With the US and European markets experiencing a decrease in the level of activity in the IPO markets due to various macroeconomic factors, principally the European financial crisis of 2011, governments are seeking to stimulate activity through legislation that aims to facilitate access to capital markets. The US Jumpstart Our Business Startups Act (JOBS Act) has received significant attention for its aim of easing the US IPO process for emerging growth companies. The European changes to implement a proportionate disclosure regime for all offerings (IPO or otherwise) by small and medium sized enterprises (SMEs) and companies with reduced market capitalizations has perhaps received less attention applying, as it does, to a far more restricted pool of companies than the JOBS Act.
US JOBS Act
On 5 April 2012, President Obama signed the JOBS Act into law. The JOBS Act is intended to ease securities law burdens on capital raising activities by smaller companies.
The JOBS Act creates a new category of “emerging growth companies” (EGCs) and eases existing requirements of the US Securities Act of 1933 (Securities Act) applicable to the US IPO process for EGCs and reduces the subsequent reporting burdens on these companies under the US Securities Exchange Act of 1934 (Exchange Act) during a phase-in period. This note summarizes provisions of the JOBS Act that are most relevant to foreign private issuer EGCs that are contemplating a public offering of securities in the United States. Click here for a more detailed summary of the JOBS Act.
The new law defines an EGC as a company that had “total annual gross revenues” of less than $1 billion in its most recent fiscal year. The $1 billion threshold, which will be indexed for inflation, is high enough to encompass a sizable majority of the companies that have completed IPOs in recent years. Companies that first sold common equity securities in a registered offering on or before 8 December 2011 are not eligible for EGC status.
A company will continue to qualify as an EGC until the earliest of the following four dates:
- the last day of the first fiscal year in which it has total annual gross revenues of $1 billion or more (as indexed for inflation);
- 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 (a company with a public equity float of $700 million or more that has been a public reporting company for at least one year and has filed at least one annual report with the US Securities Exchange Commission (SEC)); or
- the last day of the fiscal year following the fifth anniversary of its initial SEC-registered public offering of common equity securities.
Accordingly, an EGC that completes an IPO and does not subsequently attain total annual gross revenues of $1 billion or more (as indexed for inflation) could benefit from a phase-in period in excess of five years for full compliance with Exchange Act requirements so long as it does not issue more than $1 billion in non-convertible debt or become a large accelerated filer.
IPO process reforms. The JOBS Act amends the Securities Act to ease the process for an EGC to register securities with the SEC in connection with an IPO and certain other public offerings. The reforms provide for:
- Reduced financial disclosures for registration statements. An EGC will be permitted to include in its IPO registration statement only two years of audited financial statements and only two years of financial information in its management’s discussion and analysis (MD&A), rather than the three years otherwise required.
- Confidential submission of IPO registration statements. An EGC will be permitted to submit to the SEC its IPO registration statement and all amendments on a confidential basis for review by the SEC staff so long as it subsequently publicly files these materials with the SEC at least 21 days before the start of its IPO roadshow. Confidential submission would allow an EGC to avoid exposing sensitive information to competitors and the market until the EGC is reasonably confident that it will proceed with the offering. The existing practice of permitting confidential submissions (without an obligation to file publicly the initial submission) by foreign private issuers that are listed or are listing concurrently on a non-US securities exchange will not change, and remains an alternative.
- Expanded offering-related communications with institutional investors. The JOBS Act permits an EGC and persons authorised to act on its behalf to communicate orally or in writing with qualified institutional buyers (QIBs) and institutional accredited investors to “test the waters” regarding the investors’ possible interest in the EGC's securities before or after the filing date of the EGC's registration statement for an IPO or other US public offering. The new regime relaxes the long-standing SEC restriction on “gun-jumping” communications and the distribution of writings considered to constitute an unlawful prospectus.
- Liberalised restrictions on research reports and communications by research analysts. In a departure from current law, research analysts, including those working for investment banks, will be able to publish research reports regarding an EGC before or during its IPO (rather than waiting until termination of the post-IPO blackout period) even if the banks are participating in the offering. The publication of these research reports will not result in a “gun-jumping” violation or constitute an unlawful prospectus. The reports, however, will continue to be subject to existing conflict of interest restrictions, such as those under the Sarbanes-Oxley Act of 2002 (SOX). The JOBS Act also relaxes restrictions of the US Financial Industry Regulatory Authority (FINRA) that preclude research analysts from meeting with potential IPO investors or from participating in IPO-related meetings with an EGC attended by investment bank personnel, as well as FINRA prohibitions on the publication of research by research analysts associated with the underwriters of an IPO. The research appearing in permitted reports will, however, continue to be subject to the antifraud provisions of the Securities Act and the Exchange Act.
