Keynote Address at PLI – Thirteenth Annual Institute on Securities Regulation in Europe

Introduction

Thank you for that kind introduction and the invitation to speak today at what will be my debut on the international stage as the Director of the Division of Corporation Finance.  While I had the pleasure of being in London during my prior life in private practice, this is my first trip abroad in my new role and, more importantly, my first opportunity to use my newly-printed U.S. government employee passport, which, to my great disappointment, did not usher me immediately to the head of the queue at Passport Control when I arrived at the airport yesterday. 

Now, before I continue any further, please allow me to give the requisite reminder that the views I express today are my own and do not represent the views of the Commission or its staff.[1]

The New World of Capital Formation

Next week will mark the completion of my ninth month as Division Director and I will say that it has been quite exciting to be at the Commission in the midst of some of the historic changes that are occurring in securities regulation.  So, I am very pleased to have this opportunity to share with you my thoughts on some of these changes. 

And perhaps there is no better place to start than the changes that are occurring to that most fundamental function of any securities regulatory scheme: governing how a company offers and sells securities to the public.  Indeed, it is quite fortuitous that I get this chance to talk about this topic here in London, the capital of the nation whose laws, in many ways, laid the foundation of our own securities laws in the United States.  It was the Companies Act of 1844, enacted by Parliament, that first introduced the concept of mandatory disclosure through registration of prospectuses for public securities offerings.  And, in the aftermath of the 1929 crash, it was this basic principle that the drafters of the Securities Act of 1933 borrowed and turned into the cornerstone of that Act.[2]

Consequently, for almost 80 years afterwards, a company that wanted to sell securities generally had a straightforward choice to make: sell publicly by registering the offering with the SEC or sell privately through one of the exemptions from registration. 

Much has changed.  The JOBS Act, which Congress enacted in 2012, initiated historic changes to the way securities could be offered and sold and upended a long-standing, fundamental principle that had been an article of faith for generations of securities lawyers – namely, that a private offering could not be conducted by means of a general solicitation.  Among the other changes that increased the menu of options available for private financings were:   

• requiring the Commission to implement an exemption under the Securities Act for crowdfunding offerings, which is a new method of raising relatively small amounts of money from many individual investors over the Internet;
• expanding the limits for “quasi-public” offerings under Regulation A from $5 million to $50 million, while requiring some measure of ongoing information reporting (an exemption that is commonly referred to as “Regulation A+”); and
• increasing the threshold that triggers registration and public reporting under Section 12(g) of the Exchange Act from 500 holders of record to 2,000 holders of record (or 500 persons who are not accredited investors).

As most of you probably know, the Commission and the staff have been very focused on the rulemakings necessary to implement the statutory mandates of the JOBS Act.  I am proud to say that we have been making significant progress, although much remains to be done. 

In July 2013, the Commission adopted final rules to eliminate the prohibition against general solicitation in Rule 506 and Rule 144A offerings.[3]  As a result, issuers can now use general solicitation to offer securities under the new Rule 506(c) exemption, provided that all purchasers of the securities are accredited investors and the issuer takes reasonable steps to verify their status as accredited investors.  General solicitation may also be conducted in Rule 144A offerings.  Since the change became effective in September 2013, we have seen the Rule 506(c) exemption used in approximately 819 new offerings, raising approximately $9.5 billion in new capital as of the first week of March.   

In October 2013, the Commission proposed rules to implement the new crowdfunding exemption.[4]  Under the proposed rules, an issuer could use this exemption to raise up to $1 million in any 12-month period through a broker-dealer or a new type of intermediary – a funding portal – and investors would be limited in their investment size to an amount based on their annual income or net worth, with an overall cap of $100,000.  And last December, the Commission proposed rules that would update and expand the existing  Regulation A exemption by allowing offerings of up to $50 million within a 12-month period – a ten-fold increase over the $5 million limit that has existed for years.[5]  Chair White has stated that completion of these rulemakings is an important priority in 2014, which, understandably, means that it is one of my top priorities for the year as well.[6]

And when we finish these rulemakings – and we will finish them – and stand back to look at what has been created, we will be looking at a very different world than the one that existed just a few years ago.  A company seeking to raise capital will have many new options – not only in how it conducts the offering, but to whom it can sell and how much it can raise.  It will have new ways of selling securities that, just a few years ago, would have been unimaginable, if not outright illegal. 

