdens as they 
grow. These proposals would strengthen the fundraising potential for 
small, innovative biotech companies developing solutions to the health 
problems that our Nation faces.
SEC Regulation A (Direct Public Offerings)
    Regulation A, adopted by the SEC pursuant to Section 3(b) of the 
Securities Act of 1933, was created to provide smaller companies with a 
mechanism for capital formation with streamlined offering and 
disclosure requirements. Updating it to match today's market conditions 
could provide an important funding source for small private 
biotechnology companies.
    Regulation A allows companies to conduct a direct public offering 
valued at less than $5 million while not burdening them with the 
disclosure requirements traditionally associated with public offerings. 
The intent of Regulation A was to give companies which would benefit 
from a $5 million influx (i.e., small companies in need of capital 
formation) an opportunity to access the public markets without weighing 
them down through onerous reporting requirements.
    However, the $5 million offering amount has not been adjusted to 
fit the realities of the costs of development and Regulation A is not 
used by small companies today. The current threshold was set in 1992 
and is not indexed to inflation, pushing Regulation A into virtual 
obsolescence. As it stands, a direct public offering of just $5 million 
does not allow for a large enough capital influx for companies to 
justify the time and expense necessary to satisfy even the relaxed 
offering and disclosure requirements.
    Senators Tester and Toomey have introduced a Regulation A reform 
bill, the Small Company Capital Formation Act (S. 1544), which I 
believe would have a positive impact for small biotechnology companies. 
The legislation increases the Regulation A eligibility threshold from 
$5 million to $50 million while maintaining the same disclosure 
requirements. This increase would allow companies to raise more capital 
from their direct public offering while still restricting the relaxed 
disclosure requirements to small, emerging companies. The Small Company 
Capital Formation Act could provide a valuable funding alternative for 
small biotech startups, giving them access to the public markets at an 
earlier stage in their growth cycle and allowing them to raise valuable 
innovation capital. I support this legislation.
SEC Reporting Standard (Shareholder Limit)
    Although the SEC generally monitors public companies, the agency 
also keeps tabs on private companies when they reach a certain size. 
Modifying the SEC's public reporting standard would prevent small 
private biotechnology companies from being unnecessarily burdened by 
shareholder regulations.
    Once a private company has 500 shareholders, it must begin to 
disclose its financial statements publicly. Biotechnology companies are 
particularly affected by this 500 shareholder rule due to our 
industry's growth cycle trends and compensation practices. As I have 
mentioned, the IPO market is essentially closed to biotechnology, 
leading many companies to choose to remain private for at least 10 
years before going onto the public market. This long timeframe can 
easily result in a company having more than 500 current and former 
employees, most of whom have received stock options as part of their 
compensation package. Under the SEC's shareholder limit, a company with 
over 500 former employees holding stock, even if it had relatively few 
current employees, would trigger the public reporting requirements. 
Exempting employees from any shareholder limit is a minimum necessary 
measure to ensure growing biotech companies are able to hire the best 
available employees and compensate them with equity interests, allowing 
them to realize the financial upside of a company's success.
    Senators Carper and Toomey have introduced legislation, the Private 
Company Flexibility and Growth Act (S. 1824), which would address these 
barriers to private company growth. Their bill would increase the 
shareholder limit from 500 to 2000, relieving small biotech companies 
from unnecessary costs and burdens as they continue to grow. As it 
stands, the 500-person limit encumbers capital formation by forcing 
companies to focus their investor base on large institutional investors 
at the expense of smaller ones that have been the backbone of our 
industry. The legislation would also exempt employees from the 
shareholder count, allowing growing biotech companies to attract and 
hire the most qualified researchers and scientists. I support the 
Private Company Flexibility and Growth Act, as it would remove 
significant financing burdens from small, growing companies.
SEC Regulation D (Ban on General Solicitation)
    Another potential avenue for capital formation in the biotech 
industry is SEC Regulation D. Under Rule 506 of Regulation D, companies 
can conduct offerings to accredited investors without complying with 
stringent SEC registration standards. This exemption allows companies 
to access sophisticated investors (who do not need as much SEC 
protection) without burdensome disclosure requirements. However, the 
upside of this fundraising avenue is hindered by the ban on general 
solicitation in Rule 506. Companies are limited in their investor base 
by this rule, meaning that a vast pool of investors remains untapped. 
If the ban on general solicitation were lifted, growing biotech 
companies would be able to access funds from the entire range of 
wealthy SEC accredited investors without undergoing the full SEC 
registration process.
    I support Senator Thune's Access to Capital for Job Creators Act 
(S. 1831), which would require the SEC to revise Rule 506 and permit 
general solicitation in offerings under Regulation D. If enacted, this 
legislation would enhance fundraising options for growing biotech 
companies searching for innovative cures and treatments.
Closing Remarks
    The U.S. biotechnology industry remains committed to developing a 
healthier American economy, creating high-quality jobs in every State, 
and improving the lives of all Americans. Additionally, the medical 
breakthroughs happening in labs across the country could unlock the 
secrets to curing the devastating diseases that affect all of our 
families. There are many pitfalls and obstacles endemic to this effort, 
including scientific uncertainty and the high costs of conducting 
research. However, the regulatory burdens I have discussed continue to 
stand in our way without providing any real benefit to the investors 
the laws purports to protect. By making targeted changes that support 
emerging growth companies in the biotechnology industry and elsewhere, 
Congress can unburden these innovators and job creators while 
maintaining important investor protections. Congress has the 
opportunity inspire biotechnology breakthroughs and allow innovators 
and entrepreneurs to continue working toward delivering the next 
generation of medical breakthroughs--and, one day, cures--to patients 
who need them.
                      Cordell Professor of Finance
  Warrington College of Business Administration, University of Florida
                             March 6, 2012
    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee, I want to thank you for inviting me to testify. My name is 
Jay R. Ritter, and I am the Cordell Professor of Finance at the 
University of Florida's Warrington College of Business Administration. 
I have been studying the initial public offering (IPO) market for over 
three decades, and I have published dozens of peer-reviewed articles on 
the topic. I have consulted with private companies, Government 
organizations, and law firms on IPO-related matters.
    I will first give some general remarks on the reasons for the low 
level of U.S. IPO volume this decade and the implications for job 
creation and economic growth, and then make some suggestions on the 
specific bills that the Senate is considering.
    First, there is no doubt that fewer American companies have been 
going public since the tech stock bubble burst in 2000, and the drop is 
particularly pronounced for small companies. During 1980-2000, an 
average of 165 companies with less than $50 million in inflation-
adjusted annual sales went public each year, but in 2001-2011, the 
average has fallen by more than 80 percent, to only 29 small firm IPOs 
per year. The patterns are illustrated in Figure 1.


