Is the JOBS Act a Bust?

It happens all the time. The exciting coming attraction for a movie creates high expectations for a thrilling blockbuster, but when it finally comes out, it doesn't live up to the hype.

The Jumpstart Our Business Startups Act, better known as the JOBS Act, may be following just such a fate. Billed by Congress as a stimulating way to remove barriers to capital formation, reenergize the stagnant IPO market, and create jobs, it thus far hasn't lived up to high hopes.

“One view is that there was more messaging around the JOBS Act rather than what it actually did,” says David Lynn, a partner with the law firm Morrison & Foerster and co-chair of the firm's global public companies and securities practice. “The cynical side of me says it was just sort of trimming around the edges more than anything.”

Certainly the law hasn't turned the economy into the feel-good story some had hoped. Nearly a year after it was enacted, major pieces linger in limbo as the Securities and Exchange Commission sputters along with final rulemaking. Some of its promised relief and innovation runs the risk of never happening.

Despite early enthusiasm, investment bankers are among those who already appear to be losing faith in the JOBS Act. According to a December survey by consulting firm BDO USA, two-thirds of them say the legislation did nothing to increase the number of initial public offerings, since it went into effect. “I was surprised that many people had that strong of a view,” says Wendy Hambleton, a partner in the capital markets practice of BDO USA.

One of the provisions intended to encourage companies to go public, was the ability to submit pre-IPO filings to the SEC for a confidential review. It may not serve the needs of everyone, however. Many companies are in a dual track mode—hoping for an IPO, but also hoping that someone will come along and buy them. “Staying confidential doesn't help you in that effort,” Lynn says.

Some companies have shied away from the confidential process and loosened audit and internal controls requirements allowed by the JOBS Act for fear that taking advantage would signal to potential investors that they either weren't ready or had something to hide.“People fear that the reduced disclosures will have a taint of inadequate disclosure,” says Robert Robbins, a partner with the law firm Pillsbury Winthrop Shaw Pittman and leader of the firm's corporate and securities practice.

“The idea is great because the SEC and Congress have been adding so much disclosure to public companies. The problem is that it is all temporary," says David Scileppi, a shareholder with the law firm Gunster, Yoakley & Stewart. "The reprieve is nice, but they are still going to have to incur these costs at some point. What might be better is if it was made permanent and for everybody.”

Under the new rules, research reports on emerging growth companies that propose to register, or are in registration, are not considered offers under the Securities Act. They are also not subject to a quiet period or lock-up period restrictions. These provisions have also not been fully embraced.

“On the ‘test the waters' front, it has given people some flexibility just to see if the IPO is viable,” Lynn says. “But what a lot of people realized when they tried to go down that path was that investors are very busy people and they would much rather have a meeting about a deal that is actually going to happen rather than someone asking if it should happen.”

“With everything else that also happened in the market in 2012, can you stand back and say whether the JOBS Act did or didn't do what it was supposed to? Maybe it is a little early to tell.”

—Wendy Hambleton,

Partner,

BDO USA

Coming Unattractions

The real disappointment for many is that three of the most eagerly awaited benefits are still missing in action. The SEC has yet to finalize provisions that would allow crowdfunding, which lets companies raise up to $1 million over 12 months from an unlimited number of investors without hitting filing requirements. The SEC also hasn't ended the ban on advertising or marketing of private placements. And it has yet to raise the limit for securities offerings exempted under Regulation A from $5 million to $50 million. The failure to enact these provisions, say securities lawyers, may be due to underlying problems and concerns about unintended consequences they could have.

The SEC missed its New Year's Eve deadline to finalize crowdfunding and some are wondering if it will happen by 2014, or ever at all. Robbins says that even if implemented, it is unlikely to be significant. “Crowdfunding sounds like the most attractive thing to those who think it is the way people should raise money in the Internet age,” he says. “But then you get to the actual statute and you have burdens of disclosure, ongoing reporting to the SEC, and accounting costs. With the limited amount you can raise, I just don't see how you can ever really make an economic go of it while actually complying with the rules.”

JOBS ACT OVERVIEW

The following is from the Morrison Foerster publication, “JOBS Act Quick Start: A Brief Overview of the JOBS Act.”

