1 March 2012
U.S. Securities Law Briefing
United States Adopts Major Changes to Securities
Offering Rules under JOBS Act
The U.S. Congress yesterday approved the Jumpstart Our Business Startups Act (the “Act”), the most significant change to U.S. securities laws in half a decade. The Act, which President Obama is expected to sign shortly, implements the following measures:
> Five-year “IPO on-ramp” – Registration, disclosure, research report, communications and other rules are relaxed for new registrants with total annual gross revenues of up to $1 billion, for up to five years following their initial public offering.
> General solicitation allowed – The U.S. Securities and Exchange Commission (the “SEC”) is directed to remove the general solicitation and general advertising prohibition applying to unregistered offers conducted pursuant to Rule 506 or Rule 144A under the Securities Act of 1933 (the “Securities Act”).
> Section 12(g) shareholder cap – The numbers of “holders of record” triggering registration of a class of equity securities under Section 12(g) of the Securities Exchange Act of 1934 (the “Exchange Act”) is increased from 500 persons to either 2,000 persons or 500 non-accredited investors.
> Crowdfunding exemption – A new transactional securities registration exemption is established for so-called “crowdfunding” offers of up to $1 million in a 12-month period.
> Small offerings exemption – The SEC is directed to establish a registration exemption for offerings of up to $50 million, a significant increase from the current $5 million limit for small offerings under Regulation A under the Securities Act (“Regulation A”).
IPO On-Ramp for Emerging Growth Companies
The Act amends the Securities Act to create a new category of issuer, called “emerging growth companies” (“EGCs”). EGCs will be subject to more relaxed versions of, or be entirely exempt from, certain disclosure and other rules applicable to SEC-registered companies, for a period of up to five years following the first sale of common equity securities under a registration statement that is declared effective after December 8, 2011.
IPO On-Ramp for Emerging Growth
Companies ... 1
General Solicitation Allowed in Rule 506 and Rule 144A Offers... 3
Section 12(g) Shareholder Cap ... 4 Crowdfunding ... 5 Small Offerings... 6 Effective Dates ... 6 Conclusion ... 7
An emerging growth company is defined as an issuer1 that had total annual gross revenues of less than $1 billion (to be indexed for inflation every five years) during its most recently completed fiscal year. An EGC will retain its status until the earliest of:
the last day of the fiscal year during which it had total annual gross revenues of $1 billion or more;
the last day of the fiscal year following the fifth anniversary of the date of the first sale of common equity securities pursuant to an effective Securities Act registration statement;
the date on which the issuer has, during the previous three-year period, issued more than $1 billion in non-convertible debt; or
the date on which the issuer is deemed to be a “large accelerated filer” (i.e., it has an aggregate worldwide market value of voting or non-voting common equity held by non-affiliates of $700 million or more, has been SEC-reporting for at least 12 months and has filed at least one annual report with the SEC).
The Act exempts EGCs from some significant obligations imposed upon registered issuers, including:
Financial statements and MD&A – An EGC will not be required to present more than two years of audited financial statements or selected financial data in its IPO registration statement, and its Management’s Discussion & Analysis (“MD&A”) only needs to discuss the fiscal years covered by the audited financial statements.
Say-on-pay/executive compensation disclosures – An EGC will be exempt from the so-called “say-on-pay” requirements and the upcoming executive compensation disclosure rules mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”).
Sarbanes-Oxley auditor report – An EGC will be exempt from Section 404(b) of the Sarbanes-Oxley Act of 2002 (“SOX”), which requires independent external auditors to attest to the issuer’s internal controls over financial reporting.
CD&A – An EGC may satisfy the Compensation Disclosure & Analysis requirements of Regulation S-K by making the more limited disclosures required by smaller reporting companies.
Future PCAOB and accounting rules – Unless the SEC determines otherwise, an EGC will be exempt from any rules issued by the Public Company Accounting Oversight Board (“PCAOB”) requiring mandatory audit firm rotation or an “auditor discussion and analysis”2, as well as any other rules to be issued by the PCAOB. An EGC is also exempt
1 The Act does not limit the definition of EGCs to U.S. domestic companies, so we expect that non-U.S. issuers will be able to take advantage of EGC status.
from any new accounting rule applicable to public companies until the date that the rule also applies to private companies.
