The Jobs Act of 2012 — An Overview of the Principal Regulatory Reforms to Federal Securities Laws

 

April 12, 2012

 

On April 5, 2012, the Jumpstart Our Business Startups Act of 2012 was signed into law (“JOBS Act”).  The JOBS Act makes several significant changes to the federal securities laws designed to facilitate capital raising by smaller companies and to reduce the regulatory burden on these companies.

 

These changes include:

  • reducing the regulatory burden on “emerging growth companies” seeking to go public by means of an initial public offering

  • permitting general solicitation and general advertising in private offerings exempt under Rule 506 of Regulation D provided all purchasers of securities sold are accredited investors and resales of securities to qualified institutional buyers under Rule 144A

  • permitting startup businesses to raise capital through a broker-dealer or an SEC registered portal under new “crowdfunding” provisions of the JOBS Act

  • increasing the aggregate amount of securities that may be sold under Regulation A to $50 million 

  • increasing the threshold for registration of an issuer’s class of equity securities under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)

 

Certain of these provisions become effective immediately while other provisions require SEC rulemaking.  The SEC has issued certain guidance with regard to those provisions of the JOBS Act that became effective immediately.  This guidance is available on the SEC’s web site.

 

Reduced Regulatory Burden on Emerging Growth Companies

 

Definition of “Emerging Growth Company”

 

The JOBS Act reduces certain regulatory burdens on a company that is an “emerging growth company” (“EGC”). 

 

An EGC is defined as a company with total annual gross revenue of less than $1 billion during its most recently completed fiscal year.  An issuer that is an EGC as of the first day of that fiscal year continues to be an EGC until the earliest of:

  • the last day of the fiscal year during which it had total annual gross revenue of $1 billion

  • the last day of the fiscal year following the fifth anniversary of the date of the first sale of equity securities pursuant to an effective registration statement under the Securities Act of 1933, as amended (the “Securities Act”)

  • the date on which it has, during the previous three year period, issued more than $1 billion in non-convertible debt, or

  • the date on which it is deemed a large accelerated filer

 

A company shall not be an EGC if the first sale of equity securities pursuant to an effective registration statement under the Securities Act occurred before December 8, 2011.  This will serve to exclude from the definition many existing public companies that might otherwise meet the definition of an EGC.

 

Reduced Disclosure and Reporting Obligations

 

The JOBS Act reduces the regulatory disclosure and reporting burden on EGCs by exempting them from:

  • the requirement to include certain executive compensation disclosure in their IPO registration statements, instead requiring them to provide the reduced executive compensation disclosure applicable to “smaller reporting companies”

  • the requirement to provide three years of audited financial statements in Form S-1 and Form F-1 IPO registration statements, instead requiring them to provide two years of audited financial statements and two years selected financial data

  • the restriction on written or oral communications with potential investors that are qualified institutional buyers or institutions that are accredited investors prior to or following the date of filing of an IPO registration statement (the new “test the waters provision under new Section 5(d))

 

Also, the JOBS Act permits an EGC, prior to its initial public offering date, to confidentially submit to the SEC a draft Securities Act registration statement for confidential nonpublic review by the staff of the SEC prior to public filing, provided the initial confidential submission and all amendments thereto are publicly filed with the SEC not later than 21 days before the date on which it conducts a road show.

 

The SEC staff has issued guidance regarding the confidential submission of registration statements.  On April 5, 2012, the staff issued guidance regarding certain logistical requirements applicable to confidential submissions, including the medium to be used for such submissions, the address of for such submissions, and certain other requirements.

