Remarks before AusBiotech
Commissioner Daniel M. Gallagher
U.S. Securities and Exchange Commission
Sydney, New South Wales, Australia
May 1, 2012
Thank you for your welcome and for that generous introduction. It is a true honor to be here with you today, and it is especially exciting for me to return to Sydney for the first time in almost twenty years. During my junior year in college, I studied abroad here at the University of New South Wales, and Australia has held a special place in my heart ever since. And although I have heard many stories of how things have changed here in Sydney, and in Australia generally over the last twenty years, I was still struck by the dramatic changes - most for the better - since I lived here. You are truly experiencing a special period in the evolution of the Australian economy and society.
Before venturing further, I must tell you that my remarks are my own and do not necessarily represent the views of the United States Securities and Exchange Commission or my fellow Commissioners.
I arrived in Melbourne from Singapore on Saturday, and before that I was in Hong Kong, having arrived from the United States on Monday. And, as you’ve heard, I came back to the SEC as a Commissioner six months ago from the private sector. I bring those perspectives to bear this afternoon as I consider with you the role of securities market regulators in the context of encouraging vigorous capital markets and the vital investment activity on which alone they thrive.
I do that without illusions and in full awareness of the deep tremors in global capital markets just four years ago. In my capacities as Deputy and Co-Acting Director of the SEC’s Division of Trading and Markets during 2008 and 2009, I found myself at the center of the SEC’s response to that crisis.
Much action has been taken since then, both in the United States and globally, to respond to the crisis. Most notably for us in the United States was the passage of the massive, 2350-page Dodd-Frank Act in 2010, legislation offered as a relevant and timely response to the crisis. Its effect was, overnight, to propel us into a maelstrom of implementing rulemaking on multiple fronts, sometimes in conjunction with other equally independent federal regulators answerable to different congressional committees. Our rulemaking agenda increased at least ten-fold. You can be sure that U.S. regulators will be attempting to implement Dodd-Frank’s hundreds of new mandates for years to come.
I want to focus my remarks somewhat more narrowly today. I am sure that all of you, with your varied connections to the Australian biotechnology industry, may find other topics of more immediate interest. And so I want to highlight two topics that I think will be of interest to you. First, these days, I’m often asked about the new "JOBS Act" – the recently enacted U.S. law that creates an entirely new legal category of company, “emerging growth companies,” and gives them preferential treatment in the initial public offering process and during the early phase of their public life. Second, we have been prompted to direct far greater attention to building our rules on a solid empirical foundation including, notably, a rigorous economic analysis of the costs and benefits of the policy options we consider.
Even really good and timely ideas – and the JOBS Act is both – don’t always get very far in the legislative process. With that in mind, it is significant that the JOBS Act legislation flew through the House of Representatives, with a White House endorsement for tailwind, then swept past nearly all opposition in the Senate, giving the President a coveted opportunity to address the concerns of the business community and make real strides towards job creation in an election year. The word “JOBS” in the Act’s title not only gave supporters a way to avoid fumbling the title of the “Jumpstart Our Business Startups Act,” but gave them a handy way to point out that their opponents were anti-JOBS.
This legislation surprised many, particularly in light of the tone of the Dodd-Frank Act, which had became law two years before. Whatever could be said in favor of the Dodd-Frank legislation back in 2010, no one would seriously argue that it was about job creation or attracting new listings to the deep and predictable capital markets the United States has consistently offered. The JOBS Act was different, and the relevant statistical picture framed this legislative initiative.
Specifically, last year, 134 initial public offerings took place in the United States, raising almost $36 billion in capital. That’s certainly a lot. But listing activity in other markets in 2011 puts those figures into their proper context:
- Hong Kong, with a GDP and population less than one fortieth the size of the United States, saw 90 IPOs, raising over $35 billion in capital.1 Although the quality of those IPOs has been questioned by some,2 the quantity surely deserves our attention.
- Mainland China IPOs, on the Shanghai and Shenzhen exchanges, raised approximately $45 billion over more than 280 offerings.3
- Australia raised almost $1.6 billion in capital in 103 IPOs in 2011 – only 31 fewer than in the United States.4 Australia’s GDP is approximately a sixteenth the size of the U.S. economy. Your population is about one-fourteenth the size of the U.S. population.5 So congratulations are in order!