    Although there is no disagreement about the existence of this 
prolonged drought in small company IPOs, there is disagreement about a) 
the causes of the decline in IPOs, b) the implications for the economy, 
and c) what should be done, if anything, to rejuvenate the IPO market 
and spur capital formation. My opinions about the causes of the decline 
are at odds with the conventional wisdom. My opinions about the 
implications for the economy are not too different from those of some, 
such as Prof. John Coates of Harvard Law School, who testified before 
this Committee on December 14, 2011. These opinions are different, 
however, from those of the IPO Task Force, whose chair, Kate Mitchell, 
also testified on December 14, and those of the Wall Street Journal's 
editorial writers. My opinions about what should be done are similar to 
those of several witnesses, but in disagreement with those of several 
others who have a much different opinion about the causes and 
implications than I do.
The Causes of the Decline in IPO Volume
    The conventional wisdom is that a combination of factors, including 
a drop in public market valuations of tech companies, heavy-handed 
regulation such as Sarbanes-Oxley (SOX), and a drop in analyst coverage 
of small companies, have discouraged companies, especially small 
companies, from going public in the United States in the past decade. I 
agree with the conventional wisdom that these factors have discouraged 
small companies from going public, but I believe that only a small part 
of the drop in small company IPO volume can be explained by these 
factors. Instead, I think that the more fundamental problem is the 
declining profitability of small firms. In many industries, over time 
it has become more important for a firm to be big if it is to be 
profitable. Emerging growth companies (EGCs) are responding to this 
change in the merits of being a small, stand-alone firm by merging in 
order to grow big fast, rather than remaining as an independent firm 
and depending on organic (internal) growth.
    Numerous facts support the idea that small companies are not going 
public because being small is not best, whether private or public. 
These facts are documented in ``Where Have All the IPOs Gone?'', 
coauthored with Xiaohui Gao and Zhongyan Zhu.\1\ My co-authors and I 
document that U.S. public market investors have earned low returns in 
the 3 years after the IPO on the IPOs of small companies, defined as 
firms with less than $50 million in pre-IPO annual sales (2009 
purchasing power), in every decade for at least 30 years. Furthermore, 
we show that for both recent IPOs and for public companies that have 
been traded for at least 3 years, the fraction of small companies with 
positive earnings has been on a long-term downtrend, starting far 
before the tech stock bubble burst in 2000. Other studies have 
documented that a larger and larger fraction of aggregate corporate 
earnings are being earned by the largest firms, and that the fraction 
of public firms that earn positive profits in a year has been on a 
long-term decline.\2\
    \1\ See ``Where Have All the IPOs Gone?'' Xiaohui Gao, Jay R. 
Ritter, and Zhongyan Zhu, March 2012, unpublished University of Florida 
working paper. Many additional tables can be found on the ``IPO Data'' 
page of my Web site (just Google ``Jay Ritter'').
    \2\ See DeAngelo, Harry, Linda DeAngelo, and Douglas Skinner, 2004, 
``Are Dividends Disappearing? Dividend Concentration and the 
Consolidation of Earnings,'' Journal of Financial Economics, 72, 425-
456; and Fama, Eugene F., and Kenneth French R., 2004, ``New Lists: 
Fundamentals and Survival Rates,'' Journal of Financial Economics, 73, 
    In the last decade, a larger fraction of venture capital-backed 
firms have sold out in trade sales rather than go public, as documented 
by Kate Mitchell in her December 14, 2011 testimony to this Committee. 
The IPO Task Force interprets this evidence as suggesting that the IPO 
market is broken. My coauthors and I show that, of the small companies 
that do go public, there has been an increase over time in the fraction 
that is subsequently acquired, and as well as the fraction that 
subsequently make acquisitions. This ``eat or be eaten'' evidence is 
consistent with the notion that getting big fast has become more 
important over time, and does not imply that the IPO market is broken.
    My co-authors and I also show that in the last decade there has 
been no deterioration in analyst coverage for companies that do go 
public, inconsistent with the assertion that a lack of analyst coverage 
is deterring IPOs.
    My co-authors and I address whether the low profitability of small 
publicly traded firms in the last decade can be attributed to the costs 
of compliance with SOX's Section 404. To ascertain whether this is 
important or not, we add back to earnings an estimate, provided by the 
U.S. SEC, of the SOX costs incurred by small firms. We report that the 
downtrend in profitability would be present even if these costs did not 
exist. Furthermore, as Prof. John Coates mentioned in his December 14th 
testimony, there has been no resurgence of small company IPOs after the 
SEC altered the regulations to lessen these costs.
    If the U.S. IPO market is broken for small companies, but being a 
small independent firm is still attractive, we might expect to see many 
small U.S. firms going public abroad. In fact, as documented by several 
studies, only a few U.S. firms per year have gone public abroad in 
recent years.\3\ In ``Europe's Second Markets for Small Companies,'' my 
co-authors and I document that European public market investors have 
earned low returns on European IPOs from 1995-2009 that listed on 
Europe's markets that cater to emerging growth companies.\4\ 
Furthermore, we document that 95 percent of the listings on London's 
Alternative Investment Market (AIM) have been ``placings,'' restricted 
to qualified institutional buyers (QIBs). Most of these IPOs have been 
for very small amounts, and no liquid market ever developed. The 
reality is that very few of the AIM IPOs would have qualified for 
Nasdaq listing.
    \3\Doidge, Craig, G. Andrew Karolyi, and Rene M. Stulz, 2009, ``Has 
New York Become Less Competitive than London in Global Markets? 
Evaluating Foreign Listing Choices over Time,'' Journal of Financial 
Economics 91, 253-277.
    \4\See ``Europe's Second Markets for Small Companies,'' by Silvio 
Vismara, Stefano Paleari, and Jay R. Ritter, European Financial 
Management, forthcoming.
    In addition, if being small but public was unattractive relative to 
being small but private, we might see many U.S. publicly traded small 
companies going private. Instead, the vast majority of small companies 
that have voluntarily delisted have done so by selling out to a larger 
company, rather than by staying independent and going private.\5\
    \5\See Table 8 of Gao, Ritter, and Zhu (2012).
    To summarize, there is a large body of facts supporting the view 
that the drop in small company IPO activity is due to the lack of 
profitability of small stand-alone businesses relative to their value 
as part of a larger organization. In my opinion, this is the major 
reason why venture capital-backed firms are selling out (merging) 
rather than going public. This is a large firm vs small firm choice, 
not a private firm vs. public firm choice. Although the IPO market may 
need reforms, private firms are not avoiding IPOs because the IPO 
market is broken, but because being part of a larger organization 
creates more value.
Implications for the Economy of the Decline in IPO Volume
    In ``Post-IPO Employment and Revenue Growth for U.S. IPOs, June 
1996-December 2010,'' my co-authors and I document the employment and 
revenue growth for U.S. companies that went public from June 1996-
December 2010.\6\ For the 2,766 domestic operating company IPOs from 
this period, we find that the average company added 822 employees since 
their IPO. In the 10 years after going public, the average company 
increased employment by 60 percent, amounting to a 4.8 percent compound 
annual growth rate (CAGR).\7\
    \6\ Martin Kenney, Donald Patton, and Jay R. Ritter, work in 
progress for the Kauffman Foundation on ``Post-IPO Employment and 
Revenue Growth for U.S. IPOs, June 1996-December 2010.''
    \7\ The 60 percent cumulative average growth in employment and 4.8 
percent CAGR numbers are based on the 1,857 IPOs from June 1996-
December 2000.
    One can use these numbers to calculate the number of jobs that 
would have been created if the average annual volume of domestic 
operating company IPOs from 1980-2000 had continued during 2001-2011, 
rather than collapsing. In 1980-2000, an average of 298 domestic 
operating companies per year went public, whereas an average of only 90 
domestic operating companies per year have gone public since then, a 
difference of 208 IPOs per year. Over the eleven year period 2001-2011, 
this amounts to a shortfall of 2,288 IPOs, with 822 jobs per IPO lost. 
Multiplying these two numbers together results in a figure of 1.88 
million jobs that were not ``created'' due to the IPO shortfall. This 
calculation assumes that these employees would have been sitting at 
home watching TV if they weren't hired by the recent IPO firm, and that 
the roughly $100 million raised per IPO would not have been invested in 
anything else. But, in a mechanical sense, 1.88 million jobs have been 
    This 1.88 million figure is dramatically lower than the 10 million 
jobs figure that Delaware Governor Jack Markell used in his March 1, 
2011 WSJ opinion piece ``Restarting the U.S. Capital Machine,'' or the 
22.7 million figure used in the IPO Task Force report presented to the 
U.S. Treasury and this Committee in late 2011 by task force chairwomen 
Kate Mitchell. The 22.7 million number comes from a 2009 Grant Thornton 
white paper, ``A Wake-up Call for America,'' written by David Weild and 
Edward Kim. Weild and Kim make four different assumptions than my 
coauthors and I do in order to generate their 22.7 million jobs lost 
    First, Weild and Kim make the reasonable assumption that IPO volume 
should be proportional to real GDP, and since the U.S. economy has 
grown over the last 30 years, one would expect IPO activity to rise 
rather than be flat. Thus, our number, which assumes that IPO activity 
would be constant over time, is biased downwards.
    Second, on page 26 Weild and Kim make the assumption that the 
normal level of IPO activity is that of 1996, the peak of the IPO 
market, and that the volume should grow from this level. This 
assumption, that the 1996 number of 803 IPOs is normal, biases their 
number upwards. Third, they assume that each IPO that didn't occur 
would have had 1,372 employees before going public, and post-IPO 
employment grows at a CAGR of 17.8 percent, a number that implies 
employment growing by 415 percent in the 10 years after an IPO. The 
17.8 percent per year number is justified based on a ``select'' group 
of prior IPOs. In other words, they assume that thousands of companies 
that didn't go public would have grown as fast as companies such as 
Google if they had! This assumption, which I would tend to categorize 
as completely ridiculous, has a huge impact on their calculations. 
Fourth, they assume that there was an IPO shortfall starting in 1997, 
rather than 2001, and that more than 1,500 additional firms would have 
gone public in 1997-2000 and then grown their employment by 17.8 
percent per year for more than a decade. This 1997-2000 shortfall 
assumption, combined with the 17.8 percent CAGR assumption, adds at 
least 9 million lost jobs to their 22.7 million total.
What Should Be Done
    If the reason that many small companies are not going public is 
because they will be more profitable as part of a larger organization, 
then policies designed to encourage companies to remain small and 
independent have the potential to harm the economy, rather than boost 
it. Not all EGCs should stay private or merge, however, and to the 
degree that excessive burdens associated with going public, and being 
public, result in less capital being raised and wisely invested, 
standards of living are lowered. I do not think that the bills being 
considered will result in a flood of companies going public. I do not 
think that these bills will result in noticeably higher economic growth 
and job creation.
    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 EGC IPOs.
    I think that Prof. John Coates zeroed in on the tradeoffs in his 
December 14, 2011 testimony. He stated ``While the various proposals 
being considered have been characterized as promoting jobs and economic 
growth by reducing regulatory burdens and costs, it is better to 
understand them as changing, in similar ways, 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 . . . ``As he notes, fewer investor protections can 
potentially result in more fraud, with rational investors responding by 
demanding higher promised returns from all companies, resulting in good 
companies receiving a lower price for the securities that they sell. 
Good investor protection laws, and their timely and effective 
enforcement, can lower the cost of capital for good companies, but 
investor protection does impose compliance costs on all companies.
    I will now comment on some of the specific bills under 
consideration by the Senate:

