Many OTCQX International issuers, prospective issuers and other members of the OTCQX International community have asked us about the impact of the U.S. Jumpstart Our Business Startups Act, or JOBS Act, on OTCQX International issuers. This article provides an overview of those portions of the JOBS Act of particular relevance to OTCQX International issuers.
The JOBS Act, which was signed into law in April 2012, loosens restrictions around capital raises, lessens both U.S. IPO and ongoing disclosure and other obligations for many issuers, including foreign issuers, and reduces the cost of being public in the United States. Please see our Alert, JOBS Act Signed into Law: Key Provisions Affecting Public Companies, Private Capital Raises and Broker-dealers and Other Intermediaries, for a more extensive overview of the Act. For additional information on the OTCQX International quotation process, please see our White Paper, Getting Quoted on OTCQX International — An Overview for Non-US Companies.
The JOBS Act Allows Broader Marketing of U.S. Private Placements
The most immediate benefit of the JOBS Act for most OTCQX International issuers will be the elimination of restrictions on general solicitations and general advertising in connection with most U.S. private placements.
OTCQX International issuers typically are exempt from U.S. reporting pursuant to the U.S. Securities and Exchange Commission’s Rule 12g3-2(b) exemption. Because this exemption is not available to foreign issuers that publicly raise capital in the United States, OTCQX International issuers that raise capital in the United States typically do so through private placements. Under current U.S. law, issuers and intermediaries are severely limited in their ability to promote a private placement. Among other things, they cannot engage in print, Internet or broadcast advertising and are limited in their ability to engage in other activities that may condition the market for the securities being offered, such as press releases, press conferences and interviews.
The JOBS Act shifts the focus away from how prospective purchasers of privately-placed securities are solicited. The JOBS Act requires the SEC to amend existing private placement rules to allow general solicitations and general advertising in connection with private placements conducted in accordance with Rule 506 of Regulation D and Rule 144A under the Securities Act, which are the two most common private placement exemptions relied on in connection with U.S. institutional placements.
The issuer in a Rule 506 offering will be permitted to engage in general solicitations and general advertising in connection with the offering so long as it takes reasonable steps to verify that all of the purchasers in the Rule 506 offering are accredited investors. In the case of Rule 144A, which is a resale exemption for privately placed securities, there must be a reasonable belief that all purchasers are qualified institutional buyers. In most respects, these requirements are consistent with existing Rule 506 and Rule 144A offering practice and do not meaningfully limit the purchaser universe. An accredited investor generally is a higher net worth individual with individual income exceeding US$ 200,000 or net worth exceeding US$ 1 million or an entity with more than US$ 5 million of assets. A qualified institutional buyer generally is an institutional investor with US$ 100 million or more in assets under management.
Over time, these changes are likely to affect how private placements are marketed in the United States and are likely to be especially beneficial to smaller companies that are not as well known among U.S. institutional investors.
The SEC is required to adopt amendments to Rule 506 and Rule 144A giving effect to this portion of the JOBS Act within 90 days after its enactment, or by July 4, 2012. An open question that the SEC will need to address is the interplay between the amendments to Regulation D and Rule 144A and offshore offerings conducted under Regulation S, which is the exemption from U.S. registration for offshore public offerings that satisfy specified criteria.
The JOBS Act Reduces the Compliance Costs of Being Public in the United States
The JOBS Act creates a new category of U.S. issuer, the “Emerging Growth Company.” EGCs can take advantage of a transition period — what is known as the “IPO on-ramp” — before they become subject to all of the disclosure and substantive requirements applicable to other issuers. A foreign issuer, including a Canadian MJDS issuer, can be an EGC.
OTCQX International issuers typically are exempt from U.S. public company reporting under the Rule 12g3-2(b) exemption because they have not engaged in a U.S. public offering and their securities are not listed on a U.S. securities exchange (typically the NYSE, NYSE MKT or NASDAQ; in contrast, OTCQX International is classified as an inter-dealer quotation system). However, for those issuers that view an OTCQX International quotation as an initial step into the U.S. markets, to be followed in the future by a public offering in the United States and/or a listing on a U.S. securities exchange, the JOBS Act may reduce the compliance costs of being public in the United States.
To qualify as an EGC, an OTCQX International issuer must have had total annual gross revenues of less than US$ 1 billion during its most recently completed fiscal year prior to raising capital publicly in the United States or listing on a U.S. securities exchange.
