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Remarks at FIA Futures and Options Expo

Commissioner Daniel M. Gallagher

Chicago, Illinois

Nov. 6, 2013

Thank you Walt [Lukken] for your very kind introduction. I am delighted to be here today — it's not every day that an SEC Commissioner gets to speak at a futures industry conference. If you didn’t know better, you'd think that the Dodd-Frank Act actually accomplished its goal of regulatory rationalization by merging the SEC and the CFTC into a single commission, regulating all aspects of the capital markets! As you know, however, like so many other practical, commonsense reforms, that merger didn't make it into the 2319 pages of Dodd-Frank.

Today I'd like to talk about a subject I've discussed a number of times over the past year: the need for a fundamental, holistic review of equity market structure. And I'd like to focus on the specific issue of how the formation of new “venture exchanges” for equities trading can encourage and facilitate the public offerings of small and emerging growth companies to the benefit of issuers, investors, and job-seekers alike.

Over the past several decades, both the securities and futures markets have changed dramatically, and a major factor in the evolution of both sectors has been the imposition of Congressional mandates and related SEC and CFTC regulation. As I've repeated my calls for a fundamental review of today's equity market structure, I've been pleasantly surprised by the unanimity of opinion on the subject -virtually everyone with whom I've spoken on the issue has agreed that it is well past time for such a review, regardless of where they might think it should lead. I was particularly pleased when Chair White echoed this call recently in her public remarks.[1] Indeed, Congress, investors, and market participants of almost every stripe have expressed their frustration and, in some cases, downright distrust of the equities markets. And this is occurring at the same time that investors arguably have access to the most low-cost, efficient, and liquid markets in decades. Perception, as they say, is often reality, and regardless of how any of us may feel about any particular potential reform to the laws and regulations governing our equity markets, the Commission simply cannot tolerate the current perception that those markets are unfair to investors.

However, in order to address the pressing market structure issues we face, we need to understand and acknowledge how we got to where we are today. Simply put, while some of the changes to the equities markets have been the natural result of innovation stemming from competitive forces, Congressional mandates and related SEC regulations have also shaped those markets to a striking degree. This highlights the need, when we embark on a holistic review of market structure, to do so with a no “sacred cows” approach and a willingness to question the previous decisions of Congress and the Commission - some made decades ago - in order to determine whether they still make sense in today’s world. Only by questioning the premises and foundations to which we've become accustomed can we objectively evaluate what, if any, changes or improvements can and should be made.

Indeed, challenging the current rule book is consistent with the President’s Executive Order titled, “Improving Regulation and Regulatory Review.”[2] In a memo to the heads of the executive departments and agencies, including independent agencies such as the SEC, entitled “Implementation of Retrospective Review Plans,” Cass Sunstein, the President's former so called “regulatory czar,” explained that the Executive Order requires agencies to “develop plans to review their existing significant regulations in order to explore ‘whether any such regulations should be modified, streamlined, expanded, or repealed so as to make the agency's regulatory program more effective or less burdensome in achieving the regulatory objectives.’”[3]

One of the benefits of conducting a comprehensive, holistic review is that it will, in significant part, require the Commission to question whether the current regulatory paradigm best furthers the underlying capital formation purpose of the equity markets. The fundamental goals of equity markets include facilitating the ability of companies to seek public financing while allowing investors the ability to participate in a company’s economic success from an early stage. As such, it is particularly important to note the decline in initial public offerings in recent years, particularly the IPOs of small and emerging growth companies. According to a report by the IPO Task Force[4], a group formed in the wake of a 2011 Treasury conference on access to capital, between 1991 and 1999 there were an average of 547 IPOs a year. Between 2000 and 2011, however, the average fell to 192 IPOs, with IPOs of less than $50 million declining particularly precipitously.[5]

Fortunately, this decline has not gone unnoticed, as evidenced by the many academic papers, panel reports, and Congressional hearings all trying to understand and address the issue. The impact of the decline in IPOs has been significant — another study noted that “[u]p to 22 million jobs [through 2009] may have been lost because of our broken IPO market.”[6] While pinpointing the exact causes has been difficult, the independent IPO Task Force concluded, crucially, “that the cumulative effect of a sequence of regulatory actions, rather than one single event, lies at the heart of the crisis.”[7]

Paramount among these regulatory actions, of course, are the rules and regulations promulgated by the SEC. With the benefit of hindsight, we see that many of the SEC’s rules, while perhaps well-intentioned and aimed at protecting investors, have been the progeny of a one-size fits all approach unsuited to today's markets. So what has this approach led to? Sadly, although the spirit and intent of the SEC’s efforts have been to provide investor protection, their effect may have been to create barriers for small and emerging growth companies that want to enter the capital markets.

