This article outlines key features of the recently-signed Jumpstart Our Business Startups Act (JOBS Act), which is intended to streamline access to the US capital markets for a range of issuers. Among other developments, the JOBS Act reduces disclosure burdens, eases requirements for initial public offerings for certain companies, relaxes restrictions on communications around securities offerings and increases minimum thresholds for mandatory SEC reporting.
By Dorothee Fischer-Appelt (Reference: CapLaw-2012-38)

1) Introduction

The Jumpstart Our Business Startups Act (JOBS Act) was signed into law by President Obama on 5 April 2012. Its intention is to increase American job creation and economic growth by improving access to the public capital markets for emerging growth companies. The JOBS Act reduces some of the disclosure and regulatory burdens for initial public offerings (IPOs) by emerging growth companies. It also eases restrictions on communications with potential investors in US private placements and contains new rules for small company capital formation. In addition, the JOBS Act increases the thresholds that trigger registration for companies that are not currently reporting with the Securities and Exchange Commission (the SEC). The JOBS Act does not have a particular focus on foreign private issuers (FPIs), but non-US companies can make use of most of its provisions, and this article focuses on the JOBS Act’s implications for those issuers.

2) Emerging Growth Company IPOs

Title I of the JOBS Act, Reopening American Capital Markets to Emerging Growth Companies, is intended to increase capital formation through IPOs. The report that preceded the JOBS Act highlighted that growth companies create more new jobs post-IPO than growth companies that are sold in an M&A transaction. In addition, following the Sarbanes-Oxley Act, the US had been criticized for being an overly burdensome jurisdiction for listed companies, and the JOBS Act is intended to restore the US markets’ competitiveness for IPOs.

Emerging growth companies (EGCs) are not necessarily small issuers: They are companies with less than USD 1 billion of total annual gross revenues. That figure would have historically included a significant share of US IPOs. Excluded are companies that sold stock (but not debt) to the public in the US on or before 8 December 2011. An issuer that is a public company outside of the US but has not made a SEC-registered equity offering can still qualify as an EGC. EGC status is lost after a company has crossed certain thresholds (such as the last day of the first fiscal year in which the company has at least USD 1 billion in total annual gross revenues), or, the latest, on the last day of the fiscal year ending after the fifth anniversary of the IPO.

One key benefit for a FPI is the exemption from obtaining the auditor attestation report on internal controls over financial reporting mandated under section 404 of the Sarbanes-Oxley Act, and which has been costly to prepare in practice. However, an EGC will still be subject to the requirement that management establish, maintain and assess internal control over financial reporting, and its CEO and CFO will still be required to provide Sarbanes-Oxley-compliant certifications. In addition, EGCs are only required to present two (rather than three) years’ of audited financial statements in an IPO registration statement (including for the MD&A section as well as selected financial statements). It remains to be seen whether this will be taken up widely in practice, as it may be easier to market an IPO to investors where a longer track record is presented. In addition, the SEC has clarified that first-time adopters of International Financial Reporting Standards (IFRS), or otherwise required by International Accounting Standards to provide three statements of financial position, cannot benefit from this rule.

There are other disclosure liberalizations, such as the exemption from the say-on-pay rules under the Dodd-Frank Act and golden parachute provisions and detailed compensation disclosure requirements from which FPIs are already exempt.

Another benefit of EGC status is that companies are permitted to submit draft registration statements on a confidential basis, which was previously only available for FPIs and was limited by the SEC at the end of last year to FPIs that have a dual listing (and in certain other limited circumstances). If otherwise available, FPIs can elect the latter confidential submission process, provided they do not take advantage of any benefits available to EGCs. Alternatively, they can comply with the EGC rules and file confidentially under those. The new confidential filing process requires making a public filing 21 days prior to the road show, which includes the original submission and confidentially submitted amendments.

EGCs are also exempt from compliance with new or revised financial accounting or auditing standards until the date that such accounting standards become broadly applicable to private companies. It is possible to elect to adopt some but not all of the other disclosure liberalizations, but an affirmative choice has to be made for all new and revised accounting standards.

