Congress Passes Capital Formation Reform Bill (JOBS Act)

Practical Law Legal Update 6-518-5849 (Approx. 8 pages)

Congress Passes Capital Formation Reform Bill (JOBS Act)

by PLC Corporate & Securities

On-ramp to the Capital Markets for Emerging Growth Companies (IPO On-ramp)

The JOBS Act will exempt emerging growth companies from certain federal securities regulations.

The IPO On-ramp provisions are immediately effective and are not dependent on the SEC adopting rules implementing these provisions.

Definition and Status of Emerging Growth Companies

The Act defines an emerging growth company as a company with annual gross revenues of less than $1 billion during its most recent fiscal year. This definition does not exclude foreign private issuers.

A company will retain emerging growth company status and the reduced regulatory and reporting requirements associated with it until the earliest of:

The first fiscal year after its annual revenues exceed $1 billion.
The first fiscal year following the fifth anniversary of its IPO.
The date on which the company has, during the previous three-year period, issued more than $1 billion in non-convertible debt.
The first fiscal year in which the company achieves large accelerated filer status.

Even if it meets the criteria set out in the definition above, an existing public company will not be deemed an emerging growth company if it completed its IPO on or before December 8, 2011.

Exemptions for Emerging Growth Companies

Emerging growth companies will be exempt from:

Section 14A(a) and (b) of the Exchange Act, implemented by Section 951 of the Dodd-Frank Act, which require companies to hold stockholder advisory votes on executive compensation and golden parachute compensation.
Section 14(i) of the Exchange Act and Section 953(b)(1) of the Dodd-Frank Act, neither of which have been implemented yet, which require companies to disclose:
- the relationship between executive compensation actually paid and the financial performance of the company; and
- the ratio between the annual total compensation of the CEO and the median of the annual total compensation of all employees of the companies.
The requirement to provide three years of audited financial statements in their Form S-1 or F-1 IPO registration statements. Instead, emerging growth companies need only present two years of audited financial statements. In addition, in any later registration statement or periodic report, an emerging growth company would not need to provide selected financial data for any period before the earliest audited period presented in its IPO registration statement.
Compliance with new or revised accounting standards, until those standards are applicable to private companies.
The requirement to provide certain other executive compensation disclosure under Item 402 of Regulation S-K. Instead, an emerging growth company must only comply with the provisions of Item 402 applicable to smaller reporting companies.
Section 404(b) of the Sarbanes-Oxley Act, which requires auditor attestation of a company's internal controls and procedures.
Any PCAOB rules regarding mandatory audit firm rotation or an expanded auditor report.
Restrictions on communications ahead of public stock offering filings, provided the emerging growth company or any person authorized to act on its behalf communicates only with potential investors that are qualified institutional buyers (QIBs) or institutions that are accredited investors. This change would allow emerging growth companies to "test the waters" before proceeding with a contemplated offering.
The requirement to publicly file an IPO registration statement. Instead, an emerging growth company could confidentially submit its registration statement and any amendments to the SEC, provided the initial confidential submission and all related amendments are publicly filed at least 21 days before any road show. Currently it is unclear whether SEC comment letters, and corresponding company response letters, related to the staff's review of an EGC's IPO registration statement will be made public via the EDGAR system after the IPO is completed.

The JOBS Act also relaxes rules relating to research reports on emerging growth companies. The JOBS Act also prohibits certain restrictions on research analysts reporting on emerging growth companies both before and after completion of IPOs.

Regulation D and Rule 144A General Solicitation

The JOBS Act requires the SEC to amend Regulation D of the Securities Act to remove the prohibition on general solicitation and general advertising contained in Rule 502(c) as it applies to offerings under Rule 506, provided that all purchasers of the securities are accredited investors. However, an issuer conducting a Rule 506 offering relying on general solicitation or advertising will be required to take reasonable steps to verify that the purchasers are accredited investors.

