The Securities and Exchange Commission (SEC) could soon move another piece of the Jumpstart Our Business Startups (JOBS) closer to fruition if it follows through on plans to consider rules that would end the prohibition against general solicitation and advertising in certain private exempt offerings.
The JOBS Act, which was signed into law in April 2012, directs the SEC to adopt rules to eliminate the marketing prohibitions under Rule 506 of Regulation D, provided that all investors are “accredited investors.” Those generally include individuals with a net worth greater than $1 million or with an annual income in excess of $200,000. In addition, the new exemption is conditioned on the issuer taking “reasonable steps to verify” accredited investor status.
Permitting advertising in Rule 506 private offerings is a bold departure from long-standing prohibitions, notes Richard M. Leisner, a shareholder with the Tampa, Fla.-based law firm, Trenam Kemker. It is just one of several bold moves contained within the JOBS Act, the goal of which is to boost the economy by providing easier, more cost-effective access to capital.
“Anything that reduces the unnecessary burdens on capital formation and eases the way for growing companies is a good thing…although this is not without its challenges,” said Leisner, co-author of The JOBS Act: Sure, It’s a Catchy Name, But Will It Boost Capital Formation and Create New Jobs.
Leisner says the JOBS Act can be broken down into four primary pieces:
1. The “IPO On-Ramp” for Emerging Growth Companies
Creating a new class of companies, Emerging Growth Companies (EGCs), generally those with annual revenues of less than $1 billion, the JOBS Act reduces some of the costs and burdens of the IPO process and makes post-IPO life a bit easier by reducing regulatory complexity. It permits confidential registration statement filing and scales back disclosure requirements. Distribution of research reports on EGCs by the underwriters’ analysts is permitted during the registration process and research analysts can be involved in the EGC IPO process. Companies can also “test the waters” in communications before and during the registration process with certain large institutional investors. The annual requirement to include an auditor attestation of internal controls is eliminated and EGCs are granted a temporary exemption from new or revised auditing standards. All the rules for EGS are collectively referred to in the JOBS Act as the “IPO On-Ramp.”
2. Permits general solicitation and advertising in “Revised Rule 506” Private Offerings
Leisner says there has always been a great deal of uncertainty over what conduct would constitute a violation of the long-standing prohibition against general solicitation and general advertising. By removing the prohibitions, the JOBS Act removes significant liability risk from Rule 506 transactions. However, complications remain in three areas:
- It remains to be seen whether the SEC will permit any and all advertising and general solicitations or if there will be limitations
- The statutory language raises questions regarding the how the issuer must verify that its investors are, in fact, accredited investors
- There will be no “falling back” to claim compliance with the statutory private placement exemption from a defective Revised Rule 506 offering that uses general solicitation or general advertising.
The SEC is also directed to adopt rules to implement crowdfunding, which is when relatively small investment amounts are sought from many investors. Born of the social media movement, crowdfunding for profit is currently prohibited by numerous securities laws. Currently, there are quite a number of crowdfunding sites on Internet that seek “donations” rather than investments, as this eliminates the profit motive and therefore the applicability of federal and state securities laws. The JOBS Act instructs the SEC to create a new securities registration exemption for crowdfunding offerings, promising what Leisner and his co-authors call a “revolutionary departure from the establishment practices for capital raising activities.”
4. Regulation A+
The SEC is granted broad authority to adopt rules creating a new securities registration exemption for public offerings of “small issues” for up to $50 million in any 12-month period. This has unofficially been dubbed Regulation A+. “With an almost blank canvas on which to design the new exemption, the SEC has an opportunity to adopt both innovative and ground-breaking improvements to the capital formation process,” write the Trenam attorneys.
When the law became effective, the IPO On-Ramp for EGCs was the only aspect of the JOBS Act that was in full effect. However, there already are concerns that the JOBS Act may have several unintended consequences.
For example, in making it easier for smaller companies to go public through the traditional IPO route, the law also makes it easier for them to do so via high-risk reverse mergers with shell companies which in most cases are not job creation engines. There are also concerns that scaling back the regulatory complexity opens the door to fraud by eliminating key investor protections and market transparency.
Leisner acknowledges that there are issues. The key, he says, will be for regulators to “strike a balance in favor of reduced burdens on capital formation while retaining vigorous prosecution of fraud.”
The JOBS Act, he says, offers an improved opportunity for the “two girls and a guy in a garage out there who are going to go somewhere, but need access to capital to get there.”
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