The new rules also include important liberalizations with respect to research reports and communications with investors. First, the JOBS Act amends Section 2 (a) (3) of the Securities Act of 1933 (Securities Act) by adding a provision to the effect that the publication or distribution by a broker-dealer of a research report about an EGC in connection with a public offer of its common equity securities does not constitute an offer of securities. This provision applies irrespective of whether an IPO registration statement has been filed or is effective or whether the broker-dealer is participating in the offering. Distribution of research reports is not limited to qualified institutional buyers. Second, Section 15D of the Securities Exchange Act of 1934 (Exchange Act) is amended to the effect that neither the SEC nor any registered national securities association (in particular, the Financial Industry Regulatory Authority (FINRA)) may adopt or maintain any rule or regulation in connection with an IPO, restricting, based on functional role, which associated person of a broker-dealer may arrange for communications between a securities analyst and a potential investor or restricting the analyst from participating in any communications with the management of an EGC that are also attended by other associated persons of the broker-dealer.

These changes for research reports are significant, although it remains to be seen how they will impact current practices. The SEC recently issued further guidance on some of these changes. A certain reduction of the black-out period following completion of a distribution of an IPO is already noticeable, with many market participants reducing the customary 40-day blackout period to a voluntarily agreed-upon 25-day period.

However, a number of the large international banks are still subject to the global research analyst settlement, and the SEC recently confirmed that they must continue to comply with its provisions unless and until amended by court order or superseded by new rules.

In addition to the liberalization of research, the new rules also allow test-the-waters communications before, during or after the registration statement for the IPO of an EGC has been publicly filed. These communications are limited to communications with QIBs and institutional accredited investors, and are not subject to the otherwise applicable restrictions on pre-filing communications under the Securities Act or the requirements in relation to free-writing prospectuses that have to be filed with the SEC. Testing-the-waters can consist of both oral and written communications. Meetings have to be strictly limited to qualified investors as otherwise they could be deemed a road show. The formal solicitation of orders and book building would not occur during test-the-waters communications that take place pre-filing, as broker-dealers are required to make a preliminary prospectus available before soliciting customer orders.

Allowing test-the-waters communications constitutes a significant change and offers the possibility to engage in certain practices that have been widely used in non-US deals, where it has been common practice to hold investor meetings with sophisticated investors to gauge interest in a proposed offering (pilot fishing). However, test-the-waters communications are subject to US anti-fraud liability under Sections 17 and 10 (b) of the Securities Act and potential liability under Section 12 (a) (2). Therefore, as a practical matter, their use will be the subject of careful consideration, especially before a registration statement has been filed. In addition, model provisions for indemnities, covenants and representations in underwriting agreements have been developed. Further, state securities laws have to be considered (blue sky laws) where the offering is not listed on an approved national securities exchange.

This change may also affect the practice in non-SEC registered offerings, such as exempt offers under Rule 144A under the Securities Act (the exemption for private resales of securities to qualified institutional buyers). In the context of Rule 144A offerings, market practice has generally limited pilot fishing meetings in the US based on liability concerns. Depending on how widely test-the-waters communications will be used in the context of SEC-registered IPOs, pilot fishing for global offerings conducted under Rule 144A into the US and applying the safe harbor for offshore offerings under Regulation S of the Securities Act may become more common.

It remains to be seen whether the JOBS Act will pave the way for more FPIs to list and conduct their IPO in the US. The liberalizations are significant and make it easier to list initially, but FPIs will make their decision on where to list based on a number of factors, including valuations, investor base and other factors. Where a multitude of factors speak in favor of a US listing, there will be less resistance to a US listing as a result of the relaxation of rules, but the perceived liability risks in connection with a US listing remain.

