# Access to Capital and Market Liquidity > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/agency%3Asec%3A2160a7d579cbb65b ## Record - **Collection:** Agency decision - **Document type:** Agency decision ## Text Report to Congress Access to Capital and Market Liquidity As Directed by the Explanatory Statement to the Consolidated Appropriations Act, 2016 (P.L. 114-113) This is a report by the Staff of the Division of Economic and Risk Analysis of the U.S. Securities and Exchange Commission. The Commission has expressed no view regarding the analysis, findings, or conclusions contained herein. August 2017 Executive Summary In December 2015,1 Congress directed the Commission’s Division of Economic and Risk Analysis (DERA or we) to report on the impacts of the Dodd-Frank Act,2 especially the Volcker Rule, as well as other financial regulations, such as Basel III,3 on: (1) access to capital for consumers, investors, and businesses; and (2) market liquidity, including U.S. Treasury and corporate debt markets.4 The Report responds to the Congressional directive. Quantifying the effects of the regulatory reforms is challenging for several reasons. Most notably, overlapping implementations make it difficult to isolate the effect of any single rule or requirement. When the post-implementation period of one reform coincides with a preimplementation period of another, there is no clear baseline against which to separately measure the potential economic impacts. This issue is particularly acute when market participants change their behaviors in anticipation of future rules, the content of which is frequently signaled in advance by the notice and comment rulemaking process. Thus, compliance may occur in advance of the effective dates. It is also possible that many of the observed changes in market participant behaviors would have occurred absent the reforms. In particular, the immediate effects of the financial crisis—including the failures of many institutions and business models—provided strong 1 Consolidated Appropriations Act, Pub. L. 114–113, H.R. 2029. The Dodd–Frank Wall Street Reform and Consumer Protection Act, Pub.L. 111–203, H.R. 4173 (Dodd–Frank Act). 3 Basel Committee on Banking Supervision “Basel III: A global regulatory framework for more resilient banks and banking systems,” Dec 2010, (Rev Jun 2011); “Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools,” Jan 2013; “Basel III: the net stable funding ratio,” Oct 2014. For more, see http://www.bis.org/bcbs/basel3.htm 4 Because the markets for single-name credit default swaps and investment funds may interact with the U.S. Treasury and corporate debt markets, this report also analyzes those two markets. 2 2 incentives to change market practices in ways that may have simultaneously shaped the ensuing reforms. Finally, post reform macroeconomic conditions, such as the economic recovery and the low interest rate environment, are different from those leading up to and right after the financial crisis. Therefore, it is difficult to quantify the benchmark levels of primary issuance and market liquidity that would have been observed following the financial crisis and absent the ensuing reforms. For example, some market participants have noted that evidence of liquidity deterioration can be found in the number of trades that have not occurred. However, such data are not available, so we are not able to explore this metric. Although the above factors significantly limit our ability to analyze whether specific regulatory reforms caused any particular changes, DERA’s analysis provides a comprehensive and detailed review of capital raising through primary issuance and secondary market liquidity over time and in ways that allow an assessment of whether observed trends could be consistent with the effects of regulatory reforms, or with one or more of the other potential explanations. Where possible, we highlight when multiple factors could be impacting trends in issuance and/or market liquidity in either amplifying or offsetting ways. We recognize that liquidity may interact with other market characteristics, such as informational efficiency and market stability. In the Report, we do not estimate the optimal amount of liquidity for corporate bond or Treasury markets, but document the evolution of different dimensions of liquidity over time and consider whether observed changes are consistent with a variety of proposed explanations. A distinguishing feature of DERA’s Report is that it includes a comprehensive assessment of a large body of recent research in addition to original analysis performed by DERA staff. To this end, the Report’s scope differs from other existing studies, and we focus on 3 primary securities issuance and secondary market liquidity across fixed income markets. For example, the U.S. Department of the Treasury recently issued a report that included policy recommendations, based on certain conclusions regarding secondary market liquidity.5 As this report uses a different methodology than that considered in the Treasury Report, the conclusions reached in this Report may differ from those stated in the Treasury Report. We note, however, that because some Basel III requirements are still being implemented, most available evidence on potential regulatory effects centers on the Dodd-Frank Act, including the Volcker Rule, and the JOBS Act. There is comparatively little research on the impacts of Basel III reforms. We nevertheless consider the regulatory timeline for Basel III reforms in addition to the implementation of the Dodd-Frank Act and JOBS Act, and document changes in issuance and market liquidity metrics over time, including all relevant dates. However, due to the lack of available evidence, we do not specifically address the effects of Basel III reforms in Part A and Part B.VI. Main Results Part A. Primary Issuance DERA analyzed primary issuance of debt, equity, and asset-backed securities (ABS). The total capital formation from the signing of the Dodd-Frank Act into law in 2010 through the end of 2016 is approximately $20.20 trillion, of which $8.8 trillion was raised through registered offerings, and $11.38 trillion was raised through unregistered offerings.6 We do not find that total primary market security issuance is lower after the enactment of the Dodd-Frank Act 5 See U.S. Department of the Treasury, “A Financial System that Creates Economic Opportunities: Banks and Credit Unions” (June 2017) (hereinafter “Treasury Report”). 6 See Part A.II and Part A.III of the Report for the analysis of registered and unregistered offerings. 4 (including during the implementation of the Volcker Rule) and during the implementation of Basel III, and it may have increased around the implementation of the JOBS Act.7 DERA has not attempted to establish a counterfactual level of primary securities issuance that would have been attained in the absence of the Dodd-Frank Act, Basel III, and other regulatory reforms. These results are also generally consistent with active issuance in strong macroeconomic conditions and a low interest rate environment. Some of the findings we discuss in the Report are as follows:  Capital raised through initial public offerings (IPOs) ebbs and flows over time, reaching highs in 1999, 2007 and 2014, and lows in 2003, 2008, and 2016.8 It is difficult to disentangle the many contributing factors that influence IPO dynamics.  Recent years have seen an increase in the number of small company IPOs. IPOs with proceeds up to $30 million accounted for approximately 17% of the total number of IPOs in the period 2007-2011 and 22% in the period 2012-2016, following the passage of the JOBS Act in 2012.9 In 2016, more than 75% of IPOs were classified as Emerging Growth Companies (EGCs) under Title I of the JOBS Act (Title I).10  Private market issuance of debt and equity (unregistered offering activity) has increased substantially from $1.16 trillion in 2009 to $1.87 trillion in 2015, amounting to $1.68 trillion in 2016.11 Amounts raised through exempt securities offerings of debt and equity for 2012 through 2016 combined exceeded amounts raised through registered offerings of 7 The Jumpstart Our Business Startups Act, Pub. L. 112-106, H.R. 3606 (JOBS Act). See Part A.II. of the Report for the analysis of registered offerings. 9 We note that IPO activity has experienced significant declines in 2015 and 2016, and explore this development in Part A.II. 10 See Proskauer (2017). 11 See Part A.III of the Report for the analysis of exempt offering activity. 8 5 debt and equity over the same time period by approximately 26%. In comparison, the same figure for 2009 through 2011 was 21.6%. Amounts raised in reliance on the general solicitation rules under Title II of the JOBS Act, which were implemented in September 2013, remain low, representing only 3% of total amounts raised pursuant to Rule 506.  Amendments to Regulation A12 initiated by Title IV of the JOBS Act were followed by a large increase in Regulation A offering activity over the initial 18 months post effectiveness, with 97 qualified offerings seeking to raise $1.8 billion (compared with about 14 qualified offerings seeking to raise approximately $163.3 million in a typical year during 2005-2016). Based on issuer reports of amounts raised filed during 20052016, 56 issuers reported positive proceeds in Regulation A offerings, totaling approximately $314.6 million. Initial evidence on JOBS Act Title III crowdfunding activity suggests that some small pre-revenue growth firms are beginning to use crowdfunding as a securities offering method.13 Part B. Market Liquidity Evidence for the impact of regulatory reforms on market liquidity is mixed, with different measures of market liquidity showing different trends. Moreover, many of the observed changes in these measures are consistent with the combined impacts of several factors besides new rules and regulations, including, among others, electronification of markets, changes in macroeconomic conditions, and post-crisis changes in dealer risk preferences that pre-date the 12 Rel. No. 33-9741, Amendments to Regulation A (Mar. 25, 2015) 80 FR 21805 (Regulation A+ Adopting Release) 13 See Part A.III.G of the Report for initial evidence on crowdfunding activity. 6 passage of either the Dodd-Frank Act or Basel III. As noted above with respect to primary securities issuance, DERA has not attempted to estimate a counterfactual level of trading activity or average transaction costs in the absence of the recent regulatory reforms.  In U.S. Treasury markets, we find no empirical evidence consistent with the hypothesis that liquidity has deteriorated after regulatory reforms. More specifically, there is no support for a causal link between the Volcker Rule and U.S. Treasury market liquidity conditions. Changes in Treasury market liquidity are unlikely to be directly attributable to the Volcker Rule because U.S. cash Treasuries are exempt from the Volcker Rule’s prohibitions on proprietary trading.  In corporate bond markets, trading activity and average transaction costs have generally improved or remained flat. More corporate bond issues traded after regulatory changes than in any prior sample period. 14 In the post-regulatory period, we estimate that transaction costs have decreased (by 31 basis points (bps), to 55.4 bps round-trip) for smaller trade sizes ($20,000) and remain low for larger trade sizes relative to the precrisis period (estimated at 5.7 bps round-trip for trades of $5,000,000, compared to 5.8 bps pre-crisis). 14 See Table D.4, Panel B, which reports estimated half spreads for transactions of 5,000,000 (round-trip costs are double half-spreads). For the purposes of our transaction cost analysis, we split the sample into 6 sub-periods. We define January 2006 through June 2007 as the “Pre-crisis” sub-period. We designate July 2012 through May 2014 as the “Regulatory” sub-period, and June 2014 through September 2016 as the “Post-regulatory” sub-period. As discussed in Part B.IV.C, our sample period cutoffs are aligned with existing research, such as Bessembinder et al. (2016) and Bao et al. (2016). See Part B.IV.C of the Report for a more detailed analysis. 7 - Although estimated transaction costs have decreased, corporate bond trading activity in recent years has also become somewhat more concentrated in less complex bonds and bonds with larger issue sizes.15 - For some subgroups of corporate bonds, such as larger bonds (i.e., issue size greater than $500 million), certain investment grade bonds, younger bonds (i.e., less than 2 years since issuance), and longer maturity bonds (i.e., original maturity longer than 20 years), the estimated transaction costs for large trades are slightly higher than those in the pre-crisis period.16  Dealers in the corporate bond markets have, in aggregate, reduced their capital commitment since the 2007 peak.17 This is consistent with the Volcker Rule and other reforms potentially reducing the liquidity provision in corporate bonds. It is also consistent with alternative explanations, such as an enhanced ability of dealers to manage corporate bond inventory, shorter dealer intermediation chains associated with electronification of bond markets, crisis-induced changes in dealer assessment of risks and returns of traditional market making, and the effects of a low interest rate environment. These alternative explanations are not mutually exclusive or necessarily fully independent of regulatory reforms, so distinguishing between these potential explanations from the market trends data is not possible.  Although capital commitments have fallen, there has not been a commensurate decrease in the number of dealers participating in the market. We observe no notable changes in 15 See Part B.IV.B.1a) and Part B.IV.C.1 for the analysis of trends in trading activity over time and for bonds with different characteristics. 16 See Part B.IV.B, Part B.IV.C.1 and Part B.IV.C.2 for more analysis of trends in trading activity and transaction costs. 17 See Part B.IV.B and Part B.IV.C.3 for more analysis of trends in dealer activity. 8 the number of dealers providing liquidity per corporate bond issue over time, and we do not detect notable changes in trade sizes around regulatory reforms.  The evidence on dealer activity in times of stress is mixed and varies with the definition of stress. - Some existing research suggests that during times of localized market stress under strong macroeconomic conditions there may be greater adverse price impacts from trading activity (a sign of deteriorating liquidity) associated with the decline in dealer capital commitments for a small subset of bonds. Other evidence on localized stress selling does not support the finding of a deterioration in liquidity around firm specific events. - Evidence from the crisis suggests that during times of severe market stress, dealers may not lean into the wind, but instead make larger cuts in inventory of bonds that are aggressively sold by their customers.18 Such evidence supports a finding that dealers decrease liquidity provision in times of severe market stress.  