On April 5, 2012, President Obama signed legislation creating the “Jumpstart our Business Start-ups Act”, otherwise known as the “JOBS Act”. The JOBS Act aims to ease regulations on certain securities issuers, as well as facilitate an increase in the Initial Public Offering market through certain registration exemptions.
The Act seeks to alleviate regulatory burdens and facilitate investment in several significant ways, including:
- Designating certain companies who had less than $1 billion in gross revenue in their last fiscal year as “Emerging Growth Companies”, lowering hurdles such companies’ face when registering an IPO, and reducing certain disclosure requirements post-registration;
- Eliminating the prohibition on general solicitation and general advertising in certain private issuances including Rule 506 under Regulation D and Rule 144A offering, as long as purchasers of such securities are accredited investors (in the case of 506 offerings) or qualified institutional buyers (in the case of 144A offerings);
- Raising the threshold number of shareholders that triggers the need to register under the Exchange Act of 1934 requiring registration only when a company has more than $10 million in assets and their securities are held by either 2,000 shareholders of record or 500 persons who are not accredited investors;
- Expanding the permitted aggregate sale in any 12-month period under Regulation A from $5 million to $50 million, with certain additional reporting requirements; and
- Creating a new “Crowdfunding” exemption, aimed primarily at facilitating online fundraising, whereby by private issuers will be exempt from registration requirements if not more than $1 million in securities are sold in any 12-month period and securities sold to any individual investor are capped at certain levels based on that investor’s net-worth or income.
General Advertising/General Solicitation in 506 Offerings
Currently, a private placement relying on a Rule 506 exemption under Regulation D or a Rule 144A exemption is prohibited from utilizing a “general solicitation” or a “general advertisement”. The JOBS Act lifts this prohibition, allowing general solicitation and general advertising in connect with a Rule 506 or Rule 144A offering including the use of internet and traditional publications.
The JOBS Act also permits the operation of a platform or mechanism that offers for sale, purchase or negotiation without first having to register as a broker-dealer as long as the operator does not hold any securities or investor funds, receive compensation in relation to sales, and is not otherwise statutorily disqualified.
Regulation A Expansion
Under current law a Regulation A offerings by non-public companies is capped at $5 million in any 12 month period. Moreover, there is no Blue Sky pre-emption to lower registration costs. The JOBS Act increases the cap on Regulation A offerings to $50 million in any 12 month period. Additionally, offerings made pursuant to Regulation A will be considered federally covered securities and thus exempt from Blue Sky regulation if the issuer is registered on a stock exchange. Issuers will also be permitted to solicit interest in the offering prior to filing any offering statement.
However, the JOBS Act does institute additional regulation for Regulation A offerings, including:
- Requiring any issuer relying upon Regulation A to file audited financial statements annually;
- Permitting the SEC to, in its rule making authority, to require issuers relying upon Regulation A to file periodic reports and/or require audited financials to be included in Regulation A offering documents; and
- Attaching section 12(a)(2) liability regarding materially misleading offering documents.
In order for a transaction to qualify for the exemption provided for in the Crowdfunding section of the JOBS Act, the aggregate amount of all securities sold by the issuer in the preceding 12 month period must be less than $1,000,000. Additionally, the aggregate amount sold to any individual investor is limited in the following ways:
- If either the annual income or net worth of the individual investor is less than $100,000, the amount sold to such investor may not exceed the greater of $2,000 or 5% of the investor’s net worth or annual income; and
- If either the net worth or annual income of the individual investor is greater than $100,000, the amount sold to such investor may not exceed 10% of the investor’s net worth or annual income, with a maximum of $100,000.
Offers made in reliance on this exemption are required to be made through either a registered broker/dealer or through a “funding portal.” A funding portal is defined as an intermediary in a transaction specifically involving in a crowdfunded offering that does not:
- Offer investment advice;
- Solicit purchases, sales or offers to buy the securities offered or displayed on its website or portal;
- Compensate employees or agents for such solicitation or sales of securities offered on its website or portal;
- Hold, manage, possess, or otherwise hand investor funds or securities; or
- Engage in other activities as outlined by the SEC.
Additionally, any offering made pursuant to this exemption will be required to set a target offering amount and a deadline for reaching such target. Any placement relying upon this exemption may not publically advertise except to direct prospective investors to the funding portal or broker/dealer. Moreover, any investors in crowdfunded offerings will not be permitted to transfer such securities for one year unless to the issuer, an accredited investor or pursuant to an offering registered with the SEC.
Reliance upon the crowdfunding exemption will require filing with the SEC and disclosure to investors of certain information, including:
- Information regarding the issuer’s financial condition, the extent to which is dependent on the size of the offering:
- If the aggregate total target amounts of all offerings relying upon this exemption during the preceding 12 months does not exceed $100,000, the issuer is required to provide income tax returns for the most recently completed year and executive certified financial statements;
- If the aggregate total target amounts of all offerings relying upon this exemption during the preceding 12 months exceeds$100,000, but do not exceed $500,000, the issuer is required to provide financial statements as reviewed by an independent public accountant;
- If the aggregate total target amounts of all offerings relying upon this exemption during the preceding 12 months exceeds $500,000, the issuer is required to provide audited financial statements.