 

On April 10, 2012, the SEC staff of the Division of Corporation Finance issued certain Frequently Asked Questions (FAQs) regarding the confidential submission process.  The FAQs clarified that:

  • the confidential submission process is not available for the filing of a Form 10

  • the process is available to foreign private issuers

  • the Securities Act filing fee is due at the time of the first filing of the registration statement on Edgar

  • the draft registration statement does not need to be signed or to include an auditors consent, although it is to be noted that the draft will need to include a signed audit report and exhibits

  • the draft registration statement will need to be filed on Edgar if the company proceeds with the offering, initially as exhibits to the first registration statement filed on Edgar

  • an EGC that is in registration at the time of the enactment of the JOBS Act may switch to the confidential submission procedure

  • a confidential submission does not constitute the filing of a Securities Act registration statement for purposes of Section 5(c), which prohibits pre-filing offers

  • a communication pursuant to Rule 134 is not permitted until the Securities Act registration statement is filed with the SEC

 

The FAQs also state that an EGC need not regard a communication pursuant to the new “test the water” provision in new Section 5(d) of the Securities Act to be a road show triggering the 21-day filing deadline.  If an EGC does not conduct a road show, it must publicly file its registration statement no later than 21 days before the anticipated date of effectiveness of its registration statement.

 

Public Company Reporting Exemptions for EGCs

 

The JOBS Act exempts EGCs from certain public reporting requirements, including:

  • exempting EGCs from the requirement, under Section 14A(a) and (b) of the Exchange Act, to hold stockholder advisory votes on executive compensation and golden parachute compensation.  A company that loses its EGC status is required to hold a “say on pay” vote not later than the earlier of:

    • in the case of an issuer that was an EGC for less than two years after its IPO, three years after losing such status

    • in the case of all other issuers, one year after losing such status

  • exempting EGCs from Section 14(i) of the Exchange Act that requires issuers to disclose the relationship between executive compensation paid and financial performance of a company and the ratio between annual total compensation of the CEO and median annual total compensation of all employees

  • exempting EGCs from complying with new or revised accounting standards until the date that a private company is required to comply with such standards

  • exempting EGCs from any PCAOB rule regarding mandatory auditor rotation or expanded audit report, or any additional rules adopted by the PCAOB after the date the JOBS Act was enacted unless the SEC determines that the application of such additional requirements is necessary or appropriate in the public interest

  • exempting EGCs from the requirement to include auditor attestation of a company’s internal controls over financial reporting

 

An EGC may opt out of any exemption under the JOBS Act and comply with the requirements applicable to a company that is not an EGC. However, if an EGC elects to opt out of the exemption from compliance with new or revised financial accounting standards, it must do so at the time the company is first required to file a registration statement, periodic report, or other report with the SEC under Section 13 of the Exchange Act and notify the SEC of such choice, may not select some standards and not others but must comply with all such standards, and must continue to comply with such standards for as long as it is an EGC.

 

Research Reports

 

The JOBS Act significantly reduces the restriction on research related to EGCs.  Under the new provisions, the publication or distribution of a research report regarding an EGC that is the subject of a proposed public offering of equity securities of the EGC pursuant to a registration statement it proposes to file or has filed, or that is effective, is not considered an offer to buy or sell a security, even if the broker-dealer issuing the report is participating in or will participate in the registered offering. 

 

The JOBS Act also prohibits the SEC and any national securities association registered under the Exchange Act from adopting or maintaining regulations prohibiting any broker, dealer or member of a national securities association  from publishing or distributing a research report on an EGC within any period of time following the IPO date of an EGC or before the expiration of any lock-up agreement between the broker, dealer or member of a national securities association and the EGC or its shareholders.

 

Effectiveness of New Provisions

 

The foregoing provisions do not require the SEC to issue any implementing rules and become effective immediately.  As a result, EGCs going public following the JOBS Act’s enactment should expect to have a somewhat lower cost of going public pursuant to an IPO and a lower cost of being a public company.

 

Amendments to Regulation D and Rule 144A

 

Within 90 days of enactment, the JOBS Act requires the SEC to:

  • amend Rule 506 of Regulation D to eliminate the restriction on general solicitation and general advertising for offers and sales of securities pursuant to Rule 506 of Regulation D provided that all purchasers of the securities are accredited investors

  • amend Rule 144A to permit securities sold under the rule to be offered to persons other than qualified institutional buyers, including through general solicitation and advertising, provided the securities are only sold to qualified institutional buyers

 

The JOBS Act also amends Section 4 of the Securities Act to provide that offers and sales of securities under Rule 506 shall not be deemed public offerings as a result of general advertising or general solicitation.

