Thursday, March 22, 2012

Senate Passes JOBS Act, But With New Title III on Crowdfunding

The Senate passed the Jumpstart Our Business Startups JOBS Act, HR 3606, 73-26, but with a significant amendment by Senator Jeff Merkley (D-OR) that inserted a new Title III on crowdfunding that is different from the House version of Title III. The Jumpstart Our Business Startups (JOBS) Act, HR 3606, reduces the costs of going public by providing companies with a temporary reprieve from SEC regulations by phasing in certain regulations over a five‐year period, thereby allowing smaller companies to go public sooner. The measure also removes an SEC regulatory ban preventing small businesses from using advertisements to solicit investors. HR 3606 would also remove SEC restrictions that prevent crowdfunding so entrepreneurs can raise equity capital from a large pool of small investors.

Moreover, the legislation amends SEC Regulation A, increasing the offering threshold for companies exempted from SEC registration from $5 million to $50 million. The legislation also removes barriers to capital formation for small companies by raising the shareholder registration requirement threshold from 500 to 1,000 shareholders. Similarly, the legislation increases the number of shareholders permitted to invest in a community bank from 500 to 2,000 without triggering SEC filing duties.

The Merkley Amendment would, among other things, require crowdfunding intermediaries to register with the SEC as a broker or a funding portal. The House version of Title III does not require such registration or even envision it.

Title I of the legislation is the Reopening American Capital Markets to Emerging Growth Companies Act, which is designed to promote job creation and further economic growth by making it easier for more companies to access capital markets by reducing the cost of going public for small and medium size companies. The measure, co-authored by Rep. Stephen Fincher (R-TN) and Rep. John Carney (D-DE), would create a new category of issuer, the emerging growth company, which would retain that status for five years or until it exceeds $1 billion in annual gross revenue or becomes a large accelerated filer. H.R 3606 ensures investors are protected by requiring emerging growth companies to provide audited financial statements as well as establishing and maintaining internal
controls over financial reporting.

The Act would allow emerging growth companies to defer compliance with Section 404(b) of the Sarbanes-Oxley Act until the company is no longer considered an emerging growth company. The exemption from Section 404(b) would delay the hiring of an additional outside auditor to verify the company's internal controls for the five year on ramp period.Section 404(b) requires the company's auditor to report on and attest to management's assessment of the company's internal controls.

Title II of HR 3606 is the Access to Capital for Job Creators Act, authored by Rep. Kevin McCarthy, (R-CA), which would remove the prohibition against general solicitation or advertising on sales of non-publicly traded securities, provided that all purchasers of the securities are accredited investors.

The Securities Act requires that any offer to sell securities either be registered with the SEC or meet an exemption. Rule 506 of Regulation D is an exemption that allows companies to raise capital as long as they do not market their securities through general solicitations or advertising. This prohibition on general solicitation and advertising has been interpreted to mean that potential investors must have an existing relationship with the company before they can be notified that unregistered securities are available for purchase. Congress believes that requiring potential investors to have an existing relationship with the company significantly limits the pool of pool of potential investors and severely hampers the ability of small companies to raise capital and create jobs.[H. Rep. No. 112-263]

The legislation would allow small companies offering securities under Regulation D to utilize advertisements or solicitation to reach investors and obtain capital. The SEC’s ban on solicitation, first adopted in 1982, limits the pool of potential investors and hampers the ability of small companies to raise capital.

Title IV is the Small Company Formation Act, authored by Rep. David Schweikert (R-AZ), which would increase the offering threshold for companies exempted from SEC registration under Regulation A from $5 million to $50 million. The SEC has the authority to raise this threshold but has not done so for almost two decades. Congress believes that amending Regulation A to make it a viable channel for small companies to access capital will permit greater investment in these companies, resulting in economic growth.

Title V of the Act is the Private Company Flexibility and Growth Act, authored by Rep. David Schweikert (R-AZ), which increases the number of shareholders that can invest in a private company from 500 to 2,000, only 500 of which can be non-accredited investors, with 1500 having to be accredited investors as defined by the SEC. Originally, Title V raised the 500-shareholder threshold to 1000. The threshold was raised to 2000 pursuant an amendment offered by Rep. Brad Miller (D-NC).