Having these new choices, while liberating in some ways, will require new calculations on the part of companies and their advisors in the decision-making process for how they wish to conduct their offerings.  For example, a company can choose to offer the securities to the general public, without registering with the SEC, through a means of general solicitation, but must sell the securities only to accredited investors, who, as a result of the securities’ restricted status, may own securities with more limited trading liquidity.  Alternatively, it can choose to offer securities through the crowdfunding exemption, which will allow the company to publicly offer and sell the securities to anyone, but doing so will limit the amount that can be raised to $1 million during a 12-month period.  Or, perhaps, the company can look to Regulation A+, which will allow it to publicly offer and sell the securities (including through “test the waters” solicitations), but requires the filing of offering statements with the Commission for possible staff review.

But it has not only been changes in the way that capital can be raised that has the potential to transform the capital markets.  The JOBS Act changed the basic regulatory scheme for unlisted companies that has existed for 50 years by, among other things, increasing the shareholder threshold of Section 12(g) that triggers Exchange Act reporting.  Companies can now have up to 2,000 holders – although only 500 who are not accredited investors – before having to submit to registration under the Exchange Act and the attendant reporting obligations that registration entails.  Further, employees who receive their shares pursuant to an employee compensation plan through transactions exempt from Securities Act registration – who were often the reason that companies exceeded the previous limits – are not counted for purposes of the Section 12(g) threshold, nor, in the very near future, will shareholders who acquire their shares through crowdfunding offerings.   

To be sure, the new forms of “private offerings” do not rely exclusively on reaching a shareholder threshold before triggering the obligation to provide periodic information to shareholders.  Both the crowdfunding and Regulation A+ proposals would require some measure of ongoing reporting as a condition to the use of the exemption, although the exact contours await the finalization of those rules.  Nevertheless, the end product of all of these changes may be the appearance of a new type of company – one that can access the capital markets efficiently and enjoy the trading liquidity of a public company without actually being subject to much of the regulatory framework that was originally built for such companies. 

Of course, it is difficult to anticipate today all of the implications that these changes may have in the future, but there are some questions that are worth considering as this new world comes increasingly into focus. 

• Registration, with the resulting mandatory disclosure, has long been the centerpiece of the Securities Act, but what is the future of registered offerings in a world filled with new alternative avenues of public capital-raising?  Even before the elimination of the general solicitation ban, there had already been a noticeable shift from registered offerings to private offerings.  Our Division of Economic and Risk Analysis, for example, reported that in 2012, registered offerings raised $1.2 trillion in new capital while private offerings accounted for $1.7 trillion during the same year.[7]  How will registered offerings fare once all of the new exemptions are fully in place and increasingly used by companies?  What incentives will companies have to do a registered offering?
• What are the policy considerations for our existing U.S. regulatory system if this shift from registered offerings continues?  James Landis, a member of the triumvirate that drafted the Securities Act, once wrote that “[the] sale of an issue of securities…to a limited group of experienced investors [is] certainly not a matter of concern to the federal government.”[8]  One has to wonder whether he would still hold to this view if he lived in a world where securities are offered through advertisements in magazines,[9] on shipping containers,[10] and even on t-shirts worn by folks washing the windows of wealthy executives’ office buildings?[11]  What would he say today about the role of federal regulation in these types of “private” offerings? 
• What types of trading markets and liquidity will there be for securities sold pursuant to these new exemptions?  This could be a crucial consideration in the decision-making process for both issuers contemplating their various options for offering their securities and for prospective investors contemplating whether to purchase the offered securities.  Regardless of how flexible an exemption may be for the initial offering of the securities, issuers may be reluctant to use the exemption if investors are deterred from purchasing the offered securities due to the absence of an efficient and liquid secondary trading market.  The viability of these new exemptions may therefore depend not only on the shape of the final rules for the exemptions, but on the development of new trading venues for the securities that are sold through these exemptions. 
• And perhaps inextricably intertwined with the question of whether a secondary market for a company’s securities will appear is the question of what continuing disclosures, if any, the company should provide to investors seeking to buy and sell in this market.  When Congress imposed the Exchange Act registration and reporting requirement for exchange-listed securities, it did so on the premise that “[n]o investor, no speculator, can safely buy and sell securities upon the exchanges without having an intelligent basis for forming his judgment as to the value of the securities he buys or sells.”[12]  The requirement of Section 12(g) was added in 1964 to put over-the-counter securities in which there was a substantial public interest on the same regulatory level as exchange-listed securities.  How will these policy goals be affected by the appearance of a company that can raise capital from the public and enjoy an active trading market but avoid Exchange Act reporting – which may sound somewhat fantastical but will be feasible thanks to the changes to the Section 12(g) threshold, the ability to sell securities publicly without filing a Securities Act registration statement that would trigger the reporting obligations of Section 15(d) of the Exchange Act, and the appearance of trading platforms for private companies’ securities?  Indeed, the growing number of new secondary markets for securities issued by private companies to their employees and other shareholders illustrates that this question is not merely a theoretical one.[13]