 

Market participants should continue to rely on existing Rule 506 and Rule 144A safe harbors until the SEC adopts amendments to such rules.  Also, market participants should continue to satisfy applicable conditions of safe harbors, including Rule 135c, Rule 142 and Rule 155, and certain SEC guidance regarding the integration of concurrent public and private offerings, certain SEC CDIs, and no action letters, including the Black Box and Squadron, Ellenoff, Plesent & Lehrer no action letters.

 

Crowdfunding Provisions

 

Crowdfunding is the use of the internet and social media to raise capital from a large number of people in small amounts.  The JOBS Act amends Section 4 of the Securities Act to provide for a new crowdfunding transactional exemption from the registration requirements of the Securities Act.  The transactional exemption is set forth in a new Section 4(6) of the Securities Act.

 

The conditions for reliance upon the new transactional exemption include the following:

  • the aggregate amount sold to all investors (including in reliance upon the Section 4(6) exemption) during the 12 month period preceding the date of the transaction does not exceed $1 million

  • the aggregate amount sold to a single investor does not exceed (the “per investor investment limit”):

    • the greater of $2,000 or 5% of the annual income or net worth of the investor if the annual income or net worth of the investor is less than $100,000, and

    • 10% of the annual income or net worth of the investor not to exceed a maximum aggregate amount sold of $100,000 if the annual income or net worth of the investor is equal to or more than $100,000

  • the transaction is conducted through a broker or a funding portal that complies with the requirements of Section 4A(a)

  • the issuer complies with the requirements of Section 4A(b)

 

Section 4A(a) – Requirements Applicable to Crowdfunding Intermediaries

 

In order for a transaction to be exempt under new Section 4(6) of the Securities Act, it is required to be conducted through a broker or a funding portal. New Section 4A(a) requires:

  • the broker or funding portal to be registered with the SEC and any applicable self-regulatory organization

  • the intermediary to provide such disclosures, including disclosures related to risk and other investor education materials, as the SEC by rule shall determine

  • the intermediary to ensure that each investor:

  • review investor education information in accordance with standards established by SEC rule

  • positively affirm that the investor understands that the investor is risking the loss of the entire investment  and that the investor could bear the loss

  • answer questions demonstrating an understanding of the level of risk applicable to investments in startups, emerging businesses, and small issuers, the risk of illiquidity and such other matters as the SEC shall determine by rule

  • take measures to reduce the risk of fraud with respect to the transactions as established by the SEC by rule, including obtaining a background and securities enforcement regulatory history check on each officer, director and 20% holder of the equity securities of the issuer

  • not later than 21 days before the day on which securities are first sold to any investor, make available to the SEC and to potential investors any information provided by the issuer pursuant to Section 4A(b) (see below)

  • ensure that all offering proceeds are only provided to the issuer when the aggregate capital raised from all investors is equal to or greater than a target offering amount and allow all investors to cancel their commitments to invest as the SEC shall determine by rule

  • make such efforts as the SEC determines by rule to ensure that no investor during a 12 month period has purchased securities that exceed the per investor investment limit referred to above

  • comply with investor privacy or protection of information requirements adopted by the SEC

  • not compensate promoters, finders or lead generators for providing the broker or funding portal with the personal identifying information of potential investors

  • prohibit its directors, officers or partners from having a financial interest in an issuer using its services

  • meet such other requirements as the SEC may by rule prescribe

 

Section 4A(b) – Requirements Applicable to Crowdfunding Issuers

 

Under new Section 4A(b) of the Securities Act, each crowdfunding issuer is required to file with the SEC, provide to the crowdfunding intermediary, and make available to potential investors:

  • its name, legal status, physical address and website address

  • the names of its directors, officers and each stockholder owning more than 20% of its shares

  • a description of its business and business plan

  • a description of its financial condition

  • for offerings that, together with all other offerings by the issuer under Section 4(6) during the preceding 12 months that have in the aggregate, target offering amounts of:

    • $100,000 or less – the issuer must provide income tax returns for the most recent year and financial statements certified by the principal executive officer

    • more than $100,000 but less than $500,000 – financial statements reviewed by an independent public accountant

    • more than $500,000 (or such other amount as the SEC may establish) – audited financial statements

  • a description of the use of proceeds of the offering

  • target offering amount, the deadline to reach the target offering amount, and regular updates regarding progress in meeting such target amount

  • the price to the public of the securities or the method for determining the price

  • a description of the ownership and capital structure of the issuer

 

Crowdfunding issuers will be required to file with the SEC and provide to investors reports of the results of their operations and financial statements, in compliance with rules to be adopted by the SEC.