Encouraging the sustainability and growth of such small but growing businesses must be a focus for the Commission. We were reminded of the importance of this focus by the enactment of the JOBS Act in 2012. The JOBS Act passed with overwhelming bipartisan support in both the House and the Senate and was quickly signed into law by the President, who had made specific mention of the law in his 2012 State of the Union address. The JOBS Act seeks to facilitate job creation primarily by removing certain barriers to capital formation in order to facilitate IPOs. Facilitating capital formation is, of course, at the heart of what the SEC is supposed to do – indeed, it is a mandate –, and I am pleased that the Commission is finally starting to make some progress in implementing the JOBS Act. I wish we would have started sooner given what is at stake. Unlike Dodd-Frank, which addresses a largely false, yet politically convenient, narrative of the financial crisis that hit its apex over five years ago, the JOBS Act is responsive to a current and very real crisis: unemployment. As the Commission continues to implement the JOBS Act, it is critically important that the agency resist the regulatory impulse that so often hinders capital formation in a quest for the nanny state ideal of achieving perfect investor protection through the complete elimination of risk. As we have seen, time and again, the result of such government intervention is the loss of investor choice and, therefore, opportunity.[8]

Fortunately for the Commission, we have the SEC Advisory Committee on Small and Emerging Companies, which provides advice on SEC rules and policies affecting privately-held small businesses and publicly traded companies with less than $250 million in public market capitalization.[9] The Committee focuses on areas such as raising capital through securities offerings, trading in securities of smaller companies, and public reporting and corporate governance requirements of emerging and smaller public companies.[10] The Committee has made several important recommendations, and I would like to focus on one in particular that I find particularly groundbreaking: a recommendation that the Commission facilitate the creation of a distinct marketplace for the securities of small and emerging companies.[11] In proposing the creation of such a marketplace, the Committee noted its belief that “current U.S. equity markets often fail to offer a satisfactory trading venue for the securities of small and emerging companies.” The Committee concluded that this failure “has discouraged initial public offerings of the securities of such companies, undermines entrepreneurship, and weakens the broader U.S. economy.”[12] The Committee, in a nutshell, was recommending the creation of what I will call “venture exchanges.”

Before discussing the potential characteristics of venture exchanges, it is important to first review the perilous position of small and emerging growth companies in today’s public equity markets. There are many differing views as to why fewer companies, particularly small companies, have gone public over the past few decades. One expert, for example, testified to Congress in June that SEC rules, including Reg ATS in 1998, decimalization in 2001, and Reg NMS in 2005 “significantly changed the stock market structure that paid for the infrastructure of small broker dealers, research analysts and capital support required to take small companies public and to support them in the aftermarket (once they are public).”[13] This argument is premised on the idea that by reducing the spreads for broker-dealers, particularly market makers, such participants were less inclined to serve as the salesmen, traders and analysts for small companies and their often illiquid securities.

Another explanation for the decline in smaller IPOs is that the associated costs of becoming a public company for smaller businesses are incredibly high and have discouraged such companies from entering the public markets.[14] In December 2007, the Commission amended its disclosure obligations under the ‘33 and ‘34 Acts for “smaller reporting companies,” defined as companies with less than $75 million in public equity float.[15] As stated by the IPO Task Force in its “Rebuilding the IPO On-Ramp” report, however, “[w]hile the idea behind this exemption is sound, the execution falls short of market realities. First, it creates a false dichotomy within the equities space wherein a company is either a micro-cap or a large cap… Second, the current system holds even the smallest cap companies to the large-cap standards before they can go public.”[16]

Since the advent of decimalization, there has been discussion of widening the tick size increments for securities of smaller cap companies. As mandated by Section 106 of the JOBS Act, the SEC in 2012 presented a report to Congress on decimalization, and recently Congressman Sean Duffy of the House Financial Service Committee circulated a discussion draft bill that would provide for an optional pilot program administered by the SEC allowing emerging growth companies to increase the tick size at which their stocks are quoted and traded.[17] In response to these calls for a pilot program, Chair White recently noted that she has instructed the SEC staff to work with the exchanges on a pilot program that would allow smaller companies to use wider tick sizes.[18] I look forward to working with the staff on this potential pilot program.

So where do we go from here? I believe that incentivizing market makers, reviewing the mandatory disclosure and other requirements for smaller public companies, and reviewing tick sizes are important and potentially beneficial steps to addressing the dearth of IPOs. However, I believe that perhaps the best way to encourage smaller companies to go public is to combine these ideas and execute them through the development of venture exchanges.

The idea of venture exchanges is not new or unprecedented; indeed, countries such as Canada and England. have specially designed exchange markets that serve as incubators for smaller companies.[19] The key to establishing venture exchanges is to create a platform which could encourage smaller companies to enter our public markets while at the same time providing adequate protection for investors. The hope is that companies would be able to get public financing through listing on these exchanges and then be able to move onto more robust and liquid markets in the future. So here are a few ideas for the industry and potential exchanges to think about.

