On April 5, 2012, President Obama signed the Jumpstart Our Business Startups Act ("JOBS Act"),1 significantly loosening regulatory requirements for certain new public companies, private offerings and banks. The JOBS Act makes numerous amendments to the federal securities laws with the intent of stimulating economic growth by reducing compliance costs and increasing access to capital for some public and private smaller companies. As the President described it when he signed the bill into law, the JOBS Act removes "barriers that were preventing aspiring entrepreneurs from getting funding." This client alert summarizes some of the key provisions of the JOBS Act, as they relate to initial public offerings ("IPOs"), new public companies, private companies and financial institutions.
Opening Capital Markets to Emerging Growth Companies: the "IPO On-ramp"
Title I of the JOBS Act eases public reporting requirements for "emerging growth companies," which is generally defined as any company that has total annual gross revenue of less than $1 billion (as indexed for inflation every five years). A public emerging growth company will be able to rely on the relaxed reporting requirements for a limited time until its revenue exceeds $1 billion, it has issued more than $1 billion of non-convertible debt in any three-year period, it becomes a large accelerated filer or, in any event, no later than five years following its IPO. An issuer will not be an emerging growth company if the first sale of common stock pursuant to an effective registration statement occurred on or before December 8, 2011.
Although proponents of the JOBS Act have touted the law as a boost to smaller companies, the IPO on-ramp provisions described below will actually benefit the overwhelming majority of companies going public. According to the Wall Street Journal, 98 of 107, or over 91%, of U.S. companies that had an initial public offering in 2011 would have qualified as emerging growth companies.2
Compensation. Under the new law, emerging growth companies will enjoy relaxed executive compensation disclosure requirements, identical to the requirements that apply to smaller reporting companies. In addition, emerging growth companies will be exempt from the requirement of Section 953(b)(1) of Dodd-Frank Act, which would otherwise require disclosure regarding the relationship between the CEO and median of the annual total compensation of all other employees, and emerging growth companies will receive a short-term exemption from say-on-pay votes.
Financial Disclosure and Accounting Regulations. The JOBS Act also eases financial reporting requirements of results of operations. An emerging growth company will be required to provide only two years of audited financial statements in a registration statement for its initial public offering. In subsequent registration statements, an emerging growth company need not present selected financial data or management's discussion and analysis of financial condition and results of operations for any period prior to the audited period presented in the IPO registration statement. Emerging growth companies also will be exempt from certain new public company accounting standards until the new standards apply to private companies as well as public companies. Moreover, emerging growth companies will be relieved of the requirement to provide an auditor attestation report on their internal controls for financial reporting under Section 404(b) of Sarbanes-Oxley, which is generally required one or two years after an IPO for companies other than smaller reporting companies. Additionally, the JOBS Act provides that certain rules of the Public Company Accounting Oversight Board that are currently under debate, such as the proposed rule requiring mandatory audit firm rotation, will not apply to emerging growth companies.
Public Offering Communications. The JOBS Act gives emerging growth companies the opportunity for confidential review of a draft IPO registration statement by the Securities and Exchange Commission ("SEC"). It also allows investment banks to publish research reports during a public offering, even if the bank is an underwriter in the offering. The JOBS Act also exempts emerging growth companies from research analyst conflict of interest rules and restrictions on communication between management, research analysts and investment bankers. Such "three way" communications were prohibited by SEC rules in 2005 in the wake of controversy regarding conflicts of interest among investment bankers and research analysts selling IPOs, with the aim of protecting the integrity of analyst reports. The JOBS Act also prohibits the SEC and the Financial Industry Regulatory Authority ("FINRA") from restricting the publication of research reports after an IPO, which has the effect of eliminating prohibitions on so-called "booster-shot" research reports after the pricing of an IPO. However, The JOBS Act does not change any of the antifraud provisions of the federal securities laws, which will still apply to analyst research.
Normally, because federal securities laws prohibit making offers to sell new securities before a registration statement has been filed, companies are not allowed to "test the waters" to gauge interest in an offering without committing the time and expense necessary to file a registration statement with the SEC. However, the JOBS Act will allow emerging growth companies to communicate, either before or after filing a registration statement, with qualified institutional buyers ("QIBs") (institutions with over $100 million of assets under management) or institutions that are accredited investors to determine whether those investors are interested in the contemplated securities offering.
Regulation S-K and Regulatory Revisions. The JOBS Act requires the SEC to review Regulation S-K to update, modernize and simplify the registration process, and to reduce the costs associated with disclosure requirements for emerging growth companies. In addition, although the amendments to the Securities Act of 1933 (the "Securities Act") and the Securities Exchange Act of 1934 (the "Exchange Act") are effective immediately, existing rules and regulations of the SEC, FINRA, and other regulatory agencies will need to be amended to conform to the new scheme adopted by the JOBS Act. We will continue to monitor these developments.
Small Company Capital Formation
Title IV of the JOBS Act requires the SEC to increase the amount of securities that can be issued in a 12-month period under Regulation A from $5 million to $50 million. This offering type is not limited to emerging growth companies. The securities issued in this kind of public offering will not be restricted securities. In addition, these offerings will be exempt from state Blue Sky laws, so long as the securities are listed on a national securities exchange or sold to a "qualified purchaser." The SEC will promulgate rules to define qualified purchaser in this context.
Private Company Reforms
General Solicitation in Private Placements. Title II of the JOBS Act requires the SEC to make rules eliminating the ban on general solicitation for offerings under Rule 506 of Regulation D under the Securities Act if all purchasers are accredited investors. This means that private companies will be able to advertise offerings of securities, so long as they only sell to accredited investors, which generally includes individuals who meet certain income requirements or have a net worth in excess of $1 million, excluding the value of their primary residences, and certain institutional investors. Additionally, general advertising and solicitation will be permitted under Rule 144A, provided that sales are made only to QIBs.
