0001 1 U.S. SECURITIES AND EXCHANGE COMMISSION 2 3 4 5 6 ADVISORY COMMITTEE ON SMALL AND EMERGING COMPANIES 7 8 9 10 11 12 Thursday, February 25, 2016 13 9:30 a.m. 14 15 16 17 18 19 20 21 22 23 Securities and Exchange Commission 24 100 F Street, NE 25 Washington, D.C. 0002 1 PARTICIPANTS: 2 3 COMMISSIONERS: 4 Mary Jo White, Chair 5 Commissioner Kara Stein 6 7 MODERATORS: 8 Stephen Graham, Partner, Fenwick & West 9 Sara Hanks, Co-Founder & CEO, CrowdCheck 10 11 PANELISTS: 12 Robert Aguilar, CFO & COO, Cabrera Capital Markets 13 Xavier Gutierrez, President & CIO, Meruelo Investment 14 Partners 15 Brian Hahn, CFO, GlycoMimetics, Inc. 16 Kyle Hauptman, Executive Director, Main Street Growth 17 Project 18 Catherine Mott, Co-Founder & CEO, BlueTree Capital Group, 19 BlueTree Allied Angels and BlueTree Investment Fund 20 Jonathan Nelson, Founder & CEO, Hackers/Founders 21 Patrick Reardon, Owner, The Reardon Firm 22 Lisa Shimkat, State Director, America's Small Business 23 Development Center, Iowa State University 24 Annemarie Tierney, Vice President & Head of Strategy and 25 New Markets, NASDAQ Private Market 0003 1 PARTICIPANTS (CONT.): 2 3 Gregory Yadley, Corporate Practice Group Partner & Chair, 4 Shumaker Loop & Kendrick LLP 5 Laura Yamanaka, President & Co-Founder, teamCFO, Inc. 6 Michael Pieciak, Deputy Commissioner, Vermont Securities 7 Division 8 9 SEC STAFF: 10 Julie Davis, Senior Special Counsel, Division of 11 Corporate Finance 12 Sebastian Gomez, Chief, Office of Small Business Policy, 13 Division of Corporate Finance 14 Betsy Murphy, Associate Director, Division of Corporate 15 Finance 16 John Roeser, Associate Director, Division of Trading and 17 Markets 18 Joanne Rutkowski, Senior Special Counsel, Division of 19 Trading and Markets 20 21 PRESENTERS: 22 Scott Bauguess, Deputy Director & Deputy Chief Economist, 23 SEC Division of Economic and Risk Analysis 24 Brian Knight, Associate Director of Financial Policy, 25 Center for Financial Markets, Milken Institute 0004 1 PARTICIPANTS (CONT.): 2 3 Jeffrey Sohl, Professor & Director, Center for Venture 4 Research, University of New Hampshire 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 0005 1 C O N T E N T S 2 PAGE 3 Call to Order 6 4 Introductions of Chair and Commissioners and 5 Remarks 8 6 Overview of the Capital Formation Landscape 7 For Small and Emerging Companies 36 8 Presentation and Discussion of Data on the 9 Size and Scope of Small Business Capital 10 Raising through Unregistered Securities 11 Offerings 78 12 Review and Consideration of Proposed Bylaws 135 13 Overview of Recent Rulemaking and Legislation 173 14 Discussion of Future Steps 179 15 16 17 18 19 20 21 22 23 24 25 0006 1 P R O C E E D I N G S 2 MR. GRAHAM: Let's get started. 3 Sebastian, do we have a quorum? 4 MR. GOMEZ: We do have a quorum. 5 MR. GRAHAM: All right. Hello, everyone. I'm 6 Steve Graham. I am your co-chair. I am a partner at the 7 law firm of Fenwick & West, and this is the beginning of 8 my third term. And I think it's a great committee, and 9 I'm looking forward to working with all of you. And I 10 share the chair duties, if you will, with Sara Hanks. 11 So, Sara, do you want to give a 30-second -- 12 or -- 13 MS. HANKS: All right. I'm -- I am unable to 14 switch on the technology. I am Sara Hanks. I'm CEO of 15 CrowdCheck, which is a company that provides compliance, 16 due diligence and disclosure services for the online 17 capital formation, i.e. crowdfunding community. And I've 18 been a long-time securities and corporate partner, and I 19 am a proud former staffer of the SEC. 20 MR. GRAHAM: Okay. Thank you. So it's good to 21 see the returning members, few though you are. 22 Catherine, nice to see you, and Michael. 23 Michael doesn't bowl, but we love you anyway. And I 24 guess we're waiting for Greg Yadley who is stuck in 25 Florida. So hopefully he made it out. 0007 1 MR. GOMEZ: He will make it. I think he's 2 actually in the tarmac, Reagan right now, so he'll be 3 here. 4 MR. GRAHAM: Okay. And the new members. 5 Annemarie, it's nice to have you sitting at the 6 table. Now we no longer have to invite you to get your 7 expertise. You're now required to be here. So it's -- 8 (Interruption to audio.) 9 MR. GRAHAM: So to the rest of you, welcome. 10 All of you are here because you represent a cross-section 11 of those directly affected by or interested in or are 12 otherwise qualified to provide advice to the Commission 13 and its rules, regulations and policies as they relate to 14 small business capital formation. I look forward to 15 working with you to make a difference in this area, and 16 thank you in advance for your time and efforts. Those of 17 you who are new will soon realize the level of importance 18 of the assistance given to this committee by the SEC 19 staff. It is quite high and much appreciated, and thank 20 you for all you've done and all that you will do. 21 We're honored to kick things off this morning 22 with opening remarks from Chair White and Commissioner 23 Stein. The other commissioner -- because we have two 24 vacancies now -- the other commissioner, Commissioner 25 Piwowar, also wanted to be here today, but he's 0008 1 traveling, so he sends his regrets. 2 Sara, do you want to introduce Chair White? 3 MS. HANKS: Yes, we are now going to hear from 4 Chair Mary Jo White. Chair White was appointed in March 5 2013 by President Obama to serve as the 31st chair of the 6 SEC and also the third consecutive woman to serve in that 7 position. She arrived at the SEC with decades of 8 experience as a federal prosecutor and securities lawyer. 9 Prior to serving as the chair of the SEC, Chair White 10 was the U.S. attorney for the southern district of New 11 York, the only woman to hold that position in the 200- 12 plus year history of the office and the chair of the 13 litigation department at Debevoise & Plimpton in New 14 York. 15 Thank you, Chair White. 16 CHAIR WHITE: Thank you very much, Sara. And 17 good morning to everyone. I think I've shaken everyone's 18 hand. If I haven't, I will later. And let me just 19 extend a very warm welcome to all of our new committee 20 members as well as the members who are returning. 21 This committee has been a continuing source of 22 valuable expertise and advice to the Commission on a 23 variety of important issues as reflected, I think, in the 24 Commission's renewal of the committee's charter last 25 year. You don't need me to tell you, obviously, that 0009 1 small businesses play a crucial role in our nation's 2 economy, and this committee's help to ensure that the 3 views of small business owners, investors and other 4 stakeholders in this community are clearly heard loud and 5 clear here at the Commission. So that I see as your 6 role, and thank you for that role. 7 And I know from your impressive bios that I'm 8 certain that this newly constituted membership will 9 continue to the significant contributions we've had in 10 the past. Each of you really does, as Steve alluded to 11 this, raise unique insights and experiences in running, 12 nurturing, advising and -- or investing in small and 13 emerging companies. We know you have very busy schedules 14 with multiple demands on your time, and we really 15 sincerely appreciate your service on this committee. 16 I'd also like to add a special thanks to Co- 17 Chairs Steve Graham and Sara Hanks for their willingness 18 to lead the committee and also you'll permit me to extend 19 an internal thank you to the staff of the division of 20 corporation finance, in particular Betsy Murphy, 21 Sebastian Gomez and Julie Davis for their heard work in 22 supporting the committee's activities and helping to 23 organize, obviously, the meeting today. 24 I know you have a full agenda, which you're 25 anxious to get to, and so I'll just try to give a very 0010 1 quick update on our activities in a few areas of 2 particular importance to you, including some that were 3 actually the subject of recommendations from this 4 committee last year. 5 Starting with the JOBS Act rulemakings, as you 6 know, last year the Commission completed all of its major 7 rulemakings under the JOBS Act, including Regulation A+ 8 and crowdfunding, Sara. Since Regulation A+ became 9 effective in June 2015, issuers have publicly filed over 10 60 offering statements with the Commission. Some of 11 these issuers and others have, as you might imagine, 12 taken advantage of the rule that allows for nonpublic 13 staff review of draft offering statements before publicly 14 filing. 15 The crowdfunding rules will become effective on 16 May 16. And in anticipation, a number of funding portals 17 have filed with us to register to serve as intermediaries 18 in crowdfunding transactions. There's a lot of 19 excitement about these new avenues for capital raising, 20 and we are keeping a very close eye on how these markets 21 develop. 22 In October of last year, at the same time, 23 actually, we adopted regulation crowdfunding, the 24 Commission proposed changes to Securities Act Rule 147 25 for intrastate offerings and Rule 504 of Regulation D. 0011 1 The proposed changes are part of our efforts to assist 2 smaller companies with capital formation while obviously 3 maintaining investor protections. Your committee last 4 year recommended that the Commission modernize. 5 Securities Act Rule 147 to facilitate state-based 6 crowdfunding initiatives. And that recommendation was 7 fully considered in developing these proposed rules, 8 which are outstanding. 9 As you know, I think most of you, the proposal 10 taking account of the internet age, would modernize Rule 11 147 to facilitate intrastate offerings, including state- 12 based crowdfunding offerings, which would be sold to 13 residents of a particular state. The proposal would also 14 update Rule 504 to permit offerings up to $5 million in a 15 12-month period and would make it consistent with other 16 provisions of Regulation D, including a bad actor 17 disqualification provision. 18 Comment period on these proposals closed in 19 January, and the staff is reviewing the comments received 20 and developing recommendations for final rules for the 21 Commission's consideration. 22 On the topic of accredited investor, obviously 23 that definition is a very important subject for us and 24 for you and for many across the small business community 25 and elsewhere. It's of particular interest to this 0012 1 committee and in making recommendations last year this 2 committee urged that the primary -- always wise advice -- 3 that the primary goal of the Commission's review of this 4 definition should be to do no harm to the private 5 offering ecosystem by constricting the number of 6 investors who would qualify as accredited. You also 7 recommended, including within the definition, those 8 investors who meet a test of sophistication. 9 In late December a staff report was issued that 10 analyzes really various approaches for modifying the 11 definition and provide staff recommendations for 12 potential updates and modifications. There's a comment 13 file to receive the public's feedback on the report, and 14 the issues and recommendations in it, and we encouraging 15 all interested parties to give us feedback. 16 Simplified disclosure for smaller issuers. 17 Last year this committee also put forward recommendations 18 regarding disclosure by smaller issuers, including some 19 changes in the disclosure rules for smaller companies as 20 well as expanding the number of companies that qualify as 21 smaller reporting companies under our existing rules that 22 permit certain scale disclosures. 23 As you know, again, I think the staff in 24 Division of Corporation Finance is advancing its 25 Disclosure Effectiveness Initiative, which includes 0013 1 consideration of the disclosure requirements for smaller 2 companies. We also now have, as of December, additional 3 mandates under the FAST Act to update and simplify our 4 disclosure requirements. So obviously our work in this 5 area quite actively continues. 6 The committee also provided a recommendation 7 regarding the regulation of finders and other 8 intermediaries in small business capital formation 9 transactions. Staff in the Division of Trading and 10 Markets continues to review this issue. 11 The Section 4(a)(1 1/2) exemption, again, the 12 committee last year supported formalizing by rule or 13 statute the so-called Section 4(a)(1 1/2) exemption, to 14 allow certain shareholders who may not be able to rely on 15 Rule 144 to resell their shares received in a private 16 transaction. This issue was addressed by Congress when 17 it passed the RAISE Act in December as part of the FAST 18 Act. 19 And I understand, Steve and Sara, that you'll 20 be discussing the latest developments on this topic later 21 today, and I really do look forward to hearing your 22 thoughts in light of the changes made by Congress. 23 Just very briefly on market structure, we 24 appreciate, the Commission, that while market structure 25 may not fit all companies and that our market structure 0014 1 must promote capital formation for smaller companies 2 while also obviously providing for robust investor 3 protections. That is why we are conducting a pilot 4 program that will be implemented this year to help assess 5 the effective tick sizes on market quality for smaller 6 companies. While I know that this committee's 7 recommendation was to make some of those changes 8 permanent rather than as part of a pilot, you should know 9 how important your views were to the Commission's 10 decision to undertake the tick-size pilot. 11 We also continue to study and remain receptive 12 to innovative industry efforts designed to facilitate 13 secondary market liquidity for smaller companies. So I 14 wasn't quite as brief as I'd intended. So I'll stop 15 there. I really do look forward to continued thoughtful 16 and informed contributions from this committee on all of 17 the topics I've mentioned as well as others. The focus 18 of your agenda is, as usual, a good one. As I understand 19 it, you'll first be discussing the current landscape for 20 small and emerging companies seeking to raise capital and 21 then reviewing what the current data shows about the 22 extent of capital raising by small businesses through 23 unregistered securities offerings. 24 As the avenues for capital raising are changing 25 and evolving -- and indeed they are -- I think it's 0015 1 critical to be continuously looking at what's working, 2 what barriers may be preventing the facilitation of 3 capital formation and how investors are faring and being 4 protected in these new markets. So again, I'll be keenly 5 interested in today's presentations and discussions as 6 I'm sure you will be. 7 So now I will stop by thanking you again for 8 your service on this very important committee. Thank 9 you. 10 MS. HANKS: Thank you, Chair White. And thank 11 you in general for the SEC's attitude to this committee 12 and helpfulness. 13 We're now going to hear from Commissioner Kara 14 Stein. She's been a commissioner of the SEC since August 15 2013. Prior to serving as a commissioner, she served as 16 a staff director for the securities subcommittee of the 17 Senate Banking Committee where she worked on many 18 financial services, including the legislation that became 19 the Dodd-Frank Act and the JOBS Act. 20 Commissioner Stein. 21 COMMISSIONER STEIN: Thank you, Sara. 22 Good morning to everyone. I want to welcome 23 both the continuing members and the new members of the 24 Advisory Committee on small and emerging companies. I'm 25 looking forward to hearing from you today. You bring a 0016 1 lot of energy to us. You're doing this pro bono, and we 2 sort of count on you to tell us what's going on in real 3 life. Sometimes we get a little egg-heady here. A lot 4 of lawyers, a lot of accountants, and we don't 5 necessarily understand what's happening on the ground. 6 So your role is very, very important to us, and I hope 7 you all speak freely and have robust discussions because 8 that helps us as we try to formulate policy. In 9 particular policy in how it might affect small and 10 emerging businesses. 11 I want to thank our Office of Small Business 12 Policy in the Division of Corporation Finance for putting 13 this together. They spent a lot of time trying to work 14 through an agenda that will use your time as well as 15 possible while your with us. 16 So this committee has the important task of 17 providing advice and recommendations to the Commission 18 regarding privately-held small businesses and publicly 19 traded companies with a market capitalization of less 20 than $250 million. I think this year the committee will 21 have an opportunity to examine a variety of novel issues 22 impacting small and emerging companies. 23 As the chair mentioned, how will Reg A+ and Reg 24 Crowdfunding work in practice? What are the best metrics 25 we can develop to measure whether or not these new 0017 1 regulations are effective both with respect to their 2 impact on small businesses as well as on investors? 3 Which capital raising options work best for the firms 4 that form a part of the small and emerging company 5 landscape? It may be that the case that the fixes 6 envisioned by some of the new mandates under the JOBS Act 7 or other acts do not work in the manner they were 8 intended. So this goes back to where reality sort of 9 confronts people's best intentions. 10 So I'm curious as we move forward this year 11 about your recommendations for helping us to understand 12 and study what's happening in the actual market. 13 I think on a related point, are there 14 asymmetries in access to capital raising options among 15 small and emerging companies? Which companies are 16 getting funding? Are capital raising opportunities, 17 including the options available under Reg A+ and 18 crowdfunding, are they known, and are they accessible on 19 fair terms? And if not, why not? How can we best 20 support the diversity of entrepreneurial talent that 21 exists behind many of these small businesses. I look 22 forward to discussions -- examine how women and minority- 23 owned small business ventures are faring and how the 24 Commission can help. 25 Finally, I look forward to the discussion today 0018 1 on the data, size and scope of the small business capital 2 raising through traditional public offerings as compared 3 to unregistered, private securities offerings. With the 4 relative dollar amount of capital raising in the private 5 markets in 2014 eclipsing that of the public market, we 6 should examine what this means in particular for small 7 and emerging companies. 8 Also, are small businesses receiving within the 9 private markets the funding support they need to grow and 10 eventually graduate to the public markets? So I look 11 forward to your best thoughts today and the continuing 12 discussion as the year progresses. And again, thank you 13 for your public service. 14 MS. HANKS: Thank you, Commissioner Stein. 15 Now we'd like to introduce the SEC staff that 16 will be assisting the committee and assisting the 17 committee very well I might say. They're headed today by 18 Betsy Murphy, associate director of the SEC's Division of 19 Corporation Finance, and Betsy's going to introduce the 20 rest of the staff. 21 MS. MURPHY: Good morning. Before going any 22 further, I'm going to recite the standard disclaimer that 23 any views expressed by an SEC staff member today are 24 solely those of the speaker and do not necessarily 25 reflect the views of the Commission or any other member 0019 1 of the Commission staff. That done, I would like to 2 extend a very warm welcome to all of you and thank you 3 for serving on the committee and for taking the time to 4 be here today to share your experience, insights and 5 expertise with the Commission and the public. We're very 6 grateful for your service. 7 I'd also like to introduce the other staff 8 members at the table with me. Next to me is Sebastian 9 Gomez-Abero who is chief of the Office of Small Business 10 Policy in the Division of Corporation Finance; Julie 11 Davis, who is senior special counsel in the office. I 12 think most of you know this, but in addition to 13 coordinating with the Advisory Committee, the Office of 14 Small Business Policy is the SEC's main point of contact 15 with small companies. We also have John Roeser, an 16 associate director in the Division of Trading and Markets 17 and Scott Bauguess who is a deputy director and deputy 18 chief economist in the Division of Economic and Risk 19 Analysis. 20 I'll turn things back to you, Steve and Sara. 21 MS. HANKS: Thank you very much, Betsy, and all 22 of you for your past and future help. 23 We're now going to turn to an absolutely 24 impossible task. We thought it would be helpful to go 25 around the table, have everybody introduce themselves and 0020 1 summarize their brilliant careers in 60 seconds or less. 2 So if you could, each of you -- 3 MR. GRAHAM: That will require brilliance. 4 MS. HANKS: If you would each to introduce 5 yourselves and tell us a little bit about your experience 6 and what led you here. Thank you. 7 MR. AGUILAR: Great. I'll start since I'm 8 right next to Sara. My name is Robert Aguilar. I'm with 9 Cabrera Capital Markets, an investment bank and broker- 10 dealer, and Cabrera Capital Markets, an investment 11 advisor with a real estate portfolio. I'm the chief 12 operating officer and chief financial officer, and I'm 13 happy to be on the committee. 14 MR. GUTIERREZ: Good morning. My name is 15 Xavier Guitierrez. I'm the president and chief 16 investment officer for Meruelo Investment Partners, which 17 is a private investment firm in the arm of a family 18 office based in California. We own and operate a number 19 of publicly traded and privately held companies. And 20 amongst our portfolio, we actually own and operate the 21 largest Latino-owned bank based in California. So I will 22 provide some insight in terms of the financing, 23 Commissioner Stein, to the minority-owned and women-owned 24 businesses in California that we face and we finance on a 25 day-to-day basis. I also sit on the board of directors 0021 1 of the U.S. Hispanic Chamber of Commerce and I'm leading 2 their efforts on access to capital for the 4 million-plus 3 Latino-owned businesses in the United States seeking to 4 access capital. Thank you very much for having me. 5 MR. HAHN: Sorry. My name is Brian Hahn. I'm 6 CFO of Glycomimetics. Glycomimetics is an emerging 7 growth biotech company that went public back in 2014. I 8 spent 18 of my last 20 years at startup emerging growth 9 companies. We've taken two of them public, but I've also 10 been in manufacturing and technology. So I look forward 11 to sharing some of those war stories and helping to kind 12 of contribute back to that. 13 MR. HAUPTMAN: Hi, guys. I'm Kyle Hauptman. 14 I'm currently executive director of a nonprofit here in 15 D.C. called Main Street Growth Project. We're all about 16 financial policy that is pro-growth and helps the little 17 guy, loosely speaking, meaning small banks, small 18 investors and the small businesses. I did start a 19 startup in New York years ago and then I had a little bit 20 of an odd career. 21 I'll just give you the short part of it which 22 was after business school I wanted to get into finance, 23 and eschewed some small opportunities and decided to go 24 the safe route, and in 2004 joined a prestigious, solid 25 company called Lehman brothers in '04. And then -- so 0022 1 anyway, I was there right to the end if you ever want to 2 talk about that. I was shading repo trading if you know 3 what that is, short-end trading, so I kind of had a 4 ringside seat at that. But anyway, then I went to the 5 think tank world and now happy in the nonprofit world. 6 MS. MOTT: Hi, I'm Catherine Mott. I'm the 7 founder of BlueTree Allied Angels. It's one of 450 8 professionally managed angel groups in the United States. 9 I'm also the founder of the BlueTree Venture Fund, which 10 is also located in Pittsburgh. I'm chair emeritus of the 11 Angel Capital Association. It's the nonprofit support 12 organization for professionally managed angel groups and 13 for individual angels. And I'm also the past chair of 14 the Angel Resource Institute that is engaged in educating 15 and professional development and research for angel 16 investors in the United States. 17 MR. NELSON: Hi. My name is Jonathan Nelson. 18 I'm the founder of Hackers & Founders. Hacker is Silicon 19 Valley colloquial for clever problem solver, not someone 20 who might be stealing your data. 21 CHAIR WHITE: I'm glad you explained that. 22 MR. NELSON: Every time I travel, I have to 23 make that very clear. We started about 10 years ago with 24 five people and me in a bar hanging out and talking about 25 startups, and apparently hanging out in a bar and having 0023 1 nerds talk about startups is a thing, because there's now 2 115 event organizers in 45 countries around the world, 3 and a quarter of a million people have attended our 4 events. Out of that, we've built a consulting portfolio 5 where startups pay us in stock for long-term services. 6 Most of our companies come from overseas, land in the 7 Silicon Valley, and then we help them globalize from 8 there. And we've had conversations with literally 9 thousands of tech entrepreneurs. 10 In a past life I was a nurse, and I also grew 11 up in Central America, so the whole minority and women 12 thing times to be kind of a thing for us. We have a 13 blind selection process for access into our founders 14 cooperative and consulting services. And as a result, 15 our work was actually called out by the White House as 16 being some of the best in minority support in Silicon 17 Valley, which I think is really sad. 18 MR. REARDON: Hello. I'm Patrick Reardon. I'm 19 from Fort Worth, Texas. I grew up in the Carolinas, so 20 I've never lived in Washington or worked in Washington. 21 Since I finished law school in '77 I've been in private 22 practice for a variety of clients ranging from a client I 23 have now that is literally a mom-and-pop real estate 24 business run out of a house -- room in their home to 25 working with Forbes 400 individuals. It's diversified 0024 1 and varied, and I've done a lot of things, and it may 2 make me an expert on none of them, or it may just give me 3 a diverse background. I don't know which. 4 I'm awed to be here, much less to think that 5 the commissioners are listening to me for advice. Thank 6 you for having me, and it is an honor to be here. 7 MS. SHIMKAT: I'm Lisa Shimkat, and I'm with 8 America's SBDC Iowa. I'm the state director there. And 9 it is a national organization and we actually just had 10 our meeting here two weeks ago in D.C. and I told 11 everybody then, and they started saying, oh, well, I need 12 to sit down and talk about -- oh, I have another client, 13 this is what they're running into. And I told them to 14 wait until I had my first meeting. 15 But no, I am very excited to be here. I have 16 experience in both private and public sector. I've 17 worked with several different federal agencies, so have a 18 little bit of that perspective as well and really looking 19 forward to representing the small and emerging companies. 20 MS. TIERNEY: I'm Annemarie Tierney. I'm a 21 vice president at NASDAQ. I oversee new market and 22 strategy for NASDAQ private market. I started my career 23 at the SEC, very proud alumni, with Betsy. In the -- I 24 won't say when, in the early '90s. But I was in CorpFin, 25 and then I went to Skadden Arps in London where I was 0025 1 doing IPOs and bringing companies to the U.S. capital 2 market, and then I went to the New York Stock Exchange 3 where I worked on corporate governance rules and listing 4 standards. And then my career sounds kind of ADD, but 5 it's kind of varied. 6 Then I was the general counsel of a dark pool 7 broker-dealer, and then I became the general counsel of 8 Second Market, which was, at that point in time, putting 9 its toes in the private company space and that's really 10 been my focus for six, seven years. And I'm very 11 honored, as Patrick said, be a part of the committee, and 12 I look forward to learning and contributing. 13 MS. YAMANAKA: Hi. My name is Laura Yamanaka. 14 I am president and founder of a company called Team CFO. 15 We provide outsourced CFO services for small and 16 midsized businesses. I have a pretty traditional career. 17 I'm an accountant by trade, went up through the normal 18 public accounting ranks, did all the corporate reporting, 19 compliance audits, all of that. 20 Got tired of that world and I thought there was 21 a little bit more relevance in the small business world 22 and foolishly just went out and started -- did corporate 23 for a while, GE, all that stuff. And then foolishly 24 decided to jump into small business world knowing 25 absolutely nothing about what it was really like to start 0026 1 a small business, but I thought I did because in my 2 corporate life that's what I used to do. I found out it 3 was really hard to start a business when you didn't have 4 a big old banking credit line and everybody standing 5 behind you who had been doing it a for a couple hundred 6 years. Quick learner or else you die. Spent the last 15 7 years in the small business world. 8 I also sit on the -- was chair of the National 9 Women's Business Counsel. I also am past chair of NAWBO, 10 National Association of Women Business Owners. It's 11 given me a really good understanding of the broader 12 problems across the United States that I see every day in 13 our business life. I still try to keep a hands-on on 14 what it's actually like to start a business through our 15 clients, and actually in LA people were pretty excited 16 that I was going to sit on this board. 17 They felt that the SEC sometimes has something 18 for them that has no relevance in the small business 19 life. So we started the education process. So I'm 20 honored to be here, I'm excited to learn what's 21 happening, and I'm proud to be able to give a lot of good 22 input, hopefully, as far as the people who are slugging 23 it out on the streets. 24 MR. PIECIAK: Good morning. I'm Mike Pieciak. 25 I began my career working with small businesses at 0027 1 Skadden Arps doing M&A transactions and such. But about 2 two years ago I returned home to Vermont where I actually 3 do work with small businesses on a regular basis working 4 with our state-based crowdfunding initiatives and other 5 ways that we assist small businesses. I'm the deputy 6 commissioner of securities there, and I serve also as the 7 chair of the North American Securities Administrators 8 Association, corporation finance section, where we deal 9 with issues affecting small businesses and larger 10 businesses at the state level across the country. And 11 I'm happy to be back on the committee. 