The underlying premise of the Commission’s disclosure regime is that if investors are given appropriate information, they can make rational and informed investment decisions. This is not to say that the disclosure regime was meant to guarantee that investors receive all information known to a public company, much less to eliminate all risk from investing in that company. Instead, the point has always been to ensure that they have access to material investment information. Given the costs associated with public company disclosure requirements and the voluminous reporting they lead to, however, it is important to be willing to consider setting aside the one-size-fits-all approach in favor of more tailored requirements for different-sized companies. Specifically, in the case of small cap and emerging growth companies, we should consider whether the framework should be geared towards more basic, clearly material information. The goal would be to require less disclosure overall while focusing on the most important, material information in order to reassure investors that companies are not acting inappropriately or fraudulently. In addition to reducing the required Regulation S-K disclosure for small issuers, we should consider whether by eliminating some periodic reporting requirements, for example quarterly reports under Form 10-Q, we could adequately incentivize companies to go public while still providing the most meaningful information to investors.

In establishing venture exchanges, we and ultimately the venture exchanges would need to clearly delineate the necessary financial, governance and size requirements for the listed companies, using the SEC's exemptive authority as necessary. This is especially important given that the purpose of venture exchanges would be to act as incubators for smaller companies.

Our current national securities exchanges, of course, are subject to a host of regulatory requirements, including Reg NMS. In order to establish one or more venture exchanges, the Commission may need to exempt the new exchanges from certain regulatory requirements, including some in Reg NMS. The Commission should also consider whether an exemption from unlisted trading privileges requirements makes sense. Additionally, there may be a need to provide that the securities listed on venture exchanges be deemed “covered securities” and hence preempted from “blue sky” regulation. A non-NMS, non-UTP exchange would create incentives for broker-dealers to serve as market makers responsible for newly listed securities and create more robust and active markets. Additionally, allowing venture exchanges to serve as the exclusive markets for new small issuers would create incentives to promote the listings of such companies.

Providing small issuers with the ability to choose the trading tick size for their securities could serve to promote venture exchanges as well. Wider tick sizes and spreads could lead to higher commissions and, incentivize market makers to create additional liquidity for these stocks, in turn providing motivation for small investment firms to underwrite and support small cap companies.[20] In addition, listing and trading venues could consider whether to establish limitations on liability for managements and boards with respect to choosing their tick sizes. This may provide added comfort for small issuers to make such determinations without the fear of second guessing by plaintiffs' lawyers.

Another potential incentive to consider is direct payment by issuers to market makers. Concerns over the potential for abuse of such practices led to FINRA Rule 5250, which prohibits FINRA members from directly or indirectly accepting payment or consideration from an issuer of a security for acting as a market maker. However, programs recently put in place by exchanges have tried to address concerns in this context.[21] Such programs could attract smaller, less developed companies onto regulated and transparent markets by lowering transaction costs and providing enhanced liquidity for thinly traded stocks. [22] Additionally, payment by market makers may enable small broker-dealer investment firms to return to the business of underwriting and supporting small companies via research, analysis and bringing them to the market. Notably, Congressman Patrick McHenry, Chairman of the House Financial Services Committee Subcommittee on Oversight and Investigations, noted that agreements between issuers and market makers to pay for market making activity “…would allow small companies to produce an orderly, liquid market for their stocks. Research has shown that these agreements, already permitted overseas, have led to a positive influence on liquidity for small public companies.”[23]

In order for venture exchanges to work, the public and the Commission must recognize that these companies are not riskless investments. There will be companies that will not succeed. However, many will, and it is important to provide these companies with the ability to grow and prosper and to allow investors the opportunity to share in such growth and prosperity alongside these companies. While the SEC is rightly focused on protecting investors from fraud, the Commission must also actively take steps to promote capital formation. There is a price to be paid for an overly protective approach to securities regulation. In the movie Forrest Gump¸ the titular character notes of his former platoon commander, “Lieutenant Dan got me invested in some kind of fruit company. So then I got a call from him, saying we don't have to worry about money no more. And I said, that's good! One less thing.” Forrest Gump's story would have turned out differently had he lived in one of the states where securities regulators barred state residents from participating in the “too risky” IPO of that 'fruit company,' Apple Computer, Inc., which sought to raise less than $100 million.[24] Through well-designed venture exchanges governed by scaled, sensible regulation, small companies would be provided with a proper runway for them to grow while at the same time providing investors with the material disclosures they need to make informed decisions.

Thank you all for your attention. I've appreciated the opportunity to be here today and share my views on these vitally important subjects, and I wish you a successful conclusion to this conference.