S. 1791 ``Democratizing Access to Capital Act of 2011'' and S. 1970 
        ``Capital Raising Online While Deterring Fraud and Unethical 
        Non-Disclosure Act of 2011''
    These bills deal with Regulation D and its requirements on 
solicitations, and crowdfunding. In general, they reduce constraints on 
the ability of parties seeking capital to reach out to unsophisticated 
investors, potentially increasing the amount of fraud. Fraudsters are 
happy to relieve unsophisticated investors of their cash.
    An increase in fraud if these bills are passed is not, however, an 
automatic result. When eBay and Craigslist were created, a concern was 
raised about whether fraud by sellers, and bounced checks from buyers, 
would be so prevalent that an electronic exchange that matched buyers 
and sellers of nonfinancial goods and services would fail. In practice, 
both organizations have been successful at matching buyers and sellers, 
even if there are some unsatisfactory outcomes.
    In financial markets, as with eBay and Craigslist, it is possible 
that organizations will evolve that provide sufficient voluntary 
policing and certification to minimize the amount of fraud and create 
value by bringing buyers and sellers (investors and entrepreneurs) 
    I am not certain what problem crowdfunding is solving. Many 
startups are able to get funding from angel investors, and, once a 
certain threshold of size has been reached, venture capital (VC) firms 
have billions to invest. If VC firms were demanding excessively onerous 
terms, one might expect to see extremely high returns for the limited 
partners (LPs) of VC funds. Over the last decade, however, the bigger 
problem has been low returns. The market is not failing when firms with 
poor investment prospects are unable to get funding. The market is 
working when firms with good prospects are able to get funded at 
reasonable cost and grow, and firms with poor prospects are deprived of 
capital that would be wasted.
    S. 1970 appears to offer some protections to investors that are not 
present in S. 1791. I am modestly supportive of S. 1970, but not 
enthusiastic about S. 1791.
S. 1824 ``The Private Company Flexibility and Growth Act''
    This bill increases the 12(g)(1) of the 1934 Act threshold at which 
public reporting of financial statements is required from 500 to 2,000 
shareholders of record, and Section 3 removes current and past 
employees from the count. The number of beneficial shareholders, of 
course, may be far in excess of the number of shareholders of record 
since individuals normally hold shares in street name.
    On December 1, 2011, Prof. John Coffee of Columbia Law School 
testified that the shareholders of record requirement should be 
supplemented with a public float requirement: if either the 2,000 
shareholders of record threshold is passed, or if the public float is 
above $500 million, public reporting should be required.
    My suggestion would be to keep the 500 shareholders of record 
threshold, but exclude current and former employees from the count, and 
to add a public float requirement. Alternatively, the ``shareholders of 
record'' requirement should be changed to reflect the fact that for 
publicly traded firms, individuals keep their shares in street name.
S. 1933 ``Reopening American Capital Markets to Emerging Growth 
        Companies Act of 2011''
    This bill establishes a new category of issuers, called emerging 
growth companies (EGCs) that have less than $1 billion in annual 
revenue at the time of SEC registration, and exempts them from certain 
disclosure requirements, such as executive compensation. The exemptions 
would end either 5 years after the IPO or when the annual revenue 
exceeds $1 billion.
    From 1980-2011, 7,612 operating companies went public in the United 
States, excluding banks and S&Ls and IPOs involving units, an offer 
price below $5.00, or partnerships. Ninety-four (94) percent of these 
companies had annual sales of below $1 billion when they went public, 
including Carnival Cruise Lines and AMF Bowling.
    Section 3 deals with disclosure obligations. I cannot think of any 
reason for why public market investors should not need to know how much 
executives are paying themselves, nor have a say on this cost through 
shareholder voting.
    Section 6 deals with coverage from sell-side research analysts. As 
I interpret it, this legislation would abolish quiet period 
restrictions on the ability of sell-side analysts that work for an 
underwriter to provide research to institutional investors for EGCs, 
which historically have comprised 94 percent of all IPOs. Because the 
sell-side analysts are potentially privy to inside information, they 
will be at an informational advantage relative to other analysts. This 
proposed legislation is completely at odds with the logic of Reg FD, 
which seeks to create a level playing field. The proposal may have the 
effect of crowding out unbiased independent research.
    As I mentioned earlier in this testimony, my research shows that 
there has been no lack of analyst coverage of companies conducting IPOs 
in the last decade.\8\ If the purpose of Section 6 is to create 
incentives for analyst coverage because none exists, this legislation 
is based on a faulty premise.
    \8\ Table 6 of Gao, Ritter, and Zhu (2012) shows that essentially 
all IPOs with a midpoint of the file price range of above $8 receive 
coverage. This $8 cutoff is a good proxy for IPOs that are large enough 
to attract institutional investors.
           Co-Founder and Chairman, Renaissance Capital, LLC
                             March 6, 2012
    Chairman Johnson, Ranking Member Shelby, and Members of the 
    I want to thank you for inviting me to testify today. Capital 
formation, when accomplished through a transparent IPO market open to 
all investors, plays an important role in allocating capital to our 
best entrepreneurial companies, spurring significant and sustainable 
job growth. We are all concerned about economic growth and job 
creation, so it is no surprise that our eyes would turn to the IPO 
market--America's most admired system for funding entrepreneurs.
    The issue we address today is access to capital by entrepreneurial 
companies. When America's job-creating smaller companies are unable to 
access the IPO market, we need to understand why and what we can do 
about it. Measures to ease costly regulatory burdens that weigh most 
heavily on small firms may be helpful. At the same time, care must be 
taken in waiving certain disclosure and stock promotion rules that 
could result in misallocating capital to weak or fraudulent companies. 
Weak companies that ultimately fail cause job losses, not job creation, 
and result in serious stock market losses to investors who abandon the 
IPO market, as was the case after the Internet bubble burst.
Renaissance Capital's IPO Expertise
    We share the concerns of lawmakers about the IPO market and are 
honored to be asked for our thoughts on this important policymaking 
process. For over 20 years, Renaissance Capital has had a singular 
focus on the IPO market. We are involved in IPOs in three ways:

  1.  We are an independent research firm. We provide institutional 
        investors with research on IPOs. We analyze every IPO in the 
        United States and we cover the international IPO market.

  2.  We are an indexing firm. We create and license IPO indexes that 
        measure the investment returns of newly public companies. These 
        indices are used by IPO investors as a benchmark of 

  3.  We are an IPO investor. We invest in newly public companies 
        through a mutual fund and separately managed institutional 

    Regulators around the world often reach out to us about our views 
on IPO issuance, valuation and research. These regulators are studying 
the best practices of the U.S. IPO market. They know that a well-
functioning IPO market can be the most efficient way for them to 
allocate capital to their growing enterprises. A well-functioning IPO 
market is based upon full and honest disclosure of company information 
made available evenly to all public investors.
    I will start by examining the condition of our IPO market, 
including where we stand in global IPO market share, what is working 
and what is not, and the importance of investor returns in the 
equation. I will then make suggestions on the specific bills under 
The U.S. IPO Market is Doing Well Relative to IPO Markets Around the 
    While there is legitimate concern that recent issuance in the U.S. 
IPO market has been below long-term trends, the U.S. market is not 
alone. IPO markets globally have been hurt by the 2008 U.S. financial 
crisis and the 2011 European Sovereign debt crisis. However, in the 
context of weak global IPO markets, the United States has actually 
gained market share, accounting for 32 percent of global IPO proceeds 
in 2008 and again in 2011. In 2011, when international IPO issuance 
fell 50 percent, U.S. IPO issuance fell only 6 percent. This tells us 
that when put to the test of a financial crisis, investors trust the 
disclosure, transparency and depth of the U.S. IPO market more than any 
other IPO market in the world. So, despite the low IPO issuance levels, 
much of the U.S. IPO market is functioning as well as can be expected 
under challenging conditions.


Larger Issuers Continue to Access the IPO Market
    The IPO Task Force provided helpful data about IPO issuance since 
1991. This data shows that while smaller IPOs have effectively 
disappeared, larger companies raising over $50 million in IPO proceeds 
continue to access the IPO market. From 2000 to date, investors have 
experienced the weakest period of stock market returns in decades. As 
the chart shows, during this period, the larger issuers have dominated 
the IPO market. In weak markets, investors gravitate to the perceived 
safety of larger, more liquid IPOs.


    Furthermore, despite our current regulatory regime, we find little 
evidence that these larger issuers have been deterred from tapping the 
IPO market. Today, we count over 200 companies in the U.S. IPO pipeline 
seeking to raise over $52 billion in aggregate proceeds who have 
undergone financial audits, implemented Sarbanes-Oxley policies and 
filed full disclosure documents with the SEC. This is the largest 
backlog of companies lined up to go public that we have seen in over a 
decade. Over 92 percent of these companies are larger issuers seeking 
to raise over $50 million in IPO proceeds.
The U.S. IPO Market is Closed to Small Issuers
    On the other hand, as the IPO Task Force concluded, smaller IPOs of 
$50 million proceeds or less have become a reduced presence in the IPO 
market. Prior to 1999, smaller IPOs represented 50 percent or more of 
the IPO market, currently they represent less than 15 percent. Helping 
these smaller job-creating companies lower the cost of accessing the 
IPO market, while protecting investors, may help somewhat in boosting 
the presence of smaller IPOs in the market.
    However, opening the path for easier issuance by smaller companies 
only works if investors are interested in buying these IPOs. Thus, it 
is even more critical to address the investor side of the equation. At 
present, the trading market for IPOs is highly volatile with average 
IPO trading turnover on the first day often equal to the number of 
shares offered. This suggests that IPO shares are being placed with 
short-term trading clients of the IPO Underwriters. IPO shares placed 
with a broader base of fundamentally oriented investors would go a long 
way to help open the IPO market to smaller issuers. We urge 
policymakers to study ways to encourage IPO Underwriters to allocate 
IPOs to a broader base of long-term investors.
Ultimately the IPO Market Opens Up When IPO Investors Earn Positive 
    While policy to ease the way for more small issuers to accomplish 
an IPO may be helpful, the most powerful fix for the IPO market would 
be to improve returns for IPO investors. Unfortunately, there is little 
policymakers can do on this front, short of creating a Government fund 
that purchases shares in every small IPO--which we would not recommend. 
Returns to IPO investors matter because good returns for IPO investors 
drive future IPO activity. IPO issuance grows when returns are 
positive. The IPO market closes when returns are negative.


    After a long run through the 1990s of positive equity returns for 
all investors, the bursting of the Internet bubble devastated IPO 
investors, causing losses of -49 percent and -61 percent in 1999 and 
2000, respectively, far worse than the rest of the equity market. No 
wonder in the years following that disaster, investors were cautious 
about smaller IPOs, shutting off IPO issuance for these important job-
creating small companies. Over 70 percent of the IPOs during that 
period were unprofitable companies whose offerings were promoted by the 
IPO Underwriters' research analysts. We caution lawmakers to avoid new 
policies that would pave the way for IPO Underwriters to engage in 
these types of promotional activities again.
    We are encouraged that following the poor returns of 2008 and 2011, 
returns for IPO investors have turned strongly positive so far in 2012. 
These positive returns will startup the IPO issuance engine again. We 
believe that an extended period of positive returns for IPO investors 
is the most powerful solution to increasing IPO market activity leading 
to a greater presence of smaller sub-$50 million issuers. In the 
meantime, policies that assist these smaller IPOs to lower the cost of 
accessing the IPO market and improve IPO allocation to attract a 
broader base of long-term investors could provide some helpful relief.

                                * * * * *
Renaissance Capital's Recommended Improvements to the Proposed 
  1.  Focus on the companies seeking to raise under $50 million that 
        are currently shut out of the IPO market by properly defining 
        Emerging Growth Company as smaller issuers seeking to raise up 
        to $50 million.