Trading of corporate bonds on alternative trading systems (ATS) may partly account for the lower estimated average transaction costs for small trades and observed reductions in dealer capital commitments.19 - Electronic trading may facilitate efficient management of dealer inventory and reduce counterparty search costs. In addition, electronic trading could enable customers to seek liquidity directly from other customers. 18 See Part B.IV.B.2 and Part B.IV.B.3a) for a further discussion of liquidity conditions and dealer activity in times of stress. 19 See Part B.IV.C.4 for our data analysis of ATS activity. 9 - The majority of interdealer trades enjoy positive price improvement, whereas small customer trades experience negative price improvement, on average.  Trading in single-name credit-default swaps (CDS) provides an alternative channel for investors to gain exposure to corporate bond credit risk. Some measures of CDS market liquidity—total number of participants transacting in a given reference entity and various trading activity metrics—have remained stable or point to improvements. Other measures show a reduction in activity: trade sizes have decreased, quoting activity has declined, and quoted spreads for the least liquid high yield underliers have risen. Interdealer trade activity has declined after 2010, but dealer-customer activity has remained stable.20 20 See Part B.V.D for our analysis of activity in single-name CDS. 10 Table of Contents EXECUTIVE SUMMARY ........................................................................................................................... 2 INTRODUCTION ....................................................................................................................................... 13 CONGRESSIONAL DIRECTIVE ..................................................................................................................... 13 BROAD ECONOMIC CONSIDERATIONS ....................................................................................................... 14 SUMMARY OF RESULTS ............................................................................................................................. 17 METHODOLOGICAL CONSIDERATIONS ...................................................................................................... 24 PART A. ACCESS TO CAPITAL: PRIMARY ISSUANCE .................................................................. 28 I. INTRODUCTION ................................................................................................................................ 28 II. CAPITAL MARKETS FOR REGISTERED OFFERINGS ........................................................................... 31 III. CAPITAL MARKETS FOR EXEMPT OFFERINGS .................................................................................. 35 A. B. C. D. E. F. G. Introduction ................................................................................................................................ 35 General data on Regulation D and Rule 144A offerings ............................................................ 38 Rule 506(c) of Regulation D ....................................................................................................... 39 Investors in Regulation D Offerings ........................................................................................... 42 Regulation D Offering Fees ....................................................................................................... 44 Regulation A Activity Overview ................................................................................................. 47 Regulation Crowdfunding Activity Overview ............................................................................. 54 IV. THE ABS MARKET .......................................................................................................................... 60 V. TABLES ON PRIMARY ISSUANCE ...................................................................................................... 64 PART B. MARKET LIQUIDITY .............................................................................................................. 69 I. INTRODUCTION ...................................................................................................................................... 69 II. EMPIRICAL MEASURES OF MARKET LIQUIDITY .................................................................................... 70 Trading Activity ................................................................................................................................... 70 Transaction Costs ................................................................................................................................ 71 Liquidity Supply ................................................................................................................................... 72 Composite Measures ............................................................................................................................ 73 III. TREASURIES ..................................................................................................................................... 74 A. B. C. Introduction ................................................................................................................................ 74 Determinants of Liquidity Changes ............................................................................................ 77 Empirical Measures ................................................................................................................... 81 Funding Liquidity............................................................................................................................................ 82 D. E. IV. Recent Evidence ......................................................................................................................... 83 Summary..................................................................................................................................... 92 CORPORATE BONDS ......................................................................................................................... 93 A. B. Introduction ................................................................................................................................ 93 Existing Research ....................................................................................................................... 95 1. 2. 3. C. Dimensions of Liquidity ....................................................................................................................... 96 Liquidity Provision in Times of Stress ............................................................................................... 105 Drivers of Changes in Liquidity ......................................................................................................... 109 Data Analysis and Results ........................................................................................................ 126 1. Trading Activity ........................................................................................................................................ 128 2. Transaction Costs ...................................................................................................................................... 142 3. Dealer Activity .......................................................................................................................................... 161 4. Electronic Venues ..................................................................................................................................... 178 11 D. E. V. Summary................................................................................................................................... 190 Tables on Corporate Bond Liquidity ........................................................................................ 191 SINGLE-NAME CREDIT DEFAULT SWAPS (CDS) ............................................................................ 207 A. B. C. D. Introduction .............................................................................................................................. 207 Limitations on Analysis of Causal Impacts .............................................................................. 212 Spillovers between Bonds and Single-Name CDS .................................................................... 214 Exposures, Participants and Liquidity ..................................................................................... 220 1. 2. 3. 4. E. F. VI. A. B. C. D. Volume of Activity ............................................................................................................................. 220 Market Participants ............................................................................................................................. 229 Transaction Activity ........................................................................................................................... 230 Quotes and Quoted Spreads ................................................................................................................ 242 Summary................................................................................................................................... 247 Tables on Single-name CDS ..................................................................................................... 249 FUNDS............................................................................................................................................ 253 Introduction .............................................................................................................................. 253 Evidence on Bond Liquidity from Bond Ownership ................................................................. 253 Limitations in Interpreting the Data......................................................................................... 261 Summary................................................................................................................................... 263 REFERENCES .......................................................................................................................................... 265 APPENDICES ........................................................................................................................................... 274 Appendix A. Regulatory Reform Timeline......................................................................................... 274 Appendix B. Regulatory Reform Timeline: Security-Based Swap Markets ...................................... 278 Appendix C. Appendix to Access to Capital Analysis ....................................................................... 281 Regulation D Sample .................................................................................................................................... 281 Other Offerings ............................................................................................................................................. 283 Total Capital Raised In Registered and Unregistered Offerings.................................................................... 284 Appendix D. Appendix to Market Liquidity Analysis: Corporate Bonds ......................................... 285 Data Filters and Estimation ........................................................................................................................... 285 Sample Composition ..................................................................................................................................... 292 Transaction Costs .......................................................................................................................................... 295 Dealer Activity .............................................................................................................................................. 302 12 Introduction Congressional Directive The Consolidated Appropriations Act, 2016 was signed into law on December 18, 2015.21 The Explanatory Statement to the Appropriations Act22 directed the Division of Economic and Risk Analysis (DERA or we) of the U.S. Securities and Exchange Commission (Commission or SEC) to report to the Committees on Appropriations of the House and Senate, the Committee on Financial Services in the House and the Committee on Banking, Housing, and Urban Affairs in the Senate, on: the combined impacts that the Dodd-Frank Act--especially Section 619--and other financial regulations, such as Basel III, have had on: (1) access to capital for consumers, investors, and businesses, and (2) market liquidity, to include U.S. Treasury markets and corporate debt. DERA shall provide an update to the Committees on their work no later than August 1, 2016. This Report represents the considered views of staff in DERA, as informed by the processes described below, but the views expressed in this Report do not necessarily reflect those of the Commission or the individual Commissioners, or of staff of other Commission Offices or Divisions. To effectuate Congress’s direction, DERA studied (1) capital raising in the primary markets, and (2) secondary market liquidity. With regard to the first topic, DERA analyzed evidence on the evolution of the issuance of debt, equity, and ABS across registered and exempt offerings. With regard to the second topic, DERA analyzed market activity and liquidity in U.S. Government obligations (U.S. Treasuries or Treasuries) and corporate bonds, but also singlename CDS and investment companies, such as open-end mutual funds and exchange-traded 21 Consolidated Appropriations Act, Pub. L. 114–113, H.R. 2029. 