Thursday, April 05, 2012

President Signs JOBS Act Providing for IPO On-Ramp and Crowdfunding

The President signed the Jumpstart Our Business Startups (JOBS) Act, which is designed to streamline or eliminate the regulatory and legal barriers preventing emerging businesses from reaching out to investors, accessing capital, and selling shares on the public market. There are three main themes driving the passage of the Jumpstart Our Business Startups Act. The first is an effort to restart the US initial public offerings market by creating an IPO on-ramp. The second is the desire to allow companies to raise capital over the Internet through crowdfunding; and the third is the need to revise outdated SEC regulations.

The Act makes it possible for promising new businesses to go public and access financial opportunities that currently are limited to large corporations. The legislation will also allow what is known as crowdfunding, which allows groups of investors to pool money, typically comprised of very small individual contributions, to support an effort such as growing a new company.

Crowdfunding has the potential to unleash a wave of new economic opportunity by letting small businesses and start-up companies use the Internet to fund new investments.

The legislation eases and defers regulations to provide startups with an on ramp to an initial public offering. These startups are emerging-growth companies, new entities in securities regulation, and they will have as many as five years, depending on revenue size and public float, to transition to full compliance with a variety of new regulations that are expensive to new companies.

What the Act does is give small and growing companies an opportunity to grow into the ability to afford the most expensive regulation to which they would be subject. Nobody is exempted permanently. Everybody who goes public would be subject to the full panoply of regulations within 5 years or sooner if they grow faster

For example, the Jumpstart Our Business Startups Act defers compliance with two Dodd-Frank Act corporate governance provisions: an advisory shareholder vote on executive compensation and the disclosure of the median compensation of all employees compared to the CEO. It also defers compliance with Section 404(b) of the Sarbanes-Oxley Act, which mandates outside auditor attestation of the effectiveness of a company’s internal controls.

This on-ramp status allows small and mid-size companies the opportunity to save on expensive compliance costs and create the cash needed to successfully grow their businesses and create jobs. The legislation makes it easier for potential investors to get access to research and company information in advance of an IPO in order to make informed decisions about investing. The legislation also allows for crowdfunding, which facilitates the raising of capital over the Internet.

IPO ON RAMP FOR EMERGING GROWTH COMPANIES.—Title I establishes an on ramp to initial public offerings for a new category of issuers known as emerging growth companies, which are issuers that have total annual gross revenues of less than $1 billion.

The legislation is intended to address the decline in the number of companies entering the U.S. capital markets through IPOs. According to Rep. Stephen Fincher (R-TN), and co-author of the Act’s on ramp provisions, during the last 15 years, fewer and fewer start-up companies have pursued initial public offerings because of burdensome costs created by a series of one-size-fits-all laws and regulations. (Cong Rec. (March 7, 2012), p. H1226).

Title I 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, a new entity in the federal securities law, 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.

The legislation would also make it easier for potential investors to get access to research and company information in advance of an IPO in order to make informed decisions about investing. This is critical for small and medium-size companies trying to raise capital that have less visibility in the marketplace.

Essentially, emerging growth companies are exempted from certain regulatory requirements until the earliest of three dates: (1) five years from the date of the emerging growth company’s initial public offering; (2) the date an emerging growth company has $1 billion in annual gross revenue; or (3) the date an emerging growth company becomes a large accelerated filer, which is defined by the SEC as a company that has a worldwide public float of $700 million or more. The legislation thus provides temporary regulatory relief to small companies, which encourages them to go public, yet ensures their eventual compliance with regulatory requirements as they grow larger.

The Jumpstart Our Business Startups Act adapts the SEC's scaled regulations for smaller companies by more slowly phasing in regulations that impose high costs on issuers, without compromising core investor protections or disclosures. The emerging growth companies would still be required to comply with SEC-mandated quarterly and annual disclosures, but they would be exempted from the auditor attestation provisions of Section 404(b) of the Sarbanes-Oxley Act for a longer transition period, up to five years, instead of the current transition period of two years. To ensure that investors are adequately protected, an emerging growth company’s management would still be required to establish and maintain internal controls over financial reporting, as mandated by Section 404(a) of the Sarbanes-Oxley Act, and its chief executive officer and chief financial officer would still have to certify the company's financial statements.

The Jumpstart Our Business Startups Act requires emerging growth companies to provide audited financial statements for the two years prior to registration, rather than three years as is now required. This two-year period already applies to companies with a public float under $75 million, which are known as non-accelerated filers.

The Jumpstart Our Business Startups Act exempts emerging growth companies from any rules promulgated by the Public Company Accounting Oversight Board (PCAOB) that would require mandatory audit firm rotation, thereby allowing them to avoid the unnecessary costs of changing from an outside auditor familiar with the company to one that is not. The Act also gives emerging growth companies the opportunity to opt in to certain regulations by complying with them before they lose their EGC status. However, if the Financial Accounting Standards Board (FASB) adopts new accounting standards while a company is an emerging growth company, the company must comply with either all or none of the new standards while it remains an emerging growth company.

