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The JOBS Act Eases Restrictions on Capital Formation

April 6, 2012

On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups Act, or the JOBS Act, which represents the compilation of six different efforts in Congress to make it easier for smaller companies to go public or raise capital in U.S. financial markets. Some of the Act’s provisions became effective immediately upon enactment by the President, while others will require rulemaking—in some cases under tight deadlines—by the Securities and Exchange Commission (SEC).

Emerging Growth Companies

Immediately upon enactment, the JOBS Act creates a new category of issuers called “emerging growth companies” (EGCs), that would be exempt from, or subject to reduced, regulatory requirements for a limited period of time in an effort to encourage them to go public in the United States (the so-called IPO on-ramp provisions). An EGC is defined as an issuer that had total annual gross revenues of less than $1 billion during its most recently completed fiscal year. An issuer that is an EGC on the first day of its fiscal year will remain an EGC until (i) the last day of the fiscal year five years after its initial public offering, (ii) the last day of the fiscal year in which it has annual gross revenues of $1 billion or more, (iii) it has issued more than $1 billion in nonconvertible debt during a three-year period, or (iv) it becomes a “large accelerated filer” (an issuer with a public float of at least $700 million that has been an SEC reporting company for at least one year). The JOBS Act also includes measures intended to ease private capital formation and reduce public reporting requirements for small and emerging businesses.

IPO On-Ramp Provisions. EGCs will benefit from significant changes made to the initial public offering process that are intended to reduce the cost and burden of going public and of complying with public company disclosure obligations. In this regard, an EGC would provide only two years of audited financial information in its IPO registration statement, rather than the three years otherwise required. In addition, an EGC may limit its “selected financial information” from the required five years, to just the earliest audited period presented in its initial registration statement.

Despite recently reversing course in this regard for foreign issuers, however, EGCs will be permitted to submit a draft IPO registration statement to the SEC staff on a confidential basis, as long as the registration statement and any amendments are filed no later than 21 days before the issuer begins its pre-IPO road show for potential investors. This confidential submission process allows an EGC to commence its SEC review process without publicly revealing any financial or business information to potential competitors. Moreover, information described to or obtained by the SEC staff in the course of this confidential review and comment process will not be subject to disclosure under the Freedom of Information Act, and will be deemed to constitute confidential information making it unlawful for any member, officer, or employee of the SEC to disclose such information. 

The JOBS Act also expands permissible pre- and post-filing communications during a securities offering by allowing a person authorized to act on the EGC’s behalf to “test the waters” by engaging in oral or written communications with potential investors that are “qualified institutional buyers” or institutions that are “accredited investors” to determine whether such investors might have an interest in the contemplated securities offering. As such, these communications would not be subject to current “gun jumping” restrictions on pre-filing communications in Section 5(c) of the Securities Act of 1933, or the requirement that any post-filing written communications conform to the prospectus requirements of Section 10 of the Securities Act or the free writing prospectus provisions of Rule 433 promulgated thereunder.

Finally, the JOBS Act permits the publication and distribution of research reports by a broker or dealer covering an EGC that is the subject of a proposed IPO (including participating underwriters), and relaxes restrictions on securities analyst communications. These provisions apply to all public offerings of common stock by EGCs, not just EGC IPOs.

EGC Relaxed and Exempted Disclosures. With respect to reporting executive compensation, an EGC may choose to comply with the reduced disclosure requirements generally available to smaller reporting companies, whether or not it qualifies as a smaller reporting company, or opt-in to the full reporting obligations. As such, an EGC may provide executive compensation information for three (versus five) named executive officers and only for two (rather than three) years in the summary compensation table. More importantly, an EGC need not present a compensation discussion and analysis section. An existing reporting issuer that qualifies as an EGC but not as a smaller reporting company, however, may not take advantage of the scaled executive compensation disclosures.

The JOBS Act exempts an EGC from the requirement to provide a separate, non-binding advisory vote on executive compensation (a “say-on-pay” vote), including golden parachute compensation, until one to three years after it no longer qualifies as an EGC. EGCs are also exempt from certain new not-yet-effective Dodd-Frank disclosure requirements, including the “pay-versus-performance” information showing the relationship between paid executive compensation and the financial performance of the company, as well as the median total compensation of all employees compared to the chief executive officer. 

Of particular significance, EGCs are exempt from Section 404(b) of the Sarbanes-Oxley Act, which requires that auditors attest to, and report on, a management’s assessment of the effectiveness of the company’s internal control structure and procedures for financial reporting; although EGCs still will have to establish and maintain internal controls over financial reporting under Section 404(a). The JOBS Act also exempts EGCs from any rules adopted by the Public Company Accounting Oversight Board that require mandatory audit firm rotation or from complying with new or revised U.S. GAAP accounting standards until the same apply to private companies. 

Crowdfunding

The JOBS Act provides a new exemption from the registration requirements of the Securities Act for certain “crowdfunding” transactions undertaken by any U.S. private company. Crowdfunding describes a capital-raising strategy or process (often via internet platforms), whereby groups of people pool small individual investments, to support the accomplishment of a particular goal. In this regard, the JOBS Act new exemption permits non-reporting issuers to raise up to $1 million in reliance on the exemption within any 12-month period, with a maximum investment per investor of: (a) the greater of $2,000 or 5 percent of the investor’s annual income or net worth within any 12-month period (if either the investor's annual income or net worth is less than $100,000); and (b) 10 percent of the investor's annual income or net worth, not to exceed a maximum amount of $100,000 (if either the investor's annual income or net worth is equal to or more than $100,000).