With this picture and its implications very much in mind, proponents of the JOBS Act asserted that its provisions would stimulate job creation – a position that both a large, bi-partisan majority in Congress and the White House found attractive.
You don’t have to be a card carrying cynic to know that, during an election year, any bill’s chances improve dramatically if it is associated in the public mind with job creation. Of course, it helps a lot when it’s true. As one high tech venture capitalist supporter of the bill noted in arguing in favor of creating incentives for companies to go public, rather than selling their intellectual property to a larger firm: “Picture Cupertino (California) without Apple. Picture Seattle without Microsoft.”6 And that is, indeed, the point. In a world that internet technologies have done much to de-localize, companies of a certain size still have their primary existence somewhere. They have a corporate footprint in one or more places, and not in others. Companies still don’t exist only in the ether – and they do employ people.
Now I don’t suppose any of you is quite so altruistic as to wish to list in the United States primarily in order to create U.S. jobs – although if you were, I can assure you that you’d be very welcome. The classic reasons for listing in the United States are to gain: (1) access to the deepest capital markets in the world; and (b) the protections afforded by a mature, procedurally sound, and predictable legal regime. It is no coincidence that these motives of corporate officers considering where to list their companies’ securities align so closely with the SEC’s statutory mission.
The SEC’s responsibility, our mission, is to “protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.” If your company is fortunate enough to exceed the $1 billion earnings limit for an “emerging growth company” under the JOBS Act, first, congratulations – and remember that you still need to consider the benefits that listing in the United States will afford you. If, on the other hand, your company does qualify as an emerging growth company, your incentives to go public in the United States have increased dramatically.
Under the JOBS Act, your company qualifies as an “emerging growth company” if it –
- had less than $1 billion in revenues during its last fiscal year;
- went public not more than five years ago (the five years are measured from the IPO’s pricing date);
- has issued less than $1 billion in non-convertible corporate debt; and
- has issued no more than $700 million in stock to non-affiliates (which is to say, the company is not a “large accelerated filer” under our rules).
A company loses its EGC status and the associated benefits as soon as any one of those four criteria no longer applies to the company.
So you’re an EGC under the new law. What then? Emerging growth companies, which can include companies listed publicly outside the United States, are subjected to a decidedly lower regulatory burden during an “IPO on-ramp” period of five years than are larger companies and companies that went public before December of last year.
These lighter burdens are likely to translate into significant cost savings during the early years of the EGC’s public life. To cite just a handful of examples of such cost saving and streamlining provisions:
- EGCs need only provide two, rather than the traditional three, years of audited financial statements.
- EGCs may communicate with and make pre-filing offers to “qualified institutional buyers” and “institutional accredited investors.”
- EGCs may submit their draft registration statements to the SEC for non-public review – removing a disincentive associated with making public their intentions when the probability of their success is questionable.
- EGCs are exempt from the internal control audit requirement imposed under section 404(b) of the Sarbanes-Oxley Act.
- EGCs are exempt from compensation requirements imposed by the Dodd-Frank Act – those giving shareholders a say on executive pay and “golden parachutes,” for example.
- An EGC would not be subject to the registration requirements under our Securities Exchange Act until it had 2000 record owners, up from the current 500 threshold.
- And EGCs would be exempt from any requirement our Public Company Accounting Oversight Board might impose mandating audit firm rotation.
The JOBS Act represents a fundamental realignment of the incentives associated with U.S. IPOs in support of a policy of encouraging job creation through listing in the United States. If you qualify as an EGC, the proposition is designed to be irresistible.
Having said that, I must add that while most of the JOBS Act is “self-executing” and immediately effective, the SEC has a number of rules to promulgate in order to give effect to certain of its provisions. And that, in turn, brings me to the second point I want to consider with you today – our renewed focus on creating a firm empirical foundation for our rulemaking, including a more rigorous economic analysis of the costs and benefits associated with the policy options we consider.
