On April 5th of this year, President Obama signed the JOBS Act. The act, technically called the "Jumpstart Our Business Startups Act," is focused specifically on smaller companies and is intended to ease some of the regulatory burdens imposed by the securities laws on the ability of such companies to raise capital. This article will discuss briefly the background of the JOBS Act and provide an overview of its principal provisions.
The principal changes effected by the JOBS Act are:
- the designation of companies with less than $1 billion in total annual gross revenues as "emerging growth companies"; such companies are provided with certain accommodations relating to their initial public offering (IPO) of equity securities and subsequent reporting obligations;
- the elimination of restrictions on general solicitation and advertising in connection with Rule 506 and Rule 144A offerings under the Securities Act of 1933 (Securities Act);
- the establishment of an offering exemption for "crowdfunding" by non-reporting U.S. companies;
- the expansion of the scope of offerings under Section 3(b) of the Securities Act; and
- amendments to the thresholds requiring Section 12(g) registration and reporting under the Securities Exchange Act of 1934 (Exchange Act).
Many smaller companies have expressed concerns about the cost and regulatory burdens associated with raising capital. In the case of smaller public companies, these burdens have increased in recent years as the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 have expanded the disclosure obligations and liabilities applicable to public companies. The SEC has, for many years, sought input as to appropriate means to encourage small company capital formation while also assuring investor protection. Pursuant to congressional mandate, since 1982, the SEC has hosted an annual Government-Business Forum on Small Business Capital Formation, coordinated by the SEC's Office of Small Business Policy. (See the reports of each Forum since 1993.) In 2005, the SEC created an Advisory Committee on Smaller Public Companies, which issued a final report in 2006 setting forth 33 recommendations, including the elimination of general solicitation and general advertising constraints on private placements. In September 2011, as mandated by the Dodd-Frank Act, the SEC created an Advisory Committee on Small and Emerging Companies, whose work continues.
Despite these efforts, and a number of rule changes adopted by the SEC, many companies and investor groups were concerned that the SEC was not acting quickly enough to remove the regulatory burdens on small businesses. Another worrisome trend was the significant drop-off in smaller IPOs during the past decade. This concern was highlighted by a report issued in October 2011 by the IPO Task Force, a group created by the Department of the Treasury, entitled Rebuilding the IPO On-Ramp--Putting Emerging Companies and the Job Market Back on the Road to Growth.
In a very lively exchange of correspondence last year between Congressman Daniel Issa, Chairman of the House Committee on Oversight and Government Reform, and SEC Chairman Mary Schapiro, Chairman Issa posed questions to the SEC regarding a broad range of factors that appeared to inhibit small company capital formation and that may have led to the decline of the smaller company IPO market. (See Chairman Issa's March 22, 2011, letter; Chairman Schapiro's April 6, 2011, response; Chairman Issa's April 29, 2011, letter posing additional requests; and Chairman Schapiro's further response.)
The legislative impetus for the JOBS Act began in 2011 as a bipartisan effort to increase the ability of small businesses to raise capital. The bill introduced to the House (then called the Reopening American Capital Markets to Emerging Growth Companies Act of 2011) was limited to benefits for emerging growth companies, but was later expanded to cover a number of other matters. The legislation that ultimately resulted from these efforts was supported by many in the technology and venture capital communities, including Google and the National Venture Capital Association, and many entrepreneurs, and was passed by Congress as the JOBS Act at the end of March. In his signing statement, President Obama characterized the bill as follows:
Here's what's going to happen because of this bill. For business owners who want to take their companies to the next level, this bill will make it easier for you to go public. And that's a big deal because going public is a major step towards expanding and hiring more workers. It's a big deal for investors as well, because public companies operate with greater oversight and greater transparency.
And for start-ups and small businesses, this bill is a potential game changer. Right now, you can only turn to a limited group of investors--including banks and wealthy individuals--to get funding. Laws that are nearly eight decades old make it impossible for others to invest. But a lot has changed in 80 years, and it's time our laws did as well. Because of this bill, start-ups and small business will now have access to a big, new pool of potential investors--namely, the American people. For the first time, ordinary Americans will be able to go online and invest in entrepreneurs that they believe in.
