Deadline Passes for SEC to Implement JOBS Act Key Provision
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Deadline Passes for SEC to Implement JOBS Act Key Provision

by Thomas L. Hanley and Lori Buchanan Goldman

On July 4, 2012, the Securities and Exchange Commission (SEC) failed to meet the deadline imposed by the Jumpstart Our Business Startups Act, known as the JOBS Act, for implementing key provisions of the Act that would lift the ban on general solicitation activities in connection with private placements. SEC Chairman Mary Shapiro, commented on the delay, stating that the SEC expects to have a timeline for implementing the remaining parts of the JOBS Act before the end of this summer. The SEC has scheduled a meeting on August 22, 2012 to consider rules to eliminate the current prohibition on general solicitation under Regulation D of the Securities Act of 1933, as amended. It is unknown whether the SEC will consider proposing rules or adopting rules at this meeting or whether it will adopt interim rules and propose final rules. Nonetheless, several of the JOBS Act’s major provisions are currently in effect, including the provision that created emerging growth companies (EGCs) and the provision that increased the Section 12(g) registration thresholds.

The overarching goals of the JOBS Act are to make capital more accessible to companies and spur business growth. In order to accomplish these goals, the JOBS Act has significantly altered existing securities laws, making it easier for EGCs to go public and for all companies, both public and private, to raise capital through private placements. In effect, the JOBS Act is expected to enable companies to have greater control over when they will go public, reduce compliance costs and disclosure requirements for companies that choose to go public and retain their EGC status, and remove a significant restriction on companies’ ability to raise capital through private placements. Below is a recap of the portions of the JOBS Act, together with the expected time frames for implementation.

The Emerging Growth Company Paves the Way for IPOs

EGCs are defined as companies with an annual gross revenue of less than $1 billion during their most recent fiscal year. In order to help companies decide whether to go public, the JOBS Act allows EGCs to communicate with potential investors before starting the registration process, as well as file registration statements confidentially with the SEC. If an EGC becomes a public reporting company, it can take advantage of several regulatory disclosure exemptions, including financial, compensation-related and accounting exemptions.

EGCs are required to provide audited financial statements and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) for only the two most recently completed fiscal years (instead of three) in their IPO registration statements. Also, EGCs will not have to present “selected financial data” in accordance with Item 301 of Regulation S-K for any period prior to the earliest audited period presented in the registration statement.

Second, EGCs are not required to submit “say on pay” and “say on frequency” advisory votes for executive compensation to shareholders for as long as the company remains an EGC (up to five years). They are also exempt from disclosing information that shows the relationship between (1) executive compensation and the company’s performance and (2) CEO compensation and the median compensation of all employees (each of which relate to the Dodd-Frank Wall Street Reform and Consumer Protection Act and remain to be implemented by the SEC). Finally, EGCs do not have to provide audited reports of their internal controls over financial reporting under Section 404 of the Sarbanes-Oxley Act and they will not have to adopt new or revised Generally Accepted Accounting Principles (GAAP) pronouncements until the deadlines for adoption of those new or revised GAAP pronouncements by private companies. Altogether, these exemptions are expected to allow EGCs to go public with lower compliance costs and reduced disclosure obligations.

Increasing the Section 12(g) Registration Thresholds Allows Private Companies to Stay Private and Eases Restraints for Banks and Bank Holding Companies Looking to “Go Dark”

Prior to the JOBS Act, companies with total assets valued at more than $10 million and securities held by 500 or more record shareholders were required to register their stock under Section 12(g) of the Securities Exchange Act of 1934, as amended, thereby becoming a public reporting company. The JOBS Act raises the record shareholder threshold from 500 to either (1) 2,000 persons or (2) 500 non-accredited investors, in each case excluding shareholders who received their securities through a transaction exempt from registration under an employee compensation plan. Banks and bank holding companies get even a bigger break – the JOBS Act raises the record shareholder threshold from 500 to 2,000 and does not impose a lower threshold based on the number of non-accredited investors. The practical effect of these increases is to enable companies to remain private longer because they can now issue more securities privately without being forced to register with the SEC. In addition, the JOBS Act makes it easier for banks and bank holding companies to exit the public reporting system by increasing the shareholder threshold for deregistration from 300 to 1,200 registered holders.

The JOBS Act provisions which increase these Section 12(g) thresholds became effective immediately and require no further implementation by the SEC.

Lifting the Ban on General Solicitation Increases Access to Potential Investors

Despite concerns over the potential for increased fraud, the JOBS Act makes it easier for both public and private companies to access capital by raising their ability to communicate with potential investors. Currently, companies are prohibited from engaging in general solicitation when selling their securities in private placements, and the SEC traditionally has taken a broad view of what may constitute a general solicitation, which has made it difficult for companies to reach potential investors without “close contacts” with those investors.

The JOBS Act intends to lift the SEC’s prohibition on general solicitation by allowing both public and private companies to communicate with certain types of investors in connection with proposed private placements. In the context of Rule 506 offerings, companies will be able to solicit “accredited investors” in a general manner as long as they take “reasonable steps” to make sure that the investor is actually accredited. Similarly in the context of Rule 144A offerings, companies will be able to solicit qualified institutional buyers through general solicitation.

The new provisions should to make it easier for companies to access capital. This may particularly enable smaller companies to reach a broader pool of potential investors. However, it remains to be seen how and when the SEC will implement these provisions. SEC Chairman Shapiro recently stated, "While we have an important responsibility to facilitate growing companies' access to America's investment capital, we must balance that responsibility with our obligation to protect investors and our markets." A timeline for implementation is expected before the end of the summer and the SEC has scheduled a meeting on August 22 to consider rules to eliminate the prohibition against general solicitation.

