Remarks to the American Chamber of Commerce in Australia
Commissioner Daniel M. Gallagher
U.S. Securities and Exchange Commission
Melbourne, Victoria, Australia
April 30, 2012
Thank you very much for inviting me to speak with you today. I am very pleased to return to Australia. I had the distinct pleasure of living here while attending the University of New South Wales for a semester as an undergraduate student 20 years ago. I will be speaking at a similar American Chamber of Commerce event in Sydney tomorrow, and I look forward to being back in that wonderful city again.
I want to thank you for welcoming me to Melbourne, which holds the current title of most livable city in the world, unless you are, like me, an American carrying U.S. dollars, in which case it is one of the most expensive cities in the world!
It is a true privilege for me to be here today to speak with you as well. Before I begin, I must advise you that my remarks here today are my own and do not necessarily represent the views of the SEC or my fellow Commissioners.
I have just visited your long-distance neighbors in Hong Kong and Singapore, speaking with both government regulators and private sector representatives about financial crisis related regulatory policy initiatives and the related issue of the competitiveness of U.S. capital markets. Although capital market competitiveness issues in the U.S. have traditionally focused on Europe, and London in particular, the same cannot be said today.
The rise of the Australian and Asia economies, which unlike the U.S. and Europe have not experienced a financial crisis in the last several years, and the corresponding development of the financial markets in these countries, have created a new world order that policymakers in the U.S. have to respect and analyze. By studying the successes of other jurisdictions, and by ensuring that our policy choices do not needlessly impair foreign markets or the operations of U.S. financial institutions operating in those foreign markets, we can make choices that will benefit all markets.
We in America often remark that we have been blessed by our geography. Australians, of course, say the same, with equal justification. Although, in our relatively short national history, we have fought in our share of domestic and international conflicts, our geographical situation has spared us much of the physical devastation suffered by other nations during the last century, particularly during World Wars I and II. Like you, we were not so fortunate in the measure of our personal sacrifice. Our geographical position and natural resources, nevertheless, helped our economies to develop despite the severe disruptions experienced by others, particularly in Europe, and promoting the development of our capital markets, to the great benefit of our citizens, investors foreign and domestic, and our partners-in-trade around the world.
Like you, we can say that, although we have suffered our share of economic and financial crises, our free market economy and robust capital markets have conferred an enviable prosperity on our people over many years. In fact, and notwithstanding financial crises such as that which began in 2008, it is fair to point out that few in America can remember a time when the United States did not have strong and competitive capital markets. The danger is that we will begin to think we are entitled to such markets when, in reality, we must constantly act — and sometimes decide not to act — in order to preserve their vitality. My job, and that of my colleagues on the U.S. Securities and Exchange Commission, is to ensure that our capital markets remain strong and competitive. Let me unpack and elaborate on that statement.
The SEC’s threefold mission is to protect investors, maintain fair and efficient markets, and promote capital formation. All of these goals are laudable, and they are closely intertwined. A balanced approach is the key. Occasionally, we find that actions taken by the Commission to carry out one mandate have had unintended consequences with respect to another. With respect to issuers, this would be particularly true if new regulations are so draconian or ill-thought that companies choose not to go public at all or, once public, elect to go private, depriving investors of otherwise attractive investment opportunities. And, if law abiding companies choose to go public in other markets primarily to avoid costs attributable to our regulations, we had better sit up and consider our position.
Today, the possibility of going public “elsewhere” is greater than ever, thanks to the tremendous strides made by capital markets around the world, including in the places that I have been visiting during this trip. Strong markets, abundant capital, and orderly and predictable legal regimes are good things, wherever they exist. We encourage and promote them at every opportunity -- a rising tide should float all boats. However, it is incumbent upon us to study the developments in other jurisdictions, particularly the markets that have been thriving while we in the U.S. have been experiencing economic distress, to ensure that our actions are not driving capital market activity offshore. Indeed, the relevant data demands study and analysis:
- In 2011, 134 initial public offerings took place in the United States, raising almost $36 billion in capital. 1
- Over the same period, Hong Kong, with a GDP and population less than a fortieth a size of the United States,2 saw 102 IPOs, raising over $35 billion in capital.3 Although the quality of those IPOs has been questioned by some,4 the quantity surely deserves our attention.
- In 2011, IPOs in mainland China raised approximately $45 billion in over 280 offerings on the Shenzhen and Shanghai exchanges.5
- The IPOs conducted in Singapore in 2011 raised $7.6 billion6 — slightly more than 20% of the amount raised in the United States in a country with a GDP little more than a fiftieth the size of the U.S. GDP and a population little more than a sixtieth the size of the United States.7
- Australia raised almost $1.6 billion in capital in 103 IPOs last year8 — only 31 fewer than the United States despite a GDP approximately a sixteenth the size of the U.S. economy and a population approximately a fourteenth the size of the United States.9
For decades, the United States has hosted the most successful capital markets in the world, featuring an unparalleled level of fairness, predictability, efficiency, and sophistication. These markets have fueled economic growth and created countless jobs not just in the U.S., but around the world as well. It is axiomatic, however, that in capital markets, past performance is no guarantee of future results. As even the handful of IPO statistics I’ve cited shows, new issuers enjoy an unprecedented range of choices among vibrant and successful capital markets.
