A brief overview of the JOBS Act - Morrison & Foerstermedia.mofo.com/files/uploads/Images/130200-JOBS-Act.pdf · A brief overview of the JOBS Act. JOBS Act Quick Start 1 Nilene R

Nilene R Evans

David M Lynn

Anna T Pinedo

IFLRinternational Financial Law Review

JOBS Act Quick StartA brief overview of the JOBS Act

JOBS Act Quick Start 1

Nilene R Evans is of counsel in the Capital Markets Group of Morrison & Foerster. Ms Evans counselsdomestic and foreign, public and privately-held companies, advising them on issues ranging from securitiesofferings, mergers, acquisitions and dispositions to ongoing disclosure and compliance obligations,particularly the complex requirements of the Sarbanes-Oxley Act and Finra (Financial Industry RegulatoryAuthority), and general strategic planning. She has extensive experience acting as counsel for underwritersand issuers in initial and subsequent public and private equity and debt offerings, including shelf and Rule144A offerings, Pipes, at-the-market offerings and complex private equity investments. Her experiencecovers many industries including Reits, technology companies, financial companies and life sciencescompanies.

David M Lynn is co-chair of the firm’s Public Companies and Securities Practice. Mr Lynn’s practice isfocused on advising a wide range of clients on SEC matters, securities transactions and corporategovernance. Mr Lynn is well known in the area of executive compensation disclosure, having co-authoredThe Executive Compensation Disclosure Treatise and Reporting Guide. While serving as chief counsel ofthe Securities and Exchange Commission’s Division of Corporation Finance, he led the rulemaking teamthat drafted sweeping revisions to the SEC’s executive compensation and related party disclosure rules.

Anna T Pinedo has concentrated her practice on securities and derivatives. She represents issuers,investment banks/financial intermediaries, and investors in financing transactions, including publicofferings and private placements of equity and debt securities, as well as structured notes and otherstructured products. Ms Pinedo works closely with financial institutions to create and structure innovativefinancing techniques, including new securities distribution methodologies and financial products. She hasparticular financing expertise in certain industries, including working with technology-based companies,telecommunications companies, healthcare companies, financial institutions, Reits and consumer financecompanies. Ms Pinedo has worked closely with foreign private issuers in their securities offerings in theUnited States and in the Euro markets. She also has worked with financial institutions in connection withinternational offerings of equity and debt securities, equity- and credit-linked notes, and hybrid andstructured products, as well as medium-term note and commercial paper programmes.

© Morrison & Foerster and Euromoney Institutional Investor 2013. All rights reserved.

About the authors

2 JOBS Act Quick Start

We are Morrison & Foerster — a global firm of exceptional credentials. Our clients include some of thelargest financial institutions, investment banks, Fortune 100, technology, and life sciences companies.We’ve been included on The American Lawyer’s A-List for nine straight years, and Fortune named us one ofthe 100 Best Companies to Work For. Our lawyers are committed to achieving innovative and business-minded results for our clients, while preserving the differences that make us stronger. This is MoFo. Visitus at www.mofo.com.

About the firm


About the authors 1About the firm 2Introduction 5

CHAPTER 1

The IPO on-ramp 15

CHAPTER 2

The IPO process 25

CHAPTER 3

Applying Title I to other transactions 36

CHAPTER 4

Private offerings 39

CHAPTER 5

Crowdfunding 44

CHAPTER 6

Regulation A+ 49

CHAPTER 7

Exchange Act registration thresholds 61

CHAPTER 8

Research 65

CHAPTER 9

Other capital formation discussions 74

Appendix A 80Appendix B 83Appendix C 87

Contents


Many market participants were taken bysurprise by the enactment of the JumpstartOur Business Startups Act. The JOBS Act,HR 3606, was passed by the United States

House of Representatives on March 8 2012. On March 22,the Senate passed HR 3606 with an amendment to Title III(providing for the crowdfunding exemption with enhancedinvestor protections). On March 27, the House ofRepresentatives accepted the Senate’s amendment, and onApril 5, President Obama signed the JOBS Act into law. Tomany, this may sound like a quick path for legislation,especially when considered in the context of a Congressthat seemed virtually deadlocked and unable to reach theconsensus required to take action on pressing issues. Whenconsidered closely and in context, however, it becomes clearthat the Act was the culmination of an at least year-longbipartisan effort in both the House and Senate to addressconcerns about capital formation and unduly burdensomeSecurities and Exchange Commission (SEC) regulations.The JOBS Act affects both exempt and registered

offerings, as well as the reporting requirements for certainpublic issuers. A centrepiece of the Act is a new IPO on-ramp approach for a class of emerging growth companies(Title I), with confidential SEC staff review of draft IPOregistration statements, scaled disclosure requirements, norestrictions on test-the-waters communications withqualified institutional buyers (QIBs) and institutionalaccredited investors before and after filing a registrationstatement, and fewer restrictions on research (includingresearch by participating underwriters) around the time ofan offering. In addition, the JOBS Act directs the SEC toamend its rules to: • eliminate the ban on general solicitation and generaladvertising in Rule 506 offerings when sales are only toaccredited investors, along with comparable changes toRule 144A (Title II);

• establish a small offering exemption for crowdfunding(Title III); and

• create a new exemption for offerings up to $50 million(Title IV).The JOBS Act also raises the holder-of-record threshold

for mandatory registration under the Securities Exchange

Act of 1934, as amended (the Exchange Act) (Titles V andVI). In the chapters that follow, we discuss each of thesemeasures in greater detail, but before we do so, it isimportant to understand the concerns that led legislatorsto act in concert to adopt the JOBS Act.

The lifecycle for emerging companies in theUnited StatesFor a long time in the United States, a company’s financinglifecycle was generally fairly predictable. A growingcompany usually financed its business throughinvestments from friends and family, then perhaps fromangel investors, and finally, if the company was successful,from venture capital firms. Given the application ofsection 5 of the Securities Act of 1933, as amended (theSecurities Act)1 to public offerings of securities, a companywas required to limit itself to conducting small rounds offinancing, relying on various available exemptions fromthe registration requirements of the Securities Act, and totarget principally sophisticated institutional investors. Thesecurities that a company sold in these private or exemptofferings were classed as restricted securities, which meansthat the securities had never been offered pursuant to aregistration statement and were subject to certain transferrestrictions. After various successful private financingrounds, the company’s management and venture investorswould begin to consider an IPO. Once a company was anSEC-reporting issuer, it became subject to acomprehensive regulatory framework. Although thisregulatory framework may have imposed requirementsthat seemed onerous (at the time), being a public companyoffered distinct benefits. Once public, a company generallyhad many more financing opportunities. Already publiccompanies relied on raising additional capital to financetheir growth through follow-on public offerings,underwritten by one or more investment banks. From timeto time, an already public company also might conduct aprivate placement or other exempt offering as part of anoverall financing plan. Over time, as the capital markets inthe United States have undergone changes and asregulations have evolved, the cost-benefit calculus formany companies has changed. Many companies have


Introduction

concluded that going public might not be the mostdesirable liquidity event and remaining private longer orconsidering acquisition alternatives might be moreappealing. A bit of background on the securities regulatoryframework will help illustrate why the analysis changed formany companies.

Securities regulatory frameworkA privately-held company (or a company that does nothave securities that are publicly traded in the UnitedStates), whether domestic or foreign, that would like toaccess the US markets first must determine whether it iswilling to subject itself to the ongoing securities reportingand disclosure requirements, as well as the corporategovernance requirements that are part and parcel ofregistering securities publicly in the United States. Anissuer may conduct a public offering in the United Statesby registering the offering and sale of its securities pursuantto the Securities Act, and also by registering its securitiesfor listing or trading on a US securities exchange pursuantto the Exchange Act.2 Instead, an issuer may choose toaccess the US capital markets by offering its securities in anoffering exempt from the registration requirements of theSecurities Act. Finally, a private company that elects topostpone, or seeks to avoid, becoming a public companymay become subject to SEC reporting obligationsinadvertently if it has: total assets exceeding $10 million asof the last day of its fiscal year, and a class of equitysecurities held of record by either 2,000 persons or 500persons who are not accredited investors (for banks andbank holding companies, a class of equity securities held ofrecord by 2,000 or more persons), whether or not that classof equity securities is listed on a national securitiesexchange.Section 5 of the Securities Act sets forth the registration

and prospectus delivery requirements for securitiesofferings.3 In connection with any offer or sale of securitiesin interstate commerce or through the use of the mails,section 5 requires that a registration statement must be ineffect and a prospectus meeting the prospectusrequirements of section 10 of the Securities Act must bedelivered before sale.4 This means that the Securities Actgenerally requires registration for any sale of securities,although it also provides exemptions or exclusions fromthis general registration requirement. The purpose of theSecurities Act is to ensure that an issuer provides investorswith all information material to an investment decisionabout the securities that it is offering. The registration andprospectus delivery requirements of section 5 requirefilings with the SEC and are intended to protect investorsby providing them with sufficient information about the

issuer and its business and operations, as well as about theoffering, so that they may make informed investmentdecisions. These apply to offerings that are made to thegeneral public (regardless of the sophistication of theofferees). The SEC presumes that distributions notinvolving public offerings (or widespread distributions) donot involve the same public policy concerns as offeringsmade to a limited number of offerees that have access tothe same kind of information that would be included in aregistration statement. That information can be conveyedby providing disclosure or by ensuring that the offereeshave access to the information. There are a number ofregulatory restrictions on communications for issuers thatundertake a public offering, given that the SEC always hasemphasised that the prospectus should be the principaldocument used by investors in making their investmentdecision.

IPO and Exchange Act registrationIn connection with an initial public offering of securities,an issuer must provide extensive information about itsbusiness and financial results. The preparation of theregistration statement is time-consuming and expensive.Once the document is filed with the SEC, the SEC willreview it closely and provide the issuer with detailedcomments. The comment process may take as long as 60to 90 days once a document has been filed with, orsubmitted to, the SEC. Once all of the comments havebeen addressed and the SEC staff is satisfied that theregistration statement is properly responsive, theregistration statement may be used in connection with thesolicitation of offers to purchase the issuer’s securities.Depending upon the nature of the issuer and the nature ofthe securities being offered by the issuer, the issuer may useone of various forms of registration statement. Once anissuer has determined to register its securities under theSecurities Act, the issuer usually will also apply to have thatclass of its securities listed or quoted on a securitiesexchange, and in connection with doing so will register itssecurities under the Exchange Act. The Exchange Actimposes two separate but related obligations on issuers:registration obligations and reporting obligations. If anissuer becomes subject to the reporting requirements of theExchange Act, the issuer remains subject to thoserequirements until, in the case of exchange-listedsecurities, those securities are delisted, or, in the case ofsecurities listed by reason of the issuer’s asset size andnumber of record holders, the issuer certifies that it meetscertain requirements.Once an issuer conducts an IPO in the United States or

has a class of securities listed or traded on a national


securities exchange, the issuer will be generally subject tothe reporting requirements of the Exchange Act. Issuersthat have undertaken an IPO or that are SEC-reportingcompanies also will become subject to many other rulesand regulations. Over time, the regulatory burdens for public companies

have increased. In 2002, following a series of widelyreported corporate scandals involving fraudulentaccounting practices and governance abuses, the UnitedStates adopted legislation affecting all public companies,the Sarbanes-Oxley Act of 2002. Sarbanes-Oxley imposeda broad series of requirements relating to corporategovernance, enhanced public disclosure, and theimposition of civil and criminal penalties for wrongdoing.Sarbanes-Oxley and its associated rules:• require that CEOs and CFOs certify the accuracy andcompleteness of their company’s periodic reports andimpose criminal penalties for false certification;

• require the establishment and regular evaluation ofdisclosure controls and procedures, and internal controlover financial reporting designed to ensure the accuracyand completeness of the information reported to theSEC and for the preparation of financial statements;

• require the establishment by all listed companies of anindependent audit committee;

• require the disgorgement of compensation by CEOsand CFOs following an accounting misstatement thatresults from misconduct;

• impose limitations on trading by officers and directorsduring retirement plan blackout periods;

• prohibit the extension of credit to related parties; and• require the SEC to review a registrant’s filings onceevery three years.Although relief from compliance with certain of these

requirements was provided to smaller companies, increasedcompliance costs and increased liability may have had achilling effect on IPOs.

To (or not to) go publicMany commentators have noted that, over time, the UScapital markets have become less competitive, and thenumber of companies seeking to go public has declined.For example, in communications from CongressmanDarrell Issa, chairman of the House Committee onOversight and Government Reform, to Mary Schapiro,chairman of the SEC (discussed further below), Issa notedthat the number of IPOs in the US has plummeted froman annual average of 530 during the 1990s to about 126since 2001, with only 38 in 2008 and 61 in 2009.5 Thenumber of companies listed on the main US exchangespeaked at more than 7,000 in 1997 and has been declining

ever since – it is now at about 4,000.6 Meanwhile, the valueof transactions in private-company shares has grown,almost doubling in 2010 to $4.6 billion from about $2.4billion in 2009, and was expected to increase to $6.9billion for 2011.7 Other reports cite similar statistics andhighlight that smaller companies have beendisproportionately affected, with most IPOs that arecompleted involving larger companies and a significantoffering size. Although commentators would be ready tostipulate that the number of IPOs is down, there would belittle agreement regarding the causes for the decline. Quitea number of different theories have been advanced toexplain this phenomenon. Academics active in this areahave grouped the theories into two broad categories: first,those attributing the decline to regulatory overreach, andsecond, those attributing the decline to changes in theecosystem or market structure changes.Many studies indicate that companies are waiting longer

to go public as a result of anticipated costs associated withSarbanes-Oxley compliance, as well as the additional costsassociated with being a public company. For example, apublic company must incur costs for D&O insurance,director compensation (especially audit committees), anddisclosure controls and SEC reporting costs. Foreignissuers may be wary of the increased liability that comeswith being an SEC-reporting company, as well as of thelitigious environment in the United States. Many executiveofficers of privately-held companies also are concerned thatgoing public will limit their flexibility. As officers of apublic company, they are required to make very difficultdecisions, including decisions regarding financialreporting, accounting estimates and accounting policies,while they are subject to more scrutiny and more risk as aresult of their choices. Given the prospect of shareholderlitigation and other litigation concerns, theirdeterminations become fraught with risk. Earningspressure and the need to respond to many constituencies(such as research analysts, large institutional holders andaggressive hedge fund holders) may affect the decision-making processes. This may inhibit their desire to take riskand may lead them to be more conservative than theyotherwise would be. A recent survey found that, in fact,the principal reason given by senior managers of privately-held companies for remaining private is that they wouldlike to preserve decision-making control.8 In addition,actually conducting an IPO will be time-consuming andexpensive given the disclosure and financial statementrequirements.Over time, more financing alternatives have developed

for issuers. An issuer could choose to avail itself of one ofthe exemptions from registration and conduct private


offerings. There have been many regulatory changes thathave provided greater legal certainty as to the availability ofprivate offering exemptions, such as the safe harbourscontained in Regulation D, especially Rule 506. In largemeasure, as a result of these changes, a number of securitiesoffering methodologies involving exempt offerings havedeveloped and become increasingly popular. Many of theseoffering methodologies have come to resemble the processused for public distributions of securities. Investors havebecome more receptive to participating in privateplacements and owning so-called restricted securities as thelimitations on hedging or transferring restricted securitieshave been relaxed. More recently, private secondarymarkets have developed that provide liquidityopportunities for holders of the securities of privatecompanies to sell their positions.Other commentators and academics note that a variety

of market structure changes may be the cause of or maycontribute to the decline of IPOs, and, especially smallercompany IPOs. During the 1990s and early 2000s,consolidation in the investment banking sector led to thedisappearance of many boutique or speciality investmentbanks that had as their focus financing transactions forsmaller companies. Some commentators point to the dropin bid-ask spreads that took place following decimalisationin 2001. In 2003, as a result of the fallout from the dot-com boom, rules and regulations were adopted thatimposed restrictions on research analyst coverage andrequired the separation of research and investmentbanking activities. The burdensome regulations imposedsignificant compliance costs on investment banks withresearch activities and changed the nature of researchcoverage. As a result, the fewer, larger investment banksthat remained after industry consolidation focused theirresources on covering fewer companies (usually givingpreference to larger, well-capitalised companies). Thesevarious factors seemed to change the economics associatedwith smaller company IPOs and tend to favour IPOs bylarger, more established companies. Also, the viewdeveloped that larger companies, with a longer trackrecord and more predictable earnings histories, makebetter public companies or are better able to function aspublic companies.

SEC developmentsThe SEC has tried to keep pace with changes in the capitalmarkets and has consistently introduced reforms thatsought to balance investor protection needs with the needto provide issuers with access to capital. Since the early1980s, the SEC has undertaken a number of steps tofacilitate capital formation. The SEC has, among other

changes, created and modified the integrated disclosuresystem, instituted and expanded the continuous anddelayed offerings processes, permitted the electronicsubmission of most SEC filings, and generally tried toaccommodate the needs of both large and small issuers. In2005, the SEC undertook a series of changes related tosecurities offerings and offering-related communications,referred to as securities offering reform. Although thisreform benefited principally the largest and mostsophisticated issuers (well-known seasoned issuers, orWKSIs), the changes also expanded the range ofpermissible communications, even during IPOs. In December 2004, the SEC established the Advisory

Committee on Smaller Public Companies to “assist theSEC in evaluating the current securities regulatory systemrelating to disclosure, financial reporting, internal controls,and offering exemptions for smaller public companies.”9

The Advisory Committee charter stated that its objectivewas “to assess the impact of the current regulatory systemfor smaller companies under the securities laws of theUnited States and to make recommendations forchanges.”10 The Advisory Committee considered the effectof many new regulatory requirements on smaller publiccompanies, as well as capital-raising alternatives for smallercompanies. In 2006, it issued its final report, containing33 recommendations, many of which focused on capitalformation, including a recommendation that a new privateoffering exemption from the Securities Act registrationrequirements be adopted that would not prohibit generalsolicitation and advertising for transactions withpurchasers that do not need all the protections of SecuritiesAct registration requirements. The Advisory Committeenoted that the ban on general solicitation in a privateoffering resulted in excessive concern about the offeree thatmay never actually purchase securities, rather than onprotection of the actual investors. The Committee alsonoted that, given the pace of technological change, thebank had become outmoded and limited issuers fromusing the internet and other tools to communicate withpotential investors. This was not the first time that arecommendation had been made to ease the prohibitionon general solicitation. In 2007, practitioners that weremembers of an American Bar Association Committeesubmitted a letter to the SEC containingrecommendations for a comprehensive overhaul of thesecurities laws governing the private placement ofsecurities.11 The letter cited problems with the privateoffering process that impacted capital formation. In May2007, the SEC approved publication of eight releasesdesigned to update and improve federal securitiesregulations that significantly affect smaller public


companies and their investors. Ultimately, the holdingperiod requirements under Rules 144 and 145 wereshortened, making restricted securities more liquid, andsmaller public companies gained limited access to the useof shelf registration statements.Although all of these reforms modernised the securities

offering process, streamlined communicationsrequirements, and addressed certain of the concerns relatedto private or exempt offerings, the reforms did not squarelyaddress the IPO process, nor did they address many of thethorniest issues arising in exempt offerings.

Proposed changes post-Dodd-Frank In the aftermath of the financial crisis, and followingadoption of the Dodd-Frank Act, there was renewed focuson the effect of regulation on the competitiveness of theUS capital markets and on entrepreneurship and emergingcompanies. As attention in the United States turned topromoting economic activity, the dialogue related toregulatory burdens and their effect on capital formationtook on a new sense of urgency.

Issa-Schapiro correspondenceOn March 22 2011, House Committee on Oversight andGovernment Reform chairman Issa sent a letter to SECchairman Schapiro. The letter raised concerns aboutwhether the current securities regulatory framework had anegative impact on capital formation, leading to the dearthof IPOs in the US, as well as the extent to which SECregulations potentially limited other capital raisingactivities by small and emerging companies.12 The letterfrom Issa also sought specific information regardingeconomic studies conducted by the SEC staff in theseareas, along with information concerning theconsideration of costs and benefits in connection withSEC rulemakings. Issa’s letter discussed these statistics andraised questions about five topics: the decline of the USIPO market, the communications rules in connection withsecurities offerings, the 499-shareholder cap under section12(g) of the Exchange Act, organisational considerations,and new capital-raising strategies.In her response dated April 6 2011, Schapiro stated she

had requested that the SEC staff take a fresh look at theagency’s rules in order to develop ideas for the SEC aboutways to reduce the regulatory burdens on small businesscapital formation in a manner consistent with investorprotection.13 Schapiro outlined a number of new SECinitiatives in her response, including SEC staff review of (i)the restrictions on communications in initial publicofferings; (ii) whether the general solicitation ban shouldbe revisited; (iii) the number of shareholders that trigger

public reporting, including questions regarding the use ofspecial purpose vehicles; and (iv) the regulatory questionsposed by new capital-raising strategies, such ascrowdfunding. Schapiro also indicated that the SEC was inthe process of forming a new Advisory Committee onSmall and Emerging Companies, which was subsequentlyconvened.

Decline of the IPO market in the USIssa’s letter cited statistics about the declining US IPOmarket and asked whether the SEC had evaluated thereasons for such a decline. The letter asked whether thepossible reasons for the decline included increasinglycomplex SEC regulations; costs associated withcompliance with the Sarbanes-Oxley Act; the uncertaintygenerated by the pending rulemakings under the Dodd-Frank Wall Street Reform and Consumer Protection Act(generally known simply as the Dodd-Frank Act); the riskof class-action lawsuits; or the expansion of regulatory,legal, and compliance burdens. The letter also citedexamples of the IPOs of Google and GoDaddy.com thatwere delayed and cancelled, respectively, as evidence ofoverly burdensome communications rules. In her response,Schapiro discussed various reasons for the decline in theIPO market, such as each company’s own situation andmarket factors at the time of the contemplated IPO.Schapiro stated that it is difficult to determine why acompany decides to undertake an IPO or declines to do so.The costs associated with conducting an IPO andbecoming a public reporting company factor into thedecision as to whether to conduct an IPO. Schapiro statedthat the SEC had lowered these costs in recent years andthat, in 2010, approximately 40% of first-time registrantswere smaller reporting companies. Similarly, in 2010,nearly half of registered offerings conducted by first-timeregistrants were for offerings of less than $10 million. In adiscussion about the challenges faced by early-stage growthcompanies, Schapiro pointed out that such companieshave greater difficulty raising capital because of the lack ofdisclosure on a regular basis, smaller and more variablecash flows, a smaller asset base, and a larger percentage ofintangible assets. Schapiro also stated that while there are studies that

show that the number of US IPOs had declined,14 otherstudies conducted by SEC staff members indicate that forthe period 1995–2007, the US market’s share of globalIPOs in terms of total dollar proceeds and average dollarproceeds was much higher than those of the UnitedKingdom and Hong Kong.15 The other reason forcompanies to favour an IPO in the European markets isthat the underwriters’ spread is significantly lower than in


the United States. For example, the gross spread in the USfor an offering size between $25 million and $100 millionis approximately 7%, while in Europe it would beapproximately 4% for a similar offering.

The impact of the communications rulesIn his letter, Issa indicated that the communication rulesgoverning the offerings of securities potentially conflictwith the promotion of disclosure and transparency and theFirst Amendment. He requested an explanation for thepotential harm to a non-accredited investor that mayrealistically result from the receipt of an advertisement byan issuer of unregistered securities that is targeted ataccredited investors or QIB. In her response, Schapirodescribed the communications rules that apply toregistered and unregistered offerings. Under the SecuritiesAct, for registered offerings, an issuer’s ability tocommunicate varies depending on the three phases of theregistration process called the pre-filing period, quietperiod, and the post-effective period.16 During the pre-filing period before filing a registration statement, an issuermay not offer securities.17 During the quiet period (orwaiting period), an issuer can make oral offers but cannotmake written offers other than through a prospectus thatcomplies with section 10 of the Securities Act.18 In thepost-effective period, an issuer can sell and deliversecurities as long as a final prospectus that complies withsection 10(a) of the Securities Act accompanies or precedesthe delivery of the securities. Schapiro discussed the offering reforms adopted in 2005

that liberalised an issuer’s ability to communicate duringofferings.19 She also clarified that had these rules beeneffective when Google and Salesforce.com conducted theirIPOs, the SEC would not have imposed a cooling-offperiod to address gun-jumping concerns. Schapiro’s letterpoints out that with respect to offerings not registeredunder the Securities Act, issuers relying on section 4(a)(2)of the Securities Act or its safe harbour, Rule 506 ofRegulation D, generally are not allowed to use a generalsolicitation or advertising to attract investors to theiroffering. In addition, the SEC adopted Rule 155, anothersafe harbour, that allows companies to abandon a publicoffering and instead raise money through a privateoffering. Schapiro recognised that some view the generalsolicitation ban as a significant burden on capital raisingand may be unnecessary as offerees who might be locatedthrough general solicitation and who might not purchasethe securities would not be harmed.20 Others, however,support the solicitation ban on the grounds that it helpsprevent securities fraud by making it more difficult forfraudsters to attract investors or unscrupulous issuers to

condition the market.21

The 499-shareholder capIssa raised concerns about the 499-shareholder cap undersection 12(g) of the Exchange Act as being a fundamentalroadblock to private equity capital formation. The letterwent on to cite the case of the Facebook equity issuance inwhich the 499-person threshold would have beenovercome by grouping multiple shareholders into singleentities. He questioned whether the use of special purposevehicles (SPVs) for the purposes of facilitating investmentsin private companies resulted in disjointed or illiquidmarkets and prevented price discovery. In her letter, Schapiro stated that Rule 12(g) of the

Exchange Act was enacted by Congress in 1964 and thatthe securities markets have changed significantly sincethen. The section requires a company to register itssecurities with the SEC within 120 days after the last dayof its fiscal year if, at the end of the fiscal year, the securitiesare “held of record” by 500 or more persons and thecompany has “total assets” exceeding $10 million. Schapiropointed out that today, the vast majority of shares of publiccompanies are held in nominee or so-called street nameand, as a result, individual shareholders are not countedbecause the securities are not held of record by thoseindividuals. Conversely, in private companies, shareholdersgenerally hold their shares directly, or of record, and thusthose companies may exceed the 499-shareholder limitunder Rule 12(g), which would require them tocommence reporting. Schapiro stated in her letter that theissue of how holders are counted and how many holdersshould trigger registration will need to be examined.In his letter, Issa also raised concerns about Rule 12g5-

1(b)(3) of the Exchange Act. That rule states that if anissuer knows that the form of holding securities of recordis primarily used to circumvent section 12(g), thebeneficial holders will be deemed the record owners.Noting that this rule has been invoked sparingly, Schapirostated that this rule is not meant to create uncertainty forissuers but rather is intended to prevent issuers fromcircumventing the registration requirements. Schapiro also noted that Congress has provided the SEC

with broad authority, in sections 12(h) and 36 of theExchange Act, to make exemptions with respect to thesection 12(g) registration requirements and that section12(g) of the Exchange Act also allows the SEC to definethe terms “held of record” and “total assets.” Therefore, theSEC has the requisite authority to revise the shareholderthreshold if it concludes that doing so is not inconsistentwith the public interest or protection of investors.


New capital-raising strategiesThe letter from Issa raised questions regardingcrowdfunding, singling out that approach as a possiblenew method of capital formation that has gainedpopularity. Schapiro stated that she understandscrowdfunding to be a new method of capital formationwhereby groups of people pool money, typically smallindividual contributions, to support an effort by others toaccomplish a specific goal. Initially, such arrangements didnot trigger securities law issues because there was no profitparticipation. Schapiro noted, however, that interest inoffering an ownership interest in a developing business andan opportunity for a return on investment capital isgrowing. She provided an example of crowdfunding asdescribed to the staff as an offering of up to a maximum of$100,000 of equity securities of a company, withindividual investments capped at $100. She noted thatproponents of this approach to capital formation seek aregistration exemption, and the SEC has been exploringseveral approaches to address this.22 In considering whetherto grant an exemption from registration for sucharrangements, Schapiro stated that the SEC wouldconsider, for example, its experience with Securities ActRule 504, which was revised in 1999 due to concernsabout fraud in the market. The widespread use of theinternet for capital raising presents additional challenges inthis area.

Legislative and other effortsAt more or less the same time that these exchanges weretaking place, legislative efforts were moving forward thatcontemplated other changes to the capital formationprocess for smaller and emerging companies.Representative David Schweikert introduced the SmallCompany Capital Formation Act of 2011 in the US Houseof Representatives, which sought to amend the RegulationA offering threshold from $5 million to $50 million forpublic offerings by smaller companies.23 The SmallCompany Formation Act was introduced after hearings onthe topic of capital formation were held in December2010, during which industry representatives expressedsupport for Regulation A reform as well as other changesto the capital formation process. During the same session of Congress, other individual

bills were introduced that would have increased thethreshold for mandatory registration for all companiesunder the Exchange Act from 500 persons holding equitysecurities of record to 1,000 persons, and that would haveamended section 12(g) of the Exchange Act by raising theregistration threshold from 500 to 2,000 record holders ifthe issuer is a bank or a bank holding company.24

Representative Patrick McHenry introduced legislationthat would have added a crowdfunding exemption underboth section 4 of the Securities Act and section 12(g) ofthe Exchange Act. Representative Kevin McCarthyintroduced legislation to amend section 4(a)(2) of theSecurities Act to state specifically that general solicitationand general advertising would not affect the availability ofthe private placement exemption to registration undersection 5 of the Securities Act, and to direct the SEC toremove the prohibition against general solicitation andadvertising for securities issued under Rule 506 ofRegulation D, provided that all purchasers of the securitiesare accredited investors and that the issuer took reasonablesteps set forth by the SEC to ascertain that the holder isindeed an accredited investor. Of course, these individuallegislative proposals were the precursors to the JOBS Act. In March 2011, the US Treasury Department convened

the Access to Capital Conference to “gather insights fromcapital markets participants and solicit recommendationsfor how to restore access to capital for emerging companies– especially public capital through the IPO market.” Atthis conference, a small group of professionals representingbroad sectors of the IPO market decided to form the IPOTask Force to examine the challenges that emerginggrowth companies face in pursuing IPOs, and to providerecommendations for restoring effective access to thepublic markets for emerging growth companies.The Task Force published its report, titled Rebuilding

the IPO On-Ramp, in October 2011.25 In the report, theTask Force noted that after achieving a one-year high of791 IPOs in 1996, the US IPO market severely declinedfrom 2001 to 2008, averaging only 157 IPOs per yearduring that period, with a low of 45 in 2008, with IPOsby smaller companies showing the steepest declines. Thereport presents a nuanced view of the causes of thisdecline, pointing to a series of regulatory and marketstructure changes. The report notes that these changeshave coalesced and as a result have had the effect of drivingup costs for smaller companies looking to go public;constraining the amount of information available toinvestors about such companies; and shifting theeconomics of investment banking away from long-terminvesting in such companies and toward high-frequencytrading of large-cap stocks, thus making the IPO processless attractive to, and more difficult for, smaller companies.The report made four principal recommendations to theTreasury Department: providing an on-ramp (or phasingin of disclosure requirements) for smaller companies thatcomplete IPOs; improving the availability and flow ofinformation for investors before and after an IPO;lowering the capital gains tax rate for investors who


purchase shares in an IPO and hold these shares for aminimum of two years; and educating issuers about how tosucceed in the new capital markets environment. The TaskForce stressed that these recommendations purport only toadjust the scale of current regulations, not change the focuson investor protection.In December 2011, legislation, titled the Reopening

American Capital Markets to Emerging GrowthCompanies Act of 2011, was introduced that incorporatedmany of the recommendations included in the Report,including a proposal to amend section 2(a) of theSecurities Act and section 3(a) of the Exchange Act bycreating a new category of issuer called an “emerginggrowth company” and exempting these emerging growthcompanies, at least initially, from certain requirements.This legislation formed the basis of much of Title I of theJOBS Act. The legislative efforts received a boost when, in January

2012, President Obama expressed support for a number ofthese initiatives. During his State of the Union address, thePresident emphasised the need to foster innovation andencourage start-ups and small businesses. On January 312012, the President released the Startup AmericaLegislative Agenda to Congress, which reflected supportfor an increase in the offering threshold in Regulation A, a“national framework” for crowdfunding, and the adoptionof an IPO on-ramp. Shortly thereafter, the individuallegislative initiatives referenced above coalesced into asingle legislative proposal, and so we finish where westarted off, with the enactment of the JOBS Act. In thechapters that follow, we provide a summary of the mainprovisions of the JOBS Act and a discussion of their effecton capital formation.


