On April 5, 2012, President Obama signed the Jumpstart Our Business Startups Act (the “JOBS Act”) in order to address concerns about capital formation and unduly burdensome SEC regulations. The sections that follow discuss the main highlights of the JOBS Act.
II. Title II – Access to Capital for Job Creators
Title II of the JOBS Act will permit general solicitations and advertising in offerings under Rule 506 of Regulation D and under Rule 144A of the Securities Act of 1933 (the “Securities Act”).
Rule 506 of Regulation D is a long-standing exemption from the registration requirements of the Securities Act. Through this exemption, issuers can sell unregistered securities to an unlimited number of accredited investors and a limited number of non-accredited investors. Issuers of securities in such offerings, however, have been prohibited from using general solicitation or advertising to market the securities. This created a potentially significant limitation on an issuer’s ability to find and raise capital in a competitive process.
Title II of the JOBS Act has reversed that limitation to allow for the general solicitation and advertisement of a Rule 506 offering, as long as all ultimate purchasers are accredited investors. By July 4, 2012, the SEC must adopt new rules that will modify Rule 506 to provide that the limitations on solicitation and advertisement do not apply to Rule 506 transactions involving accredited investors only. This makes the identification of accredited investors especially significant. Prior to the JOBS Act, purchasers have been allowed to self-certify that they qualify as accredited investors. In a departure from this long-approved practice, however, the JOBS Act provides that issuers are now required to take “reasonable steps” to ensure investors purchasing securities through a Rule 506 offering are “accredited investors.” It remains unclear what steps the SEC will require from issuers to verify that purchasers under Rule 506 are actually accredited investors.
Title II also amends Rule 144A of the Securities Act. Rule 144A is a safe harbor exemption that allows an individual to resell restricted securities to a qualified institutional buyer (“QIB”). Within 90 days following the enactment of the JOBS Act, the SEC must revise Rule 144A to allow offers to a QIB, including by means of general solicitation or general advertising. Issuers may not use Rule 144A to offer securities, but instead may sell securities to an intermediary who can resell the securities to a QIB. However, pursuant to the JOBS Act, a reseller using Rule 144A can sell these securities only to purchasers the reseller, and any person acting on behalf of the reseller, reasonably believes is a QIB. As with the accredited investor verification, it remains to be seen what standard the SEC will set for issuers to reasonably believe a purchaser is a QIB. Moreover, current Rule 144A remains in effect until the SEC provides the new rules.
The removal of the ban on general solicitations will enable many companies not to rely solely on existing relationships for funding. A wider audience of investors can be reached via the Internet and other venues. Moreover, similar to EGCs, these companies will be able to “test the waters” on potential investor interest in their offerings since communications with investors will not be barred.
Finally, persons who maintain certain online or other platforms 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. 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.
III. Title I – Reopening American Capital Markets to Emerging Growth Companies
Title I of the JOBS Act is most commonly referred to as the “IPO On-Ramp” legislation. This is because it is meant to encourage certain companies to go public through a process that is less onerous than the current process.
Title I amends Section 2(a) of the Securities Act and Section 3(a) of the Exchange Act of 1934 (the “Exchange Act”) by creating a new category of issuer called an “emerging growth company” or an “EGC.” An EGC is an issuer with total annual gross revenues of less than $1 billion and would continue to have this status until: (a) the last day of the fiscal year in which the issuer had $1 billion in annual gross revenues or more; (b) the last day of the fiscal year following the fifth anniversary of the issuer’s initial public offering; (c) the date on which the issuer has, during the previous three year period, issued more than $1 billion in non-convertible debt; or (d) the date when the issuer is deemed to be a “large accelerated filer” as defined by the SEC. An issuer will not be able to qualify as an EGC if it first sold its common stock in an IPO prior to December 8, 2011. Below is a summary of some of the most significant benefits conferred to EGCs by Title I, which became effective immediately upon the enactment of the JOBS Act.
- 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. Additionally, an EGC is exempt from the requirement that its auditor attest to, and report on, management’s assessment of the effectiveness of the company’s internal controls.
- 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. EGCs also are exempt from certain new disclosure requirements under the Dodd-Frank Act, including the pay-versus-performance disclosure and the pay-ratio disclosure.
- The JOBS Act amends Section 5 of the Securities Act to explicitly permit EGCs or persons acting on their behalf to communicate orally or in writing with QIBs or institutions that are accredited investors prior to or following the filing of a registration statement. These oral or written communications will allow the EGCs to “test the waters” to gauge potential investor interest in advance of a public offering.
- An EGC, prior to its IPO, will be permitted to submit a draft registration statement with the SEC for confidential nonpublic review by the staff of the SEC.
IV. Title III – Crowdfunding
Crowdfunding permits entrepreneurs to pool money from individuals who have a common interest in contributing to a venture. If such an effort involves the sale of securities then the offering must be registered or must rely on an exemption. Title III provides an exemption that could apply to crowdfunding offerings. This Title 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. 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 SEC identifies are ineligible to use this exemption. The JOBS Act directs the SEC to issue final rules to implement the new exemption by January 13, 2013.
Issuers relying on the crowdfunding exemption will be obligated to provide to investors and file with the SEC, among other things, 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.
V. Title IV – Small Company Formation
This Title amends the small issuer exemption of the Securities Act, i.e., Section 3(b), by substantially increasing the dollar threshold for a Regulation A-style offering. Pursuant to Section 3(b)(2), an issuer will be able to offer and sell up to $50 million in securities within a 12 month period in reliance on the exemption. Such securities will be offered and sold publicly (without restrictions on the use of general solicitation or general advertising) and will not be “restricted securities.” The issuer may “test the waters” or solicit interest in the offering prior to filing any offering statement with the SEC, subject to any additional conditions or requirements that may be imposed by the SEC. This amendment to Section 3(b) requires implementing rules to be issued by the SEC and the JOBS Act does not impose a deadline for rulemaking.
VI. Exchange Act Registration Thresholds
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 and become subject to the Exchange Act’s reporting requirements, from 500 persons to either (a) 2,000 persons or (b) 500 persons who are not accredited investors. Section 501 also increases the total assets threshold under Section 12(g) from $1 million to $10 million, but because the SEC has previously exempted the equity securities of issuers having less than $10 million in total assets from registration, as a practical matter the asset threshold remains unchanged. This amendment to Section 12(g)(1) became effective immediately upon the enactment of the JOBS Act. 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. In frequently asked questions released on April 11, 2012, the SEC’s Division of Corporation Finance clarified that although the SEC is required to adopt rules to revise the definition of “held of record,” there is no specified timetable for this rulemaking and such regulations are not necessary for the change to be legally effective.