IFLR international Financial Law Review JOBS Act Quick Start A brief overview of the JOBS Act Nilene R Evans David M Lynn Anna T Pinedo About the authors Nilene R Evansis of counsel in the Capital Markets Group of Morrison & Foerster. Ms Evans counsels domestic and foreign, public and privately-held companies, advising them on issues ranging from securities offerings, mergers, acquisitions and dispositions to ongoing disclosure and compliance obligations, particularly the complex requirements of the Sarbanes-Oxley Act and Finra (Financial Industry Regulatory Authority), and general strategic planning. She has extensive experience acting as counsel for underwriters and issuers in initial and subsequent public and private equity and debt offerings, including shelf and Rule 144A offerings, Pipes, at-the-market offerings and complex private equity investments. Her experience covers many industries including Reits, technology companies, financial companies and life sciences companies. David M Lynnis co-chair of the firm’s Public Companies and Securities Practice. Mr Lynn’s practice is focused on advising a wide range of clients on SEC matters, securities transactions and corporate governance. Mr Lynn is well known in the area of executive compensation disclosure, having co-authored The Executive Compensation Disclosure Treatise and Reporting Guide. While serving as chief counsel of the Securities and Exchange Commission’s Division of Corporation Finance, he led the rulemaking team that drafted sweeping revisions to the SEC’s executive compensation and related party disclosure rules. Anna T Pinedo has concentrated her practice on securities and derivatives. She represents issuers, investment banks/financial intermediaries, and investors in financing transactions, including public offerings and private placements of equity and debt securities, as well as structured notes and other structured products. Ms Pinedo works closely with financial institutions to create and structure innovative financing techniques, including new securities distribution methodologies and financial products. She has particular financing expertise in certain industries, including working with technology-based companies, telecommunications companies, healthcare companies, financial institutions, Reits and consumer finance companies. Ms Pinedo has worked closely with foreign private issuers in their securities offerings in the United States and in the Euro markets. She also has worked with financial institutions in connection with international offerings of equity and debt securities, equity- and credit-linked notes, and hybrid and structured products, as well as medium-term note and commercial paper programmes. © Morrison & Foerster and Euromoney Institutional Investor 2013. All rights reserved. JOBS Act Quick Start1 About the firm We are Morrison & Foerster — a global firm of exceptional credentials. Our clients include some of the largest financial institutions, investment banks, Fortune 100, technology, and life sciences companies. We’ve been included on The American Lawyer’s A-List for nine straight years, and Fortunenamed us one of the 100 Best Companies to Work For. Our lawyers are committed to achieving innovative and business- minded results for our clients, while preserving the differences that make us stronger. This is MoFo. Visit us at www.mofo.com. 2JOBS Act Quick Start Contents About the authors 1 About the firm 2 Introduction 5 CHAPTER 1 The IPO on-ramp 15 CHAPTER 2 The IPO process 25 CHAPTER 3 Applying Title I to other transactions 36 CHAPTER 4 Private offerings 39 CHAPTER 5 Crowdfunding 44 CHAPTER 6 Regulation A+ 49 CHAPTER 7 Exchange Act registration thresholds 61 CHAPTER 8 Research 65 CHAPTER 9 Other capital formation discussions 74 Appendix A 80 Appendix B 83 Appendix C 87 JOBS Act Quick Start3 4JOBS Act Quick Start Introduction M any market participants were taken by Act of 1934, as amended (the Exchange Act) (Titles V and surprise by the enactment of the Jumpstart VI). In the chapters that follow, we discuss each of these Our Business Startups Act. The JOBS Act, measures in greater detail, but before we do so, it is HR 3606, was passed by the United States important to understand the concerns that led legislators House of Representatives on March 8 2012. On March 22, to act in concert to adopt the JOBS Act. the Senate passed HR 3606 with an amendment to Title III (providing for the crowdfunding exemption with enhanced The lifecycle for emerging companies in the investor protections). On March 27, the House of United States Representatives accepted the Senate’s amendment, and on For a long time in the United States, a company’s financing April 5, President Obama signed the JOBS Act into law. To lifecycle was generally fairly predictable. A growing many, this may sound like a quick path for legislation, company usually financed its business through especially when considered in the context of a Congress investments from friends and family, then perhaps from that seemed virtually deadlocked and unable to reach the angel investors, and finally, if the company was successful, consensus required to take action on pressing issues. When from venture capital firms. Given the application of considered closely and in context, however, it becomes clear section 5 of the Securities Act of 1933, as amended (the that the Act was the culmination of an at least year-long Securities Act)1to public offerings of securities, a company bipartisan effort in both the House and Senate to address was required to limit itself to conducting small rounds of concerns about capital formation and unduly burdensome financing, relying on various available exemptions from Securities and Exchange Commission (SEC) regulations. the registration requirements of the Securities Act, and to The JOBS Act affects both exempt and registered target principally sophisticated institutional investors. The offerings, as well as the