12 MR. GRAHAM: Well, thank you all. Impressive. 13 This is going to be great. As Chair White indicated, 14 we're going to spend some time today beginning -- to lay 15 the foundation for our term. Roughly the agenda is going 16 to address the framework within which we are dealing, the 17 nature of that universe, future steps, and of course your 18 ideas. 19 So we all understand how critical it is for 20 small businesses to be able to access capital. There are 21 any number of approaches. I think we're familiar with 22 all of them. The SEC's mission is to cover the 23 securities side of the equation, and so therefore that is 24 the focus of this committee. 25 Our committee's charter and bylaws provide that 0028 1 the committee's objective is to provide the Commission 2 with advise on its rules, regulations, policies and 3 policies with regard to its mission of protecting 4 investors, maintaining fair, orderly and efficient 5 markets and facilitating capital formation for that group 6 that Commissioner Stein defined for us just a few minutes 7 ago, namely small and emerging companies, the issuance of 8 those securities, trading in those securities and public 9 reporting and corporate governance. 10 For context as we do our work, we'd like to 11 spend some time getting a better understanding of the 12 size and scope of the nonregistered market. So this 13 morning, we'll hear from the SEC's Division of Economic 14 and Risk Analysis and to research organizations regarding 15 the markets and the data currently being captured. This 16 afternoon, we will turn to SEC initiatives and the 17 continuing legislative activity in Congress. 18 For additional context, we thought it would be 19 good to present a quick overview of the regulatory 20 landscape. This will be familiar to most of you, but it 21 might be helpful to just kind of refocus in the baseline. 22 So regardless whether security is equity, debt 23 or a more exotic instrument, a basic fundamental of the 24 federal securities law is that every offer and sale of 25 securities needs to be either registered or exempt from 0029 1 registration pursuant to whether the exemption is the 2 1933 Act. 3 Turning to the public side, a number of small 4 and emerging companies choose to go public and register 5 their securities with the SEC. These become reporting 6 companies subject to ongoing reporting obligations. 7 Since Congress passed the JOBS Act, most new public 8 companies start as emerging growth companies, and this 9 status, of course, allows a company to follow scaled 10 requirements for disclosure and audit of financial 11 statements, not to have to provide auditor attestation 12 under SOX 404(b) and choose not to become subject to 13 certain changes in accounting standards. 14 This status will continue for the first five 15 years after a company's IPO or if its total gross 16 revenues are doing a more -- has issued more than a 17 billion in nonconvertible debt in the past three years or 18 becomes a large, accelerated filer, namely its public 19 float is $700 million or more. 20 Prior iterations of this committee have also 21 been interested in the definition of smaller reporting 22 company. Currently a company qualifies as a smaller 23 reporting company if its public float is less than $75 24 million. Qualifying as a smaller reporting company means 25 a company has simplified disclosure and reporting 0030 1 requirements, including being exempt from certain 2 disclosure requirements. 3 Last term this committee recommended that the 4 Commission revise the definition to include companies 5 with a public float of up to 250 million. Related to 6 this would be a revision of the definition of accelerated 7 filer such that the auditor attestation requirement under 8 404(b) would no longer apply to companies with a public 9 float between 75 million and 250 million. And of course 10 revision to the rules also would require revision of the 11 rules to provide small reporting companies with the same 12 disclosure combinations that are currently being made 13 available to emerging growth companies. 14 We expect the term of the committee will -- we 15 expect that this term the committee will continue to 16 focus on these definitions and other ways to make the 17 environment more conducive for small IPOs as well as the 18 combinations for small companies that are already 19 publicly traded. 20 Turning to the private side of the equation, 21 Sara. 22 MS. HANKS: Yeah, so continuing Securities Law 23 101, especially for those who are listening at home, just 24 as a reminder, Steve mentioned that the offerings must be 25 registered or exempt. And if your offering doesn't fit 0031 1 within one of the exemptions that I'm going to talk 2 about, either you're registered or you're breaking the 3 law. This is kind of a binary thing. So you're going to 4 register or you're going to fit within one of these 5 exemptions. And some of these exemptions are very new. 6 Some of them are driven by the JOBS Act. And because 7 they're very new and, as Commissioner Stein mentioned, 8 we're keeping an eye on how they're developing. A lot of 9 these are going to be the subject of discussions by this 10 committee over the forthcoming term. 11 So just a reminder, Securities Act Section 12 4(a)(2) and I think there's plenty of people who are old 13 enough here that they're constantly saying 4(2) instead 14 of 4(a)(2). So forgive me if I do that. That's the 15 exemption that exempts transactions by an issuer not 16 involving any public offering. The overwhelming majority 17 of offerings under this provision, as far as we know -- 18 and this is going to be a very important thing that we're 19 talking about with respect to data and how much data we 20 capture -- the vast majority of these offerings are done 21 under Regulation D and more specifically Rule 506 which 22 is a safe harbor under Section 4(a)(2). 23 Rule 506 comes in two flavors. 506(b) is what 24 those of us who started doing -- practicing law in the 25 '80s were working with. That's a traditional Regulation 0032 1 D offering. And that allows companies to raise money 2 privately, no limit on the amount of money a company can 3 raise or the number of accredited investors. No general 4 solicitation allowed under this exemption, so use of 5 internet is somewhat limited. 6 Pursuant to the JOBS Act, this is one of the 7 new ones, the SEC promulgated Rule 506(c) which allows 8 companies to generally solicit potential investors over 9 the internet so long as all of the purchasers are 10 accredited investors and the issuer takes reasonable 11 steps to verify their status as accredited investors. 12 And we're looking forward to hearing data today about how 13 and to the extent to which these exemptions are being 14 used for private placement. 15 There's another private placement that I think 16 we do have to mention even though must companies that we 17 deal with are not going to be using it, Rule 144(a), 18 essentially a private placement made under Section 19 4(a)(2) to underwriters immediately followed by resales 20 to large institutional investors. Like I say, mostly 21 used by larger companies. 22 Intrastate offerings, there is an exemption 23 from registration for intrastate offerings. Section -- 24 Securities Act Section 3(a)(11), the Commission adopted 25 Rule 147 that we talked about earlier in 1974 as a safe 0033 1 harbor for companies seeking to meet the requirements of 2 the 3(a)(11) exemption. One of the restrictions of that 3 is the ability -- which we're going to keep coming back 4 to I think a lot over the course of the term -- is 5 securities law applies to offers as well as sales. And 6 under old 147, you could only offer to -- and potential 7 investors in your own state, which, again, limited the 8 ability to use the internet. 9 Last September the committee -- this committee 10 recommended to the Commission that it modernize Rule 147, 11 and October 30, 2015, which Chair White had mentioned, 12 the Commission proposed amendments that would modernize 13 existing Rule 147 by establishing a completely new 14 exemption from registration that would help to facilitate 15 capital formation, including offerings relying on 16 intrastate crowdfunding, which is a very new and 17 developing thing over the course of the last year. And 18 we'll get an update from Sebastian this afternoon on what 19 commenters have been saying about the proposal. 20 Crowdfunding, something close to my heart. 21 Federal crowdfunding is another significant development. 22 The Commission recently adopted rules that will allow 23 for the first time interstate securities-based 24 crowdfunding transactions. New rules go into effect on 25 May 16th, and we'll be hearing more this afternoon about 0034 1 what's happening as companies and intermediaries prepare 2 to use these new rules. 3 Another JOBS Act-driven exemption is the many- 4 IPO exemption of Regulation A. Regulation A+ also a very 5 popular nickname for this thing, but anyway, it's an 6 exemption that existed for many decades and in recent 7 decades not very much used. But following rule 8 amendments that went into effect in June 2015 due to the 9 SEC implementation of Title IV of the JOBS Act, companies 10 can now raise up to $50 million in a 12-month period if 11 they go through a scaled SEC review process. And we'll 12 hear more about Regulation A and the utilization of all 13 of these exemptions both this morning and later this 14 afternoon. 15 MR. GRAHAM: Thank you, Sara. I would just add 16 that improved liquidity continues to be an imperative. I 17 think that's one of the things that we all want to spend 18 some time focusing on. Because for me, that's pretty 19 much the long and short of it. And it is clear, as it 20 has already been mentioned, that in terms of market 21 structure to facilitate liquidity, one size certainly 22 does not fit all. Smaller companies need a regime 23 flexible enough to accommodate innovation and growth, yet 24 strict enough to protect investors. And this is another 25 topic that the committee has addressed in the past and 0035 1 certainly one that we will continue to be interested in. 2 There are just -- these are just some of the 3 concepts that make up a landscape the committee will be 4 delving into this year as we seek to help to insure that 5 the views of small business owners, investors and other 6 stakeholders in this community are clearly heard by the 7 Commission. 8 Okay. We are pleased to have with us today 9 Scott Bauguess. Did I get that close enough? 10 DR. BAUGUESS: Yes. 11 MR. GRAHAM: Okay. Deputy director and deputy 12 chief economist of the SEC's Division of Economic and 13 Risk Analysis. In these roles, Dr. Bauguess oversees the 14 Division's risk assessment and custom analytics programs 15 to enhance monitoring and investigation programs across 16 the SEC, specifically in the areas of corporate issuers, 17 broker-dealers and asset managers. 18 Dr. Bauguess joined the SEC in 2007 from Texas 19 Tech where he was on the faculty in the College of 20 Business. He continues to teach graduate courses and 21 corporate financial policy at George Washington 22 University. Dr. Bauguess received his PhD in finance 23 from Arizona State University in 2004. He also holds a 24 BS and MS in electrical engineering and prior to his 25 doctoral studies spent six years working as an engineer 0036 1 in the high tech industry. 2 So, Scott, thank you very much for joining us. 3 DR. BAUGUESS: Thanks for that kind 4 introduction. I was going to mention that my background 5 as an engineer, it's somewhat of an accident that I ended 6 up in finance and also ended up at the SEC. I never 7 would have predicted this, but here I am eight years 8 later, and it's been a wonderful ride being involved in 9 initiatives like this. 10 Before we get started, just remind me the 11 format is -- are we going to wait for Q&A at the end or 12 can people interrupt? 13 MR. GOMEZ: Completely up to you, Scott. 14 DR. BAUGUESS: Okay. So if somebody wants to 15 interrupt and ask a question, just push your microphone, 16 and I'll pause and we can go from there. 17 So the disclaimer is already given. What I 18 thought I'd do is just give a quick background of DERA 19 just to let you know what our division does. For a long 20 time we've been involved in the economic analysis, impact 21 analysis for rules and regulations. We also support 22 litigation at the Commission. We've done that for a long 23 time, too. A recent innovation of our division is risk 24 assessment. We're taking the same economic skillsets 25 that we use in litigation and rulemaking and applying it 0037 1 to help Enforcement know, see, detect misconduct in 2 markets and also to continue monitoring markets after 3 rules have been implemented. And some of that you will 4 see here in the data that we're going to present. 5 And to start, before I get into the background 6 of some of the data that we're going to show today, I 7 just want to quickly highlight that all of this work is 8 not to my own. It's of three brilliant economists that 9 collectively probably know more about the economics of 10 the JOBS Act than anybody else in the world: Rachita 11 Gullapalli, Vladamir Ivanov and Anzhela Knyazeva. And I 12 put next to them the rules that they are particular 13 experts in, and they not only helped develop the economic 14 analysis in these rulemakings and releases, but they also 15 continue to monitor the development of the markets and 16 how they're evolving. 17 And to give a little bit of an outline of what 18 I plan to do or hope to do -- and I'm sorry for those on 19 the east side of the room if you're challenged and not 20 being able to see the slides. But as to give some 21 background of the landscape of the level of capital 22 raising and where the capital raising is occurring, I 23 think this is going to complement some of the other 24 materials you're going to see following this. 25 And then it gives some general economic 0038 1 perspective about how we thought of the rulemakings and 2 the JOBS actually makings as they unraveled and share 3 with you some or the predictions that we made as part of 4 these rulemakings in terms of the likelihood of these 5 markets working. In many cases, there's big questions 6 about how well the rules will manifest and the actual 7 practice of raising capital and then speak to some of the 8 nuance of how we think about capital raising in terms of 9 generating new capital versus just reallocating how 10 capital is raised in markets. 11 And I'll run through very quickly each of the 12 rulemakings listed there. Okay. So I'll also mention 13 that we have now produce three white papers on capital 14 raising, and each time we provide new information on how 15 private and public capital markets worked. 2008 was when 16 forms and filings -- or Form D became machine readable, 17 and it was shortly thereafter that we really learned, 18 maybe for the first time, how big private offering market 19 was. 20 We realized it was a trillion dollar market in 21 advance of then until the forms of machinery -- couldn't 22 aggregate the data, and now we can. And for several 23 years we've been putting out reports of the development. 24 So you can see right here this is a chart that 25 encapsulates that level of capital raising and dollar 0039 1 terms. So the 1,000 right there refers to a trillion 2 dollars, which is a very big number. And we've broken 3 out the first two sets of columns, the time series of 4 registered offerings, debt and equity. 5 And you can see that the registered debt market 6 is far larger than the public equity market, and I think 7 that makes sense just because debt tends to be refinanced 8 and rolled over. But what was somewhat surprising back 9 when we did our first study and each year since is the 10 level of the Reg D market and it was a nice introduction 11 for Reg D and the rules underneath that was given just a 12 few minutes ago. But you can see that Reg D, which is 13 predominately equity-based securities, is tremendously 14 large. 15 And the past couple years in particular it is 16 larger when combined with other private offering 17 exemptions than public capital raising. And this is an 18 important point that private capital raising, private 19 markets are very robust. There's a lot of activity going 20 on there, and thinking about the JOBS Act, the JOBS Act 21 rules is that interstitial set of capital raising that 22 occurs between private offerings and public offerings and 23 so how they will actually work in practice, what would 24 keep -- what would get a Reg D issuer to use Reg A or not 25 to be a reporting company is what we spent a lot of time 0040 1 thinking about. 2 If you look at the number of issuers during the 3 most recently completed calendar years, you can see that 4 there were 1,427. That should just be public issuers, 5 reporting companies that raised capital either through 6 SEOs or IPOs. Regulation D, there were over 1,560 -- 7 15,632 non-fund issuers. So this could be operating 8 companies, finance companies, finance service companies, 9 anybody that was not a fund. So there's a lot more 10 entities raising capital in private markets than public 11 markets. 12 And the fund, the pooled investment funds, 13 hedge funds was another 16,000 issuers. Rule 144(a), 14 which is predominately fixed income ABS type issuers, 15 these are 4(a)(2) offers that are resold to qualified 16 institutional buyers, and there were 1,418 of those. And 17 then other private offerings and -- this is a little bit 18 of a latent variable because we can't always observe 19 private offerings if we don't have a source to collect 20 that information. We had 268, at least that we've 21 measured. 22 You probably have all seen this and known this, 23 but it's nevertheless interesting to look at again, and 24 that is if we break out the composition of public issuers 25 in terms of their reporting status -- and here we show 0041 1 them as large, accelerated filers, greater than $700 2 million in market float, non-accelerated filers that are 3 below $75 million in market float and accelerated filers 4 in between smaller reporting companies, the SRCs that 5 were previously described here, too, you can see that the 6 composition of reporting companies is predominately non- 7 accelerated filers and SRCs. That's a very large number, 8 but they make up less than 1 percent of the market 9 capitalization as far as we can measure whereas the 10 large, accelerated filers make up 95 percent. 11 And what we've seen over the past decade, 12 particularly since Sarbanes-Oxley, is that the number of 13 public issuers has dropped from over 12,000 to less than 14 8,000. But the size of the public market is increasing, 15 so there's fewer companies that are getting bigger. And 16 from an economic perspective that makes sense because the 17 fixed cost of being public has gone up. So it makes 18 sense to be bigger. So that is something that continues 19 to be the case. 20 We continue to see a number -- a decrease in 21 the number of public companies, but they're getting 22 bigger. And that's also the -- one of the reasons why 23 the IPO taskforce looked at some of these issues that 24 generated rules and provisions that were promulgated in 25 the JOBS Act. 0042 1 This was already mentioned, and I'll just 2 highlight again in the rulemakings that we did, we 3 thought carefully about small businesses and what was 4 their role in capital raising, particularly in the 5 crowdfunding release and trying to understand where 6 entrepreneurs and business startups get their capital and 7 typically it's with friends and families and 8 nonconventional sources. And how will they be able to 9 access more conventional sources? This was at the center 10 of many of the discussions that we had in our economic 11 analyses. 12 As I previewed in the outline slide and just to 13 give you an idea of how economists think about capital 14 raising -- and you would see this in the broad economic 15 considerations and the introduction of any economic 16 analysis that we have in our rules -- in terms of capital 17 raising, we try to separate two unique concepts. And 18 that is if we're going to change a rule or an exemption 19 or an offering method, it could either cannibalize 20 existing offering methods, or it could generate a new 21 source of capital for issuers that previously could not 22 access capital. 23 And it's not always easy to understand or 24 measure the difference between the two, and both have 25 merits. So if Reg A cannibalizes the Reg D market in 0043 1 terms of issuers simply switching over, that's a 2 manifestation of a more efficient method of raising 3 capital. But if Reg A were to attract issuers that 4 weren't previously able to raise capital in private 5 offering markets or using Reg D or big enough or have the 6 resources to become a reporting company, then we would 7 consider that a new source of capital. 8 I think that was probably the intent of the 9 drafters of the JOBS Act was to create new capital, but 10 both of these are things that we consider carefully and 11 think are a benefit to the broader economy. 12 Okay. So what I'm going to do here is talk 13 about each of the provisions in chronological order for 14 which they were implemented or became effective. And 15 I'll give you some views in terms of how we thought about 16 these provisions and what we've observed. Some of this 17 is our own observations that we've made from our 18 analysis. Some of it's from the academic literature 19 reports that have been made publicly since -- over the 20 past few years. 21 And starting EGCs -- and I'm going to just do a 22 quick disclaimer and ask my CorpFin colleagues to correct 23 any mistakes that I make when talking about legal 24 requirements of rules and to the extent that I get it 25 wrong, but EGCs was -- I don't know if it was self- 0044 1 executing or occurred immediately with the enactment of 2 the statute, but no rulemaking here. But after the 3 introduction of Title I, what we saw is a large number of 4 emerging growth companies, companies with less than a 5 billion dollars in revenue, going public. It's about 12 6 percent of all reporting companies today, 928 EGCs and 7 about 85 percent of all IPOs since have an emerging 8 growth company status. 9 I don't actually have it on the slide here, but 10 one of -- what's interesting is the literature today has 11 somewhat -- academic literature today is somewhat mixed 12 on the views of EGCs in terms of what that has done. The 13 direct -- there's some evidence that direct costs have 14 gone up to going public and also the indirect cost. So 15 underpricing of IPOs with EGC status compared to 16 beforehand has gone up. 17 And underpricing is the difference between the 18 final day offering price and what the shares were sold to 19 prior to going public. Historically it's been about 15 20 percent on average, and what it shows that EGCs, it's 21 higher. That could reflect increasing -- information 22 where because the provisions allow less disclosure or 23 perhaps fewer years of audited financials, investors may 24 price that as riskier and therefore have more 25 underpricing. It could also reflect -- and there's 0045 1 evidence of this -- that a new type of company is going 2 public that wasn't previously going public, which would 3 be consistent with the intent of the EGC status. 4 So for sure what we see if there's a difference 5 in pre- versus post-JOBS Act IPOs and those are the two 6 general considerations that are being debated upon in the 7 academic literature right now. 8 Let's see. 9 MS. MOTT: Scott, can I ask you a question? 10 Again -- could you repeat that again? You said you 11 noticed a pre-IPO price, so versus the actual price a 12 difference? Is that what you're saying? 13 DR. BAUGUESS: Yeah, so underpricing is 14 typically the difference between the closing price of the 15 first day of trading and the share -- the price when the 16 shares were sold to the initial set of investors. 17 MS. MOTT: So you think they were -- you're 18 saying your data shows they were underpriced? 19 DR. BAUGUESS: So all data for the past 30 20 years show that offerings are underpriced, and the 21 academic literature, not our research, but several papers 22 have now shown that underpricing has increased, which 23 means that the difference between the final day price and 24 the initial offering price -- 25 MS. MOTT: Okay. 0046 1 DR. BAUGUESS: -- has gotten bigger. And the 2 interpretation is that either is that they're risker, 3 either because of the provisions of the EGC that are now 4 available or because of the difference in the types of 5 companies that are going public. So it's really hard to 6 distinguish between the two. But for sure we know that 7 there is a difference now. 8 MS. MOTT: Okay. I just wanted to make sure I 9 understood it. Thank you very much. 10 DR. BAUGUESS: General solicitation for those 11 here at the Commission that worked on this, it was a very 12 interesting time because depending on whose view you were 13 listening to, it was either going to destroy private 14 capital markets and fraud and misconduct was going to 15 promulgate at unprecedented rates to the view that this 16 was the panacea for all investors or issuers that didn't 17 have access to capital. 18 And in a nutshell, 506(c), and I'll show you 19 some data, really hasn't been either of those things. 20 It's been taken up at a very slow pace. We haven't seen 21 increased incidents in fraud, at least discernably or 22 measureable from our activities internal here. And we 23 haven't seen that issuers are availing themselves to the 24 ability to advertise and the removal of the ban on 25 general solicitation. 0047 1 If you look at our release that we -- the 2 economic analysis of the adopting release, we made a 3 number of predictions or claims. We noted that it was 4 intended to facilitate capital formation, particularly 5 for early-stage firms. And we thought that it would 6 lower the search cost of finding accredited investors and 7 also provide accredited investors with increased 8 investment opportunities because they would be able to 9 find investments more easily. 10 At least that the was the intent, and then if 11 that were true, that would decrease the overall capital - 12 - cost of capital raising and could potentially replace 13 other offering methods. So that was the major 14 prediction. We thought it might also reduce uncertainty 15 as to whether 506 offering could be completed, and 16 there's always the issue of release of information that 17 may spoil the Reg D exemption and so there was a thought 18 that this would actually help that issue. 19 And of course, the worry about the increased 20 incident of fraud and economic terms broadly, the concern 21 that that would erode investor participation in private 22 offering markets. So that would be a negative spillover 23 effect on the good issuers because of an increased number 24 of bad issuers in that market. So those were the 25 predictions. 0048 1 As I said, we haven't seen an increase in the 2 incidence of fraud. We have an internal JOBS Act 3 taskforce and also a 506 working group that's headed by 4 corporate finance and also works the office of market 5 intelligence and enforcement. So there's special 6 attention paid to tips complaints and referrals that come 7 in. And over time, as these groups have met, we have not 8 seen the widespread fraud that was at one time a concern 9 of some constituents. 10 And at the same time, there hasn't been an 11 uptick. 506(c) has not shown nearly the amount of 12 activity that we thought. 13 Yeah. 14 MR. REARDON: I'd like to offer some anecdotal 15 observations, and the first one is that large placement 16 agents have -- such as Wall Street firms or even regional 17 firms, have preexisting relationships with hundreds and 18 hundreds of investors. And I've been involved in private 19 placements where the offers and sales have been made to 20 hundreds of investors in private placements before 506(c) 21 was ever thought of. 22 My clients who are smaller clients since the 23 enactment of 506(c) who are not using placement agents, 24 but are rather going to investors and speaking to them, 25 when I sit down with them and tell them that, well, 0049 1 you've got to tax returns or get a letter from an 2 accountant. They immediately push back and say, oh, 3 that's -- I'm never going to get anybody to invest if I 4 start prying in their personal life like that, and it's 5 just not going to work. And I'm not interested in that, 6 so let's just do it the regular way. 7 Now it's anecdotal, it's not statistical, but 8 it might be that the small fry for who I think this was 9 really intended are just scared to go out there and say 10 to these potential investors, well, I need to see your 11 financial statements or get a letter from your 12 accountant. And the reaction is, well, my money's green 13 and I'll go somewhere else. And so, for whatever that's 14 worth, you might consider that. 15 DR. BAUGUESS: I think that's a good 16 observation and also my colleagues in the Division of 17 Corporation Finance have much closer pulse to the views 18 that have come in on issues like that. I don't know if 19 they have any comments on that. 20 MR. GOMEZ: We've heard that, Patrick, that -- 21 I think it's a concern that some have expressed. We've 22 heard others' concerns as well. Anecdotally also, we've 23 heard a lot of concerns with respect to the safe harbor 24 verification at first, and then as time has progressed 25 with respect to some participants a little bit more of a 0050 1 willingness to move to the principles-based approach of 2 verification that doesn't necessarily require the issuer 3 to go and ask for specific tax information. So it seems 4 like it's an area that is still growing and developing. 5 And it may be that people are slowly getting more 6 comfortable with the principles-based approach and be 7 more willing to move away from the safe harbor. But like 8 yours, anecdotal evidence that we've heard from meetings 9 with people. 10 MR. YADLEY: I agree with that comment. I 11 think another element is still some concern particularly 12 among lawyers and other professionals, but also among 13 smaller issuers of not knowing who the people are. I 14 mean it's a great idea to be able to get investors from 15 anywhere, but then you think about these are going to be 16 equity holders in your little business, and there's just 17 a little bit of a fear factor there as well. 18 MR. NELSON: Can you double-click and expand on 19 the principles-based approach? What is principled? 20 MR. GOMEZ: I'm going to move the chair. That 21 way I don't have to squat. 