The JOBS Act in a Nutshell – Part V Exchange Act Registration and Termination

by Vanessa Schoenthaler on July 11, 2012

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Jumpstart Our Business StartupsI’m finally getting back to this series on the JOBS Act changes, plus I have a whole slew of other things that I’ve been meaning to write about but haven’t been able to get to (if there were only more hours in the day!); I may have to start an occasional link reading list just to keep tabs. In the meantime, here’s a post on the JOBS Act and Exchange Act registration and termination 101:

A company’s obligation to begin filing periodic reports under the Exchange Act can come about in one of three ways:

  • before listing its securities on a national securities exchange, such as the NYSE or Nasdaq stock markets, a company must register that class of securities under Section 12(b) of the Exchange Act; or
  • once having accumulated total assets in excess of $10 million and a class of equity securities held of record by a certain number of shareholders, a company must register that class of equity securities under Section 12(g) of the Exchange Act (before the JOBS Act went into effect, this was regularly referred to as the 500 shareholder rule); or
  • if a company registers securities for public sale under the Securities Act, but does not meet the registration requirements of Section 12(b) or 12(g) of the Exchange Act, then Section 15(d) of the Exchange Act requires that the company file certain periodic reports for at least the first fiscal year in which its Securities Act registration statement is effective.

The Section 15(d) reporting requirements are somewhat different from the Section 12(b) and 12(g) reporting requirements; most notably Section 15(d) filers are not subject to proxy rules and their officers, directors and shareholders are not subject to the beneficial ownership reporting requirements.

Once a company is obligated to file periodic reports that obligation runs until it is terminated or suspended (by the company either going private or going dark, both topics for another post).

Titles V and VI of the JOBS Act made changes to both the threshold for registration under Exchange Act Section 12(g) and the thresholds for termination and suspension of registration under Exchange Act Sections 12(g) and 15(d), respectively.

The Commission released FAQs regarding the changes back in April.

Changes to the Section 12(g) Registration Threshold

As amended, Section 12(g) now requires that a company (other than a bank holding company) register under the Exchange Act and begin filing periodic reports with the Securities and Exchange Commission once it has accumulated total assets in excess of $10 million and a class of equity securities held of record by either: (i) 2,000 persons, or (ii) 500 persons who are not accredited investors.

In the case of a bank holding company, amended Section 12(g) requires registration once the bank holding company has accumulated total assets in excess of $10 million and a class of equity securities held of record by 2,000 persons.

In addition, amended Section 12(g) excludes from the definition of “held of record” persons who receive equity securities pursuant to an employee compensation plan in a transaction exempt from Securities Act registration. The JOBS Act requires that the Commission adopt safe harbor provisions for determining when securities are received pursuant to an employee compensation plan, though does not specify a date by which such a safe harbor should be enacted.

The JOBS Act also requires that the Commission examine its authority to enforce Rule 12g5-1, relating to the definition of “held of record”, to determine if new tools are needed to enforce the rule’s anti-evasion provisions (remember all of the media attention surrounding Goldman Sachs’ creation of a special purpose vehicle to invest in pre-IPO Facebook shares, and the question of whether that SPV would count as a single shareholder for purposes of the then-500 shareholder rule?). The Commission has until August 3, 2012 to send its recommendations to Congress.

Changes to the Registration Termination and Suspension Thresholds

As noted above, a company’s obligation to file periodic reports continues until it is either terminated or suspended.

For a company with a class of securities listed on a national securities exchange and only registered under Exchange Act Section 12(b), this means until the company withdraws its exchange listing and terminates it registration with the Commission.

If, however, a company has a class of securities that is registered under Exchange Act Section 12(g), that company may only terminate its registration if the securities are held of record: (i) in most cases by less than 300 persons, but in the case of a bank holding company (as amended by the JOBS Act) by less than 1,200 persons, or (ii) by less than 500 persons where the company has total assets that do not exceed $10 million.

Similarly, a company that has a class of securities registered under Exchange Act Section 15(d) may only suspend its registration if the securities are held of record by: (i) in most cases by less than 300 persons, but again in the case of a bank holding company (also as amended by the JOBS Act) by less than 1,200 persons, or (ii) by less than 500 persons where the company has total assets that do not exceed $10 million.

