JOBS Act Liberalizes Reporting Requirements and Exemptions For Emerging Businesses and Private Issuers
On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups Act (the “JOBS Act” or the “Act”) following passage by the U.S. Senate and House in late-March 2012. The JOBS Act moved through the House and the Senate at lightning speed considering the usual election year legislative stalemate and the fundamental and sweeping changes the Act makes to existing securities laws. The Act promises to dramatically alter the securities regulatory landscape for both private and newly-public companies. Title I of the JOBS Act, which is designed to revitalize the IPO market, became effective upon enactment. However, many of the most talked about parts of the Act, such as the “crowdfunding” and private offering reforms, will not become effective until the SEC adopts rules or takes other prescribed actions. Key provisions of the JOBS Act are summarized as follows:
- Title I creates a new category of “emerging growth companies” or “EGCs” and exempts EGCs from certain disclosure and governance requirements -- EGCs are companies with total annual gross revenues of less than $1.0 billion during their most recently completed fiscal year that complete (or have completed) an IPO after December 8, 2011.
- Title II Eliminates restrictions on general solicitation in certain exempt offerings -- issuers will now be able to use general solicitation and advertising in offerings under Rule 506 to “accredited investors” and under Rule 144A for offerings to “qualified institutional buyers” (“QIBs”).
- Title III creates an exemption for a new form of capital raising, known as “crowdfunding” -- that will permit most U.S. non-reporting issuers to raise up to $1 million annually by selling small amounts of stock to numerous individuals, without being obligated to register with the SEC, provided that, among other things, certain disclosures are made available to the SEC and potential investors and offers and sales are conducted through a U.S. registered broker-dealer or “funding portal.”
- Title IV creates a new exemption under Section 3(b) of the Securities Act akin to existing Regulation A -- that will permit an issuer to offer and sell (privately or publicly) up to $50 million in securities within a 12-month period in reliance on the exemption, provided that the issuer files audited financial statements with the SEC and complies with such disclosure, financial statement and other requirements as determined by the SEC to be necessary or appropriate in the public interest.
- Title V Relaxes Section 12(g) threshold for triggering public company reporting -- by increasing the number of record-holders that trigger the requirement to register a class of equity securities under the Securities Exchange Act of 1934 (the “Exchange Act”) to 2,000 persons or 500 persons who are not “accredited investors,” rather than the current 500 record holder threshold. Significantly, for purposes of computing these thresholds, issuers may exclude both holders who received securities pursuant to an employee compensation plan in transactions exempt from the registration requirements, and investors who use the crowdfunding exemption under the JOBS Act.
The discussion below provides more detail regarding certain of the key provisions of the JOBS Act that we believe are most relevant to emerging companies, venture capitalists and private equity investors, and capital markets professionals.
Emerging Growth Companies
The JOBS Act defines an EGC as an issuer with total annual gross revenues of less than $1 billion during the most recently completed fiscal year. An issuer will be an EGC until the earliest of (a) the last day of the fiscal year in which the issuer had gross revenues of $1 billion or more, (b) the last day of the issuer’s fiscal year that is five years after the date of its IPO, (c) the date on which the issuer has, during the prior three year period, issued more than $1 billion in non-convertible debt, or (d) the date on which the issuer is deemed to be a “large accelerated filer” (requiring $700 million of public float, among other things). An issuer is ineligible to be considered an EGC if it first sold its common stock in an IPO on or prior to December 8, 2011.
Securities Disclosure and Governance Relief. The JOBS Act affords EGCs with the following significant relief from the existing regulatory and disclosure regime:
- EGCs must provide only two rather than three years of audited financial statements in their IPO Registration Statement.
- EGCs are not required to comply with new or revised accounting standards until the standards are made applicable to private companies.
- EGCs are exempted from compliance with Section 404(b) of the Sarbanes-Oxley Act, which requires companies to receive an outside auditor’s attestation regarding the issuer’s internal controls.
- Selected financial data in any registration statement or other report filed by an EGC will not need to include any period prior to the earliest audit period presented in an IPO registration statement (rather than up to five years).
- EGCs are not required to comply with mandatory audit firm rotation rules or rules requiring a supplement to the auditor’s report that may be adopted by the Public Company Accounting Oversight Board (“PCAOB”).
- EGCs are not required to comply with rules adopted by the PCAOB after the enactment of the JOBS Act unless the SEC determines the application of such rules is necessary or appropriate in the public interest.
- EGCs are not required to hold “say on pay”, “say when on pay” or “say on golden parachutes” shareholder votes on executive compensation.
- EGCs have the option to comply with executive compensation disclosures by providing the reduced level of information currently required of smaller reporting companies.
- EGCs are exempt from pending requirements to disclose the relationship between executive compensation and financial performance, and the ratio of CEO compensation to median employee compensation.
