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Despite the perception held by many that the current federal legislative and executive branches have been relatively unproductive during the current election year, the 112th Congress recently passed, with bipartisan support, the Jumpstart Our Business Startups (JOBS) Act and sent the Act to President Obama, who signed it into law on April 5, 2012. The JOBS Act is intended to improve access to the public capital markets for “emerging growth companies,” a new class of issuer that will enjoy relaxed financial, compensation, and other disclosures for up to five years after its initial public offering (“IPO”). Other notable aspects of the JOBS Act include exemptions for “crowdfunding” offerings, relaxation of the current prohibitions against general solicitation in private offerings, increased flexibility to conduct Regulation A offerings of up to $50 million without SEC registration, and the raising of the threshold for triggering public company reporting, all of which aspects are aimed at easing capital formation for small and mid-sized companies and, as a result, creating private sector jobs.
The JOBS Act is divided into seven titles, six of which contain the substantive changes or additions to prior securities law. Each of the six substantive titles, as well as a discussion of their potential ramifications, is discussed below. In addition, since some of the provisions of the JOBS Act will not be implemented immediately, an indication of the relevant implementation dates is also discussed below.
JOBS ACT
TITLE I: REOPENING AMERICAN CAPITAL MARKETS TO EMERGING GROWTH COMPANIES
Perhaps the highlight of the JOBS Act is the creation of a new class of issuer under federal securities law called an Emerging Growth Company (“EGC”). To be considered an EGC, an issuer must: (1) have less than $1 billion in annual gross revenues during its most recently completed fiscal year, (2) have been publicly traded for less than five years, (3) have a public float of less than $700 million, and (4) have not issued $1 billion in non-convertible debt in the prior three-year period. An issuer will remain an EGC until the last day of the fiscal year following its five-year anniversary of its IPO or until the EGC fails to meet the EGC criteria, whichever occurs first. An issuer will not qualify as an EGC if it first sold common equity in a registered offering on or before December 8, 2011.
An EGC will enjoy the benefits of scaled compliance and disclosure burdens, the result of which will lead to a decrease in initial and ongoing costs of being a public company, thus potentially encouraging more companies to raise capital through an IPO and become publicly traded (also known as the “IPO on-ramp”).
Under the JOBS Act, an EGC is permitted to:
• Include two years (instead of three years) of audited financial statements in its equity IPO registration statement. However, this provision does not apply to other registration statements or to periodic or other reports, such as annual reports.
• Provide Management’s Discussion and Analysis of Financial Condition and Results of Operations disclosures that correspond to the financial statements included in the IPO registration statement.
• Exclude selected financial data for any period prior to the earliest audited period included in its equity IPO registration statement. This provision applies to other registration statements and to periodic and other reports, such as annual reports.
• Comply with any new or revised accounting standard in the same timeframe as companies that are not issuers.
• Comply with the executive compensation disclosure requirements available to a smaller reporting company. Thus, the decreased burden would include: (1) an exemption from providing a Compensation Discussion and Analysis (CD&A), (2) a reduction in the number of “named executive officers,” (3) shortening executive compensation to two years from three years, (4) eliminating the following compensation tables: Grants of Plan-Based Awards, Option Exercises and Stock Vested, Pension Benefits, and Nonqualified Deferred Compensation, and (5) the elimination of the narrative disclosure of the issuer’s compensations polices and practices as they relate to the issuer’s risk management.
• Submit to the SEC a draft equity IPO registration statement for confidential review prior to a public filing. Any submission and all amendments must be publicly filed with the SEC no later than 21 days before the issuer conducts a roadshow for the applicable
public offering. However, comment letters and company response letters will be deemed to constitute confidential information and, as a result, will not be made publicly available. Issuers that qualify as an EGC in registration at the time of enactment of the
JOBS Act may switch to the confidential submission process for future amendments.
In addition, an EGC will be temporarily exempt from the following:
• Section 404(b) of the Sarbanes-Oxley Act regarding the auditor attestation report of the company’s internal control over financial reporting. However, EGCs are still required to comply with section 404(a) of the Sarbanes-Oxley Act regarding management’s report on internal control over financial reporting. Under existing rules, newly public companies are not required to provide management’s report until their second annual report.