1 Securities Act of 1933, 48 Stat. 74 (May 27, 1933),codified at 15 USC § 77a et seq.

2 Securities Exchange Act of 1934, 48 Stat. 881 (June6, 1934), codified at 15 USC § 78a et seq.

3 15 USC § 77e.4 15 USC § 77e(b).5 See

http://www.gt.com/staticfiles//GTCom/Public%20companies%20and%20capital%20markets/Files/IPO%20crisis%20-%20June%202010%20-%20FINAL.pdf.

6 See id.7 See

http://online.wsj.com/article/SB10001424052748704630004576249182275134552.html?KEYWORDS=%22new+stock+rules%22.

8 See James C. Brau & Stanley E. Fawcett, InitialPublic Offerings: An Analysis of Theory and Practice,61 J. Fin. 399 (2006), available athttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=530924.

9 Securities Act Release No. 33-8514, 87 S.E.C.Docket 1138 (Feb. 28, 2006); Exchange Act ReleaseNo. 34-50864, 84 S.E.C. Docket 1340 (Dec. 16,2004).

10 Advisory Committee on Smaller Public Companies,Charter, available athttp://sec.gov/info/smallbus/acspc.shtml.

11 Letter from Keith F. Higgins, Chair, ABACommittee on Federal Regulation of Securities, toJohn W. White, Director, Division of CorporationFinance (Mar. 22, 2007), available atwww.abanet.org/buslaw/committees/CL410000pub/comments/20070322000000.pdf .

12 Seehttp://www.knowledgemosaic.com/resourcecenter/Issa.041211.pdf.

13 See http://www.sec.gov/news/press/schapiro-issa-letter-040611.pdf.

14 See, e.g. D. Weild and E. Kim, A Wake Up Call forAmerica, Grant Thornton LLP (2009); Committeeon Capital Markets Regulation, Continued Erosionin Competitiveness of the U.S. Equity Markets(2009).

15 See C. Caglio, K. Weiss Hanley and Marietta-Westberg, Going Public Abroad: The Role ofInternational Markets for IPOs (Feb. 2011).

16 The Securities Act does not state when the pre-filingperiod begins. The SEC has stated that an issuer willbe in registration at least from the time it beginspreparing the related registration statement or thetime it has reached an understanding with anunderwriter, even if all the terms or conditions of theunderwriting arrangement have not been agreedupon. See Release No. 33-5009, Publication ofInformation Before or After the Filing and EffectiveDate of a Registration Statement Under the SecuritiesAct of 1933 (Oct. 7, 1969); Release No. 33-5180,Guidelines for Release of Information by Issuers WhoseSecurities Are in Registration (Aug. 16, 1971).

17 See Securities Act § 5(c).18 See Securities Act § 5(b)(1).19 See Release No. 33-8591, Securities Offering Reform

(July 19, 2005), http://www.sec.gov/rules/finaI/33-8591.pdf.

20 See, e.g., Final Report of the Advisory Committee onSmaller Public Companies to the U.S. Securities andExchange Commission (April 23, 2006),http://www.sec.gov/info/smallbus/acspc/acspc-finalreport.pdf; Joseph McLaughlin, How the SECStifles Investment – and Speech, The Wall StreetJournal (February 3, 2011). Concerns about thescope of the Commission’s rules on generalsolicitation and advertising have been raised by theparticipants in the annual SEC Government-BusinessForum on Small Business Capital Formation. See2009 Annual SEC Government-Business Forum onSmall Business Capital Formation Final Report (May2010),http://www.sec.gov/info/smallbus/gbfor28.pdf.

21 See Pinter v. Dahl, 486 U.S. 622, 644 (1988) (“Thepurchase requirement clearly confines §12 liability tothose situations in which a sale has taken place.Thus, a prospective buyer has no recourse against aperson who touts unregistered securities to him if hedoes not purchase the securities.”).

22 For example, crowdfunding was discussed at theSEC’s November 2010 Forum on Small BusinessCapital Formation. Participants in the Forumrecommended that the SEC consider implementing anew exemption from Securities Act registration forcrowdfunding, which would include offerings of upto $100,000 and a cap on individual investments notto exceed $100. In January 2011, representatives


ENDNOTES

from the Division of Corporation Finance’s Office ofSmall Business Policy met with a group from theSmall Business & Entrepreneurship Council, whichadvocated an exemption from registrationrequirements for crowdfunding offerings meetingspecific requirements. In addition, the Office ofSmall Business Policy and other members of theDivision of Corporation Finance Staff discussedcrowdfunding with representatives from the NorthAmerican Securities Administrators Association, theorganisation of state securities regulators, at aconference held on March 28, 2011.

23 HR 1070, available at:http://www.gpo.gov/fdsys/pkg/BILLS-112hr1070ih/pdf/BILLS-112hr1070ih.pdf.

24 Note that this change merely puts into the statutethe current requirements of SEC rules under Sections12(g) and 15(d).

25 Available athttp://www.sec.gov/info/smallbus/acsec/rebuilding_the_ipo_on-ramp.pdf.


Title I of the JOBS Act establishes a new processand disclosure regime for IPOs by a new classof companies referred to as emerging growthcompanies (EGCs). As discussed in the

Introduction, Title I of the JOBS Act was enacted based onthe recommendations of the Task Force, which sought waysto improve the offering process as a means for encouragingmore IPOs in the United States. As truly the centrepiece ofthe JOBS Act, Title I contemplates, for those companiesthat qualify as EGCs, confidential SEC staff review of draftIPO registration statements, scaled disclosure requirements,no restrictions on test-the-waters communications withqualified institutional buyers (QIBs) and institutionalaccredited investors before and after filing a registrationstatement, and fewer restrictions on research (includingresearch by participating underwriters) around the time ofan offering. Because Title I was retroactively effective toDecember 9 2011 for issuers that qualified as EGCs, it hashad the most significant impact to date on the regulation ofcapital formation transactions.Given the immediate effectiveness of Title I of the JOBS

Act, the SEC staff provided interpretive guidance in theform of frequently asked questions that are posted on theSEC’s website. The FAQs were initially issued on April 162012 and were updated on May 3 2012 and September 282012.1 These FAQs are not rules or regulations of the SEC,but rather reflect the views of the staff of the SEC’sDivision of Corporation Finance.

The definition of EGCIn order to qualify for the IPO on-ramp contemplated byTitle I of the JOBS Act, an issuer must qualify as an EGC,which is determined for the purpose of the reporting,accounting, auditing and corporate governance breaks thatthe company may use if it went public through a registeredsecurities offering on or after December 9 2011, and for anIPO at any time during the process when the EGC ismaking use of the Title I provisions.

The $1 billion in revenue testAn EGC is defined for the purposes of Title I as an issuer(including a foreign private issuer) with total annual gross

revenues of less than $1 billion (subject to inflationaryadjustment by the SEC every five years) during its mostrecently completed fiscal year.2 The SEC indicates that thephrase “total annual gross revenues” means total revenuesof the issuer (or a predecessor of the issuer, if thepredecessor’s financial statements are presented in theregistration statement for the most recent fiscal year), aspresented on the income statement in accordance with USgenerally accepted accounting principles (GAAP).3 If aforeign private issuer is using International FinancialReporting Standards (IFRS) as issued by the InternationalAccounting Standards Board (IASB) as its basis forpresentation, then the IFRS revenue number is used forthis test.4 Because an issuer must determine its EGC statusbased on revenues as expressed in US dollars, the SEC staffindicates that a foreign private issuer’s conversion ofrevenues should be based on the exchange rate as of the lastday of the fiscal year.5 For financial institutions, the SEChas indicated that total annual gross revenues should bedetermined in the manner consistent with the approachused for determining status as a “smaller reportingcompany,” which looks to all gross revenues fromtraditional banking activities. For this purpose, a financialinstitution must include all gross revenues from traditionalbanking activities. Banking activity revenues includeinterest on loans and investments, dividends oninvestments, fees from loan origination, fees from trustand investment services, commissions, brokerage fees,mortgage servicing revenues, and any other fees or incomefrom banking or related services. Revenues do not includegains and losses on dispositions of investment portfoliosecurities (although it may include gains on tradingaccount activity if that is a regular part of the institution’sactivities).6

By way of example, the SEC indicates that, in applyingthe revenue test for determining EGC status, a calendaryear-end issuer that would like to file a registrationstatement for an initial public offering of common equitysecurities in January 2013 (which would present financialstatements for 2011 and 2010 and the nine months endedSeptember 30 2012 and 2011) should look to its mostrecently completed fiscal year, which would be the most


CHAPTER 1

The IPO on-ramp

recent annual period completed, regardless of whetherfinancial statements for the period are presented in theregistration statement. In this example, the most recentannual period completed would be 2012.7

Applicability of the December 9 2011 effective dateAn issuer can qualify as an EGC if it first sold its commonstock in a registered offering on or after December 9 2011.The SEC has indicated that this eligibility determination isnot limited to initial public offerings that took place on orbefore December 8 2011, in that it could also include anoffering of common equity securities under an employeebenefit plan on Form S-8, as well as a selling shareholder’sregistered secondary offering.8 The SEC notes that justhaving a registration statement go effective on or beforeDecember 8 2011 is not a bar to EGC status, as long as nocommon equity securities were actually sold off of theregistration statement on or before December 8 2011.9

Qualification for EGC statusThe SEC has indicated that asset-backed issuers andregistered investment companies do not qualify as EGCs;however, business development companies could qualify.10

The SEC may determine, through the course of its reviewprocess or otherwise, that other particular types of issuersare not EGCs for the purposes of Title I of the JOBS Act.Previously public issuersAn issuer that succeeds to a predecessor’s Exchange Actregistration or reporting obligations under Rules 12g-3and 15d-5 will not qualify for EGC status if thepredecessor’s first sale of common equity securitiesoccurred on or before December 8 2011, as thepredecessor was not eligible for that EGC status.11

The SEC has addressed the EGC status of an issuerthat was once an Exchange Act reporting company but isnot required to file Exchange Act reports.12 The SECnotes that such an issuer can take advantage of thebenefits of EGC status, even though its initial publicoffering of common equity securities occurred on orbefore December 8 2011. In this regard, the SECindicates that if an issuer would otherwise qualify as anEGC but for the fact that its initial public offering ofcommon equity securities occurred on or beforeDecember 8 2011, and such issuer was once an ExchangeAct reporting company but is not required to fileExchange Act reports, then the SEC would not object ifsuch issuer takes advantage of all of the benefits of EGCstatus for its next registered offering and thereafter, untilit triggers one of the disqualification provisions inSections 2(a)(19)(A)-(D) of the Securities Act. Thisposition is not available to an issuer that has had the

registration of a class of its securities revoked pursuant toExchange Act section 12(j). The SEC goes on to notethat, based on the particular facts and circumstances, theEGC status of an issuer may be questioned if it appearsthat the issuer ceased to be a reporting company for thepurpose of conducting a registered offering as an EGC.The SEC recommends that issuers with questionsrelating to these issues should contact the Division ofCorporation Finance’s Office of the Chief Counsel.This interpretation seeks to address EGC status for those

companies that were taken private through private equityor management buyouts with the expectation of a liquidityevent or exit through an IPO in the future, which havemade up a relatively significant portion of the IPO marketin recent years.

Losing EGC statusStatus as an EGC is maintained until the earliest of:• the last day of the fiscal year in which the issuer’s totalannual gross revenues are $1 billion or more;

• the last day of the issuer’s fiscal year following the fifthanniversary of the date of the first sale of commonequity securities of the issuer pursuant to an effectiveregistration statement under the Securities Act (for andebt-only issuer that never sold its common equitypursuant to an Exchange Act registration statement,this five-year period will not run);

• any date on which the issuer has, during the prior three-year period, issued more than $1 billion innon-convertible debt; or

• the date on which the issuer becomes a “LargeAccelerated Filer,” as defined in the SEC’s rules.13

EGC status cannot be regained

With regard to the $1 billion debt issuance test, the SEChas indicated that the three-year period covers any rollingthree-year period, which is not in any way limited tocompleted calendar or fiscal years.14 The SEC also notedthat it reads “non-convertible debt” to mean any non-convertible security that constitutes indebtedness (whetherissued in a registered offering or not), thereby excludingbank debt or credit facilities.15 The debt test references debtissued, as opposed to issued and outstanding, so that anydebt issued to refinance existing indebtedness over thecourse of the three-year period could be counted multipletimes. The SEC has indicated, however, that the staff willnot object if an issuer does not double count the principalamount from a private placement and the principalamount from the related Exxon Capital or A/B exchangeoffer.16


The SEC also addressed two specific examples and howthe EGC status of the issuer would be determined in theevent of an acquisition or reverse merger.17

• In Example 1, Company A acquires Company B forcash or stock, in a forward acquisition. Company A isboth the legal acquirer and the accounting acquirer.

• In Example 2, Company C undertakes a reverse mergerwith Company D, an operating company. Company Dis presented as the predecessor in the post-transactionfinancial statements.In each example, the companies’ fiscal year is the

calendar year; the transactions occur on September 302012; and FAQ 24, which relates to succession ofExchange Act obligations, is not implicated. Indetermining whether Company A and Company C triggerany of the disqualifications from the definition of EGC insection 2(a)(19)(A), (B), (C) or (D) (referenced above), theSEC staff notes the following framework: (see table)

Timing of the EGC determinationSecurities Act Rule 401(a) provides that “the form andcontents of a registration statement and prospectus shallconform to the applicable rules and forms as in effect onthe initial filing date of such registration statement andprospectus,” and applies to registration statements at theinitial filing date, not at the time that a registrationstatement is submitted for confidential review.18 Therefore,

an issuer must qualify as an EGC at the time of submissionin order to use the confidential review process for aregistration statement, or any amended submission of theregistration statement. If an issuer loses EGC status whilethe SEC staff is reviewing the registration statement on aconfidential basis, then the issuer must file the registrationstatement and all of the draft submissions in order toproceed with the review process. When the EGC files theregistration statement, the issuer’s EGC status is retainedwhile that registration statement is in registration byoperation of Securities Act Rule 401(a). With regard to theuse of the permitted test-the-waters communicationsunder Securities Act section 5(d) (discussed below), anissuer must determine whether it qualifies as an EGC atthe time it engages in the test-the-waters communications.In this regard, the SEC has noted that if the issuer laterloses its EGC status by the time the registration statementis filed, then the issuer would not retroactively lose theability to utilise prior test-the-waters communications.19

Benefits available to EGCsWhen an issuer qualifies as an EGC, it may take advantageof a number of benefits in connection with its IPO andsubsequent public reporting and corporate governance.These benefits are designed to facilitate the public offeringprocess, promote communications in and around the timeof the IPO, and allow the EGC to ease into certain public


$1B annual revenues test

Five-year anniversary test

$1B issued debt during previous three years test

Large accelerated filer test

Example 1:Forward acquisition

In 2012, look to Company A’s revenues for2011.

In 2013, look to Company A’s revenues for2012, which will include Company B’s rev-enues from October 1 2012.

Look to Company A’s date of first sale.

Look to Company A’s debt issuances,which will include Company B’s debtissuances from October 1 2012.

At December 31 2012, look to CompanyA’s market value at June 30 2012.

At December 31 2013, look to CompanyA’s market value (which will includeCompany B’s) at June 30 2013.

Example 2:Reverse merger

In 2012, look to Company D’s revenues for2011.

In 2013, look to Company D’s revenues for2012, which will include Company C’s rev-enues from October 1 2012.

Look to Company C’s date of first sale.

Look to Company D’s debt issuances,which will include Company C’s debtissuances from October 1 2012.

At December 31 2012, look to CompanyC’s market value at June 30 2012.

At December 31 2013, look to CompanyC’s market value (which will includeCompany D’s) at June 30 2013.

reporting, accounting, auditing, and corporate governancerequirements.

EGC communicationsTitle I of the JOBS Act provides EGCs, or any otherperson they authorise, the flexibility to engage in oral orwritten communications with QIBs and institutionalaccredited investors in order to gauge their interest in aproposed offering, whether before or following the firstfiling of any registration statement, subject to therequirement that no security may be sold unlessaccompanied or preceded by a Securities Act section 10(a)prospectus.20 This provision allows an EGC to test thewaters for a potential IPO by communicating withinvestors and gauging their potential interest in theoffering.21 An EGC can use the test-the-waters provisionwith respect to any registered offerings that it conductswhile qualifying for EGC status. There are no form orcontent restrictions on these communications, and there isno requirement to file written communications with theSEC. In the course of reviewing the registration statementsof an EGC, the SEC staff has requested the EGCs submitany written test-the-waters materials to the SEC, so thatthe SEC staff can determine whether those materialswould provide any guidance as to information that shouldbe included in the prospectus.The SEC has addressed the interplay of these test-the-

waters communications, and the requirements ofExchange Act Rule 15c2-8(e).22 Rule 15c2-8(e) requiresthat a broker-dealer make available a copy of thepreliminary prospectus (before the effective date) for aregistered offering of securities before soliciting ordersfrom customers. If read broadly, the prohibitions of Rule15c2-8(e) might constrain the types of activities that arepermissible during test-the-waters discussions. The FAQsnote that while the JOBS Act does not amend Rule 15c2-8(e) (that is, the JOBS Act does not modify the meaningof the term “solicit”), an EGC or a financial intermediaryacting on the EGC’s behalf may engage in discussions withinstitutional investors to gauge their interest in purchasingEGC securities before the EGC has filed its registrationstatement with the SEC and after the EGC has filed itsregistration statement. During this period, the underwritermay discuss price, volume and market demand and solicitnon-binding indications of interest from customers.Soliciting such a non-binding indication of interest, in theabsence of other factors, would not constitute a solicitationfor purposes of Rule 15c2-8(e).The JOBS Act also permits a broker-dealer to publish or

distribute a research report about an EGC that proposes toregister an offering under the Securities Act or has a

registration statement pending, and the research reportwill not be deemed an offer under the Securities Act, evenif the broker-dealer will participate or is participating inthe offering. Further, no SRO or the SEC may adopt ormaintain any rule or regulation prohibiting a broker-dealerfrom publishing or distributing a research report ormaking a public appearance with respect to the securitiesof an EGC following an offering or in a period beforeexpiration of a lock-up.23 These provisions are discussed ingreater detail in Chapter 8.

Confidential review process for EGC IPO registrationstatementsTitle I provides that the SEC’s staff must review all EGCinitial public offering registration statementsconfidentially.24 An EGC may confidentially submit adraft registration statement for an initial public offeringfor non-public review, provided that the initialconfidential submission and all amendments are publiclyfiled with the SEC no later than 21 days before theissuer’s commencement of a road show.25 The SECrequires that confidential draft registration statementsand amendments be submitted through EDGAR usingsubmission form types DRS and DRS/A, respectively. Nofiling fee is due at the time of submitting the draftregistration statement.26

A confidential submission of a draft registrationstatement is not required to be signed by the registrant orby any of its officers or directors, nor is it required toinclude the consent of auditors and other experts, as it isnot filed with the SEC.27 While Securities Act section6(e)(1) requires that the initial confidential submissionand all amendments thereto be publicly filed with theSEC not later than 21 days before the date on which theissuer commences a road show, the SEC notes that uponpublic filing, the previous confidential submissions arenot required to be signed and do not require consents.28

The SEC expects that any registration statementsubmitted for confidential review will be substantiallycomplete at the time of initial submission, including asigned audit report, and the required exhibits (however,the registration statement itself is not required to be signedor to include the consent of auditors and other experts).The SEC will defer review any draft registration statementthat is materially deficient.29

The confidential submission of a draft registration doesnot constitute the filing of a registration statement for thepurposes of the prohibition in Securities Act section 5(c)against making offers of a security in advance of filing aregistration statement.30


Test-the-waters communications and the 21-day filingrequirementSecurities Act section 6(e) provides that confidentialregistration statement submissions must be publicly filedwith the SEC at least 21 days before the issuer conducts aroad show. The term “road show” is defined as “an offer …that contains a presentation regarding an offering by oneor more members of the issuer’s management … andincludes discussion of one or more of the issuer, suchmanagement, and the securities being offered.”31 Given thebreadth of this definition, the SEC has addressed the issueof whether the test-the-waters communications underSecurities Act section 5(d) that are discussed above couldbe considered a road show for the purposes of triggeringthe 21-day filing requirement.32

The SEC has noted that in a traditional underwrittenpublic offering where test-the-waters communications arenot used, the road show could be easily identified as “thosemeetings traditionally viewed as the road show when theemerging growth company and underwriters begin activelymarketing the offering.” Under these circumstances, theEGC would be able to estimate when it expects to beginthat road show, and then publicly file the registrationstatement and all of the confidential submissions at least21 days before that date. Because Securities Act section5(d) specifically contemplates test-the-waterscommunications taking place before filing a registrationstatement, and in the interest of reading the provisions ina consistent fashion, the SEC will not object if an EGCdoes not treat test-the-waters communications conductedin reliance on Securities Act section 5(d) as a road show forpurposes of Securities Act section 6(e). The SEC notes,however, that if an issuer were to have meetings or othercommunications that meet the definition of a road showand which do not fall within the test-the-waterscommunications contemplated by section 5(d), then the21-day filing requirement would be triggered based on thetiming of such meetings. If an EGC does not conduct atraditional road show and does not engage in activities thatwould come within the definition of a road show, otherthan test-the-waters communications that comply withSecurities Act section 5(d), the SEC Staff indicates that theissuer’s registration statement and confidential submissionsshould be filed publicly no later than 21 days before theanticipated date of effectiveness of the registrationstatement.33

Registration statement disclosure for EGCsThe SEC has indicated that an EGC must identify itself asan EGC on the cover page of the prospectus.34 In addition,SEC staff comments on EGC registration statements have

requested the following disclosures: • a description of how and when a company may loseEGC status;

• a brief description of the various exemptions that areavailable to an EGC, such as exemptions fromSarbanes-Oxley section 404(b) and the Say-on-Pay/Say-on-Golden Parachute provisions; and

• the EGC’s election under section 107(b) of the JOBSAct for extended transition to new or revisedaccounting standards. The SEC staff requests that if the EGC has elected to

opt out of the extended transition period for new orrevised accounting standards, then it must include astatement that the election is irrevocable. If the EGC haselected to use the extended transition period, then riskfactor disclosure must explain that this election allows anEGC to delay the adoption of new or revised accountingstandards that have different effective dates for public andprivate companies until those standards apply to privatecompanies. The SEC staff also requests that the EGC statein the risk factors that, as a result of this election, theEGC’s financial statements may not be comparable toissuers that comply with public issuer effective dates. Asimilar statement is also requested in the EGC’s criticalaccounting policy disclosures in MD&A.An EGC is required to present only two years of audited

financial statements in its initial public offeringregistration statement.35 An EGC may also limit itsMD&A to only cover those audited periods presented inthe audited financial statements. The SEC has indicatedthat, notwithstanding Securities Act section 7(a)(2)(A)’sreference to “any other” registration statement, the SECstaff will not object if an EGC presenting two years ofaudited financial statements limits the selected financialdata included in its initial public offering registrationstatement to only two years.36 For financial statementsrequired under Rules 3-05 and 3-09 of Regulation S-X, theSEC staff will not object if only two years of financialstatements are provided in the registration statement, evenif the significance tests result in a requirement to presentthree years of financial statements for entities other thanthe issuer.37 The SEC staff has further noted that it will notobject if an issuer presents the ratio of earnings to fixedcharges required by Item 503(d) of Regulation S-K for thesame number of years for which it provides selectedfinancial data.38

An EGC may comply with the executive compensationdisclosures applicable to a “smaller reporting company” asdefined in the SEC’s rules, which means that an EGC needprovide only a Summary Compensation Table (with threerather than five named executive officers and limited to


two fiscal years of information), an Outstanding EquityAwards Table, and a Director Compensation Table, alongwith some narrative disclosures to augment those tables.EGCs are not required to provide a CompensationDiscussion and Analysis, or disclosures about paymentsupon termination of employment or change in control.39

Disclosure, corporate governance, accounting and auditingreliefTitle I of the JOBS Act provides relief from a number ofrequirements for EGCs following an initial public offering.An EGC will not be subject to the Say-on-Pay, Say-on-Frequency or Say-on-Golden Parachute vote required bythe Dodd-Frank Act and the SEC rules, for as long as theissuer qualifies as an EGC.40 An issuer that was an EGC,but lost that status, will be required to comply with theSay-on-Pay vote requirement as follows: in the case of anissuer that was an EGC for less than two years, by the endof the three-year period following its IPO; and for anyother issuer, within one year of having lost its EGC status.41

An EGC also is not subject to any requirement to disclosethe relationship between executive compensation and thefinancial performance of the company, or any requirementto disclose the CEO’s pay relative to the median employee’spay (should either such requirements ever be proposed andadopted by the SEC pursuant to the Dodd-Frank Act).42

Under section 107(b) of the JOBS Act, an EGC will notbe required to adopt any update to FASB’s AccountingStandards codification after April 5 2012 that has differenteffective dates for public companies and private companiesthat are not “issuers” under section 2(a) of Sarbanes-Oxley,until those standards apply to private companies. Underthis provision, EGCs are able to take advantage of theextended transition period contemplated in those limitedsituations where there is a different effective date specifiedfor private companies. If a new or revised accountingstandard does not apply at all to private companies, thenno transition would be permitted for EGCs, or if anaccounting standard applies to both public and privatecompanies, but provides for the same effective date forboth types of companies, then no transition would bepermitted for EGCs. Section 107(b)(1) of the JOBS Actprovides that an EGC “must make such choice at the timethe company is first required to file a registrationstatement, periodic report, or other report with theCommission” and to notify the SEC of such choice. TheSEC has noted that EGCs should notify the SEC staff ofthe issuer’s choice at the time of the initial confidentialsubmission, and if an EGC is already in registration orsubject to Exchange Act reporting, then the statementmust appear in its next amendment to the registration

statement or in its next periodic report.43 Section 107(b)(2)provides that any decision to opt-out of the extendedtransition period for complying with new or revisedaccounting standards is irrevocable; however the SECallows an EGC that opted into the extended transitionperiod provision to subsequently opt out, as long as itcomplies with the applicable provisions of the JOBS Actand discloses its opting-out in the first periodic report orregistration statement following the decision to do so.An EGC is not subject to any potential rules or

standards requiring mandatory audit firm rotation or asupplement to the auditor’s report that would provideadditional information regarding the audit of thecompany’s financial statements (auditor discussion andanalysis), should such requirements ever be proposed oradopted by the Public Company Accounting OversightBoard (PCAOB). Any other new auditing standardsadopted by the PCAOB will not apply to EGC auditsunless the SEC determines that such requirement isnecessary and appropriate for investor protection.44

An EGC is not subject to the requirement for an auditorattestation of internal controls pursuant to section 404(b)of Sarbanes-Oxley. The EGC is subject to the requirementthat management establish, maintain, and assess internalcontrol over financial reporting, once that is phased-in fora issuer conducting an initial public offering after the firstyear.45

Other than the provisions for extended transition to newor revised accounting standards discussed above, an EGCmay decide to follow only some of the scaled disclosureprovisions and corporate governance breaks available forEGCs.46

The SEC will not object if a foreign private issuer thatqualifies as an EGC complies with the scaled disclosureprovisions available to emerging growth companies to theextent relevant to the form requirements for foreign privateissuers.47

Required studiesThe JOBS Act requires that the SEC conduct a number ofstudies. Under Title I, within 90 days of enactment of theAct, the SEC was required to present to Congress thefindings of a study that examines the impact ofdecimalisation on initial public offerings and the impact ofthis change on liquidity for small- and mid-cap securities.If the SEC determined that securities of emerging growthcompanies should be quoted or traded using a minimumincrement higher than $0.01, the SEC may, by rule, notlater than 180 days following enactment of the Act,designate a higher minimum increment between $0.01and $0.10.48 Also under Title I, within 180 days of


enactment, the SEC was required to present to Congressits findings and recommendations following a review ofRegulation S-K that is intended to analyse currentregistration requirements and determine whether theserequirements can be updated, modified or simplified inorder to reduce costs and other burdens on emerginggrowth companies.49 The SEC has not yet completed themandated study regarding Regulation S-K.On July 20 2012, the SEC delivered to Congress the

report required by section 106 of the JOBS Act.50 Thestudy notes the observations of the IPO Task Forceregarding the changing market structure and economicsarising from the shift to decimal stock quotes, which pointtoward a negative impact on the economic sustainability ofsell-side research and the greater emphasis placed onliquid, very large capitalisation stocks at the expense ofsmaller capitalisation stocks. The SEC’s study takes athree-pronged approach to examining the issues: (i)reviewing empirical studies regarding tick size anddecimalisation; (ii) participation in, and review ofmaterials prepare in connection with, discussionsconcerning the impact of market structure on small andmiddle capitalisation companies and on IPOs as part ofthe SEC Advisory Committee on Small and EmergingCompanies; and (iii) a survey of tick-size conventions inforeign markets.The SEC concluded that decimalisation may have been

one of a number of factors that have influenced the IPOmarket, and that the existing literature did not isolate theeffect of decimalisation from the many other factors. TheSEC also noted that markets have evolved significantlysince decimalisation was implemented over a decade ago,and that other countries have used multiple tick sizesrather than the one-size-fits-all approach implemented inthe United States. Based on the observations reported inthe study, the SEC recommends that the Commissionshould not proceed with specific rulemaking to increasetick sizes, but should rather consider additional steps thatmay be needed to determine whether rulemaking shouldbe undertaken, which might include soliciting the views ofinvestors, companies, market professionals, academics andothers on the broad topic of decimalisation and the impacton IPOs and the markets. In particular, the study notes thepossibility of a roundtable where these issues can beaddressed. The SEC announced that its staff will host aroundtable in early 2013 to discuss the impact of decimal-based stock trading on small and mid-sized companies,market professionals, investors, and US securities markets.



Appendix ADISCLOSURE AND RELATED REQUIREMENTS

Financial information in SEC filings

Confidential submissions ofdraft IPO registration statement

Communicationsbefore and duringoffering process

Auditor attestationon internal controls

Accounting standards

Executive compensation disclosure

Say on pay

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 interimperiod included in the financial statements

• No confidential filing for US issuers• Confidential filing for FPIs only in specified cir-

cumstances

Limited ability to test the waters

• Auditor attestation on effectiveness of internalcontrols over financial reporting required insecond annual report after IPO

• Non-accelerated filers not required to comply

Must comply with applicable new or revisedfinancial accounting standards

• Must comply with executive compensation dis-closure requirements, unless a smaller report-ing company (which is subject to reduced dis-closure requirements)

• Upon adoption of SEC rules under Dodd-Frank will be required to calculate and dis-close the median compensation of all employ-ees compared to the CEO

• Must hold non-binding advisory stockholdervotes on executive compensation arrange-ments

• Smaller reporting companies are exempt fromsay on pay until 2013

Under JOBS Act

• Two years of audited financial statements• Not required to present selected financial data

for any period before the earliest audited peri-od presented in connection with an IPO

• Within one year of IPO, EGC would reportthree years of audited financial statements

EGCs (including FPIs that are EGCs) may sub-mit a draft IPO registration statement for confi-dential review before public filing, provided thatsuch submission and any amendments are pub-licly filed with the SEC not later than 21 daysbefore the EGC conducts a road show, super-seding the SEC’s December 2011 position onconfidential submissions by FPIs.

EGCs, either before or after filing a registrationstatement, may test the waters by engaging inoral or written communications with QIBs andinstitutional accredited investors to determineinterest in an offering

Transition period for compliance of up to fiveyears

• Not required to comply with any new orrevised financial accounting standard untilsuch standard applies to companies that arenot subject to Exchange Act public companyreporting

• EGCs may choose to comply with non-EGCaccounting standards but may not selectivelycomply

• May comply with executive compensation dis-closure requirements by complying with thereduced disclosure requirements generallyavailable to smaller reporting companies

• Exempt from requirement to calculate and dis-close the median compensation of all employ-ees compared to the CEO

• FPIs entitled to rely on other executive com-pensation disclosure requirements

Exempt from requirement to hold non-bindingadvisory stockholder votes on executive compen-sation arrangements for one to three years afterno longer an EGC


1. Frequently Asked Questions of GeneralApplicability on Title I of the JOBS Act (April 162012; May 3 2012 and September 28 2012),available athttp://www.sec.gov/divisions/corpfin/guidance/cfjjobsactfaq-title-i-general.htm (SEC Title I FAQs).