22 So when the rules were proposed, the Commission 23 initially proposed for taking reasonable steps to verify, 24 there would be a principles-based approach in which the 25 issuer would consider the information it has about the 0051 1 investor and make a determination as to whether the 2 investor is accredited or not. During the comment 3 process, the Commission has received a lot of comments 4 from market participants and other observers who 5 indicated that they would prefer to have a safe harbor 6 for the taking the reasonable steps to verify. So in the 7 adopting release, the Commission, in response to those 8 comments, created two different ways of taking reasonable 9 steps to verify. 10 On the one hand the concept of a principles- 11 based approach, when the issuer looks at the information 12 it has, it makes a determination it's one of the options. 13 In addition to that, the Commission also added safe 14 harbors. Now when you think of safe harbors, the 15 Commission has to, in many ways, think about all of the 16 potential different situations. So in many ways the safe 17 harbor could have additional requirements that you may 18 not have to go through if you're going through the 19 principles-based approach. 20 MR. NELSON: Thank you. 21 MS. TIERNEY: I was just going to add that as 22 second market, we had a business after 506(c) was adopted 23 for about two years where we actually did verification as 24 a broker-dealer for a number of companies that were 25 utilizing it to raise capital. And I think what our 0052 1 experience showed was that, like Sebastian said at the 2 beginning, the companies and the law firms that we were 3 working with were very, very, very focused on the safe 4 harbor and following the rules. And we worked with a 5 number of issuers over two years. 6 I think the most interesting trends that we 7 started seeing towards the end -- we don't do this 8 business anymore, but towards the end where we really 9 were seeing a significant number of letters coming from 10 CPAs and law firms, which we thought was surprising. 11 People really are not comfortable giving their personal 12 financial information, even to registered broker-dealers, 13 and we were surprised to see so many accountants step up 14 and give certifications on behalf of their clients. 15 CHAIR WHITE: Scott, may I -- I think, but 16 correct me if I'm wrong. I don't know how much data we 17 have on this. But have we recently seen, in terms of the 18 uptick issue, not an increase in the number of 506(c)s, 19 but the amounts, the dollar amounts? I mean is that -- 20 have you observed that or -- 21 DR. BAUGUESS: I don't know offhand. I don't 22 have the data here on whether the amounts have gone up. 23 I do have a slide in terms of showing that it's been a 24 steady state number of issuants over three years. But 25 I'm sure that the crack staff sitting over in those seats 0053 1 is going to be able to answer that question in short 2 order. 3 (Comment off-mic.) 4 DR. BAUGUESS: That's right. They're thinking 5 about it. So let's see here. My clicker is now defunct. 6 So maybe you can -- there we go. So on the point of the 7 uptick of 506(c), one of the observations that I think is 8 consistent with some of the reservations of doing it is 9 that we see that the uptick is mostly with operating 10 companies and not funds. And the many hedge funds, 11 probably if they have to advertise the offering are 12 signaling that maybe their offering isn't as good as 13 those that don't have to advertise and there's some 14 reticence to do so. But for operating companies or small 15 businesses or companies, that is where we have seen the 16 uptick the most. And I'll show you some figures on that 17 in just a second. 18 But before we -- working again? Okay, great. 19 Let's see here. But in terms of the use of 506(c), the 20 intermediation costs -- so we see is that those who use 21 506(c), we thought -- at least we predicted in the rule 22 that if you could advertise you wouldn't need to use an 23 intermediary because you don't need to have somebody find 24 you investors anymore. 25 What we actually see is that that those who do 0054 1 do 506(c) are more likely to have an intermediary, and 2 those intermediation costs, basically what they report on 3 Form D, are higher. So this was something that was 4 inconsistent with what we predicted, but also consistent 5 with of those who are using, they're probably new types 6 of issuers. 7 And these are operating companies that 8 previously may not have issued it, and now they're 9 foraying into that market, and they're using a placement 10 agent or somebody to help them and they're advertising in 11 order to increase investor awareness of that offering. 12 And also I should say the median offer is larger, but the 13 amount raised is lower. So there's probably an increase 14 in uncertainty and higher risk in some of those 15 offerings. 16 This is a very busy chart, and it may be best 17 to consume after the fact. But there are a couple of key 18 pieces of information here. And the first is -- and 19 there are four columns. And the first column is all 506 20 offerings, initial offerings, not amended offerings, so 21 new initiated offerings that are captured on Form D. 22 Since the enactment of 506(c) or the effectiveness of it 23 on September 23, 2013 through the end of the last 24 calendar year, there have been 48, almost 50,000 25 offerings and -- reported having sold $1.5 trillion. And 0055 1 most of that is in the 506(b). So 1.17 trillion is in 2 506(b), and only -- if you look at 506(c), only 23 and 26 3 billion were raised for funds and not funds. So you can 4 see the overall level of capital is -- raised is much 5 lower. 6 If you look at the difference between the 7 average investors in an offer, 506(c) offerings for non- 8 funds operating companies are only eight investors versus 9 twelve for the classical 506(b), so they're a smaller 10 number of investors. The offering size is also smaller. 11 The median offer size is only a half million dollars 12 versus a million. And it's interesting to note that the 13 median size of a Reg D offer is a million dollars. Yet 14 it's over a trillion dollar market, which means that the 15 vast majority of offerings are tiny. 16 And it also helps provide context to other 17 offering exemptions and state law registration preemption 18 in particular that many of the smaller offerings that 19 could avail themselves of other exemptions historically 20 have used Reg D in the GAO report and others have 21 acknowledged that's likely because of the preemption 22 ability of the Reg D 506 offering. 23 MS. HANKS: Scott. 24 DR. BAUGUESS: Yeah. 25 MS. HANKS: I have a comment or observation on 0056 1 the number of investors issue because I think what we see 2 in the 506(c) field, because you are able to use a 3 special purpose vehicle, I think a number of the 4 offerings do. So my guess -- and it's just a guess -- is 5 that the low number of investors that you're seeing there 6 very frequently includes one fund that has one fund that 7 has 99 investors. Any way to get more information there 8 and drill down on that, or we're just stuck with what's 9 on Form D? 10 DR. BAUGUESS: Well, I hate to say stuck what's 11 on Form D, because Form D even as written is brilliant. 12 It gives us an insight into a market we don't have. 13 There is also a pending proposal to amend Form D to 14 collect other additional information that would help us 15 understand better how that market's working. There are 16 certain flaws with the way it currently works in -- not 17 flaws, but inability to observe everything. And a lot of 18 those caveats are highlighted in some of the work that 19 we've produced. But we do like the Form D as it 20 currently exists. 21 MS. YAMANAKA: I'd like to make a comment about 22 that. When you made the statement that the average 23 amount is a million dollars -- 24 DR. BAUGUESS: Median. 25 MS. YAMANAKA: The median, that's really low, 0057 1 right? So when you go out there and you compare the cost 2 of going through this process, you're probably -- this is 3 not something they've done before. You have to access a 4 whole different relationship pool from what you are 5 currently providing versus going to bank and getting a 6 loan for a million, which they probably have done 7 multiple times. 8 From a cost-benefit perspective, unless you are 9 planning to go through that route and you're making an 10 investment in that area, it's probably not something you 11 would really consider unless you really had a plan to 12 expand your business and continually go out for 13 additional funds that way. So the cost differential has 14 got to be tremendous, loan for a million versus going 15 through this route. 16 DR. BAUGUESS: Yeah, that's an excellent point, 17 and it speaks to the broader issue. The whole idea of an 18 IPO on-ramp was to create stages by which you could raise 19 capital to ultimately go public, and that's a very astute 20 observation. 21 This slide Chair White was asking about doesn't 22 answer her question, but it does show that this is year- 23 over-year changes and the starting date is September 24 because that's when it was enacted. And you can see the 25 vertical bars represent the number of monthly offerings, 0058 1 and the lines represent the cumulative number of 2 offerings which is on the right scale. And it's almost 3 scary how consistent this is over time. Going to the 4 third year, there is zero deviation in the rate at which 5 506(c) is being used. I don't think anybody would have 6 predicted that it would be such a steady state exemption 7 in terms of issues availing themselves to it. 8 MR. HAUPTMAN: Scott, could I ask a question? 9 DR. BAUGUESS: Sure. 10 MR. HAUPTMAN: Sorry. I'm a little late to 11 this I suppose. But could ask all of this on small 12 investors and the companies that want their funding, how 13 much was this benchmarked for best practices against 14 other countries, like how does Singapore do this, how 15 does Hong Kong do this to make sure we're doing it the 16 best way? How much was looked at -- other countries were 17 looked at in this whole process? 18 DR. BAUGUESS: That's a great question because 19 whenever we enact a new rule or regulations, you have 20 this issue of you don't have a counterfactual to what the 21 world would look like with that rule in place. And often 22 the only way we can do that is by looking at other 23 markets to see what they've done, to look at disconnects 24 and their changes of rules to see what happened to those 25 markets. Unfortunately, even though our data is limited, 0059 1 it tends to be much better than what you can get in 2 international markets. So we're often very limited and 3 only have anecdotal evidence to speak on issues like 4 that. 5 But as a point, maybe an exception to that is 6 equity-based crowdfunding which has promulgated 7 international markets probably in advance more so than 8 here, and our rules were informed on those practices. 9 And I think that even some of the -- that you might see 10 later today is going to be drawn from that pool. 11 Okay. So I'm going to speed up a little bit 12 here and just make -- give you some major takeaways from 13 the Reg A rulemaking. And this is one that really does 14 sit at the intersection of private and public capital 15 raising and why would an issuer that would use the Reg D 16 market, why would they avail themselves to Reg A and not 17 do a public offering or why would somebody who's 18 considered a public or registered offering avail 19 themselves to Reg A or the modified Reg A. 20 And so a lot of the questions that we had -- 21 and this is now -- we have six months' worth of data -- 22 were centered on those issues. And I'm just going to 23 point out a couple of things that we said in the economic 24 analysis that we wanted to watch for and in terms of the 25 potential use of Reg A. And there's tier one and tier 0060 1 two offerings. Tier two are exempt from state securities 2 registration at or up to 50 million. Tier one is up to 3 20 million, and you have to register with the states 4 securities authorities, but there are no ongoing 5 disclosure requirements and different initial disclosure 6 requirements, too, and I hope I didn't say any of that 7 wrong, Sebastian. 8 But one of the things that we asked early on is 9 why would you choose between the two, and it really is a 10 tradeoff between the cost of qualification and ongoing 11 disclosure requirements and the benefit of having access 12 to a broad investor base and the preemption of those 13 state securities, the registration process and the 14 tradeoff between whether or not going general 15 solicitation to accredited investors was better than 16 going to retail investors and not having resell 17 restrictions. 18 And all of that then hinges on liquidity, which 19 somebody has mentioned earlier, of these securities of 20 how you're going to exit this market. Will there be a 21 secondary market that trades this, these securities? Are 22 these Reg A issuers going to try to list on the big board 23 or go national market exchange? If so, then they trigger 24 12(b) registration requirements which then has more 25 onerous disclosure requirements. So the big outstanding 0061 1 question from an economic perspective is will there be an 2 ability to get liquidity for these securities in such a 3 way that it would provide a benefit over a private 4 offering and also benefit over registering your 5 securities and becoming -- with the SEC and becoming a 6 reporting company, Exchange Act reporting company. 7 The data that we have today is somewhat 8 limited, but what we see is that total capital sought is 9 about 1.3 billion of qualified followings. That 10 corresponds to 290 million. There's an even split 11 between tier one and tier two offerings roughly speaking. 12 And the median sought for tier one offerings is 13 13 million versus a tier two at 24 million and those that 14 qualified -- or qualified filings, those are seven and a 15 half and 23 million respectively. 16 If you look at who is availing themselves to 17 Regulation A, they're mostly pre-revenue firms, so these 18 are the typical startup idea generating firms, not the 19 revenue generating firms. Now there's quite a bit of 20 variation amongst the characteristics: issuer size, 21 amount sought, industry location and profitability. 22 Median assets is very low, so you can see that there's 23 not a lot of dollar value of assets. And I think 72 24 percent of the filings had -- issuers had less than a 25 million dollars in assets and 95 percent had less than a 0062 1 hundred million. And let's see here. 2 There we go. And some other observations, 90 3 percent of these are best effort offerings. There's no 4 typical firm commitment offering like you'd see with an 5 IPO. So you can see that these are higher risk firms in 6 which the intermediation definitely has a different 7 flavor to it than you would an IPO company. And most of 8 them are equity offerings. The vast majority, about 80 9 percent, are equity offerings. Half of the filings are 10 in business services, real estate and credit industries. 11 I don't know that we had any preconceived notion what 12 that would look like, but at least historically 13 Regulation A had been a way to raise capital in the 14 finance sector and banks in particular. 15 Yeah, question. 16 MS. MOTT: What was the other half? 50 percent 17 were -- what other industries did you see represented? 18 DR. BAUGUESS: Maybe my colleagues in CorpFin 19 know. 20 MR. GOMEZ: Catherine, we've seen pretty much 21 every of the industry groups in the SEC that reviewed 22 these filings have actually touched one Reg A offering. 23 So other than that 50 percent that Scott mentions there, 24 the rest of it has very dramatically -- 25 MS. MOTT: So it's just varied. 0063 1 MR. GOMEZ: Yeah. 2 MS. MOTT: So when I was looking at this and 3 thinking about it, I mean -- and the reason I'm -- I 4 guess I should say in full disclosure one of my portfolio 5 companies is evaluating Reg A+ as an option. And when I 6 think about the number of companies, it's in the 7 healthcare, med tech. So I fully expected to see a lot 8 of healthcare, med tech, maybe clean tech, some of the 9 things that are more capital-intensive in that. So I'm a 10 little surprised that business services is in there. So 11 just wanted to try to understand. Thank you. 12 MS. HANKS: Actually, if I could add something 13 on the nature of the filers, since I represent 10 percent 14 of the companies who actually did the filing, many of the 15 new companies are in what comes under the SEC filing 16 categories of computer services. And one of the things 17 we found in doing those filings, all of the options for 18 industry type, you've got like left-handed widgets and 19 right-handed widgets and big widgets and little widgets, 20 and then a whole bunch of companies fall within one 21 bucket, which the closest thing that we can find is 22 computer services or in some cases entertainment. 23 So that I think is going to limit your ability 24 to measure who's going through because we -- yeah, we're 25 all computer services in one way or the other because we 0064 1 all use computers. That was the best thing we could 2 think of. 3 DR. BAUGUESS: That's better than other. 4 MR. NELSON: And I just wanted to double-check. 5 This is a total of 67 registrations and only three 6 actually did the Reg A IPO. Is that correct? Is that 7 the data that I saw in the previously slide? 8 MR. GOMEZ: So yes, so there were 68 Reg A 9 filings in the previous slide. Keep in mind that the Reg 10 A filing, once they file with the SEC, they go through a 11 review process. And to the extent they're doing a tier 12 one, also they go through a review process at the state 13 level. And then once the review process is clear, then 14 the company can still decide the timing as to when they 15 want to qualify the offering. 16 So the previous slide noted that while there 17 had been 68 companies that initiated the process, three 18 of them have actually completed the process itself and 19 their offerings qualify, which means that they can 20 actually start selling. 21 MR. REARDON: If I can make a point, Laura, 22 your question about why you wouldn't go to a bank and get 23 this money is that under the industry comment there, 24 business services, real estate and credit industries. 25 Most of those companies are not going to be able to -- 0065 1 like business services, if they're like law firms they 2 don't have any marketable assets though than a bunch of 3 used desks that really have a tremendous discount. 4 Real estate traditionally is a combination of 5 invested equity and borrowed money and credit industries 6 is the same. Most of -- you first get the equity, you 7 get your minimum amount of equity, then you go borrow the 8 rest. And you have to have that kind of blend. So I 9 would hazard a guess that most of those companies are 10 looking as the next step to go to a bank, and they may 11 even have a bank commitment letter. If X is raised, 12 we'll lend you Y. 13 MS. YAMANAKA: Yeah, I think you're probably 14 looking for -- this is just anecdotal based on the client 15 base that I see in service and the people that I speak 16 to. Usually at that point in time, it's friends and 17 family. They have some sort of equity base first that 18 they're building up. The next step then is a traditional 19 banking relationship, which they're not starting out at a 20 million. They're going out with a lot less amount. Then 21 they're figuring out, oh, they can make some money at 22 this in order to expand. How can we do it? A million 23 dollars where I live is not that much, right, that we go. 24 And so I think perhaps a different industry -- 25 because even we've got services firms. We actually 0066 1 particularly do attorneys, and a million dollars is 2 nothing for attorneys. For all of you who extensive 3 practices, you know a million doesn't go very far. So I 4 think this point really illustrates it varies 5 tremendously by industry. 6 And to the point, Sara, that you made, that's 7 so true. Services, green tech, medical devices, medical 8 services all get kind of lumped into that computer 9 services which is probably distorting the information 10 that -- Catherine, that you see or I see when I would 11 classify the types of industries. 12 MR. GOMEZ: And one clarification, I misspoke 13 when I gave you the data. Sixty-eight companies have 14 filed with us. Seventeen of them have completed the 15 process, and three of them actually have completed the 16 sale or the transaction that they were doing, and they 17 have reported that to us to indicate that they have 18 completed the sale of the securities. 19 MR. NELSON: Is the -- any information on which 20 three companies actually did that? I'd love to talk to 21 them. Is that publicly available? 22 MR. GOMEZ: It's publicly available. I can 23 talk to you afterwards as to how you get to that data. 24 MS. TIERNEY: Just if it may be interesting, we 25 did a kind of deep dive into the Reg A+ space once the 0067 1 rules became effective to see whether there was an 2 opportunity for NASDAQ private market to work with 3 companies, especially in the tier two space. And we went 4 into the analysis with some assumptions. Catherine, 5 like, sort of that it would be med tech, healthcare, 6 companies that had to constantly raise capital and 7 probably would want to look at a different way of doing 8 that. 9 So we talked to 14 different investment banking 10 kind of companies, tier two, tier three investment banks, 11 and their take on it was that their investors' primary 12 focus is always liquidity. And so the inability to 13 provide any liquidity in the -- even the tier two space 14 because the resales are not preempt under state law kind 15 of makes that a no-go for most of the banks to take their 16 clients in that direction. 17 The other thing is they didn't see a real 18 savings between a tier two 8A and an IPO using the onramp 19 process. And IPO onramp provided more flexibility and 20 kind of better accommodations. So they didn't see a real 21 cost savings there. And then I think the other thing we 22 were hearing was to the extent that a company did choose 23 to a tier two with an 8A and they qualified to come to 24 the market, they would do that. They would come to 25 NASDAQ or they would go to the New York Stock Exchange, 0068 1 but it was really the absolute opposite of what we 2 expected to hear which was very interesting to us. 3 DR. BAUGUESS: Those are great observations, 4 and in particular the idea of raising equity to lever up 5 to get capital in different ways is a little bit 6 different than going public to get liquidity for your 7 shareholders to cash out or list. And I don't think we 8 captured that in our economic analysis, at least to the - 9 - that wasn't among our predictions. So all these 10 observations are really nice to have. Thanks. 11 MR. YADLEY: One of our clients availed itself 12 of the new Reg A process. And their thinking was they 13 weren't ready to do an IPO, but they wanted to get some 14 visibility, wanted to start the discipline. Some of the 15 things that I think we hoped would happen with this did 16 use an intermediary. The process was very smooth with 17 the SEC, but ultimately they were unable to raise the 18 funds, so they withdrew. So positive experience except 19 for where it mattered I guess, but the money was -- 20 doesn't have anything to do with the rules per se, but we 21 did a great job. 22 MS. HANKS: Only a lawyer would say that. 23 MR. YADLEY: But I think it does reflect sort 24 of what Annemarie was saying is who are the investors and 25 everybody wants everything, but what are they actually 0069 1 going to invest in, and particularly where they don't 2 know somebody and they don't know the company. It sounds 3 good, but you're still sort of gambling with an early- 4 stage company. 5 DR. BAUGUESS: I'm going to finish very quickly 6 there and just make a couple observations about 7 crowdfunding, particularly since it's not yet effective. 8 But just say from an economic perspective what we -- 9 when we first started with respect to securities 10 issuances, it was somewhat of a puzzle because it seemed 11 to an economist that you had uninformed -- with respect 12 to securities offering, an uninformed issuer trying to 13 issue securities to an uninformed investor without 14 classical intermediation. And how would you ever value 15 that? 16 And so it was somewhat of a puzzle, and maybe 17 our second question was wisdom of the what. And it took 18 some internal education to understand with respect to 19 investor protection. It really was a new way of thinking 20 about how a crowdfund issuance or issuer might enter into 21 the realm of securities issuances. But it was -- we 22 spent a lot of time in the economic analysis thinking 23 about how you would go from rewards-based to securities 24 issuances. 25 The big outstanding question is still: How 0070 1 will an investor exit the security? When we talked to 2 the Silicon Valley types a long time ago, we would often 3 receive answers like, well, if you just do it, they'll 4 figure it out. And you can imagine trying to write a 5 rule on economic analysis of if you do it, it will work. 6 It didn't meet the guidance that we have set forth in 7 economic analysis. 8 But this is still something that we're very 9 curious to see how it will unfold. We know there are 10 ways a solution can develop and manifest, particularly 11 with the creativity of Silicon Valley and already angel 12 groups have demonstrated an ability to do this type of 13 activity notwithstanding these rules and also state-level 14 crowdfunding, so innovation is bubbling up, and there's a 15 lot of learning going on and very curious to hear how 16 this committee thinks or what they're observing and how 17 this market will develop. And I'm going to conclude 18 there and pass the torch. 19 MR. GRAHAM: Any additional questions? 20 MS. HANKS: Yeah, I just had one question, 21 Scott, on the -- one of the sources, just to take you 22 back to one of the very much earlier slides, I mean sort 23 of the other lump. One thing that I always worry about 24 this whole market is that we don't have a lot of 25 visibility to the stuff that's happening that isn't doing 0071 1 -- isn't relying on Regulation D or alternatively not 2 filing Form Ds which in my prior life I did not use to do 3 because it is not compulsory. And so I think there is -- 4 I'm constantly looking at the data in tech crunch or any 5 of those guys in PitchBook. Is there any way that you're 6 looking out to see what you might be missing and 7 crosschecking that? How much are you not capturing do 8 you think? 9 DR. BAUGUESS: That's a great question. And we 10 have done in similar rulemakings, particularly the bad 11 actor release which is now a few years old, we compared 12 Form D filings to prospectuses that are filed with FINRA 13 and also ADV filings to see if there were evidence of 14 issuers that were not filing Form D. And I'm going to 15 have to jog my memory. It's been a couple years, but 16 there was surprisingly good coverage with respect to not 17 a lot missing, at least within that universe. 18 That doesn't mean -- I think I heard somebody 19 once tell me that a private offering isn't private if you 20 make it public through a Form D. And so to the extent 21 that that exists, then you're just not going to see that 22 activity, and I'll just throw it over to the CorpFin 23 colleagues in terms of the outstanding proposal on Form D 24 if they want to make any comments about how that issue 25 may or may not be addressed if we ever picked that up. 0072 1 MS. HANKS: I think that actually underlines my 2 thought that if it's not intermediated, you're just not 3 capturing it. 4 MR. GRAHAM: Well, there's -- I have a number 5 of clients I'm sure that others are in the same position 6 where like you said, Scott, if it's -- how is it going to 7 be a private financing if you're filing a Reg D or a Form 8 D? And I have many clients as a result that just done 9 file because they don't need to. I mean the nature of 10 the transaction is such that they're perfectly 11 comfortable just relying on the statutory exemption. And 12 there's a lot that is done in that area, as you know. I 13 suppose you don't pick much of that up. 14 DR. BAUGUESS: We try to find other clever 15 sources of information. A lot of this is self-reported 16 through third parties for a variety of reasons, and it is 17 a big, latent component of our analysis, but it is 18 something that we try to get at. But unless there is a 19 mandatory disclosure requirement or filing requirement, 20 there will always be this unobserved component, and we 21 just won't know what the level of compliance is with Form 22 D. 23 MR. GUTIERREZ: I actually have a question on 24 that. Sorry. Is there an intent on behalf of the SEC to 25 then create a feedback loop, especially with the 0073 1 intermediaries to see what is happening out there 2 actually on the streets, so beyond just looking at the 3 sources, but actually bringing folks in and in particular 4 those -- like I'm very curious about this episode in 5 which someone kind of went through the entire process but 6 then actually wasn't able to raise any money. 7 And so trying to understand what went right, 8 what went wrong, what did they hear back from investors. 9 Because as an investor, I certainly would love to know 10 what is it that prohibited or precluded investors from 11 actually pulling the trigger on something like this and 12 whether or not that is a rules issue or is it just a 13 comfort level with the process or possibly just with the 14 types of companies that are coming back. So I'm curious 15 as to what kind of formal feedback loop is being created 16 in order to tweak what is out there. 17 DR. BAUGUESS: I know the Office of Small 18 Business Policy gets information. Maybe they can speak 19 on it. And I'll also just note that we do have a 506 20 working group that has offices and divisions across the 21 Commission that we said we would do when the 2013 was -- 22 and general solicitation was enacted. And we continue to 23 monitor OC. Our Office of Compliance inspections 24 examination often does sweeps. They got out and they 25 talk to collect information that gets fed back. But I 0074 1 don't know if you have any comments on your operations, 2 too. 3 MR. GOMEZ: Xavier, I think it's going to be 4 interesting to see, especially in Reg A, because a 5 company like the one that Greg was mentioning actually 6 has made a filing with the SEC. That filing actually is 7 qualified, so you know that the company went all the way 8 through that process. 