The Jumpstart Our Business Startups Act exempts emerging growth companies from two new corporate governance requirements that were established by the Dodd-Frank Wall Street Reform and Consumer Protection Act. First, emerging growth companies are exempt from Section 951's requirement that public companies hold a non-binding stockholder vote on executive compensation arrangements. Second, they are exempt from Section 953(b)'s requirement that public companies calculate and disclose the median compensation of all employees compared to the CEO. But, emerging growth companies would still comply with all stock exchange corporate governance and listing requirements, including board member independence rules.

The Jumpstart Our Business Startups Act also improves the flow of information about emerging growth companies to investors by removing burdensome and outdated restrictions on communications between companies, research analysts, and investors.
The Jumpstart Our Business Startups Act also permits emerging growth companies to gauge the interest in potential IPOs by permitting greater pre-filing communications to institutional and qualified investors to determine whether an IPO is likely to be successful.

The Jumpstart Our Business Startups Act permits emerging growth companies to pre-file confidential registration statements, thereby allowing them to begin the SEC review process without publicly revealing sensitive commercial and financial information to their competitors.

REGULATION D GENERAL SOLICITATION BAN.— Title II of the Jumpstart Our Business Startups Act would allow small companies offering securities under Regulation D to utilize advertisements or solicitation to reach investors and obtain capital.
Title II removes the prohibition against general solicitation or advertising on sales of non-publicly traded securities, provided that all purchasers of the securities are accredited investors.

CROWDFUNDING.—Title III of the Jumpstart Our Business Startups Act would introduce the concept of crowdfunding, which is designed to enable aspiring entrepreneurs to access investment capital via the Internet from small dollar investors. Title III is the Senate Merkley Amendment, adds a new crowdfunding exemption from the Securities Act to allow companies to finance new businesses by allowing companies to accept and pool donations of up to $1 million over the Internet.

The crowdfunding provisions are designed to enable aspiring entrepreneurs to access investment capital via the Internet from small dollar investors across America. The possibility for capital formation through the Internet through crowdfunding is enormous, in 2011, Americans had invested $17 trillion in retirement funds. Imagine, if one percent of those investments went into crowdfunding. The result would be $170 billion of investment in startups and small businesses.

Crowdfunding allows small businesses to access the capital markets to sell equity, rather than ask for debt, to sell equity in their great start-up or new idea. Crowdfunding takes the best of microfinance and crowdsourcing and uses the power of the Internet for small businesses to have offerings in their company. Crowdfunding legislation allows a business to raise money from small investors across the country. There is no legal way to do that without this legislation. Currently, entrepreneurs without access to capital cannot raise funds in small tranches without incurring SEC oversight, The legislation “effectively allows working American families to raise money for their ideas by crowdsourcing, or raising money over the Internet.

The Act sets forth reasonable proportional caps that say if one’s income is $40,000 or less, their cap is $2,000; if they are between $40,000 and $100,000, their cap is 5 percent of their annual income; if they are over $100,000, it is 10 percent. These proportional caps allow for larger amounts of money from those who have much higher incomes but provide basic aggregate cap protections.

A person acting as a crowdfunding intermediary must register with the SEC as a broker or as a funding portal, and must also register with the appropriate SRO. The intermediary must also provide such disclosures as the SEC determines by rulemaking to be appropriate, which must include disclosures related to risks and other investor education materials.

The intermediary must also ensure that each crowdfunding investor reviews investor education information, in accordance with the standards established by SEC regulations and must positively affirm that the investor understands that the investor is risking the loss of the entire investment, and that the investor could bear such a loss.

The intermediary must also determine that the investors have an understanding of the level of risk generally applicable to investments in startups, emerging businesses, and small issuers, as well as an understanding of the risk of illiquidity. The SEC may adopt regulations specifying other matters of which the intermediary must ensure that investors have an understanding.

The intermediary must also take measures to reduce the risk of fraud with respect to such transactions, as established by SEC regulations, including obtaining a background and securities enforcement regulatory history check on each officer, director, and person holding more than 20 percent of the outstanding equity of every issuer whose securities are offered through crowdfunding.
Within the 21 days prior to the first day on which securities are sold to any investor, or such other period as the SEC may establish, the intermediary must make available to the Commission and to potential investors any information provided by the issuer pursuant to Section 4A (b).

The 21-day period allows for the opportunity for the sort of oversight that a portal can provide or the SEC can provide to stop known bad actor fraudsters.

The intermediary must also ensure that all offering proceeds are only provided to the issuer when the aggregate capital raised from all investors is equal to or greater than a target offering amount, and allow all investors to cancel their commitments to invest, as SEC regulations determine appropriate. Similarly, the intermediary must take such steps to protect the privacy of information collected from investors as SEC regulations determine appropriate.

The intermediary is prohibited from compensating promoters, finders, or lead generators for providing the broker or funding portal with the personal identifying information of any potential investor.
Issuers who offer or sell their securities through crowdfunding must file with the SEC and provide to investors and the intermediary broker or funding portal, and make available to potential investors, their name, legal status, physical address, and website address and the names of their directors and officers and any 20 percent shareholders. They must also provide a description of their business and the anticipated business plan, as well as a description of their financial condition.

