CFA Institute just released a report that explores whether the stars are now aligned for the introduction of a specialized venture market, or venture exchange, in the United States that caters to smaller, emerging companies. We believe that such an exchange could expand access by these companies to the public market, while offering investors a broader universe of investment opportunities that present reasonable investment risk and return opportunities.

In recent years, slow economic growth, reduced bank lending to small companies, and fewer IPOs have prompted policymakers to find ways to direct capital to small and startup companies through rule exemptions. But investors worry about the binary regulatory structure created by rule exemptions and the higher investment risks posed by companies taking advantage of these exemptions. A growing interest in a venture exchange in the United States to list smaller and startup companies operating under relaxed listing and regulatory rules is the outgrowth of these competing views. CFA Institute assembled an expert panel to discuss the issue and consider how to make such an exchange system viable and the findings are summarized in United States Venture Market: Has the Time Come?

Requirements to Succeed

The success of a US venture market would depend on finding a balance between issuers’ desire for lighter regulatory burdens to reduce their costs and investors’ desire for rules that ensure relevant and reliable information. Broker/dealers would require rules that allow them to make retail investors aware of and encourage their investment in venture companies without incurring potential legal risks, and regulators would need to meet their mandate of protecting investors from fraudulent issuers.

Such markets already exist outside the United States, which provides a template for US policymakers on what to do and what not to do when creating a venture market structure in the United States. London’s AIM market, for example, relies heavily on investment bankers and broker/dealers called nominated advisers, or nomads, to vet venture companies and walk them through the initial offering process. This approach imposes lower reporting requirements on listed issuers than does Toronto’s TSX Venture Exchange (TSXV), which uses a more centralized and exchange-based due diligence process, rather than a company sponsor system.

The AIM market is a more diversified market with no one industry or sector dominating, but it has suffered from a lighter and uneven regulatory and corporate governance touch; the nomad system by design leads to more variability in transparency and governance. In contrast, the TSXV has a robust company vetting system and transparency requirements to protect shareowners, but it has been tied to the market cycles of the natural resource and mining companies that dominate the listings on the TSXV. A US venture exchange could potentially offer investors a diversified market of small and emerging companies if regulatory and governance standards are sufficiently stringent to protect investors.

CFA Institute Research on a US Venture Market

Following discussions with experts and research into the concept of a venture market, we have concluded that a venture market could work in the United States. To thrive, however, such a market must be thoroughly vetted before going public, and once public, require those companies to operate under robust transparency and corporate governance standards that satisfy the needs of broker/dealers and investors.

The following is a summary of some of the issues that policymakers must consider for such markets to work:

• A robust vetting process to weed out bad actors in management, on the board, and in the principal investor ranks of potential venture companies
• A sponsor system in which broker/dealers, a similar group, or the exchange undertakes initial due diligence on venture companies
• Annual audits, with the auditor’s report included in an annual report to shareowners
• Quarterly updates on performance and financial condition
• Use of generally accepted accounting principles in the preparation of financial statements
• Timely disclosure of all important company news through normal public distribution channels
• Company principals liable for fraudulent representations made in offering documents, financial statements, or company announcements delivered through these channels
• High standards of transparency and governance, deviating from best practice standards only for legitimate reasons unique to small companies

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