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SEC Chairman Schapiro Testifies on the Commission’s Progress in Implementing the JOBS Act

by Vanessa Schoenthaler on June 29, 2012

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Jumpstart Our Business StartupsYesterday Securities and Exchange Commission Chairman Mary Schapiro gave testimony before the U.S. House of Representative’s Subcommittee on TARP, Financial Services and Bailouts of Public and Private Programs Oversight and Government Reform Committee, updating the Committee on the Commission’s progress in implementing the JOBS Act and the staff’s new guidance regarding economic analysis in rulemaking.

Among other things, Chairman Schapiro noted that:

  • the Commission expects to release the JOBS Act-mandated study on the impact of decimalization on the market for initial public offerings shortly;
  • the staff is currently in the process of reviewing Regulation S-K and preparing recommendations on how it can be updated to modernize and simplify the registration process;
  • the Commission will not meet the deadlines imposed for revising the general solicitation and general advertising requirements of Rules 506 and 144A, but it “will be in a position to act on a staff proposal in the very near future”; and
  • approximately 50 bank holding companies have already deregistered under Exchange Act Section 12(g)’s amended registration threshold, which went into effect immediately upon the JOBS Act’s enactment (in an article unrelated to Chairman Schapiro’s testimony, SNL Financial noted, that as of the end of May, 61 bank holding companies had already begun the deregisteration process).

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The Commission’s Final Rules Requiring Listing Standards for Compensation Committees and Advisers

by Vanessa Schoenthaler on June 25, 2012

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Final Rules on Compensation Committees and Compensation AdvisersSection 952 of the Dodd-Frank Wall Street Reform and Consumer Protection Act amended the Securities Exchange Act of 1934 by adding new Section 10C which requires that the Securities and Exchange Commission adopt rules directing the national securities exchanges and national securities associations to prohibit the listing of a company’s equity securities if that company does not comply with certain compensation committee and compensation adviser requirements.*

The Commission first released proposed rules and amendments to implement Section 10C in March 2011, and, thereafter, in response to a request from the Center for Capital Markets, extended the comment period through May 2011.

Last week the Commission adopted new Rule 10C-1 and amended Item 407 of Regulation S-K.

Compensation Committees Listing Standards

New Rule 10C-1 requires that, to the extent a national securities exchange lists equity securities, that exchange must adopt listing standards that address the independence of a company’s compensation committee members as well as such members’ authority to select, oversee and pay for the services of compensation advisers.

Rule 10C-1 defines a “compensation committee” to include not only board committees formally designated as compensation committees, but also any board committee that performs functions typically performed by a compensation committee (e.g., a human resources committee or corporate governance committee), and, for certain aspects of Rule 10C-1, in the absence of either a compensation or other committee that performs functions typically performed by a compensation committee, the members of a company’s board of directors who oversee executive compensation matters on behalf of the board.

The exchanges’ listing standards must prohibit the initial or continued listing of any company’s equity securities unless each member of the company’s compensation committee, as defined by Rule 10C-1, is a member of the company’s board of directors and is otherwise independent.

Subject to the Commission’s review and approval, each exchange may develop its own definition of independence, provided they take into consideration relevant factors including, without limitation:

  • a director’s source of compensation, including any consulting, advisory or compensatory fee paid by the company; and
  • whether a director is affiliated with the company, a subsidiary of the company or an affiliate of a subsidiary of the company.

There is, however, no requirement that the exchanges adopt listing standards prohibiting compensation committee membership based on any specific relationship, such as affiliate status, and they may exempt certain relationships or categories of companies as deemed appropriate.

Compensation Advisers Listing Standards

New Rule 10C-1 also requires that the exchanges adopt listing standards providing that:

  • a formally designated compensation committee or other board committee that performs functions typically performed by a compensation committee may, in its sole discretion, retain or obtain the advice of a compensation consultant, independent legal counsel or other adviser (each a “Compensation Adviser”);
  • a formally designated compensation committee, other board committee that performs functions typically performed by a compensation committee or, in the absence of a committee, members of a company’s board of directors who oversee executive compensation matters, are directly responsible for the appointment, compensation and oversight of any Compensation Adviser retained; and
  • each company must provide appropriate funding for payment of reasonable compensation, as determined by the compensation committee, to any Compensation Adviser.

Moreover the compensation committee will not be required to implement or act consistently with the advice or recommendations of any  Compensation Adviser, but rather will retain the ability and obligation to exercise its own judgement in fulfilling its duties.