  2.  Strike the proposed informational rules in S. 1933 Section 6 that 
        permit IPO Underwriters and issuing companies to promote 
        offerings and provide special information to selected clients 
        during the IPO process to avoid re-creating the Internet 

  3.  Encourage larger private companies (e.g., Facebook) to file 
        public disclosure (i.e., go public) when active trading markets 
        develop in its shares, by adding a public float requirement to 
        the proposed private company legislation.
Recommendation #1: Refine the definition of ``Emerging Growth Company'' 
        to focus on the small companies seeking to raise up to $50 
        million, replacing the proposed $1 billion revenue rule
    The S. 1933 legislation defines Emerging Growth Company as a firm 
with $1 billion in revenue. By this definition, we would be giving 
relief to over 90 percent of the companies going public, effectively 
the entire IPO market, and would include companies with very large 
market capitalizations. The real Emerging Growth Companies that need to 
be targeted are smaller issuers seeking to raise under $50 million in 
capital. Based upon our analysis, an Emerging Growth Company should be 
redefined as one seeking to raise up to $50 million with an implied 
market capitalization under $200 million. This would target the part of 
the market that needs attention.
Recommendation #2: Strike the proposed rules that permit IPO 
        Underwriters and issuing companies to promote offerings and 
        provide special information to select clients during the IPO 
    We agree that more research on companies would be favorable for 
stock trading, but Section 6 in the S. 1933 legislation, as written, 
would allow IPO Underwriters to engage in promotional activities. After 
the Internet bubble burst, investors suffered devastating losses of -49 
percent and -61 percent in 1999 and 2000, respectively, from purchasing 
overvalued IPOs pumped up by underwriter research. Over 70 percent of 
the IPOs during that period were unprofitable companies, many of which 
went out of business. As we know from bitter experience, research by 
broker dealers and their affiliates that underwrite the IPO is 
inherently biased, used as a marketing tool to sell shares in the IPO 
and, without some restrictions, provides an informational advantage to 
the IPO Underwriters' research analysts and proprietary clients, 
contrary to Regulation FD.
Recommendation #3: Improve legislation expanding the size and dollar 
        thresholds of the private placement market by adding another 
        threshold that would encourage private companies, whose shares 
        are actively trading, to go public
    The various bills seeking to expand the size of the unregistered 
(``no-doc'') private market from $5 million to $50 million and the 
number of accredited investors from 500 to 1,000, may help to open up 
more capital raising opportunities for smaller issuers. However, these 
changes may have the unintended consequence of creating a shadow IPO 
market of larger private companies. These private IPO-ready companies 
would reap the benefit of being public without taking on disclosure 
responsibilities. For example, even under the existing 500-shareholder 
limit, active private transactions in Facebook shares have occurred 
prior to its IPO filing at large cap valuations of $100 billion, the 
size of McDonald's. We recommend adding a provision to these new rules 
that encourage private companies (e.g., Facebook), who meet certain 
thresholds of transactional activity, to go public, providing full 
disclosure to all investors. We support the market capitalization limit 
proposed by Columbia University Professor John Coffee of $500 million 
or less. This would help the IPO market.
    A well-functioning IPO market is based upon the principal of full 
and honest disclosure of company information made available evenly to 
all public investors. The U.S. IPO market is functioning amazingly well 
under the stressful conditions of a global financial crisis. While 
there may be initiatives that can help improve the functioning of the 
IPO market, especially as it pertains to the most vulnerable smaller 
companies, the IPO market will heal itself starting with the larger, 
more established private companies. Waiving certain disclosure and 
stock promotion rules that could result in misallocating capital to 
weak or fraudulent companies will only endanger the recovery of the IPO 
market. It is the positive returns that investors earn from these 
larger issuers that will lead to more issuance for smaller IPOs.
              Founder and CEO, Cambridge Innovation Center
                             March 6, 2012
    Thank you for inviting me to speak today. As you know, I am the CEO 
and Founder of Cambridge Innovation Center (CIC). CIC houses 
approximately 450 startup companies in a large office tower in Kendall 
Square, Cambridge, Massachusetts. We are told that CIC has more 
startups under one roof than any other building anywhere. More than 
$1.5B dollars have been invested in these companies. We have been a 
launch-pad for several well-known companies, including Google Android 
and Great Point Energy.
    I also serve as the President of the Kendall Square Association. 
Kendall Square is home to the Massachusetts Institute of Technology 
(MIT) and more tech and biotech companies per square mile than anywhere 
else in the world, and includes such global leaders such as Amgen, 
Biogen, the Broad Institute, Google, MIT, Microsoft, Novartis, Genzyme, 
VMWare, and the Whitehead Institute. Our goal is to ensure that Kendall 
Square remains a place where the world gathers to develop breakthrough 
discoveries that positively impact our society.
    In other responsibilities, I serve on the investment committee for 
New Atlantic Ventures, a $120M early stage venture capital firm. 
Together with my partners, we have helped make dozens of investments in 
small companies.
    This past December, Massachusetts was asked to send a delegation to 
the Startup America Summit at the White House to share what we believe 
to be the national priorities for helping grow jobs through 
entrepreneurship. Many Massachusetts leaders got involved, and together 
we settled on five key measures: 1) Crowdfunding, 2) IPO on-ramp 
legislation, 3) easier Visas for overseas entrepreneurs who want to 
come create jobs in the United States, 4) better mid-skills job 
training, and 5) limitations on noncompete agreements in employment 
contracts (some States already ban them). I was selected by the group 
to present our conclusions, and I will do my best to do so again today. 
Given the topic of today's hearing, I plan to talk about the first two 
    We believe startups are at the root of restoring the United States 
to full economic health. As is now well known, a Kauffman Foundation 
study using U.S. Census data recently found that, over the last quarter 
century, all net new jobs in the United States have come from companies 
5-years old and younger. Existing firms (those 6 years old and older) 
collectively lost jobs during that same quarter-century period analyzed 
(1980 to 2005). For every job lost by existing firms, new firms 
generated three. It seems clear that supporting startups and 
entrepreneurship is the key to job creation in the United States.
    Enabling better access to capital will be the single most impactful 
step Government can take. I will speak in particular to two proposals:
1) Crowdfunding (S. 1791 and S. 1970)
    Risk capital is distributed unevenly in our country. Startups do 
not today have adequate places to go to find the money to start a new 
business. Everyday businesses that are the bread and butter of our 
communities--businesses like restaurants, small construction companies 
and the like--are starved for capital. There are, for instance, nearly 
8 million women-owned businesses in the United States, yet only a few 
hundred a year are able to raise venture capital.\1\
    \1\ Estimated to be between 140 and 280 deals per year based on 
data from the Kauffman Foundation at http://www.kauffman.org/research-
and-policy/gatekeepers-of-venture-growth.aspx and http://
    I believe that crowdfunding legislation can change this. As we have 
all heard, the Internet changes everything. One of the things that the 
Internet has changed is the ease with which an organization can 
broadcast its needs and attract supporters online. Another thing that 
has changed is that it is much harder for bad actors to hide from the 
scrutiny of the masses. Many companies have sprung up to help 
individuals and small businesses find loans, donations, and first 
customers this way. Politicians have found the Internet effective to 
raise campaign donations.
    In an example that shows the power of crowdfunding, popular Web 
site Kickstarter, which collects money from fans to support principally 
film, arts and design-oriented projects, raised almost half as much 
money for the arts in 2011 as the National Endowment for the Arts 
(NEA). Due to its rapid growth, it appears likely to roughly tie the 
NEA in 2012.\2\ The NEA acknowledged this, stating ``Kickstarter and 
the other platforms that crowdsource donations for arts organizations 
and projects are becoming increasingly important in helping the arts.''
    \2\ Analysis from Talking Points Memo at http://
    Crowdfunding proposes to harness this same power to help people 
start new businesses, and create new jobs. It will enable individuals 
to make small equity investments in others' businesses without the 
usual regulatory burdens associated with a public offering.
    Many of us in the startup community believe that such a mechanism 
will allow far more startups to get going in the United States, thereby 
creating much-needed new jobs. This is evidenced by a petition started 
by some entrepreneurs in my center, which can be found at Wefunder.com. 
They obtained commitments from more than 2,500 individuals to invest 
over $6M through crowdfunding.
    How big could the impact of crowdfunding be? Americans have about 
$30 trillion dollars in savings plans (401Ks, IRAs, and the like). Amy 
Cortese, author of the book Locavesting, points out that if Americans 
diverted just 1 percent of this amount into crowdfunding type 
investments, the amount raised would equally half of all small-business 
loans in the country, and would be about 10 times the total amount of 
venture capital invested each year in the United States. The potential 
benefit to the country from this is very large.
    The chief concern with crowdfunding is the threat of fraud. Some 
have voiced a concern that unscrupulous individuals might take 
advantage of unsophisticated investors, misrepresenting risks, and 
effectively stealing investors' money.
    While this concern is understandable, the data show that Internet 
intermediaries have been successful at blocking such fraud. United 
Kingdom-based crowdfunding startup Crowdcube, for instance, reports 
zero fraud claims after a year in business (see attached letter from 
its CEO). They achieve this in part by thoroughly vetting the 
opportunities they present for investment. Similarly, Prosper.com, a 
crowd-lending business operating under SEC regulation claims to have 
raised $124M in loans and to have no reports of fraud or 
misrepresentation. Funding Circle, out of the U.K., another crowd-
lending platform, claims to have raised 26M in 569 
transactions and reports no fraud (and only 5 defaults so far). 
AngelList is a crowdfunding platform in the United States that works 
only with accredited investors. It operates under the SEC's Regulation 
D, and has raised ``more than $100M'' in equity investments using its 
online platform. AngelList claims zero reports of fraud. Net-net, I 
conclude that if crowdfunding legislation requires that any investments 
be made through an SEC-licensed intermediary, the fraud problem can be 
    To draw a broader analogy from a different industry, as we all 
know, eBay is a Web site that permits one to buy items from people they 
have never met, and never will meet, based solely on an online 
description. On the face of it, this would similarly seem to be a 
hotbed for fraud. Yet any eBay user will tell you that the 
incorporation of a system that tracks the reputation of buyers and 
sellers significantly mitigates fraud. We believe that the analogous 
mechanisms will be developed by competing crowdfunding intermediaries, 
leading to an enviable investment environment that is safe and free 
from undue regulation.
    To the extent that there are continued concerns about fraud, one 
additional attractive market-based solution could be fraud insurance. 
Given the low actual incidence of fraud, crowdfunding proponents have 
attracted the interest of insurers who have voiced an openness to issue 
policies protecting crowdfunding investors against fraud.
    I understand that there are efforts underway to create a 
``consensus'' crowdfunding bill that would incorporate the best of the 
various bills under consideration. Having studied the topic closely, I 
would urge the drafters to do so, and to incorporate the following 

    a) Require the use of SEC-licensed intermediaries. Intermediaries, 
playing the ``eBay'' role, are the key to eliminating fraud. 
Intermediaries will compete to be attractive to investors, offering 
such incentives as anti-fraud insurance. Intermediaries would 
creatively develop competing mechanisms to reduced fraud, be that by 
manually vetting the deals, or using some other mechanism such as crowd 
input. I don't think we should legislate how the do it, since this is 
an area where we want creative innovation. Instead, any intermediaries 
deemed ineffective at eliminating fraud would simply be subject to 
losing their license. It is important that the regulations that 
intermediaries should be subject to enable them to flexibly, and at 
low-cost handle these small transactions (e.g., not subject to the full 
brunt of onerous broker-dealer regulations, but only the specific 
intermediary requirements spelled out in the bills, which all look 
fine). To the extent that a workable definition of such an intermediary 
can be agreed upon, ideally it would also be extended to the 
aforementioned Reg-D-based crowdfunding intermediaries as well, since 
they face the same issues.