reporting requirements for certain securities that a company sold in these private or exempt public issuers. A centrepiece of the Act is a new IPO on- offerings were classed as restricted securities, which means ramp approach for a class of emerging growth companies that the securities had never been offered pursuant to a (Title I), with confidential SEC staff review of draft IPO registration statement and were subject to certain transfer registration statements, scaled disclosure requirements, no restrictions. After various successful private financing restrictions on test-the-waters communications with rounds, the company’s management and venture investors qualified institutional buyers (QIBs) and institutional would begin to consider an IPO. Once a company was an accredited investors before and after filing a registration SEC-reporting issuer, it became subject to a statement, and fewer restrictions on research (including comprehensive regulatory framework. Although this research by participating underwriters) around the time of regulatory framework may have imposed requirements an offering. In addition, the JOBS Act directs the SEC to that seemed onerous (at the time), being a public company amend its rules to: offered distinct benefits. Once public, a company generally • eliminate the ban on general solicitation and general had many more financing opportunities. Already public advertising in Rule 506 offerings when sales are only to companies relied on raising additional capital to finance accredited investors, along with comparable changes to their growth through follow-on public offerings, Rule 144A (Title II); underwritten by one or more investment banks. From time • establish a small offering exemption for crowdfunding to time, an already public company also might conduct a (Title III); and private placement or other exempt offering as part of an • create a new exemption for offerings up to $50 million overall financing plan. Over time, as the capital markets in (Title IV). the United States have undergone changes and as The JOBS Act also raises the holder-of-record threshold regulations have evolved, the cost-benefit calculus for for mandatory registration under the Securities Exchange many companies has changed. Many companies have JOBS Act Quick Start5 concluded that going public might not be the most issuer and its business and operations, as well as about the desirable liquidity event and remaining private longer or offering, so that they may make informed investment considering acquisition alternatives might be more decisions. These apply to offerings that are made to the appealing. A bit of background on the securities regulatory general public (regardless of the sophistication of the framework will help illustrate why the analysis changed for offerees). The SEC presumes that distributions not many companies. involving public offerings (or widespread distributions) do not involve the same public policy concerns as offerings Securities regulatory framework made to a limited number of offerees that have access to A privately-held company (or a company that does not the same kind of information that would be included in a have securities that are publicly traded in the United registration statement. That information can be conveyed States), whether domestic or foreign, that would like to by providing disclosure or by ensuring that the offerees access the US markets first must determine whether it is have access to the information. There are a number of willing to subject itself to the ongoing securities reporting regulatory restrictions on communications for issuers that and disclosure requirements, as well as the corporate undertake a public offering, given that the SEC always has governance requirements that are part and parcel of emphasised that the prospectus should be the principal registering securities publicly in the United States. An document used by investors in making their investment issuer may conduct a public offering in the United States decision. by registering the offering and sale of its securities pursuant to the Securities Act, and also by registering its securities IPO and Exchange Act registration for listing or trading on a US securities exchange pursuant In connection with an initial public offering of securities, to the Exchange Act.2 Instead, an issuer may choose to an issuer must provide extensive information about its access the US capital markets by offering its securities in an business and financial results. The preparation of the offering exempt from the registration requirements of the registration statement is time-consuming and expensive. Securities Act. Finally, a private company that elects to Once the document is filed with the SEC, the SEC will postpone, or seeks to avoid, becoming a public company review it closely and provide the issuer with detailed may become subject to SEC reporting obligations comments. The comment process may take as long as 60 inadvertently if it has: total assets exceeding $10 million as to 90 days once a document has been filed with, or of the last day of its fiscal year, and a class of equity submitted to, the SEC. Once all of the comments have securities held of record by either 2,000 persons or 500 been addressed and the SEC staff is satisfied that the persons who are not accredited investors (for banks and registration statement is properly responsive, the bank holding companies, a class of equity securities held of registration statement may be used in connection with the record by 2,000 or more persons), whether or not that class solicitation of offers to purchase the issuer’s securities. of equity securities is listed on a national securities Depending upon the nature of the issuer and the nature of exchange. the securities being offered by the issuer, the issuer may use Section 5 of the Securities Act sets forth the registration one of various forms of registration statement. Once an