161 Cong. Rec. H9693 (Dec. 17, 2015) (statement of Chairman of the House Committee on Appropriations) https://www.congress.gov/crec/2015/12/17/CREC-2015-12-17-pt2-PgH9693.pdf 22 13 funds (ETF), that invest in corporate bonds and Treasuries, for reasons we describe below. DERA considered the hypothesis that regulatory reform efforts, including the Volcker Rule and Basel III, as well as other regulations including those adopted by the Commission pursuant to the JOBS Act mandates, were impacting primary market activity, or secondary market liquidity, or both. DERA also considered whether factors other than regulatory reforms, including market structure changes,23 evolution of market participants’ preferences after the financial crisis, or aggregate macroeconomic conditions could be contributing to observed changes in the primary and secondary markets. Because DERA is not the first to analyze and assess these economic issues, the Report begins with a critical review of the results of the body of research to date. The Report then complements the findings from existing research with original analysis by DERA staff using market information obtained from SEC filings and other public data, subscription databases, and regulatory data feeds. Broad Economic Considerations DERA has examined the evolution of the volume and structure of primary market issuances and secondary liquidity over time. The availability of different types and channels of primary issuance, such as registered and exempt issues of debt, equity, and ABS, impact how businesses access capital and influence the scope and riskiness of securities available to consumers, businesses, and investors. Five broad considerations inform our analysis. 23 We recognize that these and other confounding phenomena are not necessarily mutually exclusive or fully exogenous. For instance, we cannot distinguish between bond market electronification arising out of technological advances, market response to the financial crisis, or market response to the regulations in the immediate aftermath of the financial crisis. 14 First, capital raising in primary markets and liquidity in secondary markets are inextricably intertwined. For example, liquid secondary markets that enable investors to exit large positions quickly and at low cost can facilitate primary market issuance and placement. At the same time, if high-risk issuers select into certain forms of issuance or if primary issuance becomes split across many different forms of issuance, secondary market liquidity can decrease. Most studies focus on either the issuance of new securities or the secondary market trading and liquidity. One of the distinguishing features of DERA’s analysis is a comprehensive and simultaneous exploration of both primary issuance and secondary liquidity issues across markets. Second, the existence of substitutes for exposure to credit risk may impact activity and liquidity in bond markets. Market participants seeking exposure to the credit risk of bond issuers can choose to transact directly in the market for corporate bonds or to trade in alternative credit risk products. The existence of single-name CDS and bond funds as alternative instruments for capital allocation and cross-market arbitrage may spill over into activity and liquidity in bond markets. As a result, it is important to consider how single-name CDS and fund liquidity may interact with activity in markets for Treasuries and corporate bonds. Third, liquidity is an important characteristic of a capital market and affects the ability of investors to execute trades of different sizes, quickly, and at low cost. We recognize that liquidity may interact with other market characteristics, such as informational efficiency of capital markets and market stability. The Dodd-Frank Act was intended, among others, to promote the financial stability of the United States.24 In the Report, we do not perform a costbenefit analysis of various regulatory changes, and do not estimate the optimal amount of securities issuance or liquidity in corporate bond or Treasury markets. Instead, we document the 24 See Pub. L. No. 111-203, Preamble. 15 evolution in different dimensions of capital raising and market liquidity over time and consider whether observed changes are consistent with a variety of proposed explanations. Fourth, large sample evidence enables us to examine the issuance and trading activity of large groups of market participants using thousands, millions, and billions of observations. We explore cross-sectional heterogeneity in capital raising and trading activity by analyzing various subgroups of issuers and transactions, and report different distributional parameters (e.g., median, 25th, 75th, 99th percentiles, etc.). Statistics produced from large sample analysis may not always reflect the behaviors and experiences of market participants in smaller segments of the markets. Therefore, where we observe improvements in issuance or liquidity metrics, the findings do not necessarily imply that all market participants experienced such improvements, and vice versa. Finally, we recognize that the regulations that serve as the focus for this Report impose costs on certain groups of market participants. To the extent that such costs have a significant impact on the behavior of affected market participants, they may result in changes to issuance and liquidity. However, affected market participants may alter their business practices in response to regulatory impacts and unaffected market participants may change their activity in compensating ways, even as the regulations have their intended effect. These responses to regulation, along with other factors such as changing macroeconomic conditions may dampen observed changes in market indicators and weaken our ability to link changes in issuance and liquidity with regulatory reforms. The Report endeavors to analyze relevant research and data through the fourth quarter of 2016, where available. Our analysis focuses on evidence to date, and we recognize various related studies may be ongoing. Evidence on the impacts of the implementation of Basel III on 16 bond liquidity is relatively scarce, possibly because elements of the Basel III regime are still being implemented in the United States, and this remains a fruitful area for future research. We also note that many of the studies discussed below are working papers, representing preliminary work that has not been fully vetted by the peer review process. Summary of Results As a result of this analysis, DERA observes that the evidence as to the direction and magnitude of changes in primary issuance and secondary market liquidity after the financial crisis and ensuing regulatory reforms is mixed. The observed changes are consistent with a number of explanations, including the combined effect of various regulations, non-regulatory market structure changes, crisis-related changes to market participants’ preferences that pre-date the passage of regulatory reforms, and aggregate macroeconomic conditions (such as a low interest rate environment), among others. We also note that these explanations need not be mutually exclusive or independent. For instance, to the extent that market structure changes may have contributed to observed changes in liquidity metrics, we cannot assess whether such market structure developments occurred because of technological advances, as a result of the crisis, regulatory reforms, or some combination thereof. DERA’s analysis is focused on areas within the scope of the Commission’s jurisdiction as the primary securities regulator in the United States, i.e. having regulatory responsibilities that span both primary and secondary securities markets. Our analysis of primary issuance considers changes in the volume and structure of issuance of equity, debt, and ABS. This includes changes in IPOs, seasoned offerings, and 17 exempt offerings of debt and equity, including offerings under Regulation D and Regulation A.25 We also present preliminary evidence on offerings pursuant to Regulation Crowdfunding,26 which the Commission adopted as part of its implementation of the JOBS Act. In addition, ABS issuance supports a large volume of primary issuance, and we consider the evolution and structure of ABS issuance activity over time. We do not find that total primary market security issuance is lower after the enactment of the Dodd-Frank Act (including during the implementation of the Volcker Rule) and during the implementation of Basel III, and it may have increased around the implementation of the JOBS Act.27 DERA has not attempted to establish a counterfactual level of primary securities issuance that would have attained in the absence of the Dodd-Frank Act, Basel III, and other regulatory reforms. These observed increases are also generally consistent with active issuance in strong macroeconomic conditions and a low interest rate environment. With respect to primary issuance, capital raised through initial public offerings (IPOs) during the period of 1996 through 2016 reached highs in 1999, 2007 and 2014, and lows in 2003, 2008, and 2016.28 The post-crisis dynamics of IPO issuance are consistent with several IPO waves observed during this time period. Capital raised through secondary equity offerings (SEOs) during the 1996-2016 sample period peaked in 2009, and in recent years has been exceeding pre-crisis issuance volume. Registered debt issuance has been growing during the sample period (1996 through 2016), reaching a peak in 2016. Regulation D offerings have more than doubled since 2009, the time for which data is available. Rule 144A offerings remaining 25 See 17 CFR 230.500 through 230.508; Rel. No. 33-9415 (Jul. 10, 2013), Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, 78 FR 44771; Rel. No. 339741, Amendments to Regulation A (Mar. 25, 2015) (Regulation A+ Adopting Release) 80 FR 21805. 26 Rel. No. 33-9974, Crowdfunding (Oct. 30, 2015) 80 FR 71387 (Crowdfunding Adopting Release). 27 The Jumpstart Our Business Startups Act, Pub. L. 112-106, H.R. 3606 (JOBS Act). 28 See Part A.II. for further analysis of registered offerings. 18 stable post-crisis and comparable to pre-crisis levels. Although the volume of ABS issuance declined dramatically during the financial crisis and has been on the rise since, it is still a fraction of pre-crisis levels (our ABS sample spans 2005 through 2016). Further, we do not find evidence that costs of various types of offerings have changed notably during our sample period. Our study of liquidity in secondary markets emphasizes Treasury and corporate bond market liquidity. Following a large body of research that points to the importance of different measures of liquidity, we construct and examine a number of measures reflecting various facets of liquidity, provide a critical analysis of existing findings, and perform additional data analysis to supplement prior work. The analysis below explores different potential drivers of changes in liquidity, many of which may not be mutually exclusive or fully independent of regulatory effects. Our data analysis examines changes in secondary market liquidity metrics around regulatory reforms, the evolving role of some dealers from principal to agency trading,29 and evidence from electronic trading. With respect to Treasury markets, as we discuss below, U.S. cash Treasuries are exempt from the Volcker Rule’s prohibitions on proprietary trading. Therefore, changes in Treasury market liquidity are unlikely to be directly attributable to the Volcker Rule. Instead, the Volcker Rule may indirectly affect this market as a result of spillover effects from other markets.30 An analysis of evidence on a wide range of liquidity measures quantifying different dimensions of liquidity does not allow us to conclude that post-crisis regulations caused a reduction in Treasury market liquidity. None of the existing studies provides empirical support for a causal link 29 Generally, dealers can trade as agents, matching customer buys to customer sells, or as principals, absorbing customer buys and customer sells into inventory and committing the requisite capital. See Li and Li (2017). 30 For instance, Treasury futures are not exempt, and the Volcker Rule could indirectly impact cash Treasuries through intermarket cash-futures basis trading. 19 between various regulations, and in particular the Volcker Rule, and changing Treasury market liquidity conditions. In our analysis of market liquidity in corporate bonds, we evaluate the evidence from existing research on the evolution of corporate bond market liquidity and find that some liquidity metrics have been reported to have improved, others have remained flat, and yet others have worsened after various regulations.31 While there is little consensus in existing work concerning the direction, causal attribution, and mechanisms behind observed changes, evidence suggests that in recent years dealers have been less likely to engage in risky principal transactions. In addition, dealers generally decrease liquidity provision in times of severe market stress, such as during the financial crisis.32 With respect to the potential regulatory factors behind observed liquidity changes, there is a lack of agreement in research regarding the direction and magnitude of regulatory impacts. Moreover, studies with different measurement and empirical design often present different or conflicting conclusions.33 Most research does not find that post-trade transparency leads to a deterioration in bond market liquidity.34 Existing research on the role of electronic trading is limited,35 and there is competing evidence on the interplay between CDS and corporate bond market liquidity.36 In the sections that follow we critically assess these and other studies and discuss their implications. 31 See Part B.IV.B.3a) for a discussion of evidence of changes in market liquidity around regulatory reforms. See Part B.IV.B.2 and Part B.IV.B.3a) for a discussion of evidence on dealer provision of liquidity in normal times and in times of stress before and after various regulatory reforms. 33 See Part B.IV.B.3a) for a detailed analysis. 34 See Part B.IV.B.3c) for a discussion of existing research on post-trade transparency. 35 See Part B.IV.B.3b) for an analysis of existing findings on electronic trading. 36 See Part B.V.C for a discussion of research on spillovers between single-name CDS and reference security markets. 