Thursday, May 11, 2017

SEC advisory committee talks small offerings, tick sizes

By Anne Sherry, J.D.

The SEC Advisory Committee on Small and Emerging Companies met again to discuss, among other things, the underwriting of small offerings. Representatives from WR Hambrecht + Co. and Stephens Inc. expressed optimism about Reg A+ offerings despite a dearth of success stories. At the morning session, officials from the Division of Trading and Markets and DERA updated the committee with preliminary musings on the tick size pilot program.

Clayton’s debut. In his first public remarks as SEC Chairman, Jay Clayton said that one of his priorities for the Commission is facilitating capital-raising opportunities for all companies. Bolstering small- and medium-sized businesses helps not only those companies, but expands opportunities for investors, bolsters the economy, facilitates innovation, and furthers job creation. Chairman Clayton closed his remarks by recognizing the efforts of the agency and the committee in light of Public Service Recognition Week.

Underwriting case studies. Robert L. Malin (WR Hambrecht + Co.) presented a retrospective of some of the key Reg A+ offerings to date, including case studies of several companies that hired Hambrecht to underwrite their efforts. Malin visualized the A+ distribution strategy as a pyramid with the crowd at the base, the independent broker-dealer network above that, and finally institutional investors at the top. He stressed, however, that while Reg A provides flexibility to include crowdfunding, there is no obligation for companies to include a crowdfunding component in their offerings.

Malin’s presentation of case studies began with Elio Motors, whose offering is considered the single success in the Reg A+ market. This was a self-sponsored and -marketed offering with no underwriter or broker/dealer support; Hambrecht’s role was in getting Elio’s shares quoted on the OTCQX market. One remarkable aspect of Elio is that the company was able to generate a massive community of interested investors—6300 investors in all. The fact that 60 percent of the investors already held reservations for a vehicle speaks to their success in converting fans and enthusiasts into investors.

BeautyKind had less success in getting customers to invest. Even though this cosmetics company had a strong marketing pitch, set a $5 million minimum, and engaged the broker-dealer network, ultimately it was unable to convert its fans into investors. Other unsuccessful Reg A offerings included Aperion Biologics, Allegiancy, and NewsBeatSocial. Malin emphasized that Hambrecht does substantial due diligence and uses a data-driven selection process to identify companies that should be financed in the public markets. Most of the firm’s fees in these offerings are success fees, so it really wants the companies to succeed, and it does not take the business unless it believes the issuer will meet its target. Despite the failures, Malin remains optimistic that their Reg A holds promise. Once Hambrecht racks up a few successes, thus proving this is a legitimate way to enter the market, other underwriters will join the space.

Absence of FINRA guidance. Malin observed that one issue with the smaller, unlisted offerings is a lack of specific FINRA guidance for compliance officers. Broker-dealers are concerned about scrutiny, not liquidity—individual brokers “are hungry for product” and would like to present these types of opportunities to their clients. In many cases, these offerings address a lot of risk concerns: for example, the issuers are seeking DTC eligibility and listing on an organized market. In a Reg A+ Tier 2 offering, the company is required to have a registered transfer agent. Malin suggested that FINRA could, for example, issue guidance that amounted to a checklist of sorts giving compliance officers comfort in the event these factors are present.

Different perspectives on JOBS Act. J. Bradford Eichler (Stephens Inc.) also seemed positive about the Reg A outlook. From his perspective as an investment manager, the JOBS Act is a “total home run,” he said. Testing-the-waters, confidential filing, and reduced financial disclosure are all helpful on the front end. But, he said, clients find the Act stifling. Private equity is playing a much bigger role and these firms tend to prefer a clean exit via an M&A rather than taking the company public.

Tick size pilot. The morning session concluded with an update from Trading and Markets and DERA on the tick size pilot program. David Shillman (Trading and Markets) provided an overview of the pilot, which is eight months into its two-year run. The pilot comprises small and mid-cap companies, half of which are in a control group. The other half are split into three buckets, with a goal of testing what moving from a penny to a nickel increment will do. The most controversial bucket introduces a trade-at requirement.

David Saltiel (Trading and Markets) said that preliminary findings are not all that surprising. Spreads have widened, of course, and, as a result, more volume to trade is required to move a quote. Also as a result of the wider spreads, trading costs are higher for test group stocks. Saltiel also observed that there is a shift in where trading is taking place. All stocks have shifted away from maker-taker exchanges in favor of inverted exchanges. Two of the buckets have shifted to dark venues or ATSs, while the bucket with the trade-at requirement has shifted away from dark venues.

Amy Edwards (DERA) gave a preview of studies that the Division is planning, most likely after the SROs submit their assessment of the pilot program. DERA’s studies will involve hypothesis testing, with a goal of filling in gaps in information. Is there a way to tell who’s profiting, and can DERA disentangle some of the effects and see what the economics would be in changing tick size for all? Stephen M. Graham (Fenwick & West), who co-chairs the committee, posited that because the pilot is being done in isolation, it doesn’t consider other factors that could adversely affect the ecosystem—akin to treating only one symptom in a patient with multiple issues. But Edwards said it was too early to know what the answers will end up being, especially if the experiment is open to the idea that the answers can be different for different stocks.