There are no restrictions on the offer and sale of securities following a crowdfunding offering. Indeed, the JOBS Act specifically provides that nothing in the Act “shall be construed as preventing an issuer from raising capital though methods not described under section 4(6).” Securities purchased under the crowdfunding exemption, however, will be subject to restrictions on transfer and may only be transferred during the first year to the issuer, an accredited investor, in a registered offering or to a family member or in connection with the death or divorce of the buyer, or similar circumstances at the discretion of the SEC.

Funding Portals. The JOBS Act, however, requires a private company raising capital under the crowdfunding exemption to use an intermediary, such as a registered broker dealer or a “funding portal,” to conduct the offering. A “funding portal” is a newly-defined term under the Securities Act: any person acting as an intermediary in a crowdfunding transaction, provided that such person does not (i) offer investment advice or recommendations, (ii) solicit purchases, sales or offers to buy the securities offered or displayed on its website or portal, (iii) compensate employees, agents or other persons for the solicitation or sale of securities displayed on its website or portal, (iv) hold, manage, possess or otherwise handle investor funds or securities, or (v) engage in such other activities as the SEC determines appropriate by rule. While these funding portals will not be required to register as a broker or dealer with the SEC, they will be required to register with the SEC and with any applicable self-regulatory agency, providing such information as the SEC by rule deems appropriate.

Moreover, a number of affirmative obligations are imposed on any intermediary involved in a crowdfunding transaction (broker-dealer or funding portal), including ensuring that each investor reviews investor-education material, answers questions demonstrating an understanding of the level of risk applicable to investments in startups or emerging businesses and the risk of illiquidity, as well as to “take such measures to reduce the risk of fraud with respect to such transactions, as established by the Commission, by rule....”

Crowdfunding Rules. The JOBS Act directs the SEC to issue final rules to implement the new crowdfunding exemption, and to define criteria for the disqualification of issuers, brokers and funding portals from making use of the exemption, within 270 days after the date of enactment of the Act. The Act also directs the SEC to conduct a review of Regulation S-K to and provide a report within 180 days to Congress on how the registration requirements “can be updated to modernize and simplify the registration process and reduce the costs and other burdens associated with these requirements for issuers who are emerging growth companies.”

Access to Capital

According to the JOBS Act, “Not later than 90 days after the date of the enactment of this Act, the [SEC] shall revise [Rule 506] to provide that the prohibition against general solicitation or general advertising...shall not apply to offers and sales of securities made pursuant to [Rule 506], provided that all purchasers of the securities are accredited investors.” It doesn’t get much clearer than that. As such, persons seeking capital will be permitted to advertise and pitch their securities offerings to any audience of prospective investors without jeopardizing or voiding the registration exemption, so long as only accredited investors are permitted to purchase securities in the offering. Similarly, general advertising and solicitation will be permitted under Rule 144A, provided that sales are only made to QIBs.

In addition, the JOBS Act requires the SEC to amend Regulation A (or adopt a new similar registration exemption) to exempt from registration securities offerings of up to $50 million per 12-month period, a substantial increase from the present $5 million limit. Regulation A generally requires the filing of a simplified offering statement with the SEC, but issuers do not become subject to the current and periodic reporting requirements solely as a result of that filing. On the other hand, under amended Regulation A (or a new similar exemption), while securities may be offered and sold publicly and will not be deemed to be restricted securities, a number of significant investor protection provisions are to be imposed. When promulgated by the SEC (Congress did not specify a due date), these new provisions will include submitting audited annual financial statements and periodic disclosures to the SEC and investors that cover the issuer’s “business operations, its financial condition, its corporate governance principles, its use of investor funds, and other appropriate matters...” State blue sky laws would still apply to such offerings, unless the offering involves a "covered security" (securities offered or sold on a national securities exchange or to certain qualified purchasers).

Higher Threshold for Exchange Act Mandatory Registration

Finally, the JOBS Act amends the Exchange Act of 1934 to raise the shareholder threshold at which private companies are required to register a class of securities under Section 12(g) and become subject to the periodic and current reporting requirements as a public company. The Act would raise the current 500-shareholder threshold for mandatory Section 12(g) registration to 2,000 shareholders, so long as not more than 499 are nonaccredited investors. In this regard, however, shareholders who received their shares pursuant to exempt transactions under an employee compensation plan are not counted toward the new shareholder threshold.

The Act also would require that the SEC adopt safe harbor provisions that issuers could use to determine whether holders of their securities received the securities pursuant to an employee compensation plan in a qualifying exempt transaction. Moreover, purchasers of securities in crowdfunding transactions that are exempt under Section 4(6) also will be excluded from that threshold count.

For more information about the JOBS Act please contact D. Richard McDonald, who leads Dykema's public company practice, at 248-203-0859, or any of the listed Dykema attorneys.


As part of our service to you, we regularly compile short reports on new and interesting developments and the issues the developments raise. Please recognize that these reports do not constitute legal advice and that we do not attempt to cover all such developments. Rules of certain state supreme courts may consider this advertising and require us to advise you of such designation. Your comments are always welcome. © 2012 Dykema Gossett PLLC.

As part of our service to you, we regularly compile short reports on new and interesting developments and the issues the developments raise. Please recognize that these reports do not constitute legal advice and that we do not attempt to cover all such developments. Rules of certain state supreme courts may consider this advertising and require us to advise you of such designation. Your comments are always welcome. © 2018 Dykema Gossett PLLC.