On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups Act (the “JOBS Act”). As the Securities and Exchange Commission continues to develop rules necessary to implement several key provisions of the JOBS Act, this is a good time to review the key provisions of the JOBS Act and the status of SEC rulemaking.
The JOBS Act is designed to stimulate the growth of small companies by improving access to capital markets and reducing the regulatory reporting requirements on certain publicly-held companies. Certain provisions of the JOBS Act are effective immediately. However, several important provisions will not become effective until the SEC completes rulemaking as well as studies required by the JOBS Act.
Due to the significant rulemaking obligations that have been imposed on the SEC under both the Dodd-Frank Act and the JOBS Act, the SEC has failed to comply with most of its rulemaking deadlines under these acts.
The principal provisions of the JOBS Act appear in Titles I though VI of the Act. These provisions are summarized in the table below. The table is followed by a more detailed discussion of these provisions.
Title I – Reopening American Capital Markets to Emerging Growth Companies
The JOBS Act creates a new category of issuer under both the Securities Act of 1933 (the “Securities Act”) and the Securities and Exchange Act of 1934 (the “Exchange Act”) called an “emerging growth company.” An emerging growth company is any entity that had less than $1 billion in annual revenue during its most recently completed fiscal year.
Emerging growth companies will be allowed to file for an initial public offering under less burdensome regulations than other companies. Under the relaxed requirements, emerging growth companies are able to file a registration statement confidentially with the SEC; engage in certain “test the waters” communications with institutional buyers; provide just two years of audited financial statements (instead of the usual three years) in the registration statement; take advantage of certain streamlined disclosure requirements in the registration statement and in Exchange Act filings; and be covered more quickly by research published by investment banking firms.
After registering with the SEC, an emerging growth company will not be subject to full compliance with SEC reporting requirements until the first to occur of:
- achieving $1 billion or more in annual revenue;
- being deemed a large accelerated filer by having at least a $700 million in public float;
- raising in excess of $1 billion in non-convertible debt over a three-year period; or
- the last day of the fiscal year in which the fifth anniversary of the pricing date of the IPO falls.
Title II – Access to Capital for Job Creators
The JOBS Act requires that the SEC revise Rule 506 of Regulation D in order to permit general solicitation or general advertising in offerings exempt from registration under Rule 506, provided that all purchasers in the offering are “accredited investors” as defined in Regulation D. The rules to be issued in connection with these revisions will require issuers to take “reasonable steps” to confirm that all purchasers in such offerings are accredited investors.
On August 29, 2012, the SEC issued proposed changes to Rule 506 for public comment. The proposed rule changes do not clearly establish what “reasonable steps” an issuer should take to confirm status as accredited investors. Instead, the proposed changes provide that an issuer must make this determination in light of the facts and circumstances of each situation. The SEC received extensive public comments on the proposed rule changes, and to date the SEC has not adopted or re-proposed the rule.
Until the SEC amends Rule 506 in accordance with the JOBS Act, general solicitation and general advertising will continue to be prohibited, even if all purchasers of securities sold in a Rule 506 offering are accredited investors.
Title III – Crowdfunding
The JOBS Act creates a new exemption, Section 4(6) of the Securities Act, which allows an issuer to sell securities in small amounts to a large number of investors through a distribution method known as “crowdfunding.” Securities in a crowdfunding transaction must be sold by either a registered broker-dealer or a funding portal that is registered with the SEC and FINRA as a financial intermediary.
Section 4(6) limits the dollar amount that an issuer may sell in any 12-month period. Section 4(6) also limits the dollar amount that individual investors may invest in crowdfunding transactions. In particular:
- The total amount of securities that may be sold to all investors by an issuer, including any amount sold in reliance on the new Section 4(6) exemption during the previous 12-month period, is $1 million.
- If an investor’s net worth or annual income is less than $100,000, then the amount sold to such investor in any 12-month period may not exceed the greater of $2,000 or 5 percent of such investor’s net worth or annual income.
- If an investor’s net worth or annual income equals or exceeds $100,000, then the amount sold to such investor in any 12-month period may not exceed 10 percent of the net worth or annual income of such investor, subject to an investment cap of $100,000.
- To qualify for an exemption from registration under Section 4(6), the securities must be sold through a broker or funding portal that complies with the requirements of newly created Section 4A(a) of the Securities Act.
- The terms of a Section 4(6) offering may not be advertised except by directing investors to the appropriate broker or funding portal through which the securities are sold.
Issuers will be subject to various disclosure and filing obligations in crowdfunding transactions, and broker-dealers and portals will be obligated to perform certain due diligence and compliance obligations. Although Section 4(6) is effective, extensive SEC and FINRA rulemaking are required in order to implement the crowdfunding exemption.
Title IV – Small Company Capital Formation
Regulation A is an exemption from registration under the Securities Act that allows non-SEC reporting companies to raise up to $5 million through a public offering. Regulation A requires that an offering document resembling a public offering registration statement be filed with and reviewed by the SEC.
The JOBS Act increases the amount that may be raised in a Regulation A offering from $5 million to $50 million. Implementation of the changes to Regulation A requires SEC rulemaking, which has not yet occurred.
Title V – Private Company Flexibility
Prior to the JOBS Act, issuers with more than $10 million in assets and with securities held by more than 500 record holders were required to register under the Exchange Act and become reporting companies. The JOBS Act increases these thresholds from 500 record holders to 2,000 record holders, provided that there are less than 500 non-accredited investors. Shareholders who acquired their shares in crowdfunding transactions or through employee compensation plans are generally excluded from these calculations.
Title VI – Capital Expansion
Title VI raises the threshold for registration of banks or bank holding companies under the Exchange Act to 2,000 record holders (with no limitation for non-accredited investors).
Certain provisions of the JOBS Act are highly controversial. Many lawmakers and regulators have expressed concern that the JOBS Act will compromise investor protections and increase fraudulent activity in securities offerings. In particular, crowdfunding and the introduction of general advertising and general solicitation in Rule 506 offerings have generated significant controversy. All of that has complicated and contributed to delays in SEC rulemaking.