Equity Capital Formation (ECF) Task Force co-chairs, Scott Kupor, Managing Partner at Andreessen Horowitz and Jeffrey M. Solomon, CEO of Cowen and Company, announced today their endorsement of the Alternative Recommendation on market structure improvement recently presented to the SEC Investor Advisory Committee (the “Committee”) in a letter sent to Joseph Dear, Chairman of the Committee. The Alternative Recommendation, which calls for a pilot trading program for small-cap public companies, will be considered at the Committee’s meeting on January 31, 2014. The letter highlights the following key points:
- Small-cap public companies have suffered from a lack of capital formation. This has inhibited job creation, innovation and investment opportunities stemming from startups and small companies.
- The core problem in the capital formation issue is the lack of trading liquidity in many publicly-traded small-cap companies. Existing market structure rules have made it challenging for meaningful institutional investor ownership, the primary source of trading liquidity.
- This problem adversely impacts individual investors as they comprise the vast majority of ownership in small-cap stocks. Studies have shown that stocks achieve greater valuations with the presence of institutional investment.
- A pilot program, as outlined in the Alternative Recommendation presented to the Committee, provides for a realistic way to enable institutional investors to return to the small-cap market while balancing the needs of investor protection and promoting capital formation.
- A pilot program offers a fair process to test a market structure that we believe will have a positive impact on the US economy, individual investors, institutional investors and small companies.
Full text of the letter to the Committee follows:
|January 22, 2014|
|Chairman Joseph Dear|
|Investor Advisory Committee|
|United States Securities and Exchange Commission|
|100 F Street|
|Washington, DC 20549|
|Re:||Recommendations to the Investor Advisory Committee by its Market Structure Subcommittee regarding Decimalization and Tick Size|
The purpose of this letter is to urge the Committee, and ultimately the SEC Commissioners, to adopt the Subcommittee’s Alternative Recommendation #1, which calls for a pilot program for small-cap public companies to trade at wider spreads and limited increments. Alternative Recommendation #1 offers a clear path to testing market structure in support of small company capital formation and aligns with the interests of individual investors, the largest owners of small-cap stocks. On the other hand, the Subcommittee’s Recommendation #1, which essentially is a do nothing approach, is simply not a viable alternative to solve the Core Problem.The Core Problem It is well documented that a robust market for equity capital formation benefits private sector job growth in America. Not only has there been a substantial decline in small company IPOs over the past decade and a half, but many small-cap public companies have also suffered from a lack of capital formation which has inhibited job creation, innovation and investment opportunities stemming from startups and small companies. At the center of this small-cap capital formation issue is the lack of trading liquidity in many publicly-traded small-cap companies. Under existing market structure rules, including penny increments, the lack of trading liquidity in this segment of the market has made it challenging for meaningful institutional investor ownership. Without institutional investors, which are the primary source of trading liquidity, capital formation for small-cap companies has declined to levels well below historical levels. However, a pilot program, such as outlined in Alternative Recommendation #1, is designed to realistically enable institutional investors to return to the small-cap market. While the size of this market segment is small (companies under $750 million in market capitalization represent only 2% of US total equity trading volume), this segment is a critical component of the US economic ecosystem, an engine for company and job creation. Fixing the core illiquidity problem could have an enormous impact. To be clear, a pilot program does not affect the remaining 98% of the market and, therefore, leaves intact the benefits that investors have enjoyed since the advent of decimalization. Illiquidity Impacts the Entire Ecosystem This is not just a problem that affects small companies and institutional investors. Very importantly, illiquidity also adversely impacts individual investors in a very real way since they comprise the vast majority of ownership in small-cap stocks. Studies have shown that stocks achieve greater valuations with the presence of institutional investment. Improving the liquidity in small-cap companies through revised market structure rules will benefit small-cap companies by giving them a greater ability to raise capital to grow their businesses. Moreover, and very importantly, it will also provide individual investors in those companies a way to benefit from long-term price appreciation that comes with renewed institutional investor participation. In short, Alternative Recommendation #1 rightly suggests that a pilot program will demonstrate that individual investors will benefit from long-term price appreciation as well. A Pilot Program Is a Fair and Targeted Solution A pilot program offers a fair process to test a market structure that we believe will have a positive impact on the US economy, individual investors, institutional investors and small companies. Alternative Recommendation #1 provides several suggested guidelines to ensure clear measurements of success or failure in a pilot implementation. This includes the suggestion that the pilot programs be operational for a sufficient length of time to truly validate their long-term success or failure. The suggested guidelines are consistent with the views presented to the US Treasury in a November 2013 report, “From the On-Ramp to the Freeway: Refueling Job Creation and Growth by Reconnecting Investors with Small-Cap Companies” by the Equity Capital Formation (ECF) Task Force. The ECF Task Force is a group comprised of professionals from across America’s startup and small-cap company ecosystem. Equity markets are dynamic and complex. Changes to market practices should be considered carefully. A pilot program aimed at small-cap companies would be a highly targeted effort affecting only 2% of the market. If we can solve the small company capital formation problem, as opposed to doing nothing, we will have found a path to creating jobs, driving innovation and providing more positive investment opportunities for both individual and institutional investors.
We urge the Committee and the SEC to adopt the Subcommittee’s Alternative Recommendation #1.Respectfully submitted,
|Scott Kupor||Jeffrey M. Solomon|
|Managing Partner, Andreessen Horowitz||Chief Executive Officer, Cowen and Company|
|Co-Chair, ECF Task Force||Co-Chair, ECF Task Force|
|cc:||Honorable Mary Jo White, Chair|
|Honorable Luis A, Aguilar, Commissioner|
|Honorable Daniel M. Gallagher, Commissioner|
|Honorable Kara M. Stein, Commissioner|
|Honorable Michael S. Piwowar, Commissioner|
|Lona Nallengara, Chief of Staff|
|John Ramsay, Acting Director of SEC’s Division of Trading and Markets|
In a November 2013 report presented to the U.S. Department of the Treasury titled, “From the On-Ramp to the Freeway: Refueling Job Creation and Growth by Reconnecting Investors with Small-Cap Companies,” the ECF Task Force made a series of recommendations to enhance market structure for small-cap companies as a means to increase the potential for job creation and growth. A copy of the complete report can be accessed at: http://www.equitycapitalformationtaskforce.com.