SECURITIES AND EXCHANGE COMMISSION ADVISORY COMMITTEE ON THE CAPITAL FORMATION AND REGULATORY PROCESSES July 24, 1996 Chairman Arthur Levitt Commissioner Norman S. Johnson Commissioner Isaac C. Hunt Securities and Exchange Commission Washington, DC 20549 Dear Mr. Chairman and Commissioners: The Commission's Advisory Committee on the Capital Formation and Regulatory Processes is pleased to transmit its final report to the Commission. The Committee unanimously recommends that the Commission act promptly both to strengthen existing investor safeguards and to reduce the costs of corporate capital formation in the United States by establishing a company-based registration system. Company registration is the logical culmination of a progression over the past three decades -- a progression encouraged by Congress, investors, industry and others -- away from the transaction-based framework for the registration of securities offerings. On numerous occasions in the past, the Commission, just as it has done now by creating this Committee, has recognized the need for reforms in the transaction-based system. In 1982, for example, the Commission took a major step towards the goal of company registration by establishing its precursor -- the integrated disclosure system for the primary offering and secondary trading markets, and the concurrent adoption of the streamlined shelf registration procedure. Consistent with the view of a decade and a half ago, the Committee today believes that the transactional concepts still underlying the current scheme continue to impose unnecessary costs and restrictions on issuer access to capital. Perhaps more importantly, in many instances the transactional system also serves as an impediment to full and timely disclosure to investors and the markets, and the realization of the full potential for investor protection provided by the Securities Act. After much research, study and debate, the Committee has concluded that the significant changes in the securities markets over the past sixty years, which have accelerated in the last dozen or so, continue to strain the remnants of the current transactional registration scheme. More specifically, as detailed in the Committee's report, the Committee has identified a variety of regulatory uncertainties, complexities and anomalies, many of which stem from efforts to adapt the Securities Act's registration and prospectus delivery provisions to current market developments. Over time, the continuation of these changes will reduce the current scheme s ability to provide the highest level of essential investor protections. Moreover, certain innovations brought about by, among other factors, technology and the globalization of our markets, while benefiting issuers, have not always produced meaningful countervailing benefits for investors in either the primary offering or secondary trading markets. In fact, in certain cases, these innovations have had the unintended consequence of possibly weakening available investor protections. In addition, they have not addressed the concerns of other market participants who have legal obligations created under a scheme crafted in the 1930s, but whose ability to execute their duties has come under stress in the financing environment of the 1990s. Accordingly, the Committee commends Chairman Levitt and the Commission for charging the Committee with the responsibility to evaluate the continuing efficacy of the present scheme governing corporate capital formation, and to consider and, if warranted, recommend an alternative approach. The Committee recognizes that streamlining can be accomplished at the expense of, or at least without increasing, investor protection. Consistent with the principles of Chairman Levitt s leadership and the Commission s historical approach, the Committee refused to proceed in that direction. It assumed the mandate of crafting a system that would both increase investor protection and reduce regulatory burdens. Under the new approach, reporting companies will benefit from an offering process that essentially converts the current, stop-and-go shelf registration system into a continuous, pay-as- you-go registration process. Under a full company registration system, the one-time registration of eligible companies generally would encompass all securities that they or their affiliates might offer or sell thereafter. Issuers and investors will both benefit from this fundamental conceptual change that will eliminate artificial distinctions among the markets for the issuer's securities and the restrictions on the resale of those securities based upon the nature of the transaction in which the security was initially sold. In addition, investors benefit from an appropriately expanded reach of the Securities Act s liability protections to cover more transactions, including private placements and the flowback of offshore offerings, and more disclosures, than under the current system. Importantly, an integral part of the company registration system is improvements in disclosure practices by registered companies. Increased attention focused on the periodic reports provided to the markets makes sense. Investors rely on those reports in deciding whether to buy securities pursuant to an offering by a public company or any of its affiliates. They also rely on those reports in deciding whether to buy or sell that company's securities in the secondary trading markets. The secondary trading markets have grown so substantially, and so dwarf the primary markets, that a disclosure system that relies on high quality disclosures only when a company episodically, if ever, goes to market disserves the investing public. Moreover, in order for a streamlined offering process that relies on the existing periodic reports to work without harming investor interests, the system must ensure the highest level of integrity for those periodic reports. Any streamlining without improving the current disclosure process should not be acceptable. Consequently, the company registration model includes specific reforms tailored to enhance the accuracy and reliability of information, and the timeliness of the information, furnished by registered companies to investors and other participants in the securities markets. The company registration model also reinforces investor protection by incorporating measures that enhance the monitoring functions of underwriters, outside directors and auditors. All these reforms are loyal to the central premise that the benefits and protections of the regulatory process, heretofore triggered by the infrequent and unpredictable occasion of a public offering of securities, should operate on a continuous basis for the benefit of all investors in the company's securities. The Committee recommends that the Commission pursue as its ultimate goal the implementation of a full company registration model that eliminates completely the need to register securities offerings, thereby replacing the current transactional registration requirements and exemptions for all reporting companies. The Committee also recommends, however, that the system be initiated through a voluntary "pilot" program open only to larger, more seasoned, companies. The Committee believes that such a pilot will provide a meaningful market test of the advantages of this model and will provide greater flexibility for any experimentation or adjustment the Commission might deem necessary or appropriate. The pilot program should provide the foundation for deciding what legislative and regulatory modifications, if any, would be appropriate to complete the transition to a company registration system. In closing, the Committee's members wish to thank Chairman Levitt and the Commission for the opportunity and the privilege to serve on the Committee and to participate in these important reforms. The Committee strongly believes that this new system will provide companies and their investors with a regulatory scheme to meet their needs in the new century. At each of the times in the past when the Commission considered bold action that would both improve investor protection and streamline the capital formation process, this country's markets were the largest, the most liquid, the deepest and the most honest. Each time regulatory innovations were in fact adopted that combined both investor protection and streamlining, the markets became even better. The Commission has the opportunity to do that again here. Each member of the Committee looks forward to the Commission's progress in considering the Committee's recommendations, and remains willing to provide any additional assistance in this regard. Respectfully submitted on behalf of the Committee, The Honorable Steven M.H. Wallman Committee Chairman Members of the Committee: Professor John C. Coffee, Jr. The Honorable Barber B. Conable, Jr. Robert K. Elliott Edward F. Greene Dr. George N. Hatsopolous A. Bart Holaday Paul Kolton Roland M. Machold Dr. Burton G. Malkiel Claudine Malone Charles Miller Karen M. O'Brien Lawrence W. Sonsini