Research reports – The Act amends the definition of an “offer” under Section 2(a)(3) of the Securities Act to provide that the publication or distribution of research reports by a broker-dealer, even one participating in the offer, regarding an EGC that is the subject of a proposed public offering of common equity does not constitute an offer of the securities. There are no conditions, such as ordinary course publication requirements, as there are in Rule 138 and Rule 139 under the Securities Act.
Research analyst restrictions – The Act also prohibits the SEC and national securities associations from issuing or maintaining certain rules that restrict the ability of a research analyst to communicate with the issuer or investors and that impose research report blackout periods with respect to the securities of an EGC.
Pilot fishing communications with QIBs/IAIs – An EGC and persons acting on its behalf may freely engage, even during the pre-filing period, in “pilot fishing” communications (oral or written) with qualified institutional buyers (“QIBs”), as defined in Rule 144A under the Securities Act (“Rule 144A”), or accredited investors that are institutions (“IAIs”), as defined in Rule 501(a) under the Securities Act. Such communications are allowed before and after filing of the registration statement.
Confidential review – An EGC may submit its registration statements to the SEC for confidential review as long as the registration statement is publicly filed at least 21 days before any roadshow.
A qualifying issuer may opt out of the EGC exemption, but it must state its intention to do so when it first files a registration statement or periodic report and must then comply with the usual rules applicable to registered issuers. A company cannot chose to selectively comply with certain rules and not others. Please see the chart in Annex A for more detail regarding these exemptions, including a comparison of the rules that apply to EGCs and those that generally apply to issuers that are not EGCs.
General Solicitation Allowed in Rule 506 and Rule 144A Offers
In a change that could significantly affect the execution of unregistered offerings, the Act directs the SEC to issue, within 90 days of enactment (i.e. from the date the President signs the Act), rules providing that the “general solicitation and general advertising” prohibition3
does not apply to offers made pursuant to Rule 506 under the Securities Act (“Rule 506”) (offers to accredited investors) and
General solicitation and general advertising is defined under Rule 502(c) of the Securities Act as including, but not limited to: any advertisement, article, notice or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio; and any seminar or meeting whose attendees have been invited by any general solicitation or general advertising.
Rule 144A (offers to QIBs), which are commonly used exemptions for unregistered offerings.
The Act amends the Securities Act to state that offers and sales under Rule 506 of Regulation D will not be deemed “public offerings” as a result of general solicitation or general advertising4, and directs the SEC to remove the general solicitation prohibition that is a condition of offerings made pursuant to Rule 506.5 The issuer, however, must take reasonable steps to verify that actual purchasers are accredited investors, using methods to be determined by the SEC.
Although the general solicitation prohibition of Rule 502(c) is not technically a condition of a Rule 144A offering, market practice is to comply with the prohibition when conducting such offers. In addition, Rule 144A currently prohibits making either offers or sales to non-QIBs. The Act loosens these restrictions by requiring the SEC to issue rules specifically providing that as long as the seller “reasonably believes” that it is selling only to QIBs, the securities may be offered to non-QIBs, including by means of general advertising and general solicitation. In other words, a seller may advertise to and solicit the public for a Rule 144A offer (including through newspaper advertisements and unrestricted websites), as long as it actually only sells to those that it reasonably believes to be QIBs.