DISCLOSURE AND RELATED REQUIREMENTS

Financial information in SEC filings

Before JOBS Act

Three years of audited financial statements

Two years of audited financial statements for smaller reporting companies

Selected financial data for each of five years (or for life of issuer, if shorter) and any interim period included in the financial statements

Under JOBS Act

Two years of audited financial statements

Not required to present selected financial data for any period before the earliest audited period presented in connection with an IPO

Within one year of IPO, EGC would report three years of audited financial statements

Communications before and during offering process

Before JOBS Act

Limited ability to test the waters

Under JOBS Act

EGCs, either before or after filing a registration statement, may test the waters by engaging in oral or written communications with QIBs and institutional accredited investors to determine interest in an offering

Auditor attestation on internal controls

Before JOBS Act

Auditor attestation on effectiveness of internal controls over financial reporting required in second annual report after IPO

Non-accelerated filers not required to comply

Under JOBS Act

Not required to comply with any new or revised financial accounting standard until such standard applies to companies that are not subject to Exchange Act public company reporting

EGCs may choose to comply with non-EGC accounting standards but may not selectively comply

Executive compensation disclosure

Before JOBS Act

Must comply with executive compensation disclosure requirements, unless a smaller reporting company (which is subject to reduced disclosure requirements)

Upon adoption of SEC rules under Dodd-Frank will be required to calculate and disclose the median compensation of all employees compared to the CEO

Under JOBS Act

May comply with executive compensation disclosure requirements by complying with the reduced disclosure requirements generally available to smaller reporting companies

Exempt from requirement to calculate and disclose the median compensation of all employees compared to the CEO

FPIs entitled to rely on other executive compensation disclosure requirements

Say on pay

Before JOBS Act

Must hold non-binding advisory stockholder votes on executive compensation arrangements

Smaller reporting companies are exempt from say on pay until 2013

Under JOBS Act

Exempt from requirement to hold non-binding advisory stockholder votes on executive compensation arrangements for one to three years after no longer an EGC

Source: Morrison Foerster.

Lynn also wonders if it may be dead on arrival. “It is a great idea and a great concept, but in terms of whether it's workable at this point, or will radically alter the capital-raising landscape, the jury is still out,” he says. “Why would you want to have 5,000 shareholders when you are a tiny company that is trying to get seed capital? Would you be able to attract venture capital from investors or sell yourself in a merger if you do have this giant shareholder base that you got over the internet?”

If the SEC can finalize workable rules for some of the remaining provisions, the JOBS Act could still end up being a success, some say. Allowing solicitations for private offerings is one of the remaining pieces that could increase its success. “It is going to be huge,” says Cromwell Coulson, president and CEO of OTC Markets Group, an electronic trading exchange. “It will make it so much easier for small companies to raise capital. My hope would be the debate would be moving along now at the SEC, rather than waiting for the next chairman.”

While many fret that this could harm investors, Coulson sees things differently, and suggests that with advertising can also come transparency. “There will always be people who use public advertising wrongly, but that shouldn't stop the benefits to legitimate people,” he says.

“The ability to advertise private placements on the QVC network or through a retail store or airline's credit cards or loyalty programs, really offers a lot of possibilities,” Robbins says, adding, however, that "Congress certainly intended it to [emerge] faster."

Despite a focus on fostering IPOs, the JOBS Act also may benefit some companies that wish to remain private longer by increasing the number of shareholders they can have before needing to register with the SEC.

“It is a big change that will help a lot of companies, particularly high tech companies that are private, but have a large number of employees who have stock options, restricted stock, or some other type of equity based compensation,” Robbins says.

Lynn says the changes to Reg. A also show a “good deal of promise.” “Doing a $30 million or $50 million raise IPO is not really much of a reality these days,” he says. It too, however, remains on the back burner.

Despite the delays and concerns, count Coulson among those who think the JOBS Act will ultimately prove its value. A benefit of making it easier for companies to ramp up for a public offering is that there will ultimately be greater transparency in the marketplace, he says.

“Getting companies comfortable with being more transparent is a good thing," he says. "Just because you're not SEC registered doesn't mean you don't need a PCAOB audit.”

What's Being Mandated?

Among the legislative mandates embodied in the legislation:

·        Increasing the number of shareholders a company may have before it is required to register with the SEC as a publicly reporting company. The current trigger, 500 shareholders, increases to 500 unaccredited shareholders and a combined total of 2,000 accredited and unaccredited investors.

·        Creating a class of “emerging growth companies” with annual revenues of less than $1 billion. The JOBS Act provides them a five-year exemption from periodic SEC filing requirements and Sarbanes-Oxley rules. These companies can also submit their IPO registration and amendments to the SEC for a confidential review before going public.

·        Lifting the ban on “general solicitation” and advertising for private placements of securities.

·        Raising the limit for securities offerings exempted under Regulation A from $5 million to $50 million.

·        Increasing the number of permitted shareholders in community banks from 500 to 2,000, which has already allowed more than 100 of them to deregister and save time and money on their previous reporting regime.

·        Increasing flexibility for broker-dealers to issue research reports on emerging growth companies

·        Creating a “crowdfunding” exemption that allows companies to raise up to $1 million over 12 months from an unlimited number of investors, with each limited to an investment of $10,000 or 10 percent of their annual income or net worth, whichever is less.