Jumpstart Our Business Startups (JOBS) Act Changes the Public and Private Capital Markets Landscape

March 28, 2012

On March 27, 2012, the House passed the Jumpstart Our Business Startups Act ("JOBS Act"), as amended and passed by the Senate on March 22.  It is widely anticipated that President Obama will quickly sign the JOBS Act into law.

We believe the JOBS Act is the most significant modernization of the federal securities laws since the Securities and Exchange Commission’s 2005 Securities Offering Reform.  The JOBS Act substantially changes a number of laws and regulations in a way that is expected to make it easier for companies to go public and facilitate the public offering process, while also making it easier for companies to raise capital privately and stay private longer.  In addition, the JOBS Act is expected to reduce the cost and burden on newly public companies during their first few years as public companies.   

Executive Summary 

Below we summarize some of the most significant provisions of the JOBS Act.  Following this Executive Summary is a more detailed discussion of these and other provisions of the JOBS Act.

Facilitating IPOs and Relaxing Public Reporting Requirements for Emerging Growth Companies

  • The JOBS Act creates a new category of issuer: the "emerging growth company" ("EGC").  An EGC is a company with less than $1 billion in gross revenues during its most recently completed fiscal year (other than any such company that first sold common equity securities in a transaction registered with the Securities and Exchange Commission ("Commission") on or before December 8, 2011).  EGC status terminates after five years, or sooner if annual gross revenues exceed $1 billion or certain other specified events occur.
  • EGCs will benefit from changes that reduce the cost and burden of going public and complying with public company obligations:
    • reduced financial disclosure requirements, including the presentation of only two years of audited financial statements in an IPO registration statement and limiting the selected financial data required in registration statements and reports filed with the Commission;
    • delayed adoption of new or revised financial accounting standards;
    • an exemption from the auditor attestation requirements under Section 404(b) of the Sarbanes-Oxley Act relating to internal control over financial reporting;
    • eligibility in many cases to provide scaled-back executive compensation disclosure, including disclosure covering fewer named executive officers for fewer years and relief from the obligation to provide a compensation discussion and analysis; and
    • exemptions from certain executive compensation requirements added by the Dodd-Frank Act, including certain disclosure obligations (such as "pay-ratio" disclosure) and say-on-pay, say-on-frequency and say-on-golden parachute votes.
  • In addition, the JOBS Act reduces many restrictions that apply to securities offerings by EGCs by:
    • permitting pre-filing oral or written communications with institutional "accredited investors" and "qualified institutional buyers" to permit an EGC and persons authorized to act on its behalf to "test the waters" in advance of an IPO or other contemplated securities offering by an EGC;
    • permitting publication and distribution of research reports by a broker or dealer (including participating underwriters) covering an EGC that is the subject of a proposed IPO or other public offering of common equity securities prior to or following filing of a registration statement, and eliminating timing restrictions on publishing research reports on an ECG after its IPO or prior to the expiration of lock-up agreements entered into in connection with its IPO;
    • providing exemptions from certain research analyst conflict of interest rules and undertakings generally applicable to IPOs, including restrictions on who within an investment banking firm may arrange for communications between a securities analyst and a potential investor and restrictions on securities analysts participating in communications with management of an EGC when investment banking personnel are present; and
    • providing for confidential submission of IPO draft registration statements to the Commission, provided that such draft registration statements and amendments thereto are publicly filed no later than 21 days before the date on which the issuer conducts a road show.

Elimination of Prohibitions on General Solicitation and General Advertising in Connection with Rule 506 and Rule 144A Offerings 

  • The JOBS Act requires the Commission, within 90 days after the date of enactment of the JOBS Act, to eliminate the prohibition against general solicitation and general advertising in Rule 506 and Rule 144A offerings, provided that, in the case of Rule 506 offerings, the securities are only purchased by accredited investors and the issuer has taken reasonable steps to verify that such purchasers are accredited investors and that, in the case of Rule 144A offerings, the securities are sold only to persons that the seller and any person acting on its behalf reasonably believe is a qualified institutional buyer.

Crowdfunding

  • The Jobs Act amends Section 4 of the Securities Act to create a new registration exemption for "crowdfunding" to raise up to $1 million over a 12-month period from small investments from a large pool of investors.
  • Individuals are limited, in their annual investments in securities issued in crowdfunding transactions, to (a) the greater of $2,000 or 5% of an investor’s annual income or net worth for investors with an annual income or net worth of less than $100,000 and (b) the lesser of $100,000 or 10% of an investor’s annual income or net worth for all other investors.
  • Crowdfunding transactions will require the use of an intermediary, either a registered broker or a person registered with the Commission as a "funding portal."
  • Issuers relying on the crowdfunding exemption will be subject to certain informational and other requirements, including an obligation to file financial statements with varying levels of review depending on offering size.
  • Investors in crowdfunding transactions will be excluded from the calculation of holders of record for purposes of Section 12(g). 

New Exemption from Registration Under Section 3(b) for Public Offerings up to $50 Million 

  • The JOBS Act amends Section 3(b) of the Securities Act (the "small issuer exemption") to require that the Commission adopt a new exemption from registration for offerings of up to $50,000,000.
  • The new exemption builds upon existing Regulation A, but expands the investor protection provisions for this larger offering exemption, including:
    • requiring audited financial statements;
    • providing for Section 12(a)(2) liability for material misstatements and omissions; and
    • giving authority to the Commission to require periodic post-offering disclosures analogous to Exchange Act reporting. 

