Tags: SEC | spreads | IPO | stock

Industry Witnesses Tangle Over Securities Bills

Tuesday, 29 Oct 2013 02:23 PM

By Robert Feinberg

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The House Financial Services Committee's Subcommittee on Capital Markets and Government-Sponsored Enterprises, chaired by Scott Garrett, R-N.J., held a hearing on seven "cats and dogs" — a group of micro-bills clustered around the theme of the hearing, "Legislation to Further Reduce Impediments to Capital Formation."

Whereas many chairmen in the past had legislated by means of so-called "omnibus" bills, it has been the practice of Republicans in recent years to spread the workload among many members so that each could enjoy visibility and raise campaign contributions as a prime sponsor of what otherwise might be just a section of a much larger bill.

The witnesses were:

• Heath Abshure, Arkansas Securities Commissioner, on behalf of the North American Securities Administrators Association (NASAA)

• Michael Arougheti, CEO of Ares Capital

• J. Michael Ertel, managing director of Broker, Legacy M&A Advisors

• Alexander Frank, CFO of FIFTHSTREET

• Gary Wunderlich, Jr., CEO of Wunderlich Securities, on behalf of the Securities Industry and Financial Services Association (SIFMA)

• Tom Quaadman, vice president of the Center for Capital Markets Competitiveness, U.S. Chamber of Commerce

• David Weild, Chairman and CEO of IssuWorks

The following are the bills on which panelists were asked to comment:

• H.R. 31 – Next Steps for Credit Availability Act

• H.R. 1800 – Small Business Credit Availability Act (relating to business development companies)

• H.R. 1973 – Business Development Company Modernization Act

• H.R. 2274 – Small Business Mergers, Acquisitions, Sales and Brokerage Simplification Act

• H.R. ____ – to direct the Securities and Exchange Commission (SEC) to revise regulations regarding use of eXtensible Business Reporting Language (XBRL)

• H.R. ____ – to amend the Securities Act of 1934 to provide an optional pilot program to allow emerging growth companies to experiment with larger tick sizes for trading their stocks

• H.R. ____ – to amend securities laws relating to the treatment of emerging growth companies

The staff memorandum provides descriptions of all of the bills, except for some reason, it omits any explanation of H.R. 31. This bill would change the asset coverage ratio and treatment of preferred stock to allow business development companies to operate with increased leverage, and it would direct the SEC to revise its rules accordingly.

In opening statements, Garrett cited an increase in the number of initial public offerings (IPOs) to 150 as evidence that the so-called "IPO onramp" provisions of the Jumpstart Our Business Startups (JOBS) Act are working. Now he proposed to consider additional proposals to make it easier for small and emerging growth companies to raise capital.

Carolyn Maloney, D-N.Y., lamented that the number of IPOs has declined by 92 percent, and she supported consideration of the bills, while urging the committee to follow the suggestion of SEC Chairman Mary Jo White that it "put safety and soundness concerns first" as it proceeds to legislate in this area.

Abshure is a voluble and valuable member of the SEC's Investor Advisory Committee. The SEC also has an Advisory Committee on Small and Emerging Companies, and the two have taken conflicting positions on the JOBs Act.

The committee of small companies sees the JOBS Act as the salvation of these companies, whereas the investors have issued a formal warning of the potential for a new wave of fraud that would challenge the capacity of state regulators to police it.

On this occasion, Abshure expressed "concerns regarding the new, untested regulatory carve-outs for EGCs [emerging growth companies] and BDCs [business development companies], which would turn them into speculative hedge funds."

Arougheti explained that a business development company is more akin to an operating company than to a mutual fund and that his firm has invested $14 billion in more than 450 companies. He endorsed legislation that would allow business development companies to increase their leverage to that of a Small Business Investment company (SBIC) on the ground that this would enable investment in lower-risk companies without entailing any subsidy or risk to the government. In addition, business development companies would be allowed to treat preferred stock as equity rather than as debt, and they would be able to compete with registered investment advisers.

Ertel testified that when business brokers structure transactions, the determination as to whether they will be asset or stock sales is determined by tax considerations, and if it happens to morph into a securities transaction, a small firm may have to make an initial investment of $150,000 to $250,000 to meet SEC and FINRA requirements, even though a small firm might not do any securities transactions at all in subsequent years. Therefore, he called for a more simplified regulatory system to be tailored to his industry on the ground that this would facilitate capital formation.

Frank endorsed the view expressed by Arougheti on treating preferred stock as capital, but he opposed increasing the leverage to 2-1, because this step could lead to ratings downgrades and an increase in the cost of capital. He urged policymakers to consider "effective leverage, which would take into account the compounded leverage of all of the entities involved, not just the BDC [business development company]." In addition, he warned that increasing leverage here might counteract whatever efforts are made to reduce leverage in the banking sector.

Wunderlich supported legislation to require the SEC to proceed with a pilot program to test wider trading spreads for small and emerging companies, but he opposed restrictions on the ability to trade within the prescribed spread, because this would impair the ability to achieve price improvement.

Quaadman asked for a safe harbor to prevent litigation that might arise from tick-size pilot program.

Weild sought the widest tick size of the witnesses, at 20 basis points, and he also opposed trading within that spread. He attacked SIFMA on two fronts: first by charging that its position is informed by "dark pool" interests, then by opposing the practice known as "payment for order flow."

There was some drama at the end of the hearing when Mick Mulvaney, R-S.C., questioned the wisdom of exposing retail investors to additional risk from hedge funds and private equity funds beyond what is already presented by mutual funds.

Abshure responded that those funds are run by professional managers, but Mulvaney retorted that this does not change the fact that the retail investors are unsophisticated.

Considering that the proposed legislation is still in its formative stages, the strong, even emotional, views expressed indicate that all of the industry groups intend to fight hard, both in Congress and at the regulatory agencies, to get the most favorable regulations possible and, in some cases, to use the regulatory process to weaken the competitive posture of competitors.

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