Latest Congressional Action on Securities | JOBS Act Loosens Regulation on Smaller Companies Securities requirements in the United States tend to ebb and flow, so that a period of increasing restrictions is followed by a decade of loosening restrictions. Congress propels these changes as lawmakers respond to market needs and political tides. April 2012 marks the latest change, as the imaginatively named Jumpstart Our Business Startups Act (JOBS) introduces legislation that allows small companies to grow before having to register securities or stage an initial public offering (IPO). The JOBS Act also reduces reporting requirements for up to five years after an IPO. These opportunities include:
• New exemptions to expand ways to sell securities without registration
• Expanded communications opportunities before, during and after IPOs, for qualifying companies
• Reduced reporting requirements for up to 5 years for qualifying companies
These changes abruptly end a decade of amendments which added reporting requirements and enforcement authority, highlighted by 2002’s Sarbanes-Oxley Act and 2010’s Dodd-Frank Act. Those amendments responded to scandals and economic downturns—some of which might be blamed on the loosening of regulations ordered by major statutory revisions during the 1990s, which included expanded safe harbors (Private Securities Litigation Reform Act of 1995) and broader exemptions (Gramm-Leach-Bliley Act of 1999).
Expanding ways to raise capital without an IPO
One key principle behind the JOBS Act is to support entrepreneurs who want to raise capital and expand their companies without going public, and for public companies that want to sell more shares without the requirements of full-blown registration. The JOBS Act creates two new mechanisms to sell shares without an IPO, and eases restrictions on access to several existing mechanisms. Exemptions generally are not mutually exclusive, so a company can mix and match among those it qualifies for to chart management’s preferred pathway forward. Any or all of them allow a company to postpone full-blown Securities and Exchange Commission (SEC) regulation that would follow an IPO.
Allowing “crowdfunding” to raise up to $1 million per year without an IPO
The JOBS Act expands the 1933 Securities Act to add a structure for so-called “crowdfunding” transactions, in which relatively small amounts are solicited from multiple investors through an intermediary, up to a total of $1 million per year. This approach is based on informal fundraising ventures that have been used over the Internet in recent years—with the important distinction that targeted individuals will be making investments, not contributions. The JOBS Act provides the following conditions to qualify for this new exemption:
- Total sales to all investors by the issuer in the 12 months up to the exempt transaction (whether or not made under this exemption) is no more than $1 million.
- Each investor invests no more than the following amount in the 12 months up to the transaction:
— the greater of $2,000 or 5% of the investor’s annual income or net worth, if either is less than $100,000; and
— 10% of the investor’s annual income or net worth, if either is $100,000 or more, and the investor’s investment totals no more than $100,000.
- The transaction is conducted through an “intermediary” (broker or “funding portal”) that complies with newly established registration and reporting requirements.
- The issuer follows information filing, investor notice, and intermediary compensation rules that the SEC is to define.
The JOBS Act codifies these provisions in the 1933 Act under new sections 4(a)(6) and 4A. These provisions include “crowdfunding” in section headings but do not actually define that term. Maybe the SEC will do so in its regulations.
Allowing companies to grow and acquire more investors without an IPO
Section 12(g) of the Securities Exchange Act of 1934 already allows limited sales of equity securities (but not debt) by companies with assets and total shareholders below specific thresholds, without requiring the company to register the securities and go public. These thresholds have slowly risen over time, sometimes because Congress revises Section 12(g) and sometimes because the SEC revises its implementing regulations.
The JOBS Act codifies the SEC’s latest asset threshold and raises the shareholder threshold. Now, a company does not have to go public until it has more than:
- $10 million in total assets (raising the permanent statutory level from just $1 million, to match the level the SEC has allowed since 1996); and
- 500 persons who are not “accredited investors” (including individuals with a net worth of at least $1 million and/or income at least $200,000, the company’s officers and directors, and a variety of organizations), or 2,000 persons who are accredited investors (this raises the threshold from 500 investors of all types).
This change will allow small companies to expand their network of investors before going public.
Allowing “general solicitation and advertising” in private placements to accredited investors
Companies already sell “restricted securities” to unlimited numbers of “accredited investors” without registration (under the SEC Regulation D). Issuers must comply with SEC requirements that define these terms and establish notice and financial reporting requirements (chiefly filing of Form D). The JOBS Act directs the SEC to change one of these requirements by removing a prohibition against “general solicitation” or “general advertising” in these offerings.
Allowing non-registered offerings up to $50 million
The JOBS Act adds a new Section 3(b)(2) to the 1933 Act, empowering the SEC to exempt a qualifying class of equity, debt or convertible securities from registration requirements, if the following conditions are also met:
- The issuer can offer and sell no more than $50 million in securities under this exemption in any 12-month period.
- The securities may be offered and sold publicly.
- The securities must not be “restricted securities” within the meaning of the Securities Acts and SEC regulations.
- The issuer may solicit interest in the offering prior to filing any offering statement, in compliance with applicable SEC requirements.
- The issuer must file audited financial statements annually with the SEC.