9 Now there's nothing that requires the company 10 to tell us why didn't they actually sell. And I'm sure a 11 lot of companies would rather not tell what was -- the 12 problem was. I think we're going to get some data then 13 with respect to companies that actually went through the 14 process and still did not manage to sell. I think the 15 harder thing is going to be actually the reason why that 16 didn't happen. 17 Also, just one other thing that as an SEC 18 staffer, it's almost like nails on the chalkboard when I 19 hear that the Form D is not compulsory. The filing of 20 the Form D is a requirement under the rules, and 21 therefore it is required. I think, Sara, what you're 22 referring to is the fact that it's not a condition to the 23 exemption, so you do not lose the exemption if you fail 24 to file. 25 But I think it's important to know for everyone 0075 1 here, which I'm sure you do, but also all of those -- you 2 watching on the webcast, that the filing of the Form D 3 actually is a requirement, and it does provide very 4 helpful data to understand how the markets work. 5 MR. GRAHAM: It's a requirement if you're using 6 Form D or Regulation D. 7 MR. GOMEZ: That's correct. And I think the 8 point you were making -- 9 MR. GRAHAM: But if you're using the statutory 10 exemption -- 11 MR. GOMEZ: -- Steve, is -- exactly. And I 12 think a lot of the companies that get comfortable with 13 the 4(a)(2) exemption and they feel like they don't have 14 to go to the safe harbor in 506, well, at that point 15 they're not relying on the safe harbor in 506(b). 16 They're relying on 4(a)(2), and of course because they're 17 outside of Reg D, then they don't have to file the Form 18 D. 19 MR. YADLEY: That may -- and I doubt it's a 20 primary reason why issuers would prefer to use 506(b) 21 than (c), but certainly that puts it in the light -- you 22 can't rely on the statute if you've gone out and tried to 23 do a 506(c). 24 MS. HANKS: That's a really important point for 25 the guys watching at home is all the stuff we were saying 0076 1 about the filing of the Form D not being -- it's not a 2 condition, but it is a requirement. That's all going to 3 be absolutely irrelevant if you are doing a generally 4 solicited 506(c) because you've got to do that. 5 Sebastian will be really mad if you don't. 6 MR. NELSON: Is there any way to get additional 7 data on capital formation? As I've been thinking about 8 being on this committee, I've been thinking, holy crap, 9 this is a huge part of a GDP. Massive, massive amounts 10 of jobs come from these tiny little businesses. But it 11 feels like we're flying in the dark when it comes to how 12 they have money. I don't know. Is there any other way 13 to get that data? 14 I mean in Silicon Valley we tend to say what we 15 measure we can improve. If we're not measuring it, we 16 don't really know how well we're doing on capital 17 formation from this. I've been banging my head against a 18 wall asking people at Angel List, asking everyone that I 19 know how would you measure capital formation. The best 20 thing that I could find is could you get that data from 21 like the IRS and tax filings? 22 I have no idea what the legality of that would 23 be, but if you could actually look and say these startups 24 or these small businesses had these capital purchases or 25 this capital expense, and they had some sort of income, 0077 1 you could kind of infer from some of that. But I don't 2 know if that's even possible or not. 3 DR. BAUGUESS: So you're saying that the 4 Silicon Valley types would be for more mandatory 5 disclosure on their -- 6 MR. NELSON: I'm not -- I don't mind 7 disclosing, but that's me. For me it's -- the question 8 is not how do we disclose these stock purchases, but how 9 do we figure out how small companies get their money. 10 DR. BAUGUESS: It's an excellent question, and 11 we're always scouring for new sources, whether they're 12 PACE service, fee services, vendor services, data 13 aggregators, and we -- every new rulemaking that we 14 promulgate, we think carefully about what the disclosure 15 requirements are to the extent that it's within the SEC 16 purview, not only thinking about what the disclosure 17 requirements are, but how can we collect in a machine 18 readable format in a very parsimonious way so that we can 19 analyze it. 20 And so that's -- from an economist perspective, 21 that's one of the first things that we look at, and 22 that's one our contributions to the rulemaking process is 23 to say here's how this data would be usable and here's 24 what we would do it with it and help improve the 25 efficiency of that process. But to answer your question 0078 1 on the IRS, information, data, it's a great idea, and I'm 2 sure some of my colleagues in DERA probably know the 3 answer to that question, but I don't. 4 MR. GRAHAM: Okay. Well, we're going to have 5 to take a quick break. And so thank you, Scott, and 6 let's break. Reconvene in 10 minutes. 7 (A brief recess was taken.) 8 MS. HANKS: Okay. Welcome back, everybody. 9 Continuing the theme of data and what we do and don't 10 have, which I think is going to be a constant theme for 11 this committee for this term, we've got two experts here 12 who can help us further unpack the information that is 13 available or not available about the scope and size of 14 the unregistered markets. 15 First we're going to hear from Jeffrey Sohl, 16 professor and director for the Center for Venture 17 Research at the University of New Hampshire. The Center 18 for Venture Research has been conducting research on the 19 angel market since 1980, and I must say it's very 20 important research that I have looked at for a lot over 21 the course of the last few years. Its mission is to 22 provide an understanding of the angel market through 23 quality research. Dr. Sohl specializes in early-stage 24 finance of high growth ventures, trends in the angel 25 investor market and entrepreneurship. He has a PhD and 0079 1 MBA from the University of Maryland. 2 Following Jeff will be Brian Knight, associate 3 director of financial policy at the Center for Financial 4 Markets at the Milken Institute think tank. The Center 5 for Financial Markets works to promote financial market 6 understanding, expand access to capital and develop 7 innovating financial solutions to global challenges. As 8 manager for the financial technology and innovative 9 capital access programs for Milken Institute, Mr. Knight 10 is interested in the interplay between technological, 11 regulatory and market innovation and how best to improve 12 access to capital for business of all sizes. 13 Brian has experience working for a broker- 14 dealer with a focus on the emerging online private 15 placement market, and I am proud to say is a cofounder of 16 CrowdCheck, a company which provides due diligence and 17 disclosure services to companies and intermediaries 18 engaged in online private offerings. He has a law degree 19 from the University of Virginia. 20 Jeff and Brian, thank you very much for joining 21 us today. 22 DR. SOHL: Than you, Sara. So what I want to 23 do is just give you a little context, and let's see if 24 this works. Where is my computer that I'm pointing to? 25 Which one? Thank you. That is perfect, thank you. 0080 1 So a little bit of history. This is back in 2 1874, so real history. This is probably the first angel 3 investing we ever heard of. Alexander Graham Bell was 4 looking for money and of course the banks back then 5 thought the idea of a telephone was quite ridiculous as 6 you can see from The Boston Post. And it was obviously 7 too high tech and too advanced, and he didn't have any 8 customers. Sounds quite familiar today. 9 Two angel investors, Gardiner Green Hubbard, 10 who was a Boston attorney, and Thomas Sanders, who was a 11 Salem leather merchant actually funded Alexander Graham 12 Bell, changed the company, put it into Bell Telephone 13 Company of Boston they called it. Alexander Graham Bell 14 actually thought the first use of the telephone was to 15 project concerts to people in rural areas, and Hubbard 16 and Sanders said, no, no, no, no. We've got a little 17 communications device here we're going to work on. 18 Fast forward that about a hundred years, and 19 Anita Roddick opened up The Body Shop, one store, 1976 in 20 the UK. And wonderful summer in the UK, very hot, sold 21 tons of product, wanted to open up a whole bunch of 22 stores. Well, the venture capitalist says, well, we 23 don't do cosmetics, we don't do retail, we don't do that 24 kind of stuff. So they found a gentleman named Ian 25 McGlinn. Listen to this deal: 4,000 pounds in 1976. 0081 1 That gave him 50 percent ownership in The Body Shop. 2 That was his first ever angel investment. He was a 3 garage owner. He owned a gas station. It was an 4 extremely lucky deal. He came into the money through an 5 inheritance. There's like -- you can't go into an 6 airport or a mall or anywhere without a Body Shop today. 7 So that's a little bit of context. 8 So where is this going? Just to see what 9 investors look for. And again, I'm probably boring a 10 bunch of people, but I like to look at the context 11 because a lot of entrepreneurs think differently. 12 Everybody thinks it's that surfboard. It's the 13 technology, it's the idea. And in essence, the idea is 14 one part, and in fact, it's not really that big a part. 15 It's important, and I'm sure we've all in various walks 16 of life had heard of, oh, I got this great idea. 17 Well, it's really that entrepreneur on top of 18 that surfboard. It's the execution risk that you have to 19 watch out for. It's how that is -- that idea is put to 20 work, how it goes to market, how it's transformed from an 21 idea to really in the market place. So that surfboard is 22 great, and if it's a very good surfboard, but without 23 that entrepreneur, it's not moving. 24 And I think the third piece of the puzzle that 25 we always examine is that market niche, it's that huge 0082 1 wave of demand. There's a paying point out there, and 2 there's a lot of people that really want that paying 3 point solved. So that's that big wave. So if the surf's 4 not up, as anybody who does surfing knows, you're not 5 going anywhere on that board no matter how good the board 6 or you are. So you really need that external influence 7 of that market niche that's really flying along. 8 So with that in mind, the angel market and 9 actually the private equity market -- and by private 10 equity we all use various, different definitions. So I'm 11 going to just look at it in this way. The crowdfunding, 12 the angels and the venture capital. And I thank my 13 colleagues at Crowdnetics, they gave me all the equity -- 14 I just deal with equity crowdfunding, nothing else. They 15 gave me all the equity crowdfunding data, over 6,000 16 deals since 2013. So that's good. That's of course 17 accredited investors, because it's May 16, right, when 18 the other rules go in. 19 The angel data is all ours, and the venture 20 capital data is the National Venture Capitalist 21 Association. So we look at the crowdfunding as really 22 what I'm calling kind of the democratization of the 23 private equity markets. We're trying to -- and the idea 24 of the JOBS Act and the idea of all the regs is to allow 25 the masses to now start writing checks in the startups. 0083 1 And obviously I have my own opinions. It will be a great 2 source of data I'm hoping, and it will be a fun ride for 3 an academic analyzing that data. And I'll leave the rest 4 of my thoughts quiet for now. 5 But so that really -- you've got the founders' 6 money, and then you've got that crowdfunding kind of 7 jumping in. The numbers were are getting -- now 8 remember, this is 6,000 deals since '13, only accredited, 9 so it hasn't really been fully democratized if you will. 10 So here's some ideas. 11 Now be careful with that 20 percent success 12 rate. Those are non-vetted deals. That's anybody can 13 put the -- something up on any of these platforms, Angel 14 List, anything like that. So these are non-vetted. 15 They're not screened deals. There might be some minor 16 screening, whatever the intermediary does, but nobody 17 really screens it on the merit to my knowledge. 18 Now here's the ask -- and the raise, there is 19 obviously a huge disconnect here. The average ask is 2 20 million give or take a couple hundred thousand. And the 21 average raise is 210,00. So we are obviously not in sync 22 here in those markets. 23 However, they are relying heavily on equity as 24 one would hope. 72 percent of those deals are in the 25 equity financing. 21 percent convertible debt. I just 0084 1 hope all those people understand what convertible debt 2 is. And then about 7 percent is straight debt. My idea 3 is -- my sense is that that straight debt probably has 4 some kind of equity -- warrants something. 5 Now you -- I head when I was listening to the 6 previous speakers, we were talking about sectors. And 7 again, these are -- and, Sara, I agree with you. Some of 8 these sectors get bumped in, so it's really hard to 9 figure out what sectors we have. And again, this isn't 10 the data that I collect, so I have to kind of -- it's not 11 -- it's not an AX code level data. 12 But the best we could tell if you lump it, 13 services is the dominant, about 40-some-odd percent in 14 the services industry. Now that could be a whole bunch 15 of stuff. And then technology is the 34 percent, and 16 that seems like a lot of the -- oh, well, computer 17 services, computer technology, yeah, we use all 18 computers, so let's put it in technology. Consumer 19 goods, which I thought would be a little bit bigger, is 20 really small. 21 Healthcare, I remember the question -- I think 22 that was you, Catherine, with the healthcare. That's 23 about 5 percent, pretty tiny in the crowdfunding market, 24 not so in the angel market. And commerce, I'm not sure 25 what that is to be perfectly honest. But we literally 0085 1 just got this data. Luan Cox at Crowdnetics has 2 basically said we'll give it to you ever year, we'll 3 update it every six months for you. Have fun, and just 4 give us credit. So we're kind of looking forward to 5 having some -- there's some advantages to being an 6 academic. 7 So these are our numbers on the angel market, 8 and we go all the way back -- I just kind of cut it off 9 at 2005. We kind of just go through one recession after 10 another, so let's start in the last post-recession. 11 You can see what happens here. The market was 12 humming along at about 25 billion. Right after the Great 13 Recession or the whatever it was called, it got a little 14 clobbered, and the -- down to about 19, 17 to $19 15 billion. These are still big markets, though. Keep in 16 mind billions here. The deals really didn't change that 17 much, and I'll show you on a chart. 18 But right now to give you the latest numbers, 19 2014, and we're collecting 2015 right now, we've got 20 about 320 angels -- 320,000 angels actively investing in 21 about 73,000 deals, about $24 billion market. My guess 22 is in '15 you're going to see a slight uptick in that, 23 probably not a lot of change. But here's the carnage, 24 and you see what happened. It was kind of nice for us to 25 see, not the carnage of course, but the deals actually 0086 1 held their own during the big drawdown. So valuations 2 went way down. And it was easier to get in. 3 So the top line, which the big precipitous drop 4 is the money going into the market. And the line -- and 5 I'm color blind. So I think one of them, the darker one 6 I believe is blue, is the one that is the deals. So that 7 held pretty steady throughout the turmoil. And basically 8 just valuations went down which in some ways is not a bad 9 thing, and I'll talk a little bit about some valuations 10 that are going on right now. 11 So if we look at the graph, and let's show 12 where the gaps are here, that funding gap that's existing 13 in the seed and startup market, that's not going 14 anywhere, and you'll see some other numbers that indicate 15 that it's not going anywhere. We clearly need some more 16 money there. The angel groups that are there are doing a 17 tremendous service to the U.S. economy, to job 18 generation, to investing, but it's a lot of heavy 19 lifting, and we just need more of that. We need some 20 way, some clever public policy to facilitate the 21 development of that market. 22 The crowdfunding, my best estimate is picking 23 up that little piece of that funding gap. Some, which is 24 nice, but I really don't see it filling in that whole gap 25 because to be perfectly honest if you've got a deal, all 0087 1 things other equal and one of them has a hundred 2 investors who never wrote a check before and they each 3 have common stock versus a clean deal, you'd probably go 4 with the clean deal. Again, that remains to be seen with 5 the numbers. 6 Now what are the angels investing in? So now 7 you're going to see the healthcare. The healthcare comes 8 up. Remember those deals are going to take a bunch, 9 maybe a couple more rounds, maybe some VC rounds. But 10 there's definitely some dynamics in that market that 11 works with the angel industry. And by the way, please 12 feel free to ask questions at any time. 13 So the healthcare is always kind of a good one 14 there, but the real soft spot is the software, and I 15 shouldn't have used the term soft spot. But the software 16 is -- you could take that deal and in many cases you 17 could do two rounds as an angel, maybe syndicate the 18 second round with some other groups that you work with 19 and take that all the way to exit. 20 There's a lot of Dells and Microsofts and 21 Apples waiting to buy some really good startups, avoid 22 themselves doing R&D. It's a nice clean exit on a sale. 23 IPO is a glamor exit, but, boy, a sale is nice, clean, 24 there's no lockup period. It's usually a cash deal, 25 everybody walks away pretty good. There hasn't been too 0088 1 much dilution. 2 So that's a very good investment strategy for 3 the angel groups, and you're seeing about a quarter of 4 the deals are in that space. Biotech has had its heyday. 5 It's kind of up and down. A lot of that is the 6 bioinformatics. The retail and media, be careful. 7 That's really all the social media stuff, app 8 development, all kinds of things like that. IT services, 9 up and down. The industrial energy is the clean tech. 10 It had its heyday in 2011. 2017 (sic) was a big jump. 11 That was when there was a lot of government programs if 12 you recall on the bailout money. 13 Now here's some hard numbers on deal sizes for 14 angels. And this goes back from '08 to '14, so give you 15 a little idea of valuations. Deal size is about 3 to 16 350,000 per deal. Now there's several investors in those 17 deals, five to six investors. Each investor is putting 18 about $75,000 in it. 19 Roughly around 10 to 15 percent equity is being 20 -- this is maybe preferred stock, participating 21 preferred, common, various forms of equity. That 22 translates to a valuation somewhere between 2 and a half 23 to 2.7 million. That includes U.S. That's not Silicon 24 Valley, and I don't want to insult any of my Silicon 25 Valley colleagues here, but they tend to -- the 0089 1 valuations may be getting a little excited out there 2 shall we say. But I'll -- I have other data on that one. 3 Okay. Here's the yield rates. This is now 4 vetted deals. So remember the crowdfunding was 20 5 percent on completely unvetted, through them up on the 6 site. These are vetted. These are screened deals. By 7 and large, they're screened deals. And so you're looking 8 at yield rates. So you've got the denominator is the 9 ones you look at, the numerator -- yeah, the numerator is 10 the ones you actually invest in. Roughly around 10 to 11 15, 20 percent is the vetted deals. 12 Now when those numbers change, it's really 13 tough. Is it a numerator or a denominator? More deals, 14 more bad deals? You saw what happened, that number goes 15 back to during the heydays of 2000 running about a 16 quarter -- 25 percent, that's a little bit unsustainable. 17 It's now running around 20 percent. A lot more people 18 are understanding the angel market, especially 19 entrepreneurs. 20 Let's turn to the venture capital market. 21 Remember, angels 350,000 deal sizes, 73,000 companies 22 roughly, $2 and a half million valuations. We got a 58, 23 almost a $60 billion industry. These are not my numbers. 24 These are the VC industry. 60 billion, almost 50 25 billion in 2014 industry. Average deal size is 11 to $13 0090 1 million per deal and about 4,000 companies, not seed 2 stage at all. 3 So here's the story. Because everybody 4 remembers the story rather than those boring numbers. So 5 there is a well -- this is a true story -- a well-known 6 venture capitalist was visiting a friend of his. She had 7 rented her garage out to two Stanford students who were, 8 in fact, starting a search engine. She talked to them in 9 the house and said, look, I've got to introduce you to 10 these people renting my garage. And this VC who will 11 remain unnamed, but is well-known, said let me see, two 12 students, a search engine, no way. And his comment was: 13 How can I get out of the house without getting anywhere 14 near that garage? 15 Well, of course nobody took the flyer on Page 16 and Brin except an angel investor, Andy Bechtolsheim, 17 cofounder of Sun Microsystems, $100,000. If you look at 18 the S1 forms when it went public, Andreas made quite a 19 killing on that deal. 20 Seed deal, remember 4,300 VCs, total deals in 21 2015 of which 185 in the entire United States were seed 22 and startup. It's not a seed and startup industry. And 23 nor will it be for any time soon. 24 Now here's the scary part. Angels are 25 typically the seed. Here's why we're seeing a little bit 0091 1 of a dilemma here. We're seeing a bit of an 2 institutionalization of the angel market. Syndicating is 3 nice. Starting to look like venture capital funds is not 4 nice for the economic development and market perspective. 5 Now if that numbers an anomaly, I will be 6 singing, you'll hear me all the way down here from New 7 Hampshire if 2015 comes out back to about 50 percent seed 8 and startup deals. 25 percent seed and startup deals 9 means that we are really drying up that seed market. So 10 here's the two problems here. You've got the 11 crowdfunding taking the little piece, you've got the seed 12 and startup even on a good day is tough, and then you've 13 got the VCs pulling way to the right and so we're opening 14 up that 1 to $3 million capital gap. 15 And then if you look on way off to that slide 16 to the right -- and I have to mention this for sake of 17 people talking about it, but if I hear one more unicorn, 18 I'm going to get sick. These are $1 billion valuations. 19 You realize there's only 230 of those worldwide. It 20 bears watching, that's what I'll say. 21 Yes, Catherine. 22 MS. MOTT: Jeff, I'm really glad you're showing 23 this because one of the things I've been thinking about 24 is when I -- especially when I -- of course I follow your 25 numbers, I give you our numbers. 0092 1 DR. SOHL: That's right. 2 MS. MOTT: The average per deal with a VC 3 market being about 13.4 million per deal, they're -- 4 they've moved upstream. What I'm thinking about is is 5 there a -- like an upside down bell-shaped curve so to 6 speak? We have a lot of micro-investors, very few -- 7 like VCs, we used to see a lot of VCs in 50 to 150 under 8 management. But I don't know what the data is, and I'm 9 sure NVCA has this -- has the data. But how many VCs are 10 active in that 100 -- that 50 to a $150 million market? 11 And how many are there that are a billion and over? 12 I mean where's -- so the gap -- my sense of it 13 is there's a lot of angel investors out there, and you 14 said it right. Even the angel groups have moved upstream 15 and they're acting like micro VCs. We're syndicating, 16 we're all starting -- I mean even the angel groups are 17 starting to have microfunds that they're managing. But 18 there's also this critical thing is the reason sometimes 19 angels can't invest in new deals is because they have to 20 invest in follow-on rounds to extend the runway to make 21 sure those companies are successful because there are no 22 50 to $100 million funds in their backyard. 23 So I guess I'd like to see the data somehow 24 sliced and diced so that we could understanding this 25 funding gap is how many of the VCs all moved to these 0093 1 billion dollar funds and how many are available for 2 extending the runway. And I'm just trying to get my head 3 around what the data might look like. 4 DR. SOHL: Yeah. And we have that. I can give 5 you a little thumbnail if I'm not held to actual 6 percentages here. But you're absolutely right. And to 7 follow up on your point, Catherine, that 1 to 3 million 8 is that syndication, because, hey, somebody's got to do 9 that round. You've got to do that second round. The VCs 10 aren't going near that round now. And I always here, oh, 11 Series A, the first VC fund. Series A is the first time 12 you get outside equity. I don't care what you call it. 13 But -- so somebody has to be in that 1 to 3. 14 We're seeing two players in that. As you said, 15 the angel groups syndicating, getting a little bigger, 16 micro-VCs. Then the venture capital market is getting a 17 little bifurcated. There's these 20, 30, $40 million 18 funds that could do -- they could move. Then you've got 19 your 500, 600 million. They're not dinosaurs, they're 20 the elephants, you can't move, you can't do a deal. You 21 cannot do a 300,000, even a million dollar deal. It's 22 not worth your effort to -- it's not economically 23 feasible. So we're seeing a pretty big bifurcation in 24 the market. 25 I haven't -- really I have not kind of played 0094 1 with the '15 numbers yet, but we're seeing that in the 2 '14. So think of it as your upside-down bell-shape, the 3 two ends are going to be the 20 to 50, maybe $100 million 4 funds, somewhat nimble, can work in that 1 to $3 million 5 range, and then you've got the big 200, 500, $700 billion 6 funds. That's what we're seeing. And remember the good 7 thing is deals come to -- I mean investors come to where 8 there's good deals, so there's money to be made in that 1 9 to $3 million market. But again, my big fear is if that 10 money gets reallocated from angel investing seed startup 11 to angel investing post-seed, then we lose our acorns. 12 And again, from a market perspective, that's my big 13 concern. 14 And I think -- oh, I've got one more. Hold on. 15 There it is. Abraham Lincoln. We're in D.C. I used to 16 live here for 10 years. I used to love running around 17 the Lincoln Memorial. So this is a quote. "I know of 18 nothing so pleasant to the mind as the discovery of 19 anything which is at once new and valuable." So classic 20 angel investor statement. Thank you very much. 21 MS. HANKS: Thanks, Jeff. Can I take you back 22 to one of the things that you said very early about the 23 whole crowdfunding? 24 DR. SOHL: Mm-hmm. 25 MS. HANKS: It seems like you're treating the 0095 1 crowdfunding bit as a separate silo. And yet what I see 2 in the market is anything that is online tends to be a 3 kind of hybrid. Where you're going onto one of the 4 funding platforms, you're getting some revenues from the 5 funding platforms, but at the same time there's an 6 offline portion of that. And frequently we see the ratio 7 being 4 to 1 or 10 to 1 offline to online. 8 So two points, which is I think crowdfunding is 9 not a separate animal here. It's sometimes -- in many 10 cases, it is a separate extension. I'm also very dubious 11 about some of the numbers I see from some of the 12 platforms who say Company X listed on our platform and 13 they raised $4 million. Where of course Company X did 14 raise $4 million, but the bulk of it was offline. So how 15 do you pass -- how do you control for that? 16 DR. SOHL: Yeah, and that's an excellent point. 17 The thing -- the 4 to 1 and the 10 to 1, by your saying 18 offline/online, online from online platforms and offline 19 being angel group meetings and -- 20 MS. HANKS: Traditional angels, yeah. 21 DR. SOHL: Sure. And those could possibly be 22 two rounds, two separate rounds. Because the thing with 23 the crowdfunding is, these are X shares for Y dollars, 24 and as we all know with angels, you sit down at the table 25 and that's all negotiable. And they're not going to -- 0096 1 you come up with I'll sell you X shares for Y dollars, 2 and they're going to show you the door almost as fast as 3 if you bring your lawyer. So I think the way I see that 4 is the crowdfunding -- and I'm not seeing -- I do see 5 them as separate. I'll be perfectly honest. Because I 6 don't see the crowdfunding bringing the value adds that 7 the angels do. 8 And I also see if you take a classic angel 9 investor -- and again, we're all different obviously, but 10 let's try to get to the mean a little bit -- is cash down 11 entrepreneur, knowledge in this industry, active part of 12 their portfolio, want to give something back, and this is 13 full-contact investing. They enjoy this, they do it and 14 they want to get a board seat and help everything. 15 Crowdfunding I see you cannot -- it's face-to- 16 face in the angel market. Remember the angel market, 17 over 90 percent of your deals are within a half a day's 18 travel time of your principal residence. That statistic 19 has not changed since 1978. And I mean that is amazing 20 in today's world of Skypes and everything else. That has 21 never changed. 22 So the crowdfunding is this distance-type thing 23 where you lose the money where you lose the value add. 24 So in some ways I do tend to look at it as a separate 25 market. 0097 1 MS. HANKS: And we do see these hybrid deals 2 where we know there is a lead angel out there and 3 sometimes they're even named, and it's usually 4 piggybacking on their terms. 5 DR. SOHL: Right, but I don't consider Angel 6 List as anything but a crowdfunding platform with an 7 angel acting as a mini VC getting a carry. And maybe 8 that's cruel, but I see the classic angel, they'll be a 9 lead investor. Sure, there will be five to seven, maybe 10 ten people doing the deal, writing, negotiating, sitting 11 on the board seats. Angel List seems to me like an 12 aggregator of somebody who wants to do and deal and lead 13 it. So -- and I could very well be being way too harsh 14 as an academic. 