For international offerings relying on both Rule 144A and Regulation S under the Securities Act (“Regulation S”), it is not yet clear how amended Rule 144A would interact with the no “directed selling efforts” condition of Regulation S, which is broadly similar to the general solicitation prohibition. The Act does not make any reference to Regulation S, but we hope that the SEC will provide guidance on directed selling efforts when it issues its new rules. Until the SEC issues any guidance to the contrary, the directed selling efforts prohibition remains an important element in international securities offerings relying on both Rule 144A and Regulation S and may in practice limit the extent to which general solicitations can be made in the United States. Section 12(g) Shareholder Cap
Prior to the Act’s amendment, Section 12(g) of the Exchange Act requires an issuer with more than $10 million in assets to register any class of its equity securities that, as of the end of its fiscal year, were "held of record" by more than 500 persons. The Act increases that number to either (i) 2,000 persons
This amendment to the Securities Act suggests that private funds relying on Section 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940 to avoid registration as an investment company can make Rule 506 offerings without such offerings being deemed “public offerings” that would violate the Section 3(c)(1) and 3(c)(7) exemptions.
With respect to securities offered under Rule 506, the Act provides that a person will not be subject to broker-dealer registration solely because: the person maintains a platform (including in person or online) that permits the offer, sale, purchase, negotiation or general solicitation of such securities; the person or an associated person co-invests in such securities; or the person or an associated person provides ancillary services in connection with the securities, including due diligence services (as long as the services do not include separate compensation, investment advice or recommendations) and providing standardized documents. However, the person must not receive any compensation in connection with the purchase or sale of such securities, cannot have possession of customer funds or securities in connection with the purchase or sale of such securities, and may not be subject to statutory disqualification under Section 3(a)(39) of the Exchange Act (e.g., expulsion from membership in a self-regulatory organization or revoked broker-dealer registration).
or (ii) 500 persons who are not “accredited investors” (as the term is defined by the SEC).6
The Act excludes from the calculation persons who received securities under an employee compensation plan in exempt transactions and those who purchased securities under the new crowdfunding exemption described further below. The SEC is directed to revise the definition of “held of record” in Section 12(g)(5) of the Exchange Act to implement the amendments and to adopt safe harbor provisions that issuers can follow when determining whether holders received securities pursuant to an employee compensation plan in an exempt transaction.
The Act amends the Securities Act to create Section 4(6), a new transactional exemption from registration for “crowdfunding”. An offering is exempt under Section 4(6) if it meets the following conditions:
> The aggregate amount sold by the issuer to all investors within the previous 12-month period is $1 million or less.
> The aggregate amount sold to any investor within the previous 12-month period is capped at:
- for an investor with an annual income or net worth of less than $100,000, the greater of $2,000 or 5 percent of the investor’s annual income or net worth; or
- for an investor with an annual income or net worth of more than $100,000, 10 percent of the investor’s annual income or net worth, not to exceed $100,000.
> The offer must be conducted through an SEC-registered broker or funding portal.7 Among other things, the broker or funding portal must ensure that each investor can bear the risk of loss of the entire investment and conduct background checks on the directors and officers.
> The issuer must make certain financial disclosures that are tiered depending on the size of the offering (including audited financial statements for offers of more than $500,000) and other disclosures such as a description of the business and use of proceeds. The issuer may not advertise the terms of the offer, except for notices directing investors to the broker or funding portal, and may not pay promoters without ensuring that the promoter discloses that it was compensated.
For banks or bank holdings companies, the Act amends Section 12(g) so that the registration triggers are total assets exceeding $10 million and a class of equity securities (other than an exempted security) held of record by 2,000 or more people. The Act also provides that banks and bank holding companies may deregister if the number of holders of record falls below 1,200 persons.
A funding portal is an intermediary that does not, among other things: offer investment advice or recommendations, solicit purchases or offers to buy securities on its portal, pay its employees or other persons for solicitations in connection with the sale of securities on its portal or hold or manage investor funds or securities.
The issuer also has to file with the SEC and disclose to investors reports of its results and operations, at least once a year.
> Resales of securities sold pursuant to Section 4(6) will be restricted for a period of one year from the date of purchase to, inter alia, (i) the issuer, (ii) an accredited investor or (iii) an SEC-registered offering. Small Offerings
Finally, the Act directs the SEC to establish an exemption for “small issues” (currently capped at $5 million under Regulation A) that would allow unregistered offerings of equity, debt (including debt convertible or exchangeable into equity interests) and any guarantees of such securities. The terms and conditions of the new small issues exemption are:
> a maximum aggregate offering amount of $50 million within a 12-month period;
> the securities may be offered and sold publicly;
> the securities will not be deemed to be restricted securities; > liability under Section 12(a)(2) of the Securities Act applies;
> the issuer may solicit interest in the offering prior to filing any offering statement, on terms the SEC will determine; and
> audited financial statements must be filed with the SEC.
