Americas public capital markets are the most robust in the world and a vital source of financing for many of the worlds most innovative businesses. Unfortunately, changing market dynamics and heavy regulatory burdens are hampering capital formation for these businesses and restricting investors access to wealth creation opportunities. I recently testified on SIFMAs behalf before the House Financial Services Subcommittee on Capital Markets, Securities and Investments at a hearing entitled Legislative Proposals to Help Fuel Capital and Growth on Main Street focused on addressing these issues.
It is difficult to overstate the changes that have occurred in U.S. public capital markets over the last twenty years. Unfortunately, not all the changes have been positive. An explosion in private funding, the rise of index and passive investing, technological advances in our equities markets such as electronic trading, the development of hedge funds, high frequency trading, the maturation of international exchanges, consolidation in the investment banking industry, and yes, the impact of regulations from Sarbanes-Oxley and Dodd-Frank have all played a role in reshaping our markets.
From a peak in 1996, the total number of publicly listed domestic companies in the U.S. has fallen by almost 50%, from 8,000+ to just over 4,300. The U.S. now has about as many public companies as it did in the early 1980s. The annual number of U.S.-listed IPOs dropped from a peak of 492 in 1996 to ranging between 24 and 232 annually for the period from 2001 to 2017, despite the attempts of policymakers to revitalize this market through the Jumpstart Our Business Startups (JOBS) Act of 2012 and follow-on legislation.
I spend much of my time meeting with private company executives, their Boards and their investors, discussing alternatives for raising capital and realizing value. More often than not these decision makers cite the costs of going and staying public, the demands of quarterly reporting, regulatory and corporate governance requirements, and the reduced number of success stories as reasons that they prefer to be funded privately or to sell their business to a strategic acquirer or private equity fund. The explosion of private capital markets, led by angel investors, venture capital firms and private equity firms has allowed companies to grow their business and valuations without ever tapping public markets.
This evolution matters. One important implication is that many startup companies are being built to be sold, as opposed to being built to be independent public companies. This often does not lead to the same level of expansion and job growth that a long life as an independent public company does. Another important implication is that access to the private markets is limited to a much smaller group of high net worth individuals and institutions, effectively excluding retail investors from the value creation that occurs within these companies. Our public markets provide much greater access to wealth creation, from direct retail investing to the mutual funds that manage money on behalf of individuals, retirement plans, pension funds, and endowments.
Indeed, the need to support our public capital markets is why SIFMA, the U.S. Chamber of Commerce, and a broad coalition of stakeholders joined together recently to produce a report, Expanding the On-Ramp: Recommendations to Help More Companies Go and Stay Public, on these topics. SIFMA believes the report balances the need to streamline issuer obligations with a recognition that investor confidence is a critical component to the vibrancy of public capital markets.
Several specific recommendations within the coalition report that SIFMA believes could have a significant positive impact on public markets include:
- Lengthen the on-ramp for Emerging Growth Companies (EGCs) by expanding the ability of companies to take advantage of scaled reporting and confidential filing provisions.
- Expand the Testing the Waters provision of the JOBS Act to all issuers so that all would-be issuers can gauge investor interest ahead of an offering.
- Encouraging more research of EGCs and other small public companies through targeted changes to research regulations.
- Eliminate baby-shelf restrictions that make it very difficult for small-cap companies to timely and opportunistically raise the capital needed for expansion or research & development.
- Raising the caps on mutual fund positions in EGCs, to encourage institutional investor interest in these newly-public companies and create more robust trading of small cap stocks.
At the hearing, the House Financial Services Committee also discussed several draft bills that may improve capital formation in the U.S., and SIFMA believes some of those bills are worthy of consideration, especially the legislation that would extend the EGC on-ramp from five to ten years. The JOBS Acts on-ramp of tailored financial reporting requirements and auditing and accounting standards greatly eased the burden for smaller companies going public and the alternative standards did not dampen investor interest in their securities. Providing a longer runway for companies to scale up to the full public reporting requirements should incentivize more issuers to go and stay public.
Another critical topic policymakers should explore is the provisioning of research on publicly traded companies, which I believe is one of the most important and least understood facets of our public capital markets. At my firm, William Blair, we provide sell side research for over 600 public companies with a focus on small and mid-cap stocks, so this topic is of particular interest to me. SEC Rule 139 provides a safe harbor for research produced by broker-dealers participating in a distribution only if the issuer is a large reporting company under the 34 Act.
This arbitrary limitation means that coverage of smaller issuers must cease during an offering of their securities, a time when research would be quite valuable to investors. Impeding the provisioning of research does not protect investors in these cases and needlessly disadvantages smaller companies. Policymakers should expand the Rule 139 safe harbor to research of all issuers.
Its essential to keep in mind that no single policy change will reverse the decline in publicly listed companies or unlock the IPO market. The authors of the JOBS Act understood this and wisely took a holistic approach to improving capital formation, addressing both issuer and investor needs.
Policymakers certainly have a challenge before them, but the U.S. capital markets are the envy of the world and worth the effort to preserve. Both SIFMA and I stand ready to help policymakers in this task.
Brett Paschke is Head of Equity Capital Markets at William Blair.