• Any future Public Company Accounting Oversight Board (PCAOB) rules requiring mandatory audit firm rotation or a supplement to the auditor’s report in which the auditor would be required to provide an auditor discussion and analysis, as well as any other future PCAOB rules adopted after the JOBS Act enactment date, unless the SEC determines that such rules are necessary and in the public interest.
• Certain current and future executive compensation disclosures, such as: (1) the say-on-pay vote requirement, (2) the advisory vote on golden parachute payments requirement, (3) the requirement to disclose the relationship between executive compensation and the financial performance of the company, and (4) the CEO pay-ratio disclosure requirement.
Additionally, the JOBS Act eliminates key restrictions on publishing analyst research and on communications between securities analysts, investment bankers, management, and prospective investors while an EGC’s IPO registrations are underway. Specifically, investment bank analysts will be permitted to publish research reports on EGCs while their IPO registrations are pending, even if the investment bank is a member of the underwriting syndicate. Investment bank analysts will also be permitted to communicate with investment banks and management of the EGC, exempting underwriters from the conflict of interest rules that were previously in place. Further, an issuer will now be able to communicate with and elicit interest from qualified institutional buyers (“QIBs”) and institutional accredited investors, either before the issuer’s registration statement is filed or while registration is pending. Finally, the SEC and national securities exchanges will be prohibited from imposing restrictions on publishing research or public appearances relating to EGCs during the post-IPO quiet periods and lock-up periods.
An EGC is not required to comply with all of the provisions of Title I of the JOBS Act. Instead, an EGC may choose to forgo certain disclosures eliminated by the JOBS Act on an “a la carte” basis; provided, however, that with respect to financial accounting standards, an EGC must: (1) make a choice whether or not to comply with the accounting standards to the same extent as non-EGCs at the time the EGC files its first registration statement, (2) comply with all or none of the accounting standards to the same extent as nonEGCs, and (3) if the EGC elected to comply with the accounting standards to the same extent as non-EGCs, continue to comply as long as the EGC remains an EGC.
Title I of the JOBS Act regarding EGCs is effectively immediately.
TITLE II: ACCESS TO CAPITAL FOR JOB CREATORS
Title II of the JOBS Act substantially relaxes the longstanding ban on general solicitation and advertising in connection with certain private offerings, the result of which is intended to lead to less uncertainty for issuers regarding the marketing of their securities. For instance, the JOBS Act substantially relaxes the ban on the use of general solicitation and advertising in connection with certain private offerings made to accredited investors under Rule 506 of Regulation D by: (1) eliminating the ban as long as all purchasers of the securities in an offering are “accredited investors” under Regulation D, and (2) requiring the issuer to take “reasonable steps” to confirm the accredited investor status of all such investors.
Guidance regarding the nature of such “reasonable steps” will be provided by the SEC.
Similarly, the JOBS Act permits general solicitation and advertising to purchasers who are not QIBs, as long as the securities are resold only to persons that the seller reasonably believes are QIBs. Such relaxation on the ban on general solicitation and advertising in connection with the private offerings referenced herein is intended to facilitate a private company’s ability to identify investors who may be interested in the offering.
Finally, Title II exempts persons from required registration as a broker-dealer if the registration would have been required solely due to the fact that such person was:
• maintaining a platform or mechanism that facilitates or permits offers, sales purchases, negotiations, general solicitation or advertising, or similar activities by issuers of securities, whether online, in person, or though any other means;
• co-investing in an issuer’s securities; or
• providing certain ancillary services, such as due diligence reviews or standardized documents services.
To qualify for this exemption from broker-dealer registration, such persons and any individuals associated with such persons will have to comply with certain restrictions, including (1) receiving no compensation in connection with the purchase or sale of securities, (2) having no possession of customer funds or securities in the purchase and sale process, and (3) otherwise not being subject to certain Exchange Act disqualifications.
The SEC has until July 4, 2012 to adopt rules implementing Title II of the JOBS Act.