The question is particularly important for the proposed crowdfunding and Regulation A+ exemptions because while the statutory provisions for these exemptions include requirements for some ongoing reporting, it is left to the Commission to determine the exact parameters of what will be entirely new periodic reporting regimes.  This is an effort that will require consideration of some of the same fundamental questions that must have preoccupied the drafters of the Exchange Act in 1934 – what kind of information should an issuer provide to a holder of its securities and the marketplace in general once it completes an offering successfully?  How often should an issuer provide this information?  And at what point should the issuer’s obligation to provide this information end? 

These are just a few of the questions arising from the changes that have occurred over the last few years and that will test many of the fundamental principles upon which our current regulatory scheme rests.  The answers will depend, in large part, on how companies, investors, and the market as a whole react to these changes, which is why it is crucial that, as regulators, we have the necessary means of assessing the development of new market practices so that we can be better informed as to the need for any regulatory action.  Such information could come through new rule and filing requirements, such as those proposed by the Commission last summer for Rule 506 offerings,[14] but also through active dialogue with the stakeholders, such as those in this audience, who share our common interest of ensuring that our regulatory scheme will continue to strike the right balance between facilitating capital formation and providing the necessary investor protections.         

Disclosure Reform

Shifting gears somewhat, but staying with the topic of disclosure, at the same time that we are working on the new “private” offerings rules, we are working on an equally important initiative that may affect what it means to be a public company in the United States – disclosure reform.  As you may know, in December of last year, the staff issued a report that provides an overview of the disclosure requirements in Regulation S-K and the staff’s preliminary recommendations for updating these rules.^[15]  The report was mandated by Congress under the JOBS Act, and it is a part of the Commission’s ongoing efforts to modernize and simplify disclosure requirements and reduce compliance costs for all companies.  In connection with issuing the report, Chair White directed the staff to develop specific recommendations for updating our disclosure rules and tasked the Division with leading this effort. 

One of our goals is to address the growing concern that excessive disclosure can obscure the information that is most relevant – a concern often called “disclosure overload.”  This concern is not unique to the United States.  It has received global attention, with organizations around the world undertaking similar initiatives to address disclosure overload or reduce complexity, particularly with a focus on streamlining financial statement disclosures.  In recent years, the UK Financial Reporting Council (the “FRC”) has called for actions to improve disclosures in corporate reports by, among other things, “cutting clutter.”^[16]  Accounting organizations in Scotland and New Zealand joined forces to urge companies to “lose the excess baggage” and focus disclosures in financial statements on what is important.^[17]  The European Securities and Markets Authority issued a consultation paper on materiality in financial reporting, and disclosure overload was a common theme that arose in the responses.[18]  And, last year, the International Accounting Standards Board hosted a public forum in London to discuss disclosure overload in financial statements. 

While it may be called “disclosure overload,” “cutting the clutter,” or “losing the excess baggage,” we can all probably agree on the need to reduce immaterial disclosures that make more important information harder to identify.  Unfortunately, there is no easy answer or consensus on how to do so.  What one person sees as overload, another might very well see as important information for making an investment or voting decision.  We also recognize that the types of investors who use the information are increasingly diverse, with some investors – such as securities analysts, institutional investors, or money managers – less concerned with the volume of information because they have the necessary technology and other resources to evaluate large amounts of data.  Further, we recognize that updating our rules is only one step – albeit an important one – in improving company disclosures. 