15 MR. YADLEY: So sort of a follow-up to that. 16 As angels are aggregating -- and I think, Catherine, 17 you've told us a lot in past committee meetings about how 18 the organization is attracting more people to the angel 19 networks and they're becoming more knowledgeable in 20 bringing new funds. Do you think that there will be a 21 cyclicality to this sort of like people get out of B 22 school, and they want to work for Goldman Sachs, but as 23 soon as they know everything, they want to be on their 24 own or they want to go work at Fenwick & West and learn 25 from Stephen, and then go off and start their own firm? 0098 1 Do you think as these angels -- will they morph 2 into these sort of mini-funds as you've described them 3 and then go out because I believe what you said, that 4 people want good deals, and they're jealous of the good 5 deals, and they really don't like sharing information 6 about the best deals. So do you think there may be sort 7 of a pendulum swing back to smaller, maybe one or twosies 8 in the angel world? 9 DR. SOHL: Yeah, and certainly there's -- my 10 crystal ball gets a little cloudy at times even though 11 we're not supposed to say that as a snotty academic. But 12 sure they're going to go where the deals are and where 13 the returns are. So if there is, as is going now, this 14 retreat from seed because the 1 to $3 million deals are 15 pretty sweet. You've got a little bit of runway, you've 16 got a little bit of customers, slight less risk, a little 17 closer to exit, not much, but a little closer. 18 So there's -- and there's not a lot of players 19 in there, not a lot of competition certainly in most 20 parts of the country except that area in the left coast. 21 And so you've got -- so the money would normally move 22 into that. It's a return, risk-return tradeoff. Now as 23 that then retreats, then does the seed and startup market 24 become that much more attractive, less players, better 25 deals, much lower valuations. Maybe just no runway or a 0099 1 little bit less, but you can get to that second round 2 runway. So yes, it will take the long-term or maybe 3 long-term in this industry is three years maybe. 4 What I fear is that in the meantime we may 5 really lose the seed market, and then -- and that could 6 be too draconian. I just would like to see a little 7 public policy, keep an eye on that seed, because that's 8 hard work. It's really heavy lifting. And any way we 9 can help angels in that market. We've done a lot of work 10 in Europe, and matching funds at seed and startup deals, 11 boy that helps a lot. 12 I mean these are not -- these are federal level 13 funds over in Europe where they can grab a certain amount 14 of money on a 4 to 1 basis where the angel puts in let's 15 say 400,000 and 100,000 comes from some other fund. They 16 ride along in the terms. If it's a success, that fund 17 grows and it's -- but it's a government fund, but not a 18 government-run fund. 19 That kind of tweaking would at least give me a 20 little more solace that that angel market will always -- 21 that seed and startup market will remain a viable entity 22 and then possibly scoot up and down. No, even out the 23 troughs, because I don't want to be in a trough too long. 24 MS. MOTT: Jeff, in addition to that, I spent 25 some time in Europe last week with the angel groups, or I 0100 1 mean last year. The -- it brings new angels to the 2 marketplace because they're -- it derisks some things for 3 them and allows them to learn how to be sophisticated 4 investors. So those matching funds have done well in 5 Canada as well. 6 DR. SOHL: Yeah, we did the -- we helped 7 designed what we call the Archimedes Fund, the lever. 8 That was the Netherlands, that was Belgium. They're 9 doing very good, those funds. That's where they got the 10 term from, but of course they spell it differently. And 11 then the Canadian work we've been doing, Canada is very - 12 - I think they're pretty astute on watching that seed 13 market. 14 MR. NELSON: So I was just -- a couple of other 15 little data points. We've actually worked with the White 16 House and Mayor Bloomberg's office on immigration for 17 entrepreneurs coming here from overseas. And when they 18 created the Entrepreneur in Residence program at USCIS, 19 they were actually able to open up an 01 visa which means 20 exceptional talent visa for entrepreneurs that came who 21 had gotten funding on one of these crowdfunding 22 platforms. 23 Because if I'm not mistaken, the statistics are 24 there's about 140,000 startup profiles on Angel List and 25 less than 1 percent of those get funded every year. And 0101 1 so it's harder for you to actually raise money on Angel 2 List than it is for you to get into Harvard. And I 3 absolutely agree almost all of it -- it's an introduction 4 platform, and it helps angels become kind of mini VCs and 5 be able to help syndicate the deal for some of the hard 6 work. 7 Another data point that you had asked, Samir 8 Kaji, who is director of private equity at First Republic 9 Bank, recently published an article on CB insights. He 10 was tracking about 100 funds in the sub-$30 million range 11 that had popped up in the last year and a half. But 12 those funds are essential because before I introduced one 13 of our companies from our community to them, I'm asked to 14 have that company have between 5 and $10,000 a month in 15 recurring revenue and growing 7 percent month over month 16 before I introduce them to a seed fund. So in my mind, a 17 seed fund is now growth equity. 18 DR. SOHL: But again, that's that 1 to #3 19 million pot in that what I call post-seed. So it may 20 just be semantics. 21 MR. NELSON: That would be -- these are funds 22 that ostensibly write 250 and 500K checks. 23 DR. SOHL: Yeah, but I mean seed -- I always 24 think of seed as not really having a lot of runway yet, 25 but again, that's just -- it's semantics. The VCs will 0102 1 swear they're seed investors because they're looking from 2 one end down and vice versa. 3 MR. GRAHAM: Okay. Thank you, Jeffrey. 4 DR. SOHL: Okay. 5 MR. GRAHAM: There might be other questions, 6 but we wanted to get to Brian. And so after or during 7 your presentation, Brian, we'll continue to ask 8 questions, but why don't you go ahead and get started. 9 MR. KNIGHT: Thank you, Stephen. And thank 10 you, everyone, for having me here. 11 So thank you, everyone, for having me here. 12 I'm Brian Knight. I'm from the Milken Institute Center 13 for Financial Markets. Part of the work we do looks at 14 access to capital for small businesses and the 15 implications of financial technology in that and other 16 spaces. 17 So last year, in conjunction with the National 18 Center for the Middle Market, we did a survey of 636 19 owners and c-suite executives of private companies -- 20 there were a couple of public companies that slipped in - 21 - -with total annual revenues ranging from under a half 22 million to a billion dollars. The survey was 23 administered last January to early February. The goal 24 was to provide a snapshot of how these companies are 25 accessing external capital, how they anticipate accessing 0103 1 external capital and what is -- what factors they 2 consider when looking at external capital. 3 Our key findings, one, that debt was the 4 preferred method of outside financing, that firms when 5 they were evaluating methods of outside financing they 6 valuated the price that they were going to have to pay to 7 get the financing obviously, but also the ease of access, 8 the speed of the funding and the certainty that they were 9 going to get the funds in good order. 10 Firms were uncertain about whether bank or non- 11 bank financing was superior, but a lot of these firms had 12 strong preexisting relationships with their banks, and 13 that was cited as one of the major reasons why they used 14 bank funding. 15 At the time -- and this may be a little bit 16 stale, because of course this was pre a lot of the JOBS 17 Act provisions actually becoming effective -- there was a 18 low level of understanding and a low level of interest in 19 these potential models. And we'll see some of the actual 20 data on that here shortly. 21 First we asked these companies what methods of 22 capital have they used in the past three years. As you 23 can see, the -- it was a tie between a loan from a bank 24 and they didn't raise outside capital. They just 25 operated off retained funds or they didn't exist three 0104 1 years before. After the bank, the next options were 2 operating on retained funds or a loan from a non-bank 3 lender, then a debt investment from family and friends, 4 then money from a family office, then an equity 5 investment from family and friends. So you had to get 6 pretty far down on their list before you reached an 7 equity investment. 8 The types of firms that -- or the types of debt 9 that these firms had, bank debt was a predominate model 10 across revenue bands. Private debt increased the larger 11 a firm got, roughly speaking, and the smallest firms were 12 more likely to have no debt at all. 13 We asked them in the -- and then this next 14 year, so it's a year that just passed, how do you 15 anticipate funding your expansion plans. Cash on hand 16 was the largest answer, then going to existing -- their 17 existing credit facilities. 20 percent had no plans for 18 expansion, and 19 percent said that they would take on 19 additional debt, and then everything else fell into an 8 20 percent bucket. 21 DR. BAUGUESS: Can I ask a question? 22 MR. KNIGHT: Sure. 23 DR. BAUGUESS: How did you select these 600- 24 plus firms, and what was their general characteristics? 25 What was the identification method. 0105 1 MR. KNIGHT: So first we used a survey firm to 2 identify -- there is -- we went for a -- we banded it by 3 tiers, and I don't have -- I believe it's in the -- I 4 should mention we have -- the report's available online, 5 and my colleague, Jackson, in the back here has copies if 6 you want them. 7 We tried to match revenue band and industry 8 with their representation in the broader economy. And 9 then we used a nationwide survey, so -- 10 DR. BAUGUESS: I asked because I'm wondering 11 how much is growth firms versus somebody owns their 12 restaurant or three restaurants or something like a 13 mature, established business. Given the level of debt 14 that you see here, there must be some sort of 15 preconceived notion of stable revenue streams. So how 16 does that -- I mean it seems like a big contrast from the 17 other types of angel and startup and VC-type entities. 18 MR. KNIGHT: Right. So -- and I think you hit 19 on a good point which is that the purpose of this survey 20 was to try to get a snapshot of the economy as a whole. 21 So everyone from companies that expect to grow 22 significantly, companies that are quite large with up to 23 a billion dollars in revenue to the small, little mom and 24 pop shops. 25 I mean our view was that there's a lot of 0106 1 interest, there's a lot of focus on potentially high- 2 growth companies, and there's good reasons as to why. 3 But there are also a lot of companies that are maybe 4 flying under people's radar because they're smaller 5 companies, they don't necessarily have a clear path to 6 exit or clear goal to significant expansion, but they 7 still -- they hire people, they provide a living, they 8 provide a value to the community. 9 In terms of funding near-term expansion plans, 10 the use of cash on hand actually increased the larger a 11 firm was, which makes sense. They're more likely to have 12 cash on hand. We then asked them in the next three years 13 what do you expect. Most -- the largest group, 40 14 percent, did not expect to raise capital. Now whether 15 that's optimism that they're not going got need to or 16 pessimism that they won't be able to is unclear. 17 The next largest group, of course, was loan 18 from a bank, non-bank lender, retain funds, debt 19 investment, family offer -- and then one interesting 20 thing is that debt investment from family and friends and 21 equity investment from family and friends actually did a 22 little bit better forward-looking than they did rearward- 23 looking. So I don't know if that is more interest in 24 accessing securities market or what, but there's a slight 25 uptick there relative to what they had done in the past. 0107 1 In terms of the factors -- and I think this is 2 really some of the most interesting and potentially 3 relevant information that came out of the study. When 4 companies are looking at how they're going to get 5 financing, just generally, obviously the interest rate, 6 the cost of funding is very important to a majority of 7 them and extremely important. The largest sort of 8 component of extreme importance is the cost. But then 9 it's ease, speed and certainty. 10 Things like knowledge and expertise of the 11 industry from the funder, which of course would be 12 relevant on more or an equity angel investment side, 13 important but not critical; tax advantages, important but 14 not critical; diversification of funding source is 15 apparently not that important. Really it's how much am I 16 going to pay for this money, how quickly am I going to 17 get it, how certain is it that I'm going to get it, how 18 easy is it for me to get it. 19 When using -- when looking at non-banks for 20 financing, again, you had better interest rate, ease of 21 access, certainty and speed. What you saw Is that while 22 a better interest rate was very -- was obviously 23 important, this seemed to be -- the ease, speed and 24 certainty seemed to also become important. But then if 25 you look down at the bottom, the funding and asset 0108 1 project matching, all of the sudden, that is not the most 2 important thing to them, but it has an importance to a 3 large group of them, and I suspect that's because they're 4 looking at specialty funding. If you're not going -- 5 you're not going to sort of a general bank, you may be 6 looking at specialty funding, and so you want something 7 that matches your special need. 8 We asked: Do you think that non-bank sources 9 of funding are superior or inferior to banks? And 10 frankly I'll admit that when I saw this I was surprised. 11 It's almost a 33-33-33 split. Banks are -- 37 percent 12 consider banks to be superior to non-banks, but 35 13 percent don't know, and 28 percent don't think that 14 they're superior. 15 MR. NELSON: When you actually talk about 16 nontraditional lenders, is that banks versus credit cards 17 versus someone who might loan me money? Can you talk 18 about those distinctions a little bit? 19 MR. KNIGHT: So nontraditional lenders are non- 20 bank business lenders, not credit cards, generally issued 21 by a bank, but things like I mean a marketplace lender, a 22 specialty finance, cash -- emerging cash advance, any -- 23 and it is sort of a big pot I will admit, but that sort 24 of non-bank specialty small business lending. Uh-oh. 25 DR. BAUGUESS: While they're working on 0109 1 technical challenges, with respect to the banks, is -- 2 are these community banks, local banks, bigger banks? 3 MR. KNIGHT: All banks. 4 DR. BAUGUESS: All banks. 5 MR. KNIGHT: All banks. 6 DR. BAUGUESS: Is there a local nature of the 7 financing for these smaller loans that it's more likely 8 for a small bank to loan to small business than to go to 9 a national bank? 10 MR. KNIGHT: Well, our survey did not ask into 11 that. I do think that there's some good information out 12 there, but that was not the focus of our survey. 13 This other part I think is particularly 14 interesting is that the larger a bank -- or the larger a 15 company is, the more they like banks and the less they 16 like non-banks, which I think makes a ton of sense 17 because of course the larger a company is, they're 18 probably more likely to get a bank loan on terms they 19 like, they're more likely to have a longstanding 20 relationship with a bank. 21 Whereas the smaller a company is, the less 22 likely it is they're going to be able to get a bank loan 23 on terms they like or at all and the more they may need a 24 different -- which is another thing that came out of this 25 is that the smaller companies are more interested in 0110 1 getting a quick -- money quickly, get money with 2 certainty, get money easily. Whereas the larger 3 institutions deprioritized that relatively speaking and 4 looked more at the raw cost of the funds. 5 We asked them why would they take -- why would 6 they consider borrowing from a bank, and overwhelmingly 7 it's their strong previous relationship with their bank. 8 It's not that taking on additional debt is better than 9 other options including selling equity in their company. 10 It's not that the terms are superior. It's that they 11 know and like and have a relationship with their bank. 12 That -- the strong consideration element is 13 relatively consistent across revenue bands. The taking 14 additional debt is better than other options ticked up 15 generally speaking the larger or the more revenue a firm 16 had. These firms' perceptions of borrowing costs, 17 generally they felt like they could borrow around the 18 prevailing rate. About a quarter of them thought they 19 were borrowing below the prevailing rate, 7 percent 20 above. 21 MS. YAMANAKA: Do you have that broken down by 22 source? 23 MR. KNIGHT: By source of -- 24 MS. YAMANAKA: So meaning that the people who 25 thought they were getting a deal, below market rate, was 0111 1 that because of friends and family or was that across all 2 lending sources? 3 MR. KNIGHT: Unfortunately we did not have that 4 -- I should preface by saying that our survey firm told 5 us that we were really limited to about 30 questions or 6 people are just going to bounce off. And this was a 7 broad survey, so that's something that we wish we could 8 have gone down on and hopefully on a follow-up we can 9 dive into that. 10 In terms of right amount of debt for the 11 company, almost half believe that there should be no 12 debt. Another almost half wanted to keep it under 20 13 percent. 7 percent thought around 50 percent was 14 appropriate, and no one wanted to be highly leveraged. 15 MR. YADLEY: Brian, did any of your questions 16 go to when people were borrowing whether there was -- 17 were enhancements like equity kickers or anything like 18 that? 19 MR. KNIGHT: No, we did not go that deeply. We 20 felt that that might be a little bit difficult to convey 21 in the type of survey we were running. But it's a good 22 question. 23 In terms of debt strategy, 56 percent of 24 businesses had a conscious debt strategy. Those tended 25 to be the larger businesses. But almost none of them 0112 1 really didn't -- or almost have of them didn't have a 2 strategy. 3 The driving -- the drivers for debt levels, why 4 are people accessing debt. The -- 26 percent had no 5 debt. Another 26 percent said that they borrowed when 6 needed, that their capital structure was driven by past 7 decisions. And I think that this is important. 8 My suspicion is that this is important going 9 back to that bank relationship and bank superiority 10 question, which is if you're not constantly accessing 11 your bank, you have to -- when you run out of money, when 12 you need money, when you want to do something you go and 13 you get a loan. And if the last time the bank said yes 14 and you felt pretty comfortable with that, you're going 15 to have -- and particularly if you also have other 16 products with that bank, your bank checking account, your 17 bank credit card or your corporate credit card, et 18 cetera, you're going to have a strong relationship with 19 your bank. 20 Now if the next time you go in the future, 21 which you don't know yet, they say no, that may impact 22 your relationship with your bank, that may impact your 23 perception of how good bank funding versus non-bank 24 funding is. 25 MS. TIERNEY: Brian. 0113 1 MR. KNIGHT: Yes. 2 MS. TIERNEY: One of the things that I would 3 like to know -- like you were talking about doing some 4 follow-up with this, but you also need to maybe look at a 5 lot of these businesses, the first thing they're doing, 6 oh, money, oh, I need to talk to my banker. And I know 7 you said in here a lot of it is because maybe those 8 businesses don't understand VCs, they don't understand 9 some of the other types of markets they could utilize, 10 but sometimes it's beyond them understanding and their 11 influencers and getting the information out to the 12 bankers. Because you think of a tax implication, oh, I'm 13 going to go to my CPA. 14 You don't think of, oh, I'm going to look at 15 SEC filings or paperwork and so I think that's one thing 16 that would be good to take into consideration, that maybe 17 it's not so much that they didn't know, but their expert 18 that they refer to for ease -- because I've seen other 19 federal agencies get a bad rap for, oh, well, this one 20 said no because when they talk about regulations, well, 21 it wasn't truly the regulation. It was that entity not 22 wanting to fill out the paperwork, that banker maybe not 23 being as familiar with the process, just as a side note. 24 MR. KNIGHT: Yeah, that's a good point. And I 25 will say I omitted from this slide -- it's contained in 0114 1 the report, but we did have some questions about the SBA. 2 Almost no one used the SBA, no one liked the SBA and 3 they found it to be -- which is no knock against the SBA. 4 I think I saw Nate against the SBA here somewhere. But 5 they found the process to be burdensome, cumbersome, time 6 consuming, difficult, and so they kind of -- a lot of 7 them bounced off that and went to go do something else. 8 MS. YAMANAKA: And I have a lot of experience 9 in that and especially during the last couple years of 10 the SBA. Frankly, they have improved their processing 11 and their servicing client relationships for lack of 12 better words. But I think to your point, Lisa (sic), is 13 that if the intermediaries in the sense that the bankers 14 are not familiar with it, they're CPAs, the people who 15 are going to be the experts at presenting options, it's 16 not going to come up. 17 So I -- even -- it's -- you've got to get past the 18 barriers, the gatekeepers because business owners are not 19 experts in the SEC, in banking relationships, in tax or 20 anything. They look to their cadre of people and if they 21 don't know or if it doesn't come up or if -- sometimes I 22 have to really talk clients into things because they 23 don't want to take on debt or they don't want to pursue 24 alternatives. They go with what they're familiar with 25 and what their peer group is, too. 0115 1 So if they hear somebody -- that's why banking 2 is tremendous. If a bank were -- develops a reputation 3 as having a particular specialty in an industry, which 4 will allow you theoretically greater latitude, then all 5 those industries group in that area. So I think there's 6 some nuances in here that are not otherwise -- 7 MS. YADLEY: I think another thing may be -- 8 and I don't know if you found this to be true -- going to 9 a bank -- because I think you're right, Lisa (sic). 10 People don't know about all these other lenders. But 11 banks, even some relatively small banks under 20 billion, 12 are offering a lot of services. 13 So people call their bank, they're not just 14 getting a line of credit. They have all kinds of 15 specialized finance groups, they have equity 16 relationships, and so I think for a lot of the companies 17 probably at the higher end of your range of companies, 18 going to the bank doesn't mean the same thing as when 19 you're at the lower end and you're really going to the 20 bank for a loan. 21 MR. KNIGHT: I think -- my suspicion is that 22 that is absolutely true. I mean this survey, which, 23 again, was meant to be sort of a high-level snapshot, 24 that does seem to vie with the information regarding how 25 the larger a company is, the fonder they were of their 0116 1 bank, the better they thought of the bank and bank 2 financing versus a small company, and that seems to jive 3 with other evidence out there that the danger is that 4 banks are retrenching from the smallest of the small. 5 The big companies, banks are still more than 6 happy to work with them, it makes sense, the regulators 7 are happy with it because it doesn't pose a significant 8 credit risk, it's profitable. Whereas a smaller 9 institution or a smaller company looking for a smaller 10 loan is riskier and the underwriting costs for a small 11 loan are not that much different from the underwriting 12 costs on a big loan. So you run that risk. 13 In terms of debt-to-asset ratio, the smaller 14 firms tended to be zero to five. Larger firms tend to 15 have a higher debt-to-asset ratio. Smaller firms, not 16 surprisingly, tended to have under a half million in 17 debt. Larger firms tended to have -- like the larger 18 firms, the majority had over a half million in debt. 19 Some of them didn't know how much debt they had. So make 20 of that what you will. 21 And going back to the earlier conversation 22 about awareness of nontraditional sources of capital, and 23 let me preface this by saying this survey is about a year 24 old, things have hopefully improved somewhat. But there 25 was relatively little awareness on the part of firms of 0117 1 alternative sources of capital, private equity being the 2 most well-known. Of course we split out private equity, 3 venture capital, angel investors, peer-to-peer loans. 4 So -- and I will say in the report we do 5 preface by saying we trusted people to use their judgment 6 in terms of language. It was hard to control for that. 7 So you may want to lump private equity, venture capital, 8 angel investors all together, but obviously some people 9 viewed them differently. 10 DR. BAUGUESS: What was the question? Do you 11 know this exists and what it is? Or was it do you know 12 how to get it if you wanted to pursue it. 13 MR. KNIGHT: It's are you aware of it. And so 14 -- 15 DR. BAUGUESS: So 70 -- three-quarters of the 16 population didn't know what peer-to-peer lending was? 17 MR. KNIGHT: Apparently so. 18 MS. YAMANAKA: I'm not surprised at all. That 19 is -- if you look at the broad spectrum, there's a huge 20 number of businesses out there that they have their eye 21 on their widget and their service. And that's -- maybe 22 they've been around for a long time. They are just 23 looking at how to do what they know how to do. 24 Everything else they think is for -- or they all know -- 25 they say, ah, that's just Silicon Valley, oh, that's what 0118 1 we get -- oh, that's just a tech. I'm an old-fashioned 2 manufacturer. A very high-tech manufacturer, but they 3 think that all the private equity and venture capital -- 4 they don't even want to talk to you about it. They know 5 their banks, they've always delivered, they know the 6 game, they know the rules. 7 If I do this -- average -- if I produce this, 8 if I've got this cash flow, I know someone's going to 9 fund me. On the other thing, it's a little bit -- it's 10 nebulous because it is about relationships and they 11 haven't established those relationships. Nor do they 12 have a conduit to get them there quickly. 13 MR. YADLEY: I think that's consistent with 14 your findings, too, Brian, that equity is way down what 15 they want to give and the banks by and large are not 16 asking for -- 17 MR. KNIGHT: Well, and I mean my sense is a lot 18 of these businesses are not good equity candidates. It 19 would not be good for the business, it would not be good 20 for the investor because they're unlikely to have the 21 type of event that makes equity worthwhile. 22 MR. GRAHAM: So again, Brian -- sorry, I talked 23 over someone. Okay. Again, Brian, there is awareness 24 when you are unaware of a type of source if you will and 25 then there's awareness that has to do with whether or not 0119 1 you understand that these sources are available, but you 2 have no one to contact. I mean you have no idea how to 3 tap into it. Do your numbers cover both? 4 MR. KNIGHT: So the -- the most honest answer 5 is I don't know because the question is are you aware of 6 this sources of capital. So what was in the mind of the 7 respondent when they said, like, I've never heard of this 8 before or I know vaguely that this exists, but I have no 9 idea if it would be appropriate for me, there may be some 10 conflation there. But we don't -- so I can't -- we don't 11 have a question that teases that out. So di ton know -- 12 MR. GRAHAM: Yeah, this kind of goes back to 13 outreach, which I think -- assumption that we should kind 14 of focus on as a committee. 15 Xavier. 16 MR. GUTIERREZ: I was just going to ask a quick 17 question. Is there a goal, Brian, of doing this survey 18 again post-all of the kind of growth in the marketplace 19 lender space, and in particular because of the fact that 20 you now have very large money center regional banks that 21 are starting to utilize those platforms for small dollar 22 amount lending, basically offloading anything sub-a 23 million dollars to those platforms and whether or not one 24 awareness is increasing as a result? 25 And two, as a bank owner, we're actually seeing 0120 1 a reaction against that because of the fact that while 2 ease and certainty kind of is there, the additional 3 services that go beyond just the capital are obviously 4 lacking. And so there may actually be a retrenchment 5 back to not just community banks but to credit unions as 6 well, which is also another factor that I don't think has 7 been included in this. So it's a long-winded way of 8 asking: Are you guys going to redo it given the growth 9 over the last 12 months in marketplace lending? 10 MR. KNIGHT: I certainly hope that there is an 11 update to this survey. I haven't talked to my colleagues 12 at the National Center for the Middle Market, but I 13 definitely think -- I agree with you. I think there 14 would be value to it. 15 And like I said, I mean, some of this 16 information I hope is stale because -- and we're going to 17 get to a couple more slides here where there is 18 relatively little understanding of some of the JOBS Act- 19 related changes and it's my hope that that has improved 20 over time, particularly as these have come online -- 21 these regulations have in fact come online. 22 DR. BAUGUESS: I just wanted to echo -- I mean 23 it's a great idea. Just from the SEC perspective when we 24 do our economic analysis, this is the type of information 25 issuers search. Costs and knowing where to get capital 0121 1 we have a really hard time measuring. We don't have a 2 way to get this type of information. The extent that you 3 repeat this and show us change, maybe even alter the 4 questions to ask specifically about new exemptions would 5 be extremely valuable information to have. 6 MR. KNIGHT: Sure. 7 MR. REARDON: Sebastian, is this an opportunity 8 for your group to maybe put some educational information 9 on your part of the website that says if your banks turn 10 you down, these are the other sources you go to? I mean 11 the risk you run is that each one of these groups won't 12 like what you write about them. 13 But it seems to me that that might be something 14 that's useful even if you just link to somebody else's 15 narrative; if you're interested in venture capital, go to 16 this industry link or something like that. But for 17 somebody who just doesn't know what to do with a small 18 business, and I agree those people don't know, maybe 19 that's something that's not too hard to do and it's 20 helpful. 