2. Securities Act § 2(a)(19), 15 USC 77b(a).3. SEC Title I FAQs, supra note 1 at Question 1.4. Id.5. Id.6. SEC Title I FAQs, supra note 1 at Question 23,

referencing section 5110.2(c) of the Division ofCorporation Finance Financial Reporting Manual,available athttp://www.sec.gov/divisions/corpfin/cffinancialreportingmanual.pdf.

7. SEC Title I FAQs, supra note 1 at Question 51.8. SEC Title I FAQs, supra note 1 at Question 2.9. Id.10. SEC Title I FAQs, supra note 1 at Questions 19-21.11. SEC Title I FAQs, supra note 1 at Question 24.12. SEC Title I FAQs, supra note 1 at Question 54.13. Securities Act § 2(a)(19), 15 USC 77b(a).14. SEC Title I FAQs, supra note 1 at Question 17.15. Id.16. SEC Title I FAQs, supra note 1 at Question 18.17. SEC Title I FAQs, supra note 1 at Question 47.18. SEC Title I FAQs, supra note 1 at Question 3.19. Id.20. JOBS Act §105(c), amending Securities Act § 5, 15

USC 77e.21. Without the availability of the test-the-waters

provisions in Securities Act § 5(d), an issuer couldpotentially be deemed to be “gun jumping” whencommunicating with investors about an actual orpotential offering, based on the timing and natureof such communications.

22. Frequently Asked Questions About ResearchAnalysts and Underwriters (August 22 2012),available athttp://www.sec.gov/divisions/marketreg/tmjobsact-researchanalystsfaq.htm, at Question 1.

23. Sections 105(c) and 105(d) of the JOBS Act.24. Section 106(a) of the JOBS Act, amending

Securities Act section 6, 15 USC 77(f ). A foreignprivate issuer that qualifies as an EGC may opt touse the Division of Corporation Finance’s policy

titled Non-Public Submissions from Foreign PrivateIssuers if they meet the circumstances that theDivision has outlined in that policy, available athttp://www.sec.gov/divisions/corpfin/internatl/nonpublicsubmissions.htm.

25. For this purpose, the term “road show” is defined inSecurities Act Rule 433(h)(4).

26. Frequently Asked Questions on the ConfidentialSubmission Process for Emerging GrowthCompanies (April 10 2012), available athttp://www.sec.gov/divisions/corpfin/guidance/cfjumpstartfaq.htm (SEC Confidential SubmissionFAQs) at Question 5.

27. SEC FAQs, supra note 1 at Question 52.28. Id.29. SEC Confidential Submission FAQs, supra note 26,

Question 7.30. SEC Confidential Submission FAQs, supra note 26,

Question 6.31. Securities Act Rule 433(h)(4).32. SEC Confidential Submission FAQs, supra note 26,

Question 8.33. SEC Confidential Submission FAQs, supra note 26,

Question 9.34. SEC Title I FAQs, supra note 1, Question 4.35. Securities Act § 7(a)(2)(A), 15 USC 77g(a)(2)(A).36. SEC Title I FAQs, supra note 1 at Question 11.

The SEC would not object if an issuer that has lostits EGC status does not present, in subsequentlyfiled registration statements and periodic reports,selected financial data or a ratio of earnings to fixedcharges for periods before the earliest auditedperiod presented in its initial Securities Act orExchange Act registration statement. See SEC TitleI FAQs, supra note 1 at Question 50.

37. SEC Title I FAQs, supra note 1 at Question 16.38. SEC Title I FAQs, supra note 1 at Question 27.39. JOBS Act §102(c).40. Exchange Act § 14A(e), 15 USC 78n-1(e).41. Id.42. See Dodd-Frank Act § 953(b)(1).43. SEC Title I FAQs, supra note 1 at Question 13.44. JOBS Act § 104, amending Sarbanes-Oxley Act §

103(a)(3).45. JOBS Act § 103, amending Sarbanes-Oxley Act §

404(b).46. JOBS Act § 107.

ENDNOTES

47. SEC Title I FAQs, supra note 1 at Question 8.48. JOBS Act § 106(b).49. JOBS Act § 108.50. Report to Congress on Decimalisation (July 2012),

available athttp://www.sec.gov/news/studies/2012/decimalisation-072012.pdf.


As we discussed in the Introduction, there areimportant considerations to be analysed inconnection with pursuing an IPO. Even givenmany changes in the capital markets, and the

improved liquidity of private or restricted securities, thereare significant advantages to be gained as a result of being apublic company. Aside from the immediate capital-raisingopportunity of the IPO, going public will create a liquidpublic market for the issuer’s securities. The issuer’s securityholders will have an opportunity to monetise theirinvestment in the company. The issuer also will have anacquisition currency and be able to use its stock asconsideration in a strategic transaction. After the IPO, theissuer also will have many more capital-raising alternatives.All of these advantages will have to be weighed carefullyagainst the costs of undertaking an IPO, as well as theburdens and expense of life as a public company. A bit ofthis calculus has been made easier for companies thatqualify as EGCs. An EGC will have the opportunity topursue an IPO through an initial confidential submissionprocess. Should the issuer determine that the market willnot be receptive to the offering, or that other alternativesare more appealing, it can withdraw from the processwithout the stigma of a failed deal. In addition, an EGCmay benefit from the disclosure accommodations madeavailable by the JOBS Act. As a public company, an EGCalso will have the opportunity to ease into many corporategovernance requirements. This phase-in approach mayresult in important cost-savings for an EGC. Also, the EGCwill have the benefit of getting accustomed to life as apublic company and adding additional staff or retainingservice providers before it has to comply with some of themore burdensome requirements.

In addition to changing some of the dynamics thatmight figure into an issuer’s decision-making about anIPO, the JOBS Act also has changed the IPO process itselffor EGCs. Below, we discuss briefly the IPO process andhighlight along the way a number of the most importantdecisions that an EGC should consider, and conclude bydiscussing the opportunities for an issuer that qualifies as aforeign private issuer, or FPI, arising from the JOBS Act.

Pre-IPO planningEven though an EGC will have an opportunity to submitits IPO registration statement through the confidentialsubmission process, and proceed on a confidential basiswithout a public filing, the issuer will still have toundertake a fair bit of planning before committing toproceed with a filing.Most companies will have to make legal and operationalchanges before proceeding with an IPO. A companycannot wait to see if its IPO is likely to be successful beforeimplementing most of these changes. Many corporategovernance matters, federal securities law requirements(including Sarbanes-Oxley) as well as applicable securitiesexchange requirements must be met when the IPOregistration statement is filed, or the issuer must commit tosatisfy them within a set time period.

A company proposing to list securities on an exchangeshould review differing governance requirements of eachexchange, as well as their respective financial listingrequirements before determining which exchange tochoose. Similarly, an issuer will want to consider whetherto retain additional senior management or enter intoemployment agreements with key executive officers andsystematise its compensation practices. An issuer must alsoaddress other corporate governance matters, includingboard structure, committees and member criteria, related-party transactions, and director and officer liabilityinsurance. The company should undertake a thoroughreview of its compensation scheme for its directors andofficers, as well, particularly its use of equitycompensation. The issuer also will want to review all priorsecurities issuances for compliance with federal and statesecurities laws, including the limits of Rule 701.

Primary and secondary offeringsAn IPO may consist of the sale of newly issued shares bythe company (a primary offering), or a sale of alreadyissued shares owned by shareholders (a secondary offering),or a combination of these. Underwriters may prefer aprimary offering because the company will retain all of theproceeds to advance its business. However, many IPOsinclude secondary shares, either in the initial part of theoffering or as part of the 15% over-allotment option


CHAPTER 2

The IPO process

granted to underwriters. Venture capital and private equityshareholders view a secondary offering as their principalrealisation event. An issuer must consider whether any ofits shareholders have registration rights that could requirethe issuer to register shareholder shares for sale in the IPO.

Cheap stock“Cheap stock” describes options granted to employees of apre-IPO company during the 18–24 months before theIPO where the exercise price is deemed (in hindsight) to beconsiderably lower than the fair market value of the sharesat grant date. If the SEC determines (during the commentprocess) that the company has issued cheap stock, thecompany must incur a compensation expense that willhave a negative impact on earnings. The earnings impactmay result in a significant one-time charge at the time ofthe IPO as well as going-forward expenses incurred overthe option vesting period. In addition, absent certainlimitations on exercisability, an option granted with anexercise price that is less than 100% of the fair marketvalue of the underlying stock on the grant date will subjectthe option holder to an additional 20% tax pursuant tosection 409A of the Internal Revenue Code.

The dilemma that a private company faces is that it isunable to predict with certainty the eventual IPO price. Agood-faith pre-IPO fair market value analysis can yielddifferent conclusions when compared to a fair marketvalue analysis conducted by the SEC in hindsight based ona known IPO price. There is some industry confusion as tothe acceptable method for calculating the fair market valueof non-publicly traded shares and how much deviationfrom this value is permitted by the SEC. Companies oftenaddress this cheap stock concern by retaining anindependent appraiser to value their stock options. It nowappears, however, that most companies are using one ofthe safe-harbour methods for valuing shares prescribed inthe section 409A regulations.

Governance and board membersEven with the accommodations available to an EGC, acompany still must comply with significant corporategovernance requirements imposed by the federal securitieslaws and regulations and the regulations of the applicableexchanges, including with regard to the oversightresponsibilities of the board of directors and itscommittees. A critical matter is the composition of theboard itself. All exchanges require that, except underlimited circumstances, a majority of the directors be“independent” as defined by both the federal securitieslaws and regulations and exchange regulations. Inaddition, boards should include individuals with

appropriate financial expertise and industry experience, aswell as an understanding of risk management issues andpublic company experience. A company should begin itssearch for suitable directors early in the IPO process evenif it will not appoint the directors until after the IPO iscompleted. The company can turn to its large investors aswell as its counsel and underwriters for referencesregarding potential directors.

The Sarbanes-Oxley Act and the Dodd-Frank Actrequire publicly traded companies to implement corporategovernance policies and procedures that are intended toprovide minimum structural safeguards to investors.Certain of these requirements are phased in after the IPO.Again, quite a number of these requirements will beapplicable to an EGC and should be carefully considered.Key provisions include:• Prohibition of most loans to directors and executive

officers (and equivalents thereof ).• The CEO and CFO of a public company must certify

each SEC periodic report containing financialstatements.

• Adoption of a code of business conduct and ethics fordirectors and senior executive officers.

• Required “real time” reporting of certain material eventsrelating to the company’s financial condition oroperations.

• Disclosure of whether the company has an “auditcommittee financial expert” serving on its auditcommittee.

• Disclosure of material off-balance sheet arrangementsand contractual obligations.

• Audit committee approval of any services provided tothe company by its audit firm, with certain exceptionsfor de minims services.

• Whistleblower protections for employees who comeforward with information relating to federal securitieslaw violations.

• Compensation disgorgement provisions applicable tothe CEO and CFO upon a restatement of financialresults attributable to misconduct.

• The exchanges’ listing requirements contain relatedsubstantive corporate governance requirementsregarding independent directors; audit, nomination,and compensation committees; and other matters.

Selecting the underwritersA company will identify one or more lead underwritersthat will be responsible for the IPO. A company choosesan underwriter based on its industry expertise, includingthe knowledge and following of its research analysts, thebreadth of its distribution capacity, and its overall


reputation. A company should consider the underwriter’scommitment to the sector and its distribution strengths.For example, does the investment bank have a particularlystrong research distribution network, or is it focused oninstitutional distribution? Is its strength domestic, or doesit have foreign distribution capacity? The company maywant to include a number of co-managers in order tobalance the underwriters’ respective strengths andweaknesses.

A company should keep in mind that underwriters haveat least two conflicting responsibilities: to sell the IPOshares on behalf of the company and to recommend topotential investors that the purchase of the IPO shares is asuitable and a worthy investment. In order to betterunderstand the company – and to provide a defence in casethe underwriters are sued in connection with the IPO –the underwriters and their counsel are likely to spend asubstantial amount of time performing business, financial,and legal due diligence in connection with the IPO, andmaking sure that the prospectus and any other offeringmaterials are consistent with the information provided.The underwriters will market the IPO shares, set the price(in consultation with the company) at which the shareswill be offered to the public and, in a so-called firmcommitment underwriting, purchase the shares from thecompany and then re-sell them to investors. In order toensure an orderly market for the IPO shares, after theshares are priced and sold, the underwriters are permittedin many circumstances to engage in certain stabilisingtransactions to support the stock.

The IPO process The public offering process is divided into three periods:• the pre-filing period between determining to proceed

with a public offering and the actual SEC filing of theregistration statement; the company is in the “quietperiod” and subject to potential limits on publicdisclosure relating to the offering;

• the waiting or pre-effective period between the SECfiling date and the effective date of the registrationstatement; during this period, the company may makeoral offers, but may not enter into binding agreementsto sell the offered security; and

• the post-effective period between effectiveness andcompletion of the offering.

The registration statementA registration statement contains the prospectus, which isthe primary selling document, as well as other requiredinformation, written undertakings of the issuer and thesignatures of the issuer and the majority of the issuer’s

directors. It also contains exhibits, including basiccorporate documents and material contracts. UScompanies generally file a registration statement on FormS-1. Most non-Canadian foreign private issuers use aregistration statement on Form F-1, although other formsmay be available. There are special forms available tocertain Canadian companies.

The prospectusThe prospectus describes the offering terms, theanticipated use of proceeds, the company, its industry,business, management and ownership, and its results ofoperations and financial condition. Although it isprincipally a disclosure document, the prospectus also iscrucial to the selling process. A good prospectus sets forththe investment proposition.

As a disclosure document, the prospectus functions as aninsurance policy of sorts in that it is intended to limit theissuer’s and underwriters’ potential liability to IPOpurchasers. If the prospectus contains all SEC-requiredinformation, includes robust risk factors that explain therisks that the company faces, and has no materialmisstatements or omissions, investors will not be able torecover their losses in a lawsuit if the price of the stockdrops following the IPO. A prospectus should not includepuffery or overly optimistic or unsupported statementsabout the company’s future performance. Rather, it shouldcontain a balanced discussion of the company’s business,along with a detailed discussion of risks and operating andfinancial trends that may affect its results of operations andprospects.

SEC rules set forth a substantial number of specificdisclosures required to be made in the prospectus. Inaddition, federal securities laws, particularly Rule 10b-5under the Exchange Act, require that documents used tosell a security contain all the information material to aninvestment decision and do not omit any informationnecessary to avoid misleading potential investors. Federalsecurities laws do not define materiality; the basic standardfor determining whether information is material iswhether a reasonable investor would consider theparticular information important in making an investmentdecision. That simple statement is often difficult to applyin practice.

An issuer should be prepared for the time-consumingdrafting process, during which the issuer, investmentbankers, and their respective counsel work together to craftthe prospectus disclosure.

Financial informationThe IPO registration statement for an EGC must include


audited financial statements for the last two fiscal years;financial statements for the most recent fiscal interimperiod, comparative with interim financial information forthe corresponding prior fiscal period (may or may not beaudited depending on the circumstances); and incomestatement and condensed balance sheet information forthe last two years and interim periods presented.Early on, the issuer should identify any problemsassociated with providing the required financial statementsin order to seek necessary accommodation from the SEC.These statements must be prepared in accordance with USGAAP or IFRS as adopted by the IASB, as they will be thesource of information for Management’s Discussion andAnalysis of Financial Condition and Results of Operations(MD&A). The SEC will review and comment on thefinancial statements and the MD&A. The SEC’s areas ofparticular concern include: revenue recognition; businesscombinations; segment reporting; financial instruments;impairments of all kinds; deferred tax valuationallowances; compliance with debt covenants; fair value;and loan losses.

The pre-filing periodThe pre-filing period begins when the company and theunderwriters agree to proceed with a public offering.During this period, key management personnel willgenerally make a series of presentations covering thecompany’s business and industry, market opportunities,and financial matters. The underwriters will use thesepresentations as an opportunity to ask questions andestablish a basis for their due diligence defence.

From the first all-hands meeting forward, all statementsconcerning the company should be reviewed by thecompany’s counsel to ensure compliance with applicablerules. Communications by an issuer more than 30 daysbefore filing a registration statement are permitted as longas they do not reference the securities offering. Statementsmade within 30 days of filing a registration statement thatcould be considered an attempt to pre-sell the publicoffering may be considered an illegal prospectus, creating agun-jumping violation. This might result in the SEC’sdelaying the public offering or requiring prospectusdisclosures of these potential securities law violations. Pressinterviews, participation in investment banker-sponsoredconferences, and new advertising campaigns are generallydiscouraged during this period.

In general, at least four to six weeks will pass between thedistribution of a first draft of the registration statementand its filing with the SEC. To a large extent, the length ofthe pre-filing period will be determined by the amount oftime required to obtain the required financial statements.

The waiting periodResponding to SEC comments on the registration statementThe SEC targets 30 calendar days from the registrationstatement filing date to respond with comments. The SECreview process has not changed as a result of the JOBS Act,although the issuer should anticipate that it will receivecomments from the SEC staff regarding its EGC-relateddisclosures. Once the registration statement is submitted, ateam of SEC staff members is assigned to review the filing.The team consists of accountants and lawyers, includingexaminers and supervisors. The SEC’s objective is to assessthe company’s compliance with its registration anddisclosure rules.

It is not unusual for the first SEC comment letter tocontain a significant number of comments to which theissuer must respond both in a letter and by amending theregistration statement.

The SEC’s principal focus during the review process ison disclosure. In addition to assessing compliance withapplicable requirements, the SEC considers the disclosuresthrough the eyes of an investor in order to determine thetype of information that would be considered material.The SEC’s review is not limited to the registrationstatement. The staff will closely review websites, databases,and magazine and newspaper articles, looking in particularfor information that the staff thinks should be in theprospectus or that contradicts information included in theprospectus.

It is easy to anticipate many of the matters that the SECwill raise in the comment process. The SEC makes thecomment letters and responses from prior reviews availableon its website, so it is possible to determine the mosttypical comments arising during the IPO process. Overall,the SEC staff looks for a balanced, clear presentation of theinformation required in the registration statement. Someof the most frequent comments raised by the SEC staff ondisclosure, other than the financial statements, include:

Front cover and gatefold: Has the EGC includeddisclosure on the front cover identifying itself as an EGC?Given that a number of issuers that are EGCs havecompleted their IPOs, an EGC pursuing an IPO mayreview its filings and see the type of language that the SECstaff expects to see on the cover page. For an issuer thatchooses to use artwork, the SEC staff will consider whetherthe artwork presents a balanced presentation of thecompany’s business, products, or customers?

Prospectus summary: Is the presentation balanced?Again, in the summary section, the SEC staff will expect tosee a brief discussion that identifies that the issuer is anEGC and is electing to rely on certain accommodationsavailable to EGCs.


Risk factors: Are the risks specific to the company anddevoid of mitigating language? The SEC also will expect tosee certain risk factors relating to the issuer’s status as anEGC.

Use of proceeds: Is there a specific allocation of theproceeds among identified uses, and if fundingacquisitions is a designated use, are acquisition plansidentified?

Selected financial data: Does the presentation of non-GAAP financial measures comply with SEC rules?

MD&A: Does the discussion address known trends,events, commitments, demands, or uncertainties,including the impact of the economy, trends with respectto liquidity, and critical accounting estimates and policies?

Business: Does the company provide support forstatements about market position and other industry orcomparative data? Is the disclosure free of, or does itexplain, business jargon? Are the relationships withcustomers and suppliers, including concentration risk,clearly described?

Underwriting: Is there sufficient disclosure aboutstabilisation activities (including naked short selling), aswell as factors considered in early termination of lockupsand any material relationships with the underwriters?

Exhibits: Do any other contracts need to be filed basedon disclosure in the prospectus?

After the SEC has provided its initial set of comments, itis much easier to determine when the registration processis likely to be completed and the offering can be made. Inmost cases, the underwriters prefer to delay the offeringprocess and to avoid distributing a preliminary prospectusuntil the SEC has reviewed at least the first filing and allmaterial changes suggested by the SEC staff have beenaddressed.

Preparing the underwriting agreement, comfort letter andother documentsDuring the waiting period, the company, the underwritersand their counsel, and the company’s independent auditorwill negotiate a number of agreements and otherdocuments, particularly the underwriting agreement andthe auditor’s comfort letter.

The underwriting agreement is the agreement pursuantto which the company agrees to sell, and the underwritersagree to buy, the shares and then sell them to the public;until this agreement is signed, the underwriters do nothave an enforceable obligation to acquire the offeredshares. The underwriting agreement is not signed until theoffering is priced. In the typical IPO, the underwriters willhave a “firm commitment” to buy the shares once they signthe underwriting agreement.

Underwriters’ counsel will submit the underwritingagreement, the registration statement, and other offeringdocuments for review to the Financial Industry RegulatoryAuthority (Finra), which is responsible for reviewing theterms of the offering to ensure that they comply with Finrarequirements. An IPO cannot proceed until theunderwriting arrangement terms have been approved byFinra.

In the comfort letter, the auditor affirms itsindependence from the issuer, and the compliance of thefinancial statements with applicable accountingrequirements and SEC regulations. The auditor also willnote period-to-period changes in certain financial items.These statements follow prescribed forms and are usuallynot the subject of significant negotiation. Theunderwriters will also usually require that the auditorundertake certain agreed-upon procedures in which itcompares financial information in the prospectus (outsideof the financial statements) to the issuer’s accountingrecords to confirm its accuracy.

Marketing the offeringDuring the waiting period, marketing begins. Before theJOBS Act, it was the case that the only written salesmaterials that could be distributed during this period werethe preliminary prospectus and additional materialsknown as “free writing prospectuses,” which must satisfyspecified SEC requirements. Binding commitmentscannot be made during this period. The underwriters willreceive indications of interest from potential purchasers,indicating the price they would be willing to pay and thenumber of shares they would purchase. Once SECcomments are resolved, or it is clear that there are nomaterial open issues, the issuer and underwriters willundertake a two- to three-week road show, during whichcompany management will meet with prospectiveinvestors.

Once SEC comments are cleared and the underwritershave assembled indications of interest for the offeredsecurities, the company and its counsel will request thatthe SEC declare the registration statement effective at acertain date and time, usually after the close of business ofthe US securities markets on the date scheduled for pricingthe offering.

The post-effective periodOnce the registration statement has been declared effectiveand the offering has been priced, the issuer and themanaging underwriters execute the underwritingagreement and the auditor delivers the final comfort letter.This occurs after pricing and before the opening of trading


on the following day. The issuer then files a finalprospectus with the SEC that contains the final offeringinformation.

On the third or fourth business day following pricing,the closing occurs, the shares are issued, and the issuerreceives the proceeds. The closing completes the offeringprocess. Then, for the following 25 days, aftermarket salesof shares by dealers must be accompanied by the finalprospectus or a notice with respect to its availability. Ifduring this period there is a material change that wouldmake the prospectus misleading, the issuer must file anamended prospectus.

SPECIAL JOBS ACT-RELATED CONSIDERATIONS

Confidential submissionsAs explained in Chapter 1, an EGC may make aconfidential submission of its registration statement,provided that the initial confidential submission and allamendments are publicly filed with the SEC no later than21 days before the commencement of the issuer’s roadshow.

Although an EGC may file confidentially, and aconfidentially-submitted draft registration statement is notrequired to be signed by the issuer and its officers ordirectors, nor is it required to contain a signed auditors’consent, the confidential submission should be a completeregistration statement. The SEC may decide not to reviewa draft submission that is deemed incomplete or materiallydeficient. This will just slow down the IPO process.Moreover, the issuer and its advisers should understand, asnoted above, that the initial confidential submission willbecome publicly available. As a result, the issuer, itsadvisers and the entire working group should approach thepreparation of a confidential submission with the samerigour as they would approach the preparation of aregistration statement that will be publicly filed andavailable to all, including the issuer’s competitors.

There are few, if any, disadvantages to the confidentialsubmission process. An issuer will be able to make aconfidential submission and proceed with the reviewprocess without the glare of publicity, and without havingcompetitors become aware of the proposed offering. Theissuer will have greater flexibility to control the timing ofthe offering. If the market seems inhospitable to anoffering, the issuer may decide to delay the process and willnot subject itself to public scrutiny for doing so. If theissuer needs to withdraw the filing, again, it will be able todo so without the stigma associated with a failed or

withdrawn offering.An issuer and its bankers and advisers may not, however,

have as much insight into the IPO market given theconfidential filing process. For example, bankers may notbe aware of competitors (that are EGCs) that also arepursuing IPOs because the competitors also may beproceeding with their offerings on a confidential basis.Often having information about other companies in theIPO queue may be important because it may factor intodecisions on timing of marketing the deal, as well asdecisions regarding valuation.

Often an issuer will decide to pursue a dual-trackapproach, whereby it will decide to undertake an IPO andalso consider M&A alternatives. The IPO filings oftenserve to make acquisitive competitors that may beinterested in new opportunities aware of the issuer and theissuer’s performance. It may be more difficult to pursue adual-track strategy during the confidential submissionprocess. Of course, an issuer that is relying on theconfidential submission process may choose to make anannouncement regarding its intentions to pursue an IPO,and a few companies have issued such press releases. Sincethe confidentiality obligation rests with the SEC, and notwith the issuer, a press release of this sort is permissible,although it should be considered carefully given that itundoes many of the benefits associated with theconfidential process.

Marketing the offeringSection 5(c) of the Securities Act prohibits offers of asecurity before a registration statement is filed. While gun-jumping can be a serious concern, the 2005 safe harbourscreated by Securities Offering Reform have providedconsiderable guidance to companies about this issue.Further, the ability of EGCs to test-the-waters beforefiling, together with the elimination of the ban on generalsolicitation in connection with certain private placementsalso effected by the JOBS Act have also significantlyreduced concerns about gun-jumping. In addition, theconfidential submission of a draft registration does notconstitute the filing of a registration statement for thepurposes of the prohibition in Securities Act section 5(c)against making offers of a security in advance of filing aregistration statement.1

Section 5(b)(1) prohibits written offers other than bymeans of a prospectus that meets the requirements ofsection 10 of the Securities Act, such as a preliminaryprospectus. The bans are designed to prohibitinappropriate marketing, conditioning or hyping of thesecurity before all investors have access to publicly availableinformation about the company so that they can make


informed investment decisions. From the first all-handsorganisational meeting forward, all statements concerningthe company should be reviewed by the company’s counselto ensure compliance with applicable rules.

Testing the watersThe JOBS Act provides an EGC or any other person, suchas its underwriter, that it authorises to act on its behalfwith the flexibility to engage in oral or writtencommunications with QIBs and institutional accreditedinvestors in order to gauge their interest in a proposedoffering, whether before (irrespective of the 30-daycommunications safe harbour) or following the first filingof any registration statement, subject to the requirementthat no security may be sold unless accompanied orpreceded by a section 10(a) prospectus.

An EGC may use the testing-the-waters provision withrespect to any registered offerings that it conducts while itqualifies for EGC status. There are no form or contentrestrictions on these communications, and there is norequirement to file written communications with the SEC.The SEC staff will ask to see any written test-the-watersmaterials during the course of the registration statementreview process to determine whether those materialsprovide any guidance as to information that the SEC staffbelieves should be included in the prospectus.

The JOBS Act does not amend section 5(b)(1) of theSecurities Act, which requires that written offers mustinclude the information required by section 10. Therefore,in order to make written offers, an EGC or a foreignprivate issuer must first file (not just submit) itsregistration statement with the SEC and have apreliminary prospectus available, irrespective of theexpected commencement of the road show. In the pre-filing period, test-the-waters communications must belimited to QIBs and institutional investors, since even anEGC cannot make offers to the public until it files theregistration statement publicly.

Before engaging in any test-the-waters discussions, anEGC should consult with its counsel and coordinateclosely with the underwriter. As noted above, during thecomment process, the SEC staff will ask whether the issuerengaged in testing the waters, and will want to see anywritten materials used for this purpose. In addition, as wediscuss below, issuer’s counsel and the underwriter and itscounsel will want an opportunity to review and commenton the material. Any written materials used for thispurpose should be consistent with the informationincluded in the issuer’s registration statement. An issueralso will want to be certain that the issuer is not sharingany information that may be deemed confidential in the

course of these discussions. An investor approached duringthis phase generally will not want to be in possession of anyinformation that will remain confidential, and that may bematerial, even following the issuer’s IPO. In addition, asdiscussed further below, an issuer will be required to makecertain representations and warranties to the underwritersin the underwriting agreement relating to any test-the-waters activities and materials.

Many companies contemplating an IPO in the UnitedStates, especially foreign private issuers, were surprised bythe restrictions on offering related communicationsimposed by SEC regulations. Critics noted that thesecommunications restrictions limited an issuer’sopportunity to reach potential investors early in theprocess and, therefore, an issuer was forced to incursignificant expense in pursuing an IPO and might not haveany information about the level of investor interest andpotential valuations until the road show. In otherjurisdictions, especially in Europe and Asia, issuers and thefinancial intermediaries acting on their behalf haveconsiderably more flexibility. Often in European or Asianofferings, a lead or cornerstone investor might be securedearly in the offering process. As a result of these concerns,the ability to conduct test-the-waters communications waswell received. In practice, however, we understand that fewEGCs are conducting these conversations early in theoffering process. To the extent that EGCs are benefitingfrom the enhanced flexibility, the test-the-watersconversations are taking place shortly before thecommencement of the road show, and not early in theoffering process. It may be that, over time, the market willadapt and test-the-waters communications may becomemore commonplace.

It is also important to remember that the test-the-watersflexibility still is more limited than the approach that maybe familiar to foreign issuers. As noted in Chapter 1,during the test-the-waters phase an EGC may engage indiscussions with institutional investors but the EGC andthe underwriter cannot obtain a purchase commitment.The underwriter may discuss price, volume and marketdemand and solicit non-binding indications of interestfrom customers.

Private offerings during the IPO processAn issuer may need to raise capital while it is pursuing anIPO. Historically, there was some concern aboutconcurrent offerings. An issuer that had publicly filed aregistration statement had to consider carefully with itscounsel whether the public filing constituted a generalsolicitation that precluded the issuer from availing itself ofthe private placement exemption to complete a financing


during the pendency of its IPO. For some time,practitioners relied on existing no-action letter guidancethat was somewhat narrowly construed as permitting aconcurrent private placement to QIBs and to a handful ofinstitutional accredited investors.2 This fairly limitedapproach was modified over time and a more expansiveview was expressed by the SEC first in 2007 and confirmedin Compliance and Disclosure Interpretations.3 TheC&DI, confirming the guidance in the SEC’s 2007release, provides that

under appropriate circumstances, there can be a side-by-side private offering under Securities Act section [4(a)(2)]or the Securities Act Rule 506 safe harbor with aregistered public offering without having to limit theprivate offering to qualified institutional buyers and twoor three additional large institutional accreditedinvestors, as under the Black Box (June 26, 1990) andSquadron, Ellenoff (Feb. 28, 1992) no-action lettersissued by the Division, or to a company’s key officers anddirectors, as under our so-called “Macy’s” position.4

The SEC also clarified that a company can make a validprivate placement if the investors are identified by meansother than the registration statement.

Given this viewpoint, and even without considering therelaxation of the prohibition on general solicitation inrespect of certain Rule 506 offerings, it is clear that anEGC could either during the confidential phase or afterthe public filing of its registration statement contactinstitutional investors and discuss a potential privatefinancing. It is easy to envision that a test-the-watersconversation may morph into a discussion with aninstitutional investor about a potential private placement.An EGC should take care to be clear in its conversationswith potential investors, and ensure that any potentialinvestors understand whether they are participating in aprivate placement transaction, and purchasing securitiesthat will be restricted securities, and not expressing aninterest in participating in the IPO.

The JOBS Act has contributing to a further blurring ofthe lines between private placements and public offeringsgiven the relaxation of the prohibition against generalsolicitation and the introduction of exemptions for certainlimited offerings pursuant to section 3(b)(2) andcrowdfunding.

Flipping from confidential to publicIn a typical IPO, the issuer will continue to work with itscounsel during the waiting period in order to address theSEC’s comments on its filing, and also concurrently workon finalising various ancillary agreements, including theunderwriting agreement and lock-up agreements. The

underwriter and its counsel usually recommend that anissuer wait to finalise, and print a preliminary prospectusor red herring until the issuer and its counsel haveresponded to and addressed all of the significant commentsraised by the SEC during the review process. This ensuresthat the issuer will not have to recirculate its preliminaryprospectus as a result of any change arising during thereview process. The underwriter will wait to commence theroad show until the preliminary prospectus is prepared.