TITLE III: CROWDFUNDING
Title III of the Jobs Act, entitled “Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012” or the “CROWDFUND Act” is based on Congress’ recognition that entrepreneurs typically have sought capital from their own resources, bank loans and loans and investments from friends and family, angel investors, and venture capital investors. Congress also understood that raising capital has been difficult to do in recent years due to the tight financial markets. Accordingly, the CROWDFUND Act was implemented as part of the JOBS Act in order to help small, start-up, and emerging growth companies raise capital more effectively. Specifically, the CROWDFUND Act now permits entrepreneurs and business owners to raise up to $1 million in a 12-month period from individual investors through the internet, subject to certain requirements and limitations, which are highlighted below.
The CROWDFUND Act attempts to strike a middle ground between making capital raising easier for small issuers while still protecting investors. The disclosure obligations are reduced for issuers, but issuers still must provide certain disclosures and may use only brokers and crowdfunding portals. Additionally, officers and directors will still be liable for securities fraud if they make material misstatements or omissions in connection with the offering. The crowdfunding portals and brokers also will have certain due diligence and disclosure obligations. Investors may find it easier to invest, but at the expense of receiving reduced disclosures and will find their ability to transfer acquired stock restricted for one year after purchase (other than transfers to the issuer, an accredited investor, or to family members upon death or divorce). The best investor protection may be in the limits the law places on how much a single investor can invest in any crowdfunded entities in a single year, as discussed below.
The following are the specific requirements for the exemption:
• An issuer must be a U.S. company, a non-SEC reporting company, and can raise only up to $1 million in any 12-month period.
• An investor can invest in all crowdfunded investments in any year an amount not to exceed (a) the greater of $2,000 or 5% of the investor’s annual income or net worth if either of these is less than $100,000, and (b) 10% of the investor’s annual income or net worth not to exceed $100,000 if the investor’s annual income or net worth is $100,000 or more.
• The investment must be made through a broker or a “funding portal” that is registered with the SEC and FINRA.
• The funding portal or broker must provide the investor with certain information at least 21 days before closing on the investment. The type and level of disclosure will be determined by SEC rules, but must include at least the risks of the investment, an affirmation from the investor that he understands the risk of loss of the investment and risks related to startups, emerging businesses, and small businesses, and can bear the risk of loss of the entire investment.
• The funding portal or broker must obtain background checks and securities enforcement regulatory history for officers, directors, and 20% securities owners of the issuer.
• The funding portal or broker also must ensure that offering proceeds are provided to issuers only when the targeted offering amount is obtained and permit investors to cancel commitments under to-beestablished SEC rules.
• Issuers must make available to the SEC and potential investors any information that the issuer provides to investors and intermediaries.
• Issuers must not compensate promoters, finders, or lead generators for providing the broker or funding portal with the personal identifying information of any potential investor.
It is important to note that the JOBS Act deems the securities issued in a crowdfunding transaction to be considered “covered securities” such that any state law requirements regarding the registration of such securities are preempted by the JOBS Act.
While the CROWDFUND Act may make capital raising easier for certain issuers, the attempted middle ground between lessened disclosures and investor protection may make the exemption less attractive for both issuers and investors.
The SEC has until December 31, 2012 to adopt rules implementing the crowdfunding provisions of Title III of the JOBS Act.
TITLE IV: SMALL COMPANY CAPITAL FORMATION
Title IV of the JOBS Act, which is effectively immediately, amends the Securities Act by requiring the SEC to create a new registration exemption that will serve to form a new version of Regulation A. Such new version is intended to be more attractive and useful to companies by addressing many of the perceived shortcomings of the old Regulation A exemption, thus providing companies with a viable option to raise a significant, but limited, amount of capital without having to file a full registration statement. Only equity, debt, and debt convertible equity securities are eligible for this exemption.
Specifically, the JOBS Act increases the aggregate offering amount that an issuer may raise in a twelve-month period from $5 million to $50 million. Further, an issuer may solicit interest in the offering prior to filing an offering statement on the terms and conditions prescribed by the SEC. The JOBS Act also provides that securities offered under Title IV may be offered and sold publicly and will not be considered “restricted securities.”
In addition, and perhaps most importantly, the JOBS Act preempts state registration of Regulation A offerings if the securities are offered or sold on a national securities exchange, offered or sold through a registered broker-dealer, or offered or sold to “qualified purchasers” as defined by the SEC. Indeed, one of the primary reasons why the old Regulation A exemption was rarely used was that the exemption did not preempt state law; thus companies that obtained the federal exemption still had to register under state “blue sky” laws.
