Jumpstart Our Business Startups Act 2012
On April 5, 2012, President Obama signed into law the “Jumpstart Our Business Startups Act” (the “JOBS Act”). The JOBS Act significantly amends US securities laws in order to make raising capital in the United States more attractive to a new category of issuers known as “Emerging Growth Companies” (“EGCs”). Significantly, among other measures, the law eliminates or reduces for a period of time the regulatory requirements imposed on EGCs involved in a public offering of securities.
As the market is grappling with the new legislation, the Securities and Exchange Commission (the “SEC”) is attempting to guide issuers and other market participants through the revised process. On April 11, the SEC participated in a program through the Practising Law Institute entitled “The JOBS Act: A Dialogue with Senior Staff from the SEC Division of Corporation Finance and Private Practitioners” (the “PLI Dialogue”) and on April 16, it issued responses to Frequently Asked Questions (the “SEC FAQ”) on its website. To view the SEC FAQ, please click here.
IPO “On-Ramp”: Reduced Regulatory Requirements for Initial Public Offerings by EGCs
The “IPO On-Ramp” provisions of the JOBS Act aim to reduce or eliminate some of the regulatory requirements, including disclosure requirements, which companies have previously been subject to in the course of a public offering of its securities. In particular, the JOBS Act creates a new category of issuer, an “Emerging Growth Company”. Pursuant to the newly enacted provisions, an EGC is entitled to benefit from an “on-ramp”, or transitional period, in its initial public offering process and will not be subject to the usual rigorous disclosure requirements.
To qualify as an EGC, a company must have total annual gross revenues of less than $1 billion (as indexed for inflation every five years) for its most recently completed fiscal year. A company will continue to be considered an EGC until the earliest of:
- The last day of the fiscal year in which the company earned $1 billion in annual revenue;
- The last day of the fiscal year following the fifth anniversary of an initial public offering of equity shares in the company;
- The date on which it is considered to be a “large accelerated filer” under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”) (i.e., a public float of at least $700 million); or
- The date on which the company has issued, in any three-year period, greater than $1 billion in non-convertible debt securities.
EGC status is available to issuers whose initial public offering has occurred or will occur on or after December 9, 2011. An EGC must indicate its status as an EGC on the cover of its registration statement (i.e., prospectus).
For disclosure purposes, in connection with its initial public offering, an EGC may present two, rather than three, years of audited financial statements; in any other (non-IPO) registration statement, an EGC does not need to present selected financial data for any period prior to the audited period presented in connection with the public offering. Following its initial public offering, an EGC will move towards full compliance by adding one additional year of financial statements in each year until the previous three years of audited statements have been submitted, plus two years of selected financial data.
EGCs are now permitted to submit a confidential draft registration statement for review by the SEC as long as the confidential submission and all related amendments are publicly filed with the SEC at least 21 days before it commences its road show. During the PLI Dialogue, the SEC staff indicated that the purpose of the 21 day period is to ensure any investors have adequate time to review the registration statement. Also, during the PLI Dialogue, SEC staff noted that due to statutory mandate to keep such submissions confidential, EDGAR cannot be used for confidential submission and for the time being, the SEC is asking issuers to provide only one electronic copy of the draft statement on DVD and then to await SEC confirmation via a telephone call. The staff also confirmed that other than procedural differences required to maintain confidentiality, the confidential submission will be reviewed in the same manner as any other submissions to the SEC.
In the PLI Dialogue, the SEC addressed the scenario of an EGC that has already publically filed a registration statement (i.e., prior to passage of the JOBS Act). The staff indicated that in such circumstances, an EGC is able to switch into the process available to it as an EGC under the JOBS Act by contacting its examination team at the SEC and informing them of its intention to change to the newly available process. The staff emphasized the importance of communicating this switch to the relevant review team at the SEC.
The Securities Act of 1933, as amended (the “Securities Act”), places strict limits on communications to potential investors of securities outside of the statutory registration statement. Pursuant to the JOBS Act an EGC, or those authorised to act on behalf of the EGC, are permitted to make written or oral communications to qualified institutional investors or buyers either before or after the filing of a registration statement. This amendment is intended to allow the issuer to “test the waters” early on in the offering process in order to determine investor interest and manage the offering process accordingly.
As part of the PLI Dialogue, the SEC staff indicated that due to the wording of the statute, it would be “prudent for market participants to take the position” that “testing the waters” communications will likely be subject to liability not only under Rule 10b-5 and Section 17(a), but it should also be assumed that such communications will be subject to Section 12(a)(2) liability. In light of this, the SEC anticipates that issuers will approach this provision cautiously and market practice will develop in a measured manner over time.
Additionally, amendments have been made to provisions of the Sarbanes-Oxley Act such that an EGC is now exempt from the auditor attestation requirements for as long as it is categorized as an EGC. Furthermore, EGCs will not be required to comply with any new or revised financial accounting standard until such standard applies to private companies. This will be particularly beneficial to EGCs in light of the imminent replacement of US Generally Accepted Accounting Principles (“US GAAP”) with International Financial Reporting Standards (“IFRS”). While EGCs may choose to comply with non-EGC accounting standards, they may not selectively comply.
EGCs are now exempt from any Public Company Accounting Oversight Board (“PCAOB”) mandatory audit firm rotation requirements and PCAOB rules relating to supplements to the auditor’s report. Unless the SEC determines otherwise, PCAOB rules adopted after the date of enactment of the JOBS Act (April 5, 2012) will not apply to an audit of an EGC.
