IV. The JOBS Act’s Implications
The Act makes it easier for smaller companies to gain access to financing through the public market. These small companies will be able to expand, generating more jobs and leading to economic growth. However, some companies may not be ready to go public from a disclosure standpoint. If a small company wants to have the advantage of being a publicly traded company, the Act provides a way to do that, but there is much more regulatory scrutiny involved, so the company must be sure it has an experienced general counsel and an effective corporate secretary able to file all the necessary paperwork and deal with required disclosures. Companies should be wary and make sure they are properly prepared to go public, and not do so just because they have this window of opportunity. It is too soon to tell what will happen when the capital markets are made more accessible to smaller firms.
The Act increases the number of companies likely to request advice from securities experts. Under the new provisions, small start ups will need advice on how to crowdfund, privately held companies will be allowed to greatly increase the number of investors before publishing their financials and more small companies will be able to openly solicit for investors. Also, companies that intend to go public will be able to keep their financials secret longer. The Act eases regulations for a large number of startups and entrepreneurs, but the law comes with changes that will probably enrich corporate securities lawyers. There may be a shift from big law firms to smaller ones. Some lawyers dispute that notion, believing that any company that ventures into securities law and starts distributing equity to employees knows the stakes and will go to experienced, established law firms for advice.
Any time a new regulatory development such as the Act is established, there’s always a need for law firms to get involved and advise their clients. For example, the crowdfunding rules that allow entrepreneurs to raise up to $1 million in small sums will trigger low-level compliance work, as will a provision that allows companies to advertise their stock sales. The Act will make initial public offerings an attractive option for more companies and therefore there will be more IPO compliance work. Additionally, the Act allows private companies to raise up to $50 million in a year, instead of $5 million, without registering as a security. It is too soon to tell whether law firms that specialize in smaller, pipeline-level transactions will able to corral this market, or whether larger firms that do major IPOs will dominate.
V. SEC Actions Thus Far
On August 29, 2012, the SEC proposed rules, mandated by the Act, to eliminate the prohibition against general solicitation and general advertising in certain securities offerings. The SEC will seek public comment on the proposed rules for 30 days, then review the comments and determine whether to adopt the proposed rules.
Under existing regulations, companies seeking to raise capital through the sale of securities must either register the securities offering with the SEC or rely on an exemption from registration. Section 201(a)(1) of the JOBS Act directed the SEC to amend Rule 506 to permit general solicitation or general advertising provided that all purchasers of the securities are accredited investors. The Act also stated that “[s]uch rules shall require the issuer to take reasonable steps to verify that purchasers of the securities are accredited investors, using such methods as determined by the Commission.”
Under the new rules proposed by the SEC, companies issuing securities offerings would be permitted to use general solicitation and general advertising to market the securities, provided that: (1) the issuer takes reasonable steps to verify that the investors are accredited investors; and (2) all investors are accredited investors, because either (i) they come within one of the categories of persons who are accredited investors under existing Rule 501 or (ii) the issuer reasonably believes that they meet the categories at the time of the sale of the securities.
Currently under Rule 501, an accredited investor is a natural person who has individual net worth, or joint net worth with a spouse, that exceeds $1 million at the time of the purchase, excluding the primary residence of such person. Or, if such person has income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year.
The proposed rules are not clear as to what reasonable steps an issuer must take to verify that a purchaser is an accredited investor. The proposed rules explain that issuers are to consider the facts and circumstances of the transaction, including the following factors:
- The type of purchaser and the type of accredited investor that the purchaser claims to be.
- The amount and type of information that the issuer has about the purchaser.
- The nature of the offering, meaning:
◦ The manner in which the purchaser was solicited to participate in the offering.
◦ The terms of the offering, such as a minimum investment amount.
The Act also directs the SEC to revise Rule 144A, which governs the resale of securities primarily by larger institutional investors known as qualified institutional buyers (QIBs). Under current Rule 144A, offers of securities can only be made to QIBs. Under the proposed rules, Rule 144A would be revised so that offers of securities could be made to investors who are not QIBs as long as the securities are sold only to persons whom the seller reasonably believes are QIBs.
Further, the proposed rules would amend the form which issuers must file with the SEC when they sell securities under Regulation D. The revised Form D would add a separate box for issuers to check if they are claiming the new Rule 506 exemption, permitting general solicitation and general advertising.