- Research reports and securities analyst communications relating to emerging growth companies are subject to fewer restrictions than those relating to larger issuers.
- Both prior to and following the filing of a registration statement for an offering by an EGC, the issuer or any person authorized to act on behalf of the issuer may engage in oral or written communications with potential investors that are either QIBs or institutions that are accredited investors to determine whether such investors might have an interest in a contemplated securities offering. Such communications remain subject to the requirement to deliver a prospectus at the time of sale under Section 5(b)(2) of the Securities Act.
- Pre-IPO EGCs will be entitled to confidentially submit a draft registration statement to the SEC for review. EGCs relying on this provision must publicly file the initial draft submission and all amendments not later than 21 days prior to the commencement of a road show.
Research Reports and Communications. The JOBS Act also liberalizes the rules regarding the distribution of research reports on EGCs and communications with potential investors, as follows:
- By amending the Securities Act to provide that brokers-dealers who publish or distribute a research report on an EGC that is pursuing a public offering or that has filed a registration statement shall not be deemed to have made an offer for sale or offer to sell a security, even if the broker-dealer is participating or will participate in the registered offering.
- Broker-dealers may arrange for communications between securities analysts and potential investors in an EGC pursuing an IPO and securities analysts may participate in communications with the management of an EGC alongside persons associated with broker-dealers working for such EGC.
- Persons working on behalf of an EGC may engage in oral or written communications with potential investors that are either QIBs or accredited investors to determine whether such investors might have an interest in any public offering by the EGC.
- Brokers-dealers will not be prohibited from publishing or distributing research reports or making public appearances relating to an offering by an EGC either within prescribed time periods following an IPO or within prescribed time periods prior to expiration of any lock-up agreement with the EGC.
Opt-in Rights. In general, an EGC may choose to forgo any exemption made available by the JOBS Act and instead comply with the requirements applicable to an issuer that is not an EGC. However, if an EGC chooses to comply with accounting standards without taking advantage of the relief available under the JOBS Act, the EGC must make such choice at the time of its first SEC filing and notify the SEC of such choice, must comply with all such standards to the same extent as a non-EGC, and must continue to comply with such standards for so long as the company remains an EGC.
Review of Regulation S-K. The JOBS Act also requires the SEC to conduct a comprehensive review of Regulation S-K, the primary source of public company disclosure requirements, to determine how such requirements can be updated to modernize and simplify the registration process and reduce the costs and other burdens of disclosures for EGCs. The SEC must report to Congress on this review on or before October 2, 2012.
General Solicitation in Private Offerings
The JOBS Act requires that the SEC revise its prohibition against general solicitation of investors in connection with private placements under Rule 506 of Regulation D if all the purchasers are accredited investors. In addition, the SEC must revise Rule 144A to permit general solicitation and general advertising. These changes eliminate longstanding pillars of private placements—the non-public manner of offering and prohibition on general solicitation—which have major implications for how issuers and market intermediaries identify and communicate with investors.
The JOBS Act authorizes a new form of capital raising known as crowdfunding that has long been advocated by many emerging business advocates, pro-business lawmakers and commentators. Crowdfunding as a method of raising capital for business ventures involves the sale of securities in small increments to a large number of investors. To date, the use of crowdfunding to raise business capital has been held back by the lack of a viable exemption from the registration requirements of Section 5 of the Securities Act and by anti-fraud concerns raised by the SEC and the North American Securities Administrators Association, among others. As a result of these concerns, the final version of the JOBS Act contains amendments added by the Senate that require, among other things, that crowdfunded offerings be made through registered intermediary firms that will be obligated to reduce the risks to investors. These duties will increase the cost of crowdfunded offerings and limit the number of registered intermediary firms, which may undermine the usefulness of the exemption to emerging businesses.
The JOBS Act provides for a new, non-exclusive exemption under new Section 4(6) of the Securities Act, which sets forth the requirements for a transaction to qualify for the exemption, summarized below:
Investment and Offering Limits. The aggregate amount sold to any investor by an issuer, including in reliance on this new exemption within the preceding 12-month period, does not exceed the greater of (a) $2,000 or (b) 5 percent of such investor’s annual income or net worth, if either the annual income or net worth of the investor is less than $100,000; and 10 percent of the investor’s annual income or net worth, not to exceed a maximum aggregate sold of $100,000, if either the annual income or net worth of the investor is equal to or exceeds $100,000.
The aggregate amount that may be sold in reliance on the exemption within a 12-month period is limited to $1,000,000. Securities sold in accordance with the exemption must be sold through:
- A registered broker-dealer, or
- A newly-created category of intermediary referred to as a “funding portal,” which is an individual or entity engaged solely as an intermediary in exempt crowdfunding securities transactions that does not offer advice or recommendations or solicit sales and does not compensate employees or other persons based on securities sales.
