The other global warming: the impact of the JOBS Act on foreign issuers
The recently enacted Jumpstart Our Business Startups (JOBS) Act has provided foreign issuers with a much warmer welcome in the US. The JOBS Act was signed into law in the United States by President Obama on 5 April 2012 and, while it began with a distinctly domestic focus, the legislation will benefit foreign issuers that seek to access the US capital markets. This article examines the beneficial aspects of the Act for foreign issuers.
Background to the JOBS Act
The JOBS Act intends to recalibrate the balance of regulation in the US. For years now, business leaders have noted that the regulatory requirements to be met in order to finance companies in the US have become overly burdensome. Commentators have observed that more emerging companies were choosing to remain private longer and deferring initial public offerings or pursuing other liquidity alternatives, like M&A opportunities. Foreign issuers that may once have regarded a US IPO as the "gold standard" were choosing foreign exchanges for their initial listings. Recent studies, including a report published by the private sector IPO Task Force, pointed to the particularly dramatic decline in the number of IPOs undertaken by smaller or emerging companies during the last ten years in the US. Various legislative initiatives had been advanced that were intended to promote capital formation and encourage entrepreneurial activity by easing certain regulatory requirements. These initiatives were subsumed into the JOBS Act, which moved swiftly through the US Congress in March 2012. The JOBS Act introduces the concept of a transitional "on-ramp" for emerging growth companies to encourage them to pursue IPOs by phasing in compliance measures over time following their IPOs. The legislation includes a measure that amends the Securities Act of 1933 (Securities Act) to permit companies to conduct offerings that raise up to US$50 million through a "mini-registration" process similar to Regulation A. The JOBS Act also modifies the triggers for SEC reporting obligations. Currently, Section 12(g) of the Securities Exchange Act of 1934, as amended (Exchange Act), mandates SEC reporting (even in the absence of a company having conducted a public offering) once a company has 500 or more shareholders of record and the company has total assets in excess of US$10 million. The JOBS Act also modifies the prohibition against "general solicitation and general advertising" in connection with private placements, and provides an exemption under the Securities Act for "crowd funding" offerings. Foreign issuers will be able to benefit from all of these changes, except the ability to rely on crowd funding.
The IPO process for foreign issuers
Foreign issuers that are considering accessing the US capital markets have a number of financing alternatives. As a preliminary matter, a foreign issuer must choose between undertaking a public offering in the US, which would have the result of subjecting the issuer to ongoing securities reporting and disclosure requirements, and undertaking a limited offering that will not subject the issuer to US reporting obligations. A public offering in the US offers distinct advantages for foreign issuers. The US public markets remain among the most active and deepest equity markets in the world. However, in recent years, many foreign issuers may have been discouraged by the regulatory burdens associated with being a US reporting company, including those imposed by the Sarbanes-Oxley Act and more recently by the Dodd-Frank Act. For foreign issuers that qualify as emerging growth companies, the calculus may now have changed.
What is an EGC?
The JOBS Act creates a category of issuer, an "emerging growth company" (EGC), that may take advantage of certain newly created accommodations under the securities laws. An EGC is an issuer that had total annual gross revenues of less than US$1 billion (or the foreign currency equivalent, calculated on a US GAAP or IFRS basis) during its most recently completed fiscal year. An EGC would continue to be considered an EGC until the earliest of:
The last day of the fiscal year during which it had total annual gross revenues of at least US$1 billion.
The last day of the fiscal year following the fifth anniversary of the initial public offering of its equity.
The date on which it has, during the previous three-year period, issued more than US$1 billion in non-convertible debt.
The date on which it is considered to be a "large accelerated filer" under the Exchange Act.
What are the benefits of EGC status?
The JOBS Act liberalises the IPO process for EGCs. For example, an EGC is permitted to submit a draft IPO registration statement for confidential review by SEC staff prior to making a public filing, provided that the initial confidential submission and all amendments are publicly filed with the SEC not later than 21 days before the EGC commences a "road show." For years, foreign issuers were permitted to make confidential submissions of their IPO registration statements. However, in December 2011, the SEC reversed this policy and announced it would only review initial registration statements on a confidential basis where the issuer is: a foreign government registering its debt securities; a foreign private issuer that is listed or is concurrently listing its securities on a non-US securities exchange; a foreign private issuer that is being privatized by a foreign government; or a foreign private issuer that can demonstrate that the public filing of an initial registration statement would conflict with the law of an applicable foreign jurisdiction. Setting this guidance aside, foreign issuers that qualify as EGCs will be able to submit their registration statements confidentially to the SEC. Practitioners may want to consider that a foreign issuer could have two confidential submission alternatives available to it, if the foreign issuer qualifies as an EGC but also would be entitled to confidential submission pursuant to the SEC's revised 2011 guidance. As an EGC, the foreign issuer would be subject to the requirement to make a public filing 21 days prior to road show commencement, which does not technically apply to non-EGCs that are foreign issuers.
