On April 5, President Obama signed the Jumpstart Our Business Startups Act (or JOBS Act) into law, intending to facilitate initial public offerings (IPOs) and expand opportunities for raising private capital.1

Some key features of the JOBS Act include:

  • Easing auditing and disclosure requirements for small and mid-sized companies in IPOs and during a post-IPO transition period
    • Requires only two, instead of three, years of audited financial statements in IPOs
    • Eases certain Sarbanes-Oxley Act requirements
  • Increasing the ability of participating underwriters to publish research reports around the time of the IPO
  • Facilitating private capital formation
    • Lifts the prohibition on publicizing certain private offerings
    • Provides for a new "crowdfunding" form of securities offering
    • Increases the number of shareholders of record which companies may have prior to mandatory registration with the US Securities and Exchange Commission (SEC)

Emerging Growth Companies

The JOBS Act introduces a new category of issuer—an "emerging growth company"—with annual gross revenues of less than $1 billion. Under the JOBS Act, emerging growth companies may rely on some of the reduced disclosure requirements that are already available to companies having a public float of less than $75 million. Among other things, emerging growth companies may include only two, rather than three, years of audited financial statements in their IPO registration statement. During a transitional "on ramp" period following the IPO, emerging growth companies are also permitted to omit the auditor's attestation on internal control over financial reporting that would otherwise be required by the Sarbanes-Oxley Act. This dispensation represents a potentially significant cost savings, as companies with a public float of $75 million or more must otherwise procure such an attestation beginning with their second annual report after their IPO. During the "on ramp" period, emerging growth companies are also excluded from the requirement to submit "say-on-pay", "say-on-pay frequency" and "say-on-parachute" votes to their stockholders and enjoy reduced executive compensation disclosure compared to larger companies. The "on ramp" period ends when the issuer no longer qualifies as an emerging growth company, i.e. five years from the IPO, upon attaining a public float of at least $700 million for at least one year, generating annual gross revenues of at least $1 billion, or issuing more than $1 billion in non-convertible debt in a three year period, whichever occurs first. The advantages of qualifying as an emerging growth company are available immediately, but, in order to qualify, a company must not have sold securities in a publicly registered offering prior to December 9, 2011 (e.g. conducted an IPO or issued publicly registered securities to employees on Form S-8).

The JOBS Act also permits brokers and dealers, including underwriters participating in an IPO of an emerging growth company, to publish research reports regarding the emerging growth company around the time of the IPO, and provides that such research reports will not violate the "gun jumping" provisions of the Securities Act. This measure is intended to increase visibility for these companies in the period immediately following the IPO. Previously, underwriters involved in an IPO could not publish such research reports for up to 40 days after the IPO. The JOBS Act also removes certain rules requiring separation between research analysts and investment bankers who work in the same firm.

The JOBS Act enables emerging growth companies to gauge interest in a contemplated offering by communicating with potential investors that are qualified institutional buyers or institutions that are accredited investors in the pre- and post-filing period. Under prior rules, smaller companies could only engage in such pre-marketing communications if a registration statement was already on file. Emerging growth companies remain subject to anti-fraud liability under the federal securities laws for any oral or written communications to potential investors.

The JOBS Act also permits emerging growth companies to submit IPO registration statements to the SEC confidentially; however, the registration statement and any amendments must be publicly filed not later than 21 days before the road show. This provision means that the registration statement, including any sensitive information contained in it, would initially not be publicly accessible and would remain confidential if the company abandoned the offering prior to its public filing.

Emerging growth companies are exempt from any future rules promulgated by the Public Company Accounting Oversight Board (PCAOB) that would require rotation of audit firms or inclusion in a supplement to the audit report of additional information about the audit and the company's financial statements (auditor discussion and analysis). Other new audit rules that the PCAOB may adopt will only apply to emerging growth companies if the SEC determines that they are necessary or appropriate.

Publicizing Securities Offerings and Crowdfunding

In addition to easing IPO requirements, the JOBS Act is intended to facilitate private capital raising by permitting general solicitation and general advertising in private placements made under Rule 506 of Regulation D and Rule 144A, as long as only "accredited investors" or "qualified institutional buyers", respectively, actually purchase securities in those placements. The JOBS Act directs the SEC to implement such changes within 90 days, specifying that the rules should require issuers to take reasonable steps to verify the status of purchasers. It is important to note that, in the context of offerings to persons outside the United States without SEC registration under Regulation S, the JOBS Act did not repeal the prohibition on general solicitation and general advertising. Therefore, companies engaging in such sales in reliance on Regulation S must continue to avoid broadly disseminated "directed selling efforts" into the United States.