If developed capital markets are to retain their preeminence in international finance, we, as regulators, must protect investors without deterring new issuers from raising capital in our markets. If we make raising capital unattractive, it will go elsewhere.
While the financial regulatory reform statutes of the past decade, most notably the Sarbanes-Oxley Act and the Dodd-Frank Act, have added to our securities laws numerous new requirements intended to protect investors, they have also incontrovertibly increased the costs of being a publicly traded company in the United States. It is widely believed that this increased regulatory burden — these increased costs — affected the willingness of smaller and growth-stage companies to go public in the United States. As a result, last month, a large, bipartisan majority in our Congress passed the “JOBS Act,” which has the explicit aim of “increas[ing] American job creation and economic growth by improving access to the public capital markets for emerging growth companies.”10
“JOBS” in the JOBS Act is an acronym. It stands for Jumpstart our Business Startups. For the still-sluggish U.S. economy, a jumpstart would be welcome indeed. Hong Kong’s estimated real GDP growth rate for 2011 was 5%, slightly more than Singapore’s estimated rate of 4.9%.11 Australia’s estimated real GDP growth rate for 2011 was 1.8%. And, I would be remiss if I did not point out that China experienced a 9.2% GDP growth last year. All bested the estimated 1.5% rate for the U.S., which put the U.S. in 172nd place on the global growth list for 2011.12
The JOBS Act actually creates a new category of issuers known as “emerging growth companies,” which the Act defines as companies with annual gross revenues of less than $1 billion that have issued less than $1 billion in non-convertible debt during the previous three-year period. The Act is designed to encourage IPOs among emerging growth companies by reducing the regulatory burdens they would otherwise incur during their early years as public companies. For example, it requires emerging growth companies to provide only two years of audited financial statements in their IPO filings instead of the regularly required three years, and it exempts them from certain new public company corporate governance requirements established by Dodd-Frank. It also exempts them from Section 404(b) of the Sarbanes-Oxley Act, relieving them from the burden of engaging an independent audit firm to opine as to the adequacy of their internal financial reporting controls, a provision that has proven to be extraordinarily costly to public companies listed on U.S. markets.
The JOBS Act also increases the number of shareholders a company may have before it becomes subject to the SEC’s reporting requirements. In addition, it provides a new statutory exemption from registration requirements for “crowd-funding” transactions raising up to $1 million over a twelve-month period. It directs the SEC to amend its rules to remove the present prohibition on general solicitations in private placement offerings and to exempt from its registration requirements offerings up to $50 million in securities over a twelve-month period.
The quick, bipartisan passage of the JOBS Act provides the SEC with a timely opportunity to re-examine the costs that regulations can entail for smaller businesses looking to access the U.S. capital markets, costs that in some cases could create disincentives for a company to access those markets at all. The Act also serves one more reminder of the benefits of tightly tailored, as opposed to “one-size-fits-all,” regulation. For example, Dodd-Frank began to mitigate the unintended consequences and costs of Section 404(b) of the Sarbanes-Oxley Act by permanently exempting smaller issuers from that provision’s requirements. The JOBS Act continued that process of better tailoring the application of Section 404(b) by creating a new exemption from that Section for all emerging growth companies.
I mention Section 404(b) because it serves as a good example of a significant burden attributable to a particular regulatory provision. Many regulatory burdens are not so easy to address. Indeed, some burdens are not the result of an easily identifiable “smoking gun” regulatory provision but are instead the result of an accumulation of a number of small requirements. When applied as a whole to regulated entities such as issuers, such requirements can cumulatively result in burdens that, in turn, have material and distressing real-world effects. In the IPO context, examples include excessive requirements relating to audited financial statements and corporate governance requirements — two burdens that have been mitigated by the JOBS Act.
At a recent Commission meeting adopting new regulations, my friend and fellow Commissioner Troy Paredes stated, “I often boil down what we do as regulators to this: We draw regulatory lines that influence — and sometimes definitively determine — the economic activity that can and will occur.”13 Our jobs as regulators would be far easier if regulation were simply a matter of establishing a single line between permissible and impermissible activity. Effective and fair regulation, however, requires the drawing of many lines — between large and small, foreign and domestic, registered and unregistered, and various other categories.
It is incumbent upon regulators to be as aware of the cumulative effect of smaller burdens as we are of the immediate effect of the more obvious, larger burdens. It’s not enough simply to avoid the icebergs that can sink a ship — one must also be vigilant in scraping off the barnacles that, cumulatively, can render a ship clumsy, unresponsive, or even unfit to sail. At the risk of belaboring the metaphor, the smaller the ship, the more effect each new barnacle has.