Increased Shareholder Thresholds Under Section 12(g) for Public Company Reporting  

  •  The JOBS Act increases the "holders of record" threshold, at which a company must register a class of securities under the Exchange Act and file periodic reports with the Commission, from 500 persons to either (a) 2,000 persons, or (b) 500 persons who are not accredited investors.  The threshold for banks and bank holding companies is also increased to 2,000 persons.
  • For banks and bank holding companies, the "floor" below which an issuer may suspend filing periodic reports and terminate the registration of its securities, is increased from 300 persons to 1,200 persons.
  • Securities "held of record" will generally exclude securities issued pursuant to an employee compensation plan and securities issued in crowdfunding transactions.

Discussion

Facilitating IPOs and Relaxing Public Reporting Requirements for Emerging Growth Companies

Title I of the JOBS Act, entitled "Reopening American Capital Markets to Emerging Growth Companies," tracks many of the recommendations made by the IPO Task Force — a working group of venture capitalists, CEOs, public investors, securities lawyers, academics, and independent bankers — in its presentation to the U.S. Department of the Treasury.[1]  The statute creates a new category of issuer — the "emerging growth company" ("EGC") — generally, a company with less than $1 billion in annual gross revenues.[2]  In general, EGCs benefit from less extensive financial reporting obligations and less burdensome requirements for the audit of their financial statements, more limited executive compensation disclosure obligations that build on existing scaled disclosure rules, greater latitude with respect to pre-offering communications and research analyst coverage, and other measures designed to reduce the cost and burden of going public.[3]  Collectively, these provisions comprise what is commonly referred to as the "IPO on-ramp" for emerging growth companies.

A.   EGC Status

An emerging growth company is defined as an issuer that had less than $1 billion in gross revenues in its most recently completed fiscal year.  Issuers who have sold common equity securities pursuant to an effective registration statement under the Securities Act of 1933 (the "Securities Act") on or before December 8, 2011, however, are explicitly excluded from the definition of EGC.

Once an issuer is an EGC, it will retain that status until the earliest of:

  • the last day of its first fiscal year during which it had annual gross revenues of at least $1 billion;
  • the last day of the fiscal year following the fifth anniversary of the first sale of common equity securities pursuant to an effective registration statement under the Securities Act;
  • the date on which it has, during the previous 3-year period, issued more than $1 billion in non-convertible debt;[4] and
  • the date on which the issuer is deemed to be a large accelerated filer.[5]

B.   Benefits of Being an EGC

i.   Financial Reporting and Auditing Standards

An EGC must present only two years of audited financial statements and two years of selected financial data under Item 301 of Regulation S-K in a registration statement with respect to an IPO, instead of the customary three years for audited financial statements and five years for selected financial data.  In any other Securities Act registration statement, Exchange Act registration statement or periodic report under the Exchange Act, an EGC need not present selected financial data for any period prior to the earliest audited period presented in its effective registration statement filed in connection with its IPO.[6]  It is not yet clear, however, whether underwriters and issuers will be comfortable providing only two years of audited financial statements and selected financial data in all circumstances, whether for marketing or liability reasons.

In addition, EGC’s are permitted to comply with any new or revised financial accounting standard under U.S. GAAP (or IFRS, if applicable) on the same schedule that applies to private companies, if such standard applies to private companies.

Moreover, an emerging growth company is exempt from the requirement that its auditor attest to, and report on, management’s assessment of the effectiveness of the company’s internal control structure and procedures for financial reporting under Section 404(b) of the Sarbanes-Oxley Act.

Finally, the JOBS Act provides that, if the PCAOB adopts[7] rules mandating audit firm rotation or the presentation of an "auditor discussion and analysis,"[8] these rules will not apply to an audit of an EGC unless "the Commission determines that the application of such additional requirements is necessary or appropriate in the public interest, after considering the protection of investors and whether the action will promote efficiency, competition and capital formation." 

ii.   Executive Compensation Disclosure and Corporate Governance Requirements

In general, an EGC may choose to comply with the scaled executive compensation disclosure requirements under Item 402(m)-(r) of Regulation S-K that apply to smaller reporting companies, rather than the more exhaustive requirements under Item 402(a)-(k) and (s), whether or not the EGC otherwise qualifies as a smaller reporting company under Item 10(f) of Regulation S-K.[9]  Under this treatment, an EGC may provide executive compensation information for three (instead of five) named executive officers, may present two (rather than three) years of compensation data in the Summary Compensation Table and, perhaps most notably, need not present a compensation discussion and analysis section.  An existing issuer that is an EGC but which currently does not qualify as a smaller reporting company, however, will not be permitted to avail itself of the scaled executive compensation disclosure pursuant to the JOBS Act.[10] EGCs also are exempt from certain new disclosure requirements under the Dodd-Frank Act, including the "pay-versus-performance" disclosure under Section 14(i) of the Exchange Act and the "pay-ratio" disclosure required under Section 953(b)(1)(C) of Dodd-Frank.  Neither of these Dodd-Frank disclosure requirements is currently required of issuers, as the Commission has yet to propose and adopt implementing rules.  When the Commission does adopt implementing rules, however, the statute should operate immediately to exempt EGCs from those disclosure obligations.