    b) Enable investments larger than $1,000 for those who can afford 
it. Some of the proposed bills provide formulas for determining limits. 
Data show that 90 percent+ of the dollars raised in crowdfunding 
initiatives are from people investing more than $1,000, so it is highly 
desirable to enable larger investments. See attached chart. One way to 
address this concern would be to set a higher limit, say $100,000, or 
no limit, on the amount accredited investors can invest under 
crowdfunding legislation, effectively extending this same concept of 
crowdfunding through intermediaries to cover both crowdfunded & 
accredited investments.

    c) Don't burden the process with unnecessary restrictions that 
would render crowdfunding legislation meaningless. For instance, it is 
essential that the degree of interaction required with individual 
States be limited. Fifty States and 50 different sets of rules, and 
these small companies can't handle that amount of complexity. Limited 
State filings for the issuer's State and a State in which the majority 
of the issuer's investors live are reasonable, but, in general, it is 
imperative that State securities laws be preempted by the crowdfunding 
exemption (with the exception of State anti-fraud laws). Additionally, 
it is important that overly burdensome disclosure obligations are not 
placed on issuers. These rules were created with large issuers in mind, 
and would stifle crowdfunding. Instead, follow the example of 
Crowdcube-they have a strong incentive to eliminate fraud and do not 
list opportunities they believe to be inadequately described, or where 
stories don't check out.

    d) Don't burden crowdfunding issuers with excessive liability. 
Issuers should be subject to collective action by investors if they 
commit wrongs, but some provisions would appear to create the 
possibility for individual rights of action, and that would create an 
untenable risk for issuers.

    e) Do require a periodic ongoing review of how this is going, as 
called for in S. 1970.
2) IPO on-ramp legislation (S. 1933)
    While most jobs are created by companies 5-years old and younger, 
an exception is larger companies that go public and raise substantial 
amounts of capital. Data show that companies that go public grow their 
headcount approximately 5-fold, often creating thousands of jobs.
    Unfortunately, the current regulatory frameworks impacting public 
companies have had the unintended consequence of substantially reducing 
the number of companies that are able to go public. It costs an 
estimated $2.5M for a company to go public today, and $1.5M per year to 
stay public. These are heavy burdens for young companies to bear.
    Proposed legislation would reduce this regulatory and paperwork 
burden for so-called ``Emerging Growth Companies'': smaller, younger 
companies that are less likely to go public otherwise. This category, 
by virtue of being comprised of young companies, today represents only 
a small 3 percent of the total value of publicly traded companies. At 
the same time, it represents our future. It is important that we 
nurture it.
    Under this proposal, regulation would ``scale'', growing with a 
company's compliance abilities. I believe it is important to note that 
I personally applaud the intent of many of the regulations that are 
scaled under this bill. I believe each regulation was created with good 
intentions, and under the proposed legislation, each will, in time, be 
applied to every company that goes public. This bill simply delays the 
day that these companies must face the economic burden of compliance.
    I am hopeful that the Senate will find these proposals have merit 
and that Congressional enactment is necessary to jumpstart our economy. 
This is a time when we must be creative and work together to find 
solutions to help America get back to work.


Former Chief Accountant of the Securities and Exchange Commission, and 
                  Managing Director, Litinomics, Inc.
                             March 6, 2012
    Thank you Chairman Johnson and Ranking Member Shelby for holding 
this hearing and it is an honor to be invited to testify before you. I 
am sure everyone here at the hearing today can agree that increasing 
employment in the United States, and bringing back jobs that have left 
the country, is vitally important to our economy and the well being of 
America, and Americans. The destructive effect of the most recent 
financial crisis on American jobs, the United States (U.S.) capital 
markets, retirement and savings accounts, and families provides us 
stark lessons in this regard, if we choose to learn from them, rather 
than repeat them.
    Let me begin by noting my comments today are framed by my 
        past experiences including:

    Having been involved as an executive in starting up a 
        successful venture backed company that created jobs.

    Having served on a Commission formed in my State in the 
        1980s to explore what could be done to improve the success 
        rates of startup businesses and smaller companies.

    Serving as a trustee for two institutional investors, 
        including on the investment committees. One of those 
        institutions does invest in startup and/or growing companies 
        via investments in venture capital and private equity.

    Serving as the U.S. Securities and Exchange Commission 
        (SEC) Chief Accountant, responsible for advising the SEC 
        Chairman and Commission on matters of disclosure, transparency 
        and auditing affecting all public companies.

    Serving as a Vice President and Chief Financial Officer at 
        a semiconductor and storage systems company. Attracting capital 
        and financing was critical to the company's success as we made 
        major investments and purchases in manufacturing plants and the 
        jobs in them. We spent 2 years preparing for an Initial Public 
        Offering (IPO), including preparation of filing documents, 
        selection of underwriters, and working with sell side analysts 
        as they wrote research reports in anticipation of the offering. 
        Ultimately, due to the downturn brought on by the Asian Crisis 
        and its contagion effect on the capital markets, the IPO was 
        not completed.

    Spending 20 years of my career with a Big 4 accounting and 
        consulting firm, including spending considerable time in the 
        Emerging Business Services Group that advised and audited 
        emerging and growing businesses. This included working with 
        companies inside two business incubators in Boulder and Denver 
        Colorado for which the Boulder Incubator Board presented me 
        with the Board Partnership Award.
Initial Public Offerings
    Public offerings of stock by companies to investors are an 
important factor in the success of our capital markets. The number of 
offerings completed, as well as the amount of money raised, tracks the 
economy in general. This was noted in the Goldman Sachs Global 
Economics Weekly report February 7, 2007 which stated:

        Several recent reports have fuelled anxiety that Wall Street is 
        losing out . . . most keenly to London and is doomed to lose 
        its perch as the world's pre-eminent capital market. Studies 
        have pointed to strict legal and regulatory practices in the 
        United States as reasons why issuers are increasingly looking 
        elsewhere for IPOs. These issues are typically contrasted with 
        London's light touch regulation, more hospitable legal regime 
        and ease of migration.

        The regulatory climate does matter, and policy reform might 
        strengthen New York's competitiveness. Nonetheless, we do not 
        think this is the main problem nor indeed that Wall Street is 
        losing out in a regrettable way. Instead we see the growth of 
        capital markets outside the United States as a natural 
        consequence of economic growth and market maturation elsewhere. 
        The United States has in fact been losing market share for 
        several decades, and it trails Europe in trading of FX and many 

        Legal and regulatory factors probably do matter, and policy 
        reform might strengthen New York's competitiveness. 
        Nonetheless, we do not see them as the critical drivers behind 
        the shift in financial market intermediation, even in the 
        aggregate. Quite simply, economic and geographic factors matter 

    The reason IPO's track the economy is that investors invest to earn 
a return. When the economy is growing, companies can grow. That growth 
in revenues, profits, cash and investments such as employees fuels the 
growth in companies' stock and the returns investors seek. However, 
when the economy has stalled or is declining, and companies are not 
growing, investors simply cannot achieve the types of returns they need 
to justify making an investment. The following chart highlights that. 
As a result of the downturns in the economy that occurred during much 
of the 1970's brought on in part by withdrawal from Vietnam, the 
recession brought on by inflation at the beginning of the 1980s, the 
dot com bubble and corporate scandals, and the most recent great 
recession, investors became concerned about returns that could be 
earned in the markets and IPO's declined. As the economy and employment 
have recovered after each of these downturns, so has the IPO market.


    During the 1990s, the U.S. economy experienced high growth rates, 
which has not since been matched. Charts 1 and 2 illustrate how the IPO 
market reached an unprecedented level during the 1990s not achieved 
before or after. Some argue that is because the U.S. regulations 
protecting investors are overly onerous. Often they cite Sarbanes-Oxley 
and its Section 404(b) requirement for companies, mandating an audit of 
their internal controls as an unjustified cost. But the facts simply 
don't bear this out, and those arguments have a lot in common with the 
too common refrain--``the sky is falling.'' Those making this argument 
also cite the London AIM market as an example of a ``lightly'' 
regulated market the United States should attempt to emulate.
    However, a close examination of the issue does not support these 
individuals. First of all, the U.S. IPO market had very significant 
declines in the 1970s, 1980s, and as the last century came to a close. 
Some of those declines occurred before current regulator financial 
reporting requirements were adopted, and certainly before Sarbanes-
Oxley was adopted in 2220. In addition, if one looks at the following 
charts for the AIM market, one can see that market also experienced 
deep declines in its IPO market.
    And its recovery has significantly trailed those in the United 
States as the U.S. economy has outperformed that in Britain. One can 
only ask, why would a reasoned and thoughtful person want to copy that?


    A number of years ago, a former SEC Commissioner caused a ruckus 
when he made reference to the AIM market as being somewhat akin to a 
Las Vegas Casino. He had a point. As noted in the following chart, this 
lightly regulated market was started in the 1995/96 timeframe. If one 
had invested in the AIM market index at the time with a $1,000, one 
would no longer have the $1,000, as the market has generated a negative 
return for investors. It is no surprise then that The Daily Telegraph 
in the U.K. recently stated that: ``Recent research for The Daily 
Telegraph has also shown that at least 80 leading money managers do not 
have confidence in the current regulation of natural resource companies 
on AIM.'' (See Exhibit 1).


    Despite a market that has risen from the despair of 2009, investors 
remain cautious about giving their money to companies. The aggregate 
returns they have earned since 1999 have been somewhat meager when 
compared to the 1980s and 1990s. Baby boomers have seen their 401-K's 
turned into 201-K's by the scandals and dot com bubble at the beginning 
of the last decade with the most recent financial crisis burning them 
badly. Both the Nasdaq and Dow Jones Indexes remain well below their 
highs. And just a couple of weeks ago, an article in the Wall Street 
Journal noted that in 37 of the past 40 weeks, investors had pulled 
cash out of investments in small cap companies.
    Again, investors invest to make a reasonable return. But just as 
such returns have been fleeting for them, they have also been lower for 
Venture Capitalists (VC's). My experience has shown that VC's are 
astute at picking the companies and management teams to invest in, that 
will yield them and the investors in their funds, the highest possible 
returns. And they bring great insights and expertise to these 
companies, greatly aiding them in their efforts to grow and become 
highly successful. Yet despite all this experience, knowledge and 
expertise, as noted in the following chart, VC's and the investors in 
their funds have experienced the same impact from the downturns in the 
economy everyone else has. And that should be no surprise to anyone who 
understands fundamental, basic economics. It takes a growing economy 
such as existed in the United States in the 1990s, and exists now in 
China, India and certain other emerging countries in the world, to 
generate returns for investors.


