When President Barack Obama signed the Jumpstart Our Business Startups (JOBS) Act into law on April 5, it ushered in a new era for U.S. securities law and for companies of all sizes that access U.S. capital markets. In-house lawyers at those companies need to be aware of the changes that benefit their companies.
The JOBS Act represents the biggest change to the rules for conducting private placements of securities since the Securities Act of 1933. It also made important changes to the way companies will conduct initial public offerings, and it reduced the regulatory burden on most newly public companies.
There are two key developments in the JOBS Act for in-house counsel. It removed the restriction against general solicitation in private placements under Rule 506 of Regulation D adopted by the Securities and Exchange Commission (SEC). And it lays the groundwork for new rules benefiting emerging growth companies. The rationale behind these and other provisions of the JOBS Act is to assist growing companies by making it easier for them to raise capital.
The first of the two significant changes involves removal of the restriction against general solicitation for Rule 506 private placements.Since the initial adoption of the Securities Act of 1933, there has been an important distinction between public offerings, which were heavily regulated by the SEC, and private placements, which are exempt from the registration requirements of the Securities Act.
For years, there has been quite a bit of head-scratching among securities lawyers when trying to distinguish some public offerings from private placements. Fortunately, in 1982 the SEC adopted Regulation D, which created private placement safe harbors.
Securities offerings that meet the requirements of Regulation D are deemed to be private placements that are exempt from the registration requirements of the Securities Act. One of the safe harbors adopted by Regulation D is Rule 506.
Rule 506 permits issuers to sell an unlimited amount of securities to an unlimited number of accredited investors and up to 35 non-accredited investors. Accredited investors are investors who have income or net worth above a threshold established by the SEC.
Before implementation of the rule changes required by the JOBS Act, a securities issuer could not rely on Rule 506 if the issuer engaged in any general solicitation or general advertising, such as advertisements in the newspaper, television or radio. That’s a problem, because most private placements of securities rely upon Rule 506 for their exemption from registration. Additionally, some lawyers believe that Rule 506′s restrictions on general solicitation have limited companies’ ability to access private capital from potential accredited investors.
The JOBS Act requires the SEC to amend Rule 506 to provide that the restrictions on general solicitation will not apply to offerings made solely to accredited investors, so long as the issuer verifies that the investors meet the definition of accredited investors. The “verify” standard is stricter than the current standard, which only requires that the issuer “reasonably believe” that an investor is an accredited investor.
The SEC missed the 90-day deadline set by the JOBS Act to implement the change to Rule 506. But when the SEC releases the final amendment to Rule 506, in-house counsel should look closely at the steps the amendment requires issuers to take to verify an investor’s accredited status. When the rule change becomes effective, issuers will be able to conduct private placements in a very public manner with general solicitation and general advertising.
Emerging Growth Companies
Companies have not been going public as often in recent years, partly, I believe, as the result of the high cost of going public and maintaining that status. The JOBS Act seeks to make it easier to become a public company by slowly phasing in some of the more onerous regulatory requirements for newer and smaller public companies. The act calls these companies emerging growth companies (EGCs).
To qualify as an EGC, a company must meet five criteria: an IPO after Dec. 8, 2011; less than five years as a public company; less than $1 billion in annual revenues; less than $1 billion in debt that it has sold; and a public float of its common equity securities of less than $700 million.
Benefits of EGC status from the standpoint of securities-regulation compliance include the following.
• EGCs may submit their IPO registration statements to the SEC on a confidential basis before releasing them to the public.
• An EGC can circulate research reports about itself during the quiet period that precedes its IPO — even reports by broker-dealers participating in the IPO.
• EGCs may test the waters of a potential securities offering with qualified institutional buyers and institutional accredited investors before or after filing their registration statements.
• EGCs are only required to include two years of audited financial statements in their IPO registration statements, rather than three years.
• EGCs may use the lighter financial disclosures currently available only to smaller reporting companies.
• EGCs are exempt from some of the Sarbanes-Oxley Act’s requirements governing executive compensation disclosure and auditor attestation.
Unlike the general solicitation provisions, which require SEC rulemaking to implement the provisions of the JOBS Act, provisions relating to EGCs were effective immediately upon the enactment of the JOBS Act. Only time will tell if private U.S. companies will view potential EGC status as enough of an incentive to take on the burdens of going public.