Business Law Today May 2012

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Business Law Today May 2012

Published in Business Law Today , May 2012. 2012 by the American Bar Association. Reproduced with permission. All rights reserved. This information or anyportion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express writtenconsent of the American Bar Association.

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The JOBS Act, signed by PresidentObama on April 5th, promises signi -cant changes to the ways in which many

private companies raise capital and createsan IPO on-ramp for a new category of company, an emerging growth compa-

ny. Business lawyers, private companies,and the investor community are quicklycoming up to speed regarding the JOBSAct, the opportunities it presents, and thequestions it raises. This issue of Business

Law Today examines the JOBS Act from anumber of different perspectives.

First, in The JOBS ActAn Over-view: What Every Business Lawyer Should Know, I review some of thelead-up to the JOBS Act, and then presenta summary of the principal provisionsof the act. The other articles in this issuefocus on speci c topics. In The JOBSAct: Easing Exempt Offering Restric-tions, Elizabeth M. Dunshee and DavidM. Lynn discuss the provisions of theJOBS Act eliminating the restrictions ongeneral solicitation and general adver-tising in connection with Rule 506 andRule 144A offerings; establishing a newoffering exemption under Securities ActSection 3(b) to permit companies to offer and sell up to $50 million in securitieswithin a 12-month period; and increasing

the holders of record threshold before a private company is required to register under the Exchange Act. In Crowdfund-ing: Its Practical Effect May Be Unclear Until SEC Rulemaking is Complete,Yoichiro Taku discusses the new JOBSAct offering exemption for crowdfunding,which involves a company raising capital

by selling securities to a large number of

investors whose individual investmentsare limited in amount. In IPO On-Ramp:The Emerging Growth Company, Bon-nie J. Roe discusses this new category of issuer designated by the JOBS Act, andthe accommodations provided to such

companies in connection with their IPOsand subsequent reporting. The JOBS Actrelaxes a number of restrictions on re-search at the time of an Emerging GrowthCompanys initial public offering. DanaG. Fleischman focuses on these changesin JOBS Act on Research: Strong Buy?In addition to affecting many smaller companies, the JOBS Act may also haveimplications under the Investment Com-

pany Act. Martin E. Lybecker discussessome of these considerations in TheEffect of the JOBS Act on Private Invest-ment Companies: Foreseen Consequenc-es? Finally, a number of the changeseffected by the JOBS Act may be relevantto foreign companies. In The JOBS Actfor Foreigners, Daniel Bushner discussessome of the implications for foreign com-

panies and foreign investors.The Federal Regulation of Securities

Committee is very pleased to be takinga role in connection with the JOBS Act.As one of the largest committees in theBusiness Law Section, Fed Regs is the

principal ABA committee dealing with theSEC and federal securities law matters. Inaddition to presenting CLE programs and

publishing an Annual Review of FederalSecurities Regulation in The Business

Lawyer , the Committee covers the fullrange of federal securities law topics. Our subcommittees focus on issues of impor-tance to practitioners in connection with

the activities of many of the divisionsof the SEC, including the Division of Corporation Finance (the Disclosure andContinuous Reporting Subcommittee ; theSecurities Registration Subcommittee ; theProxy Statements and Business Combina-

tions Subcommittee ; the Employee Ben-e ts, Executive Compensation and Sec -tion 16 Subcommittee ; the Small BusinessIssuers Subcommittee ; and the Interna-tional Securities Matters Subcommittee ),the Division of Trading and Markets (theTrading and Markets Subcommittees ), theDivision of Investment Management (theInvestment Companies and InvestmentAdvisers Subcommittee ; and the HedgeFunds Subcommittee ) and Enforcement(the Civil Litigation and SEC Enforce-ment Matters Subcommittee ). We also fol-low developments at FINRA, through our FINRA Corporate Financing Rules Sub-committee . In addition, we have a number of other very active task forces and sub-committees, including our Securities LawOpinions Subcommittee . Often workingwith the Legal Opinions Committee , thesubcommittee has been a standard-setter in identifying and establishing customary

practice in this area.One of our principal activities has been

the submission of comment letters to the

SEC that express the views of securitieslaw practitioners and have helped to makeSEC rulemaking more informed and moreeffective. In connection with the JOBSAct, we recently submitted a pre-rulemak-ing comment letter relating to the elimina-tion of general solicitation and generaladvertising restrictions in Rule 506 andRule 144A transactions. In addition, at the

