The Jumpstart Our Business Startups Act Richard B. Levin April 3, 2012 Baker & Hostetler LLP - 2012
Summary Congress recently passed the Jumpstart Our Business Startups Act (the JOBS Act ). The JOBS Act: removes the prohibition on general solicitation in connection with transactions effected pursuant to Rule 506 or Rule 144A under the Securities Act of 1933 (the Securities Act ), provided that sales are limited to qualifying investors ; alters the thresholds that trigger registration of an issuer s securities under Section 12(g) of the Securities Exchange Act of 1934 (the Exchange Act ), including a different threshold for banks and bank holding companies; provides, to a new category of emerging growth companies, relief from various requirements and other restrictions applicable to IPOs and (on a transitional basis, for up to five years) from certain reporting company obligations; adds a crowdfunding exemption to the Securities Act; and authorizes the SEC to increase the amount permitted to be raised in a Regulation A offering to $50 million in any 12-month period. This discussion focuses on the general solicitation issue and crowdfunding. 3
Summary The JOBS act permits general solicitation and general advertising for Rule 506 offerings Currently, Rule 506 permits issuers to sell an unlimited amount of securities to accredited investors without requiring the registration of those securities under the Securities Act. Private issuers of securities who rely on Rule 506 will be able to offer securities through general solicitation and general advertising. These modifications to Rule 506 will provide substantial freedom for issuers to promote their offering to a wider group of potential investors under federal law. However, state Blue Sky laws will still play a role in these new offerings, as state broker-dealer laws and regulations will not be preempted by this new federal law. Issuers and their agents must be sure to understand whether engaging in a general solicitation will cause them to be required to register as a broker, dealer, sales agent, or other representative in states where they offer and sell securities. Issuers should be cautious in all statements made as part of an offering because such statements will be subject to state and federal ant-fraud rules 4
Summary The JOBS Act requires that the SEC pass rules, within 90 days, to eliminate the restriction on general solicitation for offers and sales of securities made under Rule 506, so long as all purchasers of the securities are accredited investors. This represents a major policy shift in the scope of private offerings. In the past, the SEC interpreted the ban on general solicitation or general advertising to limit offers to only a distinct group of sophisticated persons with whom the issuer has a pre-existing relationship, meaning that the securities could not be offered through any advertisements, articles, or notices published in any newspaper, magazine, publicly accessible website, or broadcast over television or radio. Following the new rules, all of these outlets will be permissible media for publicity of Rule 506 offerings. Any issuer that chooses to avail itself of this new privilege, however, will be prohibited from selling securities to any person who is not an accredited investor. Issuers who advertise to the general public in reliance on this new exemption will need to engage in meaningful due diligence with respect to accredited investor status of any new investors before finalizing a sale. Offerings conducted under Rule 144A also will be permitted by means of a general solicitation. 5
Bulletin Board Listing Services The JOBS Act provides that certain passive bulletin board type listing services are exempt from federal broker dealer registration. The new law provides that an individual or entity that maintains a platform or other mechanism that permits the offer or sale of securities, or general solicitation by issuers, whether online, in person, or by any other means is exempt from registration as a broker dealer. The platform operator and all persons associated with it may not receive compensation in a form that would require registration as a broker-dealer. The scope of this limitation should be further clarified during the SEC rulemaking process. A flat fee for an issuer to list securities, or for an investor to access a site, on the other hand, will likely be permissible fees inside of the exemption. The platform operator in addition, must refrain from ever taking possession of customer funds or securities in connection with their listing services, and will be excluded from this exemption if they are otherwise subject to a statutory disqualification under the Securities Act. Platform operators who wish to rely on this exemption and not register as a broker dealer will need to be very careful with the manner in which they receive compensation for their services. 6
Crowdfunding Issuers who are seeking to sell securities in limited amounts to a wider group of investors will soon be able to engage in crowdfunding offerings The consummation of the sale to all investors is made contingent on the offering reaching a certain dollar threshold of committed subscriptions set by the issuer prior to the commencement of the offering. This new exemption will allow private issuers to access capital from a larger group of potential investors, but will require issuers to abide by a significant set of rules aimed at protecting investors. Issuers must use a regulated intermediary to conduct the offering, they may not advertise the offering except to direct potential investors to the intermediary, they must provide substantial disclosure to prospective purchasers, they will be subject to periodic public filing requirements, and the amount of the offering is limited. Foreign issuers, reporting companies, and investment companies will not be allowed to use this exemption. Each issuer must also limit the total amount of securities it sells to individual investors based on that investors annual income and net worth. 7
Crowdfunding Subject to existing integration rules, crowdfunding is available to an issuer if the aggregate amount of securities sold by the issuer, in any offering, does not exceed $1,000,000 for the twelve (12) month period preceding the issuance of securities through a crowdfunding transaction. The current integration rules under Regulation D do not appear to be affected by the JOBS Act, but may be amended as part of the rulemaking process. The $1,000,000 cap applies to all capital raised in the specified time period, regardless of the means used to raise such capital. The aggregate amount sold to any investor, including any amount sold in reliance on such exemption during the twelve (12) month period preceding the date of such transaction may not exceed the greater of: $2,000 or five percent (5%) of such investors annual income or net worth for investors with an annual income or net worth of less than $100,000, or the lesser of $100,000 or ten percent (10%) of such investors annual income or net worth for investors with an annual income or net worth greater than $100,000. 8 Baker & Hostetler LLP