Crowdfunding Could Provide “Seed Money” for Small Business

The JOBS Act introduces a new option known as crowdfunding for small businesses to raise capital. Through crowdfunding, companies will be able to raise up to $1 million over a 12 month period by selling securities through online portals that are registered with the SEC. In order to engage in crowd funding, companies will have to provide certain disclosures to investors, such as a description of the company’s financial condition, a description of the business plan and a description of the intended use of the proceeds. Ultimately, supporters of the JOBS Act hope that crowdfunding will provide a new source of “seed money” to help jump-start the growth of smaller businesses.

The SEC’s deadline for implementing the crowdfunding provisions of the JOBS Act is December 31, 2012, however, it remains to be seen how the provision will be implemented given that Ms. Shapiro has publicly stated that the provision could “weaken investor protection.”

How the JOBS Act Can Help You

Overall, the JOBS Act makes it easier for companies to raise capital by reducing compliance costs and disclosure obligations, gives companies greater control over whether they will go public or remain private, and increases access to capital by lifting the ban on general solicitation and introducing crowdfunding. Stradley Ronon is available to assist companies in raising capital in public and private offerings, SEC reporting compliance, going public, and deregistering or “going dark.” If you have any questions or would like to discuss specific issues, please do not hesitate to call one of the following securities attorneys: Thomas Hanley, 202.292.4525; Eric Schoenborn, 856.321.2413; or Lori Goldman, 215.564.8707.

• have the authority, in its sole discretion, to retain and obtain the advice of compensation advisers, separate legal counsel or other advisers;
  
  
• be directly responsible for the appointment, compensation and oversight of the work of the compensation adviser, legal counsel or other advisers so retained; and
  
  
• be provided appropriate funding from the issuer (as determined by the committee) for the payment of reasonable compensation to committee-retained advisers.

• whether the entity employing the adviser provides other services to the issuer;
  
  
• the amount of fees received by the entity employing the adviser from the issuer as a percentage of the total revenue of that entity;
  
  
• what policies and procedures the entity employing the adviser has in place designed to prevent conflicts of interest;
  
  
• whether there are any business or personal relationships between the adviser and a member of the compensation committee;
  
  
• whether the adviser owns any stock in the issuer; and
  
  
• whether there are any business or personal relationships between the adviser or entity employing the adviser and an executive officer of the issuer.

• limited partnerships;
  
  
• companies involved in bankruptcy proceedings;
  
  
• foreign private issuers that disclose in their annual reports the reasons why they do not have an independent compensation committee; and
  
  
• open ended management investment companies registered under the Investment Company Act of 1940.

• If the company determines that the trend, event or uncertainty is reasonably likely to occur, disclosure is required;
  
  
• If the company determines that the trend, event or uncertainty is not reasonably likely to occur, no disclosure is required; and
  
  
• If the company cannot determine whether the trend, event or uncertainty is or is not reasonably likely to occur, it must evaluate objectively the consequences of the known trend, event or uncertainty on the assumption that it will occur and disclosure is then required unless the company determines that a material effect on its financial condition or results of operations is not reasonably likely to occur.

In the Ikanos case, the plaintiffs alleged that the company first learned in January 2006 that there were quality issues with certain of its semiconductor chips, but that Ikanos failed to disclose the quality issues prior to completing a $120 million stock offering in March 2006. Eventually, Ikanos determined that the chips had an “extremely high” rate of failure that warranted replacement of all units sold, ultimately resulting in a net loss for Ikanos and the decline of its share price. The U.S. District Court originally dismissed the case for failure to state a claim on which relief can be granted, concluding that no pleaded facts suggested that Ikanos knew or should have known of the magnitude of the problem at the time of the March 2006 offering. The Second Circuit reversed, holding that plaintiff’s complaint did state a claim because the real issue was not whether Ikanos could have known the magnitude of the problem, but rather that Ikanos knew of an uncertainty – the quality issues with the semiconductor chips – that could reasonably be expected to have a material impact on its net sales, revenues or income, and it therefore should have disclosed the uncertainty prior to the offering.

A more recent example of this issue has arisen in the aftermath of Facebook’s IPO, where certain disgruntled investors have argued, among other things, that Facebook failed to publicly disclose anticipated decreases in its revenue growth due to a rise in traffic on mobile devices as opposed to traditional computers. There is uncertainty surrounding Facebook’s ability to be profitable when used on mobile devices, and plaintiffs have contended that such uncertainties, coupled with the trend of increased mobile traffic, should have been disclosed pursuant to Item 303 or otherwise.

As a general practice, in connection with the preparation of quarterly and annual MD&As, each public company should determine and carefully review what trends, demands, commitments, events or uncertainties are known to management. As noted above, if management determines that a known trend, demand, commitment, event or uncertainty is not reasonably likely to occur, no disclosure is required. However, if management cannot determine that a known trend, demand, commitment, event or uncertainty is not reasonably likely to occur, then the company should make such disclosure in its MD&A unless management determines that no material effect on the company’s financial condition or results of operations is reasonably likely to occur.

Stradley Ronon is well-versed in assisting public companies in the analysis and evaluation of MD&A-related matters. If you have any questions or would like to discuss specific issues, please do not hesitate to call one of the following securities attorneys: Thomas Hanley, 202.292.4525; Eric Schoenborn, 856.321.2413; or Lori Goldman, 215.564.8707.

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