- A description of the business and business plan;
- A description of the use of proceeds from the offering;
- The price of the securities or the method to be used to price the securities prior to closing;
- The target offering amount;
- A description of management including officers, directors and each holder of more than 20% of the issuer’s shares; and
- A description of ownership and capital structure.
Following any crowdfunded offering, the issuer will be required to both file with the SEC and provide to investors reports of the results of operations and the financial statements of the issuer in a form to be determined by the SEC.
As part of the design meant to facilitate online investment in companies Congress has permitted intermediaries such as registered broker/dealers or funding portals to offer sales relying upon this exemption as long as these intermediaries:
- Register with the SEC;
- Register with any applicable Self-Regulatory Organization;
- Take measures to reduce risk of fraud (as outlined by the SEC);
- Provide investors with disclosures and education materials as required by the SEC and assure and confirm investors’ understanding of such materials;
- Ensure offering proceeds are provided to the issuer only when the target amount is achieved and permit investors to cancel their investments;
- Do not compensate promoters, finders or lead generators for identifying potential investors; and
- Ensure investors do not exceed their individual investment cap.
States will not be permitted to charge a filing fee for crowdfunded offerings unless 50% or more of the securities sold in the offering are sold to residents of that state. The states’ ability to undergo enforcement actions was not materially altered.
The Act outlines how liability will be assessed in claims brought by investors of crowdfunded offerings. Issuers are liable for investors’ losses which arise due to the issuer’s material misstatement of fact or omission made in connection with the offering, provided that the purchaser did not know of such misstatement or omission. The issuer can defend against liability if it can prove it did not know of such misstatement or omission and should not have known if reasonable care was exercised.
Threshold for Shareholder Triggered Registration Raised
Currently, a company who has both 500 shareholders of record and $10 million in assets is required to file periodic reports with the SEC under the Exchange Act of 1934. The JOBS Act raises the shareholder portion of the threshold to 2,000 total shareholders or 500 shareholders who are not accredited investors, while maintaining the $10 million asset threshold.
Additionally, the definition of the term “shareholder of record” will be changed to not include both those who receive stock as part of an employee stock option plan and those who receive funds under the crowdfunding exemption and thus do not count towards the shareholder count.
Easing Regulation of Initial Public Offerings for Emerging Growth Companies
The JOBS Act creates a new category of reporting company entitled an “Emerging Growth Company” (“EGC”). An EGC is a company that in its latest fiscal year had revenues of less than $1 billion and has not priced its IPO prior to December 8, 2011. A company will remain an ECG for a maximum of five years after their first sale via its IPO and this period will only be shortened should the company realize revenue of $1 billion in an earlier year or realize a “public float” of its common equity of $700 million or more.
Certain regulations placed on regular IPOs will be lifted for IPOs registered by EGC’s, including:
- An EGC can meet with Qualified Institutional Buyers and institutional accredited investors prior to or while a registration statement is pending in order to gauge interest;
- An EGC can file its registration statement with the SEC on a confidential basis as long as the filing is made public at least 21 days prior to the first road show;
- An EGC will only be required to provide two years of audited financial statements in its IPO registration statement and “Selected Financial Data” for only those years;
- An EGC will not be required to include an auditor attestation to their financial reporting controls in their annual Form 10-Ks;
- An EGC will only be required to disclose executive compensation data that is required of Smaller Reporting companies and will be exempt from the increased compensation disclosure requirements of the Dodd-Frank Act of 2010;
- An EGC will not be required to hold “say on pay” shareholder votes or provide executive compensation ratios as required by the Dodd-Frank Act of 2010.
In addition, certain restrictions on what research analysts and investments banks can publish about an IPO they are underwriting are lifted. Investment banks are permitted to publish research reports in connection with an EGC’s IPO, even if they are part of the underwriting group, as such reports will no longer be considered an offer for sale nor an offer to sell a security. Research analysts will also be permitted to attend meetings and communicate with management of ECGs in connection with an IPO offered by the EGC.
Congress’ intention in passing this bill was to provide capital to entrepreneurs to spur job growth. Whether or not job growth will actually occur is yet to be seen, however, it certainly provides businesses with increased access to capital, albeit not to the extent one might think. While the easing of regulations on the IPO process for EGC’s will certainly make accessing capital far easier for many smaller to mid-cap companies, Congress’ attempt to facilitate Rule 506, 144A and Regulation A offerings may be hindered by the onerous regulations attached. Moreover, the caps on crowdfunding as well as liability attached to offering documents associated with such offers may chill issuer interest in such offerings.
However, the bill recognizes the value of permitting companies to access small investors via the internet and that the restriction on general solicitation and advertising in certain private offerings is outdated an unnecessary hindrance. In the end, the true value of the JOBS Act will be realized after the SEC completes its new rulemaking responsibilities.