Although it received widespread support from the business community, the JOBS Act was not without its critics, who questioned the relaxation of important investor protections. In a letter to Congress dated March 13, 2012 (prior to final approval by Congress), SEC Chairman Schapiro expressed concern that a number of provisions should be added or modified to improve investor protections, and also noted that the rulemaking time limits imposed on the SEC in the legislation were not achievable. Further, a number of securities regulators and investor advocacy groups expressed concerns about the potential for fraud and investor exploitation that could result from the relaxed regulatory requirements. Some of these concerns, including some concerns about crowdfunding, were reflected in the final version of the JOBS Act. One of the harshest critics, former New York Governor Elliot Spitzer (referring to the provisions of the JOBS Act that removed certain restrictions on research at the time of public offerings) said, "It is a bad sequel to a bad movie. It shouldn't be called the JOBS Act. It should be called the 'Bring Fraud Back to Wall Street Act.'"
Time will tell whether the JOBS Act achieves its objective of expanding capital-raising opportunities for smaller companies without compromising important investor protections. Although many of the JOBS Act provisions are prescriptive, the SEC is charged with significant rulemaking obligations, and the SEC's ability to implement these provisions while preserving investor protections may well determine how the JOBS Act will be assessed a few years from now. In order to assist it with the rulemaking process, the SEC has (as it did in connection with the Dodd-Frank Act) invited public comments prior to the publication of its proposed rules. The comments submitted may influence the rules that the commission proposes. The opportunity to help shape not only the final rules but also the proposals can have a significant impact on the rules that are ultimately adopted. Particularly in view of the very abbreviated rulemaking deadlines, informed and helpful comments will assist the SEC to understand the implications of the proposed rulemaking, including an identification of unanticipated consequences that may result from the adoption of proposed rules.
Even though many of the JOBS Act provisions are not yet effective, the SEC has received many questions from the public relating to particular JOBS Act issues. In an effort to be responsive to these inquiries, the Division of Corporation Finance has created a web page setting forth its guidance on these matters. Among other things, the staff of the division has issued a number of " frequently asked questions" regarding JOBS Act provisions.
The JOBS Act--Principal Provisions
Although the other articles in this issue will address the provisions of the JOBS Act in more detail, it may be helpful here to review some of the major JOBS Act provisions. The following are summaries of major provisions rather than detailed descriptions.
Title I--Emerging Growth Companies
Effective upon enactment on April 5th, the JOBS Act creates a new category of company, an "emerging growth company," that is eligible for certain accommodations in connection with its IPO of equity and its subsequent Exchange Act reporting. This has been characterized as creating a transitional "IPO on-ramp" for such companies. An emerging growth company (or EGC) means an issuer that has total annual gross revenues of less than $1 billion. Once within the EGC category, an EGC remains so until the earliest of:
- the last day of its fiscal year during which it had total annual gross revenues of $1 billion or more;
- the last day of its fiscal year following the fifth anniversary of the date of its first sale of its common equity securities pursuant to an effective Securities Act registration statement;
- the date on which it has, during the previous 3-year period, issued more than $1 billion of nonconvertible debt; or
- the date it becomes a "large accelerated filer" (generally requiring one year of Exchange Act reporting history and an aggregate worldwide market value of its voting and non-voting common equity held by its non-affiliates of $700 million or more).
EGCs are entitled to a number of accommodations:
- an EGC can submit a draft equity IPO registration statement to the staff of the SEC for a confidential nonpublic review, provided that it will be required to file the draft registration statement and all amendments with the SEC not later than 21 days before the EGC's road show.
- an EGC can "test the waters" for a proposed public offering before and after filing a registration statement, provided that the "test the waters" communications are made only to QIBs and institutional accredited investors;
- an EGC only needs to present two years of audited financial statements and management's discussion and analysis (MD&A) in a Securities Act registration statement in connection with an IPO of its common equity and, in a Securities Act registration statement and Exchange Act reports, needs to present selected financial data only as far back as the earliest audit period presented;
- an EGC can elect not to comply with any new or revised financial accounting standard that has a different effective date for public and non-public companies until the date that non-public companies are required to comply;
- an EGC may comply with the executive compensation disclosure requirements applicable to smaller reporting companies, and need not prepare a compensation discussion and analysis; in addition, such companies are not required to seek "say on pay" or "say on parachute" votes from shareholders;
- an EGC need not provide auditor attestations to internal control reports, or comply with any PCAOB rule requiring mandatory audit firm rotation or any supplement to an auditor's report to provide additional information regarding the audit and the financial statements (auditor discussion and analysis);
- an EGC need not obtain an audit report on its internal control over financial reporting; and
- the SEC's rules with respect to the preparation, publication, or distribution of research reports regarding an EGC that is the subject of a proposed public offering of its common equity are relaxed, even if the broker or dealer is participating in the offering, and certain restrictions with respect to security analyst communications and post-offering communications are relaxed.