In addition to reduced disclosure requirements, EGCs are exempt from the new say-on-pay, say-on-frequency and say-on-golden parachute votes required under Section 14A of the Exchange Act implemented under Dodd-Frank.  After a company ceases to be an EGC, the first say-on-pay vote will be required not later than (a) the end of the one-year period beginning on the date it ceases to be an EGC, or (b) in the case of an issuer that was an EGC for less than 2 years following the first registered sale of equity securities, the end of the three-year period beginning on the date it ceases to be an EGC.  Note that no Commission rulemaking is necessary to implement this change, so it should be effective immediately.

iii.   IPO Procedural Changes

a.   Pre-and Post-filing Communications Permitting EGCs  to "Test the Waters"

In general, Section 5 of the Securities Act prohibits sales, deliveries, and offers of securities prior to filing a registration statement with respect to such securities.  In a significant shift, the JOBS Act amends Section 5, with immediate effect, to explicitly permit EGCs or persons acting on their behalf to communicate orally or in writing with qualified institutional buyers ("QIBs"), as defined under Rule 144A under the Securities Act, or institutions that are accredited investors, as defined under Rule 501 under the Securities Act, prior to or following the filing of a registration statement.  These oral or written communications may be undertaken  "to determine whether such investors might have an interest in the contemplated securities offering."[11]  In the absence of this amendment, such communications would constitute impermissible offers to sell or solicitations of offers to buy securities under Section 5(c).  This is a very significant change that should greatly facilitate the ability of EGCs and their underwriters to "test the waters" to gauge potential investor interest in advance of a public offering.  In keeping with current law, deliveries of securities after sale would need to be accompanied or preceded by a final prospectus.  

b.   Publication and Distribution of Research Reports By Participating Underwriters

In another very significant change, the JOBS Act immediately amends Section 2(a)(3) of the Securities Act to provide explicitly that the publication or distribution by a broker or dealer of a research report about an EGC that proposes to conduct a public offering of its common equity securities pursuant to a Securities Act registration statement, either through an IPO or a follow-on equity offering, does not constitute an offer to sell a security, and therefore will not constitute an illegal prospectus or an impermissible pre-filing offer, even if the broker or dealer is participating or will participate in the registered offering of the securities of the issuer.[12] While Rule 139 under the Securities Act has allowed underwriters to continue to publish research with respect to seasoned issuers during a public offering provided that the conditions of Rule 139 are satisfied, the ability of a broker or dealer to publish research in connection with an IPO that it is underwriting for an EGC represents a dramatic departure from what has previously been permitted. 

c.   Securities Analyst Conflicts Rules

Enacted in 2002, Section 15D of the Exchange Act required the Commission, and, upon authorization and direction of the Commission, all registered securities associations (currently only FINRA) and national securities exchanges to adopt rules designed to address conflicts of interest that can arise when securities analysts recommend equity securities.  The conflict of interest rules regulate, among other things, publication clearance and approval of reports by employees of brokers and dealers who are engaged in investment banking or other activities, supervision and compensation of securities analysts, protection of whistleblowers, structural and institutional separation between investment bankers and research analysts within the same firm, periods during which brokers and dealers who participate in offerings may not publish reports, and mandatory disclosure of conflicts of interest.  Effective immediately, the JOBS Act prohibits the Commission and any national securities association from adopting or maintaining rules that, in connection with an initial public offering of common equity of an EGC, restrict an employee of a broker, dealer or FINRA member from arranging a communication between a securities analyst and a potential investor based on such person’s "functional role" (i.e., investment banker).  The JOBS Act also prohibits the adoption or maintenance of rules that, in connection with an initial public offering of common equity of an EGC, restrict a securities analyst’s participation in communications with management of an EGC (such as pitch meetings for investment banking business) that also are attended by an investment banker or other employee of a FINRA member who is not a securities analyst. 

These provisions of the JOBS Act prohibit the maintenance of rules that have previously been adopted.  Accordingly, various rulemaking amendments will be required to conform existing rules to these provisions.    Nevertheless, although the statute does not expressly state that such existing rules are of no force and effect, we believe that the legal, and certainly the practical, effect of these amendments to Section 15D is that, to the extent that existing rules contravene these new provisions, the portions that contravene these provisions will immediately become unenforceable with respect to conduct taking place after the date of enactment of the JOBS Act.  There may be some risk, however, to proceeding immediately to allow investment bankers to facilitate communications between securities analysts and the investing public in connection with an EGC IPO, and to permit management of EGCs to meet with associated investment bankers and securities analysts simultaneously, since the interrelationship among the new provisions and any forthcoming FINRA and stock exchange rules, as well as the 2003 "global settlement agreement" reached between certain investment banks and various regulators regarding research analyst conflicts of interest, may take some time to ascertain.  Guidance is needed from FINRA and from the exchanges as to how their rules will reflect the JOBS Act.

While these provisions represent a significant shift from practice over the past ten years, importantly, the JOBS Act leaves intact other existing conflict of interest rules.  In addition, it is noteworthy that the JOBS Act does not expressly address rulemaking by national securities exchanges, which leaves open whether those exchanges are still required or permitted to maintain independent conflict of interest rules regarding conduct addressed by the JOBS Act.  We believe, however, that those exchange rules that effectively contravene the JOBS Act should be deemed invalid as to conduct occurring after the date of enactment of the JOBS Act, and anticipate that the exchanges will act quickly to amend their rules in accordance with the spirit and intent of the statute.

d.   Timing of Publication of Research Reports and Public Appearances by Brokers and Dealers 

