KCSA PUBLIC RELATIONS, INVESTOR RELATIONS BLOG
Posted by Paul Sagan on April 13th, 2012
A transformational piece of legislation for IPOs, public companies and emerging startups
Last Thursday, President Obama signed into law one of the most significant pieces of legislation for emerging and newly public companies in a generation.
The JOBS Act (Jumpstart Our Business Startups), passed by Congress in an overwhelmingly bipartisan fashion, has the potential to fundamentally change the way companies access and receive funding from the public markets. It creates a new class of public companies under the Securities Act of 1933 and the Securities Exchange Act of 1934, rewrites restrictions on private placements, creates a novel online funding mechanism for entrepreneurs and small companies, relaxes regulatory requirements for public issuers and expands the Regulation A threshold for “mini” public offerings.
While a number of provisions of the JOBS Act will not take effect immediately, and the SEC has only just begun accepting comments from the public, the significance and breadth of this legislation cannot be underestimated.
Organized into six primary Titles, perhaps the most far-reaching is Title I — Reopening American Capital Markets to Emerging Growth Companies, often referred to as the “IPO on-ramp.” Effective immediately, this provision of the Act creates a new category of issuer under federal securities laws: the emerging growth company (EGC).
EGCs have annual gross revenues of less than $1 billion, and after an IPO, have less than $700 million in publicly traded shares held by non-affiliated holders. These values are significant as they would have typically included the vast majority of companies going public over the past several years.
EGCs will initially be exempt from a broad range of requirements typically imposed on companies pursuing an IPO, including certain provisions of the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Act of 2010, for up to five years following their first sale of common equity. These include:
- Going public with only two years of audited financial statements rather than three;
- Confidential, non-public SEC review of company registration statements for IPOs, with final registration statements publicly filed 21 days before the road show;
- Dramatically eased IPO communications restrictions – allowing communications with institutional and accredited investors to “test the waters” for an IPO;
- Freer involvement with research analysts – allowing research to be published while the IPO registrations are pending, even if the investment bank is part of the underwriting syndicate; and
- Exemption from a number of compensation disclosure requirements, as well as Dodd-Frank Act “say-on-pay” voting.
In addition, emerging companies will not have to “rotate” their auditors or have them “attest” to the financial reporting controls in their Form- 10K filings and will be not be required to comply with new U.S. GAAP accounting standards until these become applicable to privately held companies.
All told, these provisions will help smaller companies significantly reduce the costs of going public and complying with the various rules and regulations of public company life. And, by allowing emerging companies to file with the SEC confidentially, and to test the waters for going public without running afoul of “gun jumping” rules, more firms can potentially see if the process is indeed advantageous for them, without having to disclose confidential business information or be embarrassed should their IPO be cancelled or delayed.
Title II, the Access to Capital for Job Creators Act requires the SEC to revise Rule 506 of Regulation D within 90 days to eliminate the ban on general solicitation and general advertising in certain private placements sold to accredited investors or qualified institutions. This is potentially a major change to current U.S. securities regulations, which have prohibited soliciting prospective investors through media and public appearances, except in the context of a registered public offering.
Depending on the SECs final rulemaking, issuers may be able to advertise offerings online, and in print or other media, as long as they exclude non-accredited investors and otherwise comply with the requirements of Rule 506. This may have implications as well for existing public companies seeking capital through private offerings or PIPE transactions and may also allow hedge funds to “advertise” their offerings.
Title III, or the CROWDFUND Act authorizing “crowdfunding,” has to date drawn the most attention from the general media, perhaps due to the recent popularity of crowdfunding sites like Kickstarter and indiegogo. This Act will potentially allow entrepreneurs to solicit small investments directly from both accredited and non-accredited investors, through a “crowdfunding intermediary,” a broker or a funding portal registered with the SEC.
Under the proposed provisions, a private company or entrepreneur may issue up to $1 million of restricted stock in any twelve-month period without triggering the registration requirements of the Securities Act of 1933. Small investors, with an annual income under $100,000, could only invest up $2,000 or 5% (whichever is greater) of their income. Larger investors (annual income over $100,000), could invest up to 10% of their annual income, up to a maximum of $100,000.
This is one of the most controversial provisions of the JOBS Act, due to contentions by critics that it will raise the specter of rampant online fraud against unsophisticated investors. Indeed the long title of the Act, “Capital Raising Online while Deterring Fraud and Unethical Non-Disclosure Act of 2012” speaks to this potential.
The Act does propose a number of provisions to guard against fraud, including: requirements to protect investor privacy; disclosures to investors regarding the risk of loss; requiring investors to answer questions demonstrating understanding of the risks; and obtaining background checks on the officers and directors of an issuer and anyone holding more than 20% of an issuer’s equity.
However, the Act would preempt state securities regulations (Blue Sky Laws) by making crowdfunded offerings “covered securities” and potentially limiting a layer of oversight. In addition, trading platforms for these crowdfunded securities would be exempt from a number of typical broker/dealer regulations.
This will no doubt remain a controversial section of the Act, and the SEC has up to 270 days to release rules for the crowdfunding exemption and crowdfunding portal regulations.
Title IV, or the Small Company Capital Formation Act, directs the SEC to look at increasing the current $5 million limit on small company Regulation A exempt offerings to $50 million in any twelve-month period. Offerings under Reg. A are often referred to as “mini” public offerings because they do not trigger certain filing obligations under the Securities Exchange Act of 1934 or the other “full bore” burdens of the Sarbanes-Oxley Act.
The continuing trend of reverse mergers into public shells as a means of tapping the public equity markets indicates a desire by small companies to have a public market in their securities. In the past, Reg. A was a relatively little-used exemption because of the $5 million offering limit, but with the proposed $50 million size, this may become a more useful option to small companies seeking to go public without the costs or complexities of Exchange Act reporting. This Title, however, will require SEC rulemaking before it becomes operative.
And finally, Titles V and VI, the Private Company Flexibility and Growth and Capital Expansion Acts, immediately increase the number of stockholders of record that a company may have before it must register with the SEC (and become subject to reporting and other requirements under the Securities Exchange Act) from 500 to 2,000. The Act specifically excludes from this number holders of employee compensation plan securities or those who purchased shares under the new crowdfunding exemptions mentioned above.
The previous 500-stockholder requirement was famously cited as one of the reasons for Facebook’s hotly anticipated IPO, and recently Facebook COO Sheryl Sandberg stated to members of Congress the Company would not have filed to go public when it did if this new provision of JOBS Act had been in place last year.
Given some of the inevitable delays in SEC rulemaking for the JOBS Act, the ultimate impact of the Act on both the public and private markets remains to be seen. And other regulatory bodies, such as FINRA and the North American Securities Administrators Association, will no doubt be studying this legislation for their own rulemaking efforts. Investment banks indeed may be wary of changing their IPO practices to take advantage of the Acts’ provision pending final guidance.
But certainly, for companies and entrepreneurs requiring capital, the Act creates a new environment to navigate – one that has both enormous potential opportunities and pitfalls.