32 20 Empirical analysis by DERA staff on corporate bond market liquidity conditions yields similarly mixed results. Following other studies, we segment the sample period into several subperiods, including the phase-in of the Trade Reporting And Compliance Engine (TRACE), precrisis, crisis, post-crisis, regulatory, and post-regulatory time periods.37 We present four main results. First, during the time periods after the crisis period we find an increase in the fraction of corporate bond issues with trades, higher levels of trading activity when traded, and greater par dollar volume traded compared to any other period except post-crisis. Second, we find that transaction costs have generally decreased or remained flat, with particularly strong declines for small trade sizes and relatively riskier investment grade (IG) bonds. However, because transaction costs can be estimated only for trades that occur, we are unable to observe how regulation and other market influencing factors may have had an effect on the ability of counterparties to find liquidity and successfully engage in a trade. In other words, trades sought but not executed cannot be empirically measured. Hence, interpreting the reported decline in transaction costs as an improvement in market liquidity requires consideration of the above evidence on changes in trading activity over time. Third, we consider changes in dealer activity as a proxy for changes in the availability of liquidity through market making activity. We find that the median number of dealers providing liquidity per corporate bond issue has remained stable across all sample periods. Moreover, we do not observe notable changes in the number of dealers providing liquidity per bond issue 37 Our sample period cutoffs are aligned with Bessembinder et al. (2016) and Bao et al. (2016). We designate the January 2003 through December 2005 as the “TRACE Phase-in” sub-period. We define January 2006 through June 2007 as the “Pre-crisis” sub-period. We designate July 2007 through April 2009 as the “Crisis” sub-period and May 2009 through June 2012 as the “Post-crisis” sub-period. Lastly, we divide the rest of our sample into two additional sub-periods. We designate July 2012 through May 2014 as the “Regulatory” sub-period37 and June 2014 through September 2016 as the “Post-regulatory” sub-period. We discuss these issues in great detail in Part B.IV.C. 21 around the changes in regulation. Across sub-periods, more dealers trade in small trade sizes. In particular, while the fraction of large size (greater than $5,000,000) principal trades is similar across sub-periods, the portion of medium size ($100,000 - $1,000,000) principal trades is larger during the “Regulatory” and the “Post-regulatory” sub-periods. Finally, we explore cross-sectional evidence on recent corporate bond quotation activity on ATS, which sheds light on the current use of electronic trading in corporate bonds. We document large cross-sectional heterogeneity in ATS activity for different types of bond issues. We find that electronification may be associated with lower trade sizes. We also find that the majority of interdealer trades enjoy positive price improvement, whereas small customer trades experience negative price improvement, on average. Overall, it is not clear that corporate bond market liquidity has deteriorated following the enactment of the Dodd-Frank Act, the implementation of the Volcker Rule, and the implementation of the Basel III reforms. As discussed below, the observed trends in market liquidity metrics are consistent with multiple alternative explanations. In addition to Treasury and corporate bond markets, we have considered changes in liquidity in other markets. Specifically, we explore: (1) potential diffusion of liquidity to singlename CDS, and (2) the evolution of fund liquidity. A recent CFA Institute survey addresses both as potential drivers of changes in secondary corporate bond market liquidity.38 Academic research also examines spillovers between single-name CDS and corporate bonds and the interaction between fund and bond liquidity.39 We consider whether these potential explanations may be consistent with observed changes in liquidity metrics. 38 39 See CFA Institute (2016). See Parts B.V and B.VI of this report. 22 The Report critically re-examines findings regarding the effect of the CDS market on bond liquidity. Existing literature finds evidence of two competing effects of trading activity in single-name CDS on bond liquidity. In particular, some evidence suggests that access to hedges of credit risk can enhance liquidity in riskier bond issues. Other evidence indicates that participants may be looking for liquidity across markets, and CDS liquidity may be crowding out bond market liquidity. That is, CDS is an alternative means by which market participants gain exposure to the credit risk of debt issuers.40 The analysis below documents changes in the volume of the market, participants, transaction and quotation activity in single-name CDS using public, commercial, and regulatory data.41 We examine three groups of measures: (1) metrics of transaction activity, including notionals, market values, and participants by credit, industry, and tenor; (2) measures of singlename CDS trading activity using a regulatory feed, including interdealer and dealer-customer notionals, trade sizes, counts, and zero trading days; and (3) quotation activity, including number of quoted underliers, quotes per underlier, quoted spreads, etc., from a commercial database. We find that interdealer trade activity has declined after 2010, but dealer-customer activity has remained stable, a result that is consistent with two competing explanations: (1) a reduced ability by dealers to find liquidity on the interdealer market; and (2) greater efficiency in dealer intermediation chains matching buyers to sellers. Consistent with the latter, the number of participants transacting in a given underlier has remained relatively constant, the fraction of zero trading days has decreased, and the frequency of trading for active underliers has remained flat 40 41 See Part B.V.C of this report. See Part B.V.D of this report. 23 or elevated after the financial crisis and reforms that have been enacted to date.42 However, quoting activity has declined, and quoted spreads for the least liquid high yield underliers have risen. Overall, our time series and cross-sectional results are consistent with several alternative explanations which are not mutually exclusive. Lastly, the analysis that follows explores fund liquidity, which contributes to a holistic picture of changes in secondary market liquidity and potential structural changes in corporate bond and Treasury markets during the past decade. In particular, research suggests that liquidity can flow from bond markets into investment companies (such as mutual funds and ETFs), and vice versa. For instance, market participants seeking exposure to the credit risk of issuers may choose to allocate into bond funds instead of underlying bonds. In this way, bond funds, particularly open-end funds and ETFs, can serve as a substitute instrument that investors can use if and when the underlying bond markets are illiquid. We find that the evidence on the interplay between fund activity and bond liquidity is mixed, that fund ownership of corporate bonds has increased over this Report’s period of interest, and that fund activity could impact liquidity measures in underlying bonds in multiple ways. Methodological Considerations DERA staff analyzed existing economic research and performed novel data analysis. Throughout this Report we discuss a number of data and experimental design issues that limit our ability to make causal determinations as to the effect of reforms on access to capital and 42 As discussed in Part B.V.B, many of the substantive Title VII rules governing the single-name CDS market have been proposed but not adopted (e.g., capital and margin requirements for dealers and major participants, swap execution facilities), and compliance with many adopted rules is not yet required (e.g., dealer registration, crossborder activity, business conduct standards etc.). 24 market liquidity. In this section we introduce some of the broad methodological considerations and limitations of the analysis. As discussed above, the Report examines primary issuance and secondary market liquidity across many markets from the early 2000s through 2016. Any study of such scope and magnitude faces challenges, and two are most salient: baselining and identification. First, Dodd-Frank, Volcker, and Basel III reforms followed a historic financial crisis and the ensuing market rally. As a result, the pre-regulatory period includes the recession and the bull market that follows. Using this period as a baseline could bias estimates for many capital raising and liquidity metrics. To address this challenge, subject to data constraints and where practicable, we have extended our samples to the early/mid 2000s to capture a longer time period prior to the enactment of regulatory reforms. Where such analysis is not possible or practicable, we recognize the sensitivity of our conclusions to the selection of the baseline period. Similarly, regulatory reforms of interest coincided with a portfolio of other policies, market structure changes, demand shifts, and types of market participants. For instance, electronic trading, low interest rates, and market participants reevaluating the risks and returns of various business models in the aftermath of the financial crisis contaminate the comparison of liquidity measures before and after regulatory reforms of interest. As a result, the direct impact of regulatory reforms on liquidity in corporate bond and Treasury markets is likely confounded with the effects of these innovations and shocks. Second, we are limited in our ability to make causal inferences. The prevalent econometric techniques used to test for causality, such as event study methodology, differencesin-differences estimation, instrumental variables, or regression discontinuity design, are not feasible for many of the analyses performed. As illustrated in Appendix A, the rules 25 implementing the Dodd-Frank Act and Basel III reforms were proposed, enacted, and adopted over several years, and in some cases have not yet been fully implemented as of this writing. Market participants widely anticipated and responded to many of these reforms years ahead of the compliance or effective dates across markets. As a result, event study evidence on the impact of reforms on transaction activity and dealer supply of liquidity is difficult to interpret. In addition, many regulatory reforms impacted large groups of participants at the same time, so we lack cleanly identified and otherwise comparable “treatment” and “control” groups of market participants. Absent well-defined treatment and control groups, the validity of differences-indifferences estimation is questionable. Where we cannot draw causal inferences, we engage in a comprehensive exploration of the current state and recent changes in primary issuance and secondary market liquidity and consider whether the observed trends and statistics are consistent with a variety of proposed explanations. Some additional limitations of the analysis include the following:  The analysis of offerings relying on the JOBS Act provisions is qualified by small sample sizes and relatively short observation periods. Thus, it is unclear to what extent it can be extrapolated to future years or periods with different aggregate conditions. Medium- and long-term success of such placements remains an area for future study.  We are cautious in using crisis or post-crisis figures as benchmarks for activity levels in normal times. Where the available data do not permit us to examine market activity for the early to mid-2000s period (e.g., single-name CDS), trend analysis is limited.  The analysis of dealer balance sheets using Financial and Operational Combined Uniform Single (FOCUS) data is limited by the exclusion of Alternative Net Capital (ANC) filers, 26 owing to a lack of comparable data for those filers during our sample period. To the extent that ANC filers may have been more affected by regulations, our estimates of changes in activity may be conservative.  Because of the unavailability of relevant data, we are unable to examine changes in dropped (unexecuted) orders, order splitting, and difficulty in executing large block orders on liquidity, among other things. The rest of the Report is structured as follows. Part A analyzes primary issuance of equity, debt, and ABS; and Part B evaluates changes in secondary market liquidity in Treasuries, corporate bonds, single-name CDS, and funds. 27 Part A. Access to Capital: Primary Issuance I. Introduction In the United States, companies can use a wide variety of securities offerings to raise capital. Securities laws require that all offers and sales of securities be either registered with the SEC under the Securities Act of 1933 (the Securities Act) or conducted under an exemption from registration. When raising capital through the sale of securities to any potential investors in the public capital market, unless the transaction qualifies for an exemption from registration,43 the issuer must register the offer and sale of securities with the SEC, a process that is accompanied by extensive disclosure at the time of the offering and subsequent reporting (a “registered” offering). Alternatively, a company can raise capital by accessing the capital markets through a transaction exempt from registration (an “exempt” or “unregistered” offering). This path allows issuers to avoid certain regulatory burdens and the increased oversight that comes with a registered offering, with the intended effect of reducing issuance costs and the time required to raise new capital. Exempt offerings may be particularly attractive to smaller firms, for whom conducting registered offerings and becoming subject to reporting requirements may generally be too costly. However, because exempt offering alternatives require issuers to disclose less information and are accompanied by less oversight, they are generally subject to investor restrictions and/or offering limits. The investor protection provisions of the exemption claimed must be met to qualify for the exemption from registration. Companies that are willing to register their transactions can access the public equity market via registered equity offerings such as IPOs and SEOs, or the public debt market via registered debt offerings. Companies with or without a registered offering or a registered class 43 See the discussion of Rule 506(c) of Regulation D, Regulation A and Regulation Crowdfunding below. 