Compensation Adviser Independence

Prior to selecting a Compensation Adviser, a compensation committee must consider six independence factors set forth in Rule 10C-1 and any other factors prescribed by the listing standards of the exchanges. The factors enumerated in Rule 10C-1 include consideration of:

  • other services provided to the company by the Compensation Adviser’s employer;
  • the fees received from the company by the Compensation Adviser’s employer as a percentage of such employer’s total revenues;
  • the policies and procedures of the Compensation Adviser’s employer that are designed to prevent conflicts of interest;
  • any business or personal relationship of the Compensation Adviser with a member of the compensation committee;
  • any stock of the company owned by the Compensation Adviser; and
  • any business or personal relationship of the Compensation Adviser or the Compensation Adviser’s employer with an executive officer of the company.

The factors should be considered in their totality, with no one factor being viewed as determinative of independence. What’s more nothing in Rule 10C-1 requires a Compensation Adviser to be independent, only that the compensation committee consider the independence factors prior to selecting a Compensation Adviser.

Exemptions

Certain categories of companies are exempt from Rule 10C-1′s independent compensation committee requirements, including limited partnerships, companies in bankruptcy, open-end management investment companies and foreign private issuers that disclose in their annual report the reason why they do not have an independent compensation committee.

In addition controlled companies and smaller reporting companies are altogether exempt from new Rule 10C-1.

What’s Next for the Exchanges

The exchanges will have until September 25, 2012 (90 days from Rule 10C-1′s publication in the federal register) to propose listing rules and amendments to implement Rule 10C-1, and until June 27, 2013 (one year from Rule 10C-1′s publication in the federal register) to have final listing rules and amendments approved by the Commission.

Disclosure of Compensation Consultant Conflicts of Interest

Section 10C of the Dodd Frank Act also requires that in any proxy or consent solicitation materials for an annual meeting (or special meeting in lieu of an annual meeting), a company disclose whether its compensation committee has retained the advice of a compensation consultant and whether the work of the compensation consultant has raised any conflict of interest and, if so, the nature of the conflict and how it is being addressed.

In implementing Section 10C the Commission notes that Item 407 of Regulation S-K already requires companies to disclose the role of compensation consultants in determining or recommending executive and director compensation. As such, a new subsection has been added to Item 407 requiring disclosure with regard to conflicts of interest and how those conflicts are being addressed. Also, in implementing Section 10C, the Commission is only requiring disclosure in proxy or consent solicitation materials for an annual meeting (or special meeting in lieu of an annual meeting) at which directors are to be elected.

Unlike the requirements of new Rule 10C-1, the new subsection of Item 407  is applicable to controlled companies, non-listed companies, smaller reporting companies and any other companies subject to the Commission’s proxy rules.

Companies must begin complying with the new disclosure requirements in any proxy or information statement for an annual meeting (or special meeting in lieu of an annual meeting) at which directors are to be elected occurring on or after January 1, 2013.

Update July 13, 2012:

Yesterday the Commission released a brief small entity compliance guide summarizing the rules related to compensation committee listing standards, from which smaller reporting companies are exempt, and the disclosure requirements related to compensation consultants conflicts of interest.

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*At present FINRA is the only national securities association and it does not list equity securities, so new Rule 10C-1 only applies to national securities exchanges like the NYSE, Nasdaq and NYSE Amex. In addition new Rule 10C-1 will not apply to over-the-counter markets like the OTC Bulletin Board or OTC Markets Group, which are interdealer quotation systems that quote rather than list securities.

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The 2011 Foreign Private Issuer Numbers

by Vanessa Schoenthaler on June 14, 2012

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Number of Foreign Private Issuers Registered and Reporting with the Securities and Exchange CommissionYesterday the Securities and Exchange Commission released an updated summary of registered and reporting foreign private issuers for the year ended December 31, 2011. Of the 965 issuers (down only 5 from last year) approximately:

  •  35.2%, or 340 issuers, were organized in Canada;
  • 13.9%, or 134 issuers, were organized in the Cayman Islands;
  • 7.4%, or 71 issuers, were organized in Israel; and
  • 5.5%, or 53 issuers, were organized in the British Virgin Islands;

The remaining 38% of issuers were organized in 48 different countries.

