Monday, November 24, 2014

Improvements to Small Business Capital Formation Debated at SEC Forum

[This story previously appeared in Securities Regulation Daily.]

By John Filar Atwood

Venture exchanges and increased tick sizes are among the ideas proposed to improve market liquidity for shares of small businesses at today’s Government-Business Forum on Small Business Capital Formation hosted by the SEC. SEC Chair Mary Jo White noted that while the JOBS Act improved access to capital markets for small businesses, investors still face considerable liquidity challenges that may hinder their investment in small businesses. She asked Forum participants to consider ways to address these challenges.

Tick size. Commissioner Luis Aguilar agreed that the lack of an active trading market for securities of small businesses is a major hurdle to capital formation. One potential fix that is already under consideration is for the SEC to change the way shares are priced. Aguilar noted, however, that the Commission’s consideration of a 12-month tick size pilot program has already generated significant criticism, including that the cost of transactions will increase if the spreads are increased.

Venture exchanges. Commissioner Daniel Gallagher is a proponent of the idea of venture exchanges. In opening remarks, he said that venture exchanges are a place where Regulation A+ shares could be listed and traded by anyone, not just accredited investors, and could be done with an exemption from state blue sky laws and with scaled listing standards. In his opinion, venture exchanges could revolutionize small business capital formation.

Venture exchanges also have the support of Commissioner Kara Stein. She said that this idea and her proposal to rebuild regional exchanges offer hope for some progress in this area. She acknowledged, however, that there are practical realities and risks when dealing with smaller issuers and less liquid markets that must be considered as new ideas are tried.

As the Forum got underway, House Financial Services Committee Chair Jeb Hensarling (R-Tex) issued a statement urging the SEC to act on recommendations that come out of the meeting. He noted that the Forum has in the past generated innovative ideas to help small businesses, some of which made their way into the JOBS Act.

Market liquidity. The first panel on the Forum’s agenda panel addressed the questions surrounding secondary market liquidity for the securities of small businesses. Panel moderator Stan Keller of Edwards Wildman Palmer said that some of the challenges referred to by Chair White include balancing increased liquidity with protection of investors and trading markets, distinguishing trading from distributions, and the absence of an information regime for companies using the small business offering exemptions.

Mike Zuppone, a partner with Paul Hastings, said that today’s trading market is inhospitable for small companies. Among the reasons, in his opinion, is that stock exchanges get very little revenue from the trading of small cap stocks, so there is no economic incentive to foster the development of a new market.

Regulation NMS. The solution will require a regulatory mindshift by the SEC, he said, particularly with respect to Regulation NMS. He asked the Commission to be open to rethinking Regulation NMS as it relates to a new trading market for small companies’ shares.

Zuppone hopes the SEC will signal to market participants that it is open to new trading technology solutions that will improve trading but also advance the Commission’s policy goals. Commissioner Michael Piwowar signaled his support of this idea, saying that one size does not fit all in market regulation and the Commission should do whatever it can to remove regulatory obstacles to small business market liquidity.

State preemption. Zuppone also offered the slightly more controversial idea of the SEC seeking legislation that would preempt state blue sky laws for the trading of Regulation A+ Tier 2 offered securities. Arkansas Securities Commissioner A. Heath Abshure said that it is premature to propose preemption of state laws when it is not clear what the exempt offering reporting regime will look like.

Abshure said that the states are opposed to allowing trading in an opaque market. He urged Forum participants and the SEC not to preempt state securities laws until there is are adequate information requirements in place.

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