and prospectus delivery requirements for securities issuer has determined to register its securities under the offerings.3In connection with any offer or sale of securities Securities Act, the issuer usually will also apply to have that in interstate commerce or through the use of the mails, class of its securities listed or quoted on a securities section 5 requires that a registration statement must be in exchange, and in connection with doing so will register its effect and a prospectus meeting the prospectus securities under the Exchange Act. The Exchange Act requirements of section 10 of the Securities Act must be imposes two separate but related obligations on issuers: delivered before sale.4 This means that the Securities Act registration obligations and reporting obligations. If an generally requires registration for any sale of securities, issuer becomes subject to the reporting requirements of the although it also provides exemptions or exclusions from Exchange Act, the issuer remains subject to those this general registration requirement. The purpose of the requirements until, in the case of exchange-listed Securities Act is to ensure that an issuer provides investors securities, those securities are delisted, or, in the case of with all information material to an investment decision securities listed by reason of the issuer’s asset size and about the securities that it is offering. The registration and number of record holders, the issuer certifies that it meets prospectus delivery requirements of section 5 require certain requirements. filings with the SEC and are intended to protect investors Once an issuer conducts an IPO in the United States or by providing them with sufficient information about the has a class of securities listed or traded on a national 6JOBS Act Quick Start securities exchange, the issuer will be generally subject to ever since – it is now at about 4,000.6Meanwhile, the value the reporting requirements of the Exchange Act. Issuers of transactions in private-company shares has grown, that have undertaken an IPO or that are SEC-reporting almost doubling in 2010 to $4.6 billion from about $2.4 companies also will become subject to many other rules billion in 2009, and was expected to increase to $6.9 and regulations. billion for 2011.7 Other reports cite similar statistics and Over time, the regulatory burdens for public companies highlight that smaller companies have been have increased. In 2002, following a series of widely disproportionately affected, with most IPOs that are reported corporate scandals involving fraudulent completed involving larger companies and a significant accounting practices and governance abuses, the United offering size. Although commentators would be ready to States adopted legislation affecting all public companies, stipulate that the number of IPOs is down, there would be the Sarbanes-Oxley Act of 2002. Sarbanes-Oxley imposed little agreement regarding the causes for the decline. Quite a broad series of requirements relating to corporate a number of different theories have been advanced to governance, enhanced public disclosure, and the explain this phenomenon. Academics active in this area imposition of civil and criminal penalties for wrongdoing. have grouped the theories into two broad categories: first, Sarbanes-Oxley and its associated rules: those attributing the decline to regulatory overreach, and • require that CEOs and CFOs certify the accuracy and second, those attributing the decline to changes in the completeness of their company’s periodic reports and ecosystem or market structure changes. impose criminal penalties for false certification; Many studies indicate that companies are waiting longer • require the establishment and regular evaluation of to go public as a result of anticipated costs associated with disclosure controls and procedures, and internal control Sarbanes-Oxley compliance, as well as the additional costs over financial reporting designed to ensure the accuracy associated with being a public company. For example, a and completeness of the information reported to the public company must incur costs for D&O insurance, SEC and for the preparation of financial statements; director compensation (especially audit committees), and • require the establishment by all listed companies of an disclosure controls and SEC reporting costs. Foreign independent audit committee; issuers may be wary of the increased liability that comes • require the disgorgement of compensation by CEOs with being an SEC-reporting company, as well as of the and CFOs following an accounting misstatement that litigious environment in the United States. Many executive results from misconduct; officers of privately-held companies also are concerned that • impose limitations on trading by officers and directors going public will limit their flexibility. As officers of a during retirement plan blackout periods; public company, they are required to make very difficult • prohibit the extension of credit to related parties; and decisions, including decisions regarding financial • require the SEC to review a registrant’s filings once reporting, accounting estimates and accounting policies, every three years. while they are subject to more scrutiny and more risk as a Although relief from compliance with certain of these result of their choices. Given the prospect of shareholder requirements was provided to smaller companies, increased litigation and other litigation concerns, their compliance costs and increased liability may have had a determinations become fraught with risk. Earnings chilling effect on IPOs. pressure and the need to respond to many constituencies (such as research analysts, large institutional holders and To (or not to) go public aggressive hedge fund holders) may affect the decision- Many commentators have noted that, over time, the US making processes. This may inhibit their desire to take risk capital