Crowdfunding Crowdfunding transactions will require the issuer to prepare disclosure documents, which must be filed with the SEC and provided to any potential investor, including: Information on the issuer, such as its name, legal status, address, and website. Names of the issuer s directors and officers, and any person who owns more than 20% of the issuer. Financial statements of the issuer, either certified by an officer, reviewed by an independent accountant, or audited by an independent accountant, based on the size of the crowdfunding offering. A description of the issuer s business and its anticipated business plan. A description of the purpose of the offering and intended use of proceeds. The target offering amount and a deadline to reach that amount. The price to the public for the securities, or the method that will be used to determine the price. Issuers must provide disclosure on the terms of the securities being offered and the rights of present and future security holders, including: A description of the ownership and capital structure of the issuer. The terms of the securities being offered as well as all classes of securities of the issuer. An explanation of how the terms of the offered securities may be modified, with information on how the rights of the offered securities may be limited, diluted, or qualified. The risks to purchasers in the offering related to their role as minority owners of the issuer. 9
Crowdfunding - Restrictions In addition to the substantial mandatory disclosures, issuers must beware of a number of restrictions that will be imposed on the offering. Investors will have rescission rights prior to the closing of the offering. The investor then must be given a reasonable period to rescind the commitment to purchase the securities. Issuers may not advertise the offering, except to direct purchasers to the intermediary conducting the offering. Compensation to promoters of the offering will be severely circumscribed to prevent the provision of undisclosed compensation to third parties for finding investors. Investors who acquire securities in a crowdfunding transaction must observe a one year period where most transfers of the securities will be restricted. The SEC is charged with developing rules that will disqualify issuers from the ability to engage in crowdfunding transactions, based in some measure on existing bad boy disqualifications. As with other types of securities offerings, issuers will be subject to liability for material misstatements and omissions in a crowdfunding offering. 10
Crowdfunding - Restrictions Given the negative comments of Chairman Schapiro and one other SEC Commissioner on crowdfunding during Congressional debate, and the authority provided by the JOBS Act to allow the SEC to engage in additional rulemaking to protect investors, it is likely that the final rules for the crowdfunding exemption will require additional disclosure by issuers and potentially additional restrictions on the manner and terms of a crowdfunding offering. One of the key restrictions on crowdfunding is that issuers must use an intermediary. A crowdfunding intermediary can either be a registered broker or a Funding Portal (a new intermediary created by the JOBS Act for the crowdfunding exemption). The intermediary must be registered with a self-regulatory organization. The intermediary will be required to provide disclosure to investors regarding investment risks, and require each investor to answer questions demonstrating that investor understands the risks of investing in early stage companies and illiquid securities. The intermediaries are prohibited from having a financial interest in any issuer using its services. Each intermediary also must perform a background check on each officer, director, and significant owner of the issuer. Subject to existing integration rules, the intermediary is charged with ensuring that the limits on the total 12 month offering amount by the issuer and the investments by individuals are observed. 11
Crowdfunding Funding Portals will not be required to register as broker dealers. The activities of Funding Portals who are not broker dealers will be severely circumscribed. Funding Portals must refrain from (i) providing any advice or recommendations regarding the securities on their portal, (ii) soliciting purchases, sales, or offers for securities listed on their portal, (iii) compensating employees or agents based on sales of securities listed on the portal, and (iv) holding investor funds or securities. An intermediary who wants to offer a full range of crowdfunding services, and be able to maintain flexibility in its revenue and compensation program, will want to seriously consider becoming or working with a registered broker dealer. The JOBS Act provides that state securities registration of crowdfunding transactions will be preempted. However, states will have authority regarding fraudulent transactions and broker dealer registration. Notice filing requirements are circumscribed, as the issuer will only need to perform a notice filing in its home state and any state where over fifty percent of the aggregate amount of the offering is sold, if any. 12
Shareholder of Record Rule Companies may have an increased number of holders of record of their securities before being required to register under the Exchange Act. Currently, companies with more than 500 shareholders of record must register their securities under Section 12(g) of the Exchange Act. Following the JOBS Act, companies can have 2,000 shareholders of record, or no more than 500 shareholders of record who are not accredited investors. The JOBS Act also codifies the exemption from registration for companies that have less than $10 million of total assets. Securities issued pursuant to employee compensation plans, and also securities issued in crowdfunding transactions, will not count towards the holder of record threshold. 13
Baker & Hostetler LLP (the Firm ) publications are intended to inform our clients and other friends of the Firm about current legal developments of general interest. They should not be construed as legal advice, and readers should not act upon the information contained in these publications without professional counsel. The hiring of a lawyer is an important decision that should not be based solely upon advertisements. Before you decide, ask us to send you written information about our qualifications and experience. 2012 Baker & Hostetler LLP Baker & Hostetler LLP 14