Issuer Restrictions. The issuer must be a non-reporting U.S. issuer that is not an “investment company” or excluded from the definition of “investment company” pursuant to statutory exemptions or SEC rulemaking. As a result, most private equity, venture capital and hedge funds will not be eligible to use the crowdfunding exemption.
Broker-Dealer Registration/Funding Portals. Crowdfunding intermediaries that are not registered broker-dealers will not be required to register as a broker-dealer under the Exchange Act or state law in connection with transactions exempt under Securities Act Section 4(6). However, intermediaries that are not broker-dealers must register with the SEC as a funding portal under rules to be adopted by the SEC.
Obligations of Intermediaries. A person acting as a broker-dealer or funding portal must take (or refrain from taking) certain actions required by new Securities Act Section 4A(a) including:
- Registering with any applicable self-regulatory organization.
- Providing risk information to investors.
- Ensuring that each investor reviews investor-education information, understands the risk of losing the entire investment and can bear such a loss, and answers questions demonstrating an understanding of the level of risk.
- Taking measures to reduce the risk of fraud, including obtaining a background and securities enforcement regulatory history check on each officer, director, and person holding more than 20 percent of the outstanding equity of every issuer whose securities are offered by such person.
- Not later than 21 days prior to the first day on which securities are sold to any investor (or such other period as the SEC may establish), making available to the SEC and to potential investors any information provided by the issuer to investors.
- Ensuring that all offering proceeds are only provided to the issuer when the aggregate capital raised from all investors is equal to or greater than a target offering amount, and allowing all investors to cancel their commitments to invest, as the SEC determines appropriate.
- Ensuring that no investor in a 12-month period has purchased securities in excess of the aggregate limit for all issuers conducting crowdfunding offerings.
- Taking steps to protect the privacy of information collected from investors.
- Not compensating promoters, finders, or lead generators for providing the intermediary with personal identifying information of any potential investor.
- Prohibiting its directors, officers, or partners (or any person occupying a similar status or performing a similar function) from having any financial interest in an issuer using its services.
- Meeting such other requirements as the SEC may prescribe.
Issuer Obligations. Issuers conducting a crowdfunded offering must comply with the following requirements of new Securities Act Section 4A(b):
- File with the SEC and provide to investors and the broker or funding portal, information about the issuer, including its address, officers, directors and principal stockholders, a description of its business plan and financial condition, and its tax returns.
- Provide, for offerings that, together with all other offerings of the issuer under section 4(6) within the preceding 12-month period, have, in the aggregate, target offering amounts of:
- $100,000 or less—(a) the income tax returns filed by the issuer for the most recently completed year (if any); and (b) financial statements of the issuer certified by the principal executive officer of the issuer;
- More than $100,000, but not more than $500,000—financial statements reviewed by a public accountant who is independent of the issuer, using professional standards and procedures for such review or standards and procedures established by the SEC; or
- More than $500,000—audited financial statements.
- Disclose the stated purpose and intended use of the proceeds of the offering sought by the issuer with respect to the target offering amount, deadline to reach the amount, and regular updates regarding the progress of meeting the target.
- Disclose to the public the price of the securities or the method for determining the price.
- Disclose the ownership and capital structure of the issuer.
- Disclose such other information as the SEC prescribes for the protection of investors and in the public interest.
- Refrain from advertising the terms of the offering, except for notices which direct investors to the funding portal or broker.
- Refrain from compensating or committing to compensate, directly or indirectly, any person to promote its offerings through communication channels provided by a broker or funding portal, without taking such steps as the SEC requires to ensure that such person clearly discloses the receipt, past or prospective, of such compensation, upon each instance of such promotional communication.
- Not less than annually, file with the SEC and provide to investors reports of the results of operations and financial statements of the issuer, as the SEC determines appropriate.
- Comply with any other requirements as the SEC prescribes, for the protection of investors and in the public interest.
Restrictions on Resales. Securities acquired in offerings pursuant to new Section 4(6) may not be transferred for a period of one year unless they are transferred to the issuer or to an accredited investor.
Preemption of State Law. Securities sold pursuant to the crowdfunding exemption are “covered securities” under the National Securities Markets Improvement Act of 1996 (“NSMIA”) and are therefore exempt from most state securities law requirements.
Civil Liability. The final version of the Act includes a provision from the Senate version that provides a private right of action for rescission against an issuer that is based on Section 12(2) of the Securities Act.
Exchange Act Registration. Securities acquired pursuant to Section 4(6) are not considered to be “held of record,” which prevents them from potentially triggering the registration requirements of Section 12(g) of the Exchange Act.