The JOBS Act prohibits the Commission and registered national securities associations (effectively, FINRA) from adopting or maintaining any rule that prohibits any FINRA member from publishing or distributing research reports or making a public appearance for a prescribed period of time following the IPO of an EGC or prior to the expiration of a lock-up agreement entered into in connection with the IPO of an EGC.  Currently, under NASD Rule 2711, a FINRA member may not currently distribute research material with respect to an issuer until after 40 calendar days following such issuer’s IPO if the FINRA member acted as a manager or co-manager in connection with the offering, or within 25 calendar days if the member acted as underwriter or dealer (other than as manager or co-manager).  Similarly, FINRA members are prohibited from issuing research 15 days prior to the expiration of a lock-up agreement entered into in connection with a securities offering if the FINRA member acted as manager or co-manager in such offering.[13]  As with the prohibition on adopting or maintaining certain conflict of interest rules discussed in above, we believe that the legal and practical effect of lifting the prohibition on IPO-related research reports is that, to the extent existing rules contravene the new provisions of the JOBS Act, the portions of the existing rules which contravene the new law are invalid as to conduct occurring after the date of enactment of the JOBS Act.  Further rulemaking will be required to conform existing rules to these prohibitions.  As with respect to the conflict of interest rules discussed above, we would caution against acting in reliance solely on the statutory provisions, as guidance from FINRA is needed.

e.   Confidential Submissions of Draft EGC Registration Statements

An EGC, prior to its IPO, will be permitted to submit a draft registration statement with the Commission for confidential nonpublic review by the staff of the Commission.  The initial confidential submission and all amendments thereto must, however, be publicly filed not later than 21 days before the issuer conducts a road show.[14]  This confidential submission will allow an EGC to begin the review process without disclosing information that may be sensitive or confidential until it has greater confidence in the likely success of the offering.[15]  

Elimination of Prohibitions on General Solicitation and General Advertising in Connection with Rule 506 and Rule 144A Offerings

Title II of the JOBS Act will permit general solicitations and advertising in offerings under Rule 506 of Regulation D and under Rule 144A under the Securities Act.  These relaxed restrictions are not limited to offerings by EGCs. 

Under the exemptions provided by Regulation D and Rule 144A, securities may be sold in private offerings without registration under the Securities Act.  Issuers of securities in such offerings historically have been prohibited from using general solicitation or advertising to market the securities.  This prohibition, however, may significantly limit the pool of potential investors.  By eliminating the ban on solicitations and advertisements by issuers and broker-dealers, the JOBS Act would permit, for example, offline and online forums that bring together investors with companies seeking to raise capital. 

The JOBS Act directs the Commission to revise Rule 506 under Regulation D and Rule 144A within 90 days after the date of enactment of the JOBS Act, to remove the prohibition against general solicitation or general advertising in offers and sales of securities made pursuant to these exemptions so long as all purchasers of the securities are accredited investors[16] (in the case of an offering pursuant to Rule 506) or sold only to persons reasonably believed to be QIBs (in the case of an offering under Rule 144A). 

The JOBS Act also provides that an offering under Rule 506 made by means of general advertising or solicitation, which otherwise complies with the requirements of Rule 506, shall not be deemed a public offering. 

In addition, persons who maintain an exchange platform with respect to securities offered and sold pursuant to Regulation D, co-invest in such securities or provide certain "ancillary services" will not be required to register as broker-dealers under the Exchange Act, subject to certain conditions.[17]  These conditions include a requirement that such persons receive no compensation with respect to purchases or sales of the securities, not be subject to any statutory disqualification from being a broker-dealer, and not have possession of customer funds or securities in connection with the purchase or sale of the securities.  The legislation leaves in place what has become the key determinant of broker-dealer status, particularly the receipt of transaction-based compensation.  It leaves open, however, whether negotiating the terms of a transaction or solicitation of purchasers will still be viewed as broker-dealer activities.

Crowdfunding

The JOBS Act amends Section 4 of the Securities Act to add new Section 4(6) and also adds a new Section 4A to the Securities Act.  Section 4(6) will allow U.S. private companies (excluding investment companies) to raise up to $1 million over a 12-month period from pools of small investors in crowdfunding transactions without registration under the Securities Act.  The JOBS Act directs the Commission to issue final rules to implement the new exemption within 270 days after the date of enactment of the JOBS Act.

Use of the Section 4(6) exemption is not available to every company.  Foreign companies, issuers already reporting pursuant to Section 13 or Section 15(d) of the Securities Act, investment companies and other companies that the Commission determines appropriate are ineligible to use this exemption.

The $1 million limitation applies to the aggregate amount of all securities sold by the issuer, whether of the same class or a different class, over the preceding 12 months (including the securities sold in the offering under the crowdfunding exemption).[18]  There is no separate restriction, however, on the issuance of securities after completion of the crowdfunding offering, and the crowdfunding provisions of the JOBS Act specifically provide that the exemption for crowdfunding shall not be construed as preventing an issuer from raising capital pursuant to other exemptions or registered offerings.  For the purposes of this exemption, the term "issuer" includes all entities controlled by or under common control with the issuer.

The amount sold to each investor is limited based on the investor’s annual income and net worth.  For an investor with an annual income or net worth of less than $100,000, the investor’s maximum aggregate annual investment in securities issued under the crowdfunding exemption over a 12-month period is capped at the greater of $2,000 or 5% of such investors’ annual income or net worth.  For investors with an annual income or net worth of greater than $100,000, such investments are capped at the lesser of $100,000 or 10% of such investors’ annual income or net worth.[19]

Securities purchased under this registration exemption will be subject to a one-year transfer restriction, during which time such securities may only be transferred (a) to the issuer, (b) pursuant to a registered offering, (c) to an accredited investor or (d) to certain family members or in connection with the death or divorce of the purchaser or similar circumstances at the discretion of the Commission.  These transfers will also be subject to other limitations as the Commission may establish.