Critical Success Factors for an IPO
    I have often counseled that not all companies should do an IPO. If 
you take someone's money, you should do so ONLY if you think it is 
likely, you will be able to yield them a reasonable return on their 
money. After all, they are owners of the business once they have bought 
stock and should be treated accordingly. Those who go public thinking 
that ``possession is 9/10ths of the law'' when it comes to cash, are in 
for a very rude awakening.
    When I served on a Colorado Commission that explored why so many 
small companies were failing in Colorado at the time, and how their 
success rate could be improved, we found that access to capital was not 
the primary cause of failure. Rather it was a lack of sufficient 
expertise and management within the company including in such areas as 
marketing and operations. While access to sufficient capital for any 
company is important, I have found that those emerging companies with 
better management teams and proven products, or products with great 
growth potential, are able to obtain it. Those are the types of 
companies VC's and private equity seek out.
    My experience has also taught me that many IPO's are not a success. 
We are all very mindful of the Googles, Apples, HP's, and Microsofts 
that have become great successes. In fact, the vast majority of the 
jobs they created have been created after an IPO, not before.
    In an American Enterprise Institute Paper titled ``Are Small 
Businesses The Engine of Growth'' Veronique de Rugy, the author states:

        It is a common belief among entrepreneurs and policymakers that 
        small businesses are the fountainhead of job creation and the 
        engine of economic growth. However, it has become increasingly 
        apparent that the conventional wisdom obscures many important 
        issues. It is an important consideration because many 
        Government spending programs, tax incentives, and regulatory 
        policies that favor the small business sector are justified by 
        the role of small businesses in creating jobs and is the raison 
        d'etre of an entire Government agency: the Small Business 
        Administration (SBA). This paper concludes that there is no 
        reason to base our policies on the idea that small businesses 
        are more deserving of Government favor than big companies. And 
        absent other inefficiencies that would hinder small businesses 
        performances, there is no legitimate argument for their 
        preferential treatment.

    And in the paper titled ``What Do Small Businesses Do?'' professors 
Erik Hurst and Benjamin Wild Pugsley state:

        In Section 3 of the paper, we study job creation and innovation 
        at small and/or new firms. First, using a variety of data sets, 
        we show that most surviving small businesses do not grow by any 
        significant margin. Most firms start small and stay small 
        throughout their entire lifecycle. Also, most surviving small 
        firms do not innovate along any observable margin. We show that 
        very few small firms report spending resources on research and 
        development, getting a patent, or even copywriting or trade 
        marking something related to the business (including the 
        company's name). Furthermore, we show that nearly half of all 
        new businesses report providing an existing good or service to 
        an existing market. This is not surprising in light of the most 
        common small businesses. A new plumber or a new lawyer who 
        opens up a practice often does so in an area where existing 
        plumbers and existing lawyers already operate.

    They go on to conclude:

        Recognizing these characteristics common to many small 
        businesses has immediate policy implications. Often subsidies 
        targeted at increasing innovative risk taking and overcoming 
        financing constraints are focused on small businesses. Our 
        analysis cautions that this treatment may be misguided. We 
        believe that these targets are better reached through lowering 
        the costs of expansion, so they are taken up by the much 
        smaller share of small businesses aspiring to grow and 
        innovate. In fact, the U.S. Small Business Administration 
        already partners with venture capitalists whose high powered 
        incentives are aligned with finding these small businesses with 
        a desire to be in the tail of the firm size distribution.

    In fact, during the heydays of the IPO market of the 1990s, many 
companies went public and took money from investors that never should 
have. Yet shortly after going public, as Exhibit 2 notes, many failed, 
causing investors great losses in their retirement and college 
education savings accounts, and destroyed over a hundred thousand jobs. 
Many large pension funds have never been able to recover to their pre 
dot com bust funding levels, leaving Americans wondering where the 
money will come for their retirement.
    At the height of the bubble, leadership of the Business Roundtable 
invited then SEC Chairman Arthur Levitt and me to dinner. At the 
dinner, they urged us to prohibit many of these companies from taking 
investors money. (The SEC did not have that regulatory power as the 
United States appropriately has a disclosure rather than merit based 
system.) They argued that rather than the investments going to 
companies who could put it to good use, investing in plants, jobs and 
research, the money was flowing into young, unproven companies that 
lacked adequate management, let alone revenues, profits and a 
substantive business plan. They turned out to be right. The capital was 
poorly allocated, and many American investors, businesses and workers 
paid a stiff price.
    Not too long after that, I had lunch with a managing director of 
one of the ``Bulge Bracket'' investment banks who had done many public 
offerings. By that time the market had cratered taking trillions of 
dollars of wealth with it. He said that in fact, Wall Street, the 
venture capitalists, attorneys and other gatekeepers, had facilitated 
the IPO of many companies that never should have gone public. He went 
on to say that whereas before the IPO market bubble got way out of 
hand, companies had to have attained at least certain levels of 
revenues for an established period of time, to demonstrate they were 
viable companies who could earn a reasonable return for their 
investors. But in the bubble, he said all that was thrown out the 
window, and any company they could take public they did. When I asked 
him why, he responded ``Because if we didn't do it, the next guy 
Conclusion on Legislation
    For any capital market to work effectively, it must provide 
investors with high quality, timely and complete financial information 
that is accurate. Conflicts inherent in the markets must preferably be 
prohibited and at a minimum must be clearly and completely disclosed to 
all participants. And there must be an enforcement mechanism that 
ensures a fair and orderly market.
    In the past, the U.S. capital markets have had a reputation for 
appropriate regulatory and enforcement mechanisms, and continues to 
attract capital, including from foreign investors. But the scandals of 
the last decade has damaged our reputation, beginning with the dot com 
IPO market bubble, to the Wall Street analysts scandal, to mutual fund 
market timing and trading frauds, to Madoff and other ponzi schemes, 
along with the once in a lifetime financial crisis brought on by 
extremely lax regulation by securities and banking regulators, and by 
people who originated bad loans, collected huge fees for doing so and 
then sold the worthless paper to investors.
    Lax regulation, in some cases the result of acts of Congress, has 
hammered the investment accounts of retirees and baby boomers that no 
longer have sufficient time to recover from the losses incurred. Laws 
that were passed by this Committee, including the Gramm-Leach-Bliley 
Act, and the Commodities Modernization Act of 2000, which prohibited 
regulation of derivates; were driving factors behind too big to fail 
companies; and resulted in a $600 trillion dollar unregulated 
derivatives market, both of which AIG and Lehman engaged in. These laws 
neither protected investors nor taxpayers, but certainly did allow them 
to be taken advantage of. It is not sufficient to say legislation will 
protect investors, it must actually do it.
    As I review the legislation before the Committee, I find it reduces 
the level of transparency and amount of information investors will 
receive. It removes critical investor protections put in place to 
protect against a repeat of past scandals. It decreases the credibility 
of the information one will receive. It not only allows market 
participants such as analysts to once again engage in behavior and 
activities that were associated with prior market disasters, it treads 
on the independence of independent standard setters such as the Public 
Company Accounting Oversight Board (PCAOB) established by this 
Committee, as well as the Financial Accounting Standards Board (FASB). 
If ill-conceived amendments regulating the cost benefit analysis the 
SEC would have to perform, that were adopted in the U.S. House of 
Representatives, I suspect investors would be well served to understand 
that handcuffs had been put on the SEC, rather than bad actors.
    The proposed legislation is a dangerous and risky experiment with 
the U.S. capital markets, and the savings of over 100 million Americans 
who depend on those markets. The evidence does not support the need for 
it. In fact, it contradicts it. I do not believe it will add jobs but 
may certainly result in investor losses. If jobs are created, as the 
evidence above indicates, it will come from growth in the economy, not 
this legislation. And finally, there has not been the type of cost 
benefit study performed with respect to the proposed legislation that 
Congress itself mandates the SEC must do before adopting such 
regulations. Senator Shelby has been correct in noting there was 
insufficient study performed before enactment of Dodd/Frank. There has 
been even less study of the bills that are the subject of this hearing 
    As a result, I do not support the various bills including the IPO 
on ramp and crowd funding legislation. I share many of the concerns 
voiced by others including the Council for Institutional Investors, 
Consumers Federation, Americans for Financial Reform, AFL-CIO to name a 
few. Their concerns are set forth in greater detail in Exhibit 3 which 
I include for inclusion in the record.
Comments on Particular Bills
    I do offer the following specific comments on the legislation for 
your consideration.
Senate Bill 1933.
Section 2 Definitions
    The definitions included in this bill would make it applicable to 
companies under $1 billion in revenue, and $700 million in market 
capitalization, for up to 5 years or until they broke those thresholds. 
While these companies are defined as ``emerging', that is serious a 
misnomer. As the charts below illustrate, this would scope in over 98 
percent of all IPO's. And the vast majority of public companies 
currently filing periodic reports are under these thresholds according 
to raw data from Audit Analytics.


