With a showing of bipartisan support for the country’s small and emerging businesses, Congress has passed the JOBS Act as a result Senate action last week and House action yesterday. All reports are that the President is poised to sign the Act into law. The Act makes sweeping changes to a number of longstanding securities laws and, as a result, provides relief to small and emerging businesses. Specifically, the Act contains: (a) an "IPO on-ramp" for emerging growth companies; (b) relief from the "no solicitation" requirement in certain private offerings; (c) a methodology for soliciting a million dollars of investment funds in small increments from a large number of purchasers in a process that is called "crowdfunding"; (d) reforms the securities offering process known as "Regulation A"; (e) provisions raising the number of shareholders an issuer must have before triggering public company reporting under the Securities and Exchange Acts of 1934 (the "’34 Act"); and (f) certain specific relief from the Securities Act of 1934 for community banks.

IPO On Ramp
In creating the initial public offering on ramp, Congress created a new category of securities issuer called an "emerging growth company", which is a company with total annual gross revenue less than $1 billion before going public. Emerging growth companies will only be required to have audited financials for two years prior to IPO registration rather than three. An emerging growth company retains its status for five years after its IPO or until the company exceeds $1 billion in annual gross revenue or has $700 million in public float. SEC regulations would generally be phased in over this five year period. Compliance with Sarbanes – Oxley Act Section 404(b) is delayed for up to five years, but the emerging growth company is still required to file annual reports with the SEC and include the management statement concerning adequate internal controls under Section 404(a). Emerging Growth Companies will also have an exemption from Dodd-Frank Act requirements calling for nonbinding stockholder votes on executive compensation and golden parachutes and the need to compare median compensation of all employees to that of the chief executive officer.

General Solicitation Permitted
Under current law, potential investors in private placement offerings are required to have an existing relationship with a company before they can be notified that unregistered securities are available for purchase. This requirement is eliminated by the JOBS Act and advertising and general solicitation in non-publicly traded securities is permitted provided that all purchasers are accredited investors. The Act requires the SEC to revise Rule 506 of Regulation D and adopt further regulations providing how a private company would verify that purchasers are accredited investors.

Crowdfunding
This portion of the Act allows small start-up companies to accept and pool small investments from the public without securities law registration. Under the crowdfunding provisions, an enterprise can raise up to $1 million per year from the general public provided that individual investments are limited to the lesser of $2,000 or five percent of annual income if the purchaser’s income is under $100,000, or ten percent of annual income up to $100,000 if the purchaser’s income is over $100,000. Crowdfunding opportunities will be limited to U.S. companies not reporting under the ’34 Act and will not be available to investment companies. While no disclosure document is required, the antifraud provisions of applicable securities law remain in place. A Crowdfunding offering will have to be conducted through a broker or a funding intermediary to be regulated by the SEC. The Act permits state laws to require a notice filing of any crowdfunding offering, but indicates that notices may only be required by the state in which the issuer is domesticated and any state in which fifty percent of the investors are located. Otherwise, state blue sky registration requirements are pre-empted. Further, crowdfunding investors are excluded from the count of shareholders for purposes of determining whether the threshold number of shareholders has been obtained for purposes of registration and reporting as a public company under the ’34 Act. The SEC has been given nine months to develop a regulatory framework for crowdfunding offerings. Given this lead time, and the need for markets to adjust to the regulations once they have been promulgated, it is unlikely that crowdfunding opportunities will be available until sometime next year.

Regulation A Reform
Regulation A currently provides a method for a company to raise equity capital based upon an offering circular filed and reviewed by the SEC that has less onerous requirements than a full-blown IPO registration statement. Regulation A does not provide any relief from state blue sky registration provisions. Existing Regulation A is restricted to a $5 million offering. The JOBS Act increases this $5 million limit to $50 million and provides for the offering document to be presented in a question and answer format. Companies using the new Regulation A will also be able to "test the waters" to ascertain the level of potential purchaser interest before committing to the full expense of Regulation A offering. Further, under the new law there will be no transfer restrictions on the securities sold under Regulation A and there will be no automatic requirement for reporting under the ’34 Act. Unfortunately, however, blue sky filing requirements are not pre-empted.

Registration and Reporting Requirements under the ’34 Act
Currently a company that has 500 shareholders must register under the ’34 Act and become a reporting public company. The new Act amends Section 12(g) of the ’34 Act to increase the number of shareholders to 2,000; however, a 500 shareholder limit is retained for non-accredited investors. In addition, employees and purchasers under employee compensation plans will now be excluded from the count.

Community Bank Relief
The Act increases the number of shareholders a community bank may have without requiring ’34 Act registration from 500 to 2,000 and will permit deregistration if the number falls thereafter below 1,200.

Initial Observations
Undoubtedly, the JOBS Act will eventually address the objective of furthering job creation and economic growth by easing access to capital markets; however, a fair number of its provisions will require SEC rule making before they can be implemented and relied upon. Thus, the eyes of all players will be on the SEC rule promulgation process. Relief from the restriction on general solicitation and the crowdfunding provisions will eventually allow entrepreneurs to access seed capital and address ongoing growth needs with greater ease and at a lower cost. The effectiveness of crowdfunding options will largely depend on SEC rule making, including whether crowdfunding offerings will have to be integrated with any subsequent or simultaneous offering to accredited investors. The changes to Regulation A will likely have limited impact without state pre-emption. The ’34 Act relief from registration and reporting requirements will be beneficial to new fledgling public companies and may also result in a wave of existing public companies making deregistration decisions. Stay tuned for SEC action results.

For more information contact:
Henry Beck, Jr.
beck@halloransage.com