The business community is often baffled by the policy decisions made by politicians and regulators, as well as the complexity of the resulting rule books. At the SEC, our rulemaking releases are long, often turgid and replete with cross-references to other equally long and complex rules that they may alter, incorporate, or otherwise augment.
There’s a serious point to be made here – one I am eager to convey to those who, like yourselves, are at the breaking edge of business’s new wave. We at the SEC are thinking a lot harder and a lot more systematically about our rulemaking processes, in particular how we assess the costs and benefits of our rules. And we know that we on the Commission won’t be the ones carrying those costs; the private sector – the locomotive of our economy – will.
There’s another point we’ve been thinking about seriously lately, and that is the problem of solutions in search of problems. We should not set about finding and adopting “solutions” until we’ve identified a pressing problem within our statutory jurisdiction that our solution would address. For the philosophers out there, I’m asking the question whether a solution is even a coherent concept in the absence of any pre-existing related problem. It’s not that we lack problems to solve – or rules to write, either; as I mentioned, our rulemaking docket is well over 10 times the level it was before Dodd-Frank.
Over the past few years, the federal courts of our “home” circuit, the U.S. Court of Appeals for the D.C. Circuit, have, in an increasingly impatient tone, demanded that we increase the rigor of the economic analysis supporting the rules we adopt. That is no mere academic abstraction. Each of the several times one of our rules has been challenged in court in recent years, the court has overturned the rule. That’s not a record we can live with. To be reversed in the D.C. Circuit Court of Appeals is, for the SEC, an institutional body blow. Losing a rulemaking appeal does not just mean that a rule falls out of our rulebook -- these losses affect the credibility of the Commission as an expert, independent agency, and that has an impact on everything we do. Regardless of party affiliation and policy preferences, no SEC Commissioner wants that to happen. The question is, of course, what we should do about it.
Here, I should touch on a few fundamentals. First, the SEC is an “independent agency.” That means the SEC is supposed to remain unconstrained by the political forces that drive Cabinet agencies. Although the Commission is composed of three members loyal to the President’s party, including the Chairman, it is in no way bound by the policy preferences of the Administration. To put it plainly, the Commission is expected to exercise independent and expert judgment to implement the securities laws of the United States, even when the President or the Congress has expressed a policy preference.
Nor, on the other hand – and this is where the courts have weighed in – is SEC rulemaking a matter merely, or ultimately, of getting at least three Commissioners to agree on the text of a release. If it were, our recent rules wouldn’t be getting reversed in court so regularly or with such stinging judicial commentary. The SEC is a creature of statute that operates within a statutory framework. And the courts are, in sum, telling us, increasingly impatiently it seems, that we are not giving them a basis sufficient to permit them to defer to our expertise even when it comes to regulating capital markets. It’s not a compliment, but it can be fixed.
Let me briefly summarize the applicable legal requirements. First, when we write rules to implement the securities laws and consider the public interest, we are required to consider how the rule will protect investors, as well as whether it will “promote efficiency, competition, and capital formation.”7 When we consider rules to implement the Securities Exchange Act, we must consider the “impact … on competition” of the proposed rule, with the proviso that we may not adopt the rule if the burden it would impose on competition is “not necessary or appropriate in furtherance of the purposes of [the Exchange Act].”8 And we are subject to the generally applicable “notice and comment” rulemaking process established under the Administrative Procedure Act of 1946, which not only requires us to put our proposed rules out for public notice and comment, but also provides that our rules may be set aside if they are “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.”9 I’ll spare you the relevant Executive orders and lesser authorities.
The requirement that the public be given a real opportunity to consider and comment on proposed rules is, of course, the foundation of notice-and-comment rulemaking. It operates as a limit on the degree to which a proposed rule can legitimately be changed between the proposal and adoption stage. If the change is too great – if the overall direction of the proposed rule is too significantly altered – then courts have held that the public may not have been afforded the required notice of and opportunity to comment on the potential rule. We are not, in other words, allowed either to hide the ball or change the game.