3) Publicity Changes

Title II of the JOBS Act contains a fundamental change in approach to publicity in the context of exempt offerings, by calling on the SEC to remove the prohibition of general solicitation and general advertising contained in Rule 144A and in Regulation D with respect to accredited investors, provided that (with respect to Regulation D) the issuer has taken reasonable steps to verify that purchasers of the securities are accredited investors, using such methods as determined by the SEC, and with respect to Rule 144A, that securities are sold only to persons that the seller and any person acting on its behalf reasonably believe is a qualified institutional buyer. These changes apply in the context of Rule 506 of Regulation D, which permits an issuer to sell securities in a private placement to an unlimited number of accredited investors, and Rule 144A, but not in other private placements. Both rules are widely used for capital raisings as they do not require any Securities Act registration. The changes entail a shift of focus from the regulation of offers to the regulation of sales of securities. The SEC proposed rules to implement these provisions on 29 August 2012.

The JOBS Act did not mention if the publicity changes would have an effect on the prohibition of directed selling efforts under Regulation S, the safe harbor that is typically used in connection with an offering outside of the US. In is proposed rules, the SEC confirmed that what constitutes directed selling efforts will continue to be interpreted in a manner consistent with the definition of general solicitation and general advertising in the context of a global offering relying on both Rule 144A and Regulation S. However, in the case of an offering conducted only outside the United States in reliance on Regulation S, the prohibition on publicity (including through unrestricted websites) in the United States constituting directed selling efforts remains.

As a result, there will likely be a number of practical implications for publicity guidelines used in global offerings combining Rule 144A and Regulation S offerings once the SEC’s rules will be adopted, including fewer restrictions on the destination of offering materials and website filters to prevent US access. At the same time, it is important to note that anti-fraud liability still applies to these offerings and associated offering materials. Widespread marketing through Internet, TV and ads in the US is unlikely to be popular. In addition, in the context of Rule 144A offerings, restrictions on publicity under state securities laws also have to be considered.

4) Small Company Capital Formation

Title IV directs the SEC to adopt more detailed rules for public offerings of equity, debt securities and convertible or exchangeable securities that do not exceed USD 50 million in the aggregate in any 12-month period beyond exemptions currently unavailable to FPIs (other than Canadian issuers). When adopted by the SEC, the new rules may offer an interesting alternative for capital raisings by smaller companies and could serve as a stepping stone to an IPO.

5) Exchange Act Registration Exemption

Titles V and VI of the JOBS Act increase the thresholds for registration with the SEC under the Exchange Act, which can require companies to register even where they have not conducted a public offering as a result of the number of their US securityholders. The minimum requirement was increased from 500 holders of record and USD 1 million of assets to 2,000 holders of record (or 500 holders who are not accredited investors) and USD 10 million of assets, effective immediately (with certain modifications for banks and bank holding companies). FPIs that are listed companies in their home jurisdictions typically avoid being caught by the Exchange Act registration requirements by taking advantage of an exemption provided in Rule 12g 3–2 (b) under the Exchange Act, which was modernized some years ago. However, this exemption is not available for non-listed companies such as many private equity, hedge and venture capital funds that may be able to broaden their US investor base and raise more funds in the US as a result of the increased Exchange Act thresholds, in particular to the extent the SEC will make conforming amendments to Rule 12g 3–2 (a) (which exempts FPIs with fewer than 300 holders resident in the US from Exchange Act registration).

6) Crowdfunding

The JOBS Act also contains a new exemption that permits raising funds over the internet from large groups of people by pooling small amounts of capital (crowdfunding). However, crowdfunding is not available to FPIs.

7) Conclusion

The JOBS Act contains the most significant changes to US securities laws in several years. The changes to the communications rules for private offerings once adopted will undoubtedly affect market practice for both US and global offerings. In addition, the introduction of the new EGC category is significant and may make it more attractive for certain non-US issuers to conduct an IPO in the US. The market practice that will evolve over the course of the next few years in the context of EGC IPOs will also likely have an impact on Rule 144A practice in many important areas such as publication of research, test-the-waters communications and disclosure of financial information in the prospectus.