OVERVIEW
In April 2012, President Obama signed into law the Jumpstart Our Business Startups Act (the "JOBS Act"), which aims generally to promote job creation and further economic growth in the United States by facilitating certain capital raising activities and reducing the regulatory burdens on smaller companies under the U.S. federal securities laws. Among other changes, the JOBS Act:
- establishes a new category of issuer, the "emerging growth company," which is eligible for an IPO "on-ramp" and exemptions from some of the reporting and other obligations under the U.S. securities laws;
- requires the Securities and Exchange Commission ("SEC") to revise its rules to remove the prohibition against general solicitation and general advertising for certain private placements and other offerings of securities;
- increases the shareholder thresholds for determining when a class of securities must be registered under Section 12(g) of the Securities Exchange Act of 1934, as amended (the "1934 Act");
- increases to $50 million the amount that may be raised in an offering under Regulation A of the Securities Act of 1933 (the "1933 Act"); and
- creates a new exemption for small offerings intended to pool small amounts of funds from large numbers of investors ("crowdfunding" offerings).1
EMERGING GROWTH COMPANIES
Definition
In order to qualify as an "emerging growth company" (an "EGC"), an issuer must:
- not have completed its initial public offering of common equity securities registered with the SEC (its "IPO") on or before December 8, 2011; and
- have had total annual gross revenues of less than $1 billion during its most recently completed fiscal year.2
Non-U.S. issuers, including Canadian issuers filing under the Multi-Jurisdictional Disclosure System ("MJDS"), may qualify as EGCs if they meet the requirements of the definition.
Once qualified, an EGC will retain that status until:
- the last day of the fiscal year in which it has total annual gross revenues of $1 billion or more3;
- the last day of the fiscal year in which the fifth anniversary of its IPO occurs;
- the date on which it has, during any previous rolling three-year period, issued more than $1 billion in non-convertible debt; or
- the date on which the issuer is deemed a "large accelerated filer" under the 1934 Act, i.e., has a public float of at least $700 million and has been a reporting issuer for at least one year.
Once a company loses its status as an EGC it cannot later regain that status, even if it satisfies the annual gross revenue test.
Relaxation of IPO requirements and restrictions—the IPO "on-ramp"
Registration Statement Disclosures. The JOBS Act reduces the scope of disclosure that would otherwise have been required of an EGC in its IPO registration statement (on SEC Form S-1 or F-1). Instead of the three years of audited financial statements ordinarily required in a registration statement, EGCs are required to include only two years of audited financial statements. Correspondingly, the management's discussion and analysis section of an EGC's IPO registration statement is required to cover only two years of financial information (as opposed to the general three-year requirement) Moreover, EGCs are required to include "selected financial data" in any other registration statement only for the periods starting with the earliest audited period presented in its IPO registration statement (rather than the five years required of other issuers). In addition, an EGC may include in its registration statement the scaled (i.e., more limited) executive compensation disclosure required of "smaller reporting companies" under the 1933 Act.4
Confidential Submission of Registration Statement. An EGC's registration statement (and related amendments) for an IPO may be submitted to the SEC for non-public, confidential review, provided that the registration statement and any amendments thereto are publicly filed at least 21 days before the commencement of any road show to market the IPO.5 According to guidance from the SEC, a foreign private issuer that qualifies as an EGC may use the confidential submission policy applicable to EGCs or, alternatively, the SEC's confidential submission policy otherwise applicable to foreign private issuers generally.6
Other Communications Regarding the IPO. An EGC or a person authorized to act on behalf of an EGC may make communications regarding the EGC's IPO prior to or during the offering to "test the waters" of investor interest, provided that the communications are made only to qualified institutional buyers ("QIBs") or institutions that are accredited investors,7 without being subject to current "gun jumping" restrictions and restrictions on permissible written communications prior to or following the filing of a registration statement. The communications will, however, be subject to the antifraud provisions of the U.S. securities laws.
Research analysts and research reports
The JOBS Act offers EGCs relief from some of the restrictions on the participation of research analysts, and the use of research reports, in marketing an EGC's securities.
The JOBS Act permits broker-dealers to publish research reports on an EGC any time before, during or after any offering of the EGC's securities, including its IPO or any other offering in which the broker-dealer is participating, without violating any publicity restrictions under the U.S. securities laws.
The JOBS Act also prohibits the SEC and the Financial Industry Regulatory Authority (FINRA) from adopting or maintaining rules that in connection with an EGC's IPO (i) restrict which brokerdealer personnel may arrange for communications between analysts and potential investors or (ii) restrict analysts from participating with other broker-dealer personnel in communications with management of the EGC. The SEC and FINRA also may not prohibit broker-dealers from publishing or distributing research reports or making public appearances with respect to the securities of an EGC within any prescribed period of time following the company's IPO or prior to the expiration of any lock-up agreement entered into in connection with the IPO.8 These provisions eliminate for EGCs the traditional "quiet period" following an issuer's IPO.