As the amount of money the startup is asking for increases the degree to which it needs to do due diligence financially and present the details increases as well. Thus, if a startup is seeking less than $100,000, its CEO simply certifies what the financials are for the company. If it is seeking from $100,000 to $500,000, then a CPA must review the financial statements. If the company is seeking more than $500,000, it will need to have audited financial statements. Senator Merkley emphasized that there is nothing that would prevent a particular web site from establishing its own standards above and beyond these particular levels. (Cong. Rec. (March 21, 2012) p. 1887).

In addition, issuers must file with the SEC and provide to investors and the intermediary broker or funding portal, and make available to potential investors, the target offering amount, the deadline to reach such amount, regular updates regarding the progress of the issuer in meeting the target offering amount, and a description of the stated purpose and intended use of the proceeds of the offering sought by the issuer with respect to the target offering amount. (Securities Act Sec. 4A(b), as added by Sec. 302(b) of the Jumpstart Our Business Startups Act)

Issuers must also provide the price to the public of the securities or the method for determining the price, provided that, prior to sale, each investor must be provided in writing the final price and all required disclosures, with a reasonable opportunity to rescind the commitment to purchase the securities.
Crowdfunding issuers must annually file with the SEC and provide to investors reports of the results of operations and financial statements as the Commission must determine appropriate, subject to such exceptions and termination dates as the Commission may establish. Nothing in the legislation should be construed as preventing an issuer availing itself of the crowdfunding exemption from raising capital through methods other than crowdfunding.

The crowdfunding provisions do three things. They streamline the process for setting up a crowdfunding portal. They streamline the process for companies to list themselves on that portal. They provide basic investor protections, the most important of which is to provide basic information about the company and for the company's officers and directors to ensure the accuracy of that information.

There will now be a streamlined registration for websites that offer crowdfunding. The Act provides two pathways. The first pathway is for a portal to register as a broker-dealer, while the second is a streamlined funding portal registration. These portals agree to provide a neutral market environment; that is, they do not solicit purchases, they do not offer investment advice, and they do not handle investor funds. Senator Merkley envisions them operating a marketplace, much as the New York Stock Exchange operates a marketplace, without recommending particular stocks. This is a unified national framework, he noted, adding that it would be untenable for the portal to have to deal with rules from 50 States. Thus, Congress has created a unified national structure for a portal to thrive in.

The crowdfunding provisions also set out basic rules of the road to protect investors
and ensure the accuracy of information companies post, companies participating
in this marketplace must disclose their basic financial information, a business plan, a target offering amount, and the intended use. The web sites are subject to oversight by the SEC. There are also aggregate annual caps, which Senator Merkley said are a key predatory protection to prevent pump-and-dump schemes.

Purchasers of securities in crowdfunding transactions are expressly authorized to bring a private action against an issuer described either at law or in equity in any court of competent jurisdiction to recover the consideration paid for the securities, with interest, less the amount of any income received thereon, upon the tender of such security, or for damages if the purchaser no longer owns the securities.

Congress believes that in order for this crowdfunding capital market to work well one has to stand behind the accuracy of the information. It has basic liability accountability; that is, directors or officers of the organization are standing behind the accuracy of what they put out. It has a due diligence protection so this is very balanced. It has a requirement that the information be relevant or germane to the conduct of the company. So that is another protection for the business itself. This can also give investors a basic belief that what is being set up are reasonable amounts of information proportional to the request and that the officers and directors are standing behind this information.

REGULATION A EXEMPTION.—Title IV of the Jumpstart Our Business Startups Act 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.

COMPANY SHAREHOLDER THRESHOLD.—Title V of the Jumpstart Our Business Startups 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.

BANK SHAREHOLDER THRESHOLD.—Title VI of the Jumpstart Our Business Startups Act raises the number of shareholders permitted to invest in a community bank from 500 to 2,000. Thus, the legislation updates the federal securities laws to ensure that smaller community banks are not required to register with the SEC and comply with burdensome reporting requirements that are intended for larger corporations.

SEC OUTREACH.— Title VII of the Jumpstart Our Business Startups Act directs the SEC to provide online information and conduct outreach to inform small and medium sized businesses, women owned businesses, veteran owned businesses, and minority owned businesses of the changes made by the Act. The section is designed to ensure that small businesses that may face unique challenges are fully aware of the benefits of the legislation

This provision came by way of a House-approved a floor amendment offered by Rep. Dave Loebsack (D-Iowa). According to Rep. Loebsack, in order for the legislation to be effective, small and medium businesses must be aware of the new opportunities they will have to expand their business and raise capital. This will be particularly important for the segment of businesses targeted the amendment, women-owned, veteran-owned, and minority-owned businesses. specifically, the Loebsack Amendment requires the SEC to provide information online and also conduct outreach to these businesses to help them utilize the changes made through the legislation. (Cong. Rec. (May 78, 2012) p. H1285)

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