A private company raising capital under this exemption will be required to use an intermediary — either a registered broker or a person registered with the Commission as a "funding portal" — that will act as a platform for investors to review the company information and handle investments.  A funding portal is newly-defined entity that, among other things, does not "solicit purchases, sales, or offers to buy the securities offered or displayed on its website or portal" or "offer investment advice or recommendations."  Registered brokers that act as intermediaries, however, will not be subject to these same restrictions.  In addition to registration with the Commission, funding portals will be subject to rulemaking by the Commission.  The JOBS Act directs the Commission, however, to issue rules that either conditionally or unconditionally exempt funding portals from the requirement to register as broker-dealers under the Exchange Act.

The funding portals and the brokers acting as intermediaries in crowdfunding transactions will be required to:

  • registers with the Commission as a broker or as a "funding portal";
  • register with any applicable self-regulatory agency;
  • provide such disclosures, including investor education materials, as the Commission determines appropriate;
  • ensure that each investor (a) reviews such investor education information, (b) affirms that such investor understands that there is a risk that the entire investment could be lost and (c) answers questions demonstrating their understanding of (i) the level of risk associated with investing in emerging businesses, startups and small issuers, (ii) the risk of illiquidity and (iii) such other matters as the Commission determines appropriate;
  • take measures to reduce the risk of fraud as specified by the Commission, including obtaining a background and a securities enforcement check on each officer, director, and 20% or greater holder of the issuer;
  • make the disclosures required by the issuers available to potential investors at least 21 days prior to the offering;
  • ensure that the offering proceeds are provided to the issuer only after the target offering amount has been met or exceeded, while allowing investors to cancel their commitment to invest;
  • ensure that no investor has exceeded the aggregate investment level permitted under the exemption;
  • take steps to protect the privacy of the information collected from investors;
  • not compensate lead generators or promoters for providing the intermediary with personal identifying information of any potential investor;
  • prohibit their officers, directors or partners from having any financial stake in the issuer using their services; and
  • meet any other requirements set forth by Commission rulemaking.

Issuers relying on the crowdfunding exemption will be subject to a number of informational and other requirements set forth in the JOBS Act, including an obligation to provide to investors and file with the Commission, and provide to the funding portal or broker, as applicable, to make available to potential investors, the following disclosures :

  • basic corporate information including name and address;
  • names of the officers and directors of the issuer;
  • names of any holder of more than 20% of the shares of the issuer;
  • description of the business plan of the issuer;
  • financial information or financial statements that are (a) certified true and complete by the issuer’s principal executive officer, in the case of offerings no greater than $100,000, (b) reviewed by an independent public accountant, in the case of offerings over $100,000 and no greater than $500,000 or (c) audited, in the case of offerings over $500,000;
  • description of the intended use of the proceeds of the offering;
  • the target offering amount, the deadline to reach such target amount and regular funding progress reports relating to the issuer’s progress in meeting the target offering amount;
  • written disclosure prior to the sale of the final price and all required disclosures, and providing investors with a reasonable opportunity to rescind the commitment to purchase;
  • a description of the ownership and capital structure of the issuer; and
  • such other information as the Commission may prescribe.

The issuer also will be required to file with the Commission annual reports setting forth the results of operations and financial statements of the issuer, as the Commission shall determine appropriate. 

Issuers are prohibited from advertising the terms of the crowdfunding offering, except for notices which direct investors to a broker or funding portal.  Any solicitor or promoter using the communication channels provided by a broker or funding portal to promote the crowdfunding offering will have to disclose the receipt of compensation in each instance of promotional communication. 

Issuers will be subject to liability to purchasers of the securities comparable to that under Section 12(a)(2) of the Securities Act for material misstatements or omissions contained in these documents. 

The JOBS Act also directs the Commission to establish "bad actor" disqualification provisions for issuers, brokers and funding portals similar to those to be adopted pursuant to Regulation D.[20]

Importantly, the JOBS Act amends Section 12(g) of the Exchange Act to direct the Commission to promulgate rules to exclude crowdfunded securities from the new 2,000 shareholder limit for private companies.   

Securities issued under the crowdfunding exemption will be "covered securities" under Section 18 of the Securities Act, and thus benefit from federal preemption of certain state securities laws and regulations relating to registration, documentation and offering requirements.  States will retain enforcement authority.  The statute clarifies, however, that states will continue to have jurisdiction over certain fraudulent, deceitful or unlawful conduct in connection with crowdfunding transactions by brokers, dealers, funding portals and issuers. The JOBS Act also restricts the states that may charge notice filing fees to the issuer’s home state and a state where at least 50% of the investors reside.  State regulation of funding portals also will be preempted, with the states retaining examination and enforcement authority.

Although the exemption is created by the JOBS Act, various provisions needed to implement crowdfunding require implementing rules to be issued by the Commission.  The JOBS Act sets a 270-day deadline for such rules but, in light of the opposition expressed by some members of the Commission to the JOBS Act generally and to the crowdfunding provisions in particular, as well as the overhang of rules yet to be adopted pursuant to the Dodd-Frank Act, it is uncertain whether these implementing rules will be adopted by the deadline.