In the SEC FAQ, the SEC indicates that although the statute only references Form S-K and not Form 20-F, a foreign private issuer that meets the definition of an EGC may take advantage of the scaled disclosure and other benefits available under the JOBS Act. Additionally, a foreign private issuer that elects to be treated as an EGC in submitting a confidential draft registration statement will be subject to the confidentiality regime under the JOBS Act. That is, a foreign private issuer who takes advantage of the scaled disclosure under the JOBS Act must then also observe the required 21 day waiting period before a road show after publicly filing its registration statement.
Research Reports and Communications with Security Analysts
In addition to reduced disclosure requirements, the JOBS Act expands the existing safe harbour to permit the publication or distribution by a broker or dealer of any research report about an EGC during the public offering process at an earlier stage than was permitted previously, even in a case where the broker or dealer will be participating in the public offering of the EGC. Additionally, analysts may publish research on an EGC immediately following an initial public offering and the SEC and any registered national securities association are now prohibited from adopting a rule banning any party from publishing a research report or from making a public appearance during post-IPO periods.
Restrictions on who may arrange for communications among securities analysts and investors in connection with an IPO have been removed; now securities analysts may participate in communications with the management of an EGC, and in addition representatives of a broker or dealer.
Executive Compensation Provisions
The executive compensation provisions of the Dodd-Frank Act do not apply to EGCs; therefore, there is no requirement for public companies to hold say-on-pay, say-on-frequency and say-on-golden-parachute shareholder votes. An EGC is no longer required to calculate and disclose the ratio of its CEO’s compensation to the median compensation of other employees. EGCs are permitted to comply with the executive disclosure requirements by complying with the reduced disclosure requirements generally available to smaller reporting companies. An issuer that loses its EGC status must hold an advisory vote on executive compensation within a year after ceasing to qualify as an EGC, or, if later, by the end of the third year after its IPO.
Other than with respect to accounting standards, EGCs are permitted to forego an exemption and immediately comply with the requirements that apply to non-EGC companies instead.
Amendments to Private Placement Provisions
The JOBS Act requires the SEC to amend both Regulation D and Rule 144A within 90 days of its enactment to lower regulatory requirements for EGCs using these private placement exemptions. In particular, EGCs will no longer be subject to the prohibition on general solicitation and general advertising, provided that all eventual purchasers of the securities are accredited investors in the case of Regulation D and qualified institutional buyers in the case of Rule 144A. The issuer must be able to prove that it took reasonable steps to verify that the purchasers of the securities are accredited investors or qualified institutional buyers, as appropriate.
New Exemptions from Registration
The JOBS Act adds a new exemption to the Securities Act for “crowdfunding”, a capital-raising strategy whereby relatively low value securities are offered to and purchased by a large number of investors. The new exemption permits non-reporting issuers to raise up to $1 million within any 12-month period, provided the maximum investment per investor does not exceed:
- the greater of $2,000 and 5% of the investor’s annual income or net worth, for those whose annual income or net worth is less than $100,000 within 12 months; or
- 10% of the investor’s annual income or net worth up to a maximum of $100,000 of securities sold for those whose income is $100,000 or more.
The transaction must be conducted through a broker or a “funding portal” (this is defined as an intermediary in a transaction involving the offer or sale of securities for the account of others pursuant to this exemption that meets certain conditions). Additional restrictions, disclosure and SEC filing requirements are placed on crowdfunding activities, including that the issuer may not advertise the terms of the offering, other than notices directing investors to the broker or funding portal.
Regulation A, under Section 3(b) of the Securities Act, is a rarely used small issuer exemption from registration for offerings up to $5 million. The JOBS Act requires the SEC to amend Section 3(b) of the Securities Act to provide for a new exemption from registration in addition to Regulation A (being referred to as “Regulation A+”):
- The exemption applies to up to $50 million of securities per year issued by non-reporting issuers.
- A civil liability provision has been added under Section 12(a)(2) for securities exempt under this provision.
- The SEC will require the issuer to submit annual audited financial statements and may require the issuer to file periodic reports.
- The SEC may require the issuer to publicly file and distribute to investors an offering statement containing specific disclosures.
- The SEC is required to review and increase biennially the offering amount limitations, and if it determines not to increase the limit, report to certain congressional committees on the reasons for not increasing the limit.
The offerings can involve debt, equity or convertible securities and can be offered and sold publicly, including by general solicitation. Notably, securities exempt from registration under this provision are only considered “covered securities” and thereby exempt from state securities registration if they are offered or sold on a national securities exchange or to a qualified purchaser.
Threshold Raised for Reporting Companies
The JOBS Act amends Section 12(g) of the Exchange Act to raise the 500-shareholder threshold to 2,000 shareholders or 500 shareholders who are not accredited investors; and provides for exclusions for shareholders who acquired shares through crowdfunding activities and also shareholders who acquired shares pursuant to an employee compensation plan, from counting towards the new shareholder threshold as well as other exempt securities transactions.
Additionally, the amendments raise the current 500-shareholder threshold for banks and bank holding companies to 2,000 shareholders; and allows for the suspension and termination of the registration and reporting obligations by a bank or bank holding company if the number of shareholders falls below 1,200.
Like the Dodd Frank Act of 2011, the JOBS Act includes mandates for the SEC to conduct studies relating to smaller issuers, including with respect to the content of registration requirements and the registration process.
The JOBS Act seeks to increase the volume of public offerings in the United States following a notable decline over the last decade. Many of the primary regulatory burdens have been lifted to create a more streamlined path to going public for smaller issuers, which should lead to a less expensive and faster route to raising capital. The JOBS Act was passed overwhelmingly by both houses of Congress and although the reasoning behind the legislation is clear, there are numerous ambiguities regarding how the legislation will work alongside existing laws and regulations.