As one of the first steps, the staff is considering the factors that may contribute to disclosure overload.  While doing so, we observed common potential sources of disclosure overload in periodic reports filed with the Commission and those identified by the FRC.  I want to highlight three examples:

• First, the FRC noted that share-based payments are “often cited as giving rise to a disproportionate number of pages of disclosure.”[19]  We share this concern and recently updated our staff guidance on critical accounting estimate disclosures for share-based compensation that is issued prior to an initial public offering.[20]  We intend for this guidance to provide companies the flexibility to eliminate disclosure about share-based compensation that is not required or necessary to make an informed investment decision.
• As another example, the FRC reported that disclosure about accounting policies is an area that can be improved.  Similarly, we have observed that companies often repeat verbatim the disclosures about critical accounting estimates in Management’s Discussion and Analysis from the section on significant accounting policies in the footnotes to the financial statements.  In other cases, companies slightly modify the accounting policy footnote with added disclosures for sensitivity analysis.  In order to reduce repetition, the staff has encouraged companies to use cross-references to the footnotes to the financial statements.  This is also an effective way to reduce repetition in other parts of the annual report, such as in risk factors, litigation and contingencies.
• Further, the FRC reported that companies may adopt a “follow the leader” approach to reporting.[21]  In other words, if one company makes a disclosure, other companies are influenced to include similar disclosure.  This is a common practice that we have observed as well.  For example, companies may include disclosure based on staff comments provided to other companies.  Companies may also add disclosures based on client alerts issued by law and accounting firms that summarize themes in our comment letters.  There is a potential for disclosure overload, however, if companies add disclosure because it happens to be the “flavor of the month,” rather than because it applies to their situation. 

These are just a few examples, and there is obviously a lot for us to think about.  We are currently in the process of commencing the review that Chair White has requested.  Our goal is to present specific recommendations for updating Regulation S-K and other ideas for addressing the issue of disclosure overload.  As part of this effort, we plan to engage in a great deal of public outreach with companies, investors, and other participants in the marketplace so all of these important stakeholders can contribute their ideas for improving our disclosure system.  Better disclosure benefits everyone in the marketplace, and we plan to work with companies and investors to achieve this common goal.

U.S. Capital Markets for Foreign Issuers

Lastly, I would be remiss if I flew all the way to England just to talk endlessly about U.S. laws for U.S. companies and left without sharing a few observations about foreign issuers. 

Foreign companies seeking to access the U.S. capital markets are, of course, subject to the same basic regulatory framework as U.S. companies when it comes to offering and selling securities.  In terms of exempt offerings, Rule 144A has long been a particularly popular capital-raising method for foreign companies.  We are therefore very interested in seeing if market practices for these offerings will change in response to the new ability to use general solicitation in Rule 144A offerings.  We are also interested in addressing any interpretive questions that may arise.  For example, in response to commenters’ questions during the rulemaking process, the Commission expressed its view that a Regulation S offering would not be integrated with a concurrent Rule 144A offering that uses general solicitation.  As many of you know, this view is consistent with the Commission’s historical treatment of concurrent Regulation S and Rule 144A offerings.[22]  I understand from our Office of International Corporate Finance that practitioners in this area have greatly appreciated this Commission guidance.

In terms of registered offerings, I am pleased to observe that many foreign companies continue to find the U.S. public market attractive and have filed registration statements so that they can access this market.  Last year, there were about 50 new foreign registrants from Asia, Europe, Latin America, and Canada, which is consistent with trends in past years.  One noteworthy trend relates to draft submissions of initial registration statements by foreign private issuers, both under the JOBS Act and under the Division’s policy for dual-listed foreign private issuers.  Since the JOBS Act was enacted almost two years ago, there have been over 100 foreign private issuers making draft submissions – an average of over one per week.  Over half of these draft submissions have resulted in the public filing of a registration statement, with most of these filings ultimately going effective.  One other interesting observation is the use of IFRS in these draft submissions.  I know that Paul Beswick will speak later at this conference, so I do not want to preempt anything he might say.  But one interesting note that I want to highlight is that approximately 50% of the draft submissions that we have received from foreign private issuers since the JOBS Act had financial statements prepared in accordance with IFRS. 

Lastly, I would like to emphasize that we understand that foreign companies sometimes face challenges that U.S. companies do not.  That is why we are open to helping you address these challenges wherever possible, whether it is by providing Rule 144(i) guidance for Canadian Capital Pool Companies that report in Canada but not in the United States[23] or by allowing foreign issuers subject to the U.S. proxy rules to avoid filing a preliminary proxy statement for routine matters required to be voted on by shareholders under foreign law.[24]  While the guidance may be new, what is not new is our desire to work with foreign companies that wish to enter the U.S markets. 

Thank you again for inviting me to speak to you this morning and for your gracious attention.