Most foreign private issuers, 48.4%, were listed on the NYSE, NYSE Amex and NYSE Arca markets, 27% were listed on the Nasdaq Global and Nasdaq Capital markets and the remaining 24.6% were quoted in the over-the-counter markets.

Overall, not much of a change from last year.

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New FINRA Rule 5123 – Private Placements of Securities

by Vanessa Schoenthaler on June 11, 2012

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Last week the Securities and Exchange Commission approved an amended version of new FINRA Rule 5123.

The approved version of the new rule, which is considerably narrower than the original version, requires that a broker-dealer who participates in a private placement of securities file with FINRA copies of the private placement memorandum, term sheet or other offering documents, or indicate that there were no offering documents used. The filing must be made within 15 days of the date of the first sale of securities.

There are, however, a number of private placements which are exempt from new Rule 5123, for example, those involving securities sold solely to certain types of investors, such as institutional accounts, qualified purchasers within the meaning of the Investment Company Act, qualified institutional buyers (QIBs), investment companies, banks, certain employees and affiliates of an issuer, and certain accredited investors within the meaning of Rule 501(a) of Regulation D (such as banks and business development companies, but not individual investors or directors and officers). Certain types of offerings are also exempt from new Rule 5123, such as those made pursuant to Rule 144A or Regulation S.

All documents and information filed under new Rule 5123 will be afforded confidential treatment and used only to determine compliance with applicable FINRA rules and regulatory requirements.

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Various and Sundry Items From the Last Week

by Vanessa Schoenthaler on June 4, 2012

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Nasdaq Proposes Changes to Marketplace Rule 5605 Relating to the Composition of Board Committees

On Wednesday the Commission published a notice soliciting comments on proposed changes to certain subsections of Nasdaq’s Marketplace Rule 5605 relating to the independence requirements of a listed company’s audit, compensation and nominations committees.

Rule 5605 generally requires that a company’s audit, compensation and nominations committees be comprised entirely of independent directors. There is a limited exception to the independence requirements (found in each of subsections (c)(2)(B), (d)(3) and (e)(3) of Rule 5605) that allows for one non-independent director to serve on a committee for up to two years if a company’s board affirmatively finds that the non-independent director’s membership is required by the best interests of the company and its shareholders.

If Nasdaq’s proposed rule changes are accepted a non-independent director with a family member who is a non-executive employee would be permitted to serve on a committee under the limited exception. As the rule is currently drafted this is not possible, even though having a family member who is a non-executive employee would not otherwise disqualify an independent director from being independent.

The text of Nasdaq’s proposed rule changes are reproduced below.

The GAO’s Report to Congress on the Commission’s Oversight of FINRA 

Section 964 of the Dodd-Frank Act requires the Government Accountability Office (GAO) to submit a report to Congress evaluating the Commission’s oversight of national securities associations registered under Section 15A of the Exchange Act, of which FINRA is the only one. On Wednesday the GAO released its report, entitled Opportunities Exist to Improve SEC’s Oversight of the Financial Industry Regulatory Authority, which examines, among other things, how the Commission oversees FINRA rule proposals and the effectiveness of FINRA’s rules and how the Commission plans to enhance its oversight of FINRA. The report emphasizes the utility of retrospectives reviews and recommends that the Commission encourage FINRA to conduct its own retrospective rule reviews and that the Commission establish a process for examining those reviews.

The GAO’s full report is reproduced below.

The Commissioners may be Attending Friday’s Meeting of the Advisory Committee on Small and Emerging Companies

On Friday the Commission published a Sunshine Act Meeting Notice related an earlier notice for a public meeting of the Advisory Committee on Small and Emerging Companies to be held this Friday.

The Committee will be discussing the JOBS Act and other matters related to rules and regulations that affect small and emerging companies. The reason for the second, Sunshine Act, notice is that a majority of the Commissioners may be attending Friday’s meeting.

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The JOBS Act in a Nutshell – Part IV Regulation A Redux

by Vanessa Schoenthaler on May 9, 2012

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Jumpstart Our Business StartupsRegulation A is a conditional securities exemption allowing for public offers and sales of up to $5 million dollars of securities in a 12-month period. To be eligible to use Regulation A a company must be organized under the laws of the United States or Canada, must not be an investment company or blank check company and must not be subject to the periodic reporting requirements of the Securities Exchange Act.

