by Edward H. Brown*

On April 5, 2012, President Obama signed the Jumpstart Our Business Startup Act, also known as the "JOBS Act", which Congress passed in March of this year. Designed to simplify access to equity, the JOBS Act contains a variety of provisions applicable to emerging companies, both public and private, which have complained in recent years that the existing regulatory requirements make it difficult for growth companies to access equity.

1.         Crowdfunding

Recognizing the growth of internet-based systems to raise funds for start-up ventures, the JOBS Act includes a specific provision permitting small companies to sell unregistered securities with limited regulatory interference.  "Crowdfunding" works through a variety of mechanisms, including voluntary contributions or the sale of incentives or rewards, which are used to avoid violating the securities laws.  The new Crowdfunding exemption will allow issuers to sell up to $1,000,000 of unregistered securities (including securities sold under the Crowdfunding exemption) during any twelve-month period.  The issuer must file with the SEC and provide to investors certain information about itself and the offering, including limited financial information.  The scope of financial information will depend upon the amount of the Crowdfunding offering, and will vary from copies of certified income tax returns for offerings of under $100,000, to reviewed financials for offerings up to $500,000, to audited financial statements for larger offerings.

Each investor also has a limitation that they may not, during any twelve-month period, invest in Crowdfunding offerings more than the greater of $2,000 or 5% of their annual income or net worth if either income or net worth is less than $100,000, or 10% of their annual income or net worth up to a maximum of $100,000 if their annual income or net worth is $100,000 or more.  Investors will also be required to hold securities acquired in the Crowdfunding offering for at least one year.

A Crowdfunding offering can be conducted through a funding portal or a broker, provided that they also register with the SEC and comply with certain regulatory guidelines to be established.  An issuer will also benefit from the fact that securities sold in a Crowdfunding offering would be "covered securities" and therefore exempt from most state blue sky registration requirements, and that persons holding securities acquired in a Crowdfunding offering will be excluded from the "held of record" calculation for purposes of determining the number of holders of securities for registration under the Exchange Act.  The SEC has 270 days in which to adopt implementing regulations.

2.         The IPO On-Ramp

Effective immediately, emerging growth companies (generally companies with annual gross revenue of less than $1 billion) that go public (or which closed their IPO after December 8, 2011) are provided with a variety of exemptions from Dodd-Frank and Sarbanes-Oxley which would substantially reduce the cost of being a public company.  Included is an exemption from Section 404(b) of Sarbanes-Oxley which requires auditor attestation of a Company's internal controls, a requirement for only two years of audited financials in their registration statement, an exemption from the Public Company Accounting Oversight Board rules regarding mandatory audit firm rotation, and an exemption from certain Dodd-Frank rules which require substantial information relative to executive compensation.  The exemptions generally continue until such time as annual revenues exceed $1 billion or the fifth anniversary of their initial public offering.

3.         Advertising of Regulation D Offerings

Rule 506 under Regulation D, the popular safe harbor for many private placement offerings, is amended to remove the prohibition on general solicitation and advertising.  This change is applicable only to Rule 506 offerings that are made to accredited investors.  The JOBS Act provides that the SEC has 90 days in which to amend the regulation.

4.         Small Company Formation

In addition to existing Regulation A, the JOBS Act creates a new exemption for issuers selling less than $50,000,000 in securities during a twelve month period.  The scope of disclosure that will be required to perfect this exemption to protect investors is to be adopted by the SEC.  The exemption permits the securities to be offered and sold publicly, and securities sold under the exemption will be "covered securities" and therefore exempt from state blue sky registration if sold to certain qualified purchasers.  Issuers will have reporting requirements with the SEC, although the intent is that these requirements be substantially less than what would otherwise be required for a public company.  This exemption will require extensive rule making by the SEC prior to going into effect, and the JOBS Act does not include a specific time frame for the adoption of such rules.

5.         Increase in Size of Privately Held Companies

The JOBS Act increased the registration threshold for privately held companies that would otherwise be required to register under the Exchange Act from 500 holders of record of a class of securities to either 2,000 holders of record or 500 holders of record who are not accredited investors under Regulation D.¹  It is important to note, however, that the number of holders of record will not include employees who receive their shares under an employee compensation plan, or securities issued pursuant to the new Crowdfunding exemption.  Implementation is also dependent on the SEC adopting rules defining "held of record" and a conforming safe harbor for determining whether all employees can be excluded, and no time limit for the adoption of such regulations was included in the legislation.

6.         Banks "Going Dark"

In addition to the provision increasing the number of holders of record necessary to require registration under the Exchange Act, the JOBS Act amends the Exchange Act to permit a bank or bank holding company to deregister and suspend reporting obligations, also known as "going dark," if the number of holders of record fall below 1,200.  Previously, the number of holders of a class would have needed to drop below 300 in order to permit deregistration and suspension of reporting obligations.  The Act gives the SEC one year to adopt implementing regulations.

It is important to remember that nothing in the JOBS Act limits or suspends any of the anti-fraud requirements as contained in the Securities Act in connection with the offering of securities.  Issuers are still under the obligation to not misstate a material fact or omit to state a material fact in connection with the offering of any securities.  In addition, most of the provisions of the JOBS Act require the SEC to adopt regulations to implement the congressional intent, and as those regulations are adopted, we will begin to have a clearer picture of the utility of the various provisions of the Act.