Exemptions from public company reporting requirements
The JOBS Act provides relief to EGCs following their IPO from certain reporting and other obligations applicable to public companies in the United States, including:
- the shareholder "say-on-pay votes" regarding executive compensation and "golden parachutes" as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank");
- the compensation analysis disclosures ("pay for performance" and CEO versus median employee compensation analysis) required (but not yet implemented by the SEC) under Dodd-Frank;
- any requirement to provide, in any other registration statement or periodic report, selected financial data for a period before the earliest audited period presented in the EGC's IPO registration statement;
- the requirement under Section 404(b) of the Sarbanes-Oxley Act that the company's independent auditor report on and attest to the company's internal control over financial reporting (although EGCs will be required to provide the Section 404(a) report by management regarding the effectiveness of such controls); and
- compliance with any Public Company Accounting Oversight Board (PCAOB) rules requiring mandatory audit firm rotation or supplement to the auditor's report (which are currently being considered by the PCAOB), or any other PCAOB rules adopted after April 5, 2012, unless and until the SEC determines that the new rules are necessary to protect the investing public.
GENERAL SOLICITATION AND GENERAL ADVERTISING FOR RULE 506 AND RULE 144A OFFERINGS
Rule 506 of Regulation D under the 1933 Act provides a safe harbor from the registration requirements of the 1933 Act for private placements of securities to investors in the United States. One condition of the safe harbor is that offers and sales may not be made by any means of "any general solicitation" or "general advertising." The JOBS Act requires the SEC to revise Rule 506 to provide that the prohibition against general solicitation and general advertising will not apply to Rule 506 offerings in which sales are made only to accredited investors. (Rule 506 currently permits sales to up to 35 non-accredited investors.) The SEC rules must also require issuers to take "reasonable steps" to verify the accredited investor status of their purchasers. It is uncertain whether the SEC will prescribe specific actions that must be taken or adopt a principles-based approach.
Rule 144A under the 1993 Act provides a safe harbor from the registration requirements of the 1933 Act for certain sales of securities to QIBs. Under Rule 144A, securities may only be offered and sold to persons whom the seller reasonably believes to be QIBs. The JOBS Act directs the SEC to amend Rule 144A to provide that securities in Rule 144A offerings may be offered for sale under the Rule to persons other than QIBs, including by means of general advertising and general solicitation, so long as the securities are sold only to persons whom the seller reasonably believes are QIBs.
The utility of these changes to non-U.S. issuers, particularly in the context of side-by-side U.S. and non-U.S. offerings, may be limited by the fact that the JOBS Act does not eliminate or relax the prohibition against "directed selling efforts" (which are generally viewed as comprising activities similar to general advertising and general solicitation), in offerings made pursuant to Regulation S under the 1933 Act. It is not known if the SEC will address this issue in its rule making.
The JOBS Act requires the SEC to issue its implementing rules no later than July 4, 2012,9 but it may not meet this deadline. Pending adoption of the rules, the current versions of Rules 506 and 144A remain in effect.
1934 ACT REGISTRATION THRESHOLD
Section 12(g) of the 1934 Act requires any issuer, including privately held companies, to register any class of equity securities (other than certain exempted securities) under the 1934 Act (and thus become subject to the periodic reporting and other obligations of public companies under the 1934 Act) if, as of the last day of any fiscal year, (i) the company had assets of more than $10 million and (ii) the class was held by 500 or more holders of record. The JOBS Act raises the threshold for registration for issuers, other than banks or bank holding companies, to (i) 500 persons who are not accredited investors (as defined in the U.S. securities laws) or (ii) 2,000 persons, whether or not accredited investors. The threshold for banks and bank holding companies was also raised to 2,000 shareholders, but without the 500 non-accredited investor alternative.
Persons who hold securities obtained in an exempt "crowdfunding" offering (as described below) or in a transaction exempt from registration under the 1933 Act pursuant to an employee compensation plan, are not counted towards the threshold. The changes to the 1934 Act registration threshold may, however, be of limited consequences to most non-U.S. issuers. Non- U.S. issuers who qualify as foreign private issuers (as almost all do) can usually rely on the exemptions from registration under the 1934 Act provided by Rule 12g3-2(a) (if they have fewer than 300 beneficial owners of the securities resident in the United States) or Rule 12g3-2(b) (if their primary trading market is a non-U.S. exchange and they make publicly available on their website or on an electronic information delivery system (e.g., SEDAR) information required to be made public or filed under their home country or exchange rules).
The JOBS Act directs the SEC to implement the provisions of the Act relating to the increased holders of record threshold within one year. The amendments to the Section 12(g) registration threshold under the 1934 Act became effective, however, as of April 5, 2012 and, according to SEC guidance, may be relied on by issuers in advance of the rule making by the SEC.
