Will there be a JOBS Act 3.0? The JOBS and Investor Confidence Act of 2018 just passed the House by a vote of 406 to 4, so, even though Senators may often be chary of jumping on the House bandwagon—remember the doomed Financial Choice Act of 2016 and then 2017— the overwhelming and bipartisan approval in the House still makes the odds look better than usual.
What does the bill, S. 488, do? (Don’t be misled by the Senate designation—the version that passed the House is a complete substitution for the Senate version, so the bill still requires a vote in the Senate.) While the bill tackles a lot of subjects, from human trafficking to international insurance standards, it contains several provisions of interest to public and thinking-of-becoming-public companies:
- requires the SEC to amend Reg D to modify the definition of general solicitation to exclude certain presentations to angel investor groups and others;
- amends the definition in the Securities Act of “accredited investor” (and mandates follow-up rulemaking) to index the $1 million net worth test for inflation and to add registered brokers and investment advisors as well as natural persons that have “professional knowledge” with education or job experience verified by FINRA or other SROs;
- allows crowdfunding investors to form “crowdfunding vehicles” advised by registered investment advisers;
- permits the registration of “venture exchanges,” that is, alternative exchanges established, either independently or as a tier of another exchange, “solely for the purposes of trading venture securities,” which are largely smaller or emerging growth public and non-public companies or companies with low trading volumes;
According to this opinion piece in the WSJ by Congressman Jeb Hensarling, Chair of the House Financial Services Committee, this provision is designed to address the problem that “too many companies that go public wither on the vine because their stocks are thinly traded and subject to high volatility. A stock with 10,000 shares of daily trading volume should not be regulated the same as one with 10 million shares. The House would address this disparity by allowing the creation of venture exchanges. Concentrating a small issuer’s trading into a single exchange would aggregate liquidity and help attract post-issuance support, including research, sales and capital commitments by market makers. This would be a game-changer for many small issuers.”
- amends the Securities Act to allow non-EGCs to “test the waters” with qualified institutional buyers or institutional accredited investors and to submit confidential draft registration statements at their IPOs and within one year post-IPO;
You might recall that the JOBS Act, which was signed into law in April 2012, allowed IPO candidates that were EGCs to “test the waters.” The test-the waters provisions in the JOBS Act significantly relaxed “gun-jumping” restrictions by permitting an EGC, and any person acting on its behalf, to engage in pre-filing communications with QIBs and institutional accredited investors to determine the potential level of investor interest before committing to the expensive and time-consuming prospectus drafting and SEC review process. (See this Cooley Alert.) Prior to the JOBS Act, only WKSIs could engage in similar testing-the-waters communications. That flexibility, together with the then-new confidential IPO filing process—which allowed EGCs to start the SEC review process on a confidential basis so that sensitive information would not be disclosed if they ultimately determined not to move forward with the offering—was intended to promote and facilitate access to the public capital markets. In June 2017, Corp Fin extended the confidential filing process, permitting non-EGCs to submit confidential draft registration statements for IPOs and for most offerings made in the first year after going public. The amendment in JOBS 3.0 would conform the Securities to Act to current SEC practice. In February of this year, the WSJ reported that “people familiar with the matter”—every reporter’s favorite source—said that the SEC is “weighing” expanding “test the waters” beyond just EGCs. The article reports that close to 40% of eligible EGCs conducting IPOs took advantage of testing the waters in 2015, but the percentage fell to less than 25% in 2016. Although, according to the article, the SEC does not “view testing the waters as a panacea for the diminished appeal of going public,” some regulators do seem to believe it will encourage companies to go public: at the San Diego Securities Conference in January, the article reports, Corp Fin Director William Hinman argued that “[i]f we can be successful in reducing the burdens associated with joining the public capital markets, we think we will get companies to join us at an earlier stage.” A 2017 Treasury report also recommended expanding this provision of the JOBS Act to allow all companies, not just EGCs, to “test the waters.” (See this PubCo post and this PubCo post.)
- amends SOX 404(b) to add a temporary exemption from the internal controls auditor attestation requirement for any company that ceased to be an EGC after the 5th anniversary of its IPO, is not a large accelerated filer and had average annual gross revenues (over the last three years) of less than $50 million as of its most recently completed fiscal year; the exemption would expire at the earliest of the end of the first fiscal year after the 10th anniversary of its IPO, when its average annual revenue exceeded $50 million or it became a large accelerated filer;
- requires the SEC to conduct an analysis and report on the costs and benefits to companies, investors and other market participants of the Form 10-Q requirement for EGCs and other reporting companies, including the costs and benefits of the public availability of the information required to be filed on Form 10–Q, the use of a standardized reporting format across all classes of reporting companies, and quarterly disclosure by some companies of financial information in formats other than Form 10–Q, such as a quarterly earnings press release;
Ironically, as the bill seeks to reduce required disclosure, research discussed in this article from CFO.com suggests that less disclosure can lead to higher risk premiums for issuers. The study looked at data from a sample of 376 companies, which included all U.S. IPOs conducted between July 1, 2009 and December 31, 2013. After comparing the IPOs of EGCs (which are subject to reduced disclosure requirements) with those of non-EGCs (companies that would have been EGCs had their IPOs occurred post-JOBS Act), the study found “considerably greater underpricing and volatility for shares of the EGCs than for those of the NEGCs in the wake of their respective IPOs.” The study authors attributed the underpricing to “a risk premium that investors demand to compensate them for their uncertainty about the value of the firm.” According to the article, the authors “found shares of EGCs to be, on average, about 12% more volatile post-IPO than those of NEGCs. And when it comes to underpricing, the contrast between the two groups was even more striking. On IPO days, the underpricing of EGC shares (the difference between the initial offering price and the price at day’s end) was on average about 55% greater than the underpricing of NEGC shares, and at 30 business days post-IPO it was more than 100% greater. At that point the difference in underpricing between the average EGC and the average NEGC amounted to a hefty 13% of IPO proceeds.”
- requires the SEC to conduct a study of and report on the issues affecting the availability of investment research for small issuers, including EGCs and companies considering IPOs, taking into account factors such as costs, conflicts of interest, competition, payment for research, concentration of investment advisers and broker-dealers, the Global Research Analyst Settlement (see this Cooley News brief), SEC and other rules, liability concerns and the “unique challenges faced by minority-owned, women-owned, and veteran-owned small issuers in obtaining research coverage”;
- requires the SEC to study and report on whether Rule 10b5-1 should be amended (and, if so, conduct conforming rulemaking) to restrict the ability of issuers and insiders to adopt 10b5-1 plans only to permitted trading windows, limit the ability to adopt multiple overlapping trading plans, establish mandatory delays between plan adoption and first trades, limit the frequency of plan modifications and cancellations, require that plans be filed with the SEC and, for issuer plans, require that boards adopt relevant policies and monitor plan transactions;
- amends the Exchange Act to require the SEC to mandate proxy disclosure, for companies with multi-class share structures, regarding the shareholdings and voting power of all classes of securities for all directors, nominees, NEOs and 5% holders; and
- requires the SEC, in consultation with FINRA, to study and report on the direct and indirect costs associated with IPOs by small- and medium-sized companies, such as underwriter fees, legal compliance costs, and to consider those costs relative to other financing alternatives as well as their impact on capital formation.