In the case of an EGC IPO, there may be an additionaldynamic to be considered. An EGC that is relying on theconfidential submission process may want to considerwhen to make its first “public” filing. As discussed inChapter 1, and above, an EGC is required to file publiclywith the SEC at least 21 days before the commencementof the issuer’s road show. The EGC may want to make apublic filing before that for a variety of reasons, however.The EGC may want to file publicly earlier in the process,perhaps after it has undergone one or two amendments, inorder to have it known to competitors or to strategicinvestors that the company is proceeding with an IPO andto make the registration statement available freely. Thismay be helpful if the issuer is contemplating a dual-trackapproach. It may be helpful in order to permit theunderwriter to interest institutional investors inpreliminary test-the-waters type discussions. Someinstitutional investors may be reluctant to commit thetime and resources to meeting with a company orevaluating a potential investment if they believe that theoffering is in a very preliminary stage. An EGC will wantto consult with counsel and consider carefully its decisionto transition from a confidential process to a publicprocess.

Disclosures and other accommodationsWe noted that one of the principal benefits of the IPO on-ramp approach is that an EGC may choose to rely on someof the disclosure accommodations made available by TitleI of the JOBS Act. An EGC may choose to present onlytwo years of audited financial information (and only twoyears of summary and selected financial data, as well as anabbreviated MD&A discussion) in its registrationstatement. An EGC and its counsel will want to considerwhether the EGC will want to present information for athird year although it is not required. In some cases, theunderwriter will have strong views regarding theinformation that should be presented in the registrationstatement. For example, the underwriter may take the viewthat the issuer’s competitors that are already SEC-reportingcompanies provide financial information for a longerperiod and it will be important to investors that the EGC


provide comparable information. The underwriter maybelieve that institutional investors in that industry sectormay demand three years of financial information. It maybe the case that there are important trends in either theissuer’s business and results of operations or in the industryas a whole that make it important to present three years ofinformation in order to ensure that an investor will be ableto evaluate all of the information that may be deemedmaterial to an investment decision, including, perhaps,trends in the issuer’s business or in the industry. Accordingto certain published reports, only a small percentage ofEGCs have availed themselves of the ability to provideinformation for a shorter period.

EGCs also have the option of relying on the smallerreporting company scaled disclosure requirements forexecutive compensation. This means, for example, that anEGC could omit a Compensation Discussion and Analysissection and present only a summary compensation table.An EGC may decide to include more substantial executivecompensation disclosures in its future filings. An EGCshould consult with its counsel, as well as with theunderwriter, regarding these disclosures.

An EGC also will have to decide whether it will opt outof the extended transition period provided for an EGC tocomply with new or revised accounting standards. AnEGC’s decision in this regard is irrevocable, and will haveto be disclosed in its registration statement. Here, again,the issuer will want to consider this decision carefully anddiscuss it with its counsel and its auditors. The underwritermay also have a view. To date, many EGCs have opted outof the extended transition period, although it is possiblethat market practice will evolve over time as participantsbecome more accustomed to the JOBS Act provisions.

Underwriting agreementsUnderwriting agreements have been revised to addressJOBS Act changes. An underwriting agreement for anEGC will contain representations and warranties by theEGC regarding its status as an EGC at each of the relevanttimes (when it made its confidential submission with theSEC, when it undertook any test-the-waterscommunications, on the date of execution of theunderwriting agreement, and so on). The EGC will beasked to represent that it has not engaged in any test-the-waters communications other than with QIBs orinstitutional accredited investors, and except as agreedwith the underwriters. To the extent that it has distributedwritten materials, the EGC will be asked to make certainrepresentations regarding the accuracy of those materials.Similarly, the EGC will be asked to make certain covenantsto the underwriters, which will include an agreement to

notify the underwriters if, at any time before the later ofthe time when a prospectus is required to be delivered inconnection with the offering, and the completion of thelock-up period, the issuer no longer qualifies as an EGC.In addition, the lock-up language applicable to an EGCalso will be revised to account for the quiet period changesincluded in the JOBS Act.

FOREIGN PRIVATE ISSUERS

Our discussions have focused on US domestic issuers;however, foreign issuers that are considering accessing theUS. capital markets will have available to them almost allof the benefits of the JOBS Act. A foreign issuer mustchoose between undertaking a public offering in theUnited States, which would have the result of subjectingthe issuer to ongoing securities reporting and disclosurerequirements, and undertaking a limited offering that willnot subject the issuer to US reporting obligations. A publicoffering in the United States offers distinct advantages forforeign issuers. The US public markets remain among themost active and deepest equity markets in the world. Inrecent years, however, many foreign issuers may have beendiscouraged by the regulatory burdens associated withbeing a US reporting company, including those imposedby the Sarbanes-Oxley and the Dodd-Frank Act. Forforeign issuers that qualify as EGCs, the IPO on-rampprocess may make the United States more hospitable.A foreign private issuer (FPI) is any issuer (other than aforeign government) incorporated or organised under thelaws of a jurisdiction outside of the United States, unlessmore than 50% of the issuer’s outstanding voting securitiesare held directly or indirectly by residents of the UnitedStates, and any of the following applies: (i) the majority ofthe issuer’s executive offices or directors are United Statescitizens or residents; (ii) the majority of the issuer’s assetsare located in the United States; or (iii) the issuer’s businessis principally administered in the United States.5 An FPImay become subject to US securities law reportingrequirements either by conducting a public offering in theUnited States by registering the offering and sale of itssecurities pursuant to the Securities Act, or by listing a classof its securities on a US national securities exchangethrough registration pursuant to the Exchange Act orbecoming subject to the Exchange Act requirements if aclass of its equity securities is held of record by 2,000 ormore persons or 500 non-accredited investors.

Important benefits are available to FPIs. For example, anFPI may exit or deregister its securities more easily than adomestic US issuer. An FPI must test its qualification onlyonce a year, and should it fail to qualify as an FPI, it has


six months to transition to the US domestic reportingsystem. US domestic issuers generally must file theirannual reports on Form 10-K within three monthsfollowing the end of their fiscal year. By contrast, an FPImust file its annual report on Form 20-F within fourmonths of the fiscal year covered by the report. This allowsan FPI slightly more time to prepare the requiredinformation. An FPI has no legal obligation to filequarterly reports. By contrast, US domestic issuers mustfile a quarterly report on Form 10-Q. Unlike a USdomestic issuer, an FPI has no legal obligation to file proxysolicitation materials on Schedule 14A or 14C inconnection with annual or special meetings of its securityholders. An FPI has no legal obligation to establish anaudit committee. The securities exchanges generallyprovide alternative corporate governance requirements forlisted FPIs, which are less burdensome than those for listedUS domestic issuers. An FPI is exempt from the SEC’sdisclosure rules for executive compensation on anindividual basis, but is required to provide certaininformation on an aggregate basis. An FPI may prepare itsfinancial statements in accordance with InternationalFinancial Reporting Standards (IFRS) as issued by theInternational Accounting Standards Board (IASB) withoutreconciliation to US generally accepted accountingprinciples (US GAAP).

An FPI may submit its initial registration statement on aconfidential basis to the SEC staff if it is listed or isconcurrently listing its securities on a non-US securitiesexchange, it is being privatised by a foreign government, orit can demonstrate that the public filing of the initialregistration statement would conflict with the law of anapplicable foreign jurisdiction. An FPI may separately usethe confidential registration statement review proceduresavailable to an EGC, if it qualifies as an EGC. An FPI canqualify to be treated as an EGC if it has total gross revenuesof under $1 billion during its most recently completedfiscal year. Total annual gross revenues means totalrevenues as presented on the income statement under USGAAP or IFRS as issued by the IASB, if used as the basisof reporting by an FPI. If the financial statements of anFPI are presented in a currency other than US dollars, totalannual gross revenues for purposes of determining whetheran FPI is an EGC should be calculated in US dollars usingthe exchange rate as of the last day of the most recentlycompleted fiscal year.

An FPI seeking to raise capital by selling securities (orADRs) in the US must file a registration statement onForm F-1 with the SEC. The registration statement onForm F-1 requires significant disclosure about the foreignissuer’s business and operations, and is similar to, but less

onerous than, the Form S-1 that most US issuers use fortheir IPOs. The SEC staff has made clear that an FPI thatqualifies as an EGC and that is using a Form F-1 may availitself of all of the disclosure accommodations available todomestic EGCs. An FPI that is an EGC also may availitself of all other benefits available to domestic EGCs,including the governance related accommodations, theability to test-the-waters, and the flexibility to have broker-dealers publish or distribute research reports about thecompany.

A foreign issuer also may decide to access the US capitalmarkets through an exempt offering, such as an offering toQIBs or an offering made in reliance on Rule 506. Oncethe SEC rulemaking relating to the relaxation of theprohibition on general solicitation is finalised, foreignissuers will be able to benefit from greater communicationsflexibility in connection with Rule 506 and Rule 144Aofferings. It is not clear whether a foreign issuer will be ableto rely on the offering exemption under section 3(b)(2). Aforeign issuer cannot rely on the crowdfunding exemption.


1. SEC Confidential Submission FAQs, supra note 26,Question 6.

2. See, e.g., Division of Corporation Finance no-actionletters to Black Box Incorporated (June 26 1990) andSquadron Ellenoff, Pleasant & Lehrer (February 281992).

3. The SEC’s integration guidance can be found in theRegulation D Proposing Release, Revisions of LimitedOffering Exemptions in Regulation D, 33-8828(August 3 2007),http://www.sec.gov/rules/proposed/2007/33-8828.pdf., pp. 52-56. See also the SEC’s Complianceand Disclosure Interpretations – Securities ActSections (last updated November 26 2008), Question139.25.

4. See, e.g., C&DI – Securities Act Sections, Question139.25.

5. Rule 3b-4(c) of the Securities Exchange Act of 1934,as amended [hereinafter Exchange Act]. An FPI ispermitted to assess its status as an FPI once a year onthe last business day of its second fiscal quarter,rather than on a continuous basis, and may availitself of the FPI accommodations, including use ofthe FPI forms and reporting requirements, beginningon the determination date on which it establishes itseligibility as an FPI. If an FPI determines that it nolonger qualifies as an FPI, it must comply with thereporting requirements and use the forms prescribedby US domestic companies beginning on the firstday of the fiscal year following the determinationdate. SEC Release No. 33-8959. Note that if an FPIloses its status as an FPI it will be subject to thereporting requirements for a US domestic issuer, andwhile previous SEC filings do not have to beamended upon the loss of such status, all futurefilings would be required to comply with therequirements for a US domestic issuer. “FinancialReporting Manual,” Division of CorporationFinance, Topic 6120.2, available athttp://www.sec.gov/divisions/corpfin/cffinancialreportingmanual.shtml. Also note that if an FPI isreincorporated as a US entity, a registrationstatement on a domestic form (Form S-4) will berequired for the exchange of shares with the new USdomestic issuer. Id. at Topic 6120.8.


ENDNOTES


While Title I of the JOBS Act is largelyfocused on capital-raising transactions,there is nothing in the JOBS Act or inthe SEC’s interpretations to suggest that

the IPO on-ramp provisions in Title I should not alsoapply in the context of other transactions conducted byEGCs pursuant to a Securities Act registration statement.The SEC’s Division of Corporation Finance has providedguidance in the form of frequently asked questionsindicating that EGCs may rely on certain of thedisclosure, communications and confidential submissionbenefits for EGCs in the context of merger and exchangeoffer transactions.1 An overriding principle of theguidance in these FAQs is that an EGC which avails itselfof the Title I provisions in the context of an exchangeoffer or a merger must comply with all of the pre-existingapplicable rules for tender offers and proxy solicitations,which might, in some cases, conflict with the more liberalcommunications approach contemplated by Title I of theJOBS Act. The SEC has also provided guidance regardingthe EGC status of issuers that are spun off from SECreporting issuers.

Availability of test-the-waters communications As discussed in Chapter 1, Title I of the JOBS Act providesEGCs, or any other person authorised to act on theirbehalf, the flexibility to engage in oral or writtencommunications with QIBs and institutional accreditedinvestors in order to gauge their interest in a proposedoffering, whether before or following the first filing of anyregistration statement, subject to the requirement that nosecurity may be sold unless accompanied or preceded by aprospectus.2 An EGC could use this test-the-watersprovision with respect to any registered offerings that itconducts while it qualifies for EGC status. There are noform or content restrictions on these communications, andthere is no requirement to file written communicationswith the SEC (although the SEC staff requests that writtencommunications be submitted to them when they reviewan EGC’s registration statement). The SEC has confirmed that an EGC may use test-the-

waters communications with QIBs and institutional

accredited investors pursuant to Securities Act section 5(d)in connection with an exchange offer or merger.3 Inaddition, the SEC staff notes that an EGC must make allrequired filings under the Exchange Act for any writtencommunications made in connection with, or relating to,the exchange offer or merger. In this regard, the SEC notesthat the JOBS Act did not amend the exchange offer ormerger requirements under the Exchange Act, such asfilings required under Exchange Act Rules 13e-4(c), 14a-12(b), and 14d-2(b), for pre-commencement tender offercommunications and proxy soliciting materials inconnection with a business combination transaction.

Confidential draft registration statement submissionsAs discussed in Chapter 1, Title I added paragraph (e) tosection 6 of the Securities Act to provide that the SECmust review all EGC initial public offering registrationstatements confidentially, if an EGC chooses to submit adraft registration statement to the SEC. An EGC mayconfidentially submit a draft registration statement for aninitial public offering for non-public review, provided thatthe initial confidential submission and all amendments arepublicly filed with the SEC no later than 21 days beforethe issuer’s commencement of a road show.4

The SEC has indicated that an EGC may use theconfidential submission process in section 6(e) of theSecurities Act to submit a draft registration statement foran exchange offer or a merger that constitutes its initialpublic offering of common equity securities.5 If an EGCuses the confidential submission process to submit a draftregistration statement for an exchange offer or merger thatconstitutes its initial public offering of common equitysecurities, the SEC notes a number of obligations underthe Securities Act and Exchange Act with respect to thetransaction. If an EGC does not commence its exchange offer before

the effectiveness of the registration statement, the EGCmust publicly file the registration statement (including theinitial confidential submission and all amendmentsthereto) at least 21 days before the earlier of thecommencement date of the road show, if any, or the

CHAPTER 3

Applying Title I to other transactions


anticipated date of effectiveness of the registrationstatement. This applies in the case of all exchange offersthat do not use early commencement, including those thatdo not qualify for early commencement under theprovisions of Rules 13e-4(e)(2) and 14d-4(b) regardinggoing-private transactions and roll-up transactions.An EGC that commences its exchange offer before

effectiveness of the registration statement pursuant toSecurities Act Rule 162 must publicly file the registrationstatement (including the initial confidential submissionand all amendments thereto) at least 21 days before theearlier of: the commencement date of the road show, if any,or the anticipated date of effectiveness of the registrationstatement, but no later than the date of commencement ofthe exchange offer in light of the filing requirement underExchange Act Rules 13e-4(e)(2) and 14d-4(b).For the early commencement of exchange offers subject

only to Regulation 14E, an EGC must file its registrationstatement at least 21 days before the earlier of thecommencement date of the road show, if any, or theanticipated date of effectiveness of the registrationstatement, but no later than the date of commencement ofthe exchange offer.An EGC must also make the required filings under

Securities Act Rule 425 (unless it is relying on theSecurities Act section 5(d) provision for test-the-waterscommunications) and Exchange Act Rules 13e-4(c) and14d-2(b) for pre-commencement tender offercommunications. An EGC must also file the tender offerstatement on Schedule TO on the date of commencementof the exchange offer under Exchange Act Rules 13e-4(b)and 14d-3(a), as applicable.In a merger where the target company is subject to

Regulation 14A or 14C and the registration statement ofthe EGC acquirer includes a prospectus that also serves asthe target issuer’s proxy or information statement, theacquirer must publicly file the registration statement(including the initial confidential submission and allamendments thereto) at least 21 days before the earlier ofthe date of commencement of the road show, if any, or theanticipated date of effectiveness of the registrationstatement. In addition, the acquirer must make therequired filings under Securities Act Rule 425 (unless it isrelying on the Securities Act section 5(d) provision for test-the-waters communications) and Exchange Act Rule14a-12(b) for any soliciting material, as applicable.6

Financial statement requirementsThe SEC has stated that if a target company which doesnot qualify as a “smaller reporting company” is to beacquired by an EGC that is not a shell company and will

present only two years of its financial statements in itsregistration statement for the exchange offer or merger, theSEC will not object if, in the registration statement filedfor the merger or exchange offer, the EGC presents onlytwo years of financial statements for the target company.7

Spin-offsThe SEC has also addressed the EGC status of an issuer inthe context of spin-offs and similar transactions. Incircumstances where a public parent issuer decides to spin-off a wholly-owned subsidiary, register an offer and sale ofthe wholly-owned subsidiary’s common stock for an initialpublic offering, or transfer a business into a newly-formedsubsidiary for purposes of undertaking an initial publicoffering of that subsidiary’s common stock, the subsidiarywould not necessarily trigger any of the disqualificationprovisions in sections 2(a)(19)(A)-(D) of the SecuritiesAct, and would thus be considered an EGC if it had lessthan $1 billion in revenues during its most recentlycompleted fiscal year.8 This analysis is focused on whetherthe issuer, and not its parent, meets the EGCrequirements. The SEC notes that, based on the particularfacts and circumstances, the EGC status of an issuer underthese circumstances may be questioned if it appears thatthe issuer or its parent is engaging in a transaction for thepurpose of converting a non-EGC into an EGC, or for thepurpose of obtaining the benefits of EGC status indirectlywhen it is not entitled to do so directly. The SECrecommends that issuers with questions relating to theseissues should contact the Division of CorporationFinance’s Office of the Chief Counsel.


1. Frequently Asked Questions of GeneralApplicability on Title I of the JOBS Act (April 162012; May 3 2012 and September 28 2012),available athttp://www.sec.gov/divisions/corpfin/guidance/cfjjobsactfaq-title-i-general.htm (SEC Title I FAQs).

2. JOBS Act §105(c), amending Securities Act § 5, 15USC 77e.

3. SEC Title I FAQs, supra note 1 at Question 42.4. For this purpose, the term “road show” is defined in

Securities Act Rule 433(h)(4).5. SEC Title I FAQs, supra note 1 at Question 43.6. SEC Title I FAQs, supra note 1 at Question 44.7. SEC Title I FAQs, supra note 1 at Question 45.8. SEC Title I FAQs, supra note 1 at Question 53.

ENDNOTES

Title II of the JOBS Act directs the SEC toeliminate the ban on general solicitation andgeneral advertising for certain offerings underRule 506 of Regulation D, provided that the

securities are sold only to accredited investors, and underSecurities Act Rule 144A offerings, provided that thesecurities are sold only to persons who the seller (and anyperson acting on behalf of the seller) reasonably believes isa QIB.Rule 506 of Regulation D is the most popular means forconducting a private offering, because it permits issuers toraise an unlimited amount of money and pre-empts statesecurities laws. In recognition of concerns aboutrestrictions on communications in private offerings, TitleII directs the SEC to revise Rule 506 to provide that theprohibition against general solicitation or generaladvertising in Rule 502(c) shall not apply to offers andsales of securities made pursuant to Rule 506, providedthat all purchasers of the securities are accredited investors.Under the SEC’s existing definition, an accredited investoris a person who falls within one of the categories specifiedin the definition, or a person who the issuer reasonablybelieves falls within one of those categories. The revisedrules must further require that issuers using generalsolicitation or general advertising in connection with Rule506 offerings take reasonable steps to verify that purchasersof securities are accredited investors, using methods to bedetermined by the SEC. With respect to Rule 144A, therule as revised must provide that securities may be offeredto persons other than QIBs, including by means of generalsolicitation or general advertising, provided that thesecurities are sold only to persons that the seller and anyperson acting on behalf of the seller reasonably believe is aQIB. The JOBS Act specifies that any offering madepursuant to Rule 506 that uses general advertising orgeneral solicitation will not be deemed a public offering.These changes to Rule 506 and Rule 144A would beavailable to all issuers, not just EGCs, as well as privatecompanies and funds.Until the SEC adopts final rules as directed by Title IIof the JOBS Act, market participants relying on the Rule506 and Rule 144A safe harbours should continue to

comply with the existing requirements of theseexemptions, and will generally continue to implementcustomary procedures for these offerings until the ruleschange. Market participants should also continue tosatisfy conditions of applicable safe harbours such asSecurities Act Rules 135c, 152 and 155, as well as complywith applicable SEC and SEC Staff guidance regardingthe integration of concurrent private and publicofferings.Title II of the JOBS Act also specifies that persons whomaintain certain online or other platforms to conductRule 506 offerings that will use general advertising orgeneral solicitation will not, by virtue of this activity, berequired to register as a broker or a dealer pursuant toExchange Act section 15, provided that enumeratedconditions are satisfied. In order to qualify for thisexemption, such a platform must not receive transaction-based compensation, take possession of customer fundsor securities, or be subject to an Exchange Act statutorydisqualification.

Rule 506 of Regulation DRule 506 of Regulation D is considered a safe harbour forthe private offering exemption of section 4(2) (now4(a)(2)) of the Securities Act. Rule 506 has proven to bean attractive means for conducting private offerings,because an issuer using it can raise an unlimited amountof money. Today, the conditions for using Rule 506 are asfollows:• The issuer cannot use general solicitation or advertisingto market the securities;

• The issuer may sell its securities to an unlimitednumber of “accredited investors” and up to 35 otherpurchasers. Unlike Rule 505, all non-accreditedinvestors, either alone or with a purchaserrepresentative, must be sophisticated: they must havesufficient knowledge and experience in financial andbusiness matters to make them capable of evaluating themerits and risks of the prospective investment;

• An issuer must decide what information to give toaccredited investors, so long as it does not violate theantifraud prohibitions of the federal securities laws,


CHAPTER 4

Private offerings

with non-accredited investors receiving disclosuredocuments that are generally the same as those used inregistered offerings, and if the issuer providesinformation to accredited investors, it must make thisinformation available to non-accredited investors aswell;

• The company must be available to answer questionsfrom prospective purchasers;

• Financial statement requirements are the same as forRule 505; and

• Purchasers receive “restricted securities.” Issuers making use of the Rule 506 exemption do nothave to file a registration statement with the SEC, but theymust file a Form D after they first sell their securities.Form D is a brief notice that includes the names andaddresses of the issuer’s owners and promoters andinformation concerning the offering.For the purposes of Regulation D, an “accreditedinvestor” includes:• a bank, insurance company, registered investmentcompany, business development company, or smallbusiness investment company;

• an employee benefit plan, within the meaning of theEmployee Retirement Income Security Act, if a bank,insurance company, or registered investment advisermakes the investment decisions, or if the plan has totalassets in excess of $5 million;

• a charitable organisation, corporation, or partnershipwith assets exceeding $5 million;

• a director, executive officer, or general partner of thecompany selling the securities;

• a business in which all the equity owners are accreditedinvestors;

• a natural person who has individual net worth, or jointnet worth with the person’s spouse, that exceeds $1million at the time of the purchase, excluding the valueof the primary residence of such person;

• a natural person with income exceeding $200,000 ineach of the two most recent years or joint income witha spouse exceeding $300,000 for those years and areasonable expectation of the same income level in thecurrent year; or

• a trust with assets in excess of $5 million, not formed toacquire the securities offered, whose purchases asophisticated person makes.Rule 506 does not include any bad actor limitationswith respect to the issuer, its affiliates and offeringparticipants; however the SEC must adopt such limitationpursuant to section 926 of the Dodd-Frank Act. The SECproposed rules implementing this mandate in May 2011,but has not yet adopted any final rules.1

Rule 144ARule 144A is a safe harbour exemption from theregistration requirements of section 5 of the Securities Actfor certain offers and sales of qualifying securities bycertain persons other than the issuer of the securities. Theexemption applies to re-sales of securities to QIBs. Thesecurities eligible for resale under Rule 144A are securitiesof US and foreign issuers that are not listed on a USsecurities exchange or quoted on a US automated inter-dealer quotation system. Rule 144A provides that re-offersand re-sales in compliance with the rule are notdistributions and that the reseller is therefore not anunderwriter within the meaning of section 2(a)(11) of theSecurities Act. A reseller that is not the issuer, anunderwriter, or a dealer can rely on the exemptionprovided by section 4(a)(1) of the Securities Act. Resellersthat are dealers can rely on the exemption provided bysection 4(a)(3).

Deregulating offers in private placementsDiscussion related to relaxing the ban on generalsolicitation has been going on since the early 1990s.Speeches and statements by SEC staff members over theyears have commented on, and acknowledged, the need torevisit private placement exemptions in light of changes incommunications patterns. The legal community also hasgiven close consideration to these questions, going as farback as the late 1990s and early 2000s. In 2001, theAmerican Bar Association’s Committee on the FederalRegulation of Securities submitted a comment letter to theSEC that suggested relaxation of the ban on generalsolicitation. At around the same time, the American BarAssociation’s Task Force for the Review of the FederalSecurities Laws also proposed that a private offering wouldqualify for an exemption from registration based on theeligibility of the purchasers of the securities and therestrictions on re-sales, and not on the number of offerees.The Advisory Committee on Smaller Public Companies,formed in 2004, advocated a relaxation of the ban ongeneral solicitation. In 2007, the SEC proposed arelaxation of the ban on general solicitation in the contextof private offerings to a new category of “large accreditedinvestors.”2

SEC rulemaking under Title IIOn August 29 2012, the SEC proposed amendments toRule 506 of Regulation D and Rule 144A under theSecurities Act to implement section 201(a) of the JOBSAct.3 The proposed amendment to Rule 506 wouldeliminate the prohibition against general solicitation andgeneral advertising contained in Rule 502(c) of Regulation


D with respect to offers and sales of securities madepursuant to Rule 506, provided that all purchasers areaccredited investors. The amendments to Rule 506 wouldrequire that for offerings involving the use of generalsolicitation, issuers take reasonable steps to verify that thepurchasers of the securities are accredited investors. Theproposed amendments would also provide that securitiesmay be offered pursuant to Rule 144A to persons otherthan qualified institutional buyers, provided that thesecurities are sold only to purchasers that the seller (orsomeone acting on the seller’s behalf ) reasonably believes isa qualified institutional buyer.The SEC’s proposed rules implement a bifurcatedapproach to Rule 506 offerings. As proposed, an issuermay still choose to conduct a private offering in reliance onRule 506 without using general solicitation. In order toimplement this approach, the SEC proposed newparagraph (c) in Rule 506, which would permit the use ofgeneral solicitation, provided: • the issuer takes reasonable steps to verify that thepurchasers of the securities are accredited investors;

• all purchasers of securities are accredited investors,either because they come within one of the enumeratedcategories of persons that qualify as accredited investorsor the issuer reasonably believes that they qualify asaccredited investors, at the time of the sale of thesecurities; and

• the conditions of Rule 501 and Rules 502(a) and502(d) are satisfied. The SEC noted that the exemption applies only toofferings made pursuant to the safe harbour provided byRule 506(c), and it does not apply to offerings relying onthe Securities Act section 4(a)(2) exemption in general. The SEC’s proposal would provide a flexible approachfor verifying the accredited investor status of purchasers ina Rule 506(c) offering. The approach reflected in theproposed rules acknowledges that reasonable efforts toverify investor status may differ depending on the facts andcircumstances. The SEC provides the following non-exhaustive list of factors that may be appropriate toconsider:• The nature of the purchaser. The SEC describes thedifferent types of accredited investors, including broker-dealers, investment companies or business developmentcompanies, employee benefit plans, and wealthyindividuals and charities.

• The nature and amount of information about thepurchaser. Simply put, the SEC states that “the moreinformation an issuer has indicating that a prospectivepurchaser is an accredited investor, the fewer steps itwould have to take, and vice versa.”

• The nature of the offering. The nature of the offeringmay be relevant in determining the reasonableness ofsteps taken to verify status: issuers may be required totake additional verification steps to the extent thatsolicitations are made broadly, such as through awebsite accessible to the general public, or through theuse of social media or email. By contrast, less intrusiveverification steps may be required to the extent thatsolicitations are directed at investors that are pre-screened by a reliable third party. The SEC stated that these factors are interconnected,and the more indicia that are in evidence that an investorqualifies as an accredited investor, the fewer steps that theissuer must take to verify status. The SEC notes that issuersshould retain adequate records to document theverification process. The proposing release did not requirethat individuals submit financial statements, and insteadsuggests that reasonable steps may include relying onpublicly available information such as purchaser’scompensation described in a proxy statement, orindependent verification of a person’s status as anaccredited investor by a third party, such as a broker-dealer,attorney or accountant, so long as there is a reasonablebasis to rely on the third-party verification. The SEC confirmed the view that Congress did notintend to eliminate the existing “reasonable belief ”standard in Rule 501(a) of the Securities Act or for Rule506 offerings. It confirmed that if a person were to supplyfalse information to an issuer claiming status as anaccredited investor, the issuer would not lose the ability torely on the proposed Rule 506(c) exemption for thatoffering, provided the issuer “took reasonable steps toverify that the purchaser was an accredited investor andhad a reasonable belief that such purchaser was anaccredited investor.”The SEC also proposed to add a separate check box forissuers to indicate whether they are claiming an exemptionunder Rule 506(c). Meredith Cross, former director of theDivision of Corporation Finance, noted at the openmeeting for the proposal that it was the staff ’s intention toform a multi-divisional task force to monitor theseofferings as a means of gaining insight into marketpractices. The SEC confirmed that the effect of section 201(b) ofthe JOBS Act is to permit privately offered funds(including private equity funds and hedge funds, amongothers) to make a general solicitation under amended Rule506 without losing the ability to rely on the exclusionsfrom the definition of an investment company availableunder section 3(c)(1) and 3(c)(7) of the InvestmentCompany Act.


In addition to the proposed changes to Rule 506, theSEC proposed to amend the rule to eliminate references tooffer and offeree, and thus require only that the securitiesare sold to a QIB or to a purchaser that the seller and anyperson acting on behalf of the seller reasonably believe is aQIB. Under this proposed amendment, re-sales ofsecurities pursuant to Rule 144A could be conducted usinggeneral solicitation, so long as the purchasers are limited inthis manner.The deadline for public comments on the proposal wasOctober 5 2012. Some of the comments submitted to datecall on the SEC to, among other things, adopt the Dodd-Frank Act-mandated bad actor rules (discussed above) atthe same time the changes to Rule 506 are adopted,impose restrictions on the form and content of generalsolicitation materials, and establish a non-exclusive safeharbour with respect to the reasonable steps to verifyrequirement. Despite continuing pressure coming fromCongress and others, the SEC has not yet adopted finalrules.

Matching servicesTitle II of the JOBS Act clarifies that persons whomaintain certain online or other platforms to conduct Rule506 offerings that will use general advertising or generalsolicitation will not, by virtue of this activity, be requiredto register as a broker or a dealer pursuant to section 15 ofthe Exchange Act, provided that certain specifiedconditions are satisfied. For example, in order not to besubject to registration as a broker-dealer, these matchingservices or platforms must not receive transaction-basedcompensation. The platform also cannot take possession ofcustomer funds or securities. The conditions specified inthis provision are generally consistent with the guidancethat the SEC staff has provided in various no-action lettersrelating to matching and other online platforms.4

On February 5 2013, the SEC’s Division of Trading andMarkets published a series of Frequently Asked Questionsaddressing the exemption from broker-dealer registrationin Title II of the JOBS Act.5

These FAQs clarify that Section 201 of the JOBS Actdoes not require further rulemaking, but notes that aplatform cannot permit an issuer to conduct a generalsolicitation in a Rule 506 offering until the SECpromulgates its final rules. The FAQs note that theexemption from broker-dealer registration in this section isapplicable only when securities are offered and soldpursuant to Rule 506. The FAQs also addresscompensation and note that:Congress conditioned the exemption on a person and its

associated persons not receiving any ‘compensation’ in

connection with the purchase or sale of such security.’ Congressdid not limit the condition to transaction-basedcompensation. The staff interprets the term ‘compensation’broadly, to include any direct or indirect economic benefit tothe person or any of its associated persons. At the same time,we recognize that Congress expressly permitted co-investmentin the securities offered on the platform or mechanism. We donot believe that profits associated with these investmentswould be impermissible compensation for purposes ofSecurities Act Section 4(b).To this end, the FAQs note that a venture fund mayoperate a matchmaking site.The FAQs also note that the availability of theexemption from broker-dealer registration should not beconstrued as suggesting that the entity is not otherwise a“broker” or a “dealer” and refers to the guidance providedby the Division of Trading and Markets on the types ofactivities typically associated with broker-dealer status. TheFAQs also note that the JOBS Act exemption does notaddress state registration requirements.