EXPANSION OF REGULATION A-TYPE OFFERINGS
Regulation A under the 1933 Act currently provides an exemption from registration for offerings by U.S. and Canadian issuers of up to $5 million per year. There are no restrictions in the manner of offering (i.e., the offering may be made publicly) or on the types of persons who may participate in the offering. The issuer is required to file an offering circular with the SEC that requires somewhat less information than a prospectus in a registered offering, but the issuer does not become subject to the reporting requirements of the 1934 Act solely by virtue of the offering. Principally because of the $5-million limitation, Regulation A is rarely used.
The JOBS Act directs the SEC to amend Regulation A (or adopt a similar new exemption) to increase the amount that may be offered to $50 million in any 12-month period. The exemption will be limited to equity securities, debt securities and convertible debt securities (including guarantees of such securities), and will not be available to "bad actors," as defined in the amendments to Rule 506 of Regulation D required to be adopted by the SEC under Dodd- Frank. Securities issued under the exemption will be federally "covered securities," and thus not subject to state securities (or "blue sky") regulation, if they are listed on a national securities exchange or sold only to qualified purchasers (as defined by the SEC for this purpose). Issuers relying on the exemption will be required to file annual audited financial statements and may be required by the SEC rules to file certain periodic disclosures regarding their business operations, financial condition, corporate governance principles, use of investors' funds and other appropriate matters.
The SEC must issue rules in order for the new or modified exemption to take effect; however, the JOBS Act does not set a deadline for adopting the new rules.
CROWDFUNDING
The so-called "crowdfunding" provisions of the JOBS Act amend the 1933 Act to create a new registration exemption for capital raising from large numbers of investors in relatively small amounts. Unlike the other provisions of the JOBS Act described in this Perspective, the crowdfunding provisions will not be available to non-U.S. issuers.
The crowdfunding exemption comes with an extensive and complex list of requirements, including a $1 million limitation on the amount that may be raised in any 12-month period and specific types of intermediaries through which a crowdfunding transaction must be conducted. The SEC is required to adopt rules effecting the crowdfunding exemption within 270 days after enactment of the JOBS Act.
The SEC has expressly stated on its website that, until these rules are issued, any offers or sales of securities purporting to rely on the crowdfunding provisions of the JOBS Act would be unlawful under the federal securities laws.
CONCLUSION
Many commentators expect that the JOBS Act will facilitate capital raising and provide relief to smaller companies from certain costly and time consuming obligations under the U.S. securities laws. The full effect of the JOBS Act will be dependent, however, on rule making by the SEC and other regulatory agencies in the coming months.
Footnotes
1 This Perspective is not intended to provide a comprehensive summary of the provisions of the JOBS Act, but rather to highlight certain aspects of the legislation. The full text of the JOBS Act is available online at http://www.gpo.gov/fdsys/pkg/BILLS-112hr3606enr/pdf/BILLS-112hr3606enr.pdf .
2 The $1 billion threshold will be indexed for inflation every five years.
3 The SEC has advised that "total annual gross revenues" means total revenues as presented on the issuer's income statement prepared in accordance with U.S. GAAP or IFRS as issued by the IASB.
4 In mandating these changes, the JOBS Act refers to the disclosure requirements that apply to domestic issuers. The SEC has advised that it will not object if a foreign private issuer complies with the scaled disclosure provisions available to EGCs to the extent relevant to the form requirements for foreign private issuers.
5 Note that (a) the filer must be an EGC at the time of submission and (b) any communications that go beyond the allowable "test-the-waters" communications (described below) should be treated as a road show for purposes of the 21-day deadline.
6 In December 2011, the SEC advised that initial registration statements filed by foreign private issuers will not be eligible for confidential treatment unless the issuer's securities currently are or concurrently with the U.S. filing will be listed on a non-U.S. stock exchange. If a foreign private issuer wishes to use the confidential submission process available to foreign private issuers generally it may not take advantage of any benefit available to EGCs; otherwise it must use the EGC confidential submission process.
7 Recipients of the communications must actually be QIBs or institutional accredited investors; there is no safe harbor for the issuer's "reasonable belief" or taking "reasonable steps" to verify the status of the recipients.
8 These provisions do not, however, affect the Global Research Analyst Settlement entered into in 2003 by 12 investment banks and the SEC. Firms subject to the Global Settlement must continue to comply with the restrictions in the Global Settlement, which, among other things, prohibit analysts' involvement in investment banking "pitches" and "roadshows." The SEC has apparently not yet decided whether to propose rules superseding the Global Settlement.
9 The JOBS Act does not mandate that the SEC remove the prohibition against general solicitation and general advertising in private placements made pursuant to the statutory exemption of Section 4(2) of the 1933 Act or under other provisions of Regulation D. Some commentators have, however, speculated that the SEC or the courts may interpret this provision of the JOBS Act more expansively in the future.
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