It should be noted that EGCs may, if they so elect, opt to comply with the requirements applicable to companies that are not EGCs.
In addition to the above provisions, Title I requires the SEC to conduct a study with respect to the impact the trading and quoting of securities in penny increments (decimalization) has had on IPOs and on the liquidity for small and middle capitalization company securities, and to report its results to Congress on or before July 4, 2012 (90 days after enactment). The SEC is also required to conduct a review of Regulation S-K to determine how the regulation can be updated to modernize and simplify the registration process and reduce the costs and other burdens associated with those requirements for EGCs. The SEC is required to submit its report to Congress, setting forth specific recommendations, by October 2, 2012 (180 days after enactment).
Title II--Elimination of General Solicitation and General Advertising Restrictions
The JOBS Act requires the SEC, on or before July 4, 2012, to revise Rule 506 and Rule 144A under the Securities Act to provide that the prohibition against general solicitation and general advertising does not apply to Rule 506 offerings, provided that all purchasers are accredited investors, or to Rule 144A offerings, provided that securities are only sold to persons the seller (and any person acting on behalf of the seller) reasonably believes is a qualified institutional buyer (QIB). The SEC is also required to adopt rules that require the issuer to take reasonable steps to verify that the purchasers of securities in Rule 506 offerings are accredited investors, using such methods as the SEC shall determine. (Note that the current definition of "accredited investor" in Rule 501 means any person who comes within any of the categories set forth in the definition, or who the issuer reasonably believe comes within any of such categories, at the time of the sale.) Title II also provides an exemption from broker or dealer registration with respect to securities offered and sold pursuant to Rule 506 if all the person does is maintain a platform or mechanism for offering, selling, purchasing, or negotiating securities or that permits general solicitation or general advertising, subject to certain conditions with respect to the activities of such person. The provisions of Title II will not become effective until the SEC completes its required rulemaking.
Crowdfunding is the raising of capital, which may involve the use of the Internet, from a large number of investors whose individual investments are limited. Title III of the JOBS Act will, following adoption of implementing rules by the SEC, permit crowdfunding by U.S.-organized issuers, subject to a number of conditions. Among other things:
- the aggregate amount sold to all investors by the issuer, including amounts sold by the issuer pursuant to crowdfunding during the 12-month period preceding the transaction, may not exceed $1 million;
- the aggregate amount sold to any single investor by the issuer, including amounts sold by the issuer pursuant to crowdfunding during the 12-month period preceding the transaction, may not exceed:
- the greater of $2,000 or 5 percent of the annual income or net worth of the investor, if either the annual income or net worth of the investor is less than $100,000; and
- 10 percent of the annual income or net worth of the investor, not to exceed a maximum aggregate of $100,000, if either the annual income or net worth of the investor is equal to or more than $100,000;
- the transaction must be conducted through an intermediary (a broker or a "funding portal"); and
- the issuer is required to:
- comply with certain disclosure and SEC filing obligations;
- comply with certain limitations on advertising the terms of the offering;
- comply with certain limitations on compensating promoters;
- file a report on the issuer's results of operations and a financial statement not less than annually with the SEC and disclose such information to investors; and
- comply with any other requirements the SEC may prescribe.
- Title III provides for a private right of action by an investor against an issuer for negligent misrepresentation (Section 12(a)(2) of the Securities Act);
- the securities purchased in a crowdfunding transaction are subject to a one-year restriction on resales, subject to certain exceptions;
- the SEC is required to adopt rules to disqualify issuers from offering securities in crowdfunding transactions, and brokers and funding portals from effecting or participating in crowdfunding transactions, if they have been subject to certain securities-related or regulatory sanctions; and
- the crowdfunding exemption pre-empts state securities law registration requirements, but specifically preserves state enforcement authority.
Although concerns have been expressed as to whether the crowdfunding provisions provide adequate investor protections, in a letter to the president referred to in a White House release relating to the JOBS Act, a consortium of crowdfunding companies committed to appropriate regulation of the industry, including an industry standard "Investors' Bill of Rights."