Conducting a Regulation A offering is somewhat analogous to conducting a registered offering, though much simpler in form and substance, and is often referred to as a “mini-registration”.

In a Regulation A offering a company must prepare and file an offering statement with the Securities and Exchange Commission. An offering statement requires disclosures similar to those made in a registration statement, including disclosures regarding a company’s business and financial condition, its officers, directors and principal stockholders, risk factors, a description of the use of offerings proceeds and so on. An offering statement also requires the filing of certain exhibits and the inclusion of financial statements, which can be unaudited but must be prepared in accordance with generally accepted accounting principles.

Once a company’s offering statement is on file it is reviewed and qualified by the Commission, similar to the process of a registration statement being reviewed and declared effective. After the offering statement is qualified an offering circular, which makes up part of the offering statement, must be delivered to prospective investors prior to any securities being sold.

Thereafter the company must file reports with the Commission detailing the securities sold and the use of proceeds from those sales. The reports must be filed every six months until substantially all of the proceeds from the offering have been applied.

Notwithstanding the sales and use of proceeds reports, and unlike in a registered offering, once a Regulation A offering is complete there are no ongoing reporting obligations; no current, quarterly or annual reports to file (unless of course Exchange Act registration is triggered by some other means, such as by crossing the shareholder threshold required for registration). What’s more, any securities sold in a Regulation A offering are unrestricted and may be freely transferred in a secondary market transaction.

Another way in which Regulation A offerings differ from most other offerings is that Regulation A permits a company to gauge investor interest, or to ”test the waters”, by means of general solicitation or general advertising prior to the filing of an offering statement. This ability to test the waters is not without limitation however, for example any written documents or scripts of oral presentations must be filed with the Commission prior to their first use. In addition, a company must also comply with the securities laws in each state in which an offer of securities is to be made, some of which do not permit general solicitation or general advertising.

One other item of note, there are also certain instances in which Regulation A can be used for secondary offerings, allowing shareholders resell up to $1.5 million of securities in a 12-month period.

Even though Regulation A does offer a simpler alternative to a full-scale registered offering it’s hardly ever used, in part because of its $5 million dollar offering limitation. In 2010 there were 25 initial Regulation A offerings filed with the Commission, but only 7 of these offerings were qualified.

A Regulation A Redux

The JOBS Act adds a new Section 3(b) to the Securities Act which calls for the Commission to implement an exemption for the public offer and sale of up to $50 million of securities in any 12-month period. There is no required time frame for implementation of this exemption.

The requirements of the new exemption start out much like an enhanced version of Regulation A. The securities, which can be equity securities, debt securities or debt securities convertible into or exchangeable for equity securities, may be publicly offered and sold and will thereafter be freely transferable (they will not be restricted securities). Additionally, subject to any terms or conditions that the Commission may prescribe, companies that wish avail themselves of the new exemption will be permitted to “test the waters” prior to undertaking an offering.

Similar to Regulation A, the new exemption contemplates the preparation and filing of an offering statement, the form and content of which the Commission will prescribed, but which may include a description of the company’s business and financial condition, its corporate governance principles, use of proceeds and audited financial statements. In addition, the exemption requires that companies file audited financial statements with the Commission on an annual basis and provides that the Commission may also require additional periodic disclosures regarding the company’s business and financial condition, its corporate governance principles and use of the offering proceeds.

Unlike Regulation A, if the securities under the new exemption are offered and sold on a national securities exchange or to qualified purchasers then they will be “covered securities” and exempt from the state securities laws.

The Commission also has the discretion to establish disqualification provisions under which the new exemption would not be available to certain companies or their affiliates for reasons substantially similar to the bad actor disqualification provisions to be established under the Dodd-Frank Act (which are themselves based on the disqualification provisions of Regulation A).

Lastly, every two years the Commission will have to review and increase, if appropriate, the $50 million offering limitation, or, if not increased, report to Congress as to why.

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The JOBS Act in a Nutshell – Part III General Solicitation and Private Offering Platforms

by Vanessa Schoenthaler on April 30, 2012

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Jumpstart Our Business StartupsThe JOBS Act makes several significant changes to the rules surrounding private capital formation. One such change being the much-discussed elimination of the prohibition on general solicitation and general advertising in certain private securities offerings. Another being the addition of an exemption from broker-dealer registration for platforms that, to a certain extent, facilitate offers and sales of unregistered securities.