21 MR. GRAHAM: I think it would be helpful, and 22 that's what I was getting at when I mentioned outreach. 23 I mean it seems to me that there's an education 24 component, and I know that that's one of the things that 25 we certainly are kind of required to focus on through the 0122 1 JOBS Act and perhaps other areas as well, but it seems to 2 me that not only is -- are we lacking in terms of -- or 3 that we could do more in terms of outreach to issuers. I 4 think we could probably do more in terms of figuring out 5 how to partner with sources as well. 6 There is -- there are foundations in other 7 organizations where I think they are sources of capital 8 that people don't fully appreciate. And for that matter, 9 you think about industry groups as well. So I think that 10 there's -- I think this is an important area, and it is 11 something that I think would -- it would be good if we 12 focus on it a little bit and maybe came up with some 13 ideas. 14 MR. GOMEZ: I think it would be extremely 15 helpful for the committee to focus on it and especially 16 tee up potential ideas of how best to reach to people. 17 One of the things that we have been doing over the past 18 year and I expect not only will continue but will 19 increase now that the rules -- the major rulemaking in 20 the JOBS Act has been finalized is the SEC partner with 21 the SBA in order to actually reach out to different 22 locations throughout the country. Part of the goal is 23 not necessarily go to the stereotypical location where 24 you expect you are going to find companies or 25 development, but also reach out to other areas that are 0123 1 not the traditionally sought after places. So nothing 2 against Boston, but let's think about is there places to 3 go other than Boston, other than the Silicon Valley where 4 we can also do outreach to groups that are interested in 5 funding. 6 The one thing that I think that's a very 7 interesting topic for the committee to take up is I 8 personally what I find to be one of the most challenging 9 aspects of the outreach is when we go to some of these 10 events, there's a lot of interest from people in learning 11 about it. And then the next logical question that comes 12 up is: Look, I have this great idea and you just talked 13 about crowdfunding, you talked about Reg A, you talked 14 about this thing called 4(a)(2), and I have no idea which 15 one is the right one for me. Can you tell me which one 16 is right for me? And that is not something that the SEC 17 can provide as far as that guidance. 18 So I think one of the things that would be very 19 important for -- to hear from the committee is not only 20 what the outreach strategy should be try to get the best 21 bang for the buck as we are using our limited resources 22 to try to provide the message, but also how do we go 23 through that gap of this is what the rules are, but at 24 the same time we're not your lawyers, and we can't serve 25 as your lawyers or advisors. How do we cross that gap so 0124 1 that they're actually able to not only get the 2 information about what the exemptions that are available, 3 but also what is the best one for that one company, which 4 of course will vary tremendously based on the type of 5 company and the situation in which they're at. 6 MR. NELSON: I also think that one of the side 7 effects of the ban on general solicitation has been it's 8 been almost illegal for me to tell people that I'm 9 raising capital for my business up until a couple years 10 ago. And so because of that, the only people who 11 generally know how to raise capital for a business are 12 accredited investors who are rich by definition. 13 So people who are not rich do not know that 14 being an angel is a thing. They probably don't know 15 angels or they don't know that people are angels that 16 they know. And so I think there's been this unintended 17 consequence in the general solicitation thing where how 18 do I start my business, credit card or I take a second 19 mortgage out of my house. The banks, no, they're not 20 going give me any money because I'm not profitable. 21 And the frequent complaint that I hear about 22 entrepreneurs and one of the reason why people come to 23 Silicon Valley to raise capital is because the general 24 consensus around the world is that it's one of the few 25 places where there actually is a market for small stock 0125 1 equity, which I think if we can try to fix some of these 2 problems and make people more aware, we move the economy, 3 which I think is pretty awesome. 4 MR. GRAHAM: Catherine. 5 MS. MOTT: I think Sebastian's comment about 6 partnering with the SBA makes sense. And because it's 7 the one place that would make sense for everyone to go to 8 it and provide a consistent message and can deliver that 9 message to all its communities. One of the things I will 10 tell you in Pittsburgh, that we have a very, very 11 proactive innovation-focused mayor. 12 And he created an innovation office. And it's 13 a one-stop shop where you can go and say I need an 14 incubator. Well, there's 20 incubators in town. I'm 15 trying to get some NIH money. Here's some suggestions 16 for you to go get and to try to apply for NIH money. So 17 there's a one-stop source there that provides a lot of 18 information. 19 I have seen in other communities -- this is not 20 trying to slap the SBDC on the hands, but SBDC in another 21 community which we are very active in where SBDC tells 22 all of the incubators is you don't need them, you just 23 need us. So it's -- there's even a lack of understanding 24 among the things that are partnering with SBA. So if we 25 can start with a general message with the SBA and kind of 0126 1 filter it into the -- all of the components that 2 integrate with the SBA, I think it might be a good start. 3 MR. REARDON: Could I add to that that I think 4 the focus, if I don't know what venture capital is, the 5 starting point is probably not the SEC rules. The 6 starting point is probably the forest and what is venture 7 capital. And perhaps even the way to do this is through 8 videos because so few people read anymore. They want -- 9 we get -- I've got a face for radio, so I wouldn't be the 10 right person. But get somebody to do it via talking -- 11 MR. GRAHAM: I don't know, Patrick. I kind of 12 see you as -- 13 MR. REARDON: No, you'd be much better. You'd 14 be much better. And somebody do a video of your bank 15 just turned you down. Well, we're going to tell you the 16 five options or six options you've got and each one of 17 these is 10 minutes long and then there's more material 18 you can get if you want to read on it. 19 But I think if we start with -- well, a 20 relative of mine just got an award for outstanding 21 performance because she took a company's website and 22 focused it from what the company wanted to what the 23 customer wanted. And here you've got to say what does my 24 customer need. And my customer needs you to hold their 25 hand and say here are the next steps for you, and by the 0127 1 way, go get a lawyer who knows how to do all this stuff 2 because it's complicated. 3 MR. GOMEZ: And, Patrick, I think we have the 4 perfect cast here for those videos because we have 5 members of all of those different groups. So we have 6 angel investors, we have bankers. So maybe that's what 7 we need to do and actually take a little bit more of your 8 time and actually have you record those videos. 9 MR. GUTIERREZ: In all seriousness, this has 10 been an issue that we talk a lot about, which is this 11 continuum of capital, right? So -- and trying to educate 12 people that what works today may not work for them 13 tomorrow, and by the way, you might not even know what 14 works for you today. And so as we think about this, I'd 15 like to encourage sort of that understanding. 16 Obviously, the SEC sits in one particular 17 aspect of that continuum, but it's not in a vacuum. 18 Right? And so I wanted to highlight that. I also wanted 19 to reiterate the point that it is very, very important to 20 educate the service providers of those companies. 21 Because at the end of the day, a small business is really 22 interested in making it, right, making payroll, 23 continuing to be profitable. They turn to their lawyer, 24 they turn to their accountant, and so really when you 25 talk about nontraditional platforms to go to, you'd be 0128 1 surprised how much education can actually get done by 2 going though those enterprises across this continuum of 3 capital. So -- 4 MR. GRAHAM: Thank you for that. 5 Brian, we're going to let you finish. 6 MR. KNIGHT: Okay. Great. So -- and 7 admittedly this one is I hope one of the staler slides 8 here. Almost 80 percent of firms were unfamiliar with 9 the JOBS Act proposals. Among -- 10 MS. TIERNEY: Does that go back to the 11 idea that before that a lot of the companies in the 12 survey are not the type of companies that would use 13 equity to raise capital, or do you think it's a different 14 issue? 15 MR. KNIGHT: So this is familiarity, so that's 16 more general. We -- among those who were familiar, about 17 90 percent at the time said that they would not consider 18 using one of these JOBS Act proposals. Among those who 19 said they would -- and admittedly this is a small sample. 20 The biggest reason was that they thought it would be 21 good public relations or followed by thinking it would be 22 -- provide better terms or be less expensive. Only about 23 a quarter of those who were interested thought that they 24 wanted to expand their investor base. 25 Among those who were -- would be hesitant or 0129 1 unwilling to use the new methods, the biggest reason was 2 that they didn't know enough to feel comfortable, which 3 of course makes sense and followed by uncertainty, so we 4 can lump those together. Potential for fraud, and then 5 they wanted to know their investors, which I think has 6 been a recurring theme about the value add -- potential 7 value add to investors, particularly on the equity side. 8 We asked if they were listed on a stock 9 exchange. Only 3 percent said they were currently 10 listed. 2 percent said they didn't know, so whatever. 11 92 percent said that they have not considered listing, 12 and 3 percent have considered it but haven't done it yet. 13 Surveys. Okay. 14 So biggest barrier to the companies of as to 15 why they wouldn't do it, the biggest one was that they 16 were just too small to consider going public, followed by 17 cost, regulation, and then lack of liquidity. So these 18 are themes that have been echoed again and again and 19 again. One, the private -- or the public markets are not 20 really a good option for a significant chunk of 21 companies. 22 That's just not -- to your continuum of capital 23 point, in that continuum of capital, I think it's very 24 fair to say that there are multiple forks in that road. 25 And so trying to -- we can fix and improve certain areas, 0130 1 and that will help with the companies that will travel 2 down that path and not necessarily help any of the other 3 companies, and that's something that people should be 4 mindful of. 5 And then I guess to sort of get to why any of 6 this matters in terms of expansion plans, 54 percent said 7 that their expansion plans would not change in response 8 to an increase of cost and capital. 28 percent said it 9 would only respond to a significant interest rate swing, 10 and 18 percent said that they were highly sensitive to 11 changes in cost and capital. 12 And then if you look, if we broke it down by 13 revenue band and the largest groups say it would not 14 change, where the smaller companies, the up to about $2 15 and a half million in revenue companies -- and my 16 suspicious is those are in a grow-or-die mode, we have to 17 do it, so we're going to do it. But then the other side 18 -- on the other side, the smallest companies were also 19 relatively speaking the most sensitive to changes. And I 20 guess those are companies that are not in a grow-or-die 21 mode, but also don't have a lot of leeway in terms of the 22 money that they can raise. 23 That -- so that's the presentation. I'm, if 24 there are any additional questions, happy to answer them 25 or try to anyway. 0131 1 MR. GRAHAM: Thank you, Brian. So open it back 2 up for questions. 3 Greg. 4 MR. YADLEY: Not a question so much, but I like 5 Sebastian's comment about the SEC's not the lawyer, so 6 you can feel free to give them Stephen's and my Texas 7 colleague's and my names anytime you want. But that is 8 not the primary goal of the lawyer, although that is part 9 of our counseling. One of the themes that's come up is 10 that people don't understand who these alternative 11 capital sources are. If they do, they don't distinguish 12 among them. 13 Another tool in the arsenal, which obviously 14 our committee has talked about in the past, is private 15 placement brokers, somebody who may know you want this 16 kind of capital source, or I know these 10 people, and 17 really the goal is not to sell their capital or their 18 sponsored fund, but to match a source. So I hope that's 19 something we'll continue to talk about at our future 20 meetings. 21 MR. GRAHAM: Okay. 22 MS. HANKS: Yeah, I certainly just wanted to 23 echo what Greg said about we need to get the finders 24 thing fixed. This term of this committee, that should be 25 one of our objectives. Do or die. The other thing I 0132 1 just wanted to mention, carrying on from the banking 2 issue, there are some jurisdictions, UK being one of 3 them, where rules are being instituted for banks when 4 banks turn down a small business loan application. 5 They're required to say, well, we're not going to give 6 you anything, but here's another source. 7 Now that's a difficult thing to dictate when 8 you have 16 different banking jurisdictions, banking 9 authorities and then 50 different state ones, but there 10 might be something like that we could do on a voluntary 11 basis. And I have talked to some local banks who might 12 be interested in saying, well, you're too early for us, 13 but here, here's a crowdfunding platform. 14 MR. KNIGHT: If I might put one bug in the 15 committee's ear, and we've submitted a comment letter 16 touching on this, one of the things that struck me when I 17 looked at this data is just how interested people were in 18 debt as an option. And I think it's worth considering 19 whether like the private offerings -- whether or not they 20 are well suited to debt offerings and whether the 21 structures and requirements around these private 22 offerings, many of which are built for either equity or 23 debt, or are capable of using either equity or debt, 24 whether or not there's any profitable way to -- if you 25 were to create a debt-specific offering, whether you 0133 1 could do it with sufficient and appropriate consumer 2 protection or investor protection while creating a lower 3 barrier because of the unique nature of debt. And so my 4 suspicion is that there might be that possibility, and 5 that might be something that's at least worth 6 contemplating going forward. 7 MR. GRAHAM: And that's -- you're talking about 8 pure debt as opposed to convertible debt? 9 MR. KNIGHT: Pure, simple, vanilla debt. 10 Basically something that functionally competes with a 11 bank loan because that seems to be where most of the 12 demand is. And to the extent that banks are retrenching, 13 there may be an unmet or unfulfilled need. And not that 14 this is going to replace banks or replace marketplace 15 lenders or replace anyone else. 16 It's more to augment the suite of options 17 available because everyone's going to have different 18 needs, wants and options available to them. But if one 19 can be created that works without creating undue risk to 20 investors, that might be a nice thing to have. 21 MR. GRAHAM: Thank you. 22 Sebastian, are you going to address this kind 23 of where we are with the finder versus broker this 24 afternoon? 25 MR. GOMEZ: So I'm hopeful that John, who was 0134 1 here this morning, will be available this afternoon in 2 case there's questions from the committee. 3 MR. GRAHAM: Kind of find out where we are. 4 Okay. Any more questions before we break for lunch? 5 Okay. Then let's break for lunch. 6 (Whereupon, at 12:36 p.m. a brief luncheon 7 recess was taken.) 8 A F T E R N O O N S E S S I O N 9 MR. GRAHAM: Okay. First we need to turn to a 10 bit of housekeeping. I don't know if you have copies. 11 But -- okay. Generally, we pass out -- well, we'll be 12 passing out current copies of the bylaws for your 13 information and for your future reference I guess. 14 The current bylaws of the committee were 15 adopted when the committee was formed in 2011. When the 16 committee was renewed by the Commission in 2015, there 17 was a change to the charter, which now states that the 18 members are appointed to serve essentially by the 19 Commission, and they will serve at the pleasure of the 20 Commission. 21 The original bylaws provided that the committee 22 was to be appointed by the chair of the Commission. So 23 that change was made. The committee has reconstituted 24 with the Commission as a whole providing greater input, 25 and that's kind of the current fact of life. 0135 1 And so it's time to amend our bylaws so they 2 kind of conform with the reality of the current charter. 3 So what we need to do is remove three words: chair of 4 the. And that's it. 5 PARTICIPANT: So moved. 6 MR. GRAHAM: Thank you. All right. Does 7 anyone want to talk about this? All right. So all those 8 in favor? 9 (Chorus of ayes.) 10 MR. GRAHAM: All those opposed? All right. We 11 have amended our bylaws. 12 Sebastian, will you provide the committee with 13 an update on the current status of rulemaking and other 14 initiatives at the Commission? 15 MR. GOMEZ: Sure. Happy to do it, and in many 16 ways the presentations this morning, especially by Scott, 17 cover a lot of the stuff that I was going to cover. So I 18 encourage you guys to chime in if you have questions or 19 if you have insight as to what you are seeing in the 20 different areas that I'll touch upon. 21 So let me start by noting again that last year 22 the Commission finished all of the major rulemaking under 23 the JOBS Act. I had a section here where I was going to 24 talk about what we're seeing in the context of Reg A 25 offerings, but Scott stole my thunder and did it much 0136 1 better than I could have done it and provided even more 2 data than I could have provided for you. 3 So I wasn't going to spend a whole lot of time 4 on Reg A unless you guys had some thoughts or some 5 insight as to what you've seen or you experience there. 6 MR. HAHN: I was going to say earlier, so we 7 went public in January of 2014, but in 2012 and early 8 2013, we were in a position where our lead compound was 9 in a phase 2 and we needed further funding. So we didn't 10 have the data yet to access the public markets for an 11 IPO. So we were looking at a lot of different avenues, 12 and Reg A popped up. At the time it was only a $5 13 million limit on that. 14 The 50 million Reg A+ would have been perfect 15 for us at that point because it would have given us an 16 opportunity to raise the money. The challenge with the 17 IPO was that we had to spend $2 and a half million on 18 lawyers, accountants and not knowing if we were actually 19 going to be able to close a deal. 20 I do think the one challenge, though, going 21 forward, though, is liquidity issue on the markets on the 22 back end. On the private side, I think the way that 23 before Reg A+ this was addressed is a lot of the public 24 investors will, in the last several years in the biotech 25 area, have started making investments in private 0137 1 companies. But they call those crossover rounds. And a 2 lot of the deal terms are structured whereas they'll do 3 the crossover round in the company, but there are certain 4 stipulations in the agreement that says if they don't go 5 public within the next 12 to 18 months, the crossover 6 investors will get more of the company. 7 So I think Reg A+ is -- it's great, it's 8 another tool in the toolbox to help companies in that 9 type of position raise money. But I do -- there is -- 10 we're going to have to take a look at the liquidity side 11 and, yeah, there are some other conversations about other 12 markets for these securities before they're actually 13 public. 14 MS. HANKS: If I could just say something about 15 the implementation of Reg A, we've done six separate 16 filings. We've done filings for six separate companies 17 and gotten nine rounds of comments, and they were 18 uniformly useful, helpful, not nitpicky. When we have a 19 foot fault of like how we've not quite filed something 20 right in part one, nobody picks us up on it. 21 They call us and say we think you might like to 22 amend that they don't even say and you should have known 23 that, Sara. And so it's been terrifically helpful. And 24 so the implementation is great. 25 I absolutely second the stuff about the 0138 1 liquidity. That's going to be a huge, huge, huge thing 2 for the investors. But one thing that when you look at 3 the adopting release and the assumptions that DERA made 4 about who would be using this, I think that the fact that 5 there is a whole load of pre-revenue companies using tier 6 two, and that's something I think possibly that the 7 commission wasn't expecting. But you're probably going 8 to see a lot more of those. 9 MR. GOMEZ: Thank you. Thank you for all those 10 thoughts. I've -- I did not introduce Joanne Rutkowski. 11 Joanne is in the Division of Trading and Markets. And I 12 was reminded by this because I was going to jump into 13 crowdfunding next. But Julie within the Division of 14 Corporation Finance and Joanne within the Division of 15 Trading and Markets work on the team that implemented the 16 rules that resulted in Regulation Crowdfunding. 17 And when I say this, I really mean it. It was 18 a very challenging project for us at the staff. On the 19 one hand, it was complex because we were creating a brand 20 new exemption in the 33 Act. But also our colleagues in 21 TM with respect to the 34 Act, there's a whole new 22 framework for intermediaries that are registering as 23 funding portals. So it was a very challenging project. 24 We did benefit from a lot of comment in that area, which 25 was very helpful, and we are eager to see how it will 0139 1 work out. 2 Just to give you an update on -- as you heard 3 this morning, the rules are not yet effective. Funding 4 portals have been able to register starting in January 5 and the chair mentioned that we've already seen some of 6 them starting to submit the form to register with the 7 SEC. 8 For issuers, as it was noted, the rules will go 9 into effect on May 19th. And although the issuers can't 10 currently file a form until that date, they will not be 11 able to file a form to actually do an offering. We did 12 open up the ability for issuers to test file, to have 13 access to what the form would look like and access the 14 system . 15 We issued a press release on December 18th 16 providing information as to how an issuer would go 17 through the process of testing the Form C. And the 18 reason we did this was two-fold. On the one hand we are 19 coming up with a new form that gets submitted via EDGAR. 20 And whenever you're dealing with a new form, there can 21 always be technical challenges. And the one thing that 22 we noted in the release and we were hoping is that as 23 people test the form to the extent that there were 24 problems with the form, they could let us know so that we 25 can address those before the effectiveness. 0140 1 The second reason for it is the scenario where 2 we are going to have issuers that are likely not familiar 3 with the process of filing something with the SEC. So 4 the idea of opening it up for them to test the form, it 5 also gives them the ability to actually see what they're 6 going to have to go through and what the form looks like 7 so that when it comes May 16th, they are more informed as 8 to what the process will be like. 9 For any of those watching and interested in 10 this, the -- as I mentioned, the instructions are on a 11 press release on the Division of Corporation Finance 12 portion of the website as to how to do it. And 13 unfortunately you have to move quick because we opened up 14 the testing December 18th, but it closes at the end of 15 this month in order to give us sufficient time to put in 16 place all of the changes that have been suggested to us 17 and fixes to the system. 18 So with that, I was going to turn to a quick 19 update on Rule 147 and 504. You heard quite a bit 20 bao9but both of those in the morning. The same day that 21 the Commission adopted final rules with respect to 22 Regulation Crowdfunding, the Commission proposed changes 23 to Rule 147 and 504. I know a lot of people have talked 24 about Rule 147, 504. 25 Sometimes we -- here at the SEC, we run the 0141 1 risk of talking so much about rules and we don't actually 2 explain what they do. So in many ways, Rule 147 is a 3 rule that is -- as was mentioned this morning, was 4 adopted by the Commission in 1974, and it's a safe harbor 5 under Section 3(a)(11) of the Securities Act. And it's 6 known as the intrastate exemption. 7 The idea of Rule 147 in Section 3(a)(11), the 8 concept behind it is that if you are conducting an 9 offering, if you're an issuer in a specific -- doing 10 business in a specific state and you're conducting an 11 offering and selling -- both offering and selling only to 12 residents of that state, then you don't have to go 13 through a process at the federal level. You only comply 14 with the requirements at the state level itself. 15 There is no limitation under the federal rules 16 as to how much an issuer can raise pursuant to Section 17 3(a)(11) or Rule 147. Although, at the state level, 18 there could be -- and many states, in fact, do have 19 requirements as to how much can be raised pursuant to the 20 intrastate exemption in that specific state. 21 Rule 504, just very briefly, when people talk 22 about Regulation D, mostly people are focusing on 506(b) 23 and (c). Rule 504 is also part of Regulation D, as -- 24 historically has been known as the seat capital 25 exemption. And currently it allows an issuer to raise up 0142 1 to $1 million over a 12-month period. 2 So why did the Commission propose amendments to 3 Rule 147 and Rule 504? We've heard from this committee, 4 we've heard from other commenters, and we worked very 5 closely with Mike and his colleagues at NASAA. And what 6 we heard is that specifically with respect to Rule 147, 7 this concept of limiting both the offer and the sale to 8 residents of a particular state was somewhat outdated and 9 difficult to implement, especially in an internet age 10 when you are trying to post your offering on the internet 11 and it's hard to limit how that offer is made only to 12 residents of a particular state, because as all of you 13 know the internet doesn't really know that you crossed 14 the boundary between one state and another. 15 So the -- these concerns led the -- and 16 additional developments in technology and communications 17 led us to believe that there was perhaps a need to 18 modernize that rule. 19 So what did the Commission specifically 20 propose? The Commission proposed creating a new 21 exemption from registration that would be Rule 147. 22 Instead of being a safe harbor, it would now be a new 23 exemption under the Securities Act that would permit 24 offerings to take part with respect to any person so long 25 as the sales were limited to residents of the same state 0143 1 in which the issuer is doing business. So you are no 2 longer limiting the offer aspect of it, but like the 3 current intrastate exemption, you continue to limit those 4 who purchase to residents of the same state in which the 5 issue is doing business. 6 The rule would also ease some of the other 7 requirements that exist in Rule 147 that would make it 8 available to a greater number of issuers to take 9 advantage of the rule. 10 The proposed amendments would limit the ability 11 of the new exemption to issuers that are either 12 registering the offering in state or issuers that are 13 making an offering under state law pursuant to an 14 exemption that limits the maximum amount that that issuer 15 could raise to no more than 5 million over a 12-month 16 period and that the state exemption also would have to 17 impose investment limitations, although it did not 18 mandate any specific investment limitations. 19 With respect to Rule 504, the proposal from the 20 Commission would raise the $1 million limit, which, by 21 the way, was set in 1988 and had not been changed since 22 then to $5 million and would also disqualify certain bad 23 actors for participating in Rule 504. The increase in 24 the aggregate offering amount would facilitate small 25 companies' ability to raise capital and also provide 0144 1 greater flexibility for states to actually come up with 2 coordinated review programs, regional coordinated review 3 programs as the maximum amount that could be offered and 4 sold would increase from 1 million to 5 million. The bad 5 actor disqualification is substantially similar to the 6 bad actor disqualification that applies to the other 7 portions of Regulation D. So in many ways it would 8 create consistency across Reg D with respect to who are 9 the bad actors that are not able to participate. 10 The comment period ended January 12th, although 11 we always welcome comments. And if comments are received 12 after that date, we'll consider them of course. The 13 Commission so far has received 26 comments on the 14 proposed amendments. And commenters generally were 15 supportive of the changes that the Commission proposed, 16 including the amendments that would permit this broad 17 dissemination of offers so long as the purchasers are 18 residents of the same state as where the issuer is doing 19 business. 20 However, many commenters did recommend that the 21 Commission did not replace the safe harbor in Rule 147 22 with this brand new exemption, but instead commenters 23 recommended that the Commission include the new exemption 24 in a separate rule and then retain but modernize to the 25 extent possible the safe harbor so that there would still 0145 1 be a safe harbor under Section 3(a)(11). 