- Deferred compliance with new or revised financial accounting standards. An EGC will not be required to comply with any new or revised financial accounting standard until such date, if any, as the standard also applies to private companies that are not considered “issuers” for purposes of SOX.
Exchange Act reforms. The JOBS Act provides EGCs with relief from various financial reporting, disclosure and other requirements under the Exchange Act for so long as the company qualifies as an EGC. The JOBS Act provides for:
- Reduced financial disclosures for registration statements and reports. An EGC will have to include in any registration statement or report filed under the Exchange Act only two years of audited financial statements and only two years of financial information in its MD&A (rather than the three years otherwise required). The presentation of selected financial data will not be required for any period before the earliest audited period presented in the EGC’s first effective registration statement under the Securities Act or the Exchange Act (compared to up to five years otherwise required).
- Exemption from auditor attestation requirement. An EGC will not be required to provide a report from its auditor under Section 404(b) of SOX attesting to its internal control over financial reporting for any fiscal year during the entire period it qualifies as an EGC. The majority of public companies must first include such a report in the second annual report filed by them following their IPO. The EGC, however, will still have to provide management’s assessment of the company’s internal control over financial reporting under Section 404(a) of SOX.
- Exemption from certain new audit rules. An EGC will be exempt from any new rules adopted by the Public Company Accounting Oversight Board (PCAOB) that require mandatory audit firm rotation or require a supplement to the auditor’s report containing additional information about the audit or the company’s financial statements. Further, if the PCAOB adopts new auditing standards, the new standards will not apply to an audit of EGC financial statements unless the SEC approves the application of the new standards to EGCs.
- Deferred compliance with new or revised financial accounting standards. An EGC will not be required to comply with any new or revised financial accounting standard until such date, if any, as the standard also applies to companies that are not Exchange Act reporting companies.
UK Proportionate Disclosure Regime
Changes are also afoot in Europe and therefore the UK with a view to reducing the administrative burden placed on smaller companies, and, therefore, their costs, when raising finance. In particular, SMEs and companies with reduced market capitalisations (both as defined by the Prospectus Directive) will be able to take advantage of a proportionate disclosure regime when preparing a prospectus in connection with a public offer or an admission to trading on a regulated market. The new regime is due to come into force on 1 July 2012 by virtue of amendments being made to the EU Prospectus Directive (2003/71/EC).
The Prospectus Directive defines:
- SMEs as companies, which, according to their last annual or consolidated accounts, meet at least two of the following three criteria:
- an average number of employees during the financial year of less than 250,
- a total balance sheet not exceeding €43 million, and
- an annual net turnover not exceeding €50 million; and
- Companies with reduced market capitalisation (Small Caps) as companies listed on a regulated market that had an average market capitalisation of less than €100 million on the basis of the year-end quotes for the previous three calendar years.
As such, the definitions will catch a far smaller number of companies than under the $1 billion threshold used in the JOBS Act.
The proportionate disclosure regime recognises that whilst SMEs and Small Caps make an important contribution to the development of the European economy and financial markets, the costs of access to financial markets can be significant for them. It therefore aims to reduce the costs for such companies by making it easier to produce a prospectus. However, whilst the new regime will reduce the administrative burden, the need to balance the regime with an appropriate level of protection for investors in respect of what may be perceived as a riskier investment than acquiring securities in a larger entity with a more proven track record, has resulted in the requirements still being more onerous than some might have desired.
Nonetheless, two changes already brought into force in the UK as a result of other amendments to the Prospectus Directive should make life easier for smaller companies when raising finance. This is because the changes increase certain thresholds at which a prospectus has to be produced, namely:
- the total size of the offer that may be made to investors before a prospectus is required has been increased from €2.5 million to €5 million; and
- the number of investors to whom an offer may be made before a prospectus is required has been increased from 100 to 150 investors.
It is clear that legislators in the United States and the European Union are taking steps to spur activity within their respective financial markets by easing the regulatory burden on smaller companies seeking to access the capital markets. In the case of the United States, the JOBS Act represents one of the most significant revisions to US securities law to occur in years via changes to the IPO process and the easing of reporting requirements for EGCs. Meanwhile, the Prospectus Directive seeks to similarly stimulate activity in the financial markets through the easing of regulatory restrictions on smaller companies. It remains to be seen what the impact of the JOBS Act and the Prospectus Directive will be on actual market practices, but it can safely be said that EGCs and smaller companies in the EU should again closely consider the attractiveness of an IPO offering.