This summer, the House Financial Services Committee passed the Main Street Growth Act, which calls for legislative changes to promote the formation of venture exchanges. The idea that securities exchanges specially designed for trading smaller and younger firms might be a useful addition to U.S. equity markets has been on people’s minds at the SEC and Congress since the SEC Advisory Committee on Small and Emerging Companies proposed it in March 2013.
Both the committee recommendation and the bill, however, are skeletal in nature. Neither do much to address the liquidity and investor-protection concerns that give some lawmakers and regulators pause. In a forthcoming essay, I set out a template for venture-exchange regulation that deals directly with these issues.
Contrary to some commentators, I argue that the best way to support liquidity is not by regulating tick sizes. Rather, I propose market microstructure rules that mandate fully transparent call-auction trading and limit trading to the listing exchange. The primary virtue of this structure is that it would concentrate liquidity on certain venues and at certain times.
Some also propose limiting venture exchanges to accredited investors. Because this would compromise liquidity, however, I contend that a better approach would be to require that the exchanges provide a warning that investing in venture-exchange companies is very risky, only suitable for sophisticated investors, and could result in total losses.
I argue that the most efficient and effective way to protect investors who participate despite these warnings would be to deemphasize ex ante regulation, in particular, mandated disclosure, much of which venture-exchange investors would likely ignore, and instead emphasize ex post regulation, in particular, SEC enforcement of the rules against securities fraud, market manipulation, and insider trading. Finally, rules could mandate venture-exchange listing standards that eliminate the smallest and youngest firms, and require that platforms engage in a substantive review of each company that seeks to list before allowing them to do so. These steps would mitigate the risks, yet leave these markets open to everyone.
The essay is forthcoming as a chapter in the Handbook on Law and Entrepreneurship (Gordon Smith & Christine Hurt eds., Cambridge Univ. Press 2017).