- Parties must comply with other applicable requirements that the SEC may establish by rulemaking.
These new provisions are considerably looser than the SEC’s existing Regulation A rules, offering conditional exemptions for small issues.
Reducing requirements on “emerging growth companies,” before an IPO and for up to 5 years after an IPO
Another key principle of the JOBS Act is to reduce compliance burdens on companies that are ramping up their public operations. The JOBS Act provides a company that qualifies under a new category called “emerging growth companies” with up to five years of reduced reporting and regulation, even after an IPO. The Act adds new definitions for this term in both the 1933 and 1934 Acts, with the following criteria. The company:
- Has registered its first sale of common equity with the SEC within its past 5 fiscal years;
- Has annual revenues no more than $1 billion (this amount will be indexed to inflation);
- Has issued no more than $1 billion in non-convertible debt within any rolling 3-year period; and
- Does not qualify as a “large accelerated filer” under SEC rules (primarily: total market float value of shares held by non-affiliates is less than $700 million).
All these provisions are optional, but the company must notify the SEC if it chooses to comply with generally requirements rather than use these exemptions and shortcuts. None is retroactive past December 8, 2011—therefore a company with an IPO before that date cannot qualify. However, one that had its registration in process with the SEC as of that date, can withdraw or revise its filings.
Facilitating pre-IPO activities
While working on an IPO, the JOBS Act offers some facilitation not available to most companies:
- Permission for broker-dealer research reports relating to a proposed or completed IPO (Previous to the JOBS Act, such offers to sell shares would normally trigger compliance requirements.);
- Permission for broker-dealer and securities analyst participation in pre-IPO communications, which are usually barred to prevent conflicts of interest;
- Permission for expanded communications to “test the waters” with potential investors; and
- Opportunity to submit a draft registration to the SEC for confidential review, at least 21 days before pre-IPO “road shows” or an IPO.
Easing requirements after the IPO
While you’re growing your company toward that $1 billion ceiling, the JOBS Act offers the following streamlining of reporting rules applicable to most public companies:
- Exemption from “say on pay” provisions that require company proxies to offer shareholders non-binding votes on executive compensation;
- Exemption from enhanced executive compensation disclosure requirements including performance-based pay for executives, and relationship between CEO and other employees’ compensation levels;
- Limit other specified executive compensation reporting requirements to details generally required by companies with market float no greater than $75 million (i.e., as though the company were a non-accelerated filer);
- Reduction of time requirement for reporting historical financial information in registration materials and post-IPO periodic reports to 2 years (from the usual 5 years);
- Exemption from requirement that auditors provide a formal assessment of the company’s internal financial controls; and
- Exemption from any new auditing rules adopted by the Public Company Accounting Oversight Board (PCAOB; which regulates auditors of public companies) unless the SEC approves application to emerging growth companies.
This all sounds great—when can you start?
The statutory changes all became effective when President Obama signed this bi-partisan bill on April 5, 2012. However, taking advantage of these new measures will be delayed until the SEC writes conforming regulations to provide details necessary for compliance.
The JOBS Act assigns SEC deadlines that vary from 90 days to 1 year, but the SEC has already notified Congress that it may not be able to meet all of them—especially since the agency is already heavily engaged in writing regulations to implement the massive regulatory expansions adopted by the Dodd-Frank Act of 2010. The SEC has started accepting comments on all JOBS Act items and is gearing up to create formal rules. Information is available on a dedicated SEC webpage at http://www.sec.gov/spotlight/jobsactcomments.shtml.
 The Sarbanes-Oxley Act of 2002 responded to a series of accounting scandals (particularly Enron’s) by adding stringent new corporate governance, accounting and reporting requirements, and creating the Public Company Accounting Oversight Board to regulate public company auditors. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 responded to near-meltdown of the U.S. and global financial systems with dramatic new regulation of financial firms, and of all parties dealing in recently-developed financial instruments (notably credit default swaps).
 PSLRA tightened procedures and proof requirements for private plaintiffs suing under the federal securities acts, and added “safe harbors” to expand the types of reports and “forward-looking statements” that can be made without fear of being sued. GLBA eliminated a variety of longstanding restrictions on securities-related activities by financial institutions.
About the Author
Jon Elliott is President of Touchstone Environmental and has been a major contributor to STP’s product range for over 25 years. He was involved in developing 16 existing products, and writes quarterly updates for them all.
Mr. Elliott has a diverse educational background. In addition to his Juris Doctor (University of California, Boalt Hall School of Law, 1981), he holds a Master of Public Policy (Goldman School of Public Policy [GSPP], UC Berkeley, 1980), and a Bachelor of Science in Mechanical Engineering (Princeton University, 1977).
Mr. Elliott is active in professional and community organizations. In addition, he is a past chairman of the Board of Directors of the GSPP Alumni Association, and past member of the Executive Committee of the State Bar of California's Environmental Law Section (including past chair of its Legislative Committee).
You may contact Mr. Elliott directly at: firstname.lastname@example.org.