2 The final thing that I just wanted to briefly 3 touch upon is the work that the staff has been doing on 4 the accredited investor definition. Dodd-Frank required 5 the Commission to review the accredited investor 6 definition as it applies to natural persons. And Chair 7 White instructed the staff to prepare a report in 8 connection with the first review. Staff primarily form 9 CorpFin and DERA worked on the report, although we did 10 get help from a lot of the other offices and divisions of 11 the SEC. And the Commission published a report on 12 December 18th that is available on our website. 13 As many of you know and you've heard so far, 14 the accredited investor definition is a keystone of 15 Regulation D. And when it comes to natural persons, the 16 definition relies on two types of thresholds. 17 Accredited investors under the current rules 18 would be an individual who has an income of more than 19 $200,000 over the last two years and an expectation that 20 they will have an income would exceed that threshold in 21 the current year. And with respect to individuals who 22 are pooling their income with their spouse, it has to be 23 a joint income that exceeds $300,000. 24 The other threshold that is used to qualify as 25 an accredited investor would be for individuals that have 0146 1 a net worth, excluding their primary residence, of more 2 than $1 million. 3 The thresholds were primarily set in 1982. The 4 200,000 and the $1 million. The 300,000 joint income 5 threshold came in in 1988, and the taking out the primary 6 residence happened in 2011. There's been a lot of talk 7 about the accredited investor thresholds and the 8 accredited investor definition because they have not been 9 updated for inflation since the 1980s. The 200,000 would 10 be approximately 500,000 today, the 300,000 approximately 11 600,000, and the $1 million approximately $2.5 million 12 today. 13 So the staff put together this report that 14 considers a number of recommendations that have received 15 -- they've received recommendations from this committee, 16 they've received recommendations from the Investor 17 Advisory Committee, and they had already received a lot 18 of public comment with respect to the definition itself. 19 So the report not only provides 20 recommendations, but it also sets forth an analysis of 21 what the impact that those recommendations could have on 22 the accredited investor pool. 23 And so to give you a flavor for what the staff 24 recommended, the staff recommended that the Commission 25 could leave the current income and net worth thresholds 0147 1 as they are now in place, but subject them to -- those 2 investors to a 10 percent limitation. The idea here 3 would be that the amount that an investor could invest in 4 any one issuer would be limited, but investors at the 5 current thresholds would be able to continue to qualify 6 as accredited investors. 7 The staff also recommended creating a new 8 inflation adjusted threshold that would not be subject to 9 this investment limitation, for example a 10 percent 10 limitation. And it could be something along the lines of 11 what the adjusted for inflation numbers would be, around 12 $500,000 for individuals, rounding up about $750,000 for 13 joint income and $2.5 million for net worth. 14 The staff also recommended additional ways that 15 the Commission could consider for individuals to qualify 16 as accredited investors that are currently not part of 17 the definition. To give you an idea of some of those, 18 many commenters have suggested that they would be 19 supportive of a minimum amount of investments thresholds. 20 So once investors have indicated that they have invested 21 more than a certain amount, then those individuals would 22 qualify as accredited investors even if their net worth 23 or their income doesn't meet the thresholds. 24 The staff also recommended considering 25 professional credentials to qualify as accredited 0148 1 investors. So for example if you've taken the Series 7 2 or the Series 65 or the Series 82 examinations, perhaps 3 those examinations could be evidence of investor 4 sophistication because of the subject matter that those 5 examinations cover. 6 The staff also recommended looking at 7 potentially investor experience. So if an investor had 8 previously participated in 10 prior private securities 9 offerings with respect to different issuers, perhaps that 10 individual has presumably developed the knowledge and has 11 done the due diligence and understand valuations, things 12 that they've learned through the process of investing in 13 those 10 prior offerings. 14 The staff also considered including 15 knowledgeable employees of private funds that would 16 qualify as accredited investors with respect to the 17 investments in those employer funds. The idea there is 18 that these employees would have significant investing 19 experience or would have sufficient access to the 20 information since they are working for the funds in which 21 they're actually investing in. 22 And then finally the last thing I was going to 23 mention -- and the report goes through a number of 24 suggestions also with respect to non-natural persons, as 25 to how the Commission could expand the definition or 0149 1 revise the definition. But the last thing I wanted to 2 mention is there's a lot of talk about the possibility of 3 an accredited investor examination and the staff 4 recommended that the Commission could explore the 5 possibility of designing such an accredited investor 6 examination. The idea of this approach would be to 7 enable financially sophisticated individuals to qualify 8 as accredited investors regardless of their wealth or 9 education by actually proactively demonstrating that they 10 can pass an examination that in many ways would look at 11 their sophistication when it comes to investing in 12 private offerings. 13 So the last thing I leave you with is what 14 would be the impact of some of these recommendations. If 15 the Commission were to only adjust for inflation, the 16 current thresholds, the current pool of the population 17 that qualifies as accredited investor is approximately 18 10.1 percent, and that pool will go down to approximately 19 3.6 percent. 20 If, on the other hand, the Commission were to 21 adjust for inflation but also come up with new threshold 22 levels -- I mean retain the current threshold levels but 23 impose a 10 percent limitation plus also come up with an 24 investments test, in essence the idea of if you have a 25 certain amount of investments, then you would be able to 0150 1 qualify as an accredited investor, our calculation from 2 our colleagues in DERA will show that the current pool of 3 10.1 percent would go up to about 11.5 percent. 4 What these figures don't account for is all the 5 other recommendations that in many ways are not 6 quantifiable to us because a lot of those tests that look 7 at other measures of sophistication, we expect that they 8 would only increase the size of the pool, but we don't 9 have data to quantify how much by how much they would 10 increase the size of the pool. 11 So I've already taken a lot of your time. 12 Joanne, I don't know if you wanted to say 13 anything about finders and -- 14 MS. RUTKOWSKI: I guess it's no news is good 15 news on finders. It's really -- I was listening to 16 Sebastian talk about crowdfunding. It reminded me about 17 we always have this tension in the broker-dealer space 18 because the scope of the definition is so broad, and 19 there's so many different types of limited purpose 20 broker-dealers. And that certainly is something that 21 we've been studying and we're trying to develop 22 approaches. 23 But at the same time, broker-dealers, 24 intermediaries, folks who are playing with other people's 25 money play an important role as gatekeepers. I mean even 0151 1 funding portals in the final rule have a safe harbor that 2 allows them to determine whether and under what 3 conditions to admit -- I'm sorry, issuers to their 4 platform. 5 So it's a serious endeavor, it's a balancing 6 act, there are some no action letters out there. We did 7 the M&A broker no action letter a few years ago. Paul 8 Anka is still kicking around. FINRA is trying to step up 9 to the plate, I think, with the crowdfunding initiative. 10 They had to revisit the rule book. I know they have out 11 for comment with us the capital acquisition brokers. And 12 there's a March deadline on that. 13 So I guess the short answer is the staff is 14 continuing to study, but it's not an easy answer. 15 MR. GRAHAM: Is there any thought of interim 16 steps? 17 MS. RUTKOWSKI: I think we're open to the full 18 range of possibilities. 19 MR. YADLEY: Hi, Joanne. I'm usually the voice 20 of reason. And I totally agree with what you said. You 21 weren't hear this morning. We touched on this briefly. 22 There are no easy answers, but I think this committee 23 made recommendations last time and we did have a whole 24 range of ideas to think about. While we may not get to 25 the finish line and there may be differences of viewpoint 0152 1 on this committee, within the staff, at the Commission 2 level, it really doesn't seem to us that we shouldn't do 3 something and propose. Because not that more study 4 wouldn't reveal more nuances, but since the ABA taskforce 5 report in 2005, I think we've pretty much identified 90- 6 plus percent of the issues. 7 And so just speaking as a member of the 8 committee, I hope that we will move from the study phase 9 to a proposal stage and I think the chairs and the rest 10 of my fellow committee members can weigh in, but I think 11 we are very willing to be a part of that process and be 12 helpful, and our prior recommendations sort of set the 13 table for not just studying but making some 14 recommendations, and I hope you will. 15 MS. RUTKOWSKI: Thanks, Greg. I appreciate it, 16 and I will take the message back. 17 MR. REARDON: I deal with this issue regularly. 18 I have small clients. And it's very difficult when 19 somebody shows up with a -- to your client and says I can 20 raise a million dollars for you with my rolodex and they 21 don't have a license. It's very hard to convince your 22 client that this person is probably promising what he or 23 she cannot deliver and in addition is going to get them 24 in trouble for violating the law. 25 Frankly, I've lost a number of clients over 0153 1 that, over my refusal to be involved with that. And this 2 has been going on for years, and I've spoken to -- who 3 was the head of CorpFin during Mary Shapiro? 4 PARTICIPANT: Meredith Cross? 5 MR. REARDON: Yeah, I spoke to her. She put me 6 touch with somebody in the Fort Worth office of the SEC. 7 I talked to her and she said, well, can you give me some 8 names. So I gave a name, somebody who's within the 9 shadow of the building at the SEC's offices in Fort 10 Worth. Nothing ever happened that I saw. 11 I went back and looked at the Daniel meetings 12 that are held in November that all the studies are on 13 there. And without looking very hard, the furthest back 14 I found was 1997 that a recommendation was made that this 15 be dealt with. Okay? So -- and there have been a 16 multitude of studies. You've written a paper on it. I 17 mean frankly I think it's -- the bar at least has taken 18 this as far as it can be taken. I heard somebody who's 19 on the staff this year told that a lawyer who's 20 interested in this that this person at the SEC would not 21 have time to get to this this year. 22 First of all, I'd like to meet somebody who's 23 so busy they don't have anything else to do for a year. 24 That's impressive. But I think where -- from my 25 standpoint that this has been studied almost as much as 0154 1 the Torah and the New Testament. And somebody, either 2 the Commission decides they're going to ask on this and 3 get serious about it or don't waste our time on it. 4 Okay? And frankly I'm tired of being your enforcement 5 division on this issue. And there are a lot of crooks 6 out there that are stealing from small business people or 7 wasting their time, and it needs to be dealt with. But 8 no more study is needed. 9 MS. HANKS: If I could just add to that one 10 again and just to build on what Greg was saying, in 11 addition to -- since the taskforce stuff came out, I mean 12 we now have the whole online capital formation platforms, 13 and I'm seeing all the time the guys who are trying to 14 comply with the law are at a disadvantage with the guys, 15 and it's really not fair to them. 16 There are some platforms out there totally 17 violating the broker-dealer laws however interpreted, not 18 within any no action letter, because they're like we 19 don't need any stinking no action letters. They're just 20 doing their thing. And they say literally it must be 21 legal, nobody's been arrested for it. I get that quote a 22 lot. 23 And on the other hand, you've got the companies 24 who are using them. If you're using an unregistered 25 broker-dealer, you now have a rescindable transaction, so 0155 1 they've got a problem. And the good guys have a problem, 2 too, the guys who are saying, well, I went out and I had 3 to study for the Series 7 and it took me a while, but now 4 I've done it. So it's a matter of equity. 5 MS. RUTKOWSKI: I very much appreciate 6 everything you're saying and I will take it back. 7 MR. GRAHAM: Any other comments on finders 8 versus brokers? I do think that our recommendation was 9 very complete, that -- I don't know what more we could 10 say, but I think if I remember right, in our 11 recommendation we did talk about the possibility of 12 taking interim steps, understanding that there -- I mean 13 we're here to try to find ways to facilitate capital 14 formation by small businesses. 15 And I don't know the extent it would help, but 16 intuitively you just have to feel that coming up with a 17 rule that's going to enable the people with the rolodex 18 and not receive transaction-based compensation and all 19 the rest would go a long way toward it helping with the 20 situation that we talked about this morning in terms of 21 trying to let -- trying to educate small businesses as to 22 how they can go about and access capital and educate them 23 and who they might go to. I think maybe we need another 24 study just for that, and I'm only being partially 25 facetious. 0156 1 I think the important point is that we should 2 be able to do something and I'm fairly confident that 3 even though it might appear to be small that it might 4 prove to be significant. 5 The accredited investor definition, has 6 everybody seen the report? You should -- if you haven't 7 seen it, you should download it or just put it on your 8 screen and take a look. Yeah, I think that one of the 9 things that we should do as a committee is take a good 10 look at that report and see to what extent there may be 11 other suggestions that we might want to give in addition 12 to the recommendation that we provided last term. 13 And I know that our member, Patrick, has 14 submitted a letter for one and I think that it probably 15 would make sense for us as a committee to take a look at 16 that report and take the opportunity to weigh in. 17 Do you have anything else? 18 MS. MOTT: Stephen? 19 MR. GRAHAM: Yeah. 20 MS. MOTT: I'm sorry. I was hoping we would 21 address this. So thank you. And I know that the Angel 22 Capital Association, the public policy committee is about 23 to submit a letter as well. I do think this is important 24 for us to address because it can have a significant 25 impact on the amount of capital -- seed capital that's 0157 1 available for companies to get off the ground. So 2 critically important. I just want to emphasize it is -- 3 your numbers I think are pretty close to the impact that 4 it's going to have on the pool of investors. So 5 important for us to address. Thanks. 6 MR. NELSON: Just two comments. One is could 7 we actually have that report emailed to us? 8 MR. GOMEZ: Yes, we'll do that. 9 MR. NELSON: I'd also just be interested in 10 getting kind of a gut feel from the other members of the 11 committee whether they feel that more -- looser standards 12 or stricter standards need to actually be created? Do we 13 need more investments into small businesses and loosening 14 the pool of available capital or because do we need to 15 actually tighten up because of instances of fraud and 16 that sort of stuff? 17 I'd be just curious to see where everybody else 18 is. I have -- I hang out with entrepreneurs all the 19 time, so the more capital is available to them, the 20 better. I've seen in maybe 10 years two instances of 21 just outright fraud. But that's just me. 22 MR. GRAHAM: Yeah, well, it's -- I'll let other 23 people respond. But again, we're faced -- kind of the 24 core issue that we're dealing with, if you will, is 25 removing the barriers to capital formation for small 0158 1 business. And certainly when this committee took up the 2 issue and formulated a recommendation, our sense was kind 3 of just that as far as the points that you're making, and 4 that is that we're dealing with a system that currently 5 works. I don't know what the numbers are. It's 6 somewhere between a trillion and two million and two 7 trillion I guess and as far as magnitude of the market if 8 you will. 9 MR. NELSON: Could I just interject right 10 there? What I saw in the report when I read it last 11 night wasn't $2 trillion. That was funds and all private 12 capital. But small business was 166 billion of that 13 paper. I could be wrong, but that's what I saw was only 14 166 billion. 15 MR. GRAHAM: That could be. Anyway, it's -- 16 however you want to kind of define small business, just 17 kind of looking at the private placement market, it's 18 big. And that is -- we all know that that is written by 19 506, and I guess in today's lingo, Rule 506(b). And so 20 you've -- you have a market, it's clearly substantial, 21 it's clearly important from the standpoint of our economy 22 and job creation and all the rest. And so why constrict 23 that? Why come up with a set of rules that are going to 24 -- intuitively you would think would hurt that market and 25 hurt the -- and reduce the amount of capital that's 0159 1 available? 2 Well, one way might be the existence as fraud 3 as you suggest. And certainly one of the things that we 4 have to keep in mind is investor protection. We all kind 5 of understand that. But I'm not really aware of an issue 6 that relates to fraud that can somehow be tied back to 7 those thresholds. 8 MS. HANKS: I think that's true. If we look at 9 what happened in the presentations to this committee last 10 session where we did have some presentations on the 11 existence of fraud. Yes, there is fraud in the private 12 market sometimes, but it is not driven by where the 13 definition of accredited investor is, and nobody's been 14 able to come up with any evidence that that was the case. 15 MS. TIERNEY: I think I'd also note the last 16 time that the definition of accredited investor was 17 amended was Dodd Frank. And the investor's primary 18 residence was backed out of the equation of net worth, 19 and that decreased the pool of people who could invest I 20 think at that point from like 9 percent to 7 percent. 21 And that had a big impact on the market just then. 22 The idea of increasing dollar thresholds in a 23 market where there's no real investor protection issues 24 that anyone can point to with specificity, potentially 25 decrease it to 3.6 just because there's a construct that 0160 1 things should have been adjusted for inflation makes no 2 sense. And I think that everything that we see, 3 especially people who are retail investors and not even 4 accredited investors who get so unhappy that they can't 5 invest in the private company space in 506 already, it 6 just doesn't make sense to go to a more restrictive 7 definition. 8 MR. GRAHAM: And that's also assuming that the 9 initial numbers were -- 10 MS. TIERNEY: Agree. 11 MR. GRAHAM: -- too high. I mean maybe -- or 12 too low or something. It assumes that they were correct. 13 MS. TIERNEY: I'd like to see the numbers drop. 14 MR. GRAHAM: There's two. 15 MR. HAUPTMAN: Just to Jonathan's question, I 16 know we're not having a poll here, but that would be 17 three votes here for reducing the standard. I'm not 100 18 percent convinced that on the whole having an accredited 19 investor standard is useful to begin with provided all 20 parties agree that those who engage in fraudulent 21 activity should have the book thrown at them. Accredited 22 investor standard does not exist in other countries, and 23 things still work out over there as well, other places. 24 And to protect the investor, protect from 25 fraud, fair enough. Again, that's a prosecution's war. 0161 1 But I would expand the definition of protection. The way 2 you can help protect me is by letting me invest in a 3 company as I'd like to. 4 MR. GRAHAM: Catherine. 5 MS. MOTT: one of the things I want to add for 6 the committee is that when the Angel Capital Association 7 looked at how this is going to impact the angel groups in 8 the United States, it really impacted the middle part of 9 America. It didn't impact LA, it didn't impact Boston or 10 New York. Because 500,000 in New York is like making 11 250,000 in Cincinnati, Ohio or Pittsburgh, Pennsylvania, 12 whatever. I mean I look at the composite of our local 13 angel group as surgeons who make 300, 350, but if they 14 were living in New York, they would be making 500. 15 So the decrease is -- 16 (Interruption to proceeding.) 17 But anyways, it's really -- the economic impact 18 of middle America is going to feel it the most, and 19 that's where it's going to hurt the most. So -- 20 MR. GOMEZ: I just wanted to point out and be 21 clear when I gave the numbers the only adjusting the 22 numbers for inflation actually is not a recommendation in 23 the staff study. But there's been enough discussion 24 about it that I wanted to throw that number out there. 25 The 11.-some percent would be the number if you were to 0162 1 actually do all of the staff recommendations. If you 2 were to only impose a 10 percent limitation, granted the 3 pool would stay the same. 4 Where a -- I don't know, Catherine, based on 5 your membership, as to whether if you're limiting how 6 much someone can invest by 10 percent, whether that would 7 actually cut the dollar amount or not. I mean I think 8 that's an interesting question. 9 MS. MOTT: Actually we go through an 10 orientation program with our investors, and we actually 11 recommend that they limit 5 to 10 percent of their net 12 worth. But we also encourage them to spread it across 13 several different companies because it's a risky asset 14 class. So minimum 10, but we encourage you to go to 18 15 to 25. And actually the data shows -- well, from some of 16 the studies out there, there's still a minimal amount of 17 data out there in the studies. 18 Once you get up to 36 percent, you even have a 19 better chance of -- but it's -- so we do encourage that, 20 to limit it to that. So -- and we've always encouraged 21 them not to include their residence, even prior to it 22 being promulgated. So I mean it's just -- so, yeah, I 23 hear you, but I'm just -- I get nervous when I see the 24 number 500,000, but -- who will be impacted, so -- 25 MR. GRAHAM: So isn't -- I don't know where I 0163 1 come out on this exactly, but isn't it kind of 2 paternalistic to tell people how much they can invest or 3 not? And is that really what we should be in the 4 business of doing? 5 MS. MOTT: Yeah, we don't tell them. We advise 6 them. 7 MS. HANKS: I would say anyone who's been 8 through the Angel Capital Association training program 9 should automatically be admitted as an accredited 10 investor because -- 11 MR. GRAHAM: Good point. 12 MR. YADLEY: And I guess that's one of the 13 things, getting beyond the inflation adjustments and the 14 numbers, the other thing -- and I think the staff and the 15 staff study are terrific because we all agree that the 16 number, whatever it is, $200,000 a year, a million 17 dollars net worth is just a number. As Steve pointed 18 out, it really hasn't been a problem for decades, so -- 19 but okay, we can quibble about whether that number should 20 be adjusted. 21 But beyond that, the other ideas for expanding 22 the pool makes perfect sense because we all know that 23 those numbers are just a proxy for people who need less 24 protection than other people. So people that have 25 credentials and background and experience investing or 0164 1 through their education or jobs, I think, again, that's a 2 great way to allow them to be part of America's culture 3 of capitalism and democracy. And we should promote that. 4 And by the way, it will lead to job creation, which 5 we're all in favor of. 6 MR. GRAHAM: Kyle. 7 MR. HAUPTMAN: For all the talk of inequality 8 that we hear about these days, it would seem odd to me to 9 have our official policy be that the best investment 10 opportunities are limited by law to the 1 percent. Only 11 they can get the top investment opportunities. And one 12 of the ways that one becomes the 1 percent is via 13 entrepreneurship, which we are also making more difficult 14 for them to do. 15 We're trying to protect this club -- we're not 16 trying to, but this could be the effect -- protect the 1 17 percent. Number one, you get the investment 18 opportunities, and number two, no one will be clamoring - 19 - fewer people will be clamoring to join you in that 20 group because their startup idea we're making harder to 21 fund. 22 MR. GUTIERREZ: I'd like to make a comment. I 23 often say that the issue is not access to capital, but 24 the issue is because there's quite a bit of capital out 25 there. And so I look at it from the perspective of the 0165 1 small business owners. Right? And if we are creating a 2 regime and we are creating a platform whereby we're 3 limiting the capital that exists out there, the ones who 4 are really going to be impacted are going to be those 5 business owners. So I'd like to change the framework of 6 -- this conversation as you've pointed out, Steve, is 7 about capital formation opportunities. And for us to be 8 limiting opportunities I feel is really going against 9 that basic tenet. 10 The second point I wanted to make is I think 11 dovetailing on something that Kyle mentioned, which is I 12 do believe there's a dubious connection between someone's 13 net worth and their financial sophistication. I know 14 plenty of folks who are financially very successful who 15 quite frankly would be considered unsophisticated 16 investors, and I think it would be a shame if we begin to 17 limit those who are allowed to put their money wherever 18 they'd like to based on what they've already accomplished 19 financially. 20 MR. GRAHAM: Thanks. Jonathan. 21 MR. NELSON: One of the things that I'm also 22 sensitive to is having been in kind of public service 23 roles before, when you get it right, no one knows, but if 24 you get it wrong, you're in the newspaper sitting in 25 front of Congress. And that's an awful job. And I thank 0166 1 you guys for your service, because it's amazing what you 2 guys are attempting to do, which is prevent all of 3 America from fraud and create markets. 4 But I think on this side of the table not being 5 the public servant but someone kind of being out there in 6 industry, I would like to think as a committee how do we 7 communicate very, very strongly that I, for instance, 8 want much more access to capital, and I very much want 9 not to protect investors from themselves, but to truly 10 protect them from fraud. Those are where we want the 11 things, the lines to be drawn. 12 These are my opinions and not necessarily those 13 of the SEC. 14 MR. GRAHAM: Well, thank you for that, 15 Jonathan. 16 Can we move on now? Okay. So at this time I'd 17 like to ask Annemarie to -- with your discussion on what 18 the advisory committee recommended last term with respect 19 to 4(a)(1 1/2) and its codification into 4(a)(7). It's 20 all yours. 21 MS. TIERNEY: Well, I had the honor of 22 presenting this committee last March, almost a year ago, 23 about what we saw was a market need to create a new 24 exemption in the private company space for resales of 25 securities, which was a codification of a legal construct 0167 1 that's referred to as 4(a)(1 1/2). And at that point 2 there was a bill in Congress that created a new federal 3 exemption. 4 That bill was signed into law by the President 5 on December 4th of last year, and it basically creates a 6 new safe harbor for resales of private securities. 7 Buyers have to be accredited, and there can't be general 8 solicitation. 9 There is information requirements, so the 10 exemption is only available to a seller if an issuer 11 consents to provide certain information, including two 12 years of financial statements prepared in accordance with 13 U.S. GAAP or IFRS if it's a foreign company. Information 14 about the company's business, names of their officers and 15 directors, some kind of routine things like the name of 16 the issuer, which I don't think is a problem for most 17 companies, their address, title and class. 18 The nice thing about the exemption is it gets 19 rid of a lot of noise around 4(a)(1 1/2) that existed in 20 the space where Steve and I and many of you operate, 21 which is private company, kind of later-stage private 22 companies that have a significant employee or former 23 employee base who have trouble getting value for their 24 equity unless they can locate a buyer, sell the 25 underlying common stock to fund the exercise of the 0168 1 options and the income tax consequences. 2 And what we were seeing was a mixed bag of 3 opinions from different law firms that we were working 4 with where some law firms were very comfortable if 5 somebody used the proceeds of the underlying -- sale of 6 the underlying common to cover the cost. 7 Some were not comfortable with that, so we were 8 seeing some companies requiring their employees to sign 9 promissory notes or give checks to the company in order 10 to participate in the liquidity program where the options 11 were being exercised. So there's just a lot of noise 12 around the space. 13 The other thing about 4(a)(1 1/2), since it's a 14 legal construct, it's not actually a safe harbor in the 15 rules. It wasn't -- resales were not preempt under state 16 law, so as an intermediary in the private company space, 17 it was virtually impossible for us as a broker-dealer to 18 help locate buy-side interest. 19 The state law that deals with broker-dealers 20 says that the bid has to be unsolicited, which is the 21 flip from the primary space where if you're a broker- 22 dealer and you have a preexisting relationship with your 23 clients, you can market primary opportunities as long as 24 the investment is suitable to them. In the secondary 25 space, you can't market opportunities at all. And that 0169 1 just didn't make any sense to us. So 4(a)(7) gets rid of 2 that problem as well by creating preemption. 