On Thursday, April 5, 2012, President Obama signed the Jumpstart Our Business Startups Act (the JOBS Act), a bipartisan bill designed to help companies go public, raise capital privately, and remain private longer. This alert provides a brief overview of some of the principal provisions of the JOBS Act.

The JOBS Act implements significant changes to the Securities Act of 1933, as amended (the Securities Act) and the Securities Exchange Act of 1934, as amended (the Exchange Act). The JOBS Act, among other things:

  • Creates a new class of issuer called the emerging growth company (EGC)
  • An EGC is a company with less than $1 billion in gross revenue during its most recently completed fiscal year, other than a company that first sold common equity securities in a transaction registered with the Securities and Exchange Commission on or before December 8, 2011.
  • A company will be considered an EGC until the earlier of five years, when annual gross revenues exceed $1 billion, or certain other specified events occur.
  • EGCs will be subject to reduced public company disclosure obligations including, reduced financial disclosure requirements, delayed adoption of new or revised financial accounting standards, an exemption from attestation requirements for auditors under the Sarbanes-Oxley Act of 2002, the ability to provide reduced executive compensation disclosure, and exemptions from certain executive compensation requirements created by the Dodd-Frank Act.
  • EGCs are permitted to engage in general solicitation of qualified institutional buyers or institutions that are accredited investors to determine whether such investors might have an interest in a contemplated securities offering.
  • Eliminates certain existing prohibitions on general solicitation in private offerings
  • Any company is permitted to communicate with and notify accredited investors under Rule 506 offerings and qualified institutional buyers under Rule 144A offerings through online and offline forums.
  • Offerings made under Rule 506 through general solicitation and advertising would not be deemed public offerings if otherwise compliant with Rule 506.
  • SEC rulemaking to be implemented within 90 days of enactment is required.
  • Creates new private placement exemptions permitting “crowdfunding”
  • U.S. private companies are permitted to raise up to $1 million over a 12-month period from large pools of small investments subject to individual investment limits.
  • Crowdfunding transactions must not be conducted by the issuer, but instead through an intermediary—either a registered broker or a “funding portal.”
  • Issuer is required to provide certain disclosures to investors and intermediaries and to file such disclosures with the SEC.
  • Increases the dollar amount of securities that may be publicly offered and sold under Section 3(b) of the Securities Act of 1933, as amended:
  • “Small issuer exemption” from registration for offerings of up to $50 million created; however, the company will still be subject to civil liability under Section 12(a)(2) of the Securities Act for material misstatements and omissions.
  • A company may solicit interest in the offering prior to filing an offering statement, but will be required to file audited financial statements annually with the SEC.
  • Increases registration thresholds under Section 12(g) of the Exchange Act of 1934, as amended
  • Threshold requiring registration with the SEC is increased to either (a) 2,000 holders of record or (b) 500 persons who are not accredited investors.
  • Record holder count for determining whether registration is required shall not include securities held by persons who received such securities pursuant to an employee compensation plan in transactions exempt from registration requirements.

Reopening American Capital Markets to Emerging Growth Companies

Definitions:

The JOBS Act amends Section 2(a) of the Securities Act and Section 3(a) of the Exchange Act, to add the definition of “emerging growth company.” An emerging growth company, or EGC, is defined as an issuer with total annual gross revenue of less than $1 billion during its most recently completed fiscal year, other than an issuer that made its first sale of common equity securities pursuant to an effective registration statement on or before December 8, 2011. An issuer that falls under the definition of EGC as of the first day of that fiscal year shall continue to be considered an EGC until the earlier of:

(a) the last day of the issuer’s fiscal year in which it had total annual gross revenue of $1 billion or more;

(b) the last day of the issuer’s fiscal year following the fifth anniversary of the date of the first sale of common equity securities pursuant to an effective registration statement;

(c) the date on which the issuer has, during the previous three-year period, issued more than $1 billion in non-convertible debt; or

(d) the date on which the issuer is deemed to be a large accelerated filer[i].