An EGC may elect to provide only two (rather than three) years of audited financial statements and a correspondingly reduced Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) in a registration statement related to a common equity IPO. Going forward, an EGC may elect to omit selected financial data and MD&A information for any period prior to the earliest period for which audited financial statements were presented in the IPO registration statement. In its recent guidance, the SEC has confirmed that these exemptions will be available to foreign private issuers. Of course, an EGC will want to discuss with its counsel and other IPO advisers whether it should provide additional (optional) disclosures for prior periods. In some instances, an issuer may want to include information for prior periods for competitive reasons, or to illustrate a trend affecting its business. Also, to the extent a foreign issuer already is listed and reporting in its home country, information for prior periods may be readily available and already published.
"Testing the waters" communications
The JOBS Act relaxes certain of the restrictions on communications prior to and during the offering process. The JOBS Act permits an EGC, or a person acting on its behalf, whether before or after the filing of a registration statement, to "test the waters" and gauge market interest in a potential offering by engaging in oral or written communications with potential investors that are QIBs or institutional accredited investors. The issuer will want to consider carefully the types of discussions that it will conduct while it is in registration even within this new, more flexible rubric. For example, an issuer will want to consider whether it is comfortable sharing, on a confidential basis, with institutional investors information for periods prior to those presented in its registration statement or information that is more detailed than that which will be included in the registration statement. Investors in receipt of information that is material and that will remain non-public may be restricted from trading on the basis of that information even after the IPO. For a foreign issuer that is already public, these questions may be tackled more easily in that detailed information will be available through its home country filings. Institutions contacted during this test-the-waters process may be interested in making a private investment in the company prior to the IPO. The issuer and its counsel will want to structure the private investment carefully, considering the type of securities that will be offered, the purchase price and other terms.
The JOBS Act promotes research coverage of EGCs by relaxing many prohibitions relating to research that were adopted in the aftermath of the tech bubble. The JOBS Act permits investment banks to publish and distribute research reports about an EGC that may be conducting an IPO either prior to the filing of the IPO, during the IPO, or immediately following the IPO. The research report will not be deemed to constitute an "offer", even if the broker-dealer publishing the report is participating or will participate in the IPO. The JOBS Act also relaxes many of the restrictions on communications between research and banking at investment banks in order to facilitate diligence or other discussions about EGCs. Certain investment banks that are subject to a court-ordered settlement relating to the conduct of research may be required to obtain further relief in order to benefit from the loosening of the prohibitions on joint research/banking communications. Foreign issuers may be accustomed to pre-deal research reports in their home countries; however, it is not clear whether banks will make use of the ability to publish research prior to the completion of an issuer's IPO. Also, for foreign issuers that are already reporting companies in their home countries, it is not clear whether US underwriters will make use of published research in connection with the issuer's US IPO.
Phase-in of governance requirements
An EGC also will be able to defer its compliance with various governance requirements, including, in the case of a domestic US issuer, newly adopted "say-on-pay" and related provisions imposed by the Dodd-Frank Act. A domestic or foreign EGC will not be subject to the requirement for an auditor attestation of internal controls pursuant to Section 404(b) of the Sarbanes-Oxley Act. Most of the other governance requirements, such as the requirement that management establish, maintain, and assess internal control over financial reporting, and CEO and CFO certifications, remain in place for an EGC. An EGC also will not be required to comply with any new or revised financial accounting standard until the date that such accounting standard becomes broadly applicable to private companies. An EGC will be subject to a transition period for any required PCAOB mandatory audit firm rotation and any supplemental audit report information requirement, unless the SEC determines that such requirement is necessary and appropriate for investor protection.
Exempt offerings by foreign issuers
Given the registration requirements that are applicable to issuers that register their securities with the SEC, many issuers choose to access the US capital markets through targeted financings exempt from the registration requirements of the securities laws. Foreign issuers may avail themselves of these exemptions to raise capital from US investors. Likewise, foreign private issuers that already are US reporting companies may choose to rely on exempt offerings to raise additional capital. Regulation D was intended to facilitate capital formation by providing issuers with a safe harbour from the Securities Act registration requirements. Because Regulation D provides a non-exclusive safe harbour from registration, an issuer that fails to satisfy the objective criteria of Regulation D may still be in a position to rely on the broader Section 4(2) private placement exemption. Over time, issuers have come to place great reliance on Rule 506 of Regulation D, which permits issuers to sell their securities in a private placement to an unlimited number of accredited investors, provided that issuers comply with the general requirements of Regulation D. Rule 502(c) of Regulation D prohibits the issuer or any person acting on its behalf to offer or sell securities by any form of general solicitation or general advertising. Even prior to the JOBS Act, the SEC had been considering whether this prohibition against general solicitation had become outmoded given the prevalence of internet communications and the use of social media. The JOBS Act requires that the SEC undertake rule-making to revise the prohibition against general solicitation. Within 90 days following enactment of the JOBS Act, the SEC must revise Rule 506 to make the prohibition against general solicitation or general advertising contained in Rule 502 inapplicable in the context of Rule 506 offerings, provided that the issuer takes reasonable steps to verify that all purchasers in the offering are accredited investors. Also within the same time period, the SEC must revise Rule 144A(d)(1) to permit the use of general solicitation or general advertising in connection with Rule 144A offerings. During this interim period, issuers should continue to implement the customary safeguards in connection with any Rule 506 or Rule 144A offering.