The bottom line is, as the Court of Appeals for the D.C. Circuit persists in reminding us, clear: Either we build each of our rules on a solid empirical foundation and give the public a real opportunity to consider and comment on how it will affect them, or we run a serious risk of having our rules judicially nullified. Our policy choices should flow from the data; what we know should support what we do. That’s really just common sense. And it’s how you make business decisions. What’s awkward is that the courts have so persistently had to remind us to do the obvious, the legal minimum.
Let us turn, then, to the question of what putting a sound empirical foundation under our regulatory policy choices should, in practice, mean. Then, finally, I want to turn back to the question how that relates to promoting the global competitiveness of our markets. In testimony before two congressional committees over the past two weeks, the Chairman of the SEC has confirmed that SEC rulewriting divisions must follow newly issued internal guidance that requires a rigorous cost-benefit analysis conducted by our economists as a precondition to recommending that the Commission adopt rules.
This newly binding guidance requires that economists in the SEC’s Division of Risk, Strategy, and Financial Innovation must now be engaged from the very earliest stages of policy formulation through proposal and adoption of any rule. That’s as true if our rulemaking stems from a congressional mandate, as if we identify both the problem and its potential solutions on our own initiative. The guidance implies, and will be an important tool in driving, a major cultural change throughout the SEC. It requires that we consider seriously the policy and institutional disincentives to adopting rules that fail to take account of the relevant market data and extant empirical analysis.
So where does that leave us – and, moreover, why should you in Australia’s biotechnology industry care? First, we have learned that the attractiveness of U.S. capital markets is not a given. Neither we, nor any of those who wish to conduct their investment activity in “fair, orderly, and efficient markets,” can any longer afford the assumption that companies will elect to go public in our markets without regard to the nature or magnitude of the costs we impose. We compete with markets both developed and emerging, according to standards of conduct we have inspired -- though perhaps others have a greater national awareness of the relevance of their securities markets to their economic well-being.
As regulators, we can make our markets more or less attractive, against the backdrop of the constant that is the depth of our markets and the predictability of the legal regime that is their foundation. When we consider proposed regulation, and the economic policy context in which we operate, we must think increasingly consciously not only of the protections we hope to give investors, but of the incentives and disincentives we create for capital formation itself in our public markets. Fair, transparent, and deep capital markets are good. Risk-free capital markets have no future. Were we somehow to create one, it wouldn’t offer opportunity enough to attract either companies to list or investors, who would do just as well in savings accounts or Treasury bills.
The JOBS Act is one healthy indication that the United States has awakened to the need to make the deepest and safest capital markets in the world attractive to the emerging growth companies that give life to our economy and those of other developed economies like Australia’s. We must hope we’ve succeeded in creating a new awareness of the need for regulatory balance – eyes wide open to both the costs and benefits of any policy choice we consider. To that end, I look forward to working to ensure that the rules we must adopt to implement certain portions of the JOBS Act are consistent with the purposes that drove its enactment. I look forward to welcoming you and your companies into U.S. markets if you make that choice – I encourage you to take a serious look – and I am grateful for your hospitality and attention this afternoon.
That concludes my prepared remarks, and I would be happy to answer any questions you may have.
1 PWC, “2011 U.S. IPO Watch Analysis and Trends (February 2012),” http://www.pwc.com/en_US/us/transaction-services/publications/assets/pwc-ipo-watch-annual-report-2011.pdf.
2 See, e.g., Prudence Ho & Nisha Gopalan, “Pain for Hong Kong’s IPO Buyers,” The Wall Street Journal, April 30, 2012, online and print editions (page C1).
3 PWC, “2011 U.S. IPO Watch Analysis and Trends (February 2012),” supra note 1.
4 See Tony Featherstone, “Float Review: No Survivors,” Weekend Financial Review (Australia), Dec. 28, 2011, updated Dec. 30, 2011 (online).
5 CIA World Factbook (available at https://www.cia.gov/library/publications/the-world-factbook/).
6 James Freeman, “Kate Mitchell: How Silicon Valley Won in Washington,” The Wall Street Journal, April 6, 2012 (online edition).
7 National Securities Markets Improvement Act of 1996, P.L. 104-290, 110 Stat. 3416 (1996), secs. 106(a), (b), and (c).
8 Securities Exchange Act, sec. 23(a)(2).
9 5 USC 706(2)(A).