3 Securities still under 4(a)(7) are covered 4 securities. And so it's just another tool in the box of 5 shareholders and employees of private companies to allow 6 them to get liquidity for their shares to the extent that 7 the company is willing to provide the information. So 8 we're really excited about it. 9 You don't have to hear me talking about the 10 need to codify 4(a)(1 1/2) which you've been hearing for 11 three years-plus. So I'm sure this is very exciting to 12 Sebastian and all of the people at the SEC as well. 13 MR. GRAHAM: Do you have a sense of the impact 14 it's going to have on secondary market liquidity? 15 MS. TIERNEY: One thing that we thought would 16 be really interesting -- and we're going to put this out 17 in the next week or so -- was we did a review of all of 18 the secondary liquidity programs that we'd done over the 19 past two years, and we looked at the information that 20 issuers provided to participants in our market to get a 21 sense of where there might be friction points that might 22 be uncomfortable. 23 What we found that was in about -- I think the 24 number is 74 percent of the cases -- 74 percent of the 25 transactions that we did, U.S. GAAP financials were 0170 1 provided. That was a good percentage. We were pretty 2 happy with that. Some of the companies that we work with 3 didn't have U.S. GAAP financials. They just provided 4 financial statements. But 74 percent provided two years 5 of GAAP financial statements. 6 Another requirement is that if the balance 7 sheet is more than six months old, you have to provide 8 interim financial statements. That we saw less of, I 9 think 38 percent of the transactions that we did, 10 included interims. And I think the market -- and 11 Stephen, he probably knows better than I, but I just 12 don't think the market put that much emphasis on 13 interims, and companies didn't really consider them to be 14 that material because they were growing so fast or they 15 were expanding in different ways. So that's something 16 that we felt was interesting. 17 So I think that what's going to happen is that 18 to the extent a company is sponsoring a liquidity event, 19 they're either allowing their shareholders to transfer 20 securities to a buyer and they've got a good relationship 21 with the seller or they've engaged a platform or some 22 kind, NASDAQ, private market, whomever to actually 23 facilitate the liquidity program. 4(a)(7) is going to 24 become the exemption of choice because it clears out all 25 the noise around the opinion practice and also the cost 0171 1 of the exercise. To the extent the issuer is not willing 2 to provide information, 4(a)(7) also makes it very clear 3 that it's a non-exclusive safe harbor. So 4(a)(1 1/2) 4 construct still exists as currently applied. So now you 5 have two options. 6 The only other exemption that we really see 7 utilized our in our space is Rule 144. And in the 8 private company space, that means you have to hold the 9 stock for 12 months, and it doesn't include tacking 10 period for holding options in most cases. So for most of 11 the people that we work with, the shareholders that we 12 work with, they can't satisfy 144. So, again, 4(a)(7) is 13 an excellent choice for them and 4(a)(1 1/2) still 14 operates to give them more choices. 15 MR. GRAHAM: Do you see from -- do you see the 16 potential for friction in the -- kind of in the new 17 4(a)(7) rule related to the information requirement and 18 the potential liability of issuers? 19 MS. TIERNEY: I've heard that question a bit. 20 I would think that to the extent that an issuer is 21 providing disclosure, it has -- in the context of the 22 exemption, the information is to be provided to sellers 23 and buyers. I don't think there's an increased level of 24 information. If a company is providing fraudulent 25 information, it has liability already under the 0172 1 securities laws. So I don't think there's a greater 2 degree of liability. And again, it's the company's 3 option if they want to provide the information. 4 MR. GRAHAM: Is there anything else that you 5 think we need to do as a committee to bring additional 6 clarification to anything? 7 MS. TIERNEY: There are some -- I think the 8 part that's tricky is that the exemption's built into the 9 statute, not into a rule. So the staff doesn't have the 10 ability to actually make changes themselves I don't 11 think. So we are actually working with some members of 12 Congress on some technical amendments that we think would 13 be helpful where there's terminology used that's not 14 specific to the securities laws. 15 So it that goes forward, I'm sure I would come 16 back to the committee and sort of let you know what we're 17 doing and potentially get a recommendation, if you all 18 agree, to support a technical amendment. 19 And one of the things that took us by surprise 20 was the change of the information requirement to 21 something that the purchaser can wave which was in an 22 earlier version of the bill to the actual requirement 23 that it be provided. So we think we're still working 24 through that concept as well. 25 MR. GRAHAM: Okay. We were supposed to spend a 0173 1 moment or two on what's happening on the congressional 2 side of things, and I skipped over that. 3 Sara. 4 MS. HANKS: Because it's less interesting, I 5 think, than what Annemarie was talking about. One thing 6 with respect to the 4(a)(7) changes, which I think were 7 good as far as they go, it's not the answer to -- it's 8 not the liquidity answer that we're looking for yet. 9 There is other stuff that needs to be done. I mean one 10 of the things that 4(a)(7) answers is the ability when 11 you are doing a resale to an accredited investor, you can 12 now not have to bother with state regulations, and that's 13 nice. But we need that for all of the private market 14 securities that are going to be traded, and that does not 15 yet exist. 16 So I'm going to totally gallop through a few of 17 the congressional initiatives that are out there just to 18 make sure that everyone knows what's out there and who 19 knows whether any of these will ever go anywhere in that 20 we are now just a few days away from Super Tuesday. So 21 who knows whether this will go anywhere. 22 There's been a lot of interest in Congress in 23 making changes to the securities laws for fostering 24 capital formation over the course of the last few years. 25 The JOBS Act, of course, and all of the various 0174 1 initiatives that were gathered into the JOBS Act is one 2 of the best examples of that, but this is a continuing 3 process. And there's a few bills floating around 4 congress at the moment that could eventually end up being 5 JOBS Act 2.0, 3.0, whatever you want to call it this 6 week. 7 On February 1st, the House passed with 8 overwhelming bipartisan support a bill that would amend 9 the definition of accredited investor in Section 2(a)(15) 10 of the Securities Act, which relates to Section 4(a)(5) 11 of the Securities Act, which is an exemption that I did 12 not mention this morning because it doesn't get used. 13 The staff would never be able to say this, but it's an 14 identical definition for an unused exemption that is 15 identical to the one that does get used in Regulation D. 16 I am assuming -- and the staff does not have to 17 answer this, of course, that the staff would likely, as 18 they have done in the past, change both definitions in 19 tandem, because that would be the logical thing to do, 20 and I don't think they have any prohibition on that. 21 What the definition would do is some of the 22 things we've just been talking about: codify current net 23 worth and income thresholds, include persons who the SEC 24 determines by regulation to have demonstrable educational 25 job experience to qualify such persons of having 0175 1 professional knowledge of a subject related to a 2 particular investment such that they're allowed to be 3 accredited investors. And the SEC, of course, can expand 4 this. 5 There is another set of bills that would 6 establish the Office of the Advocate for Small Business 7 Capital Formation, which would, in effect, take -- 8 probably take this committee and make it a statutory 9 committee, appoint an advocate for the business sort of 10 parallel to the current investor advocate, which is a 11 separate office within the Commission and also require 12 the Commission to respond formally to the recommendations 13 made in the annual meeting every year that the -- I 14 forget what it's called now, but the Small Business Forum 15 is the short name. 16 Anyone watching who isn't aware of this, this 17 happens usually the week before Thanksgiving every year, 18 and it's a really entertaining and democratic process 19 where a lot of people other than the usual talking heads 20 can be heard by the Commission. So, everyone, that is 21 webcast and that's -- all that the afternoon breakout 22 sessions are usually broadcast by phone, and so people 23 should participate wherever they are. 24 Also, February, the House passed a package of 25 bills titled: The Capital Markets Improvement Act of 0176 1 2015. It's got a number of different elements, including 2 changes to Rule 701, which is an exemption for securities 3 issued to compensatory benefit plans, E swaps, which 4 would increase the level at which a written plan has to 5 be disclosed. There's -- it would also include the M&A 6 broker exemption that we talked about earlier, the 7 exemption that the SEC has issued by no action letter to 8 certain people acting as M&A brokers or business finders 9 put that into law. It's fine as far as it goes, but it's 10 already in the no action. 11 It would -- the collection of bills would also 12 exempt emerging market -- emerging growth companies from 13 having to use XBRL, which is the tagging system whereby 14 you say this is our net revenues, and it's always -- so 15 that somebody who searched doing machine searching of 16 filings could compare apples to apples in a company's 17 accounts. It's a useful idea, but it is very difficult 18 to do in some circumstances. So that burden would be 19 reduced, and there's also a proposal that the SEC be 20 directed to draft a rule providing a safe harbor for 21 covered investment fund research reports. 22 Whether any of these are going to go anywhere 23 is debatable. A veto threat is a possibility with 24 respect to that last collection that I mentioned. And as 25 I said, we're a few days away from Super Tuesday, so who 0177 1 knows. 2 MR. GRAHAM: Nice wrap-up. Thank you. 3 Well, again, one of the questions that we have 4 to keep asking ourselves is: What is in the way of 5 efficient capital formation for small business? As I 6 mentioned earlier, in terms of useful rulemaking and 7 policy, I think that three things that seem most 8 important to me, and that's liquidity, complexity and 9 certainty. 10 I think in terms of liquidity, no one is going 11 to get into something if they can't get out of it. In 12 terms of complexity, rules that should take you to a good 13 place are -- it's a nice idea. But if they're so complex 14 that they -- as to be not useful, then of course they 15 become not useful. Certainty is the other one. It's -- 16 make sure that the whatever rules that we have out there, 17 there's some degree of certainty associated with it. 18 I think that's one reason why -- I mean I don't 19 know, but I think that's probably one reason 506(c) is 20 slow on the uptake because of all of the uncertainty that 21 kind of surrounded verification. I guess that seems to 22 be settling down a bit, but we'll see what the future 23 holds. But I think we've talked about a few things today 24 that probably are worth following up on. The definition 25 of accredited investor, no need to say anything more at 0178 1 this time, but I reiterate that everyone should get a 2 copy of the report and read it and let's start exchanging 3 ideas. 4 The -- we talked about, again, the issue with 5 finders versus brokers. That's -- I think many of us 6 think that that's important, and I think many of us think 7 that small steps could be taken that could have a 8 noticeable impact. 9 The whole issue with respect to one-size-fits- 10 all in the markets, that's one that I think continues to 11 be significant. I think people understand that fact, but 12 there's still I think work to be done in order to find a 13 way to structure markets so they're more conducive or 14 more friendly to smaller public companies. 15 And then of course we talked about outreach. I 16 think that's something that we haven't focused on, I 17 think sufficiently. And again, whenever -- when you 18 think of outreach, you tend to think in terms of trying 19 to educate the companies, trying to educate the issuers. 20 But I think this may include also educating capital 21 sources and maybe thinking in terms of partnering with 22 industry groups. 23 There's much work to be done, and as in most 24 cases, we have to be careful not to let perfection be 25 kind of the enemy of the very good. And so I think that 0179 1 hopefully we can begin to take some incremental steps 2 that will have a real impact. And with that, I wanted to 3 give everybody an opportunity to give some of their ideas 4 before I wrap things up. 5 So, Catherine. 6 MS. MOTT: Thank you, Stephen. Stephen and 7 Sara, could we possibly review the definition of general 8 solicitation? Here's my thoughts about that is that -- 9 and I think that's why you see more 506(b) offerings than 10 you do (c). If we could, carve out demo days or what we 11 call demo days, venture fair, pitch competitions as not 12 general solicitation. 13 I think that a lot of attorneys are saying to 14 their clients, look, when you go to these demo days, 15 don't talk about raising money; just talk about what your 16 company does because you're going to cross that threshold 17 that means you have to file 506(c), and you can't go back 18 and file for 506(b) once you go down that path. 19 And so what that then does is then the whole 20 venture community says, well, forget it, I don't want -- 21 look at this company now. So I think we have some -- we 22 could simplify that definition so that we understand it 23 so that the issuers understand how they play in the 24 marketplace. 25 MR. GRAHAM: Thank you. 0180 1 Sebastian, I can't call up those CDIs. Is -- 2 MR. GOMEZ: Catherine and Steve, I think that's 3 a good topic to touch upon. There is no black and white 4 definition of what general solicitation is. The staff 5 has been getting a lot of questions or had been getting a 6 lot of questions as to what constitutes or doesn't 7 constitute. The staff provided some guidance in the form 8 of CDIs. 9 There was also no action letter that the staff 10 issued last year providing some insight on that. But I 11 think if the committee desires to do so, that might be an 12 interesting topic where we could get someone from the 13 staff to present to the committee as to what the staff 14 has done with respect to interpretive guidance and no 15 action letters. 16 MR. GRAHAM: So this might be another situation 17 where we're moving the ball forward, but maybe we're at 18 the 50-yard line in terms of having sufficient certainty? 19 MR. GOMEZ: I just -- I'm not sure where the -- 20 MR. GRAHAM: 30-yard line? 21 MR. GOMEZ: -- goal line is. And I think if you 22 ask different people -- 23 MR. GRAHAM: 15-yard line? 24 MR. GOMEZ: -- where the goal line is, I think 25 people would have different ideas. And in part it's 0181 1 because general solicitation is not black and white, and 2 it's facts and circumstances. So in many ways what the 3 staff was trying to do was provide some guidance as to 4 the things that may be and may not be general 5 solicitation. 6 It used to be that about 20 years ago there was 7 quite a lot of no action guidance in this area, and then 8 in many ways what the staff did is go back and look at 9 that no action guidance in the form of CDIs. And the new 10 letter that the staff provided in essence update, bring 11 forward that guidance. 12 In some respects it did not change from what 13 was before, and in some other respects there was what 14 some may view as potential expansion as to what had been 15 done before. So it might be a topic that is worth for 16 the committee to hear from the staff and then the 17 committee can always decide whether we are on the 50-yard 18 line or whether we are almost at the touchdown. 19 MR. GRAHAM: All right. 20 MR. YADLEY: I think that's a great idea. I 21 was yesterday talking with a British friend. An American 22 was saying he thought he liked cricket, but he was always 23 confused because he never knew when the game ended, and 24 there actually are rules for when the game ends. 25 So I think where the goal line is is very 0182 1 important, and so I think the Commission and the staff 2 should be commended for bringing out the lore and the 3 prior guidance which was there and expanding it to the 4 extent you can, and I think our committee may have views 5 about in the same way that Rule 147 has changed with 6 technology and practice and communications that the goal 7 line may in fact have moved in a way that we can promote 8 capital formation and still protect investors and stay 9 true to the language of the statute. 10 MR. GRAHAM: Annemarie, were you going to -- 11 MS. TIERNEY: If we're going to stay on the 12 general solicitation -- and that could be a little, kind 13 of drilled down, I think one of the things that's in the 14 current non-exclusive safe harbor for verification which 15 is a real kind of friction point is that if you're 16 verifying somebody under net worth, they -- it's only 17 good for 90 days. And the documents have to be within a 18 certain number of days. 19 Under self-certification under -- for 506(b) 20 purposes, people certify one time a year that they're 21 accredited. So I don't understand why for 506(c) 22 purposes now you're putting people in a bucket where they 23 have to potentially be certified at least once a quarter. 24 And I know for angels that we were dealing with, it was 25 really painful for them. Like we just did this. And if 0183 1 it was just past the 90-day and 92nd day from the date 2 that we did it, maybe we verified on March 1st, but the 3 deal didn't close until two months after that, and then 4 we had -- it was very painful. 5 I don't understand the investor protection or 6 other policy position that's supported by that policy. 7 But to the extent you can get unnecessary friction out of 8 the verification process, I think that would go a long 9 way to helping people think it was worth going through 10 the process. 11 MR. GRAHAM: Thanks. 12 Jonathan. 13 MR. NELSON: I would love to know what sort of 14 things can we do as a committee. Can we resolve to 15 recommend something that general solicitation be defined 16 as X, Y and Z? Can we -- 17 MS. HANKS: We can try. 18 MR. NELSON: This is not the opinion of the SEC 19 or the President, but as the people who have been asked 20 to give our opinions, how do we give our opinions? Is it 21 a discussion? Is it a dialogue? What's the end product 22 that we're delivering? 23 MR. GRAHAM: What's kind of the mechanism? One 24 thing that I would commend you to are the recommendations 25 as the committee in past years. And what -- they're all 0184 1 on the website I'm sure. What we do is we have meetings 2 like this. And the issues come up, and there's some 3 issues that we decide then to kind of focus on and drill 4 down on. And with those issues as we move toward 5 consensus, we develop recommendations, and then we 6 consider recommendations specifically and talk about 7 them, amend them, pass them. 8 MR. GUTIERREZ: I'd like to make a comment in 9 closing. When I think about the issue of capital 10 formation, I always think of the two players, right? 11 There's the business and then there's the capital 12 provider. What I'd like to see from this committee is 13 obviously the issues that we've discussed that are in the 14 way of businesses being able to access capital, whether 15 that's education, whether that's not knowing exactly what 16 the options are that our out there, whether that's 17 maneuvering through this maze of regulatory environment 18 in terms of issuing. So there's that whole, I guess, 19 effort. 20 I'd also like to raise the issue of part of the 21 inefficiency in the capital markets has to be who the 22 providers are. So one of the conversations we haven't 23 talked about are how do we help foster capital sources 24 that may have better understanding and knowledge base of 25 these businesses, whether that's because we diversify who 0185 1 those capital sources are, I mean specifically talking 2 about women and minority-led investment firms and whether 3 or not this committee can be engaged in that or just 4 through different types of folks from different 5 industries that may or may not believe or understand that 6 they could be part of the capital source universe. 7 So I'm not sure if that's an endeavor that this 8 committee could take on, but clearly that is part of this 9 discussion of making capital formation more efficient is 10 taking a look at the face of the capital providers. 11 MR. GRAHAM: For me that's included under 12 outreach. I mean you've got people with pools of money 13 that want something. And they know what they want, and 14 they're willing to pay for it. And then you have 15 businesses that -- saying, gee, I can do this or this or 16 this. And -- but there's only one thing that this 17 capital source wants. And if -- it's that kind of 18 disconnect that's out there that we should be able to 19 help -- kind of help, kind of get things aligned in the 20 right way. 21 MS. YAMANAKA: I'd like to chime in on that. I 22 really support that idea. I think that there's a lot of 23 tension that have applied to traditional sources, and the 24 world has changed out there. We're competing 25 internationally more. They have different types of 0186 1 market sources for capital formation within their own 2 countries and entities, and I think we're at a 3 competitive disadvantage if we don't at least offer 4 something similar, and it could be through minorities, 5 women-owned businesses. 6 But what's good in the opportunities for that 7 group is going to be good for small business in general. 8 So I think that this is a perfect opportunity to expand 9 our opportunities and how we look at things. I do think 10 we need to fix and make -- address how things are done 11 traditionally. But to really try to throw -- and I don't 12 mean to create a whole bunch of work for everybody. I 13 really apologize. 14 But I think it's already happening underneath. 15 It's percolating under the radar. People don't know 16 they're doing certain things. In some ways perhaps 17 they're a little bit not in compliance. But if we can 18 take a look, understand what is currently happening, 19 magnify the positive impacts of that, start to measure 20 how much of that capital formation actually is occurring 21 that we can't track because I think John was saying 22 earlier we don't -- they don't know because they don't 23 file, right? That it might be very, very interesting to 24 find out where that is leading to in the chain upwards. 25 MR. GRAHAM: Okay. Anyone else? 0187 1 MR. HAHN: I've got -- a potential topic for 2 discussion is around short-selling disclosures. So in 3 December, NASDAQ filed a rulemaking petition with the SEC 4 asking it to take action to require disclosures of 5 investors' short positions in parity with existing 6 disclosure requirements for long positions. 7 So currently investment managers in funds must 8 publicly disclose long positions and significant long 9 transactions on a quarterly basis. Short positions, on 10 the other hand, are only reported in an aggregate manner 11 by the national exchanges. Lack of transparency creates 12 an environment with potential for manipulative or abusive 13 conduct. 14 I'm not sure about other industries, but in 15 biotech we're particularly vulnerable to short 16 manipulation due to the thinly traded stock and long time 17 between news events. Just to be clear, nobody's talking 18 about -- nobody's proposing any limits on short selling. 19 It's simply an issue of equitable transparency in 20 reporting. 21 MR. GRAHAM: Okay. That's a good point. 22 Annemarie. 23 MS. TIERNEY: So as a result of the JOBS Act 24 and other SEC initiatives, we have a much wider range of 25 options now for capital raise we've already discussed 0188 1 today. I think the committee should take a look at 2 places where -- you said earlier that there's 3 complications in what's out there that potentially makes 4 these exemptions not interesting to companies. And we 5 touched on earlier the idea that you could be a tier two, 6 Reg A company putting out periodic information, and 7 there's no resale safe harbor available to you under the 8 federal securities laws. 9 So one of the things I think we probably might 10 be worth looking into for us is supporting some kind of 11 amendment to Section 18 to cover transactions that occur 12 -- securities issued under tier two to the extent that 13 the companies voluntarily periodically reporting. I've 14 got all my words right. But that just seems odd to me. 15 They're periodically reporting, they're putting 16 information in the market. But you don't have a resale 17 exemption for your shareholders. 18 MR. GRAHAM: Right. 19 MS. HANKS: I think that's an important thing. 20 I think there's a lot of people who don't understand 21 that that is actually a problem out there. 22 MS. TIERNEY: You told me, Sara. So I believe 23 it. 24 MR. GRAHAM: So, Lisa. 25 MS. SHIMKAT: I kind of want to just know -- 0189 1 we've talked about a lot of things, but -- so what are 2 the next action steps? Especially -- obviously I am more 3 heavily or could potentially be more heavily involved in 4 the outreach side and the education. In seeing the 5 report that we had earlier, there was a lot of good 6 points there and a lot of discussion around the 7 information and the statistics that maybe sometimes 8 statistics open our eyes to not really our shortcomings, 9 but maybe we're focusing on the wrong issue. 10 And so as we looked at getting additional 11 training out there for the decision makers, who are 12 people going to, where are they getting their 13 information, and it's just like trying to go to the 14 newspaper to try to advertise to millennials. Are we 15 doing what we need to do to get information out there 16 when it comes to the different types of equity? 17 So what would the next steps be? I mean what - 18 - 19 MR. GRAHAM: What we do is following this 20 meeting, Sara and I and the staff will try to make some 21 sense of our discussions, and then we will kind of 22 formulate a path forward and you all will be able to 23 react to that. 24 Patrick, did you have anything else you want to 25 add? 0190 1 MR. REARDON: I would say studying sources of 2 liquidity because I know the investors I have represented 3 are always interested in small company exit strategies, 4 that they're interested in that. So that would be a 5 topic that I would be interested in. 6 MR. NELSON: I'd be interested in talking to 7 some of the crowdfunding platforms in Europe, like 8 Cedars, and some of maybe the regulators in the EU and 9 just hear from them about how has it gone to not have an 10 accredited investor limit, have they noticed fraud, that 11 sort of stuff. It would be interesting to, I don't know, 12 talk with someone like Kiva who does capital formation 13 overseas in a very interesting way. Would that be 14 considered a securities offering if a group of people got 15 together online and -- like to an entrepreneur here? I 16 don't know. That sort of stuff would be fascinating to 17 me. 18 MR. GRAHAM: I don't think we've ever brought 19 anybody from overseas. I don't know if that's in our 20 budget. 21 MR. GOMEZ: I thought your law firm's budget 22 was -- and, Steve, we can follow up on that and see what 23 the options are. 24 MR. GRAHAM: Okay. So, Catherine, anything 25 else? Okay. Kyle? 0191 1 MR. HAUPTMAN: Just to that, whether we have a 2 live human being here from Europe or not, their 3 perspective I think is important. Somebody just told me 4 the other day that they wanted to list their company on 5 the French exchange for startups. They had to go abroad 6 to meet their needs. It's just a sentence I'd like to 7 never hear again. 8 MR. GRAHAM: Brian? Xavier? Robert? 9 All right. Then can I entertain a motion to 10 adjourn four minutes early? 11 MR. YADLEY: Just before we do that, just one 12 more thing. We're talking about budget. Obviously, our 13 budget is only for four meetings a year. And we talked 14 informally earlier about limitations on dates for 15 meetings and the importance of having a facility that 16 will accommodate our requirements under the Advisory 17 Committee Act be public and so on. But our committee 18 only has 13 members. 19 So as we try and finalize the dates for this 20 year, if two or three people can't be there, that's a 21 real chunk of the committee. And so to the extent we can 22 finalize the dates for May and October and circulate them 23 before they're finalized so that you see how many 24 committee members would be not just inconvenienced by, 25 for example, I have a public company client annual 0192 1 meeting and board meeting that has been moved twice, and 2 it's -- 3 MR. GRAHAM: I agree with you 100 percent, and 4 we will get right on that and see if we can't get those 5 things pinned down. But we need to respect everyone's 6 schedule and respect my promise to get your out of here 7 at 3:30. 8 PARTICIPANT: Do you need a second? 9 MR. GRAHAM: Do I need a second? Yes. Okay. 10 All those in favor? 11 (Chorus of ayes.) 12 MR. GRAHAM: And -- 13 (Whereupon, at 3:30 p.m., the committee meeting 14 was concluded.) 15 * * * * * 16 17 18 19 20 21 22 23 24 25 0193 1 PROOFREADER'S CERTIFICATE 2 3 In The Matter of: ADVISORY COMMITTE ON SMALL AND 4 EMERGING COMPANIES 5 File Number: OS-0225 6 Date: February 25, 2016 7 Location: Washington, D.C. 8 9 This is to certify that I, Nicholas Wagner, 10 (the undersigned), do hereby swear and affirm that the 11 attached proceedings before the U.S. Securities and 12 Exchange Commission were held according to the record and 13 that this is the original, complete, true and accurate 14 transcript that has been compared to the reporting or 15 recording accomplished at the hearing. 16 17 _______________________ _______________________ 18 (Proofreader's Name) (Date) 19 20 21 22 23 24 25