Issuers also should understand that in order to take advantage of the Title IV exemption, the issuers will be required to file audited financial statements with the SEC on an annual basis. Additionally, issuers may be required to file with the SEC and distribute to prospective investors offering statements and financial statements that include a description of the company’s business operations, financial condition, corporate governance principles, and use of investor funds. The SEC may also require issuers to make periodic disclosures of this type of information. Finally, issuers will be subject to liability under section 12(a)(2) of the Securities Act.
TITLE V: PRIVATE COMPANY FLEXIBILITY AND GROWTH
Previous securities law required issuers to register with the SEC and start filing periodic reports at such time as any class of their equity securities was held of record by 500 or more persons, unless the issuer had assets of less than $10 million. Title V of the JOBS Act, which is effective immediately, raises the shareholder count ceiling significantly, to a maximum of either 2,000 persons in total or 500 persons who are not “accredited investors.” Furthermore, a company may de-register under the Exchange Act if the number of record holders decreases below 300 persons.
Title V also revises the definition of “held of record” to exclude individuals receiving securities through employee compensation plans in transactions exempted from the registration requirements of the Securities Act. Finally, Title V requires the SEC by rule to exempt, conditionally or unconditionally, from the registration provisions of the Exchange Act securities acquired pursuant to an offering made under the new crowdfunding exemption.
The intent of Title V is to encourage companies who were not yet willing or able to take on the additional burdens of becoming a public reporting company to seek to raise capital and expand their businesses.
TITLE VI: CAPITAL EXPANSION
Similar to Title V of the JOBS Act, Title VI permits a greater number of record holders of bank and bank holding companies without triggering the registration requirement. Under Title VI, a bank or bank holding company that is an issuer must register when such company has total assets exceeding $10 million and a class of non-exempted equity security held of record by 2,000 or more persons. Previously, the threshold for banks or bank holding companies to register was 500 record holders. However, unlike Title V of the JOBS Act, there is no registration requirement for banks or bank holding companies based on the number of non-accredited investors. A bank or bank holding company may de-register when such company has fewer than 1,200 holders of record.
Section 12(a) of the Exchange Act was amended on April 5, 2012 to raise the registration requirements, but the SEC has until April 5, 2013 to adopt rules implementing the provisions of Title VI of the JOBS Act.
REQUIRED STUDIES
In addition, the JOBS Act also requires certain federal government agencies to conduct several studies, including the following:
• Within 90 days of enactment, the SEC is required to submit to Congress its findings related to the impact that “decimalization” (trading and quoting securities in $0.01 increments) has had on IPOs and the liquidity for small- and mid-cap securities.
• Within 90 days of enactment, the Comptroller General is required to submit to Congress the results of its study on the impact of state laws regulating securities offerings (i.e., “blue sky laws”) on offerings made under Regulation A.
• Within 120 days of enactment, the SEC is required to submit to Congress its recommendations concerning whether new enforcement tools are needed to enforce the anti-evasion provision of Rule 12g5-1(b)(3) of the Exchange Act.
• Within 180 days of enactment, the SEC is required to submit to Congress its findings and recommendations related to a review of Regulation S-K to determine how the requirements can be updated to simplify the registration process and reduce the costs and other burdens for EGCs.
CONCLUSION
In passing the JOBS Act, President Obama and Congress have sought to increase private companies’ access to capital without some of the burdensome regulations of prior securities law. Proponents of the JOBS Act believe that if the Act is successful, companies that are able to raise additional capital while limiting costs of securities law compliance will be in a better position to, among other things, expand their businesses, create additional jobs, and lower the current unemployment rate. However, opponents of at least some of the provisions of the JOBS Act believe that the Act may lead to an increase in abuse and fraud in our markets. Indeed, on March 13, 2012, Mary L. Schapiro, the Chairman of the SEC, wrote a letter to the Senate Committee on Banking, Housing, and Urban Affairs expressing her concerns that certain provisions of the JOBS Act that ease long-standing regulations would expose investors to harm. In any event, companies should become familiar with the provisions of the JOBS Act as soon as possible and determine whether or not they should take advantage of some of the capital raising tools contained therein.