1. SEC Release No. 33-9211 (May 25 2011), availableat http://www.sec.gov/rules/proposed/2011/33-9211.pdf.

2. SEC Release No. 33-8828 (August 3 2007),available athttp://www.sec.gov/rules/proposed/2007/33-8828.pdf.

3. SEC Release No. 33-9354 (April 29 2012),available athttp://www.sec.gov/rules/proposed/2012/33-9354.pdf.

4. See, e.g., Oil-N-Gas Inc. (June 8 2000) andProgressive Technology (October 11 2000).

5. Frequently Asked Questions About the Exemptionfrom Broker-Dealer Registration in Title II of theJOBS Act (February 5 2013), available athttp://www.sec.gov/divisions/marketreg/exemption-broker-dealer-registration-jobs-act-faq.htm.

ENDNOTES


Title III of the JOBS Act addressescrowdfunding, an outgrowth of social mediathat provides an emerging source of funding fora variety of ventures. Crowdfunding works

based on the ability to pool money from individuals whohave a common interest and are willing to provide smallcontributions for a venture. Given the difficulty in relyingon existing exemptions from registration for crowdfundingefforts involving the offer and sale of securities, Title III ofJOBS Act amended section 4(a) of the Securities Act to adda new paragraph (6), which provides for a newcrowdfunding exemption from SEC registration (subject torulemaking by the SEC), as well as pre-emption from stateBlue Sky laws.

Crowdfunding can be used to accomplish a variety ofgoals (such as raising money for a charity or other causes ofinterest to the participants), but when the goal is of acommercial nature and there is an opportunity forcrowdfunding participants to participate in the venture’sprofits, it is likely that federal and state securities laws willapply. Absent an exemption from registration with theSEC, or registering the offering with the SEC,crowdfunding efforts that involve the offer and sale ofsecurities are in all likelihood illegal. In addition to SECrequirements, those seeking capital through crowdfundingneed to be aware of state securities laws, which includevarying requirements and exemptions. By crowdfundingthrough the internet, a person or venture can be exposedto potential liability at the US federal level, in all fiftystates, and potentially in foreign jurisdictions.

Existing exemptions present some problems for personsseeking to raise capital through crowdfunding. RegulationA requires a filing with the SEC and disclosure in the formof an offering circular, which would make conducting acrowdfunding offering difficult. The Regulation Dexemptions generally would prove too cumbersome (withthe possible exception of Rule 504), and a private offeringapproach or the intrastate offering exemption isinconsistent with widespread use of the internet forcrowdfunding.

The potential illegality of crowdfunding effortsinvolving the offer and sale of securities was demonstrated

in the SEC enforcement action In the matter of MichaelMigliozzi II and Brian William Flatow,1 which the SECbrought against two individuals in connection with theirefforts to allegedly raise small contributions using theinternet in order to purchase Pabst Brewing Company for$300 million. Migliozzi and Flatow settled the proceeding,consenting to a cease and desist order relating to thealleged violation of the registration provisions of theSecurities Act. The order indicates that Migliozzi andFlatow established the BuyaBeerCompany.com website,and then used Facebook and Twitter to advertise thewebsite. They sought pledges from participants in thecrowdfunding effort, and in return participants were toldthat if the $300 million necessary to purchase Pabst wasraised, the participants would receive a “crowdsourcedcertificate of ownership” as well as an amount of beer of avalue equal to the money invested. While no monies wereever collected from the crowdfunding participants whomade the pledges, the SEC alleged that Migliozzi andFlatow nonetheless violated the registration provisions ofthe federal securities laws by offering the security (in thiscase, the crowdsourced certificate of ownership) withoutregistering the offer with the SEC or having an exemption,such as the private placement exemption, available for theoffer.

In recent years, crowdfunding advocates have requestedthat the SEC consider implementing an exemption fromregistration under the federal securities laws forcrowdfunding efforts. For example, a rulemaking petitionsubmitted by the Sustainable Economies Law Centersuggested that the SEC exempt crowdfunding offerings ofup to $100,000, with a cap on individual investments notto exceed $100.2 Also, following a recent SEC Forum onSmall Business Capital Formation, the Small Business &Entrepreneurship Council submitted commentssuggesting that the SEC adopt a small business offeringexemption for offerings of less than $1 million with a limiton the amount any one individual could contribute to nomore than 10% of the previous year’s stated income of theissuer or up to $10,000 per individual. Before enactmentof Title III of the JOBS Act, the SEC was consideringwhether to implement an exemption for crowdfunding, in

CHAPTER 5

Crowdfunding


addition to a variety of other measures to encourage capitalformation.

When HR 3606 was originally adopted in the House ofRepresentatives, the bill included Title III, titledEntrepreneur Access to Capital. This Title provided for anexemption from registration under the Securities Act forofferings of up to $1 million, or $2 million in certain caseswhen investors were provided with audited financialstatements, provided that individual investments werelimited to $10,000 or 10% of the investor’s annualincome. The exemption was conditioned on issuers andintermediaries meeting a number of specific requirements,including notice to the SEC about the offering and theparties involved with the offering, which would be sharedwith state regulatory authorities. The measure would havepermitted an unlimited number of investors in thecrowdfunding offering, and would have pre-empted statesecurities regulation of these types of offerings (except thatstates would be permitted to address fraudulent offeringsthrough their existing enforcement mechanisms). TheHouse measure also contemplated that the issuer wouldstate a target offering amount and a third-party custodianwould withhold the proceeds of the offering until theissuer has raised 60% of the target offering amount. Theprovision also contemplated certain disclosures andquestions for investors, and provided for an exemptionfrom broker-dealer registration for intermediaries involvedin an exempt crowdfunding offering.

After it was adopted, the House crowdfunding measuredrew a significant amount of criticism, with much of thatcriticism focused on a perceived lack of investor protections.In a letter to the Senate leadership, then-SEC chairmanMary Schapiro noted that “an important safeguard thatcould be considered to better protect investors incrowdfunding offerings would be to provide for oversight ofindustry professionals that intermediate and facilitate theseofferings,” and also noted that additional information aboutcompanies seeking to raise capital through crowdfundingofferings would benefit investors.

In the Senate, an amendment to HR 3606 that wassubmitted by Senator Merkley and approved by the Senateprovided additional investor protections for exemptcrowdfunding offerings. Many of these protections maynow present difficulties as the SEC and marketparticipants seek to make use of the JOBS Actcrowdfunding exemption.

Title III of the JOBS ActTitle III of the JOBS Act addresses crowdfunding byproviding an exemption from registration provided that: • the aggregate amount sold to all investors by the issuer,

including any amount sold in reliance on thecrowdfunding exemption during the 12-month periodpreceding the date of the transaction, is not more than$1 million;

• the aggregate amount sold to any investor by the issuer,including any amount sold in reliance on thecrowdfunding exemption during the 12-month periodpreceding the date of the transaction, does not exceed:

• the greater of $2,000 or 5% of the annual income or networth of the investor, as applicable, if either the annualincome or the net worth of the investor is less than$100,000, or

• 10% of the annual income or net worth of an investor,as applicable, not to exceed a maximum aggregateamount sold of $100,000, if either the annual incomeor net worth of the investor is equal to or more than$100,000;

• the transaction is conducted through a registered brokeror funding portal that complies with the requirementsof the exemption; and

• the issuer complies with a number of specificinformational and other requirements specified underthe exemption. Title III specified that the SEC must issue rules to

implement this provision not later than 270 days followingenactment. The SEC has not yet proposed or adopted anyrules, and until final rules are adopted, the crowdfundingexemption contemplated by Securities Act section 4(a)(6)is not available.

Requirements as to intermediariesAn exempt crowdfunding offering must be made throughan intermediary that has registered with the SEC as abroker or as a so-called funding portal. Funding portalswill not be subject to registration as a broker-dealer, butwould be subject to an alternative regulatory regime withoversight by the SEC and the Financial IndustryRegulatory Authority (Finra), to be determined byrulemaking at the SEC and the Finra. A funding portal isdefined as an intermediary for exempt crowdfundingofferings that does not:• offer investment advice or recommendations;• solicit purchases, sales, or offers to buy securities offered

or displayed on its website or portal; • compensate employees, agents, or other persons for

such solicitation, or based on the sale of securitiesdisplayed or referenced on its website or portal;

• hold, manage, possess, or otherwise handle investorfunds or securities; or

• engage in other activities as the SEC may determine byrulemaking.


A crowdfunding intermediary must provide specifieddisclosures to investors and take other steps related to theoffering oriented toward investor protection, such as:• ensuring that all offering proceeds are only provided to

issuers when the amount equals or exceeds the targetoffering amount, and allowing for cancellation ofcommitments to purchase in the offering;

• ensuring that no investor in a 12-month period hasinvested in excess of the limit described above in allissuers conducting exempt crowdfunding offerings;

• taking steps to protect privacy of information; • not compensating promoters, finders, or lead generators

for providing personal identifying information ofpersonal investors;

• prohibiting insiders from having any financial interestin an issuer using that intermediary’s services; and

• meeting any other requirements that the SEC mayprescribe.

Requirements as to issuersIssuers also must meet specific conditions in order to relyon the exemption, including making filings with the SECand providing to investors and intermediaries informationabout the issuer (including financial statements, whichwould be reviewed or audited depending on the size of thetarget offering amount), its officers, directors, and greaterthan 20% shareholders, and risks relating to the issuer andthe offering, as well specific offering information such asthe use of proceeds for the offering, the target amount forthe offering, the deadline to reach the target offeringamount, and regular updates regarding progress towardreaching the target. A crowdfunding issuer will also besubject to reporting requirements after the offering, as theSEC may determine pursuant to its rules. Securities sold incrowdfunding offerings are not restricted securities, butthey are subject to transfer restrictions for one yearfollowing the sale.

The SEC’s rules adopted under Title III will alsoprohibit issuers from advertising the terms of the exemptoffering, other than to provide notices directing investorsto the funding portal or broker, and will require disclosureof amounts paid to compensate solicitors promoting theoffering through the channels of the broker or fundingportal.

A purchaser in a crowdfunding offering could bring anaction against an issuer for rescission in accordance withsection 12(b) and section 13 of the Securities Act, as ifliability were created under section 12(a)(2) of theSecurities Act, in the event that there are materialmisstatements or omissions in connection with theoffering.

The crowdfunding exemption is only available fordomestic issuers that are not reporting companies underthe Exchange Act and that are not investment companies,or as the SEC otherwise determines is appropriate. Badactor disqualification provisions similar to those requiredunder Regulation A are also required for exemptcrowdfunding offerings.

The Title III exemption pre-empts state securities lawsby making exempt crowdfunding securities “coveredsecurities”; however, some state enforcement authority andnotice filing requirements would be retained. Stateregulation of funding portals will also be pre-empted,subject to limited enforcement and examination authority.

SEC and Finra guidanceOn May 7 2012, the SEC’s Division of Trading andMarkets issued frequently asked questions which addresseda number of questions regarding crowdfundingintermediaries under Title III of the JOBS Act.3 The SEC’sanswers described the various provisions of Title IIIapplicable to crowdfunding intermediaries that areoutlined above.

Finra has established an interim form to seekinformation from prospective funding portals intending toapply for membership with Finra pursuant to Title III ofthe JOBS Act. Finra has invited prospective fundingportals to complete the Interim Form for Funding Portalsvoluntarily until Finra and the SEC adopt final rulesimplementing Title III of the JOBS Act and establishingthe registration procedures for funding portals.4

Until the SEC and Finra rules are adopted, Finra will usethe information collected with the Interim Form forFunding Portals to become more familiar with theproposed business models, activities and operations offunding portals. Once the final crowdfunding rules areadopted, additional information will be required offunding portals seeking to actually register with Finra andthe SEC. The information Finra now requests includes:• contact and general information about the funding

portal; • ownership and funding information about the

prospective funding portal; • information about the prospective funding portal’s

management; and • information about the funding portal’s business

relationships, business model and compensation. Finra will treat information submitted using the Interim

Form for Funding Portals as confidential.


Appendix AINTERMEDIARY COMPARISON

Regulatory environment

Conduct of business

Costs

Availability ofcrowdfunding exemption

Broker-dealer

Well-established SEC and Finra rules regard-ing registration and ongoing obligations

Handling customer funds and securities, making investment recommendations, compensated for sales of securities, etc.

Significant registration costs, as well as ongoing compliance costs.

Available for issuers using broker-dealer’s platform.

Funding portal

To be-established SEC and Finra rules regard-ing registration and ongoing obligations.

Restrictions on activities traditionally considered to be those activities characteristicof broker-dealer status.

Expected to be less burdensome ongoing obligations, thus lower costs involved.

Available for issuers using funding portal’splatform.


1. SEC Release No. 33-9216 (June 8 2011).2. Sustainable Economies Law Center, Petition for

Rulemaking, Petition No. 4 -605, available athttp://www.sec.gov/rules/petitions/2010/petn4-605.pdf.

3. Frequently Asked Questions About CrowdfundingIntermediaries (May 17 2012), available at:http://www.sec.gov/divisions/marketreg/tmjobsact-crowdfundingintermediariesfaq.htm.

4. The IFFP is available at:http://www.finra.org/Industry/Issues/Crowdfunding/.

ENDNOTES

As we discuss in Chapter 4, most issuers rely onexemptions from registration adopted pursuantto section 4 of the Securities Act to raise capital.There are, however, a number of other

exemptions from registration that may be available toissuers. Section 3(b) of the Securities Act authorises theSEC to adopt rules and regulations exempting securitiesfrom registration if the SEC finds that registration “is notnecessary in the public interest and for the protection ofinvestors by reason of the small amount involved or thelimited character of the public offering…” One of theexemptions that the SEC adopted pursuant to section 3(b)of the Securities Act is Regulation A.1 Pursuant toRegulation A, issuers that are not SEC-reporting companiesmay raise up to $5 million through sales of their securitiesin interstate offerings without complying with theregistration requirements of the Securities Act.2 RegulationA also provides controlling stockholders, as well as non-affiliates, an opportunity to sell their unregistered securities.A Regulation A offering is not a private offering. In fact, itis often referred to as a mini-registration. Regulation Aincorporates a number of conditions that in certain respectsresemble the registration requirements of section 5 of theSecurities Act. For example, in order for an issuer to availitself of the Regulation A exemption, it must:• prepare and file with the SEC an offering statement for

the SEC’s review and approval;• deliver the offering statement to prospective investors;

and• file periodic reports of sales after completion of the

offering.The requirements for the offering statement are not as

onerous as those applicable to a section 10 prospectus, andthe issuer is not subject to section 11 liability in respect ofthe offering statement.Due to the low offering threshold, and without a

corresponding state blue sky exemption for securitiesoffered in Regulation A offerings, Regulation A has notprovided a viable capital-raising vehicle for smallercompanies in recent years, and Rule 506, which has nooffering threshold, has become the most commonly usedexemption from registration.

Regulation A reform has been considered at varioustimes in recent years, but it was not until 2011 and 2012that legislative efforts to amend the exemption took shape.As discussed below, these legislative proposals, if passed,would have raised the offering threshold and modernisedexisting Regulation A. Ultimately, however, many of theseconcepts were incorporated into Title IV of the JOBS Act,titled Small Company Capital Formation. Title IV of theJOBS Act amends section 3(b) of the Securities Act,increasing the dollar threshold for a Regulation A-styleoffering, but does not actually amend existing RegulationA. Below we provide an overview of current Regulation Aas it is likely that this existing framework will beincorporated into the new section 3(b)(2) offeringexemption.

Regulation ARegulation A was enacted during the Great Depression topromote capital formation for small businesses. One of theSEC’s primary purposes in adopting Regulation A was toprovide a simple and efficient process by which smallbusinesses could raise limited amounts of capital, whileensuring that investors had access to current information.When originally enacted, section 3(b) authorised the SECto exempt only “small” issues involving offerings of$100,000 or less. Over time, this dollar threshold wasadjusted. In 1980, the small issue exemption was increasedby Congress to $5 million.3 The SEC did not actuallyincrease the threshold until 1992, however.4 In 1992, theUS economic downturn5 provided the necessary backdropfor the SEC to modernise Regulation A in order topromote small business capital formation.6 Reinvigoratingsmall business was linked to creating job opportunities andspurring economic growth.7 In July 1992, the SECadopted a number of small business-related initiatives thatincluded significant amendments to Regulation A.8 Thesechanges were intended to facilitate “access to the publicmarket for start-up and developing companies and … [toreduce] the costs for small businesses to undertake to havetheir securities traded in the public markets.”9 Theamendments increased the threshold amount to $5 millionin any 12-month period, including no more than $1.5


CHAPTER 6

Regulation A+

million in non-issuer resales. Also, the amendmentspermitted issuers to use a simplified disclosure documentand to test the waters before preparing the mandatedoffering circular. The SEC also extended the safe harbourprovisions for forward-looking statements to statementsmade in a Regulation A offering circular or any writtenmaterial submitted to the SEC. Finally, the SEC clarifiedthat an issuer would not be precluded from relying on theexemption if it had endeavoured in good faith to complywith the terms, conditions, and requirements ofRegulation A.

Regulation A requirementsThe availability of Regulation A is conditioned uponmeeting certain substantive and procedural requirements.10

The principal requirement relates to the dollar size of theoffering. If that requirement is met, the issuer must file theappropriate forms with the SEC. Failure to comply witheither the dollar limit or the filing requirements results inthe loss of the exemption and a violation of section 5 underthe Securities Act.

Eligible issuersThe Regulation A exemption is available for any US orCanadian entity that has its principal place of business inthe United States or Canada11 and is not subject toreporting obligations under section 13 or section 15(d) ofthe Exchange Act immediately before the offering.12 Thefollowing issuers are ineligible to offer or sell securitiesunder Regulation A:(i) any issuer that is a development stage company that

either has no specific business plan or purpose, or hasindicated that its business plan is to merge with anunidentified company or companies;13

(ii) any investment company registered or required to beregistered under the Investment Company Act of 1940;14

and(iii) any entity issuing fractional undivided interests in

oil or gas rights, or similar interest in other mineral rights.15

Rule 262 of Regulation A also contains certain bad actorprovisions, identifying specific types of improper conductundertaken by an issuer or certain affiliated parties thatwill disqualify the issuer from being able to avail itself ofRegulation A.16

OfferingsRegulation A may be used by an issuer to conduct aprimary offering of its securities with the proceeds to beused by the issuer, as well as to conduct a secondaryoffering of securities on behalf of selling security holders.17

There are a few limitations built into Rule 251(b) as it

relates to secondary offerings of securities on behalf ofselling security holders. First, no affiliate resales arepermitted if the issuer has not had net income fromcontinuing operations in at least one of its last two fiscalyears. Second, Rule 251(b) maximises the offering amountto $1.5 million offered by all selling security holders.Continuous or delayed offerings may be made pursuant toRegulation A if permitted by Rule 415.18 An offeringcircular for a continuous offering must be updated toinclude, among other things, updated financial statements,12 months after the date the offering statement wasqualified.19

Integration of offeringsRule 251 of Regulation A provides for certain integrationsafe harbors. Rule 251(c) provides that offers or sales madein reliance on Regulation A will not be integrated with:(i) prior offers or sales of securities; or(ii) subsequent offers or sales of securities that are:

(a) registered under the Securities Act, except asprovided in Rule 254(d),

(b) made in reliance on Rule 701,(c) made pursuant to an employee benefit plan,(d) made in reliance on Regulation S, or(e) made more than six months after the completion of

the Regulation A offering.Rule 251(c)(1) provides certainty from integration with

respect to any offers or sales of securities. For example, anissuer could make a private offering under section4(a)(2)or Regulation D before commencing a Regulation Aoffering without risking integration of the private offeringwith the Regulation A offering. For offerings madesubsequent to the Regulation A offering, the Rule251(c)(2) safe harbour period begins at the latest “sixmonths after completion of the Regulation A offering;”20

however, depending on how the offering is structured, asenumerated by Rule 251(c)(2)(i)–(iv), it may beginimmediately subsequent to completion of the RegulationA offering. In addition, a note to Rule 251(c) providesthat, if the integration safe harbour is unavailable, offersand sales still may not be integrated with a Regulation Aoffering, subject to the particular facts and circumstances.An issuer and its adviser may consider the traditional SECfive-factor integration test in analysing the offerings.

Offering disclosuresAn issuer who seeks to rely on Regulation A must still fileand qualify an offering statement.21 The offering statementis intended to be a disclosure document that providespotential investors with information that will form thebasis for their investment decision. In addition, in July


1992, as part of its Small Business Initiative, the SECadopted significant amendments to Regulation A.22 Theseamendments imposed requirements for the offeringcircular, which had the effect of creating more similaritiesbetween an offering circular and a prospectus used in aregistered offering. An offering circular is generally lessdetailed, however. Rule 253(a) provides that an offeringcircular must include the narrative and financialinformation required by Form 1-A.23 Rule 252(a) alsorequires that “any other material information necessary tomake the required statements, in the light of thecircumstances under which they are made, not misleading”be included.Part II of Form 1-A sets forth the specific information

required to be disclosed and provides two formats for theoffering circular: all corporate issuers may use Model A ofPart II of Form 1-A and disclose the information requiredby the form; and all other issuers, and any issuer that sochooses (including corporate issuers), may use either Part Iof Form S-1, except for the financial statements requiredby Form S-1, or Model B of Part II of Form 1-A.24

Depending on the type of issuer, the required disclosurecontent must follow either Model A, which follows aquestion-and-answer format, or Model B, which isgenerally similar to an S-form registration statement, orPart I of Form S-1. Financial statements for the precedingtwo fiscal years must be filed as part of the offeringstatement and included in the offering circular under bothmodels.25 Unless an issuer has prepared audited financialsfor other purposes, the financial statements to be filedunder Regulation A need not be audited.26 The financialstatements must be prepared in accordance with generallyaccepted accounting principles (GAAP) in the UnitedStates. Regulation A filings are not currently made via theSEC’s electronic filing system (known as EDGAR).

LiabilityAn exempt offering pursuant to Regulation A is excludedfrom the operation of section11 of the Securities Act.Regulation A offerings are, however, subject to theantifraud provisions under the federal securities laws.

Offering communicationsAn issuer engaged in a Regulation A offering hassubstantial flexibility regarding offering communications.This is especially true if one compares the types ofcommunications permitted under Regulation A with thelimitations on issuer communications in connection withmost private placements. No sale of securities can becompleted without the use of an offering circular; however,an issuer may solicit retail investors, including investors

that are not accredited investors. In addition, an issuer maytest the waters before preparing and filing offeringmaterials. This is an important advantage associated with aRegulation A offering. In the pre-filing period, before theissuer files an offering statement, Rule 254(a) allows anissuer to publish or deliver to prospective purchasers awritten document or to make scripted radio or televisionbroadcasts to determine whether there is interest in acontemplated securities offering.27 An issuer must complywith specified requirements in connection with any test-the-waters communications, including the use of certaindisclaimers on any offering materials used for this purpose.

Character of the securities sold in a Regulation A offeringThe securities sold in a Regulation A offering are notconsidered “restricted securities” under the Securities Act.As a result, the securities are not subject to any transferrestrictions and may be offered and sold to retail investors.This is important to an issuer that would like an activetrading market to develop for its securities followingcompletion of a Regulation A offering. However, theissuer’s securities may not be listed or quoted on asecurities exchange, and, as a result, there may not be aliquid market for the securities.The securities are not considered “covered securities” for

blue sky purposes, as discussed below.

Reporting requirementsAs discussed above, the Regulation A exemption isavailable only to certain issuers that are not SEC-reportingcompanies. Following its completion of a Regulation Aoffering, an issuer is not subject to ongoing disclosureobligations (unless it has undertaken multiple offeringsand become subject to Exchange Act reportingrequirements as a result of the dispersed nature of theholdings of its equity securities). As a result, there may belimited publicly available information about the issuer.The issuer may voluntarily choose to apply to have itssecurities listed or quoted on a national securitiesexchange, but it is not required to do so.

Finra reviewFor any public offering of securities, Finra Rule 5110prohibits Finra members and their associated persons fromparticipating in any manner unless they comply with thefiling requirements of the rule.28 Rule 5110 also containsrules regarding underwriting compensation. Rule 5110(b)requires that certain documents and information be filedwith and reviewed by Finra, and these filing and reviewrequirements apply to securities offered under RegulationA.29


Considerations in conducting a Regulation AofferingAdvantagesAn exempt offering, including, for example, a RegulationD offering, is subject to several limitations, and a registeredpublic offering may be too time-consuming and costly foran issuer. Using Regulation A to offer securities mayprovide an issuer with an offering format that is similar toa registered offering, but is more efficient. While there aremany similarities between an offering circular and aprospectus, the preparation of an offering circular isgenerally simpler. An offering circular is less detailed thana prospectus for a registered offering. As a result, it istypically less costly for an issuer to conduct a Regulation Aoffering. The costs associated with external advisers, suchas counsel and auditors, also will be lower in connectionwith a Regulation A offering. Also, management timedevoted to the preparation of the offering circular will beless.30 The review process undertaken by SEC staff isgenerally shorter than the review and comment process inconnection with a full registration. A registrationstatement on Form S-1 would always be subject tocomplete review by the SEC staff in connection with anissuer’s initial public offering. Timing is often the mostimportant determinant of success for an offering. Inabilityto initiate an offering during a favourable market windowmay result in the issuer not being able to conduct anoffering at all. Regulation A may provide flexibility to theissuer in this respect.

No limitation on offereesRegulation A does not impose any limitations on offerees.In contrast to Rules 505 and 506 of Regulation D,Regulation A does not limit the number of offerees orinvestors that can participate in an offering, nor does itimpose any requirement that offerees be accredited orsophisticated investors.

Nature of securitiesSecurities offered and sold pursuant to Regulation A areoffered publicly and are not “restricted securities.” Thesecurities are freely tradable in the secondary market(assuming that there is a secondary market) after theoffering. As a practical matter, the securities likely willtrade on the Pink Sheets or in the over-the-counter marketunless the issuer has taken steps to list the class of securitieson an exchange. No holding period applies to the holder ofsecurities purchased in a Regulation A offering. Because anissuer may remain a non-reporting company aftercompletion of a Regulation A offering, there may not bean active secondary market. If a smaller company chooses

to list a class of securities on a major exchange, it willbecome subject to Exchange Act reporting.31 Certaininstitutional investors have limitations on the amount thatthey may invest in “restricted securities.” These restrictionsgenerally would not apply to investments in securitiesissued pursuant to Regulation A.

Testing the waters, advertising, and general solicitationThe ability to test the waters in connection with aRegulation A offering may make a Regulation A offeringmore appealing (if the dollar threshold is increased) than aRegulation D offering, even with the proposed relaxationof the prohibition on general solicitation for certainofferings made pursuant to Regulation 506.

DisadvantagesDollar thresholdAlthough there are many significant benefits associatedwith a Regulation A offering, the dollar thresholdundermines the benefits and reduces the utility of theexemption.32 Often an issuer will look to engage anunderwriter to assist with structuring and marketing theoffering. Similar to a registered offering, the underwritingeffort may be on a best-efforts or a firm commitment basis.The recent history of Regulation A shows that it is unlikelythat a large well-established broker dealer will underwrite aRegulation A offering. With the current offering thresholdof $5 million, participating in a Regulation A offering maynot provide most broker-dealers with sufficient financialincentive. This is not a new issue – in fact broker-dealerparticipation was discussed in connection with the 1978and 1992 amendments to Regulation A.33 These concernsled to proposed legislation in Congress in March 2011 toamend section 3(b) of the Securities Act by increasing theoffering threshold from $5 million to $50 million.

Requirement of state registrationOfferings made pursuant to Regulation A must satisfy stateblue sky laws in each state where the offering is to takeplace. Critics argue that this is one of the big impedimentsto more active use of Regulation A.34 Many states have notcoordinated their exemptions to accommodate RegulationA offerings.35 Regulation A securities currently are not“covered securities” within the meaning of section 18(b) ofthe Securities Act.36 As a result, an offering likely willtrigger a merit review in those states that are merit reviewstates (unless waivers can be obtained), which may causedelays in qualifying Regulation A offerings. Bycomparison, offerings of securities listed on majorexchanges (Nasdaq and NYSE) have been exempt fromstate review since 1996 pursuant to the NSMIA.37


Similarly, securities offered pursuant to Rule 506 ofRegulation D, promulgated under section4, are exemptfrom state securities registration requirements.38

Proposals to amend Regulation AThere have been various efforts to amend Regulation A.Commentators noted that, while over the years theoffering threshold has been increased to the current $5million amount, the dollar amount has not kept pace withchanges related to capital formation. The topic ofincreasing the Regulation A dollar threshold was discussedat the SEC’s Government-Business Forum on SmallBusiness Capital Formation on November 18 2010.39

Moreover, in 2009, the recommendation to raise the dollarthreshold made it into the final report of the SEC’sGovernment-Business Forum on Small Business CapitalFormation.40

Statistics demonstrate that the offering threshold ofRegulation A is too low and does not align with marketrealities.41 Observers have, in fact, highlighted this issue fora long time, because “the cost of making the offering,including fees for attorneys and accountants and printingcosts consume an inordinate percentage of the proceeds ofthe offering.”42 The threshold has not been increased foralmost 20 years.43 Smaller and emerging companies havefaced many capital-raising challenges in recent years.Changes in market structure and other developmentsaffecting the IPO market have led to a paucity of IPOs forsmaller companies.44 Smaller companies also have foundthe costs associated with being a public, reportingcompany increase. Regulation A has not provided a viable capital-raising

vehicle for smaller companies principally due to the lowdollar threshold and the burdens associated with state bluesky compliance. In connection with a hearing before theHouse Committee on Financial Services on December 82010, regarding amending the Regulation A offeringthreshold to $30 million, William R Hambrecht,chairman and CEO of WR Hambrecht + Co, stated that,“according to public records, since 2005 there have onlybeen 153 Regulation A filings and of those 153, anastoundingly low number of 13 have actually priced.”45

Representative Barney Frank, who chaired the hearing,noted that the proposal to amend Regulation A should notbe “a partisan or terribly controversial one.” Hearingparticipants noted that the small IPO market has virtuallydisappeared. Representative Anna G Eshoo testified that,“[I]n 2004, there were 40 IPOs at $50 million or less. In2005, there were 38 IPOs at $50 million or less. In 2009,there was one.”46

Following the financial crisis, concerns about the

availability of capital for smaller, emerging companiesintensified, led, in March 2011, to the introduction oflegislation that would have increased the Regulation Aoffering threshold. On March 14 2011, RepresentativeDavid Schweikert introduced in the US House ofRepresentatives the Small Company Capital FormationAct,47 which was designed to encourage small companies toaccess the capital markets – allowing them to invest andhire employees.48 In introducing the proposed legislation,Schweikert, vice-chairman of the House Financial ServicesSubcommittee on Capital Markets and GovernmentSponsored Enterprises, said: “Taking a small businesspublic is an important, but expensive process that requiresmillions in underwriting costs … Raising the Regulation Athreshold to $50 million is one way to lower those costsand promote economic growth and job creation. At a timewhen so many small businesses are in need of capital, thisis a common sense proposal that will make our capitalmarkets more vibrant and competitive.”49

As discussed in the Introduction, the Small CompanyCapital Formation Act was part of a broader effort toaddress US job creation and economic competitivenessand to amend or repeal certain sections of the Dodd-FrankWall Street Reform and Consumer Protection Act.50 Inconnection with the legislative proposal, the HouseCommittee on Financial Services Subcommittee onCapital Markets and Government Sponsored Enterprisesheld a hearing on March 16 2011, regarding theselegislative proposals to promote job creation, capitalformation, and market certainty, including the SmallCompany Capital Formation Act.51 Industryrepresentatives testified in support of the proposedRegulation A reform,52 as exemplified by testimony fromDavid Weild, senior adviser of Grant Thornton, whoprovided an analysis of the devastating decline in numbersof small IPOs, demonstrating that small businesses andentrepreneurs cannot access the capital they need to growand create jobs.53 Weild applauded the Small CompanyCapital Formation Act as the beginning of a campaign tobring back the small IPO market. In addition to the costbenefits for small companies, he noted that an increasedoffering threshold opens up the Regulation A exemptionto an offering size that would allow companies to list onthe NYSE and NASDAQ and to avail themselves of theblue sky exemption, thus avoiding very costly state-by-state filings. Other observers voiced a preference for anincreased Regulation A threshold combined with Congressalso pre-empting state regulation for these offerings similarto Regulation D offerings. Weild also noted theimportance of the test-the-waters provision of RegulationA, citing a steady increase in IPOs that are postponed,



withdrawn, priced below the low end of the IPO filingrange or that have broken the IPO price within 30 days ofthe completion of the offering as potentially ruinous tosmaller companies.54

This legislation would have amended section 3(b) of theSecurities Act by requiring the SEC to increase theaggregate offering amount to $50 million for exemptofferings of securities. The legislation also would haveamended section 18(b)(4) of the Securities Act byincluding in the definition of “covered security”:a rule or regulation adopted pursuant to section 3(b)(2)

and such security is —(i) offered or sold through a broker or dealer;(ii) offered or sold on a national securities exchange; or(iii) sold to a qualified purchaser …”55

Accordingly, certain Regulation A offerings would havebeen pre-empted from state blue sky review.56

In June 2011, the House Committee on FinancialServices approved an amendment to the Small CompanyCapital Formation Act, which provided that “theCommission shall require an issuer to file audited financialstatements with the Commission annually” (ouremphasis).57 Title IV of the JOBS Act incorporates thisreporting requirement in the context of the section 3(b)(2)exemption that it references. The legislation was met with strong bipartisan support.