An issuer will retain EGC status until the earliest of:
- The end of the fiscal year during which it had total annual gross revenues of US$ 1 billion or more;
- The end of the fiscal year following the fifth anniversary of its U.S. equity IPO;
- The date on which it has issued more than US$ 1 billion in non-convertible debt during the prior three year period; or
- The date on which it is deemed to be a “large accelerated filer” (i.e., in addition to certain other requirements, an issuer with a worldwide non-affiliated public float of at least US$ 700 million as of the end of the second quarter of its most recently completed fiscal year).
The U.S. IPO registration statement for an EGC in most cases only is required to include two years of audited financial statements, as compared to three years under prior disclosure requirements. In addition, selected financial data and full fiscal year “Management’s Discussion & Analysis” disclosure generally is not required in filings for any period preceding the audited financial statements contained in the IPO prospectus. Furthermore, EGCs are not required to comply with any new or revised financial accounting standards that are of general applicability until private companies also are required to comply with those standards.
EGCs also are exempt from Section 404(b) of the Sarbanes-Oxley Act, which requires auditors to attest to and report on management’s assessment of internal control over financial reporting. For many EGCs, this is expected to result in meaningful cost savings.
Other benefits to EGCs include the ability to “test the waters” with institutional investors in advance of a U.S. public offering and more flexibility around the timing of the publication of research by analysts, bringing U.S. regulations more in line with market practice outside of the United States. However, it is still too early to predict how U.S. practice around pre-marketing and research will change with respect to EGC public offerings. EGCs also can make confidential IPO submissions with the SEC, although, for some foreign issuers, the confidential submission protocol is less generous than that currently available to them.
Looking Further Down the Road
A More Robust Exemption for Smaller Company Offerings?
The JOBS Act requires the SEC to adopt what is commonly referred to as the “Regulation A+” exemption.
Current Regulation A is a small offering exemption from registration under the Securities Act. Not more than US$ 5 million may be raised pursuant to the Regulation A exemption in any 12-month period. As a result, the exemption is infrequently used since the compliance costs outweigh the benefits to most issuers. The JOBS Act requires the SEC to adopt rules increasing the maximum amount that can be raised under this exemption or a new exemption to US$ 50 million. Issuers will be able to publicly “test the waters” before launching a Regulation A+ offering. In addition, under certain circumstances, securities sold under the exemption will not be required to comply with U.S. state securities laws.
Securities offered and sold under the exemption will not be treated as restricted under the Securities Act, meaning that they can be publicly resold by purchasers without any holding period. In addition, an issuer that conducts an offering pursuant to the Regulation A+ exemption will not become a Securities Exchange Act registrant (which triggers significant ongoing U.S. public reporting requirements) solely by virtue of having completed a Regulation A+ offering.
There are still a number of significant questions surrounding the Regulation A+ exemption, so its utility generally and for OTCQX International issuers in particular remains to be determined. Most significantly for foreign issuers, the current Regulation A exemption is available only to U.S. domestic and Canadian issuers. It is uncertain whether other foreign issuers will be eligible to use Regulation A+. In addition, issuers that offer securities in reliance on the Regulation A+ exemption will be required to file an offering circular for review with the SEC, the content of which is not fleshed out in the JOBS Act and will be covered in future SEC rule-making. And, although they will not be subject to ongoing periodic reporting requirements generally, Regulation A+ issuers will be required to file audited financial statements with the SEC annually. The JOBS Act permits the SEC to adopt other ongoing periodic disclosure requirements regarding, among other things, the issuer and its business operations, financial condition and corporate governance principles. If the Regulation A+ exemption is too cumbersome and expensive to use, issuers may find U.S. private placements more attractive for capital-raising, especially in light of the JOBS Act liberalization of public communications in connection with private placements.
Unlike most other aspects of the JOBS Act, the Act does not specify an outside date for the adoption of the Regulation A+ exemption. Given the significant number of other rule-making initiatives that it currently has to contend with, many of which are behind schedule, it may be some time before the SEC proposes rules that implement the Regulation A+ exemption.
A Change in How EGC Securities Are Traded?
The JOBS Act requires the SEC to conduct a study examining the transition to trading and quoting securities in one penny increments, also known as decimalization. The study is required to examine the impact that decimalization has had on the number of IPOs. The study also is required to examine the impact that decimalization has had on liquidity for small- and mid-cap company securities and whether there is sufficient economic incentive to support trading of these securities in penny increments. The SEC is required to submit its findings to Congress by July 4, 2012.
To the extent that the SEC determines that EGC securities should be quoted and traded using a minimum increment of greater than US$ 0.01, within 180 days following the enactment of the JOBS Act, the SEC may designate a minimum increment of up to less than US$ 0.10 for the quotation and trading of EGC securities. An increase in the minimum trading increment of EGC securities may increase broker dealer interest in trading the securities of smaller less-liquid EGCs.