Disclosure Obligations

The JOBS Act amends Section 14A(e) of the Exchange Act to exempt an EGC from certain compensation-related disclosure provisions imposed by the Dodd-Frank Act on U.S. public companies that require a shareholder advisory vote on executive compensation (a “say-on-pay” vote), on the frequency of such “say-on-pay” votes and on any golden parachute compensation. The JOBS Act also amends Section 14(i) of the Exchange Act to exempt an EGC from mandatory disclosure relating to the relationship between executive compensation actually paid by an issuer and the financial performance of the issuer and disclosure related to the annual compensation of the chief executive officer, the median of the annual total compensation of all employees of the issuer except the chief executive officer, and the ratio of the two as required by Section 953(b)(1) of the Dodd-Frank Act.

The JOBS Act amends Section 7(a) of the Securities Act to provide that an EGC need not present more than two years’ of audited financial statements (as opposed to three years’ of audited financial statements that it was previously required to present) in order for a registration statement with respect to an initial public offering (IPO) by an EGC of its common equity securities to be declared effective, and for any other registration statement to be filed with the SEC by an EGC; and EGCs need not present selected financial data pursuant to Item 301 of Regulation S-K for any period prior to the earliest audited period presented in connection with its IPO. In addition, an EGC may not be required to comply with any new or revised financial accounting standards until such date as a private company (i.e., a company that is not an “issuer” as defined by Section 2(a) of the Sarbanes-Oxley Act of 2002) is required to comply with such new or revised accounting standard. Corresponding changes to the Exchange Act were instituted to address an EGC’s periodic reporting obligations. An EGC will comply with Item 303(a) of Regulation S-K by providing information in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section for the periods it covers in its financial reports. An EGC will comply with Item 402 of Regulation S-K by disclosing the information required by a smaller reporting company, limiting the quantitative and qualitative disclosure required under Item 402 regarding executive compensation, and not requiring a compensation discussion and analysis section.

Internal Controls Audit

The JOBS Act exempts an EGC from complying with Section 404(b) of the Sarbanes-Oxley Act of 2002 which requires a public accounting firm that prepares or issues an audit report for the issuer to attest to and report on the assessment made by the issuer’s management as to the issuer’s internal control over financial reporting.

Auditing Standards

The JOBS Act amends Section 103(a)(3) of the Sarbanes-Oxley Act to provide that any rules of the Public Company Accounting Oversight Board (the PCAOB) requiring mandatory audit firm rotation or changes to the auditor’s report to provide additional information about the audit and the financial statements of the issuer shall not apply to an audit of an EGC. In addition, any future rules adopted by the PCAOB will not apply to audits of EGCs unless the SEC determines the requirements are necessary or appropriate in the public interest, after considering the protection of investors and whether the action will promote efficiency, competition and capital formation.

Availability of Information

The JOBS Act amends Section 2(a)(3) of the Securities Act so that the publication or distribution by a broker or dealer of a research report about an EGC that is the subject of a proposed IPO or follow-on equity offering shall not be deemed an offer for sale or an offer to sell a security, even if the broker or dealer is participating in or will participate in the IPO or follow-on equity offering.

The JOBS Act amends Section 15D of the Exchange Act to prohibit the SEC or any other national securities association registered under Section 15A from adopting or maintaining rules that, in the context of a common equity IPO of an EGC:

(a) restrict, based on functional role, which associated persons of a broker-dealer may arrange for communications between a securities analyst and a potential investor; or

(b) restrict a securities analyst from participating in any communications with the management of an EGC that is also attended by any other associated person of the broker-dealer whose functional role is other than as a securities analyst.

The JOBS Act amends Section 15A of the Exchange Act to prohibit the SEC or any national securities association from adopting or maintaining any rule prohibiting a broker-dealer from publishing or distributing any research report or making a public appearance, with respect to the securities of an EGC, within prescribed time frames following an IPO or prior to the expiration of agreements after the IPO between the broker-dealer or member of a national securities association and the EGC or its shareholders that restricts or prohibits the sale of securities held by the EGC or its shareholders after the IPO.