We must always bear in mind the fact that, regardless of the benefits they may afford investors, our regulations inevitably impose costs and other burdens on companies. These, because they are generally fixed costs imposed on a smaller revenue stream, can have a disproportionate effect on smaller companies, with their more limited personnel and infrastructure.
A couple of specific examples may give us some perspective on the real-world costs of recent securities legislation and its implementing rules. I invite you to consider the compliance burdens cited by two U.S. financial institutions:
The first institution is a regional bank with approximately $78 billion in assets by the end of 2011. It conducts little in the way of nonbanking operations, it does not engage in sophisticated proprietary trading, and it is not a globetrotting institution. And yet, its compliance costs have soared from $50 million in 2003 to $95 million in 2011. If you add on the costs of FDIC insurance and the revenue lost from important new banking regulations, the total hit to the firm’s bottom line is $342.6 million, or 28% of the bank’s 2011 pre-tax income.14
That’s a lot of barnacles.
The second institution is a large money-center bank with approximately $2.25 trillion in assets by the end of 2011. This bank estimates that, for the next few years, tens of thousands of its employees — three thousand of them full-time — will be required to work on complying with new regulations, at a total cost to the bank and its shareholders of nearly $3 billion.15
As an American politician once said: “A billion here, a billion there, pretty soon, you’re talking real money.”16
As I mentioned earlier in my remarks, notwithstanding the recent financial crisis, America has enjoyed a long period of relative prosperity since World War II, and much of that has been driven by a free market economy and vibrant capital markets. One could argue that we in the United States, including U.S. Government regulators, might have begun to take the vitality of our capital markets for granted.
The symptoms of stagnant job creation woke us up to the need to think critically about the costs we impose — to look not only at the benefits of sound regulation, but also at whether they are sufficient to justify the costs we have learned that they can entail. At a time when the rest of the world is developing attractive capital markets, our goal must be to rise to the challenge of improving our own — of reducing unnecessary or redundant regulatory drag in order to promote job creation and foreign investment. The JOBS Act is a welcome step in the right direction. Its prompt implementation and continuing to look critically at how our regulatory thicket may unnecessarily impede economic growth will improve the chances that this new century will be even more prosperous for America than the last.
Thank you very much for your kind attention. I would be delighted to answer any questions you may have.
1 See PWC, “2011 U.S. IPO Watch — Analysis and Trends” (February 2012), http://www.pwc.com/en_US/us/transaction-services/publications/assets/pwc-ipo-watch-annual-report-2011.pdf.
2 See CIA World Factbook (available at https://www.cia.gov/library/publications/the-world-factbook/).
3 See PWC, “2011 U.S. IPO Watch — Analysis and Trends” (February 2012), supra, note 1.
4 See Prudence Ho and Nisha Gopalan, Pain for Hong Kong’s IPO Buyers, The Wall Street Journal, April 30, 2012, at C1.
5 See PWC, “2011 U.S. IPO Watch — Analysis and Trends” (February 2012), supra note 1.
6 See Hong Kong Stock Exchange, “Hong Kong Leads World in IPO Fundraising for Three Consecutive Years and Attracts More International Listings,” HKE 2012-01-02-e, at Table 1 (http://www.hkex.com.hk/eng/newsconsul/newsltr/2012/documents/2012-01-02-e.pdf).
7 See CIA World Factbook, supra note 2.
8 See Tony Featherstone, “Float Review: No Survivors,” Weekend Financial Review (Australia), Dec. 28, 2011, updated Dec. 30, 2011 (online).
9 See CIA World Factbook, supra note 2.
10 Jumpstart Our Business Startups Act, Pub. L. No. 112-106, 126 Stat. 306, 306 (2012).
11 See CIA World Factbook, supra note 2.
13 Commissioner Troy A. Paredes, Statement at Open Meeting to Adopt the Joint Final Rule, Joint Interim Final Rule, and Final Interpretations Regarding the Further Definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant,” “Major Security-Based Swap Participant,” and “Eligible Contract Participant,” April 18, 2012 (available at http://sec.gov/news/speech/2012/spch041812tap.htm.)
14 See Comment Letter from Douglas A. Sheline, Senior Vice President and Assistant Treasurer, M&T Bank, to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, et al. (Feb. 10, 2012) (available at http://www.sec.gov/comments/s7-41-11/s74111-186.pdf); M&T Bank Corp., 2011 Annual Report xix-xx (2012); see also http://finance.yahoo.com/q/bs?s=MTB+Balance+Sheet&annual.
15 See http://finance.yahoo.com/q/bs?s=JPM+Balance+Sheet&annual; JPMorgan Chase & Co., 2011 Annual Report 17 (2012).
16 This is likely an apocryphal statement. See http://en.wikipedia.org/wiki/Everett_Dirksen; http://www.dirksencenter.org/print_emd_billionhere.htm.