In November 2011, the House of Representativesoverwhelmingly approved the Small Company CapitalFormation Act of 2011 by a vote of 421 to one.Companion legislation was introduced in the Senate inSeptember 2011 by Senators Jon Tester and Pat Toomey.But for a few minor differences, the Senate bill wassubstantially similar to the Small Company CapitalFormation Act. Ultimately, the changes that werecontemplated in these bills were incorporated into theJOBS Act, albeit with some modifications.It is important to note that, throughout the preceding

few years, when commentators were considering amendingRegulation A to increase the dollar threshold and addressstate blue sky matters, the proposals had as theirunderlying premise that smaller issuers that were not SEC-reporting companies would be able to conduct one ormore Regulation A offerings and elect either to remainnon-reporting issuers, or voluntarily seek to have theirsecurities listed and quoted on a national securitiesexchange (thereby becoming SEC-reporting companies)and use Regulation A as an alternative to a traditional IPO.The notion of an IPO on-ramp, or scaled approach toIPOs for emerging growth companies, had not yet beenproposed.

Title IV of the JOBS ActAs noted above, Title IV of the JOBS Act does not amendexisting Regulation A. Instead, section 401 of the JOBSAct amends section 3(b) of the Securities Act by adoptinga new section (b). Pursuant to the new section 3(b)(2), the SEC is

authorised to promulgate rules or regulations creating anexemption that is substantially similar to the existingRegulation A.An issuer would be able to offer and sell up to $50

million in securities within a 12-month period in relianceon the exemption. The issuer may offer equity securities,debt securities, and debt securities convertible orexchangeable for equity interests, including any guaranteesof such securities. The securities sold pursuant to theexemption will be offered and sold publicly (withoutrestrictions on the use of general solicitation or generaladvertising) and will not be considered “restrictedsecurities.” The issuer may test the waters or solicit interestin the offering before filing any offering statement with theSEC, subject to any additional conditions or requirementsthat may be imposed by the SEC. The civil liabilityprovision in section 12(a)(2) shall apply to any personoffering or selling such securities.The securities will be considered “covered securities” for

NSMIA purposes (and not subject to state securitiesreview) if: the securities are offered and sold on a nationalsecurities exchange, or the securities are offered or sold toa “qualified purchaser” as defined under the SecuritiesAct.58 These provisions are more limited than thoseoriginally contained in the standalone Regulation Alegislation. During the consideration of the Regulation Alegislation, it became clear that perhaps the only significantsource of controversy regarding modernizing Regulation Arelated to state blue sky qualification. State securitiesregulators, through the North American SecuritiesAdministrators Association (Nasaa), expressed concernsabout the potential for fraud and abuse related to offeringsfor small companies, including offerings completedpursuant to Regulation A. Nasaa opposed certain aspectsof the proposals to modernise the regulation of theseofferings that would involve broader state blue sky pre-emption.59

The SEC will require that the issuer file audited financialstatements with the SEC annually. The SEC may imposeother terms, conditions or requirements deemed necessaryfor investor protection, including a requirement that theissuer prepare and file electronically with the SEC anddistribute to prospective investors an offering statementand any related documents, including a description of theissuer’s business and financial condition, its corporate

governance principles, the intended uses of proceeds, andother appropriate matters. The SEC also may require anissuer that relies on the exemption to make available toinvestors and file with the SEC periodic disclosures. Thebad actor disqualification provisions applicable for theexemption shall be substantially similar to thedisqualification provisions contained in the regulationsadopted pursuant to section 926 of the Dodd-Frank Act(which looks to the bad actor disqualification provisions incurrent Regulation A).Not later than two years after enactment and every two

years thereafter, the SEC shall review the offering thresholdand report to the Committee on Financial Services of theHouse of Representatives and the Committee on Banking,Housing, and Urban Affairs of the Senate on its reasons fornot increasing the dollar amount.Unfortunately, unlike other sections of the JOBS Act,

Title IV of the JOBS Act did not specify a time period inwhich the SEC was required to undertake rulemaking inorder to give effect to the provisions relating to section3(b)(2). At this time, it is not clear whether the SEC willchoose to amend current Regulation A by incorporatingthese new requirements, or whether it will choose to adopta new exemption under section 3(b)(2), and leave currentRegulation A intact.The chart in Appendix A compares the current

Regulation A requirements and the new section 3(b)(2)exemption.60

Required studySection 402 of the JOBS Act requires that the ComptrollerGeneral must conduct a study on the impact of blue skylaws on offerings made under Regulation A. Within threemonths of enactment of the Act, the Comptroller Generalmust deliver the report to the Committee on FinancialServices of the House of Representatives and theCommittee on Banking, Housing, and Urban Affairs ofthe Senate.The study titled Factors that May Affect Trends in

Regulation A Offerings was delivered in July 2012.61 Thestudy notes that there are a number of factors that havecontributed to the lack of utility of the Regulation Aexemption, and highlights the time and expense associatedwith state blue sky compliance. The study concludes thatwithout pre-emption of the state blue sky requirements,Regulation D may continue to be used in favour ofRegulation A.

Implementation effortsAs of the time of writing, the Staff of the SEC has statedpublicly that it has assembled a working group within the

SEC to work on implementation of the section 3(b)(2)exemption; however, the SEC has not released anyproposal, nor has it indicated whether it intends to adaptthe current framework for Regulation A offerings to thenew exemption.Commentators have submitted letters to the SEC

regarding the section 3(b)(2) exemption, and urged theSEC to move forward quickly to propose regulations forthese offerings.

Use of the section 3(b)(2) exemptionMany clients have asked us why an issuer might choose torely on section 3(b)(2) if the issuer could rely on Rule 506of Regulation D. An exempt offering, including, forexample, a Regulation D offering, may still be subject toseveral limitations that may not be appealing to an issuer,and a registered public offering may still be too time-consuming and costly. Using the new section 3(b)(2)provisions to offer securities can provide an issuer with anoffering format that is similar to a registered offering withcertain accompanying advantages, but may be moreefficient. It might be especially appealing for an issuer toconsider this type of offering as a precursor to an IPO. Anissuer will be required to prepare and furnish certainoffering disclosures in connection with a section 3(b)(2)offering, while there are no information requirementsassociated with a Rule 506 offering. In practice, however,most issuers will prepare some disclosure materials to sharewith prospective investors, even in a Rule 506 offering. Anissuer may want to preserve the opportunity to approachinvestors that are not accredited, and may do so inconnection with a section 3(b)(2) offering. Securities soldin a Rule 506 offering will be “restricted securities” that aresubject to transfer restrictions. This may limit the marketfor the securities. An investor may have a preference forpurchasing securities that are not “restricted securities” andthat may be freely transferred.A non-reporting company may choose to undertake a

section 3(b)(2) offering or a Regulation D offering andremain below the shareholder threshold for requiredExchange Act reporting. If it were to do so, a market for itssecurities may or may not develop. A non-reportingcompany that undertakes a section 3(b)(2) offering mayalso use the offering as an IPO.The new section 3(b)(2) exemption should be flexible

enough to facilitate a contemporaneous listing on asecurities exchange for an issuer that elects to become areporting company following completion of its section3(b)(2) offering. An emerging company may be able tosatisfy the market capitalisation and public floatrequirements of a securities exchange upon completion of


its section 3(b)(2) offering. Under current law, if an issuerwere to seek to list its securities on a national securitiesexchange in conjunction with, or following the completionof, a section 3(b)(2) offering, it would be required toprepare and file with the SEC a registration statement onForm 10. Many of the comment letters submitted to theSEC on Title IV of the JOBS Act have suggested that theSEC modify the approach to Exchange Act registration forthose issuers that choose to use a section 3(b)(2) offering asan IPO. Now, of course, an issuer that qualifies as anemerging growth company also would be able to avail itselfof the Title I on-ramp approach. A traditional IPO, evenwith the accommodations now made available to emerginggrowth companies by Title I, may not be a realisticalternative for smaller companies. Many investment bankswill only undertake an IPO if it is of a certain size, andsmaller companies may still seek to undertake IPOs inwhich they offer up to $50 million in securities. Forsmaller IPOs of the sort that were once common in theUnited States, the section 3(b)(2) alternative may provethe only realistic approach. Ultimately, however, and asnoted in the GAO study on Regulation A offerings, theutility of the new exemption will depend entirely on theimplementing rules and whether the rules address stateblue sky pre-emption and information requirementsappropriately.



Appendix ARegulation A requirements as compared with the new section 3(b)(2) exemption

Offering limit

SEC filing requirements

Blue sky requirements

Limitations oninvestors

Restrictions onresale of securities

Offering communications

Financial statementrequirements

Disqualification provisions

Periodic reporting

Regulation Aexempt public offering

Up to $5 million within the prior 12-month period.

Must file with the SEC a Form 1-A, which isreviewed by the SEC staff.

Blue sky law compliance is required, without inmany cases the possibility for a more streamlinedregistration by coordination process.

No limits on investors, except to the extentimposed under state laws.

No restrictions on the resale of securities, exceptto the extent that the securities are held by affili-ates.

An issuer may test the waters to determine ifthere is interest in a proposed offering before fil-ing the Form 1-A. Sales literature may be usedbefore the filing of the Form 1-A, after filing, andfollowing qualification.

A current balance sheet, as well as income state-ments for a period of two years, as well as anyinterim period. Financial statements must be pre-pared in accordance with GAAP but do not haveto conform to Regulation S-X and, in most cases,do not have to be audited.

Felons and bad actors disqualified from the offer-ing in accordance with Securities Act Rule 262.

No reporting required after the offering, otherthan to disclose the use of proceeds.

Section 3(b)(2) exempt public offering

Up to $50 million within the prior 12-month period.

Must file with the SEC and distribute to investorsan offering statement, which will likely bereviewed by the SEC staff.

Blue sky law compliance is required, exceptwhen the securities are offered and sold on anational securities exchange, or the securities areoffered or sold to a qualified purchaser.

No limits on investors, except to the extentimposed under state laws.

No restrictions on the resale of securities, exceptto the extent that the securities are held by affili-ates.

An issuer may test the waters to determine ifthere is interest in a proposed offering before fil-ing an offering statement.

Audited financial statements must be included inthe offering statement, as determined by theSEC.

Felons and bad actors disqualified from the offer-ing in accordance with rules adopted under sec-tion 926 of the Dodd-Frank Act.

Audited financial statement must be filed andprovided to investors annually, and the SEC mayrequire other periodic disclosures.

1 Securities Act Release No. 66, 1933 WL 28878(Nov. 1, 1933).

2 Regulation A consists of Rules 251 through 263. 17CFR §§ 230.251–.263, hereinafter cited by rulenumber.

3 See Pub. L. No. 96-477, § 301, 94 Stat. 2275, 2291(1980).

4 See Small Business Initiatives, Securities Act ReleaseNo. 6949, 1992 WL 188930 (July 30 1992).

5 President Bush announced: “[the] goal . . . is to . . .eliminate or revise those [securities laws] that clearlyimpose costs that exceed their benefits, and [to]ensure that other regulations are implemented in acost-effective manner.” Council of EconomicAdvisers, The Annual Report of the Council ofEconomic Advisers, in ECONOMIC REPORT OFTHE PRESIDENT, 191 (1992).

6 The SEC highlighted in the proposing release thedecline in the number of small business IPOsbetween 1986 and 1991 as well as the decliningnumber of Regulation A filings between 1981 and1991. See Securities Act Release No. 6,924, 1992WL 52840 (March 11 1992) (“Since 1986, equityIPOs have declined each year until the turnaroundin 1991. Forty-four Regulation A financings werefiled in FY 1991 with the Commission,representing financings of $41.5 million, in contrastwith 439 filings covering financings of $408 millionin FY 1981.”).

7 See id. (“Small businesses are the cornerstone of theU.S. economy. The approximately 20 million smallbusinesses in the United States employ more thanhalf of the domestic labor force, produce nearly halfof the gross domestic product and created the vastpreponderance of new jobs during the period from1988 through 1990.”).

8 See Small Business Initiatives, Securities Act ReleaseNo. 6949, 1992 WL 188930 (July 30 1992).

9 See id. at *2.10 See generally Rules 251–63. 17 CFR §§

230.251–.263.11 Rule 251(a)(1). An issuer that is a corporation, an

unincorporated association, or a trust must beincorporated or organised “under the laws of theUnited States or Canada, or any State, Province,Territory or possession thereof, or the District ofColumbia.”

12 Rule 251(a)(2). The requirement that the issuer is anon-reporting company was added to Regulation Ain 1992. See Small Business Initiatives, SecuritiesAct Release No. 6949, 1992 WL 188930 (July 301992).

13 Rule 251(a)(3). The term “development stagecompany” is not defined in Regulation A or Rule405. However, the adopting release makes clear thatRule 251(a)(3) is intended to disqualify only “blankcheck” companies. See 1992 WL 188930, at *3.

14 Rule 251(a)(4).15 Rule 251(a)(5). Note that Rule 251(a)(5) does not

prevent companies in the oil and gas industry fromusing Regulation A for offerings of, for example,their common stock or bonds.

16 See Rule 262(a), (b), and (c).17 See Rule 251(b).18 Rule 251(d)(3).19 Rule 253(e)(2).20 Rule 251(c)(2)(v).21 See Rule 252(e) and (g).22 See Small Business Initiatives, Securities Act Release

No. 6949, 1992 WL 188930 (July 30 1992).23 Rule 253(a).24 See Form 1-A, Part II. 17 CFR § 239.90.25 See Form 1-A, Part F/S. If the issuer has been in

business for less than two years, financial statementsfor that shorter period are required. Id.

26 Id.27 Rule 254(a).28 See Finra Rule 5110.29 See NASD Notice to Members 92-28 (May 1992);

see also NASD Notice to Members 86-27 (Apr.1986).

30 The SEC has emphasised this advantage in the past.See, e.g., Securities Act Release No. 5977, 1978 WL196028, at *2 (September 11 1978).

31 An issuer may choose to prepare and file a Form 10to register one or more classes of securities undersection 12 of the Exchange Act with the SEC.

32 See A Proposal to Increase the Offering Limit UnderSEC Regulation A: Hearing Before the H. Comm. onFin. Servs., 111th Cong. 10 (2010) (statement ofMichael Lempres, Asst. Gen. Counsel, SVBFinancial Group) (“The impetus behind thecreation of regulation A was very good one.Unfortunately, in recent years, as you’ve been


ENDNOTES

hearing, regulation A has not proved to be a usefulcapital raising vehicle for small issuers. It was usedonly a total of 78 times during the 10-year periodbetween 1995 and 2004. An average of eight filingsa year with the maximum amount of $5 millioneach really proves the irrelevance of regulation A intoday’s economy. It’s simply not a viable vehicle ascurrently structured.”).

33 See Small Offering Exemption, Securities ActRelease No. 5997, 1978 WL 171024 (November 161978) (proposed amendment dealing with firmunderwriting); see also Small Business Initiatives,Securities Act Release No. 6949, 1992 WL 188930(July 30, 1992).

34 See, e.g., Lawmakers Propose Raising Regulation AOffering Limit, PIPES REP. (December 21 2010).

35 Some states offer “coordinated review” (“CR”),allowing issuers to receive the comments from oneCR office even though the Regulation A offering isto be conducted in several states, which reduces thereview process and costs. CR-SCOR is a programthat “provides for coordinated review of an offeringof securities in two or more states located within ageographic group when the offering is intended tobe made in reliance upon an exemption fromregistration with the US Securities and ExchangeCommission (SEC) under Rule 504 of SECRegulation D or SEC Regulation A.” CR-SCOR,www.coordinatedreview.org/crscor.html (last visitedOctober 7 2011). New York, California, andFlorida are not participating in the CR-SCORprogramme.

36 Securities Act § 18(b), 15 USC § 18(b).37 National Securities Market Improvement Act of

1996, Pub. L. No. 104-290, 110 Stat. 3435(October 11 1996). NSMIA preempts statequalification and registration requirements for“covered securities,” which includes issuer offeringsof securities listed on Nasdaq or the NYSE andsecurities exempt from registration under federalsecurities law, including pursuant to rulespromulgated under section4(a)(2) of the SecuritiesAct.

38 Rules 504 and 505 were promulgated under section3(b) of the Securities Act and do not preempt statesecurities law requirements. However, most stateshave adopted changes to their state securities lawsthat essentially duplicate the provisions ofRegulation D.

39 See 29th ANNUAL SEC GOVERNMENT-BUSINESS FORUM ON SMALL BUSINESS

CAPITAL FORMATION, RECORD OFPROCEEDINGS (November 18 2010) (statementof David Hirschmann, President and CEO of theCenter for Capital Markets Competitiveness at theUS Chamber of Commerce).

40 See 2009 ANNUAL SEC GOVERNMENT-BUSINESS FORUM ON SMALL BUSINESSCAPITAL FORMATION 17 (2009).

41 See Statement of William R. Hambrecht, Chairman& Chief Exec. Officer, WR Hambrecht + Co.)(“According to public records, since 2005 therehave only been 153 Reg A filings and of those 153,an astoundingly low number of 13 have actuallypriced.”).

42 Hearing on Capital Formation Before the S.Subcomm. on Small Business, 95th Cong. 589(1978) (statement of Sen. Lowell Welcker).

43 See A Proposal to Increase the Offering Limit UnderSEC Regulation A: Hearing Before the H. Comm. onFin. Servs., 111th Cong. 3 (2010) (statement ofRep. Anna Eshoo, Member of Congress, Cal.)(“The main problem is that hardly anybody uses it.Currently, there is little incentive to support thesmall initial public offerings under Regulation A. Infact, the current regulations are a disincentive,burdening a $5 million offering with $1 million to$2 million in underwriting expenses. So that is apretty good reason why people aren’t using it.”).

44 Smaller IPOs suffered a “rapid decline” from 1996to 2000. Before 1996 there was an average of 520IPOs per year, after 2000 there was only an averageof 134 IPOs per year. DAVID WEILD &EDWARD KIM, WHY ARE IPOS IN THE ICU,3, 7 (Grant Thorton 2008), available atwww.grantthornton.com/staticfiles/GTCom/files/GT%20Thinking/IPO%20white%20paper/Why%20are%20IPOs%20in%20the%20ICU_11_19.pdf.

45 See A Proposal to Increase the Offering Limit UnderSEC Regulation A: Hearing Before the H. Comm. onFin. Servs., 111th Cong. 32 (2010) (preparedstatement of William R. Hambrecht, Chairman &Chief Exec. Officer, WR Hambrecht + Co.).

46 See statement of Rep. Anna G. Eshoo, Member ofCongress, Cal.

47 See Small Company Capital Formation Act of 2011,HR 1070, 112th Cong. (1st Sess. 2011).

48 See Press Release, Fin. Servs. Comm.,Administration Could Help Small Business GainAccess to Capital by Helping Pass the SmallCompany Capital Formation Act (March 22 2011),available at


http://financialservices.house.gov/News/DocumentPrint.aspx?DocumentID= 236861.

49 See press release issued by the House FinancialServices Committee, available athttp://financialservices.house.gov/press/PRArticle.aspx?NewsID=1817.

50 Pub. L. No. 111-203, 124 Stat. 1376 (July 212010) [hereinafter Dodd-Frank].

51 See Press Release, Fin. Servs. Comm.,Administration Could Help Small Business GainAccess to Capital by Helping Pass the SmallCompany Capital Formation Act (March 22 2011),available athttp://archives.financialservices.house.gov/press/PRArticle.aspx?NewsID=1817.

52 See generally Legislative Proposals to Promote JobCreation, Capital Formation, and Market CertaintyBefore the Subcomm. on Capital Markets and Gov.Sponsored Enterprise of the H. Comm. on Fin. Servs.,112 Cong. 24 (2011).

53 Legislative Proposals to Promote Job Creation, CapitalFormation, and Market Certainty Before theSubcomm. on Capital Markets and Gov. SponsoredEnterprise of the H. Comm. on Fin. Servs., 112Cong. 24 (2011) (prepared statement of DavidWeild, Senior Advisor, Grant Thornton LLP).

54 See DAVID WEILD & EDWARD KIM, GRANTTHORNTON LLP, CAPITAL MARKET SERIES:MARKET STRUCTURE IS CAUSING THE IPOCRISIS (October 2009), available atwww.grantthornton.com/staticfiles/GTCom/Public%20companies%20and%20capital%20markets/Files/IPO%20crisis%20-%20Sep%202009%20-%20FINAL.pdf.

55 See Amendment in the nature of a substitute to HR1070 offered by Mr. Schweikert, no. 1, available athttp://financialservices.house.gov/UploadedFiles/062211hr1070schweikertam.pdf.

56 As originally proposed, the legislation did notprovide for a state blue sky law exemption.

57 Amendment to the Amendment in the Nature of aSubstitute to HR 1070 Offered by Mr. Ackerman,no. 1a (emphasis added), available athttp://financialservices.house.gov/UploadedFiles/062211hr1070ackermanam.pdf. As originallyproposed, the legislation provided that the SECmay require an issuer to file audited financialstatements with the SEC and distribute suchstatements to prospective investors.

58 Currently, there is no definition under theSecurities Act of a “qualified purchaser.” The SEC

would be required to adopt a definition.59 See Letter from David S. Massey, North Carolina

Deputy Securities Administrator, NASAA President,to Spencer H. Bachus, Chair., House FinancialServices Committee, et al. (June 15 2011), availableat www.nasaa.org/wp-content/uploads/2011/07/6-15-11-NASAA_Comment_Letter_HR1070_HR1082.pdf.

60 This chart originally appeared in Morrison &Foerster’s alert, “The JOBS Act,” found athttp://www.mofo.com/files/Uploads/Images/120326-The-JOBS-Act.pdf.

61 See study available athttp://www.gao.gov/assets/600/592113.pdf.



Before the enactment of the JOBS Act, ExchangeAct section 12(g) required registration of a classof an issuer’s equity securities if, as of the last dayof the issuer’s fiscal year, the issuer had more than

$10 million in assets and the class of equity securities washeld of record by 500 or more persons.1 Once thesethresholds were crossed, an issuer would have to register theclass of equity securities within 120 days of the end of thefiscal year, and then begin filing current and periodicreports with the SEC.2 The definition of “held of record”for these purposes counts as holders of record only personsidentified as owners on records of security holdersmaintained by the company, or on its behalf, in accordancewith accepted practice. An issuer could only deregister aclass of equity securities under section 12(g) when suchclass of equity securities is held of record by less than 300persons, or by less than 500 persons and the total assets ofthe issuer has not exceeded $10 million on the last day ofeach of the issuer’s three most recent fiscal years. ExchangeAct section 12(g) was originally enacted out of concern thatissuers who were not listed on a national securities exchangecould nonetheless be widely held and traded over thecounter, and therefore disclosure should be available toinvestors in such issuers through SEC registration andreporting.Leading up to the JOBS Act changes to the Exchange

Act registration/deregistration thresholds, concerns wereraised about the fact that the 500 person held-of-recordthreshold had not been revisited since 1964. Theseconcerns focused on the fact that issuers sometimes had togo public sooner than they might otherwise want to byvirtue of the mandatory registration provisions in section12(g), and the possibility of SEC registration andreporting could serve to discourage private companiesfrom raising capital and using equity awards to compensateemployees. At the same time, concerns were expressed withissuers going dark and ceasing their SEC reporting bybringing the number of holders of record below thederegistration threshold. As a result of these concerns, avariety of proposals were advanced relating to possibleamendments to section 12(g) registration thresholds. Someof these proposals sought to reduce the number of issuers

required to report pursuant to the Exchange Act, forexample, by raising the shareholder threshold,3 byexcluding employees, or by excluding accredited investors,QIBs or other sophisticated investors from thecalculation.5 The SEC also received a rulemaking petitionrequesting that the SEC revise the held of record definitionto look through record holders to the underlying beneficialowners of securities in order to prevent issuers from ceasingto report in certain circumstances.5 Before April 5 2012,the SEC was conducting a comprehensive study of theseissues and was actively considering the various proposals.

Raising the registration and deregistrationthresholds in Titles V and VIAs amended by Titles V and VI, Exchange Act section12(g) now requires registration of a class of equitysecurities if, at the end of its fiscal year, an issuer has at least$10 million in assets and a class of equity securities held ofrecord by either 2,000 persons, or 500 persons who are notaccredited investors. Banks6 and bank holding companies7

are not required to register unless they have, at the end ofthe fiscal year, at least $10 million in assets and a class ofequity securities held of record by 2,000 or more persons.Under Exchange Act section 12(g)(4) before theenactment of the JOBS Act, an issuer could deregister aclass of equity securities when either the issuer has $10million or less in assets and the class of equity securities isheld by fewer than 500 holders of record, or the class ofequity securities was held by fewer than 300 holders ofrecord. The JOBS Act increased the 300 persons held-of-record threshold in Exchange Act section 12(g)(4) onlywith respect to banks and bank holding companies, raisingthat threshold from 300 to 1,200 persons. The JOBS Actdid not increase the 300 persons held-of-record thresholdfor deregistration for issuers that are not banks or bankholding companies.Under the JOBS Act, Exchange Act section 12(g)(5) was

amended to provide that the term “held of record” doesnot include “securities held by persons who received thesecurities pursuant to an employee compensation plan intransactions exempted from the registration requirementsof section 5 of the Securities Act.” The SEC is directed to

CHAPTER 7

Exchange Act registration thresholds


amend its Rule 12g5-1 definition of “held of record” toreflect this amendment to the statute. The SEC also isdirected to adopt safe harbour rules for issuers to follow indetermining whether holders of their securities receivedthe securities pursuant to “an employee compensation planin transactions that were exempt from the registrationrequirements of section 5 of the Securities Act of 1933,”and securities sold in exempt crowdfunding offerings willalso not be included in determining whether registration isrequired under section 12(g).On April 11 2012, the Division of Corporation Finance

issued Frequently Asked Questions on Changes to theRequirements for Exchange Act Registration andDeregistration, which confirmed that the Title V and TitleVI provisions raising the Exchange Actregistration/deregistration thresholds were, for the mostpart, immediately effective, thereby providing issuers withthe ability to avoid registration in 2012 and going forward,and, specifically with regard to bank holding companies, toterminate their registration/reporting obligation.8

In Frequently Asked Question 4, the SEC noted that ifa bank holding company with a class of equity securitiesheld of record by less than 1,200 persons as of the first dayof the current fiscal year has a registration statement that isupdated during the current fiscal year pursuant toSecurities Act section 10(a)(3), but under which no saleshave been made during the current fiscal year, then thebank holding company may be eligible to seek no-actionrelief to suspend its section 15(d) reporting obligation. TheStaff has now been granting these no-action letters.9

As mentioned above, section 503 of the JOBS Actrequires the SEC to revise the definition of “held of record”to exclude, from the section 12(g)(1) holder of recordcalculation, persons who received the securities pursuant toan employee compensation plan in transactions exemptedfrom the registration requirements of section 5 of theSecurities Act; however, the SEC has not yet proposed oradopted any implementing rules. In Frequently AskedQuestion 5, the SEC noted that an issuer (including a bankholding company) may exclude persons who receivedsecurities pursuant to an employee compensation plan inSecurities Act-exempt transactions, whether or not theperson is a current employee of the issuer. While section 503of the JOBS Act directs the Commission to adopt “safeharbor provisions that issuers can follow when determiningwhether holders of their securities received the securitiespursuant to an employee compensation plan in transactionsthat were exempt from the registration requirements ofsection 5 of the Securities Act of 1933,” in the SEC’s viewthe lack of a safe harbour does not affect the application ofExchange Act section 12(g)(5).

Required studyThe SEC was required to examine its authority to enforceRule 12g5-1 to determine if new enforcement tools arerequired to enforce the anti-evasion provision contained in(b)(3) of the rule, and to provide recommendation toCongress within 120 days of the enactment of the JOBSAct. On October 16 2012, the SEC staff published theresults of this mandated study, concluding that thestatutes, rules and procedures as currently formulatedprovide the Division of Enforcement with sufficient toolsto investigate and bring a case for section 12(g) violationsbased on section 12g5-1(b)(3).10

Treatment of savings and loan holdingcompaniesOn November 28 2012, Representatives Steve Womack(R-Ark) and Jim Himes (D-Conn) asked former SECchairman Schapiro to extend to savings and loan holdingcompanies (SLHCs) the benefits of the JOBS Act increasein the section 12(g) registration threshold from 500 to2,000 for banks and bank holding companies. Similarly,the Congressmen believed that JOBS Act-mandatedincrease in the deregistration threshold for banks and bankholding companies from 300 to 1,200 should also be madeavailable to SLHCs. They noted that, as sponsors of theoriginal bill, they had not intended to treat SLHCsdifferently from banks and bank holding companies.While the Title V and VI changes were effective onenactment, the letter stated the hope that the SEC, whenit updated its rules to reflect JOBS Act changes, wouldtreat SLHCs in the same manner as bank holdingcompanies.


Appendix ASHAREHOLDER TRIGGERS

Total assets at fiscal year-end thattrigger reporting requirement ifshareholder trigger is breached

Total number of holders of recordthat trigger reporting

Total number of holders of recordto exit reporting

Effectiveness

Companies other than banks andBHCs

$10 million

2,000 holders of recordOR

500 non-accredited holders ofrecord

300 or fewer holders of record

Immediately effective

Banks and BHCs

$10 million

2,000 holders of record

1,200 or fewer holders of record

At the end of the issuer’s first fiscalyear following enactment of the JOBS

Act


1. These thresholds were set forth in Exchange Act §12(g)(1) and Exchange Act Rule 12g-1. Whensection 12(g) was enacted in 1964, the assetthreshold was set at $1 million. The asset thresholdwas most recently increased to $10 million in 1996.SEC Release No. 34-37157 (May 1 1996), availableat http://www.sec.gov/rules/final/34-37157.txt.

2. In addition, section 16 reporting and short-swingliability apply to insiders, beneficial ownershipreporting applies to significant stockholders, theSEC’s proxy rules apply to the issuer, and the variousSarbanes-Oxley Act and Dodd-Frank Act provisionsapply as a result of Exchange Act section 12(g)registration.

3. See, e.g., Comment Letter from American BankersAssociation to SEC (November 12 2008), availableat http://www.sec.gov/rules/petitions/4-483/4483-21.pdf.

4. See, e.g., 2009 Annual SEC Government-BusinessForum on Small Business Capital Formation FinalReport (May 2010), available athttp://www.sec.gov/info/smallbus/gbfor28.pdf.

5. Petition from Lawrence Goldstein to SEC (February24 2009), available at:http://www.sec.gov/rules/petitions/2009/petn4-483-add.pdf. See also Petition for Commission Action toRequire Exchange Act Registration of Over-the-Counter Equity Securities (July 3 2003), available at:http://www.sec.gov/rules/petitions/petn4-483.htm.

6. Under Exchange Act section 12(i), banks do notregister their securities or file reports with the SEC.

7. The term “bank holding company” is defined in theBank Holding Company Act of 1956.

8. Frequently Asked Questions on Changes to theRequirements for Exchange Act Registration andDeregistration (April 11 2012), available at:http://www.sec.gov/divisions/corpfin/guidance/cfjjobsactfaq-12g.htm.

9. See, e.g., Peoples Financial Services Corp. (August16, 2012); Central Virginia Bankshares, Inc. (August8, 2012); AB&T Financial Corporation (July 272012); Botetourt Bankshares, Inc. (July 24 2012);First Ottawa Bankshares (July 23 2012); PotomacBancshares, Inc. (July 23 2012); Skagit StateBancorp, Inc. (July 20 2012); TouchmarkBancshares, Inc. (July 17 2012).

10. Report on Authority to Enforce Exchange Act Rule

12g5-1 and Subsection (b)(3) (October 15 2012),available at:http://www.sec.gov/news/studies/2012/authority-to-enforce-rule-12g5-1.pdf.