The JOBS Act amends Section 5 of the Securities Act to permit an EGC to engage in oral or written communications with potential investors that are qualified institutional buyers[ii] or institutions that are accredited investors[iii] to determine whether such investors might have an interest in a contemplated securities offering, either prior to or following the date of filing of a registration statement with respect to such securities with the SEC. This means that before undertaking an IPO or other securities offering, an EGC, or persons authorized to act on its behalf, may “test the waters.”

Other Matters

The JOBS Act amends Section 6 of the Securities Act by permitting an EGC, prior to its IPO, to confidentially submit to the SEC a draft registration statement for review, provided that the initial confidential registration statement and all amendments thereto are publicly filed with the SEC not later than 21 days before the date on which the issuer conducts a road show.

If the SEC determines that the securities of an EGC should be quoted and traded using a minimum increment of greater than $0.01, the SEC may (pursuant to the JOBS Act, and by rule not later than 180 days from the enactment of the JOBS Act) designate a minimum increment for EGC securities that is greater than $0.01 and less than $0.10. The SEC shall also conduct a study examining the transition to trading and quoting securities in one penny increments.

Opt-In Right

An EGC may choose to forego an exemption provided by the JOBS Act and instead comply with the requirements that apply to an issuer that is not an EGC. This choice may be subject to certain restrictions as it relates to new or revised financial accounting standards.

Review of Regulation S-K

Not later than 180 days after the date of enactment of the JOBS Act, the SEC will provide a report to Congress reviewing Regulation S-K, which sets forth the reporting requirements for SEC filings used by public companies, and its registration requirements.

General Solicitation

The JOBS Act charges the SEC with amending Rule 506 of Regulation D and Rule 144A under the Securities Act to eliminate the prohibition on general solicitation and advertising in offerings pursuant to the exemptions under those rules, provided that, in the case of Rule 506 offerings, the sales are limited to accredited investors and the issuer has taken reasonable steps to verify that the purchaser is an accredited investor and, in the case of the Rule 144A offerings, the sales are limited to those persons the issuer reasonably believes are qualified institutional buyers. The elimination of the prohibition on general solicitation and advertising would allow any company, not only smaller companies and EGCs, to communicate with and notify accredited investors under Rule 506 offerings and qualified institutional buyers under Rule 144A offerings through online or offline forums. The JOBS Act also provides that an offering made under Rule 506 by means of general solicitation and advertising, and which otherwise complies with the requirements of Rule 506, will not be deemed to be a public offering.

Additionally, persons who (a) maintain a platform or mechanism permitting the sale, offer, purchase or negotiation of securities, (b) co-invest in such securities, or (c) provide “ancillary services” (including due diligence services or provision of standardized documents to issuers or investors) with respect to such securities, may be exempt from registration as a broker or dealer under the Exchange Act. The exemption will apply if such person (a) receives no compensation in connection with the purchase or sale of such security, (b) does not have possession of customer funds or securities in connection with the purchase or sale of such securities, and (c) is not subject to statutory disqualification from being a broker or dealer.

The SEC is required to amend these rules not later than 90 days after enactment of the JOBS Act.

Crowdfunding

Title III of the JOBS Act is called the “Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012” or the “CROWDFUND Act.” The CROWDFUND Act creates new Section 4(6) of the Securities Act which exempts from registration under the Securities Act offers and sales of securities through “crowdfunding,” permitting U.S. private companies to raise up to $1 million over a 12-month period from large pools of small investments. The crowdfunding exemption applies to the offer or sale of securities by an issuer, provided that:

(a) the aggregate amount sold to all investors, including any amount sold in reliance on such exemption during the 12-month period preceding the date of such transaction, is not more than $1 million;

(b) the aggregate amount sold to any single investor, including any amount sold in reliance on such exemption during the 12-month period preceding the date of such transaction (whether or not by the same issuer), does not exceed: (a) the greater of $2,000 or 5 percent of the annual income or net worth of the investor, if such annual income or net worth is less than $100,000; and (b) 10 percent of the annual income or net worth of the investor (not to exceed $100,000), if such annual income or net worth is equal to or greater than $100,000;

(c) the transaction is not conducted by the issuer but instead through an intermediary—a registered broker-dealer or funding portal that complies with the requirements of the new Section 4A(a) of the Securities Act[iv]; and

(d) the issuer complies with the disclosure requirements set forth in the new Section 4A(b) of the Securities Act[v].