New Exemption from Registration Under the Small Issuer Exemption for Public Offerings up to $50 Million

Section 401 of the JOBS Act amends the small issuer exemption to require that the Commission add a new exemption for securities offerings of up to $50,000,000.  The JOBS Act leaves in place the existing authority for the Commission to exempt issuances of securities of up to $5 million, pursuant to which the Commission previously adopted the existing exemptions from registration provided by Regulation A and by Rules 504 and 505 under Regulation D under the Securities Act. 

The JOBS Act sets forth a number of specific parameters that must govern the new exemption, which are comparable to, but somewhat more expansive than, the requirements for an offering under current Regulation A.   

The Commission is also permitted to add such other terms, conditions or requirements as it determines necessary in the public interest and for the protection of investors, and the JOBS Act does not set a deadline for rulemaking to enact this exemption.   

The following chart sets forth a comparison of the required and optional elements of the new exemption under Section 3(b)(2) and the corresponding provisions of Regulation A:  

Regulation A

New Exemption Under Sec. 3(b)(2)

Securities unrestricted

Securities unrestricted

Public offering

Public offering

"Testing the waters" permitted

"Testing the waters" permitted

Unaudited annual financial statements

Commission must require annual audited financial statements

Offering circular may follow one of three formats, including a "Q&A" format; no electronic filing required or permitted

Offering circular form to be determined; Commission may require offering circular to be electronically filed

No ongoing reporting obligations[21]

Commission may require issuer to file periodic disclosures regarding:

  • the issuer,
  • business operations,
  • financial condition,
  • corporate governance,
  • use of investor funds, and
  • other matters

No liability under Section 12(a)(2) of Securities Act

Liability under Section 12(a)(2)

Bad actor restrictions on participants

Expanded bad actor restrictions on participants[22]

Securities issued under the new exemption will be "covered securities" under Section 18 of the Securities Act, and thus benefit from federal preemption of certain state securities laws and regulations, only if the securities are offered or sold on a national securities exchange or are offered and sold only to qualified purchasers. 

Biennially, the Commission must review the offering amount limitation created under the new exemption and increase it as the Commission deems appropriate.  Should the Commission determine not to increase the offering amount limitation, it will be required to report to the House Committee on Financial Services and the Senate Committee on Banking, Housing, and Urban Affairs on its reasons for not doing so.

In light of the opposition expressed by some members of the Commission to the JOBS Act, as well as the overhang of rules yet to be adopted pursuant to the Dodd-Frank Act, it may take some time for the Commission to adopt rules to implement this new exemption.

Increased Shareholder Thresholds Under Section 12(g) for Public Company Reporting

Section 501 of the JOBS Act increases the holders of record threshold, at or above which an issuer is required to register such securities under Section 12(g) of the Exchange Act, from 500 persons to either (a) 2,000 persons or (b) 500 persons who are not accredited investors.  The JOBS Act also increases the total assets threshold under Section 12(g) from $1 million to $10 million, but because the Commission has previously exempted the equity securities of issuers having less than $10 million in total assets from registration,[23] as a practical matter the asset threshold remains unchanged.

Section 601 of the JOBS Act increases the holders of record threshold for banks and bank holding companies to 2,000 or more persons.  This section also raises the holders of record threshold below which a bank or bank holding company may suspend its duty to file reports and terminate the registration of its securities, from 300 persons to 1,200 persons.[24]

In addition, Section 502 of the JOBS Act amends Section 12(g)(5) of the Exchange Act to provide that the definition of securities "held of record" will exclude securities held by persons who received the securities pursuant to an employee compensation plan in transactions exempted from the registration requirements of the Securities Act.[25]   Section 503 of the JOBS Act requires the Commission to adopt safe harbor provisions that issuers can follow to provide issuers with certainty in making the determinations with respect to securities received pursuant to employee compensation plans.

Finally, as noted in the discussion of crowdfunding, above, purchasers of securities in crowdfunding transactions that are exempt under Section 4(6) of the Securities Act also will be excluded from the count.

Commission Outreach

Under Section 701, the Commission must provide online information and conduct outreach to inform small and medium sized businesses, women owned businesses, veteran owned businesses, and minority owned businesses of the changes made by the JOBS Act.

* * * * *

Effectiveness of JOBS Act Provisions

Set forth below is a table setting forth for each significant provision of the JOBS Act (a) whether such provision will be effective immediately upon enactment or whether agency action is necessary to implement the provision and (b) the deadline under the JOBS Act for the adoption of such implementing regulations. 

Provision

Effectiveness

Amendments to financial reporting and auditing standards

Effective immediately upon enactment of the JOBS Act

Amendments to compensation disclosure and corporate governance requirements

In general, effective immediately upon enactment of the JOBS Act

Exemption from rules requiring "pay-for-performance" and "pay-ratio" disclosure obligations, which rules have yet to be adopted by the Commission, will be effective immediately upon the effectiveness of such rules

Pre- and post-filing communications permitting EGCs to "test the waters"

Effective immediately upon enactment of the JOBS Act

Publication and distribution of research reports by participating underwriters

Effective immediately upon enactment of the JOBS Act

Securities analyst conflict rules

Prohibition on Commission or FINRA from adopting or maintaining rules that, in connection with the IPO of an EGC, restrict investment bankers from arranging communications between analysts and investors is effective immediately

Prohibition on adopting or maintaining rules that, in connection with the IPO of an EGC, restrict simultaneous meetings of analysts and investment bankers with an EGC’s management is effective immediately

Notwithstanding that these prohibitions are effective immediately, there may be risks to undertaking these activities in the absence of guidance from FINRA and the stock exchanges as to how the JOBS Act will affect existing rules that currently prohibit these activities, and until the impact of the JOBS Act on the 2003 "global settlement agreement" can be ascertained

