President Obama discusses and signs the JOBS Act
The text below is from the offices of Polsinelli Shughart
The Jumpstart Our Business Startups (JOBS) Act has passed Congress and is on its way to being signed into law by President Obama. In only a few weeks’ time, Congress made several important changes to the federal securities laws to aid small businesses.
Key provisions of the new Act include:
- Relaxing federal securities regulation for businesses that qualify as “emerging growth companies”
- Allowing public solicitation in certain exempt private offerings under Rule 506 of Regulation D
- Creating a new crowdfunding exemption from federal securities laws to aid private businesses raising capital
- Raising the limit on exempt small offerings under Regulation A to $50 million
- Raising the threshold for companies with broadly held equity securities from registering with the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934 (Exchange Act)
Several stand-alone securities law reform proposals originated in the House this session, enjoying varying degrees of success. As we previously discussed, House leadership bundled many of these proposals in late February and placed them on the fast track as H.R. 3606, the Jumpstart Our Business Startups (JOBS) Act. In March, both the House and Senate quickly passed the JOBS Act. The Senate version differed slightly from the House version, and on March 27th the House agreed to the Senate’s version.
Emerging Growth Companies
The Act creates a new class of reporting company called an “emerging growth company.” To qualify, an already registered reporting company must have gross revenues for its last fiscal year under $1 billion. Qualifying companies receive several breaks, much like existing “smaller reporting companies,” including:
- Exemption from pay-versus-performance disclosures in proxy statements
- Exemption from say-on-pay and golden parachute votes by shareholders
- Relaxed disclosure of financial information
- Possible exemptions from new accounting standards
- Relaxed executive compensation disclosures
- Exemption from public accountant reports on internal financial controls
- Provisions designed to facilitate public offerings, including confidential SEC reviews of draft registration statements.
The help afforded to these companies may not stop there. In addition to the Act’s changes, the SEC must study its registration rules for ways to simplify the stock offering registration process for emerging growth companies.
General Solicitation in Private Offerings
Many companies raise capital without registering their offerings with the SEC. This is accomplished primarily through private offerings under the exemption in Rule 506 of Regulation D. Recent SEC analysis estimates at least $905 billion was offered under Regulation D in 2010. An underpinning of Regulation D has been its prohibition on general solicitation and mandate that issuers have pre-existing relationships with investors in these offerings.
In a groundbreaking change to the private market for securities, the Act directs the SEC to allow general solicitation and advertising in exempt private offerings made under SEC Rule 506, so long as sales are made only to accredited investors. Similarly, the Act directs the SEC to permit general solicitation and advertising in sales of securities pursuant to SEC Rule 144A to persons reasonably believed to be qualified institutional buyers.
Crowdfunding started as an approach based in social media converting the traditional local fundraising efforts led by charitable organizations, creative ventures and even political campaigns to widespread online campaigns. Numerous crowdfunding sites have popped up offering venues for fund-seekers to post projects in need of a pre-determined amount of funding. Capital is typically pledged by funders in exchange for personal satisfaction and/or tangible rewards. The entrepreneurs’ offer of equity in exchange for financing has not survived in the crowdfunding phenomena primarily because in such cases the crowdfunding model constitutes a general solicitation and offer to sell a security when an equity interest is offered in exchange for funds. The Act changes that by creating a new crowdfunding exemption from registration for securities offerings.
In a 12-month period, a company may sell up to $1 million in securities through an intermediary, such as a registered broker or qualified funding portal, to the public without registering the offering. Investors participating in the offering are limited in how much they can invest per company in a twelve-month period, based on their income and net worth. Investors who annually earn less than $100,000 or have a net worth below $100,000 are limited to the greater of $2,000 or 5 percent of the investor’s annual income or net worth. Investors who annually earn at least $100,000 or have a net worth of at least $100,000 are limited to 10 percent of the investor’s annual income or net worth, not to exceed $100,000. The method for calculating annual income is unspecified. Net worth is to be calculated under new SEC rules consistent with the net worth calculation for accredited investors, as recently revised by the Dodd-Frank Act.
The exemption is not without catches though. Both companies and intermediaries they use must meet a number of requirements. Specifically, intermediaries must:
- Register with the SEC as a broker or “funding portal,” a new defined term
- Register with applicable self-regulatory organizations (SROs)
- Provide disclosures to be set by the SEC in a future rulemaking
- Ensure investors review investor-education information to be established by the SEC, affirm that the investor could lose the investment and can bear a total loss, and answer questions demonstrating an understanding of the investing risk associated with small issuers, potential illiquidity of the securities, and any other topics set by the SEC
- Take precautions to be set by the SEC to reduce fraud, including running background checks on the issuer’s directors, officers, and stockholders holding 20% or more of the issuer’s shares
- Provide to the SEC and potential investors at least 21 days before a sale disclosures from the issuer set by the Act
- Ensure that proceeds are delivered to the issuer only after a target set by the issuer is met and allow investors to back out as rules to be made by the SEC allow
- Follow new SEC rules to ensure investors are not exceeding the limits set by the exemption
- Protect investor privacy, as required by new SEC rules
- Not compensate promoters, finders, or lead generators
- Not allow persons associated with the intermediary to have a financial interest in any issuer using the intermediary
- Comply with any other rules the SEC determines necessary.
As may be evident, the Act gives the SEC broad discretion to regulate this exemption, so there is considerable uncertainty in its exact form. Polsinelli Shughart will be monitoring opportunities for our startup and entrepreneurial clients as the SEC implements the crowdfunding exemption.
Registration Exemption for Small Offerings
The Act effectively raises the threshold for offerings under Regulation A (the SEC’s abbreviated registration for small offerings) from $5 million in a twelve-month period to $50 million during that period.
Registration Exemption for Parties Involved in Private Offerings
The Act also amends § 4 of the Securities Act of 1933 to exempt the following persons involved in Rule 506 offerings from registration as broker-dealers: private offering platform providers, offerors and associates who co-invest in their offerings, and offerors and associates who provide ancillary services such as due diligence and standardized documents. To be eligible, the exempt person or associate may not receive a commission, may not hold customer funds or securities, and may not be subject to a statutory disqualification for wrongdoing under the Exchange Act.
Polsinelli Shughart will be reviewing new opportunities these changes create for our clients.
Company Registration Threshold
In addition to requiring companies to register their securities offerings with the SEC absent an applicable exemption, the federal securities laws require companies of a certain size to register with the SEC. Registration triggers significant reporting obligations and costs to newly public companies under Section 13 of the Exchange Act.
To relieve growing businesses from the costly burden resulting from these reporting requirements, the Act raises the size threshold above which issuers must register with the SEC under the Exchange Act. The new thresholds are $10 million in assets (formerly $1 million) and either 2,000 shareholders or 500 persons who are not accredited investors (formerly 500 shareholders). These thresholds exclude employees who are shareholders through their participation in an employee stock plan.