Cross-border private placements and Rule 144A offerings
Many foreign issuers that are not US reporting companies rely on institutional debt placements as financing alternatives. An institutional debt placement may offer a cost-efficient financing alternative. Most investors in institutional private placements are US financial institutions, with insurance companies being the most common. In some cases, non-US institutional investors also may participate. Typically, the issuer offers debt securities directly to a limited number of institutional investors through a placement agent. Though institutional private placements may be conducted in reliance on Rule 144A, the issuers in these institutional debt offerings generally rely on Section 4(2). Practitioners may or may not rely on Rule 506 in connection with these transactions. Practitioners should note that the JOBS Act does not amend Section 4(2) of the Securities Act. As a result, at the outset of a transaction, the issuer and its advisers will want to consider whether the transaction will be conducted in reliance on Rule 506 (to take advantage of the additional flexibility to use general solicitation) or in reliance on Section 4(2), in which case, no general advertising or general solicitation may be used.
Rule 144A/Regulation S offerings
A foreign issuer also may conduct a Rule 144A offering. A Rule 144A offering may be structured as a standalone, or one-time, offering, or frequent issuers may often establish a Rule 144A continuous offering programme for their debt securities. The relaxation of the prohibition on general solicitation in the context of a Rule 144A offering may be helpful to foreign issuers. However, many Rule 144A offerings or continuous offering programmes include a contemporaneous Regulation S offering component for sales to non-US persons. The JOBS Act did not address the prohibition contained in Regulation S against "directed selling efforts". A general solicitation may be regarded as a directed selling effort. In the absence of additional guidance or clarification from the SEC, practitioners may be reluctant to encourage issuers to avail themselves of the additional flexibility for offering communications for combined Rule 144A/Regulation S offerings.
US reporting companies often rely on private placement transactions, or PIPE transactions, to raise additional capital when the public markets are not hospitable. Typically, a PIPE transaction will be structured as a Section 4(2)/Regulation D placement of securities. To the extent that the issuer is relying on Rule 506, it may now be able to take advantage of the greater flexibility for communications; however, should the issuer fail to meet the conditions for the Regulation D safe harbour, if it has engaged in general solicitation, it likely will not be able to rely on the Section 4(2) private offering exemption. Generally, an issuer will want to avoid premature public disclosures relating to a proposed PIPE transaction, until the issuer has entered into definitive purchase agreements with investors. As a result, the issuer may not avail itself of the ability to engage in broader communications and will likely choose to enter into confidentiality undertakings with potential PIPE purchasers, and defer a public announcement.
The JOBS Act amends Section 3(b) of the Securities Act, which provides an exemption from registration for certain smaller public offerings. The SEC is required to undertake rule-making to implement the changes to Section 3(b)(2), which may include revising existing Regulation A. Pursuant to the Section 3(b)(2), an issuer will be able to offer and sell up to US$50 million in securities within a 12-month period in reliance on the exemption. The issuer may offer equity securities, debt securities, and debt securities convertible or exchangeable for equity interests, including any guarantees of such securities. The securities sold pursuant to the exemption will be offered and sold publicly (without restrictions on the use of general solicitation or general advertising) and will not be "restricted securities". The issuer may "test the waters" or solicit interest in the offering prior to filing any offering statement with the SEC, subject to any additional conditions or requirements that may be imposed by the SEC. The securities will be considered "covered securities" for NSMIA purposes (and not subject to state securities review) if: the securities are offered and sold on a national securities exchange, or the securities are offered or sold to a "qualified purchaser". Existing Regulation A is available only to issuers organised in the US and Canada. It is not clear whether new and improved Regulation A, or Regulation A+, will be available to other foreign issuers.
Whether or not the US Congress was focused on the importance of reducing the burdens associated with accessing the US capital markets to foreign issuers, the JOBS Act is likely to do exactly that. After over a decade of making it progressively more challenging for small and mid-cap foreign issuers to access the US capital markets, Congress has taken an important first step towards a warmer offering climate for foreign issuers.