markets have become less competitive, and the and may lead them to be more conservative than they number of companies seeking to go public has declined. otherwise would be. A recent survey found that, in fact, For example, in communications from Congressman the principal reason given by senior managers of privately- Darrell Issa, chairman of the House Committee on held companies for remaining private is that they would Oversight and Government Reform, to Mary Schapiro, like to preserve decision-making control.8 In addition, chairman of the SEC (discussed further below), Issa noted actually conducting an IPO will be time-consuming and that the number of IPOs in the US has plummeted from expensive given the disclosure and financial statement an annual average of 530 during the 1990s to about 126 requirements. since 2001, with only 38 in 2008 and 61 in 2009.5 The Over time, more financing alternatives have developed number of companies listed on the main US exchanges for issuers. An issuer could choose to avail itself of one of peaked at more than 7,000 in 1997 and has been declining the exemptions from registration and conduct private JOBS Act Quick Start7 offerings. There have been many regulatory changes that changes, created and modified the integrated disclosure have provided greater legal certainty as to the availability of system, instituted and expanded the continuous and private offering exemptions, such as the safe harbours delayed offerings processes, permitted the electronic contained in Regulation D, especially Rule 506. In large submission of most SEC filings, and generally tried to measure, as a result of these changes, a number of securities accommodate the needs of both large and small issuers. In offering methodologies involving exempt offerings have 2005, the SEC undertook a series of changes related to developed and become increasingly popular. Many of these securities offerings and offering-related communications, offering methodologies have come to resemble the process referred to as securities offering reform. Although this used for public distributions of securities. Investors have reform benefited principally the largest and most become more receptive to participating in private sophisticated issuers (well-known seasoned issuers, or placements and owning so-called restricted securities as the WKSIs), the changes also expanded the range of limitations on hedging or transferring restricted securities permissible communications, even during IPOs. have been relaxed. More recently, private secondary In December 2004, the SEC established the Advisory markets have developed that provide liquidity Committee on Smaller Public Companies to “assist the opportunities for holders of the securities of private SEC in evaluating the current securities regulatory system companies to sell their positions. relating to disclosure, financial reporting, internal controls, Other commentators and academics note that a variety and offering exemptions for smaller public companies.”9 of market structure changes may be the cause of or may The Advisory Committee charter stated that its objective contribute to the decline of IPOs, and, especially smaller was “to assess the impact of the current regulatory system company IPOs. During the 1990s and early 2000s, for smaller companies under the securities laws of the consolidation in the investment banking sector led to the United States and to make recommendations for disappearance of many boutique or speciality investment changes.”10The Advisory Committee considered the effect banks that had as their focus financing transactions for of many new regulatory requirements on smaller public smaller companies. Some commentators point to the drop companies, as well as capital-raising alternatives for smaller in bid-ask spreads that took place following decimalisation companies. In 2006, it issued its final report, containing in 2001. In 2003, as a result of the fallout from the dot- 33 recommendations, many of which focused on capital com boom, rules and regulations were adopted that formation, including a recommendation that a new private imposed restrictions on research analyst coverage and offering exemption from the Securities Act registration required the separation of research and investment requirements be adopted that would not prohibit general banking activities. The burdensome regulations imposed solicitation and advertising for transactions with significant compliance costs on investment banks with purchasers that do not need all the protections of Securities research activities and changed the nature of research Act registration requirements. The Advisory Committee coverage. As a result, the fewer, larger investment banks noted that the ban on general solicitation in a private that remained after industry consolidation focused their offering resulted in excessive concern about the offeree that resources on covering fewer companies (usually giving may never actually purchase securities, rather than on preference to larger, well-capitalised companies). These protection of the actual investors. The Committee also various factors seemed to change the economics associated noted that, given the pace of technological change, the with smaller company IPOs and tend to favour IPOs by bank had become outmoded and limited issuers from larger, more established companies. Also, the view using the internet and other tools to communicate with developed that larger companies, with a longer track potential investors. This was not the first time that a record and more predictable earnings histories, make recommendation had been made to ease the prohibition better public companies or are better able to function as on general solicitation. In 2007, practitioners that were public companies. members of an American Bar Association Committee submitted a letter to the SEC containing SEC developments recommendations for a comprehensive overhaul of