An issuer will also be required to provide to investors and file with the SEC annual reports setting forth the results of operations and financial statements of the issuer. Issuers are prohibited from advertising the terms of any offering made pursuant to the crowdfunding exemption, except for notices which direct investors to the broker-dealer or funding portal, as applicable. Any promoter compensated for using the communication channels provided by a broker-dealer or funding portal to promote the crowdfunding offering must disclose the receipt of such compensation upon each instance of such promotional communication. Additionally, issuers will be subject to liability to purchasers of the securities comparable to that under Section 12(a)(2) of the Securities Act for material misstatements omitted from these documents and disclosures.

Any securities issued in connection with an exempt crowdfunding offering may not be transferred by the purchaser for a period of one year from the date of purchase unless the securities are transferred to (a) the issuer, (b) an accredited investor, (c) as part of an offering registered with the SEC, or (d) to a family member in connection with the death or divorce of the purchaser, or similar circumstance.

Securities issued in connection with an exempt crowdfunding offering will also be “covered securities” under Section 18 of the Securities Act. As such, they will benefit from exemption of certain state securities laws related to registration, documentation, and other offering requirements. However, states will not be exempted from their authority to take enforcement action on any issuer, funding portal or any other person using the exemption from registration provided under Section 4(6).

The CROWDFUND Act provides that a registered funding portal shall be exempt from the requirement to register as a broker or dealer under Section 15(a)(1) of the Exchange Act if such funding portal (a) remains subject to the examination, enforcement and rule making authority of the SEC, (b) is a member of a national securities association registered under Section 15A, and (c) is subject to any other requirements the SEC may deem appropriate.

Use of the new Section 4(6) exemption is not available to every company. Foreign companies, issuers already subject to the reporting requirements under Section 13 or Section 15(d) of the Exchange Act, investment companies, and other companies that do not satisfy standards that the SEC determines appropriate are ineligible to use this exemption.

Small Company Capital Formation

The JOBS Act amends Section 3(b) of the Securities Act to provide additional exemptions for equity securities, debt securities, and debt securities convertible or exchangeable into equity interests, including any guarantees of such securities, as long as the securities contain the following terms and conditions:

(a) the aggregate offering amount of all securities offered and sold within the prior 12-month period in reliance on this exemption may not exceed $50 million;

(b) the securities may be offered and sold publicly;

(c) the securities shall not be restricted securities;

(d) the civil liability provision of Section 12(a)(2) shall apply to any person offering or selling such securities;

(e) the issuer may solicit interest in the offering prior to filing any offering statement on such terms and conditions as the SEC may prescribe;

(f) the SEC will require the issuer to file audited financial statements with the SEC annually; and

(g) any other terms or conditions the SEC deems necessary in the public interest and for the protection of investors must be met.

The SEC may also require an issuer of a class of securities exempted above to make available to investors and file with the SEC periodic disclosures. The SEC will review the offering amount limitation every two years.

Increased Thresholds under Section 12(g) for Public Company Reporting

Currently any issuer with more than $10 million of assets and 500 or more holders of record of any class of securities is required to register such securities with the SEC. Section 501 of the JOBS Act raises the record holder threshold for registration for most issuers to either (a) 2,000 persons or (b) 500 persons who are not accredited investors. Section 601 of the JOBS Act raises the record holder threshold for banks and bank holding companies to 2,000 or more persons. This section also raises the record holder threshold, which permits termination or suspension of reporting obligation with respect to securities of a bank or bank holding company, from 300 persons to 1,200 persons.