In addition, the JOBS Act requires the SEC to amend Rule 144A under the Securities Act to permit securities sold under Rule 144A to be offered to non-QIBs, including by general solicitation or general advertising, provided that sales of the securities are only made to persons the seller (or any person acting on its behalf) reasonably believes to be QIBs.

The SEC must revise Rule 506 and Rule 144A within 90 days after the date of enactment.

In addition, the JOBS Act provides that any person acting to bring issuers and potential purchasers together for a Rule 506 offering will not be required to register with the SEC as a broker or dealer if that person complies with certain requirements, including that it may not:

Receive any compensation in connection with the purchase or sale of the securities.
Have possession of customer funds or securities in connection with the purchase or sale of the securities.

Crowdfunding

The JOBS Act adopts a new registration exemption under Section 4 of the Securities Act for crowdfunding.

The SEC must issue rules necessary to implement the crowdfunding conditions and other provisions of this section of the JOBS Act within 270 days after the date of enactment.

Conditions for Crowdfunding

The new crowdfunding exemption will allow issuers to sell unregistered securities to the public if:

The total amount sold by the issuer, including amounts sold in reliance on this crowdfunding exemption during the preceding 12 months, does not exceed $1 million.
The aggregate amount sold to any single investor by the issuer, including amounts sold in reliance on this crowdfunding exemption during the preceding 12 months, does not exceed:
- the greater of $2,000 or 5% of the annual income or net worth of that investor, if either the annual income or net worth of the investor is below $100,000; and
- 10% of the annual income or net worth of the investor, up to a maximum aggregate amount sold of $100,000, if either the annual income or net worth of the investor is $100,000 or more. A natural person's income and net worth is to be calculated for these purposes using the SEC rules used to measure the income and net worth of an accredited investor.
The transaction is conducted through a broker or funding portal that complies with the requirements of new Section 4A(a) of the Securities Act, which include:
- registering with the SEC as a broker or a "funding portal" and with any applicable self-regulatory organization;
- providing any disclosure, including disclosure related to risks and other investor education materials, as the SEC may require by rule;
- taking measures to reduce the risk of fraud, including background and securities enforcement regulatory checks on the officers, directors and 20% shareholders of each issuer whose securities it offers and any other requirements the SEC may adopt;
- ensuring that the issuer may only receive the offering proceeds when the aggregate capital raised from all investors equals or exceeds a targeted offering amount, and permit all investors to cancel their commitments to invest, as the SEC may, by rule, determine appropriate; and
- undertaking any efforts the SEC may require to ensure that no investor purchases an amount of crowdfunding securities during any 12-month period that, in the aggregate, from all issuers, exceeds the per-investor limit described above.
The issuer complies with the requirements of new Section 4A(b) of the Securities Act, under which each crowdfunding issuer must file with the SEC, provide to investors and the broker or funding portal, and make available to potential investors, information about itself and the crowdfunding offering, including:
- a description of its financial condition. The level of detail of the required disclosure depends on the level of crowdfunding activity undertaken by the issuer during the preceding 12 months. For offerings that, together with all other crowdfunding offerings by the issuer in the past 12 months, have, in the aggregate, target offering amounts of $100,000 or less, the issuer must provide income tax returns for its most recently completed year and financial statements certified by the principal executive officer. If the target offering amounts exceed $100,00 but are less than $500,000, the issuer must provide financial statements reviewed by a public accountant that is independent of the issuer. For offerings with target offering amounts exceeding $500,000 (or such other amount as the SEC may establish by rule) in total in the past 12 months, the issuer must provide audited financial statements; and
- the price to the public of the securities or the method for determining the price. Before each sale, each investor must receive written notice of the final price and all required disclosure, with a reasonable opportunity to rescind its purchase commitment.

The crowdfunding exemption from the registration requirements of the Securities Act is not available to an issuer that:

Is not organized under the laws of a US state or territory or the District of Columbia.
Is a public company, required to file reports with the SEC under Section 13 or Section 15(d) of the Exchange Act.
Is an investment company or is excluded from the definition of investment company by Section 3(b) or 3(c) of the Investment Company Act of 1940.