28 of securities can raise capital via exempt debt and equity offerings, such as Regulation D offerings or Rule 144A offerings. Recent changes to the securities laws made by the JOBS Act, which was enacted in 2012, and its implementing regulations, were designed to promote both registered and exempt offerings. Title I of the JOBS Act streamlined the registered offering process for a class of issuers called emerging growth companies (EGCs).44 Other provisions of the JOBS Act expanded options for exempt securities issuance: Title II required that the SEC permit general solicitation under Rule 506 of Regulation D and Rule 144A (subject to certain conditions); Title III required that the SEC create a new method of raising capital (crowdfunding); and Title IV required that the SEC update a little-used exempt offering provision (Regulation A). It is thus reasonable to expect that these changes may have important effects on the amount of capital being raised in exempt offerings. Since the JOBS Act is specifically focused on the primary capital markets, in this section we explore whether any developments in these markets may be linked to the JOBS Act. Where relevant, we also discuss whether observed changes can be linked to the Dodd-Frank Act. It is challenging to establish causality with respect to either regulation, however, because so many other factors could affect the primary capital markets—factors for which we cannot control. The JOBS Act was signed into law on April 5, 2012, and the several titles that comprise it went into 44 The JOBS Act defines EGCs as an issuer with less than $1 billion in total annual gross revenues during its most recently completed fiscal year. If an issuer qualifies as an EGC on the first day of its fiscal year, it maintains that status until the earliest of (1) the last day of the fiscal year of the issuer during which it has total annual gross revenues of $1 billion or more; (2) the last day of its fiscal year following the fifth anniversary of the first sale of its common equity securities pursuant to an effective registration statement; (3) the date on which the issuer has, during the previous 3-year period, issued more than $1 billion in nonconvertible debt; or (4) the date on which the issuer is deemed to be a “large accelerated filer” (as defined in Exchange Act Rule 12b-2). See also Rel. No. 33-10332, Inflation Adjustments and Other Technical Amendments Under Titles I and III of the JOBS Act (Mar. 31, 2017), available at https://www.sec.gov/rules/final/2017/33-10332.pdf (raising the $1 billion limit to $1.07 billion to adjust for inflation) (JOBS Act Technical Amendments Release). 29 effect in the period from 2012 (Title I) through 2016 (Title III). Since these changes took effect over several years, it is difficult to pinpoint any causal relationship between the passage of either regulation as a whole or the implementation of different provisions, and developments in the capital markets. More generally, it is important to note that issuers will choose the type of offering that is optimal from their point of view in terms of costs and benefits. Those costs and benefits may depend on the current regulatory environment but will also depend on various other factors such as the general state of the economy, interest rate cycles, etc. For example, prior economic studies document the presence of hot and cold markets for registered equity offerings.45 These hot and cold markets are driven by macroeconomic factors, changes in the level of information asymmetry between investors and issuers, and changes in investor sentiment. It is also possible that registered and exempt capital markets will respond differently to these factors, and may function as either substitutes or complements. For example, it is possible that when registered markets are cold companies switch to exempt capital markets, and vice versa. Alternatively, a hot registered market could prompt companies to seek additional financing from exempt markets in preparation of future public offerings. Finally, while our analysis focuses on securities issuance, we recognize that bank lending is an important source of financing for issuers, and consumer lending is a valuable source of consumer access to capital. However, such lending falls within the statutory authority of banking regulators and the Consumer Financial Protection Bureau (CFPB), and the Commission is a primary regulator of capital markets. The analysis below, therefore, does not examine 45 See, e.g., Lowry and Schwert (2002), Helwege and Liang (2004), Gao et al. (2013), and Arikan and Stulz (2016) 30 lending markets directly, but considers asset-backed securitization markets, which support a large volume of primary lending in an originate-to-distribute model. II. Capital Markets for Registered Offerings One of the channels through which businesses can raise capital in the United States is a registered offering. In this section, we consider the issuance of equity and debt in the registered market, and document the evolution in the volume and structure of such issuance over time. Total registered issuance in the United States has increased steadily from 2011 through 2016, as shown in Figure C.1. It grew from $1.42 trillion in 2015 to $1.49 trillion in 2016. The period 2013-2016 witnessed the largest registered issuance in the US for the last 11 years. Figure 1 plots capital raising in the IPO and SEO markets during the period 1996-2016. The data suggests that IPO activity reached highs in 1999, 2007 and 2014, and lows in 2003, 2008, and 2016. Figure 1. Capital raising through registered equity offerings (in $ billions), 1996-2016 250 $ Billions 200 150 100 50 0 Equity SEO Equity IPO Source: DERA analysis 31 Figure 1 illustrates the cyclicality of issuance activity and shows the dynamics of IPO issuance through economic booms and busts. We cannot determine whether the Dodd-Frank Act, which was enacted in 2010, notably affected IPO activity since we are unable to identify mechanisms through which the Dodd-Frank Act would have impacted, positively or negatively, IPO activity. For example, several of the Dodd-Frank Act’s executive compensation provisions were not implemented in the sample period, and several other provisions of the Act did not apply to EGCs following the enactment of the JOBS Act. In contrast, as can be seen from Figure 1 the JOBS Act, which was enacted on April 5, 2012 and included provisions concerning IPOs and exempt offerings, may have had a positive effect on IPO activity. However, the observed effects are also generally consistent with higher issuance in strong macroeconomic conditions. Further, we also observe a decline in IPOs in 2015 and 2016. We recognize that certain provisions of the JOBS Act concerning various types of exempt offerings were implemented in 2015 and 2016. However, given the overall size of those markets documented below, a shift in capital raising from traditional IPOs to Regulation A or crowdfunding offerings cannot explain the decline in IPO activity in recent years. At the same time, the 2015-2016 decline in IPOs is consistent with changes in investor demand, market saturation and the increased availability of private funding and other alternatives for exit. A recent industry analysis has also identified a market correction stemming from historically high market valuations, political and macroeconomic uncertainty, and the availability of private capital enabling firms to selectively time IPOs as potential contributing factors.46 Post-crisis evolution in IPO issuance is broadly consistent with historical patterns of IPO waves. 46 Ernst & Young, May 2017, “Looking behind the declining number of public companies: An analysis of trends in US capital markets,” https://www.sec.gov/spotlight/investor-advisory-committee-2012/ey-an-analysis-of-trends-inthe-us-capital-markets.pdf 32 IPOs by EGCs may be becoming the prevailing form of issuance in some sectors. For example, Proskauer (2017) finds that 78% of IPO issuers in 2016 were EGCs, with a particularly high concentration of EGC IPOs in health care, telecommunications, energy and power, and financial service sectors (between 86% and 95%). At the same time, EGCs represented only 17% and 43% of IPOs in industrial and consumer/retail sectors respectively. Proskauer (2017) also estimates that 90% of EGC issuers between 2013 and 2016 that disclosed testing-the-waters communications operated in the health care and telecommunications and media sectors. Issuers in those sectors often have shorter operating histories and lack revenue or net income, which is consistent with greater opacity and risk of EGC issuers. Title I of the JOBS Act was intended to make it less costly for EGCs to go public. Research by Dambra et al. (2015) finds that the number of IPOs, and especially those by small issuers, has increased notably over pre-JOBS Act levels. However, another study, Chaplinsky et al. (2016), finds no reduction of direct issuance costs, accounting, legal, or underwriting fees for EGCs, and observes an increase in indirect issuance costs in the form of underpricing.47 Proskauer (2017) estimates average IPO expenses as a percentage of base deal for 2016 placements, and finds that EGCs incur higher total IPO expenses (difference of 2.21%). However, unlike Dambra et al. (2015) and Chaplinsky et al. (2016), this statistic is descriptive and does not account for the potential selection of opaque and risky issuers into EGC status, or control for differences in EGC and non-EGC issuer growth, profitability, sector and other fundamentals.48 47 Underpricing is typically defined as the percentage difference between the market closing price on the day of the initial public offering and the offer price at which underwriters sell shares to investors. 48 See Lowry et al. (2017) for a comprehensive overview of finance research on IPOs since 2000. 33 More generally, it is difficult to disentangle the above effects of the JOBS Act from the effect of the general improvement in macroeconomic activity during this period. Prospective registered equity issuers are exposed to aggregate economic and industry-level risks. Negative macroeconomic shocks that reduce cash flows or increase the level of risk can reduce valuations making offerings appear less attractive to investors and leading to a decrease in the number of deals and/or deal sizes. Such aggregate trends similarly affect cycles in registered offering activity. Small issuers may be relatively more affected by downturns if their cash flows are lower and less diversified and if they lack sufficient collateral to obtain debt financing when their internal cash flow declines. Table 1 lists the number of offerings, the average and median offer size, and the average and median gross spreads for both IPOs and SEOs. Consistent with Figure 1, these statistics show that the average and median offering sizes for IPOs are close to what they were prior to the crisis. There has also been an increase in small company IPOs—IPOs with proceeds up to $30 million were approximately 17 percent of the total number of IPOs in the period 2007-2011 and 22 percent in the period 2012-2016. Figure 2 presents capital raising activity in the registered debt market for 2005-2016. Consistent with findings in other studies, the amount of funding obtained through the registered debt market on an annual basis is much larger than that obtained through the registered equity market. The dollar volume of registered debt appears to have increased in recent years, which may be a result of improving macroeconomic conditions and a low interest rate environment. As economic prospects for companies improve, companies tend to increase investment, increasing their demand for financing. Table 2 presents summary statistics for registered debt offerings and 34 shows that the average and median offer size of these offerings are much larger than those of IPOs and SEOs. Figure 2. Capital raising through registered debt offerings (in $ billions), 1996-2016 1,400,000 1,200,000 $ Billions 1,000,000 800,000 600,000 400,000 200,000 0 Public debt Source: DERA analysis Next, we consider the cost of registered debt offerings. Because of the low level of interest rates, companies may be able to obtain debt financing at low cost. We find that the average and median gross spreads are notably lower for registered debt offerings. The gross spreads reported in Table 2 are similar to what prior economic studies have documented (Fang (2005)): issuers raising capital through registered bond issues pay commissions between 0.7% and 1.5% of the size of the offering. III. Capital Markets for Exempt Offerings A. Introduction Having considered registered offerings, we now turn to the analysis of exempt issuance. Total primary unregistered issuance in the United States, which is the capital raised through all 35 the different types of unregistered offerings discussed below, has increased from 2010 through 2016, as shown in Figure C.2. Most recently, it dropped from a peak of $1.87 trillion in 2015 to $1.68 trillion in 2016. During the period 2009-2016, total primary unregistered issuance has consistently outpaced total primary registered issuance. Amounts raised through exempt securities offerings of debt and equity for 2012 through 2016 combined exceeded amounts raised through registered offerings of debt and equity over the same time period by approximately 26%. In comparison, the same figure for 2009 through 2011 was 21.6%. This market is governed by several exemptions from registration, including those under Sections 4(a)(2), 3(b) and 3(a)(11) of the Securities Act. For example, Section 3(b) is the exemptive authority for Rule 504 under Regulation D as well as Regulation A.49 Other parts of the exempt market rely on “safe harbors”: rules and regulations that set forth specific conditions that, if satisfied, ensure compliance with an exemption from registration. For example, issuers can use Rule 506(b) of Regulation D, which is a non-exclusive safe harbor under Section 4(a)(2), Regulation S for offerings outside of the United States, and Rule 144A, for the resale of restricted securities to qualified institutional buyers. Finally, Rule 506(c) of Regulation D is a stand-alone exemption for unregistered sales to accredited investors by means of general solicitation. Bauguess et al. (2015) provide a comparative analysis of the characteristics of these and other offering exemptions and safe harbors. 49 In 2015, Regulation A was amended to reflect the changes included in Title IV of the JOBS Act. Among the changes in Regulation A is an increase in the amount of capital that can be raised (from $5 million to $50 million) and preemption from state registration and review for certain offerings. See Rel. No. 33-9741, Amendments to Regulation A (Mar. 25, 2015) (Regulation A+ Adopting Release). Rule 504 was amended, effective January 20, 2017, to increase the amount of capital that can be raised (from $1 million to $5 million) and to add the disqualification of certain bad actors. Rule 505 has been repealed effective May 22, 2017. See Rel. No. 33-10238 Exemptions to Facilitate Intrastate and Regional Securities Offerings (Oct. 26, 2016) 81 FR 83494. We included the historical Rule 505 data in our analysis. 36 The importance of exempt capital markets as a source of financing in the economy is underscored by the fact that less than 0.02% of the estimated 28.8 million firms in the United States are currently exchange-listed firms.50 Moreover, there has been a steady and substantial decrease in the number of reporting companies in the United States.51 During this period, exempt offerings of securities have contributed substantially to capital formation in the U.S. economy, particularly for small and emerging companies that are often considered to be the engine for creating new jobs,52 driving innovation, and accelerating economic growth. Hence, exempt capital markets provide an important financing alternative for companies that, for various reasons, forego financing in the registered capital markets. Data for some of these exemptions are more readily available than for others. For example, because issuers relying on Section 4(a)(2) are not required to file any document with the Commission, offering information available in the commercial databases likely underestimates the amount of capital raised through this exemption. Similarly, the available data on Regulation D offerings could underestimate the true amount of capital raised through such offerings. While Regulation D requires the filing of a notice on Form D no later than 15 days after the first sale of securities, that filing is not a condition to the provision. Accordingly, it is 50 See SBA, Office of Advocacy, United States Small Business Profile (2016), available at https://www.sba.gov/sites/default/files/advocacy/United_States.pdf. See also Barry Ritholtz, Where Have All the Public Companies Gone?, BLOOMBERG VIEW (Jun. 24, 2015). 