Additionally, Section 502 of the JOBS Act amends Section 12(g)(5) of the Exchange Act to provide that the record holder count shall not include securities held by persons who received such securities pursuant to an employee compensation plan in transactions exempted from the registration requirements of the Securities Act. Securities acquired pursuant to an offering that is exempt under Section 4(6) are to be exempted from the Section 12(g) provisions.

The JOBS Act contains significant revisions to the U.S. securities laws, changing a number of laws and regulations in a way expected to reduce disclosure and reporting obligations for EGCs making it easier for EGCs to consummate an IPO, while also eliminating restrictions on private offerings making it easier for companies to raise capital privately.

Members of Ballard Spahr’s Securities Group are available to assist clients as they prepare to address these new requirements. Please contact Practice Leaders Justin P. Klein at 215.864.8606 or kleinj@ballardspahr.com; Gerald J. Guarcini at 215-864-8625 or guarcini@ballardspahr.com; or Mary J. Mullany at 215-864-8631 or mullany@ballardspahr.com; or any member of the Securities Group with any questions.


[i] As defined in Rule 12b-2 of the Exchange Act.

[ii] As defined in Rule 144A of the Securities Act.

[iii] As defined in Rule 501 of Regulation D of the Securities Act.

[iv] Pursuant to Section 4A(a), any person acting as an intermediary in a transaction consummated pursuant to Section 4(6) must:

(a) register with the SEC as a broker or a funding portal;

(b) register with any applicable self-regulatory organization;

(c) provide disclosures, including disclosures related to risks and other investor education materials as the SEC may deem appropriate;

(d) ensure that each investor (i) reviews such investor education materials, (ii) positively affirms their understanding that they are risking the loss of their entire investment and that they can bear such loss, and (iii) can answer questions demonstrating an understanding of the level of risk and illiquidity in connection with the investment;

(e) take measures to reduce the risk of fraud with respect to such transactions, including obtaining a background history check on each officer, director and person holding more than 20 percent of the outstanding equity of the issuer;

(f) make the disclosures required by investors available to the SEC and the investors at least 21 days prior to the offering;

(g) ensure that the offering proceeds are provided to the issuer only when the target offering amount has been met, and allow all investors to cancel their respective commitments to invest;

(h) ensure that no investor has exceeded their aggregate investment limit as prescribed under Section 4(6);

(i) take steps to protect the privacy of information collected from investors;

(j) not compensate promoters, finders or lead generators for providing the intermediary with any personal identifying information of any potential investor;

(k) prohibit their officers, directors or partners from having any financial interest in any issuer using its services; and

(l) meet any other requirements set forth by the SEC.

[v] Any issuer relying on the crowdfunding exemption is subject to the requirements of Section 4A(b) which provide that the issuer must provide to investors, intermediaries and file with the SEC, the following information:

(a) its corporate information, including its name, legal status, address and website address;

(b) the names of its officers, directors and any holder of more than 20 percent of its shares;

(c) a description of its business and business plan;

(d) financial information or financial statements that for offerings which, including the preceding 12-month period, have, in the aggregate, target offering amounts of (i) $100,000 or less, include the issuer’s prior years’ tax return and financial statements certified by its principal executive officer, (ii) more than $100,000 but less than $500,000 have been reviewed by an independent certified public accountant, and (iii) more than $500,000, have been audited;

(e) a description of its intended purpose and use of the proceeds of the offering;

(f) the target offering amount and deadline to reach such amount, as well as regular updates by the issuer on its progress in meeting such amount;

(g) written disclosure prior to the sale of the final price and all required disclosures, providing investors with a reasonable opportunity to rescind their commitment to invest;

(h) a description of the ownership and capital structure of the issuer; and

(i) such other information as the SEC may require.


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This alert is a periodic publication of Ballard Spahr LLP and is intended to notify recipients of new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have.