Other Provisions

The crowdfunding section of the JOBS Act imposes additional requirements, including:

Restriction on resales. An investor cannot transfer securities acquired in a crowdfunding offering for one year from the date of purchase, except in limited circumstances.
Exemption from blue sky laws. Securities sold under the crowdfunding provisions of the JOBS Act will be considered covered securities under Section 18(b)(4) of the Securities Act and exempt from state blue sky registration requirements, but would be subject to state enforcement authority.
Exclusion from shareholder cap. Securities acquired in a crowdfunding offering are not deemed to be held of record for purposes of Section 12(g) of the Exchange Act (see General Shareholder Threshold for Exchange Act Registration). Any person holding those securities is excluded from the record holder calculation.

Exemption of Certain Securities (Small Company Capital Formation)

The JOBS Act adopts a new exemption from registration under Section 3(b) of the Securities Act for certain types of securities. This new exemption is in addition to existing Regulation A.

The SEC will be required to issue rules or regulations to exempt securities that are offered in compliance with certain terms and conditions, including:

The aggregate amount of securities issued under this exemption within the past 12 months does not exceed $50 million.
Other terms and conditions that the SEC may determine necessary for investor protection, which can include a requirement that the issuer file with the SEC and deliver to prospective investors an offering statement, on any terms or conditions that the SEC may prescribe, including audited financial statements and other information about the issuer.

Securities to be issued under this exemption:

May be offered and sold publicly.
Will not be considered restricted securities.
Will be considered covered securities under Section 18(b)(4) of the Securities Act and exempt from state blue sky registration requirements if the securities are offered or sold:
- on a national securities exchange; or
- to qualified purchasers (to be defined by the SEC).

Issuers relying on this exemption:

Must be required to file audited financial statements with the SEC annually.
May solicit interest in the offering before filing any offering statement, on any terms and conditions that the SEC may prescribe.
May be required to file periodic disclosures with the SEC about its business operations, financial condition and other matters.

The new exemption requires the SEC to issue implementing rules or regulations, but the JOBS Act does not specify a timeframe for this rulemaking.

General Shareholder Threshold for Exchange Act Registration

The JOBS Act amends Section 12(g)(1) of the Exchange Act to increase the registration threshold for issuers that are not banks or bank holding companies. This revised threshold applies to foreign private issuers as well.

An issuer will be required to register a class of equity securities under the Exchange Act within 120 days after its fiscal year end if on the last day of that fiscal year:

Its total assets exceed $10 million.
The class of securities is held by either 2,000 persons or 500 persons who are not accredited investors.

In addition, securities held by employees who received them under an employee compensation plan in a transaction exempt from registration are not deemed to be held of record for purposes of the record holder calculation under Section 12(g). Securities issued under the new crowdfunding exemption are also excluded from the Section 12(g) record holder calculation (see Crowdfunding).

The JOBS Act requires the SEC to issue rules relating to the definition of "held of record" and a safe harbor for determining whether their employees can be excluded from the definition, but does not specify a timeframe for this rulemaking.

Shareholder Threshold for Bank and Bank Holding Company Exchange Act Registration

The JOBS Act further amends Section 12(g) of the Exchange Act to modify the registration threshold for issuers that are either a bank or a bank holding company. A bank or bank holding company will be required to register a class of equity securities under the Exchange Act within 120 days after its fiscal year end if on the last day of that fiscal year:

Its total assets exceed $10 million.
The class of securities is held by 2,000 or more persons.

The JOBS Act also amends Section 12(g) and Section 15(d) of the Exchange Act to permit deregistration and suspension of reporting obligations, respectively, in the case of a bank or a bank holding company if the number of record holders of that security falls below 1,200 persons (instead of the 300 person threshold applicable to all other issuers).

The SEC must issue rules implementing these provisions within one year from the date of enactment.

Congress Passes Capital Formation Reform Bill (JOBS Act) | Practical Law