SEC Reports to Congress on Investment Research on Small Issuers
Commentary by Steven Lofchie
As required by the Consolidated Appropriations Act of 2021, the SEC reported to Congress on issues that may discourage the production of investment research concerning small issuers.
In the report, SEC Staff emphasized the importance of research as a valuable tool for small issuers that seek to increase stock liquidity and gain investor recognition. Staff cited negative factors impacting the production of investment research, which include a decline in the overall number of IPOs, falling equity commissions, fewer institutional investors that invest in small issuers, a shift to passive investment strategies, and an increase in reliance on in-house research. Staff stated that the extent of the impact of these factors is still unclear.
In light of its findings, the SEC recommended continued monitoring of research trends and continued consideration of any potential actions that may be appropriate to increase the demand, volume and quality of investment research of small issuers.
Commentary
This issue has required attention for going on two decades. When the SEC clamped down on the conflicts of interest in the production of investment research, it also reduced much of the incentive for firms to produce research while raising the costs of such production. However justified the regulatory actions were, some greater consideration should have been given to their obvious negative consequences and as to whether those negative consequences might be to some extent mitigated. An SEC study two decades after the fact that can only conclude that more study is needed, is disappointing.
Here is the fundamental problem in a nutshell. It is not profitable for broker-dealers to produce research regarding small issuers. Therefore, they do not do so. It makes no sense to conduct activities that subject firms to liability and lose money. The SEC should find a path to make this activity at least potentially profitable. Continued "monitoring" seems an inadequate response to a fundamental problem in capital markets that inhibits the ability of small businesses to attract attention and raise money.