Remarks Of Isaac C. Hunt, Jr. Commissioner* U.S. Securities and Exchange Commission Washington, D.C. "Underwriting: The Year that Was, Trends, and Comments" RIBA Mid-Atlantic States Capital Conference Pentagon City, VA April 18, 1997 _____________ * The views expressed herein are those of Commissioner Hunt and do not necessarily represent those of the Commission, other Commissioners or staff. U.S. Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549 Good afternoon. Thank you for inviting me to this year's conference. I know that your organization is committed to strengthening the capital formation process for emerging growth companies. I also am aware that during the last three years, RIBA-member firms managed or co-managed more than 500 underwritings. Those underwritings raised over five billion dollars of new capital for a vital sector of the American economy. That is something to be proud of, and I applaud your efforts. The Year In Review. 1996, of course, was a terrific year for underwriters as a whole, and not just in the market niche dominated by your firms. According to a January article in Investment Dealers' Digest, new issues raised 115 billion dollars in the U.S. in 1996, 40% more than in 1995. Initial public offerings accounted for 50 billion dollars of that total, which is an increase of 66% from 1995. The size of some of last year's IPOs was staggering: Lucent Technologies three billion dollar deal was the largest domestic IPO in history, and Deutsche Telekom AG's 11.3 billion dollar deal was the largest foreign IPO in the United States. These big deals were big news. In my view, however, the two most significant items last year in the underwriting arena were related to your sector of the marketplace: the emerging growth sector. But before I offer begin that discussion, let me make the disclaimer that the views I express today are my own, and may not represent those of the SEC, my fellow Commissioners, or the staff of the SEC. Direct Public Offerings. First, 1996 saw even more small companies launching their own IPOs on the Internet, what some refer to as "direct public offerings." To the extent that those offerings need to be registered with the SEC, they are subject to our filing requirements and antifraud provisions but not to an underwriter's scrutiny. And, to the extent that underwriters are not there to provide scrutiny, the issuer, along with its directors and accountants, are left to the task of disclosing any and all material risks to investors. Yet as was noted in the recent report of the Advisory Committee on the Capital Formation and Regulatory Processes -- ably chaired by my fellow Commissioner, Steve Wallman -- many believe that our Securities Act disclosure system is so successful because of the effect of the Act's liability provisions on underwriters and other "gatekeepers." Underwriters, of course, scrutinize the company, its business and its management, and that level of scrutiny is predicated largely on the exposure to liability for false or misleading disclosures in the registration statement. The use of direct public offerings likely will continue. The Internet only will become more accessible to average Americans. Further, let's look at the age group of Americans probably most accustomed to "surfing the net" -- for this purpose, let me use the more technologically agile set between the ages of 15 and 35. This group soon will begin to make their own savings and investment decisions, if they haven't done so already. Market participants and the Commission should assume that this generation of investors will be as comfortable making investment decisions on the Web as my generation is over the telephone. After all, Web-surfers race through the maze that is the World Wide Web the same way that a bicycle messenger races through city streets. Perhaps the only thing left to be decided for these new investors is whether they will conduct their trades via computer hook-ups with more traditional brokers, through specially designed computer trading systems, or by directly logging onto an issuer's Web site. Without question, the Commission is compelled to respond to this changing environment. We must regulate where appropriate, but we must deregulate if that is the better course. Yet this environment also means new pressures for you and your firms. You may be asked by clients to use the Internet to help sell all or part of an underwriting. You may have to provide clients with services unrelated to traditional underwriting and brokerage. And, there likely will be pressures on price. Underwriting in a "Hot" Market. My second observation is that 1996 saw remarkable interest by investors in new issuances, whether they were large or small. The IDD article I referred to earlier noted that with a few obvious exceptions -- such as the failed IPO for Wired Ventures -- underwriters had it relatively "easy" in 1996, especially in the first half of the year. The article quoted a managing director and senior manager of a large firm's equity group as saying that "mutual funds,especially emerging growth funds, contributed greatly to new issues doing well." Of course, I'll leave it to each of you whether you had an easy 1996, and whether micro-cap fund managers were chomping at the bit to get at your clients's stock. And, even if this were the case in 1996, I certainly can't predict whether that will continue. But this type of business environment raises its own unique concerns. You may have seen the recent story in the Wall Street Journal regarding Emanuel Pinez, the former CEO of Centennial Technologies. He's in jail awaiting trial on securities fraud charges. There also has been Commission action against him, and I won't discuss that in any detail. Pinez is charged with, among other things, padding Centennial's books with phony sales. In the Wall Street Journal article, a Centennial representative states that the alleged conduct went undetected for three years by the company's managers as well as by its board. Further, Centennial's auditor and four brokerage firms helped the company raise 30 million dollars during that time but, apparently, didn't detect any problems. The article notes that "reports of improprieties and untruthful, even outlandish, claims" followed Mr. Pinez wherever he went in life. "In a less-hectic