General Solicitation and General Advertising in Private Offerings

Section 201 of the JOBS Act requires that within 90 days of its enactment, or by July 4, 2012, the Securities and Exchange Commission revise Regulation D to eliminate the prohibition on general solicitation and general advertising in private offerings made in reliance on the safe harbor afforded by Rule 506, provided that only accredited investors participate in the offerings.

In its current form, Rule 506 allows an unlimited amount of capital to be raised from an unlimited number of accredited investors and up to 35 sophisticated non-accredited investors, provided, however, that whenever non-accredited investors participate in an offering certain information disclosure requirements must be met. In its current form Rule 506 also explicitly prohibits general solicitation and general advertising, regardless of whether participating investors are accredited or non-accredited.

Section 201 of the JOBS Act also requires that the Commission, again by July 4, 2012, revise Rule 144A to provide that securities sold thereunder may be offered to persons other than qualified institutional buyers (QIBs), including by means of general solicitation or general advertising, provided that the securities are ultimately sold only to persons that the seller or anyone acting on the seller’s behalf reasonably believe to be QIBs.

Like Rule 506, Rule 144A is a safe harbor for sales of unregistered securities. Where they differ is that Rule 506 addresses sales of securities by an issuer (akin to a primary offering), whereas Rule 144A addresses resales by persons other than an issuer (akin to a secondary offering). Very generally, the safe harbor afforded by Rule 144A allows for resales of a limited category of qualifying securities to QIBs. Rule 144A resales often follow in close proximity to the private offering in which the securities being resold were originally issued.

So how are these changes going to impact the market for private securities offerings?

Insofar as Rule 506 offerings are concerned, over time we may see a shift from other types of Regulation D offerings to Rule 506 offerings, but lifting the ban on general solicitation and general advertising is not likely to have a significant impact on the type of investors participating in Rule 506 offerings.

Based on a recent report by the Commission’s Division of Risk, Strategy and Financial Innovation (FSHI), Rule 506 is already by far the most popular private offering exemption; used in over half of all the private offerings examined in FSHI’s report. And, even though Rule 506 allows for participation by up to 35 non-accredited investor, almost 90% of all Regulation D offerings (Rules 504, 505 and 506 combined) are made up entirely of accredited investors. So, while we may ultimately see even more Rule 506 offerings, there’s not much room for a shift in the ratio of non-accredited to accredited investors.

As for transactions set up to take advantage of the Rule 144A resale exemption, they only make up a small number of the private offerings conducted each year and they generally involve larger companies that already are, or immediately become, subject to the Exchange Act’s reporting requirements. Compared to Rule 506 offerings, Rule 144A transactions are fairly niche and, while I don’t have anything in the way of stats to back it up, I don’t think that we’re going to see any great shift toward Rule 144A offerings just because general solicitation and general advertising is permitted.

Where lifting the ban on general solicitation and general advertising will undoubtedly have the greatest impact is in the amount of information about private offerings that becomes publicly available. Hopefully this will result in a better understanding of how private capital formation works, as opposed to an overload of information that is of diminishing value or quality.

One other item of note here is that, despite the JOBS Act having taken effect, the current prohibition on general solicitation and general advertising remains in place until the Commission adopts amended or new implementing rules and those rules themselves take effect.

The Platform Exemption to Broker-Dealer Registration

Finally, Section 201 the JOBS Act creates an entirely new exemption from the broker-dealer registration requirements for anyone that maintains a platform or other mechanism that permits offers, sales, purchases or negotiations of securities, or permits general solicitation, general advertising or related activities by an issuer that is offering securities, regardless of whether those activities take place online, in person or by some other means.

What’s more, the exemption is available even if the person maintaining the platform invests in or provides “ancillary services” related to the securities that are made available through the platform. Ancillary services are defined to include due diligence services, provided no compensated investment advice is given, and the provision of standardized documents, provided there is no involvement in the negotiation process and the parties are free to use their own transaction documents if they choose to.

Lastly, the exemption is contingent on there being no transaction related compensation, no possession of securities or customer funds and no involvement by persons subject to statutory disqualification under Section 3(a)(39) of the Exchange Act.