The SEC may include other conditions, including electronic filing, distribution of the offering statement in a certain form (including audited financial statements), bad actor disqualification provisions and periodic disclosures. Effective Dates
The effective dates of the provisions of the Act are as follows:
> IPO on-ramp – All the provisions relating to EGCs, including those relating to research reports and pilot fishing communications, are effective upon enactment, but an issuer may not claim EGC status if the first sale of its common equity securities pursuant to an effective registration statement occurred on or before December 8, 2011.
> General solicitation – The amendment to Section 4 of the Securities Act stating that offers and sales under Rule 506 shall not be deemed public offerings due to general solicitation or general advertising is effective upon the Act’s enactment. However, the SEC has 90 days from enactment to issue implementing rules. Because these rules should also provide guidance as to the reasonable steps for verifying that purchasers are accredited investors, it would be prudent to wait until the SEC issues final rules before taking advantage of the changes to Rule 506. With respect to the amendments to Rule 144A to provide for offers to persons other than QIBs, including by means of general solicitation or general advertising, the SEC has 90 days from enactment to issues its new rules.
This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts, or contact the editors.
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> Section 12(g) shareholder cap – The increase to the Section 12(g) shareholder threshold is effective upon enactment.
> Crowdfunding exemption – The crowdfunding provisions are effective upon enactment, although the SEC is directed to issue rules within 270 days that will implement the new exemption.
> Small offerings exemption – The Act specifies the terms of the small offerings exemption, but the exemption will not be effective until the SEC issues rules as directed by the Act. The Act does not set a deadline for the SEC to issue such rules.
We welcome the move to liberalize capital formation in the United States. However, a number of questions still remain regarding how the changes will be implemented. While the SEC rulemaking as directed by the Act will be critical to answering many of these questions, the SEC may not address all the uncertainties raised by the Act.
In particular, if the SEC does not address the issues raised by the Act’s general solicitation provisions for Rule 506 or Rule 144A offerings that include a Regulation S tranche, market participants will have to determine how to balance the greater freedom of communication in US private placements with the more restrictive communication requirements of Regulation S. In addition, we expect a debate among market practitioners about the application of the Act’s more liberal disclosure and research-related provisions to unregistered offerings made by EGCs, which may conflict with the requirements of the issuer’s home market (such as EU Prospective Directive requirements for three years of audited financial statements). It is also important to note that the Act does not make any changes to the applicability of Section 10(b) of, or Rule 10b-5 under, the Exchange Act to unregistered offerings, which may limit the Act’s effect on market practice with respect to unregistered offerings.
We will continue to monitor developments in this area and welcome any queries you may have.
Comparison of Requirements Applicable to
Emerging Growth Companies and Other Registered Issuers
Below is a comparison of the requirements applicable to emerging growth companies and non-EGC issuers that are registering equity securities with the SEC. Where relevant, the chart notes in the column covering non-EGC issuers when there are different requirements for foreign private issuers (most non-U.S. issuers), large accelerated filers (more than $700 million in public float), accelerated filers ($75 million or more in public float), non-accelerated filers (neither large accelerated or
accelerated filers) and smaller reporting companies (public float of less than $75 million or if no public float, annual revenues of less than $50 million).
Requirements Other Issuers (Non-EGCs) Emerging Growth Companies
Financial statement disclosure
An issuer must present audited financial statements (balance sheet, income statements, statement of changes in equity, cash flow statement and related notes) for each of its three most recent fiscal years and selected financial information (income statement and balance sheet data) for each of its last five fiscal years.
Smaller reporting companies may provide audited financial statements for just the two most recent fiscal years.