    Given the nature of the experiment being run through this proposed 
legislation, I would strongly urge the threshold be reduced to $75 
million. Experimenting with such a large segment of public companies 
and IPO's, as the proposed thresholds would, is highly risky and 
chances putting millions of Americans at risk.
Section 3 Disclosure Obligations
    This section would reduce by a third, the amount of credible, 
audited financial information investors would receive. That information 
is the lifeblood of the capital markets and necessary for making 
informed decisions on where capital should be allocated. Yet this vital 
information is proposed to be seriously restricted by this legislation.
    My experience tells me that successful IPO's, are done by companies 
with sufficient track records to demonstrate they are worthy of an 
investment. If a company has been established for more than 2 years, 
then it should continue, as has been the practice for decades, to 
present 3 years of audited financial information to investors. If 
companies are unable to do this, I would be seriously concerned if they 
are ready for the ``prime time'' of being a public company, and are not 
likely to generate sufficient returns to warrant an investment.
    This section also impinges on the independence of the FASB as it 
exempts emerging companies from having to adopt new accounting 
pronouncements. As a result, if the FASB were to adopt a new 
pronouncement in response to a significant problem such as the off 
balance sheet special purpose entities of Enron or the off balance 
sheet reporting at Lehman, emerging companies may well avoid having to 
implement such standards for a period of time, leaving investors once 
again in the dark.
    As noted at Exhibit 4, Senator Shelby has correctly defended the 
independence of standard setters such as the FASB. His counsel should 
be heeded once more and this provision regarding accounting 
pronouncements should be removed from the legislation.
Section 4 Internal Controls Audit
    As discussed earlier, Sarbanes-Oxley Section 404(b) has not been 
the reason there has been a decline in the number of IPO's. Companies 
under $75 million in market capitalization have never had to implement 
SOX 404(b) so it cannot be the reason such companies have not gone 
public. And for those companies that do go public, they have not had to 
implement SOX 404(b) at the time of the IPO or at the subsequent annual 
report filed with the SEC. It is only at the time of the second annual 
report that a public company must complete an audit of its internal 
controls. This is a reasonable exemption from the requirements of SOX 
404(b) that should be retained rather than replaced.
    Data has clearly demonstrated that prior to the enactment of SOX, 
thousands of companies were not complying with the internal control 
provisions of the Foreign Corrupt Practices Act of 1977. As SOX was 
implemented, the chart below highlights the numbers of companies that 
were found not to have complied with the law. SOX 404(b) did bring much 
greater transparency to the number of companies that had inadequate 
internal controls, and that as a result, had to correct their financial 


    As SOX 404(b) was implemented, erroneous financial statements, that 
in most instances had previously been attested to by the executives, 
came to light in record numbers. In a February 2007 report by Glass 
Lewis, where I was the Vice President in charge of the research, found:

        Companies with U.S.-listed securities filed 1,538 financial 
        restatements in 2006, up 13 percent from what had been a record 
        number in 2005. About one out of every 10 public companies 
        filed a restatement last year, compared with one for every 12 
        in 2005. Of the latest restatement batch, 118 were by foreign 

        If there was any lingering question about whether these figures 
        matter, consider this: The median stock return of companies 
        that filed restatements last year was minus 6 percent. That was 
        20 percentage points lower than the return of for the Russell 
        3000 stock index in 2006.

    The report went on to list key findings:

Key Findings
    1,244 U.S. companies and 112 foreign companies--1 of every 
        10 companies with U.S.-listed securities--filed 1,538 financial 
        restatements to correct errors

    2,931 U.S. companies, about 23 percent, filed at least one 
        restatement during the last 4 years; 683 companies restated two 
        or more times

    Restatements by companies required to comply with SOX 404 
        declined 14 percent; restatements by non-SOX 404 companies rose 
        40 percent

    Difference in audit fees between SOX 404 and non-SOX 404 
        companies pales in comparison to cost of corporate accounting 
        frauds and executive compensation

    One-third of larger companies and two-thirds of microcap 
        companies that restated still claimed to have effective 
        internal controls over financial reporting

    The median 1-year stock return of companies that restated 
        last year was 20 percentage points lower than the return of the 
        Russell 3000 stock index in 2006.

    Companies with deficient internal controls tend to be poorly 
managed companies that underperform their peers in the markets, and 
which yield lower returns to investors. Accordingly, information on the 
quality of internal controls is very important to investors. The chart 
below highlights this issue, and notes that investors in companies that 
have poor internal controls and restatements cost investors dearly. 
However, those who question the costs of SOX 404(b) often disregard 
such data, caring only about the cost to the company and not the huge 
economic benefit to investors.


    The General Accountability Office and SEC have also issued studies 
and reports on their findings on the benefits of SOX 404(b). One such 
report captioned ``United States General Accounting Office Report to 
the Chairman, Committee on Banking, Housing, and Urban Affairs, U.S. 
Senate (October 2002) FINANCIAL STATEMENT RESTATEMENTS Trends, Market 
Impacts, Regulatory Responses, and Remaining Challenges'' GAO-03-138 

        The 689 publicly traded companies we identified that announced 
        financial statement restatements between January 1997 and March 
        2002 lost billions of dollars in market capitalization in the 
        days around the initial restatement announcement. For example, 
        from the trading day before through the trading day after an 
        initial restatement announcement, stock prices of the restating 
        companies that we analyzed fell almost 10 percent on average 
        (market adjusted). We estimate that the restating companies 
        lost about $100 billion in market capitalization, which is 
        significant for the companies and shareholders involved but 
        represents less than 0.2 percent of the total market 
        capitalization of NYSE, Nasdaq, and Amex. However, these losses 
        had potential ripple effects on overall investor confidence and 
        market trends. Restatements involving revenue recognition led 
        to greater market losses than other types of restatements. For 
        example, although restatements involving revenue recognition 
        accounted for 39 percent of the 689 restatements analyzed, over 
        one-half of the total immediate losses were attributable to 
        revenue recognition-related restatements. Although longer term 
        losses (60 trading days before and after) are more difficult to 
        measure, there is some evidence that restatement announcements 
        appear to have had an even greater negative impact on stock 
        prices over longer periods. The growing number of restatements 
        and mounting questions about certain corporate accounting 
        practices appear to have shaken investors' confidence in our 
        financial reporting system.

    This finding is very consistent with research and findings of the 
Staff of the SEC while I was Chief Accountant. As a result, I believe 
the data clearly supports that the benefits of SOX 404(b) to investors 
significantly outweigh the costs. Congress should conduct a cost 
benefit test, consistent with what it mandates of the SEC, if it 
exempts any additional companies from SOX 404(b).
Section 5 Auditing Standards
    Section 5 is troubling for two reasons. First, Congress established 
the PCAOB to regulate auditors of public companies. At the time it did 
so, it acknowledged that such an entity would be able to do a better 
job of that than Congress itself.
    The PCAOB has a project on its agenda, as the direct result of very 
troubling findings arising from its inspections of public companies. 
This project as instituted because auditors have been found to be 
lacking in independence, professional skepticism and reasonable 
judgment. The project is in the early stages and a concept release 
seeking public comment has been released. Yet, at this very early stage 
Congress is proposing to step in and override the PCAOB, preventing it 
from adopting rules on mandatory rotation.
    Audits are only worth paying for, if they are independent. A dozen 
years ago, the SEC rewrote the auditor independence rules. But these 
rules were watered down as a result of undue pressure from Congress as 
it bowed to the whims of the auditing profession lobby. That turned out 
to be a disastrous decision as Enron, WorldCom, Adelphia, Xerox and a 
host of other corporate scandals arose in which it appeared the 
auditors lacked independence.
    Congress is now poised to make the same mistake, yet again. 
Instead, it should allow the process to run its normal course, obtain 
the comments from the public, conduct the 4 public hearings it has 
undertaken, and wait for the outcome of the deliberations.
    The second concern with Section 5 is that it requires the SEC to 
perform a cost benefit analysis of each new rule the PCAOB promulgates. 
The legislation wording as currently crafted, puts a premium on the 
cost to the company rather than the benefit to investors and capital 
    And I understand it, any cost benefit study would need to be 
completed within 60 days of the adoption of a new PCAOB rule. Often 
that is simply not possible, and so the legislation in essence would 
exempt emerging companies as defined from new PCAOB rules.
    At a minimum, the language should be changed to balance any cost 
benefit analysis. The SEC should also be given a reasonable period of 
time to conduct such studies. In addition, while I was Chief 
Accountant, the industry refused to provide data useful to a cost 
benefit study. If the industry was once again to refuse to provide 
necessary data to the SEC or PCAOB, those agencies should be exempted 
from the cost benefit study requirement provided they can demonstrate 
any new rule would adequately protect investors and was in investors' 
best interests.
    It is also worth noting that the restrictions that Congress 
proposes to place on the SEC, the PCAOB and the FASB apply to all 
companies defined as emerging companies. This would include for 
example, the population of Chinese companies that in recent years have 
become an emerging scandal in and of themselves. Investors have and 
continue to suffer losses in investments of such companies. One must 
ask, is it really good public policy to roll back regulations as 
proposed for such companies when the problems grow larger by the day.
    I would urge the Committee to consider adding to this section of 
the legislation, the bi-partisan proposal by Senator Reed and Grassley 
that would enhance the transparency of the enforcement activities of 
the PCAOB. As the press and public have rightly pointed out, this would 
enhance the credibility of the agency and permit investors to 
understand whether there are serious questions about the quality of 
audits they are receiving from certain auditors.
Section 6 Availability of Information About Emerging Growth Companies
    This is an ill-conceived and poorly thought out section of the 
bill. As a CFO, I watched as analysts engaged in ``marketing'' the 
underwriting of IPO's and public companies to investors. They were 
anything but independent and their research was misleading. They were 
in essence, an extension of sales and underwriting arms of the 
investment banking firms. This led to the Wall Street Analyst Scandal 
discussed further at Exhibit 5. It also resulted in investors being 
mislead and suffering significant losses on their investments.
    Unfortunately this legislation legitimizes this type of behavior. 
And it fails to recognize the importance of independent research as 
well as meaningful disclosure of conflicts that do exist. Rather it 
establishes a process whereby analysts can once again engage in issuing 
conflicted reports and avoid accountability for their actions.
    Below is a chart that reflects the type of reporting this 
legislation is likely to bring about. As noted, even after the dot com 
bubble had burst, and just before the largest corporate scandals in 
this country erupted, analysts were still touting stocks.


