JOBS Act Liberalizes Securities Regulations for "Emerging Growth Companies" and Certain Private Offerings

Business Services Client Alert 
Spring 2012

On April 5, 2012, the President signed into law the Jumpstart Our Business Startups Act (JOBS Act). Once its various provisions become effective and the SEC promulgates the necessary rules, several key features of the federal U.S. securities law regime will be significantly relaxed for smaller companies that are considering IPOs and companies raising capital through private offerings.

"Emerging Growth Companies"

One of the stated aims of the JOBs Act is to encourage growing companies to access the domestic IPO market. This goal is furthered through amendments of the Securities Act of 1933 (“Securities Act”) and the Securities Exchange Act of 1934 (“Exchange Act”) that both relax the IPO process and significantly ease the post-IPO compliance burdens of smaller companies referred to as “emerging growth companies.” These “IPO on-ramp” or “IPO accelerator” measures will be effective immediately when the JOBS Act is signed into law and are not dependent upon SEC rulemaking delays.

New category of “emerging growth company.” The term “emerging growth company” includes companies with less than $1 billion of annual gross revenues during the most recently completed fiscal year with a built in index for inflation. (Commentators have pointed out that this definition effectively covers the vast majority of all companies that have recently conducted IPOs.) A company remains an emerging growth company from the time of its IPO until:

  • the end of the fiscal year in which its annual gross revenues exceeds $1 billion;
  • the date on which it has issued more than $1 billion in non-convertible debt during the previous three-year period;
  • the date on which it becomes a “large accelerated filer” (generally a company with at least $700 million in public equity float and at least a one year SEC reporting history); or
  • the end of the fiscal year following the fifth anniversary of its IPO.

Easing of IPO requirements. The JOBS Act eases the requirements for emerging growth companies to conduct an IPO by allowing them to:

  • include only two, rather than three, years of audited financial statements in a registration statement;
  • limit the “selected financial information” and “management discussion and analysis” disclosures in an IPO registration statement and subsequent filings (previously five years worth of information) to the earliest audited period presented in its IPO registration statement;
  • communicate with potential investors that are qualified institutional buyers (QIBs) or institutions that are accredited investors to solicit interest in a contemplated securities offering (orally or in writing), either before or after the filing of a registration statement; and
  • submit the initial draft of the IPO registration statement and related amendments to the SEC for confidential review, so long as these submissions are publicly filed at least 21 days prior to the road show.

Other provisions will ease the regulatory burdens on broker/dealers during the IPO process.

Reduced post-IPO regulatory burden. Following the IPO, emerging growth companies will have the benefit of lower compliance standards for as long as they meet the definition of an “emerging growth company.” Following are some of the less-stringent continuing disclosure standards applicable to emerging growth companies:

  • not required to obtain auditor attestation report on internal control over financial reporting as required by Section 404(b) of the Sarbanes-Oxley Act of 2002 and related SEC rules;
  • not required to comply with new financial accounting standards until the same time that private companies are subject to the new standard;
  • not required to comply with any PCAOB rules requiring mandatory audit firm rotation or a supplement to the auditor’s report where the auditor provides additional information about the audit and the financial statements;
  • not required to comply with any new PCAOB rules adopted after the JOBS Act’s enactment date unless the SEC specifically requires compliance;
  • exempt from executive compensation disclosures and limitations applicable to other reporting companies (such as “say-on-pay votes,” golden parachute disclosures, pay versus performance and ratio of CEO pay to median employee pay disclosures; and less stringent executive compensation disclosures based on “smaller reporting company” standards).

Note that these rules will not change the regulatory requirements for companies that went public before December 2011, regardless of whether they would satisfy the definition of an emerging growth company.

Private Offering Reforms

Allowance of General Advertising in Rule 506 and Rule 144A Offerings. The JOBS Act makes sweeping changes to one of the most common federal private offering exemptions used by small companies in the United States – Rule 506 of Regulation D. The JOBS Act requires that the SEC amend its rules within 90 days to allow general solicitation and general advertising in connection with private securities offerings pursuant to Rule 506 if all of the purchasers are accredited investors and the company takes reasonable steps to verify the purchaser’s accredited investor status (using methods to be determined by the SEC).

In addition, online and other platforms that permit the offer or sale of securities, general solicitations or general advertisements for Rule 506 offerings will be exempt from broker/dealer registration requirements under the Exchange Act so long as certain conditions are met.

Similar revisions will be made to the limitations of Rule 144A, by which large issuers annually raise billions of dollars of capital from large institutional investors.