Increased Threshold for Regulation A-type Offerings (“Regulation A+”)
The JOBS Act amends Section 3(b) of the Securities Act to provide a new exemption for securities offerings based on the seldom-used Regulation A exemption that will permit an issuer to offer and sell up to $50 million in securities within a 12-month period in reliance on the exemption. The SEC is directed to review the offering amount limitation every two years and increase the amount as appropriate.
Title IV of the JOBS Act requires the SEC to adopt rules implementing the following terms and conditions:
- The securities may be offered and sold publicly and the securities will not be considered “restricted securities.”
- The civil liability provisions in Section 12(a)(2) of the Securities Act shall apply to any person offering or selling such securities.
- The issuer may solicit interest in the offering prior to filing any offering statement, subject to compliance with SEC rules.
- The issuer must file with the SEC annual audited financial statements and such other periodic filings as the SEC may require.
- The only securities that may be offered are equity and debt securities and debt securities convertible or exchangeable for equity interests, including any guarantees of such securities.
The SEC may impose additional terms and conditions for the protection of investors in these offerings, including:
- a requirement to file electronically with the SEC and distribute to investors an offering statement that contains audited financial statements and other information about the issuer.
- a requirement to file and make available to investors periodic disclosures regarding the issuer, its business operations, financial condition, corporate governance principles, use of investor funds and other matters.
- disqualification provisions pursuant to which the exemption will not be available to certain issuers.
The JOBS Act exempts Regulation A+ offerings from state securities laws relating to registration, documentation and offering requirements if the securities are offered and sold on a national securities exchange or sold to “qualified purchasers,” as defined by the SEC.
Increase in thresholds for Exchange Act 12(g) Registration
The JOBS Act also generally increases the number of stockholders of record a company may have prior to the time it is required to register a class of equity securities under the Exchange Act. Previously, a company with assets exceeding $10 million was required to register under the Exchange Act within 120 days after the last day of the first fiscal year in which it had 500 holders of record of a class of equity securities. The JOBS Act increases the number of equity holders of record requiring registration to either 2,000 persons, or 500 persons who are not accredited investors. Additionally, the definition of “held of record” in Section 12(g) will not include securities held by persons who received the securities pursuant to an employee compensation plan in transactions that were exempt from the registration requirements of Section 5 of the Securities Act and investors who purchased securities pursuant to the crowdfunding exemption.
The changes made by the JOBS Act have the promise of dramatically altering the capital raising and regulatory landscape for both private and newly-public companies and providing new opportunities for these companies to grow without some of the burdens associated with being a public company. The future of crowdfunding, perhaps the most controversial of the Act’s new provisions, remains to be seen. The SEC is perceived by many as hostile to the concept given the opportunities for fraudulent conduct and has a great deal of room to further restrict crowdfunding through the rulemaking process. In addition to the initial compliance costs, issuers also will need to weigh the ongoing costs of crowdfunded offerings, including the annual reporting requirement contemplated by the Act.
Moreover, while the crowdfunding exemption was added to the federal securities laws as of April 5, 2012, the SEC is required to issue rules to implement the disclosure and filing obligations, disqualification criteria, funding portal registration requirements and other transfer restrictions within 270 days of the Act’s enactment. Accordingly, as a practical matter, the crowdfunding exemption will not take effect until December 31, 2012 (or such earlier date as the SEC issues final rules to implement such provisions).
The U.S. IPO market has been depressed for a number of years and the lack of a vibrant IPO market and the role of post-IPO companies as job-creators is a major driver of the JOBS Act reforms. We are hopeful that the liberalization of so-called EGCs contained in Title I will help to stimulate interest in IPOs as an exit strategy for private equity and venture capital investors. We also are encouraged by the Act’s generous new “Regulation A+” exemption provided in Title IV, which could turn out to be the Act’s sleeper provision. This new exemption will permit an issuer to offer and sell up to $50 million in unrestricted securities within a 12-month period and also permits an issuer to “test the waters” for the offering prior to filing any offering statement with the SEC. This flexibility, together with the potential for “covered securities” treatment under NSMIA, should generate interest from mid-market companies looking for new, more efficient, approaches to raising capital.
Although the language of the JOBS Act is highly detailed and technical, the ultimate success or failure of the Act to achieve its stated goal of generating significant economic growth depends in large part on the SEC’s implementing regulations, especially regarding crowdfunding and the new Regulation A+ exemption. We are hopeful that the SEC will strongly consider the fundamental goals of the JOBS Act in its rulemaking proposals in order to give the provisions an opportunity to succeed. We will be providing updates as rules are proposed and circumstances warrant.
This Alert has been prepared for general informational purposes only and is not intended as specific legal advice. No legal or business decision should be based solely on its content.