At the first anniversary of the JOBS Act, it’s time to consider whether the JOBS (Jumpstart Our Business Startups) Act is getting the job done in terms of promoting access to capital formation for emerging companies in the United States. Some may say it is premature to make any assessment, even a preliminary one, given that many of the provisions of the JOBS Act require the US Securities and Exchange Commission (SEC) to undertake rulemaking, and that the rulemaking deadlines have not been met. However, many of the Act’s provisions were immediately effective, and have been tested by the market.
The JOBS Act affects both exempt and registered offerings, as well as the reporting requirements for certain public issuers. The centrepiece of the JOBS Act is a new ‘IPO on-ramp’ approach for ‘emerging growth companies’ (Title I), with confidential SEC Staff review of draft initial public offering, or IPO, registration statements, scaled disclosure requirements, no restrictions on ‘test-the-waters’ communications with qualified institutional buyers (QIBs) and institutional accredited investors before and after filing a registration statement, and fewer restrictions on research around the time of an offering. The JOBS Act also directs the SEC to amend its rules to eliminate the ban on general solicitation and general advertising in certain private placements made pursuant to Rule 506 when sales are only to accredited investors, and in Rule 144A offerings to QIBs (Title II); establish a small offering exemption for crowdfunding (Title III); and create a framework for a new exemption for offerings raising up to $50m in proceeds, referred to as Section 3(b)(2) or Regulation A+ (Title IV). The JOBS Act also raises the holder-of-record threshold for mandatory registration under the Securities Exchange Act of 1934, as amended (the ‘Exchange Act’) (Titles V and VI), permitting growing companies whose stock ownership has become dispersed to remain private longer and defer becoming an SEC-reporting company.
Setting aside the merits or utility of any particular change brought about by the JOBS Act, it is important to recognise that the adoption of this legislation signalled the recognition on the part of US legislators that perhaps the regulatory balance needed to be recalibrated. Since 2002, with the passage of the Sarbanes-Oxley Act, the requirements imposed on public companies and on financial intermediaries (in 2003 with adoption of regulations relating to research) have become progressively more burdensome. During the same period, there have been significant market structure changes and technological advancements that have affected capital formation. But for Securities Offering Reform in 2005, which addressed principally capital-raising by the most sophisticated and largest companies, there have been very few changes in the regulation of securities offerings. And even fewer changes in the regulation of exempt and hybrid securities offerings. The JOBS Act is an important step, but only a first step, in promoting capital formation, responding to the needs of smaller and emerging companies, and acknowledging that the traditional financing ‘lifecycle’ (from friends-and-family to venture financing to IPO) for US companies has changed.
The provisions of Title I of the JOBS Act, the IPO on-ramp, were immediately effective. SEC Staff promptly issued guidance in the form of various sets of Frequently Asked Questions that assisted market participants to avail themselves of the new accommodations. Over 100 IPOs by emerging growth companies, or EGCs, have now been completed. Most EGCs have taken advantage of the confidential filing process and have submitted their registration statements for review and comment by the SEC before making any public filing. EGCs also have taken advantage of the ability to present abbreviated executive compensation disclosures in their offering documents. Many market participants have been reluctant to take advantage of certain other accommodations. For example, most EGCs are still presenting three years of financial information, instead of the permissible two years. Although an EGC, or its bankers, may approach institutional investors to gauge their interest in an offering, these ‘test-the-waters’ communications have proceeded cautiously. Title I also eliminates artificial research ‘quiet periods’ and attempts to encourage investment banks, including those participating in offerings, to publish research regarding EGCs. Even after the JOBS Act, significant additional changes would be required in order to effect real changes in equity research.
The provisions of Titles V and VI of the JOBS Act relating to the Exchange Act threshold also were immediately effective. Many banks have suspended their SEC filings as a result of the higher thresholds. Even prior to these changes, many private companies were choosing to remain private longer and deferring IPOs or choosing other liquidity alternatives. It is reasonable to anticipate that with these changes, and with the growth of private secondary markets and the enhanced flexibility to conduct private or exempt offerings, more companies will be able to finance their growth without undertaking IPOs.
The JOBS Act also has redrawn the boundaries between ‘private placements’ and ‘public offerings.’ Title II of the Act requires the SEC to implement rules to permit the use of general advertising in private placements made pursuant to Rule 506. Once these rules are finalised, an issuer, or its advisers, may be able to identify potential investors with which neither has had a pre-existing relationship. New financing models are continuing to be introduced that use the internet or other broad-based communications to contact accredited investors in the context of private placements. Another provision of Title II provided certainty that ‘matchmaking’ sites could use the internet to reach accredited investors (and eventually, once rules are finalised, non-accredited investors) and facilitate capital formation, without having to register as broker-dealers.
The SEC Staff has provided further no-action letter guidance to sponsors of matchmaking sites regarding the types of activities that would be deemed permissible without broker-dealer registration. These no-action letters offer a glimpse into new internet-based quasi-venture or early-stage ‘private equity’ financing approaches that may come to be important for emerging companies. Significant capital can be raised through private offerings made pursuant to Rule 506, or eventually through small public offerings made pursuant to Regulation A+, making these ‘hybrid’ offering formats important to emerging companies for which the IPO on-ramp is still too steep or too expensive a climb.
So, has the JOBS Act done the job? If one were to identify the task as reviving interest in financing innovative, growing companies, then the answer would be an unqualified yes. The JOBS Act has restarted an important dialogue on capital formation, as well as on the continuing disclosure requirements for smaller public companies in the United States. Undoubtedly, as the SEC moves ahead to implement the required rules, we can anticipate that many interesting questions will need to be addressed regarding the additional steps needed to reinvigorate the IPO market and restore investor confidence in IPOs.
Anna T. Pinedo and James R. Tanenbaum are partners at Morrison & Foerster. Ms Pinedo can be contacted on +1 (212) 468 8179 or by email: firstname.lastname@example.org. Mr Tanenbaum can be contacted on +1 (212) 468 8163 or by email: email@example.com.
© Financier Worldwide
Anna T. Pinedo and James R. Tanenbaum
Morrison & Foerster