Timing of publication of research reports and public appearances by brokers and dealers

Prohibition on the Commission and FINRA from adopting or maintaining rules that prohibit any FINRA member from publishing or distributing research reports or making a public appearance for a prescribed period of time following the IPO of an EGC or prior to the expiration of a lock-up agreement entered in connection with the IPO of an EGC is effective immediately

Notwithstanding that these prohibitions are effective immediately, there may be risks to acting in reliance solely on the statutory provisions in the absence of guidance from FINRA

Confidential submission of draft registration statements

Effective immediately upon enactment of the JOBS Act; however, Commission and its staff will likely need some time to put in place procedures for receiving and responding to confidential submissions

Elimination of prohibitions on general solicitation and general advertising in connection with Rule 506 and Rule 144A offerings

Requires implementing rules to be issued by the Commission; Commission to issue rules within 90 days

Crowdfunding

Crowdfunding exemption immediately effective upon enactment of the JOBS Act; various provisions needed to implement crowdfunding require implementing rules to be issued by the Commission; Commission to issue rules within 270 days

New exemption under Sec. 3(b) of Securities Act

Requires implementing rules to be issued by the Commission; no deadline for rulemaking

Increased shareholder thresholds under Section 12(g) for public company reporting

Statutory changes under Section 12(g) are effective immediately upon enactment of the JOBS Act

Commission is required to adopt rules to revise the definition of "held of record" to exclude securities held by persons who received the securities pursuant to an employee compensation plan in an exempt transaction, but such regulations are not necessary for the change to be legally effective

Safe harbor relating to exclusion from the Section 12(g) stockholder threshold of securities held by persons who received the securities pursuant to an employee compensation plan in an exempt transaction requires Commission rulemaking; no deadline for rulemaking

Commission required to adopt rules to implement the changes to the Sec. 12(g) shareholder thresholds for banks and bank holding companies within one year, but such regulations are not necessary for the changes to be legally effective


   [1]   Rebuilding the IPO On-Ramp: Putting Emerging Companies and the Job Market Back on the Road to Growth, IPO Task Force (October 20, 2011) (available at https://www.documentcloud.org/documents/327129-ipo-task-force-report.html).

   [2]   The JOBS Act provides for this revenue threshold to be indexed for inflation every 5 years, to reflect the change in the Consumer Price Index for All Urban Consumers published by the Bureau of Labor Statistics.

   [3]   In general, an EGC may choose to forgo the exemptions available to EGCs.  To the extent that it chooses to forgo the exemptions relating to the extension of time to comply with new or revised financial accounting standards, however, it must make this choice as an initial matter and notify the Commission of this choice at the time the company is first required to file a registration statement, periodic report or other report with the Commission.  The EGC must then comply with the more burdensome accounting standards and thereafter continue to comply with such standards to the same extent as a non-EGC.

   [4]   We believe that the reference to the issuance of debt refers to debt securities only, and not to other indebtedness such as bank or trade debt, but we would expect the Commission or its staff to issue rules or guidance to clarify this point.  It appears that all debt issuances, whether issued in registered or private transactions, will be included in this calculation.  The statute does not specify whether registered debt securities issued in an A/B exchange offer will be counted in this calculation; we would also expect the Commission or its staff to issue rules or guidance to clarify this point.  Because the registered debt securities represent, effectively, the same indebtedness that was issued in the initial private issuance, the Commission may determine that such securities should not be included in the calculation in order to prevent "double counting" this indebtedness.

   [5]   Under Exchange Act Rule 12b-2, an issuer is deemed to be a large accelerated filer "after it first meets the following conditions as of the end of its fiscal year: (i) the issuer had an aggregate worldwide value of the voting and non-voting common equity held by its non-affiliates of $700 million or more as of the last business day of the issuer’s most recently completed second fiscal quarter, (ii) the issuer has been subject to the requirements of 13(a) or 15(d) for a period of at least 12 calendar months, (iii) the issuer has filed at least one annual report pursuant to [S]ection 13(a) or 15(d) of the [Exchange Act] and (iv) the issuer is not eligible to use the requirements for smaller reporting companies . . . for its annual and quarterly reports."  Notably, because large accelerated filer status is based upon market capitalization rather than gross revenues, if the price of an issuer’s publicly traded stock increases rapidly, it may lose EGC status more quickly than it might anticipate.

   [6]   Relatedly, an EGC need not include in the MD&A contained in its Securities Act or Exchange Act registration statements or its Exchange Act reports a discussion of periods prior to the earliest year for which audited financial statements are required to be presented.

   [7]   The statute also provides that any such existing rules shall not apply to the audit of an EGC, but no such rules are currently in place.

   [8]   These provisions relate to the PCAOB’s Concept Release On Possible Revisions To PCAOB Standards Related To Reports On Audited Financial Statements, PCAOB Release No. 2011-003 (June 21, 2011) and its Concept Release On Auditor Independence And Audit Firm Rotation, PCAOB Release No. 2011-006 (August 16, 2011), which discuss and request comment on the potential of these and other measures to improve the usefulness of audit reports and bolster auditor independence.

   [9]   Item 10(f)(1) of Regulation S-K provides generally that "smaller reporting company" means "an issuer that is not an investment company, and asset-backed issuer . . . or a majority-owned subsidiary of a parent that is not a smaller reporting company and that . . . (i) Had a public float of less than $75 million as of the last business day of its most recently completed second fiscal quarter . . . or (ii) In the case of an initial registration statement under the Securities Act or Exchange Act for shares of its common equity, had a public float of less than $75 million as of a date within 30 days of the date of the filing of the registration statement . . . or (iii) In the case of an issuer whose public float as calculated under paragraph (i) or (ii) of this definition was zero, had annual revenues of less than $50 million during the most recently completed fiscal year for which audited financial statements are available."