An EGC is only required to present two years of audited financial statements in its IPO registration statement. Its selected financial data in connection with any other registration statement only needs to cover the same years covered by its audited financial statements in its IPO registration statement (i.e., the two most recent fiscal years).
MD&A An issuer must provide an MD&A section that satisfies Item 303(a) of Reg. S-K by analyzing in narrative fashion its operating results, capital resources and other financial information for its previous three fiscal years.
A smaller reporting company’s MD&A is only required to cover its last two years of financial information.
An EGC satisfies Item 303(a) of Reg. S-K by providing the MD&A disclosure for the fiscal years covered by the audited financial statement periods (i.e., the two most recent fiscal years). The content requirements of Item 303(a) otherwise remain unchanged.
CD&A An issuer must satisfy Item 402 of Reg. S-K by providing a CD&A, which is comparable to an MD&A for executive officer compensation. The issuer must describe the compensation of its CEO, CFO and the next three most highly paid executive officers, and provide, among other things, tables with quantitative information regarding executive officer
compensation during the last three fiscal years. Smaller reporting companies do not have to provide a CD&A and only have to provide more limited quantitative information (including a summary compensation table) regarding the CEO and the next two most highly paid executive officers.
An EGC may satisfy Item 402 of Reg. S-K by making the more limited disclosures permitted to issuers with a market value of outstanding voting and non-voting common equity held by non-affiliates of less than $75 million (presumably referring to smaller reporting companies).
SOX internal controls requirements
Under SOX, an issuer must provide:
- an assessment by management of the issuer’s internal control over financial reporting (§ 404(a)); - an attestation report of its independent auditors of the management assessment of internal controls (§ 404(b)); and
- CEO/CFO certifications regarding the accuracy of the annual or quarterly report and the company's disclosure controls and procedures and internal control over financial reporting (§ 302 and § 906). Non-accelerated filers do not need to provide the Section 404(b) auditor’s report.
An EGC does not have to comply with Section 404(b)’s auditor report requirement, but does have to satisfy the other SOX requirements.
Requirements Other Issuers (Non-EGCs) Emerging Growth Companies Research reports Research reports may be deemed to constitute an
offer of securities unless they fall within the safe harbors provided by Rules 137, 138 and 139 under the Securities Act. To the extent a broker-dealer is participating in the offer, the Rule 139 safe harbor requires that the issuer meet certain reporting requirements and the that research report be made in the “regular course” and cannot represent the initiation of research.
The Act amends the definition of offer under Section 2(a)(3) of the Securities Act to provide that the publication or distribution of research reports by a broker-dealer (even one participating in the offer) regarding an EGC that is the subject of a proposed public offering of common equity does not constitute an offer of the securities. There are no conditions, such as ordinary course publication requirements, as there are under Rule 138 and Rule 139 under the Securities Act.
Research analyst conflicts of interest rules
There are NYSE and NASD rules governing the relationship between investment banking employees and research analysts, in order to lessen conflicts of interest. The rules include prohibitions on: - banking employees from directing research
analysts to engage in sales or marketing or communications with customers about a transaction; and
- research analyst participation in road shows or communications with issuers regarding transactions while in the presence of banking employees.
Similar prohibitions are included in the research analyst rules proposed by FINRA in 2008, which would incorporate the NYSE and NASD rules. The FINRA rules were expected to be re-proposed later this year.
Similar prohibitions were also included in the 2003 research analyst global settlement, but were removed in 2010 because the NYSE and NASD rules already covered the same issues.
The SEC and national securities associations may not issue or maintain rules in connection with the IPO of common equities of an EGC that:
- restrict, based on functional roles, which broker-dealer associated persons may arrange for communications between a securities analyst and a potential investor; or - restrict a securities analyst from participating
in any communications with EGC management that is also attended by a broker-dealer associated person.