stock market," the article reports lawyers and investment bankers as saying, "underwriters might have done a thorough background search that could have raised red flags and prevented the Centennial debacle." In fact, a lawyer from a large law firm -- probably, one not involved with Centennial -- is quoted in the article as saying that underwriters have been so busy "that they often rely exclusively on meetings with management for their information." Now I don't know what happened with respect to the firms discussed in the article. I am not making any judgments. But I appreciate the article's point: that it may be hard for underwriting firms to provide appropriate scrutiny in a market such as this one, where: (1) issuers need quick money, (2) underwriters need to move to the next deal, and (3) investors's collective appetites seem insatiable. I suggested earlier that there may be concerns where an underwriter is not involved in a deal. But those same concerns may be present if an underwriter's scrutiny is limited because of the pressures of a "hot" market. Perhaps I have sounded a little "gloom-and-doomish," but please do not overestimate my concerns. I do not wake up at night in fear of the next direct public offering, and nor should investors. I know that issuers in those offerings and the gatekeepers involved will try to do the right thing. I also know that, day in and day out, underwriters do a tremendous job for the markets and investors. After all, it's only the failures that get reported in the press or end up on my desk as enforcement recommendations. Proposed Changes to Rule 430A. Still, I bring the concerns I just expressed "to the table" when I consider SEC action that might impact underwriting practices. And it is in this context that I view the SEC's recent proposed revisions to Rule 430A under the Securities Act. Under current rules, a company that is not eligible to use shelf registration faces restraints on timing its offering to meet financing needs and market windows. It must coordinate the effectiveness of its registration statement with the time that it would like to offer and sell its securities. It then must price the securities promptly after effectiveness, subject to the somewhat limited flexibility afforded by Rule 430A. In general, the SEC's proposed changes to Rule 430A would allow smaller, less-seasoned issuers to delay the pricing of securities offerings for a significant amount of time after registration is declared effective. One commentator called the proposal a "back-door primary shelf." The proposal would provide increased flexibility for smaller issuers to take advantage of market conditions. The changes also might reduce the need for these issuers to rely on Regulation S and private placements. In particular, an eligible company could delay pricing its offering beyond the Rule's current 15-day period. It could omit the same information from the prospectus before pricing as currently, and omit the name of the managing underwriter. In fact, the company could delay pricing and naming an underwriter for a year after effectiveness. The company eventually would provide the omitted information in a Rule 424(b) prospectus supplement not subject to SEC staff review. To be eligible, the company would comply with certain limited conditions beyond those already in Rule 430A. Most significantly, it would deliver a red herring to investors 48 hours before sale (as currently is required for IPOs). The prospectus would be accompanied by the company's latest 10-Q and current 8-Ks unless the supplement has that information. The issuer also would have to be a reporting company for the last 12 months. Curiously, the proposal would not require those reports to have been timely during that period. At the open SEC meeting on this proposal, I stated that I had serious reservations. In general, my concerns are with the possible consequences of the proposed changes on retail investors who, along with micro-cap mutual funds, probably are the chief purchasers of the securities touched by the rule. However, I thought it appropriate for the SEC to propose the changes and seek comments from the investment community and the public. First, the proposal would permit significant "disaggregation" of disclosure. By that, I mean it would allow an issuer to send to a purchaser, with the confirm, the following: a prospectus omitting the pricing information, a supplement, a 10-K, the most recent 10-Q, and mandated 8-Ks. That's a lot of disclosure, but I don't know that it is good disclosure. On some level, the investor may not be able to use the information to make an informed investment decision. Perhaps more important to this audience, the quality of disclosure delivered to investors may be reduced if the proposal has a negative impact on the ability of underwriters to conduct effective due diligence. Now, I don't know whether that will occur, but it must be considered. The SEC's proposing release discusses the possible impact of the rule on underwriting practices, and asks a number of questions. I'll read you just a portion of that discussion: Under the current offering process for smaller companies, ample time exists for these "gatekeepers" to carry out due diligence activities. Concerns have been raised that the expedited access to the markets that would be provided by these proposals could make it difficult for gatekeepers, particularly underwriters, to perform adequate due diligence ... This may be particularly true if a company is able to seek aggressive competitive bids from several underwriters in a very short time frame immediately before offering its securities. Unfortunately, time does not permit me to read the entire discussion. I urge you to read it -- the release is available on our Web site -- and let us know what you think. The one comment I have seen is not from an underwriter; it states, and I quote, "a reputable underwriter would not have sufficient time to perform adequate due diligence" under the new proposals (end of quote). I look forward to your comments on the proposal. While the comment period expires April 29, just contact us if you need more time to respond. I assure you that I will carefully consider your comments -- whether they be pro or con. Thank you for the opportunity to share my views with you.