  [10]   Section 102(c) of the JOBS Act provides that EGCs "may comply with [Item 402 of Regulation S-K] by disclosing the same information as any issuer with a market value of outstanding voting and nonvoting common equity held by non-affiliates of less than $75,000,000."  In general, an issuer that has a public float of less than $75 million qualifies as a smaller reporting company and, as a result, may avail itself of the scaled executive compensation provisions of Item 402.  Under Item 10(f)(2)(iii), however, "once an issuer fails to qualify for smaller reporting company status, it will remain unqualified unless . . . its public float . . . was less than $50 million as of the last business day of its second fiscal quarter."  As a result, unless the Commission or its staff issues rules or guidance to the contrary, Section 102(c) of the JOBS Act will not enable an existing issuer as of the time that the JOBS Act was enacted (i.e., that went public after December 8, 2011 and before the JOBS Act was signed into law) that  is an EGC, but that has previously failed to qualify as a smaller reporting company, to take advantage of the scaled executive compensation disclosure provisions.

  [11]   This change is not limited to IPOs or to equity offerings.  As a result, "testing the waters" would also be permitted in connection with follow-on equity offerings and debt offerings by EGCs.

  [12]   The definition of "research report" under the JOBS Act is broad and largely tracks the definition contained in the existing safe harbors relating to research reports provided by Rules 137, 138 and 139 of the Securities Act.   It includes any written or oral communication that features "information, opinions, or recommendations with respect to securities of an issuer or an analysis of a security or an issuer, whether or not it provides information reasonably sufficient upon which to base an investment decision."  In addition, it is noteworthy that the JOBS Act effectively carves out such reports from the definition of "prospectus" under Section 2(a)(10) of the Securities Act, which would have the effect of not subjecting them  to "prospectus" liability under Section 12(a)(2) of the Securities Act.

  [13]   The JOBS Act does not address current research report or public appearance restrictions with respect to secondary offerings, such as FINRA’s current 10 day blackout period following such an offering.  It also does not address blackouts applicable to a waiver or termination of a lock-up agreement, or to periods following expiration, waiver or termination of a lock-up agreement.  For example, current FINRA rules restrict publication of research reports or analyst public appearances 15 days prior to and after the expiration, waiver or termination of a lock-up agreement with respect to a securities offering.

  [14]   Securities Act Rule 433(h)(4) defines a "road show" as "an offer (other than a statutory prospectus or a portion of a statutory prospectus filed as part of a registration statement) that contains a presentation regarding an offering by one or more members of the issuer’s management . . . and includes discussion of one or more of the issuer, such management, and the securities being offered . . . ."

  [15]   Note that, because these confidential submissions eventually must be filed prior to completing the offering, the confidential submission process only delays the public disclosure of this information — it does not prevent its public disclosure if the offering is completed.  The issuer still must request confidential treatment of information that otherwise is required to be disclosed in its registration statement and other documents filed with the Commission pursuant to the procedures contained in Rule 406 under the Securities Act.  If the offer is not completed, however, the JOBS Act provides for such submission to remain confidential.

  [16]   The JOBS Act also mandates that the revised Commission rules require that the issuer take reasonable steps to verify that purchasers of securities under the exemption are accredited investors.

  [17]   Permitted "ancillary services" include due diligence services not involving compensated investment advice or recommendations to issuers or investors.  Ancillary services also include the provision of standardized documents to issuers and investors, so long as the person does not negotiate the terms of the issuance for third parties, and issuers are not required to use the standardized documents as a condition for using the ancillary services.

  [18]   Seemingly, a company seeking to issue securities in reliance on the "crowdfunding" exemption will need to count all shares of restricted stock granted to employees, as well as all other stock issuances, in the prior 12 months against the $1 million limitation.

  [19]   The income and net worth of a person is required to be calculated in accordance with the Commission’s rules for calculating income and net worth of an "accredited investor."  Thus, the value of a person’s primary residence would not be included in measuring his or her net worth.

  [20]   See n.22, below.

  [21]   Subject to the requirement to file an Exchange Act registration statement (and subsequent obligation to file periodic reports) if holders of record exceed the thresholds of Section 12(g) under the Exchange Act.

  [22]   To be substantially similar to those that are adopted with respect to participants in private placements under Rule 506 of Regulation D.  The Commission proposed rules on May 25, 2011 to implement these "bad actor" provisions of Dodd-Frank, Disqualification of Felons and Other "Bad Actors" from Rule 506 Offerings, Release No. 33-9211, 76 FR 31518 (June 1, 2011), but has not yet adopted final rules.

  [23]   Rule 12g-1 under the Exchange Act.

  [24]   Section 602 directs the Commission to issue regulations to implement the changes in Section 601, but because these changes amend the Exchange Act directly, they should have immediate legal effect without Commission action.

  [25]   Section 503 directs the Commission to "revise the definition of ‘held of record’ pursuant to [S]ection 12(g)(5) . . . to implement the amendment made by Section 502," but because the JOBS Act amends the Exchange Act directly to specifically exclude these securities from the meaning of "held of record," these changes should have immediate legal effect without Commission action.

Gibson, Dunn & Crutcher LLP 

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