 

The new crowdfunding exemption is not available to non-US issuers, public reporting companies, or investment companies.  Also, the SEC is required to adopt rules within 270 days disqualifying certain intermediaries and issuers from relying upon the Section 4(6) exemption.

 

Crowdfunding investors are to be excluded from the new shareholder cap under Section 12(g) of the Exchange Act.

 

Restrictions on Advertising and Compensation

 

A crowdfunding issuer may not:

  • advertise the terms of the offering, except for notices directing investors to the intermediary

  • compensate or commit to compensate any person to promote its offerings through communications channels provided by a broker or funding portal without taking such steps as the SEC shall by rule require to ensure that such person discloses the receipt of such compensation

 

Resale Restrictions

 

Securities issued pursuant to a Section 4(6) exemption may not be transferred during the one year period beginning with the date of purchase, except to, or as part of:

  • the issuer

  • an accredited investor

  • a member of the family of the purchaser in connection with the death or divorce of the purchaser

  • an offering registered with the SEC

 

The securities may be subject to such additional restrictions as the SEC may establish by rule.

 

Blue Sky

 

Securities issued in reliance upon Section 4(6) are “covered securities” for purposes of Section 18(b)(4) of the Securities Act thereby exempting them from state blue sky registration requirements (but not from the anti-fraud provisions of such laws).

 

Amendments to Regulation A

 

The JOBS Act requires the SEC to amend Regulation A, among other things, to increase the amount of securities that may be sold in a Regulation A offering during a 12 month period to $50 million and to make certain other rule changes, including a requirement that issuers must file audited financial statements.  No deadline for the rulemaking was established.

 

Increase in Exchange Act Registration Threshold

 

The JOBS Act amends Section 12(g) of the Exchange Act to increase the shareholder threshold at which a company must register under the Exchange Act and excludes certain shareholders in meeting such threshold.  This should enable private companies to raise equity capital from a larger number of investors before triggering the registration requirements under the Exchange Act.  Prior to the amendments, an issuer was required to register under the Exchange Act once it had $10 million or more in assets and its equity securities were held by 500 or more security holders.

 

Section 12(g)(1)(A) was amended to provide that an issuer  (other than a bank or bank holding company) must register a class of equity securities under the Exchange Act within 120 days after the last day of its first fiscal year on which:

  • it had total assets exceeding $10 million, and

  • the class of equity securities was held of record by either

    • 2,000 persons, or

    • 500 persons who are not accredited investors

 

The JOBS Act also adds a new Section 12(g)(1)(B) applicable to an issuer that is a bank or bank holding company.  A bank or bank holding company must register a class of equity securities under the Exchange Act within 120 days after the last day of its first fiscal year ended after

April 5, 2012, on which:

  • it had total assets exceeding $10 million

  • the class of securities is held of record by 2,000 persons

 

Securities held by persons who received the securities under an employee compensation exempt from registration under Section 5 of the Securities Act are not to be deemed “held of record” for purposes of Section 12(g)(1).  The SEC is required to revise the definition of “held of record” pursuant to Section 12(g)(5) to implement the foregoing amendments  although the JOBS Act did not specify a timetable for this rulemaking.

 

The foregoing amendments became effective immediately upon enactment of the JOBS Act.

For more information, please contact: 
 

Neil R.E. Carr                                                               
Direct Dial: +1 202 587 2983                                       
neil.carr@somertons.com                                             

 

Kathleen L. Cerveny

Direct Dial: +1 202 779 9507

kathleen.cerveny@somertons.com

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