51 The decline in the number of US-listed firms in 1996-2003 represents approximately 74% of the decline from 1996 to 2016. See Ernst & Young, May 2017, “Looking behind the declining number of public companies: An analysis of trends in US capital markets,” https://www.sec.gov/spotlight/investor-advisory-committee-2012/ey-ananalysis-of-trends-in-the-us-capital-markets.pdf. Also see Doidge et al. (2017). 52 During the period 1998-2008, U. S. Small Business Administration estimates show that small businesses contributed almost 50% of U.S. non-farm GDP and accounted for 55% of U.S. employment, including 66% of all net new jobs since the 1970s. See Robert Longley, Top Ten Reasons to Love US Small Businesses THOUGHTCO, at https://www.thoughtco.com/reasons-to-love-us-small-businesses-3319899 (Sept. 4, 2015) (citing Office of Advocacy, Small Business Administration). See also Small Business Administration, Small Business Quarterly Bulletins, at https://www.sba.gov/advocacy/small-business-quarterly-bulletins. 37 possible that some issuers do not file a Form D for offerings under Regulation D.53 In addition, there is no requirement to file a Form D amendment reporting the total amount actually raised in the offering under Regulation D.54 Data used in the primary issuance analysis is described in more detail in Appendix C. B. General data on Regulation D and Rule 144A offerings Figure 3 shows the amounts raised in Regulation D offerings, given the data limitations discussed above, and Rule 144A offerings. The amount of capital raised through Regulation D offerings is much larger than that raised in the Rule 144A market. When combined, the capital raised through Regulation D and Rule 144A offerings in a year is consistently larger than the total capital raised via registered equity and debt offerings. Most Regulation D offerings (over 66%) include equity securities; by contrast, in the Rule 144A market, the vast majority of issuers are financial institutions and over 99% of securities are debt securities. Table 3 provides summary statistics on the number of Regulation D offerings and the average and median offering amount.55 The number of Regulation D offerings is an order of magnitude larger than the number of registered debt and equity offerings. However, the average and median offer sizes of Regulation D offerings are much smaller than those of registered equity and debt offerings. 53 Separate analysis by DERA staff of Form D filings by funds advised by registered investment advisers and broker-dealer members of the Financial Industry Regulatory Authority, Inc. (FINRA) suggests that Form D filings are not made for as much as 10% of unregistered offerings eligible to use the Rule 506(b) safe harbor under Regulation D. 54 See the General Instructions to Form D. An update to Form D may be required to reflect a change in the information previously filed, except that certain less substantial changes enumerated in Rule 502 of Regulation D (e.g., an increase in the offering amount of less than 10%) do not trigger the requirement to update the filing. If the requirement to update is triggered, current information must be provided for the entire form. 55 Due to data availability constraints, the analysis of Regulation D issuance covers 2009 through 2016 38 Figure 3. Capital raised through Regulation D and corporate Rule 144A offerings (in $ billions), 2005-2016 1600 1400 $ Billions 1200 1000 800 600 400 200 0 2005 2006 2007 2008 2009 Regulation D offerings 2010 2011 2012 2013 2014 2015 2016 Corporate 144A offerings Source: DERA analysis C. Rule 506(c) of Regulation D Title II of the JOBS Act directed the Commission to engage in rulemaking to permit general solicitation in Rule 506 offerings, provided that sales are made only to accredited investors and the issuer takes reasonable steps to verify purchasers’ accredited investor status. The Commission subsequently adopted Rule 506(c) of Regulation D, permitting the use of general solicitation and advertising subject to such conditions. From September 23, 2013, to December 31, 2016, a total of 5,374 issuers disclosed in their Forms D that they initiated 5,474 new Rule 506(c) offerings (Table 4). During that period, almost $70.6 billion was reported raised in initial Form D filings. An additional $37.1 billion was reported to be raised in amended form D filings, some of which were originally initiated as Rule 506(b) offerings. During the same period, there were 65,772 new Rule 506(b) offerings that reported to raise $2,186.2 billion in initial Form D filings, and an additional $1,935.8 billion was reported to be raised in amended form D filings. Though large in absolute terms, issuances claiming the new Rule 506(c) 39 exemption have accounted for only 3% of the reported capital raised pursuant to Rule 506 since becoming effective in September 2013, through December 31, 2016. While the underlying motivation for permitting general solicitation was to boost capital formation through increased accessibility of certain issuers to accredited investors, the vast majority of Regulation D issuers continue to raise capital through Rule 506(b) offerings. Some have noted that the novelty of the Rule 506(c) provisions after decades of non-permissibility of general solicitation in Regulation D offerings may be one reason why Rule 506(b) continues to dominate the Regulation D market. In particular, issuers with pre-existing sources of financing or intermediation channels, or both, may not yet have a need for the new flexibility. Other issuers may become more comfortable with market practices as they develop over time, including, among other things, certainty over what constitutes general solicitation.56 There may also be concerns about the added burden or appropriate levels of verification of the accredited investor status of all purchasers.57 For instance, Warren (2015) indicates that investor privacy concerns regarding the disclosure of confidential financial information may be behind issuer reluctance to rely on Rule 506(c) provisions. Markets may develop more efficient means for verifying investor status over time. Regulatory uncertainty has also been identified as a possible explanation for the relatively low level of Rule 506(c) offerings. For example, certain pooled investment funds that need to comply with Commodity Futures Trading Commission (CFTC) regulations continued to be 56 See, e.g., Keith Higgins, Director of the Division of Corporation Finance, U.S. Securities and Exchange Commission, Remarks before the 2014 Angel Capital Association Conference (Mar. 28, 2014) available at http://www.sec.gov/News/Speech/Detail/Speech/1370541320533. See also comments of Jean Peters, Board member, Angel Capital Association, at the 33rd Securities & Exchange Commission Government-Business Forum on Small Business Capital Formation (Nov. 20, 2014). 57 See comments of Jean Peters, Board member, Angel Capital Association, at the 33rd Securities & Exchange Commission Government-Business Forum on Small Business Capital Formation (Nov. 20, 2014). 40 subject to the CFTC’s prohibition on advertising after September 23, 2013 (and at least until September 2014), and therefore could not use Rule 506(c).58 Further, the Commission’s proposed amendments to Regulation D and Form D at the time Rule 506(c) was adopted have elicited widely divergent views from commenters, with some commenters expressing the view that the “overhang” from the proposed (but never finalized nor withdrawn) rule has chilled use of the new exemption.59 Additional analysis in Table 4 shows that the average amount reported sold in an initial Rule 506(c) offering ($13 million) is much smaller than the average amount reported sold in a Rule 506(b) offering ($26 million). The lower amounts reported to be raised at the date of initial filing may be because issuers that anticipated difficulties raising capital in a timely manner chose the Rule 506(c) market so that they would have an ability to advertise or generally solicit their offering to a broader audience of potential investors. It is also possible that some sophisticated investors perceive the election of the Rule 506(c) exemption as a signal that issuers anticipate difficulties in raising sufficient capital and consequently consider it a less attractive offering, which could also dissuade issuers from using the new exemption for their financing needs. Overall, it is not clear whether offerings under Rule 506(c) are indicative of new capital formation or a reallocation from other offering types. Consistent with the somewhat limited uptake of new Rule 506(c), we do not observe a notable migration of existing issuer capital raising activity from Rule 506(b) to Rule 506(c). In particular, only a small number of offerings 58 See Letter from Gary Barnett, Director, Division of Swap and Intermediary Oversight, CFTC to Regina Thoele, National Futures Association, available at http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/14-116.pdf. 59 See Warren (2015). See also Keith Higgins, Director of the Division of Corporation Finance, U.S. Securities and Exchange Commission, Remarks before the 2014 Angel Capital Association Conference (Mar 28, 2014) available at https://www.sec.gov/news/speech/2014-spch032814kfh (noting that then-Chair White had stated publicly that issuers are not required to comply with the proposed rule, and that appropriate transition provisions would be considered for ongoing offerings if a final rule were adopted). 41 switched from relying on Rule 506(b) to Rule 506(c). From September 23, 2013 to December 31, 2014, approximately 398 continuing Regulation D offerings switched their exemption to Rule 506(c).60 These “switched” offerings have reported capital raisings of $12 billion. There has been a similar movement in the number of “repeat” issuers (issuers that used to access the Regulation D market via Rule 506(b) offerings) that have switched their offering types from Rule 506(b) to subsequent Rule 506(c) offering: issuers that had a prior Regulation D offering initiated 447 new Rule 506(c) offerings. These issuers have reported capital raisings of $16.7 billion. D. Investors in Regulation D Offerings Regulation D allows both accredited and non-accredited investors to participate in private offerings, with an unlimited number of non-accredited investors in Rule 504 offerings, while former Rule 50561 and Rule 506(b) offerings may include no more than 35 non-accredited investors. Only accredited investors can participate in Rule 506(c) offerings. On the basis of information collected from Form D filings, most participants in Regulation D offerings are accredited. For example, on average 9% of new offerings included non-accredited investors for the period 2009-2016 (Table 5). Offerings by financial issuers and real estate investment trusts (REITs) are more likely to have non-accredited investors (13% of offerings had at least one such investor during 2009-2016), while offerings by venture capital funds only rarely include nonaccredited investors (only 1% of offerings have at least one such investor). 60 The transition guidance in the Rule 506(c) Adopting Release clarifies that only offerings initiated prior to September 23, 2013, can rely on the transition guidance to switch their exemption to Rule 506(c). See Rel. No. 339415, Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings (July 10, 2013). 61 As noted above, the repeal of Rule 505 became effective May 22, 2017. See Rel. No. 33-10238, Exemptions to Facilitate Intrastate and Regional Securities Offerings (Oct. 26, 2016). 42 Aggregated Form D information also indicates that, on average, more than 260,000 investors participated in Regulation D offerings for the period 2009-2016, of which more than 103,000 participated in offerings by nonfinancial issuers, more than triple the number of investors that participated in offerings by hedge funds. However, the number of unique investors is likely less than 260,000. Because an investor can participate in more than one Regulation D offering, our aggregation likely overstates the actual number of unique investors, and we have no method of estimating the extent of overlap. The mean number of investors per offering (14) is substantially larger than the median (4), indicating the presence of a small number of offerings with a large number of investors. Much of this skew appears to be driven by financial offerings. For the period of 2009-2016, the median number of investors per offering varied between two and seven across all types of offerings. During the same period of time, the mean number of investors in nonfinancial offerings was nine, while the mean number of investors in financial, pooled investment funds (e.g., hedge funds, private equity funds, and venture capital funds) and REIT offerings varied from 15 to 25. Offerings involving non-accredited investors are typically smaller than those that do not involve non-accredited investors. This is evident in Table 6 below which shows that while the presence of non-accredited investors is large in former Rule 505 offerings (40%), where the number of non-accredited investors is limited to 35 and offering limit is $5 million, the proportion is much higher for offerings under Rule 504 (58%) that have access to an unlimited number of non-accredited investors but historically had an offer limit of $1 million. Interestingly, a notably lower percentage of Rule 506(b) offerings (8%), including those that have an offer size of up to $5 million, report selling or intending to sell to a non-accredited investor. The big difference between Rules 506(b) and (c) and other rules under Regulation D is 43 that the former have preemption from state registration and review.62 Rule 506(b) provisions, unlike Rule 504 or former Rule 505 provisions, also require the non-accredited investors to be “sophisticated.”63 Thus, while issuers may prefer to raise capital under Rule 506(b) because of the preemption of state registration and review, non-accredited investors who are also not sophisticated are thus unable to participate in a Rule 506(b) offering. E. Regulation D Offering Fees When an intermediary is used in a Regulation D offering, there is notable variation in the fees across each class of issuer. We calculate the total fee for an offering as the sum of commissions and finder’s fees, scaled by the offering amount. Information from Form D filings indicates that total fees are smallest for pooled investment funds and largest for nonfinancial issuers (Figure 4). Nonfinancial issuers paid on average about 6% in total fees for Regulation D offerings in 2009-2016. In comparison, a company going public pays an average gross spread of 7% to its IPO underwriters, while a reporting company raising equity through a follow-on (seasoned) equity offering pays an average gross spread of about 5.4%. Issuers raising capital through registered bond issues pay commissions between 0.9% and 1.5% of the size of the offering. 