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The JOBS Act in a Nutshell – Part II Research Reports and Communications Related to Emerging Growth Companies

by Vanessa Schoenthaler on April 19, 2012

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Jumpstart Our Business StartupsSection 105 of the JOBS Act sets out to improve the availability of information about emerging growth companies by eliminating some of the prohibitions on communications and activities that can take place around a registered offering.

Under the Securities Act of 1933, the offering registration process is divided into three periods:

  • the “pre-filing period” which begins with the decision to publicly offer securities and continues until the filing of a registration statement with the Securities and Exchange Commission;
  • the “waiting period” or “quiet period” which begins with the filing of a registration statement and continues until the Commission declares that registration statement effective; and
  • the “post-effective period” which begins once the registration statement is declared effective.

The kinds of communications and activities that are permissible vary depending on where you are in the registration process. For example, prior to enactment of the JOBS Act, the Securities Act generally prohibited any communications containing oral or written offers of securities during the pre-filing period. During the waiting or quiet period, the Securities Act permitted oral offers as well as written offers made by means of a Section 10 prospectus.

The term “offer” is broadly defined to encompass “every attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value” and has been construed by the courts and the Commission to include “the publication of information and statements, and publicity efforts … [that], although not couched in terms of an express offer, may in fact contribute to conditioning the public mind or arousing public interest … ” in a company or its securities.

Pre-Filing and Waiting or Quiet Period Communications

The JOBS Act significantly changes the communications rules is by allowing an emerging growth company, or any person authorized to act on behalf of an emerging growth company, to engage in oral or written communications with potential investors that are qualified institutional buyers (QIBs) or institutional accredited investors (IAIs) in order to gauge their interest in an offering prior to or following the company’s filing of a registration statement (i.e., during the pre-filing and waiting or quiet periods). A practice often referred to “testing the waters”. Unlike many of the other changes addressed below, an emerging growth company’s ability to test the waters is neither limited to its IPO nor offerings of its common equity and, as such, can be used in follow-on offerings and offerings of debt securities.

Again, prior to enactment of the JOBS Act, oral and written offers of securities were generally prohibited during the pre-filing period and while there were no explicit restrictions on oral offers during the waiting or quiet period written offers had to be made by means of a Section 10 prospectus.

Research Reports

Another way the JOBS Act changes the communications rules is by allowing a broker-dealer to publish and distribute research reports about an emerging growth company that proposes to or is in the process of registering its common equity (i.e., during the pre-filing and waiting or quiet periods) without the reports being deemed an offer of securities, even if the broker-dealer will also be participating as an underwriter in the offering.

For purposes of the exclusion the JOBS Act carves out a slightly expanded definition of the term “research report”, which covers oral as well as written and electronic communications that provide information, analysis, opinions or recommendations about an emerging growth company or its securities, whether or not the information is reasonably sufficient to base an investment decision on.

In addition, the JOBS Act prohibits the Commission or any national securities association, FINRA presently being the only one, from adopting or maintaining any rule or regulation that would prohibit a broker-dealer from publishing or distributing a research report or from making a public appearance with respect to the securities of an emerging growth company following the company’s IPO or in advance of the expiration of its IPO related lock-up agreements (i.e., during the post-effective period).

Before the JOBS Act went into effect, a broker-dealer participating as an underwriter in a company’s IPO was prohibited from publishing and distributing research reports and from making public appearances with respect to the company’s securities prior to and for a period of 40 days following the IPO, and for a period of 15 days both prior to and after the expiration of its IPO related lock-up agreements (these rules remain unaffected with respect to IPOs of non-emerging growth companies).

Analyst Communications

The JOBS Act also prohibits the Commission or any national securities association from adopting or maintaining any rule or regulation in connection with the IPO of an emerging growth company’s common equity that would restrict who at a broker-dealer may arrange for communications between a research analyst and a potential investor, or restrict a research analyst from participating in any meetings with the company’s management that non-analyst employees of the broker-dealer also attend.

Before the JOBS Act went into effect, a research analyst was prohibited from directly or indirectly engaging in communications with current or prospective investors in the presence of a company’s management or a broker-dealer’s non-analyst employees, and was prohibited from participating in company road shows or other meetings.

One thing the JOBS Act doesn’t do is relieve broker-dealers of their obligations related to conflicts of interest or research analysts from the disclosure and certification requirements of Regulation AC.