    At a minimum, the legislation should adopt the investor protection 
measures encompassed in the well known Wall Street settlement. This 
includes provisions that ensure the analyst has to remain independent 
of the underwriting and investment banking function, and that any 
conflicts are disclosed in a complete and transparent fashion.
    With the Wall Street settlement requirements having lapsed, 
behavior among Wall Street analysts has quickly returned to what it was 
before the settlement. No one should be surprised if the outcome and 
history is repeated once again.
    The Administration has indicated, and the title of the hearing 
today would suggest, that the legislation should include investor 
protections. Currently Senate Bill 1933 and the other bills have fallen 
way short in this respect. Other commenters and people who have already 
testified have eloquently pointed that out. I hope the Committee will 
give due consideration to those points. For example, at Exhibit 6, the 
ICI has voiced its strong opposition to general solicitations noting 
they are not appropriate for the U.S. capital markets. At Exhibit 7, 
Professor Jay Brown has noted some reasoned changes that should be 
made. And at Exhibit 3, several organizations have made meaningful 
suggestions very worthy of consideration and acceptance.
    In addition to those improvements to the legislation, I would add:

  1.  Private offerings, which in all likelihood will reduce rather 
        than increase the number of IPO's, should be regulated. 
        Currently, the SEC does not have the resources to engage in 
        meaningful regulation. Accordingly, the State securities 
        regulators should be permitted to regulate offerings and 
        protect investors in their communities when the SEC is unable 

  2.  Recent reports have highlighted the level of recidivism that has 
        occurred on Wall Street and gone unchecked. I would urge the 
        Committee to adopt stronger enforcement penalties that ratchet 
        up as recidivism occurs. Penalties such as those included in 
        SOX for auditors are much more appropriate today than existing 
        penalties given changes in the markets.

  3.  Sanctions should be strengthened for both private and public 
        offerings, when it is found a seller of securities has failed 
        to undertake and ensure the suitability of a security for the 
        investor, or has failed to conduct meaningful and necessary due 
        diligence. All too often we have seen underwritings in which 
        the investment bankers failed to ensure adequate disclosure of 
        key risks and financial data. This is especially true when one 
        relaxes rules governing solicitation.

  4.  The definition of an accredited investor should be changed. Tying 
        this definition to wealth is inappropriate as we saw with many 
        of the investors in recent Ponzi schemes, such as in the Madoff 
        matter. The seller should be required to obtain a statement 
        from the investor that they not only have a specified level of 
        assets, but also have a reasonable working knowledge to permit 
        them to appropriately analyze the intended investment. If the 
        broker has knowledge that contradicts this, then the investor 
        should not be accredited.
    More jobs and a larger number of qualified IPO's is something we 
all strive for. But IPO's have to be successful for not only those 
selling stock, but also for those buying shares. This legislation is 
currently unbalanced and likely to result in more unsuccessful 
investments for investors. In the long run, history has judged clearly 
that such incidents serve to reduce IPO's, cost jobs, and cost 
investors money sorely needed for retirement and education.

                           D. WADDILL

Q.1. What do you feel are the primary reasons for the decline 
in the number of initial public offerings for smaller 
companies? Do you foresee a return to the number of IPOs from 
the late 1990s?

A.1. Did not respond by publication deadline.

Q.2. In S. 1933, an ``emerging growth company'' would include 
companies with up to $1 billion in revenues. What are your 
views on whether this is the appropriate number and whether 
revenues is the appropriate metric to identify companies that 
should get reduced regulatory requirements?

A.2. Did not respond by publication deadline.

Q.3. What would be the effects of exempting an ``emerging 
growth company'' from having its auditor attest to the 
effectiveness of its internal financial controls on the company 
and on investors?

A.3. Did not respond by publication deadline.

Q.4. What types of companies would you expect to use 
crowdfunding to raise capital, instead of going to other 
sources of funds such as private equity fund, venture capital 
fund or banks? What types of investors do you expect to invest 
through crowdfunding?

A.4. Did not respond by publication deadline.

Q.5. Professor Ritter in his testimony identified the 
possibility that if a company is very successful, and has 
multiple rounds of financing, there is a possibility that ``the 
small investors wind up exposed, being diluted out.'' Mr. Rowe 
stated that ``it's a valid concern.'' How do you feel that this 
issue should be addressed for small investors in crowdfunding 

A.5. Did not respond by publication deadline.

Q.6. Ms. Smith testified that ``the transparency of our [IPO] 
markets are very poor, which hurts and scares a lot of 
investors in the markets.'' She suggested greater use of the 
SEC's EDGAR Onliner system to post transcripts of road shows or 
a red-lined copy of amended registration statements. Do you 
feel that the transparency of the IPO market could be enhanced 
in ways that would encourage more investors to invest in IPOs?

A.6. Did not respond by publication deadline.

Q.7. You testified that ``For my company to try and prepare for 
Sarbanes-Oxley compliance will be somewhere between $3 million 
to $3.5 million.'' You later testified ``from our company's 
point of view, when we look at the use of capital . . . do we 
want to spend $3 million ramping up into Sarbanes-Oxley 
compliance?'' Costs are a relevant factor to this discussion. 
Please describe the types of costs that you have identified for 
your company to comply with Sarbanes-Oxley that would total a 
cost of $3-$3.5 million.

A.7. Did not respond by publication deadline.


Q.1. What do you feel are the primary reasons for the decline 
in the number of initial public offerings for smaller 
companies? Do you foresee a return to the number of IPOs from 
the late 1990s?

A.1. I think that the primary reason for the decline in IPOs, 
especially small company IPOs, is a lack of investor enthusiasm 
due to low stock market returns, which in turn is due to the 
lack of profitability of most small companies after going 
public. From 1980-2009, 3,761 companies went public in the 
United States that had less than $50 million ($2009) in annual 
sales in the year before the IPO. From the closing market price 
on the first day until their 3-year anniversary, the average 
small company IPO had a 3-year buy-and-hold return of only 4.7 
percent, and performance relative to the broader stock market 
of -35.7 percent. The small company IPOs from 1980-2000 were 
unprofitable (negative EPS) in 58 percent of their first three 
fiscal years after the IPO. This percentage has increased to 73 
percent for the small company IPOs from 2001-2009.
    I believe that the deteriorating profitability of small 
company IPOs is attributable to a long-term trend in many 
sectors of the global economy, especially in the technology 
industry, that is favoring big companies. Many sectors are now 
``winner takes all'' markets, where getting big fast has become 
more important than it used to be. Small companies are 
accomplishing this by selling out to a bigger company, rather 
than staying independent. Thus, the issue is big vs. small, not 
public company vs. private company.

Q.2. In S. 1933, an ``emerging growth company'' would include 
companies with up to $1 billion in revenues. What are your 
views on whether this is the appropriate number and whether 
revenues is the appropriate metric to identify companies that 
should get reduced regulatory requirements?

A.2. I believe that revenue is an appropriate measure, although 
$1 billion may be too high.

Q.3. What would be the effects of exempting an ``emerging 
growth company'' from having its auditor attest to the 
effectiveness of its internal financial controls on the company 
and on investors?

A.3. I am in favor of dropping the auditor attestation 
requirement. A more effective way of deterring securities fraud 
is to penalize the people who commit the fraud.

Q.4. What types of companies would you expect to use 
crowdfunding to raise capital, instead of going to other 
sources of funds such as private equity fund, venture capital 
fund or banks? What types of investors do you expect to invest 
through crowdfunding?

A.4. I do not expect crowdfunding to be very successful. 
Venture capitalists provide both money and advice. I do not 
think that there are a lot of great investment opportunities 
out there that will be identified and funded through 

Q.5. Professor Ritter, in your testimony you identified the 
possibility that if a company is very successful, and has 
multiple rounds of financing, there is a possibility that ``the 
small investors wind up exposed, being diluted out.'' Mr. Rowe 
stated that ``it's a valid concern.'' How do you feel that this 
issue should be addressed for small investors in crowdfunding 

A.5. One possibility would be to have anti-dilution provisions 
as the default. It is very possible that private sector 
intermediaries will insist on this without Government 

Q.6. Ms. Smith testified that ``the transparency of our [IPO] 
markets are very poor, which hurts and scares a lot of 
investors in the markets.'' She suggested greater use of the 
SEC's EDGAR Online system to post transcripts of road shows or 
a red-lined copy of amended registration statements. Do you 
feel that the transparency of the IPO market could be enhanced 
in ways that would encourage more investors to invest in IPOs?

A.6. Her suggestion to flag changes in the S-1 s is a good 
idea. One issue that was not discussed is why investment 
banking fees (the gross spread) are much higher in the United 
States than in Europe. If a company sets an offer price of $10 
per share and pays a gross spread of 7 percent, the company 
nets $9.30 if the stock trades at $11.00, the company has 
received $9.30 for shares worth $11.00, and this $1.70 cost 
(direct and indirect) is more than 15 percent of the $11 market 
price. If these costs were lowered, more companies would go 

                         SHELTON SMITH

Q.1.a. What do you feel are the primary reasons for the decline 
in the number of initial public offerings for smaller 

A.1.a. While the global financial crisis in 2008 and 2011 
reduced investor interest in stocks overall, as well as IPOs; 
it is the outsized losses that investors suffered from owning 
stocks of smaller newly public companies when the Internet 
bubble burst in 2000 that is the primary reason for the decline 
in the number of offerings for smaller companies. After the 
Internet bubble burst, many unprofitable and overvalued smaller 
newly public companies went out of business. Investors lost 
trust in this segment of the IPO market and in the underwriting 
firms that promoted these offerings.

Q.1.b. Do you foresee a return to the number of IPOs from the 
late 1990s?

A.1.b. The high IPO activity levels of the 1990s were above 
historical norms and the culmination of 20 years of strong 
stock market returns following the weak 1970s. However, we 
could foresee achieving above average IPO levels again, but 
only after investors experience a sustained period of positive 
stock market returns. As investor confidence returns, more 
capital will be allocated to equities and a rising number of 
smaller companies will be able to access the IPO market.

Q.2. In S. 1933, an ``emerging growth company'' would include 
companies with up to $1 billion in revenues. What are your 
views on whether this is the appropriate number and whether 
revenues is the appropriate metric to identify companies that 
should get reduced regulatory requirements?

A.2. We believe that revenue is not an appropriate metric to 
identify a company as an ``emerging growth company''. 
Differences in revenue recognition and profit margins among 
companies in different industries make revenue a poor measure 
to judge company size. We believe that market capitalization (a 
measure of company value) is the most appropriate metric to 
measure the size of a company.
    We define an emerging growth company as one having a market 
capitalization below $250 million, a definition also used by 
the SEC (see attached). Our data shows that companies with less 
than $250 million in market capitalization typically offer IPOs 
of $50 million or less. It is these companies seeking to raise 
$50 million or less that have had difficulty accessing the 
public markets as shown by the IPO Task Force data.

Q.3. What would be the effects of exempting an ``emerging 
growth company'' from having its auditor attest to the 
effectiveness of its internal financial controls on the company 
and on investors?

A.3. Investors may be more cautious about investing in an 
emerging growth company that is exempt from the auditor test. 
This could result in a higher cost of capital for the company. 
However, for a smaller company (