ENDNOTES


As discussed in the Introduction, the capitalmarkets have undergone significant changes inthe last decade. In 2003, as a result of legal andregulatory developments, the business of

research coverage changed quickly and fundamentally.These changes were brought about as a result of the entryby a number of investment banking firms into the GlobalResearch Analyst Settlement (the Global Settlement), theadoption of SRO rules relating to research, and thepromulgation by the SEC of Regulation AC. The GlobalSettlement addressed the most serious perceived conflictsbetween investment banking and research departmentsduring the dot-com boom, and required implementation ofvarious prophylactic measures by investment banking firmsthat provided research coverage, including separatingbanking and research structurally and physically, requiringa chaperone to monitor communications between the two,and requiring analyst compensation be determinedindependently and not be based on banking revenues.Regulation AC was designed to ensure research analystindependence and integrity by requiring that researchanalysts certify the truthfulness of the views expressed inresearch reports and public appearances. The rules adoptedby the NASD (Finra’s predecessor) and NYSE followedalong the same lines and also addressed the timing ofresearch reports in connection with offerings. In addition toimposing significant compliance burdens, together, theGlobal Settlement and the rules and regulations relating toresearch also brought about a significant cultural shift, andchanged fundamentally the role of research analysts and thebusiness of research coverage.1 In part, as a result of thesechanges, research coverage for smaller companies declined.As noted in the IPO Task Force Report, the lack of researchcoverage adversely impacts trading volumes, companymarket capitalisations and the total mix of informationavailable to market participants. In order to promote capitalformation by emerging growth companies, the IPO TaskForce Report recommended that policymakers consider theexisting restrictions on research, and adopt measures toencourage additional research coverage of emerging growthcompanies in order to improve the flow of information.Title I of the JOBS Act addresses certain of the concerns

raised by the IPO Task Force Report by implementing anumber of changes to the restrictions on the timing of, andon the publication of, research reports relating to emerginggrowth companies. As discussed below, however, the JOBSAct does not address the research safe harbours contained inthe Securities Act, nor does it address the regulations thatmandate the separation of research and investment bankingfunctions. In order to put the JOBS Act research-relatedchanges in context, below we provide a summary of therules and regulations governing the research function andthe release of research reports.

The regulatory framework applicable toresearchThe rules and regulations that apply to the relationshipbetween the research and investment banking departmentsof an investment banking firm include: Finra ConductRule 2711; NYSE Rule 472; SEC Regulation AC (AnalystCertification); and Rules 137, 138, and 139 under theSecurities Act. In addition, certain firms are bound by theterms of the Global Settlement.

During the dot-com boom, research analysts publishedreports recommending investments in the securities ofmany companies with which their firms had an advisory orinvestment banking relationship. In 1999, the SEC begana review of industry practices regarding the disclosure ofresearch analysts’ conflicts of interest. Committees of theUS House of Representatives and the Senate also heldhearings on research analysts’ conflicts of interests. In April2002, the SEC announced a formal inquiry into industrypractices concerning research analysts, their conflicts ofinterest and their relationships with the investmentbanking departments within their firms. Civil complaintswere filed by the SEC and other federal and stateregulatory and law enforcement authorities against thesefirms. The Global Settlement is an enforcement agreementfirst announced in December 2002 and finalised on April28 2003, among the SEC, NASD (now Finra), the NYSE,the New York State Attorney General and 10 of the then-largest investment banking firms in the United States(referred to here as the settling firms). As part of the GlobalSettlement, the settling firms agreed to several measures

CHAPTER 8

Research


designed to prevent abuse stemming from pressure byinvestment bankers on research analysts to providefavourable coverage of specific issuers or securities. Thesettling firms were required to separate their investmentbanking and research departments from each other bothphysically and with information firewalls. Additionally, thebudget allocation for research was to be independent ofinvestment banking. Research analysts were alsoprohibited from attending IPO pitches and road showswith investment bankers. Finally, research analysts’previously issued ratings about issuers had to be disclosedand made available. In addition to these regulatory actions,each settling firm was enjoined from violating the statutesand rules that it was alleged to have violated, and were alsorequired to pay fines to their investors, fund investoreducation and pay for independent third-party marketresearch. The Global Settlement remains in effect,although its terms have been modified from time to time.

The Sarbanes-Oxley Act required the SEC to addressconflicts of interest involving research analysts andinvestment bankers. In response to Sarbanes-Oxley, theNASD and the NYSE established rules and safeguards toseparate research analysts from the review, pressure andoversight of investment banking personnel. These rules areintended to ensure the integrity of research and to protectinvestors from being misled as a result of a failure todisclose potential conflicts of interest. On July 29 2003,the SEC announced the approval of a series of changes tothe rules affecting research analysts, generally embodied inFinra Rule 2711 and NYSE Rule 472 and referred to as theSRO rules. The SRO rules have since been amended manytimes (most recently on October 11 2012 to conform theSRO Rules to provisions of the JOBS Act).

The Global Settlement and SRO rules address reportinglines, requiring that research and investment banking beseparate units, and research not report to banking.Research must be physically separated from investmentbanking. This physical separation must be reasonablydesigned to ensure that there will not be any intentional orunintentional flow of information between research andinvestment banking. Research must have its own resourcesfor compliance and legal services. In addition, the researchbudget may not be controlled by investment banking, andcompensation for research personnel cannot be tied toinvestment banking business or revenues.2

Both the SRO rules and Regulation AC mandate thatresearch reports include certain disclosures. Researchreports must include disclosures relating to any actual orpotential conflicts of interest. For example, a researchreport must disclose whether a firm does or seeks to dobusiness with the company covered by the report; whether

it has received, or expects to receive, compensation fromthe subject company within a specified time period; andwhether analysts or other persons own securities of thesubject company. Regulation AC requires that reportscontain prominent certifications regarding the viewsexpressed in the research report, and attesting that theanalyst’s compensation was not tied to or related to specificrecommendations or views expressed by the researchanalyst in the research report.

The Global Settlement also limits the participation ofresearch personnel in offering related activities. Researchpersonnel may not participate in efforts to solicit businessfor investment banking, including, among other things,participating in any pitches, or otherwise communicatingwith a company or prospective client for the purpose ofsoliciting investment banking business.3 Further, SECinterpretive guidance states that it would be inconsistentwith section I.9 of Addendum A to the Global Settlementto allow investment banking personnel to include anyinformation regarding any research analyst employed bythe firm in a pitch book or any other presentationmaterials used to solicit investment banking business.Research personnel are not allowed to participate in anyroad shows sponsored by the company or investmentbanking related to a public offering or other investmentbanking transaction. However, SEC interpretive guidanceprovides that research personnel may listen (in listen-onlymode) or view a live webcast of these road shows. Researchpersonnel may also access other widely attendedpresentations to investors from a remote location, but ifthe presentation is in the firm’s building, they must be in aseparate room.

The Global Settlement permits certain communicationsbetween a research analyst and an issuer in connectionwith an offering. At an issuer’s request, investment bankingpersonnel may arrange for a department of the firm otherthan research to provide the issuer access to previouslypublished reports regarding that issuer that would beavailable from other sources. Should an issuer requestinvestment banking personnel to arrange a meetingbetween the issuer and a research analyst, the investmentbankers must instruct the issuer to contact research directlyand may not notify research in advance. A research analystis permitted to attend a meeting with an issuer and answerquestions regarding the analyst’s views on the company,but may not use it as an opportunity to solicit investmentbanking business, and investment banking personnel maynot be present or participate in any of these meetings.

The SRO rules subject member firms to quiet periodsduring which they may not publish research and duringwhich analysts may not make public appearances following


initial and secondary offerings and around thetermination, waiver or expiration of lock-up agreements,subject to certain exceptions.

Restrictions on communications affectingresearchIn addition to these rules and regulations that affect thestructure and business of research coverage, the SecuritiesAct imposes restrictions on offering relatedcommunications that impact the dissemination of researchreports.

A research report4 may be considered an offer or a non-conforming prospectus under the Securities Act.Information, opinions, or recommendations by a broker-dealer about securities of an issuer proposing to registersecurities under the Securities Act may constitute an offerto sell such securities, particularly when the broker-dealerparticipates in the distribution as an underwriter ormember of the selling group.5 The issuance of a researchreport in advance of a public offering could also technicallyconstitute gun-jumping (the illegal solicitation of an offerbefore a registered offering) and, as a result, a section 5violation.

Until relatively recently, the nature and content ofcommunications made around the time of a securitiesoffering were generally very limited because the SEC tookan expansive view of the concept of an offer. Under section2(a)(3) of the Securities Act, an offer is defined broadlyand includes every attempt or offer to dispose of, orsolicitation of an offer to buy, a security or interest in asecurity, for value.6 Before an issuer filed a registrationstatement, all offers in any form were prohibited.7 Betweenthe filing of the registration statement and its effectiveness,the only written offers that were permitted were those filedwith the SEC and that conformed to the requirementsapplicable to a statutory prospectus under section 10 of theSecurities Act.8 After the registration statement wasdeclared effective, written materials still were required tomeet the section 10 prospectus requirements. Additionaloffering-related materials were permitted only if a finalprospectus (conforming to the section 10(a) requirements)was delivered before or along with the additionalmaterials.9 These limitations did not relate to the accuracyor content of the communications. Any violation of theserules was considered gun jumping.10 The SEC’s restrictiveposition was founded on the belief that “the means ofcommunications were limited and restrictingcommunications (without regard to accuracy) to thestatutory prospectus appropriately balanced availablecommunications and investor protection.”11

In 2004, the SEC decided to revamp the securities

offering communications regime. In its release proposingthe Securities Offering Reform the SEC stated:

The capital markets, in the United States and aroundthe world, have changed significantly since thoselimitations were enacted. Today, issuers engage in all typesof communications on an ongoing basis, including,importantly, communications mandated or encouraged byour rules under the Exchange Act. Moderncommunications technology, including the Internet,provides a powerful, versatile, and cost-effective medium tocommunicate quickly and broadly. [footnote omitted] Thechanges in the Exchange Act disclosure regime and thetremendous growth in communications technology areresulting in more information being provided to themarket on a more non-discriminatory, current andongoing basis. Thus, while the investor protection concernsremain, the gun-jumping provisions of the Securities Actimpose substantial and increasingly unworkablerestrictions on communications that would be beneficial toinvestors and markets and consistent with investorprotection.12

As a result, as part of its 2005 Securities OfferingReform, the SEC redesigned the regulation ofcommunications in order to limit the types ofcommunications that would be deemed offers for purposesof section 5 of the Securities Act or prospectuses forpurposes of section 12(a)(2) of the Securities Act. Inconnection with Securities Offering Reform, the SECbroadened the existing safe harbours under the SecuritiesAct for certain research reports, which are contained inRules 137, 138, and 139. These safe harbours for certainresearch reports apply to all types of issuers (as opposed tothe JOBS Act’s provisions which apply only to emerginggrowth companies, or EGCs) who meet the requirementsof Rules 137, 138 and 139. The safe harbours expresslyexclude research reports from the definition of offers,offers for sale, and offers to sell13 under section 514. Notethat the safe harbours only apply to research reportsdistributed in advance of or during a public offering, aRule 144A offering or a Regulation S offering.15 It isunlikely, however, that a research report that meets therequirements set forth in the safe harbours would beconsidered a “general solicitation” in the context of aprivate placement.

Rules 137, 138, and 139 are designed to protectanalysts, brokers, and dealers from general solicitation andgun-jumping violations in connection with their regularlydisseminated research reports. In the Securities OfferingReform release, the SEC recognised that certain events,including passage of Sarbanes-Oxley, Regulation AC,revisions to the self-regulatory organisation rules governing


broker-dealers, and the global research analyst settlement,16

had addressed the “veracity and reliability” of researchreports, as well as other potential abuses associated withthese reports.17 In particular, the SEC stated that it expectsresearch reports “will better disclose conflicts of interestrelating to research of which investors should be aware.”18

In light of these developments, the SEC decided it was“appropriate to make measured revisions to the researchrules that are consistent with investor protection but thatwill permit dissemination of research around the time ofan offering under a broader range of circumstances.”19 Rule137 applies to broker-dealers not participating in aregistered offering and therefore not classed asunderwriters. In order not to violate the gun-jumpingprovisions and solicitation prohibitions, the broker-dealermust publish the report in the ordinary course of itsbusiness, and may not receive any consideration from, oract under any direct or indirect arrangement with, theissuer of the securities, a selling security holder, anyparticipant in the distribution of the securities, or anyother person interested in the securities. Furthermore, theissuer may not be, nor have been in the past three years: ablank cheque company,20 a shell company,21 or a pennystock issuer.22

Rule 138 applies to broker-dealers participating in thedistribution of a different security from that beingdiscussed in the research reports. Rule 138 permits abroker-dealer that is participating in the distribution of anissuer’s securities to publish and distribute research reportsthat either: relate solely to the issuer’s common stock, debtsecurities, or preferred stock convertible into commonstock, where the offering involves solely the issuer’s non-convertible debt securities or non-convertiblenon-participating preferred stock; or relate solely to theissuer’s non-convertible debt securities or non-convertible,non-participating preferred stock, where the offeringinvolves the issuer’s common stock, debt securities, orpreferred stock convertible into common stock. In order totake advantage of Rule 138, the broker-dealer mustregularly report on the types of securities that are thesubject of the research report. The issuer involved must notbe a blank cheque company, shell company or penny stockissuer and be either:• a reporting company (foreign or domestic) and current

in its Exchange Act filings; or• a foreign private issuer that meets all of the registrant

requirements of the revised Form F-323 (other than thereporting history provisions of General Instructions IA1and IA2(a) to Form F-3) and either: – satisfies the $75 million minimum public float

threshold in General Instruction I.B.1. of Form F-3,

or– is issuing non-convertible securities other than

common equity, and meets the provisions of GeneralInstruction IB2 of Form F-3; and either:

has its equity securities trading on a “designatedoffshore securities market” as defined in Rule902(b) of the Securities Act, and has had themtrading for at least 12 months, orhas a worldwide public float of $700 million ormore.

Rule 139 applies to broker-dealers participating in theregistered distribution of the same security as thatdiscussed in their disseminated research reports. Thebroker-dealer must publish or distribute research reports inthe regular course of its business, and such publication ordistribution cannot represent either the initiation ofpublication or the re-initiation of publication. The issuermay not be a blank cheque, shell or penny stock issuer, andmust: • have filed all required Exchange Act reports during the

preceding 12 months; • meet all the registrant requirements of the revised Form

S-3/F-3 (other than the reporting history provisions ofGeneral Instructions IA1 and IA2(a) to Form F-3), andeither: – satisfies the minimum public float threshold in

General Instruction IB1 of Forms S-3/F-3, – is or will be offering non-convertible securities other

than common equity and meet the thresholdpursuant to General Instruction IB2 of Form S-3/F-3,24 or is

a WKSI as defined in Rule 405 of the SecuritiesAct, ora foreign private issuer that satisfies the samerequirements as for Rule 138.

Over time, commentators have noted that the SEC’scommunications rules are outmoded and need to berevised because they have the effect of inhibiting moreinformation from being made available to the investingpublic. The IPO Task Force Report recommended that theSEC expand the existing safe harbours in order to permitbroker-dealers to initiate coverage and distribute researchon IPO issuers without being deemed to have offeredsecurities through the research reports, and include oral (inaddition to written) communications within the scope ofthe safe harbours.

JOBS Act Title I changesRecognising the contribution of research coverage to themarket for emerging companies, the JOBS Act attemptedto address some logistical issues relating to the diligence


activities undertaken in connection with IPOs; however, itdid not supersede the Global Settlement. The JOBS Actalso eliminated certain quiet period restrictions onpublication of research reports in offerings by emerginggrowth companies.

Research reports and offersSection 105 of the JOBS Act permits a broker-dealer topublish or distribute a research report about an EGC thatproposes to register an offering of common stock underthe Securities Act or has a registration statement pending,and the research report will not be deemed an offer undersection 2(a)(3) of the Securities Act, even if the broker-dealer will participate or is participating in the offering.Section 105(a) of the JOBS Act defines a research report as“a written, electronic, or oral communication that includesinformation, opinions, or recommendations with respectto securities of an issuer or an analysis of a security or anissuer, whether or not it provides information reasonablysufficient upon which to base an investment decision” (ouremphasis). This differs from the definition of a researchreport in the SRO rules and Global Settlement, where theinformation contained in the report must be reasonablysufficient to form the basis for an investor’s decision.Accordingly, the definition of research report for purposesof the JOBS Act would encompass nearly any written ororal communication relating to an EGC or its securitiesmade by a broker-dealer.

Section 105(a) of the JOBS Act provides that a researchreport published by a broker-dealer about an EGC that isplanning a public offering of common equity securitieswill not be considered an offer for purposes of section2(a)(10) and section 5(c) of the Securities Act. As a result,the issuance of a written research report by a broker-dealerwill not trigger a section 5 violation and would notconstitute a written offer “by means of a prospectus” forpurposes of potential liability under section 12(a)(2). Bycontrast, the JOBS Act does not provide an exemptionfrom section 12(a)(2) liability for testing-the-waterscommunications under the JOBS Act, but only fromsection 5. Therefore, a research report would have greaterprotection from liability under the JOBS Act than testing-the-waters materials. Whether an oral research report maybe subject to section 12(a)(2) liability is more complicated.The JOBS Act does not provide a safe harbour undersection 12(a)(2) with respect to oral research reports.Consequently, an oral research report could still result insection 12(a)(2) liability if it is deemed to constitute anoffer of a security. As a general matter, it is worth notingthat the JOBS Act has no impact on liability under Rule10b-5 or state anti-fraud laws.

Research participation in certain meetingsSection 105(b) prohibits any SRO and the SEC fromadopting any rule or regulation that would restrict a broker-dealer from participating in certain meetings relating toEGCs. The JOBS Act also removes restrictions on whowithin an investment bank can arrange for communicationsbetween research analysts and prospective investors inconnection with an EGC IPO, permitting investmentbankers to be involved in those arrangements. Further, aresearch analyst would be permitted to engage in anycommunications with an EGC’s management when otheremployees of the investment bank, including the investmentbankers, are present.

Under section 105(b) of the JOBS Act, an associatedperson of a broker-dealer, including investment bankingpersonnel, may arrange communications between researchanalysts and investors. This activity would include, forexample, an investment banker forwarding a list of clientsto the research analyst that the analyst could, at his or herown discretion and with appropriate controls, contact. Inturn, a research analyst could forward a list of potentialclients it intends to communicate with to investmentbanking personnel as a means to facilitate scheduling.Investment bankers can also arrange, but not participatein, calls between analysts and clients. In August 22 2012,the SEC’s Division of Trading and Markets published ahighly anticipated series of JOBS Act Frequently AskedQuestions entitled ‘About Research Analysts andUnderwriters,’ which addressed various research-relatedmatters. In the SEC FAQs, the SEC has stated that sucharranging activity, without more, would not violate FinraRule 2711 or NYSE Rule 472 although it notes that firmsshould be mindful of other provisions of the Exchange Actand the SRO Rules as well as the applicability of theGlobal Settlement.25

The JOBS Act prohibits a national securities associationor the SEC from maintaining rules restricting researchanalysts from participating in meetings with investmentbanking personnel and an EGC in connection with anEGC’s IPO. Before the enactment of the JOBS Act,research personnel were prohibited from attendingmeetings with issuer management that were also attendedby investment banking personnel in connection with anIPO, including pitch meetings. Section 105(b) of theJOBS Act permits research personnel to participate in anycommunication with the management of an EGCconcerning an IPO that is also attended by any otherassociated person of a broker, dealer, or member of anational securities association whose functional role isother than as an analyst, including investment banking


personnel. The SEC has interpreted this section asprimarily reflecting a Congressional intent to allowresearch personnel to participate in EGC managementpresentations with sales force personnel so that the issuer’smanagement would not need to make separate andduplicative presentations to research personnel at a timewhen resources of the EGC may be limited.

The SEC stated in the SEC FAQs that researchpersonnel must limit their participation in such meetingsto introducing themselves, outlining their researchprogramme and the types of factors that they wouldconsider in their analysis of a company, and asking follow-up questions to better understand a factual statementmade by the EGC’s management. In addition, after thefirm is formally retained to underwrite the offering,research personnel could, for example, participate inpresentations by the management of an EGC to educate afirm’s sales force about the company and discuss industrytrends, provide information obtained from investingcustomers, and communicate their views.26

In their October 11 2012 amendments (which becameeffective retroactive to April 5 2012, the date the JOBS Actwas enacted), Finra amended Rule 2711(c)(4) to conformto the provisions of the JOBS Act, specifically to providethat, while research analysts are prohibited from solicitingbusiness for investment banking, they are not preventedfrom attending a pitch meeting in connection with aninitial public offering of an EGC that is also attended byinvestment banking personnel; provided, however, that aresearch analyst may not engage in otherwise prohibitedconduct in such meetings.27

In the SEC’s view, section 105(b)(2) of the JOBS Actallows a firm to avoid the ministerial burdens of organisingseparate and potentially duplicative meetings andpresentations among an EGC’s management team,investment banking personnel, and research analysts.Section 105(b)(2) did not address communications whereinvestors are present together with company management,analysts and investment banking personnel. Therefore, theSEC has taken the view that this provision of the JOBS Actdoes not affect the SRO rules prohibiting analysts fromparticipating in road shows or otherwise engaging incommunications with customers about an investmentbanking transaction in the presence of investment bankersor the company’s management. These rules apply tocommunications with customers and other investors anddo not depend on whether analysts, investment bankers,and management are participating jointly in suchcommunications.28

The FAQs confirm that Regulation AC is not affectedby the JOBS Act.

Quiet periodsA broker-dealer participating in an issuer’s IPO is generallysubject to certain blackout periods with respect topublishing of research reports about such issuer. Thepublication of research is prohibited in advance of the IPOand, once the IPO has priced, no research can be publisheduntil 40 days following the offering. Additionally, thepublication of any research must be suspended for the 15days before and after the release or expiration of any lock-up agreement.

The JOBS Act now prohibits any national securitiesassociation (which includes Finra) or the SEC fromadopting any rule or regulation prohibiting a broker-dealerfrom publishing or distributing a research report ormaking a public appearance with respect to the securitiesof an EGC within any prescribed period of time followingthe EGC’s IPO or the expiration date of any lock-upagreement. This eliminates the traditional post-IPO quietperiod for EGCs.

On October 11 2012, the SEC granted acceleratedapproval for amendments to the SRO rules, effectiveimmediately, that conform to the requirements of theJOBS Act related to research analysts and research reportsin certain offerings by EGCs. In addition, theamendments eliminated the quiet periods in connectionwith IPOs and secondary offerings of EGCs by theadoption of new Finra Rule 2711(5), which states that thelock up periods discussed in paragraphs (f )(1), (f )(2) and(f )(4) of Finra Rule 2711, “shall not apply to thepublication or distribution of a research report or a publicappearance following an initial public offering orsecondary offering of the securities of an EmergingGrowth Company” (seehttp://www.sec.gov/rules/sro/finra/2012/34-68037.pdf ).

The JOBS Act also did not explicitly permit publicationor distribution of a research report relating to an EGCafter the expiration, termination, or waiver of a lock-upagreement or prohibit quiet periods after a follow-onoffering of an EGC’s securities. The adoption of theamendments to the SRO Rules have made clear that boththe SEC and Finra interpret the JOBS Act to apply equallyto permit publication of research reports on an EGC’ssecurities, no matter how the lock-up period ends – bytermination, expiration, or waiver – both before and afterthe termination, expiration, or waiver of the agreement,eliminating all quiet periods for EGCs.

Section 105(d) of the JOBS Act provides that neither anSRO nor the SEC may adopt or maintain any rule orregulation prohibiting a broker-dealer from publishing ordistributing a research report or making a public


appearance with respect to the securities of an EGCfollowing an offering or in a period before (althoughnotably not after) expiration of a lock-up.

The FAQs also clarify that the JOBS Act should beunderstood to apply to NYSE Rule 472 to the same extentas it applies to NASD Rule 2711. Further, the FAQsexplain that the Staff views the prohibition on quiet periodrules contained in section 105(d)(2) as applying to thequiet periods on research at the termination, waiver,modification, etc. of a lock-up agreement (in connectionwith an emerging growth company IPO or a follow-onoffering) regardless of the means by which the lock-upperiod comes to a close.

Other restrictions on researchThe JOBS Act does not affect or amend most of theexisting rules and regulations dealing with the separationof research and investment banking, even in relation toEGCs. The JOBS Act does not address or amendRegulation AC. The JOBS Act does not directly addressthe Global Settlement and, as the Global Settlement is ajudicial order and not an SEC or Finra rule, it istechnically not affected by the enactment of the JOBS Act.It is important to remember, however, that the GlobalSettlement only affects the eight remaining settling firms.All other broker-dealers not party to the Global Settlementare able to take advantage of the self-effectuatingprovisions of the JOBS Act described above. It remains tobe seen whether the settling firms will petition the courtfor another amendment to the Global Settlement toconform to the provisions of the JOBS Act. The JOBS Actalso does not address the existing research safe harbours,and it is unclear when the SEC will amend Rules 137, 138,and 139 to address the effects of the JOBS Act. The tablein Appendix A compares the actions, as they relate toresearch and investment banking personnel, which arepermitted before and after the enactment of the JOBSAct.29

The future of researchTo date, following enactment of the JOBS Act, most firmshave proceeded cautiously in respect of research relating toEGCs. In the United States, there has not been (giventraditional restrictions on offering relatedcommunications) any history of pre-deal research. It is notclear that firms will become comfortable with pre-dealIPO research even following the JOBS Act. Firms havepublished research reports on EGCs that have completedtheir IPOs; however, generally, these research reports havebeen published at least 25 days following completion ofthe IPOs. Even firms that are not parties to the Global

Settlement have not been quick to publish research reportsimmediately upon completion of the IPO. Over time, aspractitioners become more comfortable with the newrules, and compliance departments of investment bankingfirms are able to adapt to these new rules, market practicemay evolve. Commentators continue to emphasise theimportance of availability to retail investors of informationthat is contained in research reports. The experiences inrecent offerings have led many to advocate for additionalchanges related to research reports and to calls to requirethat any research views shared with institutional investorsor with a limited number of investors be shared morebroadly. We discuss these issues further in Chapter 9.


Appendix A

May research personnel …

publish research reports concerningthe securities of an issuer immedi-ately following its IPO or expirationof any lock-up agreement?

publish research reports concerningissuers that are the subject of anypublic offering of common equitysecurities (even if the firm is partici-pating in the offering)?

participate in meetings with repre-sentatives of an issuer, attended byinvestment banking personnel?

contact potential investors in anissuer’s IPO?

make public appearances concern-ing the securities of an issuer?

solicit business for investment bank-ing personnel?

engage in communications withpotential investors in the presence ofinvestment banking personnel?

share price targets and ratings withan issuer before the launch of adeal?

be compensated based on invest-ment banking revenue?

Pre-JOBS Act

All issuers

Prohibited

Prohibited

Prohibited

Prohibited

Prohibited

Prohibited

Prohibited

Prohibited

Prohibited

Post-JOBS Act

EGC

Permitted

Permitted

Permitted

Permitted

Permitted

Prohibited

Prohibited

Prohibited

Prohibited

Non-EGC

Prohibited

Prohibited

Prohibited

Prohibited

Prohibited

Prohibited

Prohibited

Prohibited

Prohibited


1 See IPO Task Force Report, available athttp://www.sec.gov/info/smallbus/acsec/rebuilding_the_ipo_on-ramp.pdf, at 26.

2 See Global Settlement (I)(1):http://www.sec.gov/litigation/litreleases/finaljudgadda.pdf; Finra Rule 2711; NYSE Rule 472.

3 See Global Settlement Addendum A.4 A research report is defined as a written

communication that includes information, opinions orrecommendations with respect to securities of an issueror an analysis of an issuer, whether or not it providesinformation reasonably sufficient upon which to basean investment decision. Rule 137(e) of the SecuritiesAct.

5 See Adoption of Rules Relating to Publication ofInformation and Delivery of Prospectus by Broker-Dealers Prior to or After the Filing of a RegistrationStatement Under the Securities Act of 1933, SecuritiesAct Release No. 33-5101, 1970 WL 10585 (November19 1970).

6 See, e.g., id. at n.88 (“the publication of informationand publicity efforts, made in advance of a proposedfinancing which have the effect of conditioning thepublic mind or arousing public interest in the issuer orin its securities constitutes an offer …”) (citingSecurities Act Release No. 33-5180, 1971 WL 120474(August 20 1971)).

7 Section 5(c) of the Securities Act, 15 USC § 77e(c).8 Section 5(b) of the Securities Act, 15 USC § 77e(b).9 See the definition of prospectus in section 2(a)(10) of

the Securities Act, 15 USC § 77b.10 Securities Offering Reform Release, No. 33-8591,

2005, WL 1692642 (July 19 2005), at 39–40. Gun-jumping refers to the illegal solicitation of an offerbefore a registered offering.

11 Reform Release, supra note 10, at 16.12 Id. at n.55. See also id. at 41–42.13 See section 2(3) of the Securities Act.14 See Rules 137–39 of the Securities Act.15 See Rule 139(b)–(c) of the Securities Act.16 See SEC Litigation Release No. 18438 (Oct. 31, 2003).17 Reform Release, supra note 11, at 155.18 Id.19 Id. at 156. Research reports issued in reliance on Rule

137, 138, or 139 continue to be subject to theantifraud provisions of the federal securities laws,including liability under section 17(a) of the Securities

Act, section 10(b) of the Exchange Act, and Rule 10b-5 of the Exchange Act.

20 A blank cheque company is a development stagecompany that has no specific business plan or purposeor has indicated its business plan is to engage in amerger or acquisition with an unidentified company orcompanies, other entity, or person. SEC Rule419(a)(2).

21 A shell corporation is a company that serves as avehicle for business transactions without itself havingany significant assets or operations. SEC Rule 405.

22 A penny stock issuer is a very small issuer of low-pricedspeculative securities. Since penny stocks are difficult toaccurately price, there are specific SEC rules that mustbe satisfied before a broker-dealer can sell a pennystock, and the SEC does not allow the issuer to usecertain exemptions from the registration requirementswhen selling their securities. Exchange Act Rule 3a51-1.

23 Effective as of September 2 2011, the SEC amendedForm S-3 and Form F-3 by revising GeneralInstruction IB2 to eliminate the use of credit ratings asa transaction eligibility standard and replace it with analternative set of standards. The new standards providethat an offering of non-convertible securities is eligibleto be registered on Form S-3 or Form F-3 if the issuermeets the Registrant Requirements in GeneralInstruction IA, and either has issued at least $1 billionof non-convertible securities in transactions registeredunder the Securities Act, other than equity securities,for cash during the past three years, has outstanding atleast $750 million of non-convertible securities, otherthan common equity, issued in primary offerings forcash registered under the Securities Act (each asmeasured from a date within 60 days of the filing ofthe registration statement); or is a wholly ownedsubsidiary of a WKSI.

24 Id.25 See SEC FAQs, supra note 3 at Question 3.26 See SEC FAQs, supra note 3 at Question 4.27 See http://www.sec.gov/rules/sro/finra/2012/34-

68037.pdf28 See SEC FAQs, at Question 5.29 This chart originally appeared in Morrison & Foerster’s

Frequently Asked Questions About Separation ofResearch and Investment Banking.

ENDNOTES


As we noted in the Introduction, the JOBS Actwas the continuation of a dialogue regardingthe impact of increased regulation andincreased disclosure requirements on capital

formation and on the IPO process more specifically. In themonths ahead, the SEC must continue to make progresswith the implementation of the regulations required by theJOBS Act. It is also likely that, in addition to these rule-making initiatives, we will see additional consideration of anumber of topics related to capital formation in the UnitedStates. Below, we highlight what we believe to be a few ofthe areas that are likely to receive substantive attention inthe near future.