The JOBS Act also creates an exemption from broker-dealer registration for any person that maintains a platform or mechanism that permits the offer, sale, purchase, or negotiation of or with respect to securities, or permits general solicitations, general advertisements, or related activities, in connection with Rule 506 offerings. However, such persons will not qualify for the exemption if they receive compensation in connection with the sale of the security, have possession of customer funds or securities, or are subject to a statutory disqualification pursuant to Section 3(a)(39) of the Exchange Act.
Crowdfunding. Title III of the JOBS Act provides for a new type of private placement, dubbed "crowdfunding." The law allows private companies to sell up to $1 million worth of securities in any 12-month period through a broker or funding portal. Such portals would be required to register with the SEC and other applicable self-regulatory organizations. Individual investors would not be allowed to invest more than (a) the greater of $2,000 or five percent of their annual income or net worth, if either the investor's net worth or annual income is less than $100,000; or (b) 10%, not to exceed $100,000, of the investor's annual income or net worth, if the investor's annual income or net worth is equal to or greater than $100,000.
Companies that rely on the crowdfunding exemption must make financial and other applicable information available to both the SEC and investors at the time of the offering, and then annually thereafter. The level of disclosure is based on the size of the offering, with audited financial statements being required for offerings over $500,000. Crowdfunding investors may bring civil actions against companies for material misstatements or omissions in disclosures provided in connection with a crowdfunding offering.
Crowdfunding portals must be registered with the SEC as either a broker or a "funding portal." A funding portal acts as an intermediary in crowdfunding transaction, but it must not offer investment advice, solicit sales or offers to buy the securities displayed on its website or portal, compensate other persons for such solicitation, or possess or otherwise handle investor funds or securities. If these requirements are met, along with any additional limitations that may be included in rules to be adopted by the SEC, the funding portal can act as an intermediary in crowdfunding transactions without being registered as a broker.
Threshold for Public Company Reporting Regulations. Currently, the Exchange Act requires a company with more than $10 million in assets to register with the SEC as a public company when it has 500 or more shareholders of record. Title V of the JOBS Act will allow a private company to have up to 2,000 record holders before it become subject to public reporting obligations, as long as fewer than 500 are non-accredited investors. For purposes of the 2,000 shareholder threshold, shareholders who received securities pursuant to an employee compensation plan and crowdfunding investors will not be counted as shareholders of record. The 500-investor rule has provided an impetus for some famous IPOs in the past, because companies rarely want to take on the burden of public reporting under the Exchange Act without the concomitant benefits of an IPO. Raising the threshold will give private companies the flexibility to delay an IPO, rather than being forced to go public before the business is ready. However, the allure of stock liquidity and raising additional capital is certain to continue to draw companies to conduct public offerings.
Title VI of the JOBS Act specifically applies to banks and bank holding companies and, similar to Title V, increases the public company reporting threshold from 500 shareholders of record to 2,000 shareholders of record. Furthermore, whereas the previous record shareholder threshold for deregistration by existing public companies was 300, Sections 601(a)(2) and 601(b) of the JOBS Act revises that threshold to 1,200 shareholders of record for banks and bank holding companies. This means that existing public banks and bank holding companies will be able to deregister their shares if they have less than 1,200 shareholders of record. The deregistration threshold for other existing public companies remains at 300.
It is important to note that a proposed amendment to the JOBS Act would have required banks and bank holding companies to "look through" street name shareholders of record to the beneficial owners of such shares for purposes of the aforementioned thresholds, but that amendment was voted down and is not included in the final law. As such, shares held in street name are counted as one record shareholder for each broker in whose name such shares are titled, regardless of the number of beneficial owners of such shares.
Effective Date of JOBS Act Provisions
While some provisions of the JOBS Act are effective immediately, others will be delayed while regulatory agencies make rules to clarify the new law. For example, the IPO on-ramp provisions of Title I generally became effective upon signing. However, the SEC must takes steps to amend Regulation D to adopt implementing rules regarding general solicitation for Rule 506 offerings within 90 days of April 5, 2012. Similarly, the SEC has 270 days to adopt implementing rules facilitating the crowdfunding provisions. Changes to Regulation A (or a similar provision with a $50 million offering limitation) also require the SEC to promulgate new rules. The SEC is required to report on changes to Regulation S-K within 180 days. The SEC is also directed to revise the definition of "held of record" for purposes of calculating the 2,000 shareholder public company reporting threshold. Section 602 of the JOBS Act directs the SEC, within one year of the date of enactment of the Act, to issue final regulations implementing Title VI and the amendments to the Exchange Act made thereby. It remains unclear as of the date of this alert exactly what regulations are necessary to implement Title VI, given that the JOBS Act itself adjusts the public reporting thresholds and there is already a well-established process in place in the existing law for deregistration of shares.
While the JOBS Act received bipartisan support and the support of trade groups such as the National Venture Capital Association, many consumer protection advocacy groups and other commentators fear that easing regulations will open the door to fraud in the public markets and harm investors. Many of the regulatory restrictions that are being eased by the JOBS Act have their roots in the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Wall Street Reform and Consumer Protection Act, which grew out of major corporate and accounting scandals. In addition, while reduced public company reporting requirements are expected to decrease the cost of regulatory compliance, investors may be reluctant to invest in an emerging growth company's stock in the absence of the augmented disclosure being provided by larger companies.
Now that the JOBS Act has become law, the SEC and other regulatory agencies will start the work of drafting regulations and interpretations to clarify the law. While the JOBS Act promises to reduce regulatory restrictions on certain growth companies, the details of how the law will be implemented, along with the law's long term impact on the integrity of the financial system and the companies themselves, remain to be seen.
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