Congress Passes JOBS Act: Reducing the Burden for Capital Raising Activities for Smaller Companies
On March 27, 2012, the U.S. House of Representatives passed an amended version of H.R. 3606, or the Jumpstart Our Business Startups (JOBS) Act.[1] The JOBS Act is being characterized favorably by both the White House and Republican Congressional leadership as a measure designed to facilitate capital raising by reducing regulatory burdens. In particular, the legislation creates a separate class of issuers under the Securities Act and the Exchange Act called "emerging growth companies." Those companies will be exempt from some of the more onerous accounting and disclosure requirements currently applicable to all public companies.
The JOBS Act had been previously approved by the U.S. Senate and has been sent to the White House, where it is expected to be signed by the President.
Highlights of the JOBS Act
Initial Public Offerings/Emerging Growth Companies. The JOBS Act alleviates some of the burdens of the IPO process and being a public company for "emerging growth companies" by amending the Securities Act, the Exchange Act, and the Sarbanes-Oxley Act to provide for reduced reporting requirements (i) in IPO registration statements and (ii) for a period of up to five years after an emerging growth company's IPO. "Emerging growth companies" are generally defined as issuers with annual gross revenues of less than $1 billion and a public float of less than $700 million.[2]
Emerging growth companies will be:
- Exempt from auditor attestation of internal control assessments under Sarbanes-Oxley Section 404(b);
- Able to file an IPO registration statement with the SEC on a confidential basis, provided that the registration statement is filed publicly within 21 days of the commencement of the road show;
- Able to communicate with accredited investors and qualified institutional buyers in advance of potential IPOs, as well as follow-on and secondary public offerings;
- Able to involve research analysts more freely in the IPO process by permitting research to be published during the period immediately following the IPO; and
- Exempt from certain compensation disclosure requirements, as well as Dodd-Frank Act "say-on-pay" voting.
Furthermore, emerging growth companies will be subject to relaxed financial disclosure, accounting, and auditing requirements, including:
- The disclosure of only two years of audited financial statements (rather than three years);
- No mandatory disclosure of selected financial data for periods prior to those periods presented in its financial statements;
- A grace period with respect to certain new or revised financial standards; and
- An exemption from Public Company Accounting Oversight Board rules adopted after the date of enactment of the JOBS Act.
Because the emerging growth company provisions of the legislation are subject to a December 8, 2011 effective date, qualifying companies that have gone public after December 8, 2011 will be eligible for this special status.
Observations. These amendments are clearly intended to help smaller companies access the U.S. capital markets and are expected to significantly reduce the costs of emerging growth companies going public and complying with public company rules and regulations. This, together with the ability to file a registration statement on a confidential basis and the relaxation of "gun jumping" rules by enhancing flexibility in communicating with potential investors prior to an IPO, will encourage smaller companies to "test the waters" without disclosing confidential information or suffering adverse publicity should their IPOs be cancelled or delayed. Accordingly, the JOBS Act will likely encourage emerging growth companies to go public sooner in order to take advantage of the other benefits of being a public company, such as investor and employee liquidity, the availability of a liquid currency for acquisitions, and favorable publicity.
Impact on Private Placements. The JOBS Act requires the SEC to revise Regulation D to remove the prohibition against general solicitation and advertising in offers and sales of securities conducted under Rule 506, provided that the ultimate purchasers of securities qualify as "accredited investors" under the SEC's current definition. The legislation also requires the SEC to make comparable changes to Rule 144A to permit solicitation of nonqualified institutional buyers, provided that only qualified institutional buyers purchase the offered securities.
The JOBS Act requires the SEC to adopt implementing rules on these changes to Regulation D within 90 days.
Observations. These changes represent a major shift in the private placement process and provide issuers and placement agents with additional tools to raise capital without the burden and expense of filing a registration statement. These changes permit persons engaging in unregistered transactions to enjoy many of the same benefits of public offerings, but avoid the time constraints of SEC review and the burden of SEC registration.[3]
Among the topics that the SEC must address in its rulemaking is what steps an issuer must take to verify "accredited investor" status.[4]
Registration Threshold. The legislation also raises the threshold for registration under the Exchange Act. The JOBS Act amends Section 12(g) of the Exchange Act to increase the limit on shareholders of record from 500 to 2,000 or, in the alternative, 500 persons who are not (i) "accredited investors," (ii) employees of the issuer who received shares pursuant to an employee compensation plan, or (iii) investors who received shares under the "crowdfunding"[5] exemption of the JOBS Act.[6]
Observations. The number of shareholders of record of an issuer's equity securities often differs markedly from the number of beneficial owners. These revisions do not change the rules relating to DTC or shares held by private equity funds or "special purpose vehicles." As a result, the beneficial owners who hold their shares through DTC or these other entities will continue to not be counted for purposes of this revised threshold. This change will also allow certain issuers the flexibility to stay private longer, while increasing their shareholder base, without triggering public reporting obligations that may result in further development of private secondary markets. Finally, for private investment funds that rely on Section 3(c)(7) of the Investment Company Act, the increase in the shareholder threshold will provide them with the flexibility to add investors up to the new limit without registering under the Exchange Act.
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[2] An issuer may qualify as an emerging growth company until the last day of the fiscal year following the fifth anniversary of its IPO, but it would lose its status before the end of this period in the event its annual gross revenues equaled or exceeded $1 billion, it issued more than $1 billion of nonconvertible debt in a three-year period, or it became a "large accelerated filer" under SEC rules. Under SEC rules, a "large accelerated filer" is defined as an issuer that: (i) has at least $700 million in voting and nonvoting stock held by nonaffiliates as of the last day of its second fiscal quarter (analyzed at the end of such fiscal year); (ii) has been subject to the Exchange Act for at least 12 calendar months; and (iii) has filed at least one 10-K.
[3] The JOBS Act also amends Section 3(b) of the Securities Act to require the SEC to establish an exemption for securities that are offered and sold in a 12-month period with an aggregate offering price not to exceed $50 million. This exemption contains conditions, including the requirement that covered issuers file audited financial statements annually with the SEC, and provides that the civil liability provisions of the Securities Act are applicable to offers and sales of these securities.
[4] In order to comply with Sections 3(c)(1) or 3(c)(7) under the Investment Company Act, private funds (e.g., private equity, venture capital, real estate, and hedge funds) need to conduct their securities offerings in a manner that does not constitute a public offering. The JOBS Act addresses this issue by providing that an offering conducted under revised Rule 506 of Regulation D would also not be viewed as a public offering for purposes of the federal securities laws, including the Investment Company Act.
[5] The JOBS Act's "crowdfunding" provisions would also exempt from registration small capital raising transactions—up to an aggregate amount of $1 million per year—with individual investors. The aggregate amount sold to each individual investor under this exemption is limited to a maximum amount based on the investor's income or net worth, and issuers engaged in eligible transactions must satisfy basic informational and SEC filing requirements, among other conditions.
[6] The JOBS Act also provides for increased thresholds for banks and bank holding companies.