The JOBS Act creates a new "crowdfunding" exemption from registration. Crowdfunding typically refers to raising early-stage capital from a pool of non-professional investors who each contribute a modest sum, often as the result of the issuer's promotion of the opportunity online. Under the new exemption, companies can issue securities without SEC registration valued at up to $1 million in any 12-month period, as long as sales to any one investor do not exceed (i) the greater of $2,000 or 5 percent of the annual income or net worth of investors whose annual income or net worth is less than $100,000; and (ii) 10 percent of the annual income or net worth of investors whose annual income or net worth equals or exceed $100,000, up to a maximum investment of $100,000. Securities issued pursuant to the crowdfunding exemption are generally exempt from regulation by the states, other than with respect to fraud, but are subject to transfer restrictions. Crowdfunding securities may not be resold for one year from purchase unless to the issuer, an accredited investor, in a registered offering, or to a family member or for certain family planning purposes. The crowdfunding exemption is not available to non-US companies, investment companies, Exchange Act reporting companies and others that the SEC may specify.

Issuers cannot conduct crowdfunding transactions directly, but must utilize a broker or a "funding portal" as an intermediary that must register with the SEC and any applicable self-regulatory organization (e.g. a national securities exchange). The funding portal is a new designation under the JOBS Act; funding portals may not offer investment advice or recommendations, solicit sales, pay sales-based compensation, handle investor funds or securities or perform other activities that the SEC may prohibit. The JOBS Act also prohibits issuers from advertising the offering other than by directing investors to the intermediary or compensating any person for promoting its offerings unless in accordance with rules to be prescribed by the SEC. Further, issuers must provide certain information about the company and the offering to investors, potential investors, intermediaries and the SEC. Such information includes annual reports about the issuer's results of operations and financial statements.

The JOBS Act creates liability for issuers in crowdfunding transactions with respect to communications that include material misstatements or omissions that the issuers cannot prove they did not know about or could not reasonably have known about. The JOBS Act directs the SEC to issue rules in the next 270 days in order to implement and further define the crowdfunding exemption.

Relief from Public Company Registration; Expanded Fund-Raising Limits under Regulation A

The JOBS Act further provides relief from the obligation of a company to register its securities under the Securities Exchange Act of 1934 (Exchange Act). It increases the number of stockholders of record a company with more than $10 million in assets may have from 500 to 2,000, including up to 500 non-accredited investors, before that company must register with the SEC and begin periodic reporting under the Exchange Act. Further, the JOBS Act excludes from such number of stockholders of record (i) investors who invest pursuant to the crowdfunding exemption (subject to conditions the SEC may impose) and (ii) persons who become stockholders through certain employee compensation plans, including in reliance on Rule 701. While the increase to a maximum of 2,000 holders of a class of securities prior to compulsory SEC registration is effective immediately, the Act directs the SEC to adopt rules within one year to clarify which stockholders acquiring shares through employee compensation plans are excluded from this figure.

The JOBS Act also increases the number of stockholders of record of banks and bank holding companies to 2,000 or more before they must register with the SEC and begin periodic reporting under the Exchange Act, and it increases the threshold below which they may suspend their Exchange Act reporting obligations from 300 to 1,200 stockholders.

Finally, the JOBS Act mandates that the SEC, without a prescribed timeline, create a new category of securities exempt from the registration requirements of the Securities Act of 1933, thereby effectively increasing the size of Regulation A offerings to cover sales of up to $50 million of such securities by a company within any 12-month period, subject to the annual filing of audited financial statements and other conditions to be prescribed by the SEC, including limited periodic reporting requirements. Regulation A offerings, currently limited to sales of up to $5 million of securities in any 12-month period, are subject to fewer disclosure requirements than are offerings registered with the SEC. The securities offered pursuant to this exemption will not be "restricted securities" and will be immediately and freely resalable to the public and issuers may "test the waters" for interest in their offerings prior to filing an offering document on such terms and conditions as the SEC may prescribe.

Conclusion

Proponents of the JOBS Act assert that it will reduce the "time to market" for emerging growth companies planning an IPO, particularly those that would not qualify as "smaller reporting companies" with less than a $75 million public float, and diminish some of the costs of IPOs, permitting these companies to use more of their new capital to grow their businesses. Critics have challenged the JOBS Act, arguing that it reduces investor protection, which may lead to investors demanding a premium to balance the reduced disclosure. The full impact of the JOBS Act will not be known for some time as the SEC adopts all of the relevant rules, and issuers, financial intermediaries and their counsel develop best practices for taking advantage of the dispensations available under the JOBS Act. The SEC is currently accepting public comments on the rules to be promulgated under the JOBS Act and has provided limited guidance in the form of frequently asked questions.

Footnotes

1. On March 8, 2012, the US House of Representatives passed the JOBS Act; the US Senate passed the JOBS Act on March 22, and the House passed the amended version on March 27. Please refer to our prior alert discussing the House version.

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