Corporate Services Law Update 03/30/12 Jennifer Eichholz
On March 27, 2012, Congress passed the Jumpstart Our Business Startups Act (the "JOBS Act"), which President Obama is expected to sign promptly. The bill makes important changes to federal securities laws and is intended to increase access to capital for small businesses and to encourage initial public offerings by emerging growth companies. Some elements of the JOBS Act are effective immediately and others will require rulemaking by the Securities and Exchange Commission ("SEC").
Access to Capital
The JOBS Act includes reforms designed to expand opportunities for companies to raise capital in private and public offerings without registration with the SEC under either the Securities Act of 1933 or the Securities Exchange Act of 1934, as follows:
Crowdfunding. The JOBS Act removes current securities law restrictions so as to enable "crowdfunding." Private companies will now be able to raise a limited amount of money from large groups of small investors, whether or not they are accredited, without registration under federal or state securities laws. Such issuers will be required to utilize an SEC-registered broker or a newly created class of SEC-registered funding portals for such crowdfunding offerings. The total amount raised cannot exceed $1,000,000 (or up to $2,000,000 if the company provides audited financial statements) in any 12-month period. The issuer will not be permitted to advertise the terms of the offering, other than notices that direct investors to the broker or funding portal. Both the issuer and intermediary will need to meet certain requirements in order to rely upon this new crowdfunding exemption, including the filing of certain annual and other information with the SEC. Finally, issuers, executives and directors will continue to be liable to purchasers of these securities for any material misstatements or omissions. This provision will require SEC rulemaking in order to become operative.
The annual aggregate amount that an individual may invest in crowdfunding investments is limited to:
- the greater of $2,000 or 5 percent of the investor's annual income or net worth within any 12-month period if either the investor's annual net income or net worth is less than $100,000; and
- 10 percent of the investor's annual income or net worth, not to exceed $100,000, if either the investor's annual net income or net worth is equal to or greater than $100,000.
Limit of Regulation A Offerings Raised From $5 Million to $50 Million. Under the JOBS Act, private companies will now be able to sell up to $50 million in securities in a public offering without having to register with the SEC. The SEC is required to either amend Regulation A (the conditional exemption for small issuances) or adopt new rules to permit the offer and sale of up to $50 million of unrestricted debt, equity or convertible debt securities in any 12-month period without registration under federal securities laws. Regulation A offerings currently allow private companies raising less than $5 million to avoid certain disclosure requirements typically associated with an IPO. One key attraction here is that companies that file under Regulation A do not have to issue the periodic reports to shareholders that are required for conventional publicly held companies. In contrast to the new offering options under crowdfunding, these offerings must comply with state securities laws, unless such securities are offered or sold on a national securities exchange or sold only to qualified purchasers. These offerings will also need to comply with regulations to be issued by the SEC, including the filing of an offering memorandum containing certain required disclosures. Private companies utilizing this new exemption will need to annually file audited financial statements and such other periodic disclosures as the SEC determines. This provision will require SEC rulemaking in order to become operative.
General Solicitation in Regulation D Offerings and Rule 144A Sales. The JOBS Act will lift the current ban on general solicitation or general advertising in private sales exclusively to accredited investors under Rule 506 of Regulation D or exclusively to qualified institutional buyers under Rule 144A. Thus, in these types of offerings, companies and their brokers can advertise the merits of their stock or other securities to the general public. However, the issuer must take reasonable steps to verify the status of persons who actually invest. The JOBS Act also provides that any person who sells securities in a valid private placement under Rule 506 is not subject to broker-dealer registration if the securities are offered on trading platforms that meet certain conditions, including no compensation in connection with the purchase or sale of securities and no possession of customer funds or securities in connection with the purchase or sale of securities. This provision will require SEC rulemaking in order to become operative.
Increase in Number of Shareholders. Under the JOBS Act, a private company may now have 2,000 shareholders of record before it is required to register under the Securities Exchange Act of 1934 and thereby become subject to periodic reporting, proxy rules and other requirements. Of the 2,000, up to 499 may be unaccredited investors. Prior to the JOBS Act, a company was required to register once it has $10,000,000 in assets and 500 shareholders of record. This revision specifically excludes shareholders who received their securities pursuant to an employee compensation plan after the required SEC rulemaking. In addition, the SEC will be required to exempt by rule the shareholders of the securities purchased under crowdfunding. This provision of the JOBS Act is effective immediately.
The JOBS Act contains significant reforms to the initial public offering process for emerging growth companies and exempts these companies from a number of disclosure and other requirements for up to five years following their IPOs, as follows:
Introduction of Emerging Growth Companies. The JOBS Act defines an "emerging growth company" as any issuer with less than $1 billion in revenues in its last fiscal year. This new threshold would have included the substantial majority of companies that went public in the U.S. over the last few years. An issuer will continue to qualify as an emerging growth company until the earliest of:
- the end of the fiscal year in which its revenues exceed $1 billion;
- the end of the fiscal year following the fifth anniversary of its IPO;
- the date on which it has issued more than $1 billion in nonconvertible debt in a three-year period; or
- date it becomes a "large accelerated filer" (which currently includes seasoned issuers with a worldwide public float of $700 million or more).