62 States retain the authority to investigate and bring enforcement actions for fraud, impose state notice filing requirements, and collect state fees. 63 Non-accredited investors in Rule 506(b) offerings must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment, or the issuer must reasonably believe immediately prior to making any sale that such purchaser comes within this description. See Rule 506(b)(2)(ii). 44 Figure 4. Total fees paid by type of Regulation D issuer: 2009-2016 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Hedge Fund Private Equity Other Venture Fund Investment Capital Fund Fund Financial Services Real Estate Non‐Financial (Operating) Source: DERA analysis In contrast to operating issuers, hedge funds raising capital through Regulation D offerings and private equity funds paid about 1%. Brokers and finders are no more costly, on average, than the underwriters who charge fees for registered offerings, so fees do not provide an obvious reason for their relatively infrequent use in exempt offerings. The availability of general solicitation under new Rule 506(c) may have changed the role of intermediaries in these offerings relative to their role in the traditional offerings under Regulation D. During the period between September 23, 2013, and December 31, 2016, intermediary usage in Rule 506(c) offerings was dramatically higher among operating and financial issuers, compared to similar Rule 506(b) issuers (Figure 5). Overall, Rule 506(c) offerings exhibited a higher level of intermediary usage (33% of new offerings) than Rule 506(b) offerings (17% of new offerings). The higher usage of intermediaries in Rule 506(c) offerings may relate to issuers, and especially non-fund issuers, seeking to rely on outside entities, including third-party online platforms, to verify accredited investor status, a requirement for using general solicitation. 45 Figure 5. Role of intermediaries in Rule 506(c) market: September 23, 2013 - December 31, 2016 % of offerings with Intermediaries 10% 40% 8% 30% 6% 20% 4% 10% 2% 0% 0% Venture Hedge Fund Private Equity Other Capital Fund Fund Investment Fund Financial Services Commission & Fees (% of total amount sold) 12% 50% Real Estate Non‐financial 506(b) Intermediary Usage 506(c) Intermediary Usage 506(b) fees 506(c) fees Source: DERA analysis On average, Rule 506(c) offerings also pay higher fees than Rule 506(b) issuers. Figure 5 shows that operating issuers paid almost 6.1% in fees in 506(c) offerings, relative to 5.3% paid by such non-fund, nonfinancial Rule 506(b) offerings. Figure 6 depicts the fees for different offering sizes, irrespective of issuer type or provision under Regulation D. Average total fees decrease with offering size (Figure 6). Unlike the gross spreads in registered offerings, the differences in commissions for Regulation D offerings of different sizes are large: the average commission paid by issuers engaging in offerings of up to $1 million (6.2% over the period 2009-2016) is more than three times higher than the average commission paid by issuers engaging in offerings of more than $50 million (1.9% over the period 2009-2016). These results are consistent with larger deals generating economies of scale for the involved intermediaries. Even so, the vast majority of the offerings are conducted without the use of a financial intermediary. 46 Figure 6. Total fees paid by size of Regulation D offering: 2009-2016 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% $0 ‐ <1million $1 ‐ <5million $5 ‐ <10million $10 ‐ <50million Greater than $50million Source: DERA analysis Overall, capital formation through private placement of securities has increased substantially since the onset of the financial crisis. Amounts raised through exempt securities offerings have outpaced the level of capital formation through registered securities offerings during recent years. In Parts A.III.B through A.III.E, we have provided insights into a large segment of the exempt securities market—offerings conducted in reliance on Regulation D. Next, we turn to another type of exempt offerings, namely, offerings under Regulation A. F. Regulation A Activity Overview Regulation A is an exemption from registration for small offerings under Section 3(b)(2) of the Securities Act. Prior to June 19, 2015, it enabled issuers to raise up to $5 million in a 12month period (subsequently, up to $50 million). It is available to issuers organized, and with a principal place of business, in the United States or Canada. Historically, the Regulation A exemption was not available to Securities Exchange Act of 1934 (Exchange Act) reporting companies, investment companies (including business development companies), development 47 stage companies that have no specific business plan or purpose or have indicated that their business plan is to engage in a merger or acquisition with an unidentified company or companies, issuers of fractional undivided interests in oil or gas rights or a similar interest in other mineral rights. In addition to these existing categories of ineligible issuers, the newly amended Regulation A also excludes issuers that have not filed certain ongoing reports required by Regulation A, issuers subject to certain Section 12(j) orders by the Commission, and issuers subject to “bad actor” disqualification under Rule 262. Title IV of the JOBS Act added Section 3(b)(2) to the Securities Act, directing the Commission to adopt rules exempting from registration public offerings of up to $50 million annually. On December 18, 2013, the Commission proposed rules to implement Title IV of the JOBS Act by modernizing and expanding Regulation A and, on March 25, 2015, the Commission adopted final rules.64 The final rules expand Regulation A into two tiers: Tier 1, for securities offerings of up to $20 million (that tracks more closely “old” Regulation A); and Tier 2, for offerings of up to $50 million. Under the final rules, Tier 2 issuers are required to include audited financial statements in their offering documents and to file annual, semiannual, and current reports with the Commission. With the exception of securities listed on a national securities exchange, upon qualification, purchasers in Tier 2 offerings either must be accredited investors or are subject to specified limitations on their investment. The amendments to Regulation A took effect on June 19, 2015, and may have resulted in changes in the type of offerings and issuers in this market in potentially notable ways. 64 See Regulation A+ Adopting Release. 48 We consider Regulation A offerings qualified by the Commission during 2005-2016.65 A little under half of offerings were identified as being by issuers in the financial sector. The most common jurisdiction of incorporation was Delaware. Figures 7 and 8 report the number of qualified offerings and amounts sought in qualified offerings between 2005 and 2016. Figure 7. Number of qualified Regulation A offerings, 2005-2016 90 80 70 60 50 40 30 20 10 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: DERA analysis In a typical year during 2005-2016, there were about 14 qualified offerings seeking to raise approximately $163.3 million. We note that there were substantially more issuers seeking to raise capital under Regulation A during June 19, 2015– December 31, 2016 (97 qualified offerings seeking to raise up to approximately $1.8 billion in the aggregate). We do not have complete information about amounts raised during that time. We estimate, on the basis of issuer 65 Where relevant and where sufficient information was available, we focused on unique offerings and exclude postqualification amendments or new filings that are substantially similar to prior filings by the same issuer. We sought to maintain accuracy, but some measurement error is inevitable. For some offerings, offer amounts were not available in offering circulars. Offerings with missing information on amounts sought were excluded from the totals. 49 reports of amounts raised filed during 2005-2016 that are available to us, that 56 issuers reported positive proceeds in Regulation A offerings, totaling approximately $314.6 million.66 The total includes 27 issuers that reported in 2015-2016 an aggregate of approximately $238.6 million in proceeds raised in completed and ongoing offerings qualified under amended Regulation A. Figure 8. Aggregate amounts sought in qualified Regulation A offerings, 2005-201667 1800 1600 1400 1200 1000 800 600 400 200 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: DERA analysis The evolution of Regulation A offering activity during the period under consideration, 2005-2016, was affected by several relevant market and institutional considerations. First, the Commission amended the Regulation A exemption in 2015 as part of implementing the mandate 66 Some issuers filed reports of sales with zero proceeds. Additionally, incomplete information is available to us regarding the outcomes of Regulation A offerings during the examined period. Amounts raised are based on the reports of sales filed during the examined period and thus reflect a lag: they do not include amounts raised during the examined period that are reported at a later date, amounts raised in offerings in progress (unless the issuer has opted to report them during the examined period), or amounts raised and reported after the end of the examined period. For some offerings in the pre-amendment period, final reports of sales on Form 2-A were either not available or not accessible electronically from EDGAR or ThomsonOne. Thus, we cannot determine with certainty whether all of the offerings that qualified during the examined period have commenced or if any have been abandoned or terminated by issuers. 67 These amounts are not inflation-adjusted. Since larger aggregate offering amounts were observed at the end of the examined period, expressing offering amounts in 2005 dollars had the effect of accentuating the differences between pre-amendment and post-amendment annual totals. 50 of Title IV of the JOBS Act. Second, compared to the size of the registered offerings and private placement markets, Regulation A experienced relatively limited use during the examined period, particularly prior to the effectiveness of the 2015 amendments. When the number of observations is small, statistical analysis lacks power and may be easily skewed by a few observations. Thus, any inference regarding potential trends or the set of issuers seeking to participate in this market must be approached with considerable caution. Third, to the extent that the Regulation A market serves as a smaller-scale alternative to a traditional IPO or SEO or as a method of financing merger and acquisition transactions, growth outlook—and, in turn, the extent of investor interest in a potential offering—at the economy and industry level can affect Regulation A activity. We discuss these considerations in greater detail below. The end of the examined period includes the months immediately following the effectiveness of Regulation A amendments. Although the period after the effectiveness of the amendments was relatively short, it was characterized by increased filing activity, with filers taking advantage of the expanded Regulation A provisions and seeking qualification of larger maximum offering amounts than under pre-amendment Regulation A. While it is too early to assess the extent to which Regulation A amendments will affect the amount of capital formation over the long run, based on the early indications available so far, aggregate filing counts and aggregate offer amounts and deal sizes have likely increased relative to the pre-amendment period. Furthermore, the 2015 Regulation A amendments contained certain provisions that may have ramifications for the development of a potential secondary market in Regulation A securities. Specifically, the creation of an ongoing reporting regime for issuers in Tier 2 offerings may contribute to a reduction in information asymmetries between issuers and 51 investors and enable issuers to meet the requirements for having their securities quoted on one of the higher over-the-counter (OTC) market tiers, potentially resulting in improved liquidity for Regulation A investors. However, at this time, for the majority of issuers secondary trading in Regulation A securities is either at a nascent stage or nonexistent. Prior to the adoption of Regulation A amendments, analysis indicated that among the factors that could potentially be related to limited use of Regulation A were compliance with state securities review and qualification, a comparatively low $5 million offering limit, the timing and cost associated with filing an offering statement with the Commission for qualification, and the availability of other exemptions under the federal securities laws.68 While Regulation A activity has exhibited a notable increase after the effectiveness of the Regulation A amendments, absolute levels of filing activity have remained low compared to other unregistered offerings such as Regulation D and Rule 144A, potentially consistent with issuers, service providers, and investors adjusting and learning about the new provisions. To the extent that the Regulation A amendments require an initial period of adjustment and/or confront market participants with a learning curve, the Regulation A offering activity may not be representative of the typical level of Regulation A offering activity expected after the market has gained experience with amended Regulation A. At the same time, it is possible that future Regulation A offering activity may remain modest. Issuers may continue to prefer Rule 506(b) offerings and private placements in reliance on Section 4(a)(2) because of their lower initial and ongoing compliance related cost and the absence of an offering limit. Issuers that elect to undertake an initial public offering may continue to favor the traditional IPO route and become Exchange Act reporting companies. 