Title IV--Securities Act Section 3(b) Amendments
The JOBS Act expands the scope of the exemptions from registration under Section 3(b) of the Securities Act, permitting the SEC to exempt up to $50 million of securities offered and sold within a 12-month period in reliance on the new exemption. This increase responded to criticisms regarding the limitations of current Regulation A and Rule 504, which have not been widely used. Under the new provision, among other things:
- the securities eligible for the new exemption are limited to equity, debt, debt convertible or exchangeable into equity, and guarantees of such securities;
- the securities may be offered and sold publicly, and are not deemd to be "restricted securities";
- any person offering or selling the securities is subject to civil liability under Section 12(a)(2) of the Securities Act;
- the issuer may "test the waters" by soliciting interest in the offering prior to filing any offering statement with the SEC;
- the issuer will be required to file audited financial statements with the SEC annually, and will be subject to such periodic disclosure obligations as the SEC may determine;
- the SEC is authorized to adopt other terms, conditions, or requirements, including offering statement preparation, filing, and distribution requirements; in addition, the SEC may provide disqualification provisions for persons subject to certain securities-related or regulatory sanctions; and
- the securities will be treated as covered securities, thereby pre-empting state securities registration requirements if they are offered and sold on a national securities exchange or offered or sold to a "qualified purchaser" (as yet to be defined by the SEC pursuant to Section 18 of the Securities Act).
The implementation of the statutory amendments under Title IV is subject to SEC rulemaking.
Titles V and VI-- Exchange Act Section 12(g) Triggers
Prior to the JOBS Act, a company that had, at the end of a fiscal year, over $10 million in assets and a class of equity securities (other than exempted securities) held of record by 500 or more persons was required to register the class of securities under the Exchange Act. As a result of Section 12(g) registration, a company becomes subject to SEC reporting obligations. For a number of companies, this reporting trigger became problematic, and risked forcing them into public company status prior to the time they otherwise would have wanted to become subject to the burdens of public company compliance. The JOBS Act has now amended these triggers. Section 12(g) now provides that an issuer is not required to register under Section 12(g) until, at the end of a fiscal year, it has over $10 million in assets and a class of equity securities (other than exempted securities) held of record by either:
- 2,000 persons; or
- 500 persons who are not accredited investors (as defined by the SEC).
Importantly, Section 502 of the JOBS Act provides that, for the purpose of determining whether an issuer is required to register a class of equity security under Section 12(g), the definition of "held of record" does not include securities held by persons who received the securities pursuant to an employee compensation plan in transactions exempt from the registration requirements of the Securities Act (such as pursuant to Rule 701). Although the amendments to Section 12(g) became effective upon enactment of the act, SEC rulemaking will be necessary to determine how some of the changes will be implemented. Further, the JOBS Act provides for the SEC to exempt from Section 12(g), either conditionally or unconditionally, securities acquired pursuant to a crowdfunding offering.
With respect to banks and bank holding companies, the applicable threshold has now been increased to 2,000 holders of record, without a further test based on the number of persons who are not accredited investors. Although the JOBS Act did not change the standards for deregistration under Section 12(g) or Section 15(d) of the Exchange Act for non-bank companies, it amended the provisions applicable to banks and bank holding companies to permit deregistration and a termination of Exchange Act reporting if the number of holders of record of a class of securities is reduced to under 1,200.
Also, in addition to requiring SEC to amend the definition of "held of record" to reflect the exclusion of securities held by employees in exempt offerings pursuant to employee compensation plans as described above, the SEC is required to adopt safe harbor provisions that issuers can follow when determining whether holders of their securities fall into this exclusion. Finally, the SEC is required to examine its authority to enforce the "holder of record" provision in Exchange Act Rule 12g5-1 to determine if new enforcement tools are needed to enforce the anti-evasion provision contained in the rule, and to report to Congress by August 3, 2012 (120 days after enactment).
The SEC is currently engaged in the significant rulemaking and studies required by the JOBS Act, with the first rulemaking (under Title II of the JOBS Act), and the first study (the decimalization study under Title I) required by July 4, 2012. As with all legislation intended to achieve a specific purpose, most securities practitioners' eyes are keenly focused on the implementation of the statutory provisions by the SEC, and on whether the desired objectives will be achieved.