An issuer that first sold securities in its initial public offering on or prior to December 8, 2011 will not qualify as an emerging growth company.
Changes to the Existing IPO Process. The JOBS Act substantially revises the IPO process as it now exists in relation to emerging growth companies, as follows:
- Financial Information. An emerging growth company will be required to present no more than two years of audited financial statements or selected financial data in its IPO registration statement.
- Communications with Institutional Investors. Emerging growth companies (or persons authorized to act on their behalf) will now be permitted to communicate, orally or in writing, with potential investors that are qualified institutional buyers or institutional-accredited investors to determine whether such investors might have an interest in a contemplated securities offering, both before and after filing or effectiveness of a registration statement.
- Analyst Reports. The publication or distribution by a broker or dealer of research reports about an emerging growth company engaged in a proposed public offering, whether before or after the registration statement has been filed or declared effective, will not constitute an offer for sale even if the broker or dealer is participating in the offering. The existing rules that currently limit the ability of a broker or dealer to publish reports about an emerging growth company during or immediately after the IPO are also relaxed. The JOBS Act will enable communication among analysts and issuers through the elimination of restrictions on who may arrange for communications between securities analysts and investors and by allowing securities analysts to participate in communications with an emerging growth company's management alongside other representatives of a broker or dealer.
- Confidential Review. The JOBS Act will entitle an emerging growth company to confidential nonpublic review by the SEC of its IPO registration statement. Such initial confidential submission and all amendments must be publicly filed 21 days before the start of such company's roadshow.
These "IPO on-ramp" provisions are effective immediately.
Changes to Financial and Disclosure Requirements.The JOBS Act reduces certain disclosure and financial reporting obligations for emerging growth companies:
- Say-on-Pay. An emerging growth company is not required to hold shareholder votes on executive compensation and golden parachutes until one to three years after it no longer qualifies as an emerging growth company.
- Disclosure of Executive Compensation. Under the JOBS Act, emerging growth companies are allowed to disclose executive compensation in the same manner as "smaller reporting companies," which must disclose compensation for only three, not five, executive officers and do not have to provide a compensation discussion and analysis. Also, emerging growth companies are not required to provide the comparison of executive compensation to company performance or a ratio of CEO to median worker pay.
- Regulation S-K. The JOBS Act requires that the SEC review and revise Regulation S-K in order to simplify registration and compliance for emerging growth companies.
- No Auditor Attestation. Auditors of an emerging growth company will not be required to attest to its internal controls under Section 404(b) of the Sarbanes-Oxley Act. This exemption will be available for up to five years after its IPO as long as the issuer is deemed an emerging growth company. Prior to the JOBS Act, companies with a worldwide public float of $75 million or more were required to include an auditor attestation in the second annual report on Form 10-K they file after going public. Under the JOBS Act, emerging growth companies are still required to establish and maintain internal controls and to include CEO and CFO certifications.
- Accounting Standards. Emerging growth companies are not required to comply with any new or revised financial accounting standard until such standard is generally applicable to companies that are not subject to Exchange Act public company reporting. Emerging growth companies may choose to comply with accounting standards to the same extent that a nonemerging growth company is required to comply. If an emerging growth company chooses to comply with nonemerging growth company accounting standards, it will not be able to select certain accounting standards to comply with and not others, but must comply with all such accounting standards.
- Auditor Rotation. Under the JOBS Act, rules that require mandatory audit firm rotation and auditor discussion and analysis that may be adopted by the Public Company Accounting Oversight Board will not apply to emerging growth companies. Nor, unless the SEC otherwise determines, will any future audit rules promulgated by the Public Company Accounting Oversight Board.
These financial and disclosure provisions are effective immediately.
The JOBS Act represents a significant reduction in the restraints that private companies face in raising capital. For many private companies, the JOBS Act will make capital accessible that otherwise would not be, and will allow dramatic expansion without entering the public company reporting scheme under the Exchange Act.
If you have questions regarding the JOBS Act, please contact Steven P. Emerick at (602) 230-5517 / [email protected], Christian J. Hoffmann III at (602) 229-5336 / [email protected], Jennifer Eichholz at (602) 230-5509 / [email protected], Joseph D. Masterson at (414) 277-5169 / [email protected], Ryan P. Morrison at (414) 277-5401 / [email protected], Geoffrey M. Ossias at (602) 229-5231 / [email protected] or your Quarles & Brady LLP attorney.
 H.R. 3606 Jumpstart Our Business Startups Act.