The House of Representatives yesterday voted 380-41 to approve the Jumpstart Our Business Startups Act (H.R. 3606) (the “JOBS Act”), which was previously approved by the Senate by a vote of 73-26. The JOBS Act is now headed to President Obama, who is expected to sign it into law. Many of its provisions take effect immediately without further rule-making by the Securities and Exchange Commission (“SEC”) or other agencies. This bipartisan legislation is designed to stimulate job growth by making it easier and less costly for smaller companies to raise capital in the United States through a loosening of regulatory restrictions applicable to private offerings, initial public offerings and certain newly public companies.
Changes to Private Company Regulations and Rules
The JOBS Act:
- Increases the thresholds at which companies are required to register under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), (i) from $1 million to $10 million in total assets and (ii) from 500 to 2,000 holders of record of a class of securities, if no more than 500 holders of record are unaccredited (disregarding for each such threshold individuals holding securities pursuant to an employee compensation plan).
- Requires the SEC to revise Rule 506 within 90 days following the enactment of the JOBS Act to eliminate the ban on general solicitation and general advertising in certain private placements that are sold only to accredited investors or qualified institutions.
- Provides small companies with a new method of raising capital called “crowdfunding,” which has been popularized by online platforms such as Kickstarter and Profunder, by allowing issuers to raise up to $1 million within any 12-month period from investors without triggering the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”), as long as the transactions are made through an SEC-approved broker or funding portal. The crowdfunding rules also contain:
- Annual Caps: For an investor with annual income or net worth below $100,000, the investor’s annual investment in crowdfunded securities is capped at $2,000 or 5% of the investor’s annual income or net worth. For an investor with annual income or net worth above $100,000, the aggregate annual investment is capped at 10% of the investor’s annual income or net worth.
- Regulations Applicable to Funding Portals and Brokers of Crowdfunded Securities: Funding portals and brokers of crowdfunded securities must register with the SEC and must comply with several requirements intended to reduce fraud, including: (i) protecting investor privacy; (ii) providing disclosures to investors regarding the risk of loss; (iii) requiring investors to answer questions demonstrating understanding of the risks; and (iv) obtaining background checks on the officers and directors of an issuer and anyone holding more than 20% of an issuer’s equity.
- Restrictions on Issuers: Companies selling crowdfunded securities are prohibited from advertising their issuances outside the funding portal or broker. In addition to periodic follow-on filings with the SEC, an issuer must provide the SEC with an initial filing that includes: (i) a description of the business and its financial condition; (ii) income tax and financial statements; and (iii) descriptions of the ownership and capital structure of the business. Issuers will be liable for material misstatements or omissions made in the course of issuing their securities.
The crowdfunding provisions of the JOBS Act will be effectuated following a 270-day SEC rule-making period to
reconcile the practical differences between the JOBS Act and the current rules and enforcement actions of the SEC
and other regulatory bodies.
- Expands the exemption available to “small issue” securities under the Securities Act by increasing the registration exemption from $5 million to $50 million. Small issue securities under this exemption will be unrestricted and may be publicly offered and sold, so long as the issuer files audited financial statements with the SEC and complies with other terms or conditions set by the SEC. An issuer using the exemption is required to make periodic disclosures to investors and the SEC regarding its finances, operations and other corporate matters. States may not regulate small issue securities if the security is sold on a national securities exchange or offered or sold to a qualified purchaser.
Impact on the Process of Going Public
- Emerging growth companies, or companies with gross annual revenue of less than $1 billion during their most recently completed fiscal year that are not large accelerated filers, will be permitted to:
- provide two years of audited financial statements in S-1 or F-1 registration statements instead of three years;
- confidentially file S-1 or F-1 registration statements and subsequent amendments with the SEC, provided the initial confidential submission and all amendments are publicly filed at least 21 days prior to the IPO “roadshow” (which preserves the level playing field between domestic and foreign private issuers established by the SEC in December 2011, but in a manner closer to the treatment historically afforded to foreign private issuers); and
- hold meetings prior to or during a public offering with institutional accredited investors and qualified institutional buyers to “test the waters” to determine whether such investors might have an interest in a contemplated securities offering without being subject to current “gun-jumping” restrictions on pre-offering communications.
- Investment banks are permitted to publish or distribute research reports about an emerging growth company that proposes to file a registration statement or is in registration even if the investment bank is participating or will participate in the offering.
Phase-In for Newly Public Emerging Growth Companies
The JOBS Act provides for a phase-in of certain regulations applicable to public companies, including certain provisions of the Dodd-Frank Act of 2010 and the Sarbanes-Oxley Act of 2002. An issuer will not qualify as an emerging growth company if it first sold its common stock in an IPO prior to December 8, 2011. An issuer will be able to retain its status as an emerging growth company until the earliest of: (i) the last day of the fiscal year in which its total gross revenues exceeded $1 billion; (ii) the last day of the fiscal year following the fifth anniversary of its first sale of common equity pursuant to an effective registration statement; (iii) the date on which such issuer has, during the previous three-year period, issued more than $1 billion in non-convertible debt; and (iv) the date on which such issuer is deemed to be a “large accelerated filer.” We expect the SEC to provide additional guidance on the transition to an emerging growth company for those issuers currently in registration and those that have gone public during the period between December 8, 2011 and the enactment of the JOBS Act.
Emerging growth companies are not subject to:
- the requirement to seek annual approval of executive compensation, commonly referred to as a “say-on-pay” vote, in proxy or consent materials;
- new or revised financial accounting standards until such date as the accounting standard becomes broadly applicable to private companies; or
- the requirement for an auditor attestation of internal controls pursuant to Section 404(b) of the Sarbanes-Oxley Act (although the CEO and CFO of an emerging growth company will still be responsible for establishing and maintaining internal controls over its financial reporting and certifying to those internal controls in its periodic filings).
The JOBS Act also requires the SEC to conduct a review of Regulation S-K (which contains disclosure rules applicable to both offerings under the Securities Act and periodic reporting under the Exchange Act) and to report to Congress within 180 days following the enactment of the JOBS Act with rule-making proposals to modernize and simplify the registration process and reduce the costs and other burdens of these rules for emerging growth companies.
Existing public companies that seek to raise capital through private offerings or PIPE transactions will also be impacted by the changes related to Rule 506 offerings described above.
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The JOBS Act is intended to significantly impact a wide range of companies, including start-ups seeking to raise their first funds, cash-strapped technology and life science companies seeking additional financing or access to the public markets, and newly public companies trying to reduce the high costs of being a reporting company. As with other recent attempts to reform these regulatory regimes, the impact of such broad efforts may ultimately look different from what the drafters originally intended. We expect the SEC to respond with additional rulemaking as well as clarifications and guidance and will be tracking those developments as well as the reactions of companies and market participants to this new regulatory landscape. Please contact your Goodwin Procter LLP attorney or any of the attorney contacts listed here with questions or concerns.