the The SEC has tried to keep pace with changes in the capital securities laws governing the private placement of markets and has consistently introduced reforms that securities.11 The letter cited problems with the private sought to balance investor protection needs with the need offering process that impacted capital formation. In May to provide issuers with access to capital. Since the early 2007, the SEC approved publication of eight releases 1980s, the SEC has undertaken a number of steps to designed to update and improve federal securities facilitate capital formation. The SEC has, among other regulations that significantly affect smaller public 8JOBS Act Quick Start companies and their investors. Ultimately, the holding public reporting, including questions regarding the use of period requirements under Rules 144 and 145 were special purpose vehicles; and (iv) the regulatory questions shortened, making restricted securities more liquid, and posed by new capital-raising strategies, such as smaller public companies gained limited access to the use crowdfunding. Schapiro also indicated that the SEC was in of shelf registration statements. the process of forming a new Advisory Committee on Although all of these reforms modernised the securities Small and Emerging Companies, which was subsequently offering process, streamlined communications convened. requirements, and addressed certain of the concerns related to private or exempt offerings, the reforms did not squarely Decline of the IPO market in the US address the IPO process, nor did they address many of the Issa’s letter cited statistics about the declining US IPO thorniest issues arising in exempt offerings. market and asked whether the SEC had evaluated the reasons for such a decline. The letter asked whether the Proposed changes post-Dodd-Frank possible reasons for the decline included increasingly In the aftermath of the financial crisis, and following complex SEC regulations; costs associated with adoption of the Dodd-Frank Act, there was renewed focus compliance with the Sarbanes-Oxley Act; the uncertainty on the effect of regulation on the competitiveness of the generated by the pending rulemakings under the Dodd- US capital markets and on entrepreneurship and emerging Frank Wall Street Reform and Consumer Protection Act companies. As attention in the United States turned to (generally known simply as the Dodd-Frank Act); the risk promoting economic activity, the dialogue related to of class-action lawsuits; or the expansion of regulatory, regulatory burdens and their effect on capital formation legal, and compliance burdens. The letter also cited took on a new sense of urgency. examples of the IPOs of Google and GoDaddy.com that were delayed and cancelled, respectively, as evidence of Issa-Schapiro correspondence overly burdensome communications rules. In her response, On March 22 2011, House Committee on Oversight and Schapiro discussed various reasons for the decline in the Government Reform chairman Issa sent a letter to SEC IPO market, such as each company’s own situation and chairman Schapiro. The letter raised concerns about market factors at the time of the contemplated IPO. whether the current securities regulatory framework had a Schapiro stated that it is difficult to determine why a negative impact on capital formation, leading to the dearth company decides to undertake an IPO or declines to do so. of IPOs in the US, as well as the extent to which SEC The costs associated with conducting an IPO and regulations potentially limited other capital raising becoming a public reporting company factor into the activities by small and emerging companies.12 The letter decision as to whether to conduct an IPO. Schapiro stated from Issa also sought specific information regarding that the SEC had lowered these costs in recent years and economic studies conducted by the SEC staff in these that, in 2010, approximately 40% of first-time registrants areas, along with information concerning the were smaller reporting companies. Similarly, in 2010, consideration of costs and benefits in connection with nearly half of registered offerings conducted by first-time SEC rulemakings. Issa’s letter discussed these statistics and registrants were for offerings of less than $10 million. In a raised questions about five topics: the decline of the US discussion about the challenges faced by early-stage growth IPO market, the communications rules in connection with companies, Schapiro pointed out that such companies securities offerings, the 499-shareholder cap under section have greater difficulty raising capital because of the lack of 12(g) of the Exchange Act, organisational considerations, disclosure on a regular basis, smaller and more variable and new capital-raising strategies. cash flows, a smaller asset base, and a larger percentage of In her response dated April 6 2011, Schapiro stated she intangible assets. had requested that the SEC staff take a fresh look at the Schapiro also stated that while there are studies that agency’s rules in order to develop ideas for the SEC about show that the number of US IPOs had declined,14 other ways to reduce the regulatory burdens on small business studies conducted by SEC staff members indicate that for capital formation in a manner consistent with investor the period 1995–2007, the US market’s share of global protection.13 Schapiro outlined a number of new SEC IPOs in terms of total dollar proceeds and average dollar initiatives in her response, including SEC staff review of (i) proceeds was much higher than those of the United the restrictions on communications in initial public Kingdom and Hong Kong.15 The other reason for offerings; (ii) whether the general solicitation ban should companies to favour an IPO in the European markets is be revisited; (iii) the number of shareholders that trigger that the underwriters’ spread is significantly lower than in JOBS Act Quick Start9