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The SEC Releases the Division of RSFI’s Report on Regulation D Offerings

by Vanessa Schoenthaler on April 11, 2012

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Yesterday the Securities and Exchange Commission’s Division of Risk, Strategy and Financial Innovation released a report analyzing information extracted from all Form D filings made with the Commission between January 2009 and March 2011. The report, entitled Capital Raising in the US: The Significance of Unregistered Offerings Using the Regulation D Exemption, coincides with a slide presentation given before the Advisory Committee on Small and Emerging Companies in October 2011. The report looks at the amount of capital raised using the Regulation D exemptions (Rules 504, 505 and 506) as compared to the amount of capital raised using other methods, public and private, and gives us a bit of insight into common Regulation D offering characteristics and the companies that most frequently avail themselves of the Regulation D exemptions.

Common Regulation D Offering Characteristics

Using information reported in response Item 13 of Form D, the report begins by estimating the total amount of capital raised in Regulation D offerings for the 2009 and 2010 calendar years (take a look at the report’s appendix for some of its methodologies and assumptions, including the treatment of Form D amendments). Item 13 of Form D requires that a company specify:

  • the total amount of securities to be offered (Item 13(a)), expressed as a dollar value or as an “Indefinite” amount (indicating that the total offering amount is undetermined or cannot be determined at the time of the Form D filing);
  • the total amount of securities that have been sold as of the time of the Form D filing (Item 13(b)); and
  • the total amount of securities that remain to be sold (Item 13(c)).

Based on a review of these figures the report estimates that, for the 2009 and 2010 calendar years, capital raised through Regulation D offerings ranged from a minimum (calculated using Item 13(b)) of approximately $587 and $905 billion, respectively, to a maximum (calculated using Item 13(a)) of approximately $1.5 and $1.2 trillion, respectively. With the average offering size being approximately $30 million, but the median offering size only being approximately $1 million, suggesting that a large number of smaller offerings took place.

Among the available Regulation D exemptions, Rule 506 was by far the most popular one to be claimed during the period examined. Rule 506 allows you to raise an unlimited amount of capital from an unlimited number of accredited investors, and up to 35 non-accredited investors, provided certain information and other requirements are met.

The data also reveals that during the 2009 and 2010 calendar years the total amount of capital raised in Regulation D offerings was more than twice the total amount of capital raised in public equity offerings. There are, however, other factors that might be influencing these findings, not the least of which being the state of the capital markets during the period in question. It’ll be interesting to see if this trend continues as the environment for public equity improves.

Another interesting bit of information revealed by the data is the number and type of investors that typically participate in a Regulation D offering. Only approximately 10% of investors that participated in offerings during the period examined were non-accredited investors. With approximately 90% of offerings being made up of entirely accredited investors. In addition almost 90% of offerings involved approximately 30 investors or less.

Common Company Characteristics

The report also gives us some insight into the type of companies that most frequently avail themselves of the Regulation D offering exemptions. For example, Item 4 of Form D requires that a company identify its industry group and Item 5 asks that it disclose its revenue range (though companies have the option to “Decline to Disclose”).

Based on a review of the responses to Item 4, nearly one-third, or 29%, of the Form D filers in 2009 and 2010 identified themselves as pooled investments funds (of which approximately half, or 55%, further identified themselves as hedge funds). Of the remaining companies, approximately 15% identified themselves as being in the technology industry, approximately 10% in the health care industry and approximately 8% in the real estate industry.

While approximately half of all companies declined to disclose their revenues, of the companies that did make the disclosure nearly 20% had no revenues at all and another approximately 20% had revenues of $25 million dollars or less (the chart below accounts for a $1.00 – $5 million revenue range and a $1 million – $5 million revenue range, but Form D calls for disclosure in the $1.00 – $1 million and $1 million – $5 million revenue ranges, so it’s unclear to me as to whether there’s overlap in the chart or a typo, though I assume the latter). Finally, less than 4% of all companies raising capital in a Regulation D offering reported revenues in excess of $25 million.

Additionally, during the period examined approximately 25% of all companies that raised capital in a Regulation D offering were foreign companies.

And, of the universe of public companies, approximately 10% raised capital in a Regulation D offering, with those relying on Regulation D tending to be smaller and less profitable then their peers.

A complete copy of the report is embedded below, it’s brief and there are plenty of additional charts to flip through:

(Download File)

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