[1] Chair Mary Jo White, “Focusing on Fundamentals: The Path to Address Equity Market Structure,” October 2, 2013, available at

[2] Executive Order 13563 of January 18, 2011, “Improving Regulation and Regulatory Review,” available at

[3] Memorandum for the Heads of Executive Departments and Agencies, “Implementation of Retrospective Review Plans,” October 26, 2011, available at

[4] The task force was comprised of “a small group of professionals representing the entire ecosystem of emerging growth companies – venture capitalists, experienced CEOs, public investors, securities lawyers, academicians and investment bankers,” excerpt from “Rebuilding the IPO On-Ramp: Putting Emerging Companies and the Job Market Back on the Road to Growth,” issued by the IPO Task Force, October 20, 2011 available at

[5] See “Rebuilding the IPO On-Ramp: Putting Emerging Companies and the Job Market Back on the Road to Growth,” issued by the IPO Task Force, October 20, 2011 available at at 2, 5.

[6] “A Wake-up Call for America,” D. Weild and E. Kim, Grant Thornton at page 2, November 2009, available at . See “Rebuilding the IPO On-Ramp: Putting Emerging Companies and the Job Market Back on the Road to Growth,” issued by the IPO Task Force, October 20, 2011 available at

[7] See “Rebuilding the IPO On-Ramp: Putting Emerging Companies and the Job Market Back on the Road to Growth,” issued by the IPO Task Force, October 20, 2011 available at at 1.

[8] See Commissioner Daniel M. Gallagher, “Statement at Open Meeting regarding Proposed Amendments to Regulation D, Form D and Rule 156 under the Securities Act,” July 10, 2013 available at

[9] See “Advisory Committee on Small and Emerging Companies,” available at

[10] Id.

[11] See “SEC Committee on Small and Emerging Companies Recommendation Regarding Separate U.S. Equity Market for Securities of Small and Emerging Companies,” February 1, 2013, available at

[12] Id.

[13] See “Statement of David Weild, Senior Advisor-Grant Thornton before the U.S. House of Representatives Financial Services Committee Capital Markets and Government Sponsored Enterprises Subcommittee,” June 12, 2013, available at

[14] See “Rebuilding the IPO On-Ramp: Putting Emerging Companies and the Job Market Back on the Road to Growth,” issued by the IPO Task Force, October 20, 2011 available at

[15] See “Smaller Reporting Company Regulatory Relief and Simplification,” Release Nos. 33-8876, 34-56994; 39-2451 (Dec. 19, 2007) [73 FR 934].

[16] See “Rebuilding the IPO On-Ramp: Putting Emerging Companies and the Job Market Back on the Road to Growth,” issued by the IPO Task Force, October 20, 2011 available at at 10.

[17] See United States House of Representatives Committee on Financial Services Memorandum regarding October 24, 2013 Subcommittee on Capital Markets hearing on “Legislation to Further Reduce Impediments to Capital Formation,” October 23, 2013, memorandum available at

[18] Chair Mary Jo White, “Focusing on Fundamentals: The Path to Address Equity Market Structure,” October 2, 2013, available at

[19] See for example the TSX Venture Exchange and the U.K.’s Alternative Investment Market.

[20] See “Statement of David Weild, Senior Advisor-Grant Thornton before the U.S. House of Representatives Financial Services Committee Capital Markets and Government Sponsored Enterprises subcommittee,” June 12, 2013, available at

[21] See “Order Granting Approval of a Proposed Rule Change, as Modified by Amendment Nos. 1 and 3 Thereto, to Establish the Market Quality Program,” March 20, 2013 available at See “Notice of Filing of a Proposed Rule Change and Amendment No. 1 Thereto to Establish the Market Quality Program,” December 21, 2012, available at See “Notice of Filing of Proposed Rule Change and Amendment No. 1 Thereto to Implement a One-Year Pilot Program for Issuers of Certain Exchange-Traded Products ("ETPs") Listed on the Exchange,” April 5, 2013, available at

[22] See “Notice of Filing of a Proposed Rule Change and Amendment No. 1 Thereto to Establish the Market Quality Program,” December 21, 2012, available at

[23] Id. and See also “Payments to Market Makers May Improve Trading in Smaller Stocks,” by Nina Mehta, Bloomberg, November 15, 2011. At the time he made these remarks, Rep. McHenry was Chairman of the Subcommittee on TARP, Financial Services and Bailouts of Public and Private Programs of the House Oversight and Government Reform Committee.

[24] “Apple Computer Set to Go Public Today; Massachusetts Bars Sale of Stock as Risky” By Richard E. Rustin and Mitchell C. Lynch, Wall Street Journal, December 12, 1980.

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