Crowdfunding Exemption. The JOBS Act creates an entirely new way for private companies to raise capital without registration under federal or state securities laws - crowdfunding (i.e., raising capital from a large group of investors who individually make small investments, usually via a “crowdfunding” website). The new crowdfunding offering exemption will be subject to rules to be adopted by the SEC, which will include several significant limitations designed to protect investors:

  • $1 million limit on the aggregate amount of all securities sold to investors in reliance on the crowdfunding exemption during any 12-month period;
  • strict limits on the aggregate amount sold to any investor in reliance on the crowdfunding exemption during any 12-month period;
  • the securities are sold through a broker or funding portal that complies with certain requirements, including registering with the SEC as a broker or funding portal and registering with any applicable self-regulatory organization; and
  • numerous other requirements to be imposed by the SEC, including (1) disclosing to the SEC, potential investors, and the funding portal information that includes the company’s anticipated business plan, financial condition, financial statements and ownership and capital structure, (2) a prohibition on advertising the terms of the offering except for notices that direct investors to the broker or funding portal and (3) filing with the SEC and providing to investors at least annually reports of the company’s results of operations and financial statements as determined by SEC rule making.

Crowdfunding offerings would not be available to companies that are already public, foreign companies, registered investment companies, certain exempt investment companies, and other companies determined by the SEC. Issuers and promoters would still be subject to liability for material misstatements and omissions. Securities sold pursuant to the crowdfunding exemption would be “restricted” and thus not available for re-sale by the investor, except in certain limited cases (redemption by the issuer, sales to accredited investors or registered offerings).

In addition, while crowdfunding offerings would be exempt from state registration requirements, state enforcement agencies would have the authority take enforcement action against in the case of fraud, deceit or other unlawful conduct.

Regulation A Offering Reform. The SEC must adopt rules to expand the Regulation A limited offering exemption by increasing the aggregate offering amount permitted over a 12-month period from $5 million to $50 million. Unlike the crowdfunding exemption, offerings pursuant to the expanded Regulation A exemption would be subject to registration under state securities laws unless the securities are (1) offered or sold on a national securities exchange or (2) offered or sold to qualified purchasers.

Increase in Number of Shareholders Triggering Exchange Act Registration

Companies other than banks or bank holding companies. For companies other than banks or bank holding companies, the number of shareholders of record triggering registration and reporting under the Exchange Act increases from 500 to 2,000 shareholders, subject to the limitation that there may be no more than 500 shareholders of record that are not accredited investors.

Banks and bank holding companies. For banks and bank holding companies, the trigger for Exchange Act registration and reporting increases from 500 to 2,000 shareholders. It does not matter how many of these shareholders are accredited or unaccredited. In addition, the threshold for “going dark” (terminating public company disclosures) for banks and bank holding companies would increase from 300 to 1,200 shareholders of record.

Exclusions from Shareholder Calculation. The SEC is required to adopt rules to provide that shareholder of record calculations referred to above would exclude employees that received company securities pursuant to an employee compensation plan in a transaction exempt from the Securities Act’s registration requirements (e.g., offerings exempt under Rule 701) and purchasers of securities pursuant to the crowdfunding exemption.

Effect of JOBS Act

While not a sweeping reform of federal securities laws, the JOBS Act contains a number of significant provisions that may result in meaningful changes for certain issuers. For example, the changes to private offerings through Rule 506, Rule 144A and Regulation A are possibly significant. The reform of the general solicitation restrictions in Rule 506 and Rule 144A offerings will make a real and lasting difference in the ability of businesses to access the capital markets through these exemptions. On the other hand, the reform of the Regulation A process may not do much to encourage companies to raise more capital through this “quasi-public offering” exemption. The requirements to file financial statements and some amount of period disclosure seem likely to limit its attractiveness to businesses.

The effect of the JOBs Act in increasing domestic IPOs is likely to be mixed. The relaxation of the IPO process and deferral of some of the more expensive post-IPO governance requirements for emerging growth companies may incentivize more companies to conduct an IPO. However, by raising the triggering requirement for a company to register its shares to 2,000 shareholders, the act allows many companies to delay the IPO decision. The JOBS Act also does nothing to address risk of litigation in shareholder strike suits, which is a primary concern of many business executives.

The new crowdfunding exemption is certainly novel, but may turn out to be of little value to small issuers because of its filing requirements and possibility of more “investor protection” requirements through SEC rule making.

Rule making Timeline

The rule making timeline is aggressive, with most of the rule making activities mandated to be complete within one year. However, the SEC is already having difficulty meeting the Dodd-Frank rule making requirements, so it remains to be seen if they keep up with the schedule in the JOBS Act.