Research report black-out periods
There are NYSE and NASD rules establishing certain black-out periods during which research reports and public appearances may not be made, including:
- if a broker-dealer is managing the IPO of an issuer, no research reports or public appearances regarding the issuer are allowed for 40 days (10 days for secondary offers) after the offer date (except those eligible for the Rule 139 safe harbor and involving actively traded securities); - if a broker-dealer is participating in an IPO, no
research reports or public appearance about the issuer is allowed for 25 days after the offer date; or
- if a broker-dealer is managing an offering of an issuer, no research reports or public appearance about the issuer is allowed for 15 days prior to or after the expiration of a lock-up or other agreement between the broker-dealer and the issuer and its shareholders (except those eligible for the Rule 139 safe harbor and involving actively traded securities).
FINRA’s 2008 proposed research analyst rules, which would incorporate the NYSE and NASD rules, would have eliminated the 10-day quiet period after secondary offerings and the 15-day quiet period after expiration of a lock-up.
The SEC and national securities associations may not issue or maintain rules prohibiting broker-dealers from publishing or distributing research reports or making public
appearances with respect to the securities of an EGC:
- within a prescribed time following the IPO offering date; or
- within any prescribed period of time prior to the expiration date of any agreement between the broker-dealer and the EGC or its shareholders restricting or prohibiting the sale of securities by the EGC or its shareholders after the IPO date.
Requirements Other Issuers (Non-EGCs) Emerging Growth Companies Pilot fishing
communications with QIBs/IAIs
In general, an issuer may not make offers (oral or written) during the pre-filing period. The only exception is for well-known, seasoned issuers (“WKSIs”) or anyone acting on their behalf (except, importantly, an underwriter or dealer participating in the offer), who are permitted to communicate with investors during the pre-filing period.
During the waiting period (after the registration statement has been filed but before it goes
effective), only oral, not written, offers are permitted.
An EGC or any authorized person on behalf of an EGC may engage in oral or written communications with QIBs or institutional accredited investors prior to or following the filing of a registration statement to determine if they are interested in the proposed offer.
Confidential submission of registration statement
An issuer is required to submit its registration statements to the SEC for review publicly through the EDGAR system.
Until recently, foreign private issuers and foreign governments submitting a registration statement for the first time had the option of confidential review, but now only certain categories of first-time non-U.S. filers – including foreign private issuers that are listed or are concurrently listing securities on a non-U.S. securities exchange – have the option of confidential review.
An EGC may submit its registration statements to the SEC for confidential review as long as it is publicly filed at least 21 days before any roadshows. The SEC does not have to disclose the information pursuant to FOIA requests.
Say-on-pay/golden parachutes vote
In 2011, the SEC issued rules requiring issuers to provide shareholders with a non-binding advisory vote on executive compensation, the frequency of the say-on-pay vote and “golden parachute” compensation arrangements with executive officers in connection with merger transactions (together, the “shareholder advisory votes”).
These requirements generally do not apply to foreign private issuers.
An EGC is exempt from all the shareholder advisory vote requirements. However, an issuer must comply with the frequency of say-on-pay vote requirement within one year of leaving EGC status, unless it has been an EGC for less than two years.
Executive compensation disclosures
The Dodd-Frank Act mandates that the SEC issue rules (which have not yet been proposed) requiring issuers to make disclosures regarding the ratio of the CEO’s compensation to median employee compensation and the relationship between executive compensation paid and the issuer’s financial performance.
Foreign private issuers are unlikely to be subject to these disclosure rules.
An EGC is exempt from the executive compensation disclosure rules that the SEC will issue pursuant to the Dodd-Frank Act.
Future PCAOB rules
The PCAOB governs the auditors of public companies and sets auditing standards. The PCAOB is currently considering a mandatory audit firm rotation requirement.
An EGC would be exempt from any PCAOB rules requiring mandatory audit firm rotation or an auditor discussion & analysis, as well as any other later PCAOB rules, unless the SEC decides it is necessary to apply such rules to EGCs.
Future U.S. GAAP changes
SEC rules require an issuer’s financial statements to comply with U.S. GAAP (or, for foreign private issuers, IFRS as issued by the IASB or local GAAP with a reconciliation to U.S. GAAP).
An EGC can use the same extended compliance period for new or revised accounting standards that are available to private companies.