Accredited investor statusAs discussed in Chapter 4, Title II of the JOBS Actrequired that the SEC implement regulations relaxing theprohibition against general solicitation and generaladvertising in connection with certain private offeringsconducted pursuant to Rule 506 under Regulation D. TheJOBS Act also required an additional measure ofverification of the investor’s status as an accredited investorin connection with any Rule 506 offering employinggeneral solicitation. Investor verification was requiredgiven that for private placements where general solicitationwas used it was possible for an issuer or a financialintermediary working on the issuer’s behalf to contactpotential investors with whom neither the issuer nor thefinancial adviser had a pre-existing relationship.Congresswoman Maxine Waters was the sponsor of anamendment to HR 2940 that created the requirement ofreasonable steps to verify, and her language was ultimatelyincluded in section 201(a)(1) of the JOBS Act. Watersexplained the rationale for her amendment as follows:

… I am concerned about the process in whichaccredited investors verify that they are in fact accredited.As I understand it, it is currently a self-certificationprocess. This obviously leaves room for fraud … If we arerolling back protections for our targeted audience ofsophisticated individuals, we must take steps to ensurethat those folks are in fact sophisticated.1

Historically, in the United States, the statutory private

placement exemption, or section 4(a)(2) exemption, wasavailable for a “private offering,” which was understood tobe an offering made on a limited basis to a group ofinvestors with whom the issuer, or the issuer’s agent, had apre-existing relationship, and who were in a position tohave or to obtain certain information about the issuer. Anoffering made under proposed Rule 506(c) would still beconsidered a private placement; however, it would involvean offering to investors with whom the issuer potentiallyhad no pre-existing relationship, and who might notnecessarily receive any specified information about theissuer before making their investment decision. As a result,many commentators writing to the SEC about itsproposed Rule 506 rules have expressed investorprotection concerns. Commentators have noted that thereis enhanced opportunity for fraudulent practices wheregeneral solicitation is used. News about a potential privateoffering may reach investors that are not accreditedinvestors, and the information circulated about a potentialinvestment opportunity may contain puffery or othermisstatements. As a result of these concerns, many,including SEC Commissioner Aguilar have suggested thatthe SEC should revisit the definition of accredited investorand consider whether the definition sufficiently identifiesinvestors that have the requisite financial sophistication tofend for themselves and not have the protections associatedwith registered securities offerings.2

Recent changes to the definition of accreditedinvestorOn December 21 2011, the SEC amended the accreditedinvestor standards in its rules under the Securities Act toimplement section 413(a) of the Dodd-Frank Act.3 Thechange to the net worth standard was effective uponenactment by operation of the Dodd-Frank Act on July 212010; however, section 413(a) also required the SEC torevise its Securities Act rules to conform to the newstandard.4 Rules 2155 and 501(a)(5)6 under the SecuritiesAct set forth the accredited investor standards.7 Pursuant tosection 413(a) of the Dodd-Frank Act, the SEC is requiredto adjust the net worth standard for natural personsindividually or jointly with their spouse, to “more than

CHAPTER 9

Other capital formation discussions


$1,000,000 … excluding the value of the primaryresidence.”8 Before the adoption of section 413(a), thestandard under Rules 215 and 501(a)(5) required aminimum net worth of more than $1 million, butpermitted an individual investor and his or her spouse toinclude the net equity value of their primary residence incalculating whether they qualified for accredited investorstatus.9

In amending Rules 215 and 501(a)(5) to conform to thenew standard under the Dodd-Frank Act, the SECadopted identical language in the two rules,10 definingindividual accredited investor status to require net worthin excess of $1 million, provided that “[t]he person’sprimary residence shall not be included as an asset.” Thefinal accredited investor definition is consistent with theapproach taken in the proposing release with respect to thebasic treatment of the primary residence and indebtednesssecured by the primary residence.11 The final rules alsoprovide a specific provision addressing the treatment ofincremental debt secured by the primary residence that isincurred in the 60 days before the sale of securities to theindividual in the exempt offering and certain newgrandfather provisions.

The new standard discusses the treatment of mortgagedebt in calculating net worth. “Indebtedness that issecured by the person’s primary residence, up to theestimated fair market value of the primary residence at thetime of the sale of securities, shall not be included as aliability …”12 Thus, under the final rules, as in theproposing release, net worth is calculated by excludingpositive equity an investor may have in its primaryresidence.13 The SEC believed this approach to be the mostappropriate way to conform its rules to section 413(a)stating: “it reduces the net worth measure by the netamount that the primary residence contributed to networth before enactment of section 413(a), which webelieve is what is commonly meant by ‘the value of aperson’s primary residence’.”14 The final rules also providethat any excess of indebtedness secured by the primaryresidence over the estimated fair market value of theresidence is considered a liability for purposes ofdetermining accredited investor status on the basis of networth, whether or not the lender can seek repayment fromother assets in default.15 In the SEC’s view, the full amountof the debt incurred by the investor is the most appropriatevalue to use in determining accredited investor status.16

Continuing review and mandatory studySection 413(b) of the Dodd-Frank Act provides that fouryears after enactment, and every four years thereafter, theSEC must review the accredited investor definition as

applied to natural persons, including adjusting thethreshold, although it may not be lowered below $1million.17 Section 415 of the Dodd-Frank Act requires theComptroller General of the United States to conduct aStudy and Report on Accredited Investors examining “theappropriate criteria for determining the financialthresholds or other criteria needed to qualify for accreditedinvestor status and eligibility to invest in private funds.”18

The study is due three years after the enactment of theDodd-Frank Act and is expected to be taken into accountby the SEC in future rulemakings in this area.19

Proposed revisions of the accredited investorstandardThese recent changes to the accredited investor standarddid not fundamentally alter the basic premise of thedefinition – that is, net worth continues to be used as aproxy for financial sophistication, or, at least for the abilityto bear a certain measure of investment risk. Thecommentators writing to the SEC in connection with theRule 506 rulemaking have noted that perhaps the networth test has outlived its usefulness and that otherstandards should be considered that might better identifya category of investors not needing the protectionsafforded in connection with registered securities offerings.For example, the Investment Company Institute in itscomment letter stated:

We firmly believe that the income and net worth testsin the definition of accredited investor no longer servestheir intended purpose: to identify a universe ofindividual investors that can fend for themselves and donot need the protections of the securities laws. There is noquestion that the income and net worth tests havesubstantially eroded since 1982, when they wereestablished.Others have cited greater concerns in connection with

offerings using general solicitation conducted by privatefunds or hedge funds, and have suggested that the SECconsider a separate sophistication standard for offerings byprivate funds. Yet another group of commentators hasobserved that the level of financial literacy remainsremarkably low. In fact, the SEC published a study onfinancial literacy, mandated by section 917 of the Dodd-Frank Act, which found that retail investors in the UnitedStates lack basic financial literacy.20

Large accredited investorsIn August 2007, the SEC proposed a variety of changesrelating to private placements, some of which wereadopted. In those proposals, the SEC had consideredcreating a new a new exemption (Rule 507) from the


registration provisions of the Securities Act for offers andsales of securities to “large accredited investors” pursuantto the general exemptive authority provided in section 28of the Securities Act that would permit an issuer to publisha limited announcement of the offering. In addition, theproposals incorporated a definition of large accreditedinvestor based on the accredited investor definition, butwith higher and somewhat different dollar amountthresholds, and would have made changes such that legalentities considered accredited investors if their assetsexceed $5 million would be required to have $10 millionin investments to qualify as large accredited investors; thatindividuals generally would be required to own $2.5million in investments or have an annual income of$400,000 ($600,000 with a spouse) in order to qualify aslarge accredited investors, compared to the currentaccredited investor standard of $1 million in net worth oran annual income of $200,000 ($300,000 with a spouse).Large accredited investors that participated in exemptofferings would be considered qualified purchasers undersection 18(b)(3) of the Securities Act, thereby resulting incovered security status and the pre-emption of certain statesecurities regulation. The SEC proposal also includedadding an alternative investments-owned standard fordetermining accredited investor and large accreditedinvestor status. Ultimately, these provisions of the 2007proposals were not adopted; however, there is reason tobelieve that consideration of the Rule 506 rulemaking maylead to re-evaluation of these measures.

Content standards and filing requirementsThe Rule 506 rule proposals also have led to suggestionsfrom commentators that for Rule 506 offerings relying ongeneral solicitation the SEC should consider theappropriateness of imposing content standards on thematerials used in the sales process. Some commentatorsnote that issuers and financial intermediaries should berequired to include disclaimers or warning labels on thematerials that are used to market Rule 506 offerings usinggeneral solicitation. Currently, there are no specifiedinformation requirements in connection with traditionalRule 506 offerings. There are, however, certain requireddisclosures contemplated in the context of crowdfundedofferings. Other commentators note that specialrequirements should be imposed in the context of Rule506 offerings by private funds. The Investment CompanyInstitute, for example, advocated in its letter that the SECimpose content restrictions on private fund advertising,prohibit performance advertising by private funds untilregulations are promulgated that would standardiserequirements for performance information, and require

Finra review of the materials used in connection with theseofferings. Others have suggested that the SEC considerrequiring issuers to file or submit the materials used inconnection with their general solicitation so that the SECcan study the types of information used for this purpose.

Offering-related communicationsIn the Introduction, we reviewed an exchange ofcorrespondence in 2011 between Congressman DarrellIssa and SEC chairman Schapiro relating to, among otherthings, capital formation. In those 2011 letters, Issaquestioned whether the SEC’s regulations relating tooffering related communications had a chilling effect oncapital formation. The SEC committed to review its rulesrelating to offering related communications. The Issa-Schapiro dialogue had a second act in mid-2012. In June,Issa wrote a letter to Schapiro inquiring about theregulatory structure applicable to IPOs.21 The letterspecifically address “barriers to communicating withinvestors” during the IPO process. Issa referenced publicreports that noted that during the Facebook IPO certain ofthe underwriters may have provided institutional investorswith information about revenue forecasts for Facebook,and questioned whether SEC regulations relating tooffering communications had the effect of creatinginformation disparities. Issa also questioned whether therewere sufficient safe harbours for research reports such thatresearch analysts would be encouraged to make reportsavailable broadly, including to retail investors. This was notthe first time that concerns had been raised regarding thedissemination of information in IPOs. Going as far back as2003, a committee convened by the New York StockExchange and the NASD at the SEC’s request, referred toas the IPO Advisory Committee, published a report thatmade a number of recommendations that were designed torestore investor confidence in IPOs.22 The IPO AdvisoryCommittee report included a section on levelling theplaying field that suggested that issuers be required tomake a version of their IPO roadshow available publicly onan unrestricted basis; and that underwriters disclose finalIPO allocations to issuers. In her response letter dated June19 2012, Schapiro reiterated the SEC’s views that thestatutory prospectus should be the primary source ofinformation for investors, but referred to variouscommunications reforms, including Securities OfferingReform in 2005, which had relaxed restrictions oncommunications.23 Schapiro also recognised theimportance of research reports and observed that the SEChad modernised the safe harbours for research reports. Aswe discuss in Chapter 8, the JOBS Act provides greaterflexibility to publish research reports relating to EGCs. As


Schapiro noted in her letter, however, despite that greaterflexibility, investment banks may choose not todisseminate broadly their research and may providedifferent research products to different types of investors.The SEC does not mandate that research reports be madepublicly available. Moreover, although the SEC hasliberalised offering communications and underwriters havethe opportunity to use “underwriter” free-writingprospectuses in order to make available supplementalinformation about an issuer or the offered securities, inpractice, these are rarely used.

Issa’s letter also inquired whether there should bebroader safe harbours to address the inclusion of forward-looking information and projections in prospectuses andin free-writing prospectuses, and asked the SEC toconsider whether additional safe harbours should beadopted to protect communications, including forecasts,made in research reports. Schapiro noted the existence ofsafe harbours for certain forward-lookingcommunications. She also pointed out that liability wouldnot extend to a research analyst’s failure to predictaccurately an issuer’s future performance.

This most recent Issa-Schapiro exchange makes forinteresting reading, and may be the beginning of a broaderdiscussion related to offering communications, and afurther levelling of the playing field as between retail andinstitutional investors. We would anticipate that the SECwill continue to consider the regulations applicable tooffering communications.

The structure of IPOsThe Issa letter to Schapiro also raises some fundamentalquestions regarding the structure of IPOs in the UnitedStates, where the book building process has long beenrelied upon for public offerings. As part of the bookbuilding process, underwriters will meet with institutionalinvestors and the issuer and the underwriter will conduct aroad show that will include in-person meetings withgroups of institutional investors. During the marketingprocess, the underwriters will gather informal indicationsof interest from institutional investors about the extent oftheir interest in an investment in the issuer’s securities, andtheir pricing sensitivities. Over the marketing period, theunderwriters begin to form a book of interest based onthese conversations.

Issa questions whether this traditional book buildingapproach allows the underwriters to exercise too muchdiscretion over the IPO process, and questions whether theapproach may be fraught with conflicts that may lead toinaccurate pricing. Issa cites to the experience of theFacebook IPO. He also wonders whether the process has

the effect of foreclosing opportunities for meaningful retailparticipation in IPOs. Finally, Issa asks the SEC tocomment on whether it has considered whetheralternatives, such as auction-based pricing, would be morebeneficial and potentially less subject to overpricing andconflicts of interest. Again, this is another area that hadbeen explored many times before Issa’s letter. The IPOAdvisory Committee in 2003 considered whetheralternatives to the book building approach should beadvanced. In other jurisdictions, there are examples ofmodified book building approaches, where specifiedpercentages are reserved for retail investor orders, as well asexamples of auction-based approaches. Academics havedevoted substantial attention to considering whether bookbuilding or auction-based approaches are beneficial toissuers and investors. In fact, Schapiro in her response toIssa provides a very thorough survey of the leadingacademic literature on IPO under-pricing and theadvantages and disadvantages associated with the bookbuilding and the auction-based models. More or less at thesame time, the US Senate Banking Committee’sSubcommittee on Securities, Insurance and Investmentheld hearings examining the IPO process. Legislators hadas their objective considering whether the IPO process isfair and transparent, and whether the IPO market operateseffectively for both institutional and retail investors. DrAnn Sherman provided testimony regarding the IPOmethods used in different countries and commented onthe costs and benefits of various approaches, concludingthat retail investors are unlikely to contribute to moreaccurate IPO pricing. Sherman and other participants inthe hearing did conclude that there was unequal access toinformation regarding IPOs. Sherman suggested requiringissuers to make their road show materials publiclyavailable. Others suggested extending the application ofRegulation FD in order to make certain that retailinvestors had access to the same information that wasprovided to institutional investors.

It is likely that academics, legislators and the SEC willcontinue to consider changes in the IPO process in thenear future.

Disclosure requirementsThe JOBS Act’s IPO on-ramp provisions attempt tostreamline the disclosure requirements for EGCsundertaking an IPO; however, as we discuss in Chapter 1,in practice, market participants have been reluctant to takefull advantage of certain of these benefits. The SEC also ismandated by Title I of the JOBS Act to undertake a studyof the disclosure requirements set forth in Regulation S-K.Many practitioners have noted that even with the scaled


disclosure requirements applicable to smaller reportingcompanies and the disclosure accommodations madeavailable to EGCs by the JOBS Act, the SEC disclosurerequirements and disclosure practices still seem to result inincredibly detailed and lengthy IPO documents that areoften hundreds of pages long. Commentators have notedthat, for a retail investor, it may be difficult to wadethrough dense disclosures, and to assess which risks aremost critical to the issuer’s future prospectus and businessresults. For this reason, some commentators haveencouraged the SEC to review whether certain disclosurerequirements may be modernised or simplified.

The in-betweenersAs we have noted elsewhere, over time, the SEC has donemuch to modernise its regulations relating to offeringcommunications, and also has adopted changes to improvethe capital formation process. Securities Offering Reformin 2005 simplified the offering process for the largest andmost sophisticated public companies, WKSIs, andprovided these companies with greater flexibility foroffering related communications. Companies that areconsidered smaller reporting companies are entitled to relyon certain scaled disclosure requirements. Now, EGCsmay elect to take advantage of the IPO on-ramp disclosureaccommodations. Many mid-sized companies cannotbenefit from EGC status (due to the timing of their initialofferings of equity securities) and are larger than smallerreporting companies and not entitled to scaled disclosureprovisions. We refer to these companies as in-betweeners.Their disclosure and reporting concerns have not beenaddressed. In addition, these companies have capital-raising needs that also have not been addressed bySecurities Offering Reform or by the modifications madeto the eligibility requirements for use of shelf registrationstatements for primary offerings. We anticipate that theSEC will continue to evaluate the need to address capitalformation issues, and will consider making appropriateadjustments to existing regulations for these issuers.

Information requirements and continuingreporting requirementsIn the post-JOBS Act world, there may be some disparitiesin the information requirements that arise for an issuerdepending on the securities offering exemption that theissuer chooses to rely on in connection with its capital-raising efforts. For example, following enactment of theJOBS Act, an issuer may conduct a Rule 506 offeringusing general solicitation and make sales to investors thatare verified to be accredited investors. The issuer is notsubject to any information requirements. The securities

sold in a Rule 506 offering will be covered securities. Thesecurities also will be restricted securities. Conceivably, anissuer could conduct multiple Rule 506 offerings, and, ifthe issuer remains below the holder-of-record threshold,the issuer would remain exempt from any requirement toprovide information to security-holders. By contrast, anissuer might choose to raise modest amounts of capital incrowdfunded offerings through a funding portal or abroker-dealer made to a broader universe of potentialinvestors, provided that the issuer complies with certainlimited information requirements and thereafter makespublicly available certain limited information. Thesecurities sold in a crowdfunded offering will be restrictedsecurities. Title IV of the JOBS Act contemplates that anissuer that is not an SEC-reporting company may rely onthe new section 3(b)(2) exemption to offer securitiespublicly, which will not be restricted securities, providedthat the issuer satisfies certain information requirements.Following a section 3(b)(2) offering, the issuer may chooseto remain private although it will have issued shares in abroad-based offering, and may be subject to certain SECreporting requirements, although these are likely to belimited. In addition, given the growth of private secondarymarkets, the securities of a private company may beactively traded through the facilities of a private secondarymarket and, provided the issuer remains under the holder-of-record threshold, it will not be subject to informationrequirements. There also may be issuers that have securitiesthat trade on the Pink Sheets and there may not necessarilybe robust publicly available disclosures for investors. It islikely that this is an area on which the SEC will focus aspart of its investor protection mission.

Going forwardGiven that the SEC still must undertake significantrulemaking in order to comply with the mandate of theJOBS Act, it would be premature to make any assessmentsregarding the impact that the Act has had (or will have) oncapital formation in the United States. It is not too early,however, to conclude that it has been a catalyst forimportant discussions regarding the appropriate balancebetween regulation and disclosure requirements andefficient access to the capital markets. We hope that thelively dialogue that the JOBS Act has reignited willcontinue as it will lead to innovation and interesting andworthwhile emerging companies being given anopportunity to reach the public markets.


1. House Financial Services Subcommittee on CapitalMarkets and Government Sponsored EnterprisesHolds Markup on HR 1965, HR 2167, HR 2930,HR 2940 and a Draft Bill Concerning SmallCompanies and Regulatory Relief, 112th Cong., 1stSess. (Congressional Hearing held October 5 2011),Congressional Quarterly Transcripts at 8-9.

2. See, for example, Commissioner Luis Aguilar’sstatements titled “Increasing the Vulnerability ofInvestors,” available athttp://www.sec.gov/news/speech/2012/spch082912laa.htm.

3. Net Worth Standard for Accredited Investors,Securities Act Release No. 9287, InvestmentCompany Act Release No. 29891, 2011 WL6415435 (December 21 2011) (the Net WorthStandard Adopting Release).

4. On January 25 2011, the SEC proposedamendments to the accredited investor standards. SeeNet Worth Standard for Accredited Investors,Securities Act Release No. 9177, InvestmentCompany Act Release No. 29572, 2011 WL 231559(January 25 2011).

5. 17 CFR § 230.215.6. 17 CFR § 230.501(a)(5).7. Rule 501 defines the term “accredited investor” for

purposes of exempt and limited offerings underRules 504, 505 and 506 of Regulation D. Rule 215defines the term “accredited investor” under section2(a)(15) of the Securities Act, setting the standardsfor accredited investor status under section 4(5) ofthe Securities Act, formerly section 4(6), whichpermits offerings solely to accredited investors of upto $5 million, subject to certain conditions. 15 USC77d(5). Former section 4(6) of the Securities Act wasrenumbered section 4(5) by section 944 of theDodd-Frank Act.

8. Section 413(a) of the Dodd-Frank Act, Pub. L. No.111-203, § 413(a) (2010), states: “The Commissionshall adjust any net worth standard for an accreditedinvestor, as set forth in the rules of the Commissionunder the Securities Act of 1933, so that theindividual net worth of any natural person, or jointnet worth with the spouse of that person, at the timeof purchase, is more than $1,000,000 (as suchamount is adjusted periodically by rule of theCommission), excluding the value of the primary

residence of such natural person, except that duringthe 4-year period that begins on the date ofenactment of this Act, any net worth standard shallbe $1,000,000, excluding the value of the primaryresidence of such natural person.”

9. See 17 CFR § 230.215(e) and § 230.501(a)(5)(2010).

10. The SEC stated: “… so the two rules will implementSection 413(a) of the Dodd-Frank Act in the sameway.” See Net Worth Standard Adopting Release at*4.

11. See id. at *5.12. See Rule 501(a)(5)(i)(B) (as amended).13. Id.14. Id.15. See id. at *7.16. Id. The SEC further explained: “that is the basis on

which interest accrues under the mortgage and theamount that third parties would look to in assessingcreditworthiness.” Id.

17. Dodd-Frank Act, § 413(b).18. Dodd-Frank Act, § 415.19. See Net Worth Standard Adopting Release at *3.20. Study is available at:

http://www.sec.gov/news/studies/2012/917-financial-literacy-study-part1.pdf.

21. Letter dated June 19 2012 is available athttp://s3.documentcloud.org/documents/370607/issa-ipoletter-june2012.pdf.

22. Seehttp://www.finra.org/web/groups/industry/@ip/@reg/@guide/documents/industry/p010373.pdf.

23. See letter athttp://online.wsj.com/public/resources/documents/secipoletter0826.pdf.

ENDNOTES


EMERGING GROWTHCOMPANIES (EGCS)

Qualifying as an EGC

Disqualification as anEGC

IPOs by EGCs

Ongoingdisclosures/governancerequirements

RESEARCH REPORTS

Permitted communications

Conflicts, separation,disclosures

REGULATION D

Rule 506 offerings

BROKER-DEALER REGISTRATION

Platforms/matchingservices

CROWDFUNDING

Offering threshold

EGC defined as an issuer with total gross revenues of less than $1 billion

EGC until the earliest of:(A) last day of the fiscal year during which issuer’s total gross revenues exceed $1 billion; or(B) five years from IPO; or(C) the date on which issuer has sold more than $1 billion in non-convertible debt; or(D) date on which issuer becomes a large accelerated filer (public float of $750 million).

• Confidential submission available• Must file publicly at least 21 days before roadshow• Two years audited financials required (instead of three)• May elect to rely on certain scaled disclosures available to smaller public reporting

companies (such as for executive compensation)• May engage in testing the waters with QIBs and IAIs

• May opt into voluntary disclosures• Subject to phase-in for say-on-pay and say-on-golden parachute requirements• Subject to phase-in for any PCAOB mandatory rotation or modified audit report requirement• Exempt from section 404(b) attestation (but subject to requirement for management assess-

ment of internal control requirement over financial reporting and to CEO/CFO certificationrequirement)

• Not required to adopt FASB standards until broadly applicable to private companies

• Research report on EGC not an offer• Research report on EGC not subject to quiet period or lock-up period restrictions• Distribution participants may publish research before commencement of an offering, during

an offering, or post offering

• Reports subject to required conflicts disclosures and certifications• Modifies separation/chaperoning requirements in connection with certain activities for EGCs

General advertising/general solicitation permitted provided that the issuer verifies purchasers areall AIs

Not required to register as broker-dealers solely as a result of participation or involvement in Rule506 offerings that use general solicitation or general advertisement, provided that platform doesnot receive transaction-based compensation, handle customer funds or securities, or participate indocumentation

The aggregate amount sold to all investors by the issuer, including any amount sold in reliance onthe crowdfunding exemption during the 12-month period preceding the date of the transaction, isnot more than $1 million

APPENDIX A: JOBS ACT: SUMMARY OVERVIEW


Investment threshold

Manner of offering

Information

Funding portals

Liability

Status of securities

Other conditions

REGULATIONA+/3(B)(2) EXEMPTION

Eligible issuer

Offering threshold

Status of securities

Liability

Other conditions

EXCHANGE ACTTHRESHOLD

Issuer not a bank orbank holding company

Issuer is a bank or bankholding company

Held of record

The aggregate amount sold to any investor by the issuer, including any amount sold in reliance onthe crowdfunding exemption during the 12-month period preceding the date of the transaction,does not exceed:

• the greater of $2,000 or 5% of the annual income or net worth of the investor, as applica-ble, if either the annual income or the net worth of the investor is less than $100,000; or

• 10% of the annual income or net worth of an investor, as applicable, not to exceed a maxi-mum aggregate amount sold of $100,000, if either the annual income or net worth of theinvestor is equal to or more than $100,000

Transaction must be conducted through a broker or funding portal

Information filed and provided to investors regarding the issuer and offering, including financialinformation based on the target amount offered

Funding portals will be subject to SEC and SRO regulation

Subject to section 12(a)(2) liability

Covered securities for NSMIA

Issuers must file with the SEC and provide to investors, no less than annually, reports of theresults of operations and financial statements of the issuers as the SEC may prescribe

Non-reporting issuer with principal place of business in Canada or the United States

$50 million in issuer’s securities in a 12-month period; SEC required to review threshold andreport on threshold to Congress

Covered securities for NSMIA if either:• listed/traded on a securities exchange; or• sold to a qualified purchaser

Subject to section 12(a)(2) liability

SEC empowered to impose additional conditions, including a requirement to file annual auditedfinancial statements

Becomes subject to reporting within 120 days after last day of fiscal year ended in which issuerhad:

• total assets in excess of $10 million; and• a class of equity securities (other than exempted securities) held of record by either 2,000

persons, or 500 persons not AIs

Becomes subject to reporting within 120 days after last day of fiscal year ended in which issuerhad:

• total assets in excess of $10 million; and• a class of equity securities (other than exempted securities) held of record by 2,000 persons

May deregister if class of equity securities held of record by fewer than 1,200 persons

Excludes: securities held by persons who received the securities pursuant to an employee com-pensation plan in transactions exempt from section 5 registration requirements and securities soldpursuant to crowdfunding exemption


This chart first appeared in a Morrison & Foerster publication

REQUIRED STUDIES

Decimalisation

Regulation S-K

Blue Sky laws and regulation A

Section 12 SEC enforcement authority

SEC, within 90 days of enactment; SEC also must consider within 180 days of enactment anyrecommendations regarding the minimum trading increments for EGCs

SEC, within 180 days of enactment, must report to Congress on its review of Regulation S-K andits recommendations concerning changes to S-K requirements for EGCs to simplify burdens

Comptroller General, within 3 months of enactment, must report to Congress on its study of theimpact of blue sky laws on Regulation A offerings

SEC, within 120 days of enactment, must report to Congress on its assessment regarding addi-tional enforcement tools that may be needed for it to enforce anti-evasion provision in section12(b)(3)


Aggregate

offering price limitation

Number of investors

$1 million

(12 months)

Unlimited

$5 million

(12 months)

35 plus unlimited

accredited

No limit

At p

rese

nt:

35 plus unlimited

accredited

As

prop

osed

:As an alternative, all

purchasers are accred-

ited investors and the

issuer takes reason-

able steps to verify

that the purchasers are

accredited investors

No limit

Unlimited

Up to $50 million

(12 months)

Unlimited

The aggregate amount

sold to all investors by

the issuer, including

any amount sold in

reliance on the section

4(6) exemption during

the 12-month period

preceding the date of

the transaction, is not

more than $1 million

Unlimited

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APPENDIX B: COMPARISON OF US SECURITIES EXEMPTIONS


Investor

qualifications

None required

None required

Purchaser must be

sophisticated (alone or

with representative);

accredited presumed

to be qualified

Must be QIBs

“Qualified purchaser”

(for blue sky exemp-

tion); or retail (if no

blue sky exemption

sought

Investors are subject

to the limitation that

the aggregate amount

sold to any investor by

the issuer, including

any amount sold in

reliance on the section

4(6) exemption during

the 12-month period

preceding the date of

the transaction, does

not exceed:

•the greater of

$2,000 or 5% of

the annual income

or net worth of the

investor, as applica-

ble, if either the

annual income or

the net worth of the

investor is less than

$100,000; or

•10% of the annual

income or net worth

of an investor, as

applicable, not to

exceed a maximum

aggregate amount

sold of $100,000, if

either the annual

income or net worth

of the investor is

equal to or more

than $100,000

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Limitations on manner

of offering

Limitations on resale

Issuer qualifications

Notice of sales

No general solicitation

permitted

Restricted

No Exchange Act

reporting blank-cheque

or investment

companies


permitted

Restricted

No investment compa-

nies or issuers

disqualified under

Regulation A (except

upon SEC

determination)

At p

rese

nt:


permitted

As

prop

osed

:As an alternative, gen-

eral solicitation is per-

mitted provided that all

purchasers are accred-

ited investors and the

issuer takes reason-

able steps to verify that

the purchasers are

accredited investors

Restricted

None

As proposed:

General solicitation will

be permitted, provided

that securities are sold

only to QIBs

Restricted

None; following offer-

ing issuer must make

current information

available

Nones

General solicitation

permitted

Not restricted

US or Canada,

operating company;

not a bad actor

Notices required

General solicitation

permitted only through

an intermediary (a

funding portal or bro-

ker-dealer)

Issuers are prohibited

from advertising the

terms of the exempt

offering, other than to

provide notices direct-

ing investors to the

funding portal or bro-

ker-dealer

Securities are subject

to transfer restrictions

for one year following

the purchase, subject

to certain exceptions

US domestic issuers

that are not reporting

companies under the

Exchange Act and that

are not investment

companies (or as the

SEC otherwise deter-

mines is appropriate);

not a bad actor

Notices required

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Five copies of form D to be filed with SEC within 15 days after first sale

(called for by Regulation D, but not required for exemption).


Information requirements

SEC review

1. If purchased solely by

accredited investors, no

information specified.

2. If purchased by nonac-

credited investors,

a. nonreporting compa-

nies under the Exchange

Act must furnish the same

kind of information as in a

registered offering, or in a

Regulation A offering if eli-

gible, but with somewhat

modified financial state-

ment requirements;

b. reporting companies

must furnish (i) specified

Exchange Act documents

or (ii) information con-

tained in the most recent

specified Exchange Act

report or Securities Act

registration statement on

specific forms, plus, in any

case, (iii) updating infor-

mation and limited addi-

tional information about

the offering.

c. Issuers must make

available before sale:

i. Exhibits

ii. Written information

given to accredited

investors;

iii. Opportunity to ask

questions and receive

answers;

d. Issuers must advise

purchasers of the limita-

tions on resale.

None

Rule 144A contains no

information requirements;

however market practice

generally requires prepa-

ration of an offering mem-

orandum that contains

information similar to that

contained in a registered

offering, although some-

what abbreviated, or such

information may be incor-

porated by reference if it

is publicly available

None

Information requirements

expected to be compara-

ble to those contained in

Regulation A.

Subject to SEC review

Issuers must provide to

investors and intermedi-

aries information about

the issuer (including finan-

cial statements, which

would be reviewed or

audited depending on the

size of the target offering

amount), its officers,

directors, and greater

than 20% shareholders,

the ownership and capital

structure of the issuer and

risks relating to the issuer

and the offering, as well

specific offering informa-

tion such as the use of

proceeds for the offering,

the target amount for the

offering, the deadline to

reach the target offering

amount, and regular

updates regarding

progress toward reaching

the target, and such other

information that the SEC

will require

Reports to investors (filed

with the SEC) required

not less than annually and

must include results of

operations and financial

statements of the issuer,

as the SEC determines.

No review process con-

templated by the statute

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None


APPENDIX C: EGC IPO PROCESS

The SEC must review the

draft registration statement

on a confidential basis

An EGC may remain in the

confidential review process

until required to file Form S-1,

with the SEC issuing com-

ments and the EGC respond-

ing with draft submissions

The Form S-1 and all prior

confidential submissions

must be filed 21 days before

the road show

After filing the Form S-1, the

process is the same as a pre-

JOBS Act IPO

An EGC or any other person authorized by the EGC can “test the waters” in

communications with QIBs and institutional accredited investors before or

during the IPO

Broker-dealers, including those participating in the IPO, can publish research

before, during or after the IPO without the research being deemed an “offer”

under the Securities Act

File

S-1

Sub

mit

Dra

ft S

-1R

oad

show

S-1

Eff

ectiv

e


Documents

A brief overview of the JOBS Act - Morrison & Foerstermedia.mofo.com/files/uploads/Images/130200-JOBS-Act.pdf · A brief overview of the JOBS Act. JOBS Act Quick Start 1 Nilene R