68 See GAO, Factors that May Affect Trends in Regulation A Offerings, GAO-12-839 (July 2012), available at http://www.gao.gov/assets/600/592113.pdf (GAO Report). 52 Additionally, a lack of secondary market liquidity may discourage investors from participating in Regulation A offerings at valuations that the issuer finds attractive. Furthermore, investors may hesitate to invest in issuers about which the market has less information (known as “information asymmetry”) because of concerns about adverse selection (lower quality issuers choosing to raise financing). In many cases, a venture capital fund or a major underwriter, which may provide implicit certification of the prospects of a startup or small issuer, is not involved. Most Regulation A issuers are small companies without analyst coverage or notable institutional ownership, and both tiers of offerings subject issuers to disclosure requirements that are less extensive than those imposed on Exchange Act reporting companies. While institutions may be in a better position to analyze information about opaque issuers and overcome adverse selection, less sophisticated investors may have greater difficulty in evaluating the prospects of an issuer on the basis of offering materials alone. In addition, while venture capital and angel investors may be able to negotiate downside protection options for their investments in high-risk and high-information asymmetry companies, less sophisticated investors may have less bargaining power in negotiating offering terms. Having less information about the issuer may discourage such investors from investing or may lead investors only to invest in offerings at valuations below those that the issuer would find attractive. Finally, we note that there is not enough evidence at this time to determine whether the increase in capital formation following amendments to Regulation A has served as a complement to or a substitute for capital raising via other methods. Overall, early signs indicate that amended Regulation A may offer a potentially viable public offering on-ramp for smaller issuers as an alternative to a traditional registered IPO and offer either an alternative or a complement to other securities offering methods that are exempt 53 from Securities Act registration. Preliminary evidence suggests that there has been an increase in Regulation A offering activity in the initial period since effectiveness of the Regulation A amendments; different types of issuers have initiated offerings; and issuers participating in the offerings have generally sought to utilize the new provisions afforded by the 2015 amendments. Like other small-scale analyses, the findings of this analysis of the Regulation A market are qualified by the sample size and the relatively short observation period, thus, it is unclear to what extent it can be extrapolated to future years or periods with different aggregate conditions. The types of issuers that use this offering method in the future may differ from early adopters, and medium- and long-term outcomes of Regulation A issuers remain an area for future analysis. Further, questions remain regarding future offering outcomes and trends in intermediary involvement and secondary market liquidity as the Regulation A market continues to develop. G. Regulation Crowdfunding Activity Overview Title III of the JOBS Act (Title III) amended Section 4 of the Securities Act and created a new exemption from registration for Internet-based securities offerings of up to $1 million69 over a 12-month period. Title III was intended to help small and startup businesses conduct lowdollar capital raising on the Internet. It can be thought of as an Internet-based method` of raising seed financing from a broad, mostly retail investor base. Title III included a number of investor protection provisions, including investment limitations, issuer disclosure requirements, and a requirement to use regulated intermediaries. The SEC proposed securities-based crowdfunding rules on October 23, 2013, and adopted the final “Regulation Crowdfunding” rules on October 69 On March 31, 2017, the Commission adopted amendments to increase the amount that issuers can raise through crowdfunding to adjust for inflation. The maximum aggregate offering amount increased to $1,070,000, and the new thresholds became effective on April 12, 2017. See JOBS Act Technical Amendments Release. 54 30, 2015, to implement the requirements of Title III.70 Issuers were able to use the new exemption beginning May 16, 2016, when Regulation Crowdfunding became effective.71 While securities-based crowdfunding under Regulation Crowdfunding shares certain similarities with non-securities-based (lending-based, reward-based, donation-based, and royaltybased) crowdfunding, such as the ability of the public to participate and the use of an Internetbased platform to solicit backers, there are important distinctions. Non-securities-based crowdfunding campaigns do not involve a profit or revenue-sharing model and are generally not subject to regulation under federal securities laws. Although any crowdfunding backer may have nonpecuniary reasons for participating, backers in non-securities based crowdfunding campaigns are more likely to be guided by such motives. Overall, the differences in the legal framework, characteristics of fundraisers, and objectives of funders limit extrapolation from non-securities based crowdfunding to Title III crowdfunding. Regulation Crowdfunding established requirements for issuers and intermediaries seeking to participate in an Internet-based crowdfunding offering. The key provisions are summarized below:72  A given issuer is able to raise up to $1,070,000 across all crowdfunding offerings in a 12month period. An issuer must raise at least the target amount to receive funds. Crowdfunding securities are generally subject to resale limitations for one year. 70 See Rel. No. 33-9470, Crowdfunding (Oct. 23, 2013) 78 FR 66427 (Crowdfunding Proposing Release); Rel. No. 33-9974, Crowdfunding (Oct. 30, 2015) 80 FR 71387 (Crowdfunding Adopting Release). 71 Provisions related to funding portal registration became effective on January 29, 2016, to give funding portals additional time to undergo the SEC registration and FINRA membership process. 72 See Crowdfunding Adopting Release for details. In the JOBS Act Technical Amendments Release, the Commission revised the investment limits and other dollar amount thresholds in Regulation Crowdfunding to adjust for inflation. The inflated-adjusted amounts are reflected below. 55  The rules impose limits on the amount that an investor can invest in all Title III crowdfunding offerings over a 12-month period. Investors with both an annual income and net worth of at least $107,000 can invest up to 10% of the lesser of annual income or net worth, but an investor’s total investment across all Title III offerings may not exceed $107,000 in a 12-month period. Other investors can invest the greater of either $2,200 or 5% of the lesser of their annual income or net worth.  Crowdfunding issuers are subject to disclosure requirements at the time of the offering (on Form C), during the offering’s progress and on completion of the offering (on Form C-U) and annually in the form of annual reporting requirements (on Form C-AR). Additionally, in offerings of over $107,000 in a 12-month period, financial statements must be reviewed by an independent accountant, and in offerings of over $535,000 in a 12-month period (except the issuer’s first crowdfunding offering), financial statements must be audited.  Crowdfunding securities must be offered through an SEC-registered intermediary, either a broker-dealer or a funding portal, a new intermediary type established in Regulation Crowdfunding. These intermediaries must take measures to reduce the risk of fraud, make required disclosures about issuers available to the public, provide communication channels to permit discussion of offerings on the platform, disclose the compensation received by an intermediary, provide educational materials to investors, and comply with additional requirements related to investor commitments, notices to investors, and 56 maintenance and transmission of funds. Registered funding portals that participate in crowdfunding offerings may engage in a narrower set of activities than broker-dealers.73 Given the offering limits, crowdfunding is primarily used by relatively small issuers, thus many of the economic considerations applicable to small and early-stage issuers apply to crowdfunding as well.74 The availability of solicitation over the Internet and sales to investors nationwide, irrespective of the location of the issuer (as long as the issuer is a U.S. issuer) distinguish Regulation Crowdfunding from intrastate securities-based crowdfunding regulated under state law that historically has relied on Securities Act Rules 147 or 504.75 The statistics reported in Table 7 are based on the analysis of data as reported in EDGAR filings of Forms C, C-U, and CFPORTAL through December 31, 2016, except as specified otherwise.76 For offerings that have been amended, the information is generally based on the latest amendment associated with that central index key (CIK) and file number as of the report date, except as specified. Between May 16, 2016, and December 31, 2016, excluding 24 withdrawn77 offerings and potential duplicate filings,78 there were 163 unique offerings by 156 issuers (including 7 issuers 73 Among other things, a funding portal cannot offer investment advice or recommendations; solicit purchases, sales or offers to buy the securities offered or displayed on its platform; compensate employees, agents or other persons for solicitation or based on the sale of securities on its platform; and hold, manage, possess, or otherwise handle investor funds or securities. 74 See Crowdfunding Adopting Release. 75 See Crowdfunding Adopting Release. To facilitate intrastate securities-based crowdfunding, the Commission recently amended Rule 147 and Rule 504 and adopted a new intrastate offering exemption as Rule 147A. See Rel. No. 33-10238, Exemptions to Facilitate Intrastate and Regional Securities Offerings (Oct. 26, 2016). Amendments to Rule 504 took effect on January 20, 2017. The amended Rule 147 and the new Rule 147A took effect on April 20, 2017. 76 Data comes from the XML portion of Forms C and C-U and amendments to them. When we refer to offerings, we refer to initiated offerings that have not been withdrawn, unless specified otherwise. We analyze withdrawn offerings separately. When discussing completed offerings, we refer to offerings that have reported proceeds of at least the amount raised on Form C-U. Unless specified otherwise, offerings with Forms C-U filed without proceeds information reported are excluded from the analysis. 77 Withdrawn offerings include unique offerings for which a Form C-W was filed and a new Form C or amendment was not subsequently filed and offerings that used an intermediary that filed a Form CFPORTAL-W to withdraw its [Footnote continued on next page] 57 that filed for more than one crowdfunding offering).79 Of those, 28 offerings reported meeting their target amount on Form C-U as of December 31, 2016.80 Statistics are presented at the offering level. The median (average) offering between May 16, 2016, and December 31, 2016, targeted approximately $53,000 ($110,000). For almost all of these offerings, oversubscriptions up to a higher maximum were accepted (the median issuer set the maximum close to the $1 million limit in the final rules). Of the offerings that reported having raised at least the target amount, the median (average) amount reported raised was notably larger, at approximately $171,000 ($290,000).81 Amounts reported raised are based on filings of Form C-U and generally pertain to completed and not ongoing offerings. Under the final rules, interim progress updates may be provided by the intermediary and are not required to be filed on EDGAR, but issuers must file Form C-U within 5 business days of reaching the target amount for offerings that do not accept amounts in excess of the target amount known as “oversubscriptions” and within 5 business days funding portal registration, even if the filings themselves had not been withdrawn. During this time period, 24 offerings were classified as withdrawn. The remaining sample may contain additional withdrawn or abandoned offerings that have not been identified using these criteria (e.g., offerings that have reached the deadline date but have not been associated with filing activity or updates) and additional offerings may be classified as withdrawn at a future date (e.g., if the issuer withdraws an offering or if the portal through which it is offered withdraws its registration). Overall, since amounts sought may not be successfully raised, statistics on the amounts sought should be interpreted with caution. The actual ex post amount of capital formation in this market may be considerably lower than the amounts sought in offerings that had been initiated. 78 Cases of multiple filings by the same filer on Form C with substantially similar offering information made within a short span of time are consolidated into a single offering. 79 See Ivanov and Knyazeva (2017). 80 In addition, there were four Forms C-U filed during January 1, 2017 - January 15, 2017, for offerings with deadline dates in 2016; for one of two offerings for which Forms C-U were filed before January 1, 2017, without proceeds information, proceeds information was obtained on the funding portal page. As of January 15, 2017, approximately $10 million in proceeds was reported raised for 33 offerings by issuers filing Forms C-U. No offerings have been withdrawn on Form C-W between January 1, 2017, and January 15, 2017. 81 Unless specified otherwise, amounts raised are based on data through December 31, 2016. If data from note 80 above is added, the median (average) raise becomes approximately $171,000 ($303,000), which illustrates the caveat that estimates obtained from a small sample can be highly sensitive to the addition of new data. 58 of reaching the offering’s deadline date for offerings that accept oversubscriptions.82 The offering characteristics in Table 8 show that a typical offering was due to close within 4-5 months of initiation.83 With very few exceptions, issuers permitted oversubscriptions— investments above the target amount sought. Issuers took advantage of the flexibility afforded by Internet solicitation to raise as much capital as possible in a crowdfunding offering. As can be seen from Table 8 and Figure 9, the most popular security issued was common or preferred equity, accounting for 36% of offerings. Debt accounted for 20%, and ther [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Asec%3A2160a7d579cbb65b. Public record. Not legal advice.