Our Mini-Theme: The JOBS Act
http://apps.americanbar.org/dch/committee.cfm?com=CL410000http://apps.americanbar.org/dch/committee.cfm?com=CL410000http://www.americanbar.org/content/aba/publications/business_lawyer_home.htmlhttp://www.americanbar.org/content/aba/publications/business_lawyer_home.htmlhttp://apps.americanbar.org/dch/committee.cfm?com=CL410032http://apps.americanbar.org/dch/committee.cfm?com=CL410032http://apps.americanbar.org/dch/committee.cfm?com=CL410042http://apps.americanbar.org/dch/committee.cfm?com=CL410028http://apps.americanbar.org/dch/committee.cfm?com=CL410028http://apps.americanbar.org/dch/committee.cfm?com=CL410002http://apps.americanbar.org/dch/committee.cfm?com=CL410002http://apps.americanbar.org/dch/committee.cfm?com=CL410002http://apps.americanbar.org/dch/committee.cfm?com=CL410002http://apps.americanbar.org/dch/committee.cfm?com=CL410054http://apps.americanbar.org/dch/committee.cfm?com=CL410054http://apps.americanbar.org/dch/committee.cfm?com=CL410014http://apps.americanbar.org/dch/committee.cfm?com=CL410014http://apps.americanbar.org/dch/committee.cfm?com=CL410018http://apps.americanbar.org/dch/committee.cfm?com=CL410016http://apps.americanbar.org/dch/committee.cfm?com=CL410016http://apps.americanbar.org/dch/committee.cfm?com=CL410026http://apps.americanbar.org/dch/committee.cfm?com=CL410026http://apps.americanbar.org/dch/committee.cfm?com=CL410008http://apps.americanbar.org/dch/committee.cfm?com=CL410008http://apps.americanbar.org/dch/committee.cfm?com=CL410023http://apps.americanbar.org/dch/committee.cfm?com=CL410023http://apps.americanbar.org/dch/committee.cfm?com=CL410053http://apps.americanbar.org/dch/committee.cfm?com=CL410053http://apps.americanbar.org/dch/committee.cfm?com=CL510000http://sec.gov/comments/jobs-title-ii/jobstitleii-7.pdfhttp://sec.gov/comments/jobs-title-ii/jobstitleii-7.pdfhttp://sec.gov/comments/jobs-title-ii/jobstitleii-7.pdfhttp://sec.gov/comments/jobs-title-ii/jobstitleii-7.pdfhttp://apps.americanbar.org/dch/committee.cfm?com=CL510000http://apps.americanbar.org/dch/committee.cfm?com=CL410053http://apps.americanbar.org/dch/committee.cfm?com=CL410053http://apps.americanbar.org/dch/committee.cfm?com=CL410023http://apps.americanbar.org/dch/committee.cfm?com=CL410023http://apps.americanbar.org/dch/committee.cfm?com=CL410008http://apps.americanbar.org/dch/committee.cfm?com=CL410008http://apps.americanbar.org/dch/committee.cfm?com=CL410026http://apps.americanbar.org/dch/committee.cfm?com=CL410026http://apps.americanbar.org/dch/committee.cfm?com=CL410016http://apps.americanbar.org/dch/committee.cfm?com=CL410016http://apps.americanbar.org/dch/committee.cfm?com=CL410018http://apps.americanbar.org/dch/committee.cfm?com=CL410014http://apps.americanbar.org/dch/committee.cfm?com=CL410014http://apps.americanbar.org/dch/committee.cfm?com=CL410054http://apps.americanbar.org/dch/committee.cfm?com=CL410054http://apps.americanbar.org/dch/committee.cfm?com=CL410002http://apps.americanbar.org/dch/committee.cfm?com=CL410002http://apps.americanbar.org/dch/committee.cfm?com=CL410002http://apps.americanbar.org/dch/committee.cfm?com=CL410028http://apps.americanbar.org/dch/committee.cfm?com=CL410028http://apps.americanbar.org/dch/committee.cfm?com=CL410042http://apps.americanbar.org/dch/committee.cfm?com=CL410032http://apps.americanbar.org/dch/committee.cfm?com=CL410032http://www.americanbar.org/content/aba/publications/business_lawyer_home.htmlhttp://www.americanbar.org/content/aba/publications/business_lawyer_home.htmlhttp://apps.americanbar.org/dch/committee.cfm?com=CL410000http://apps.americanbar.org/dch/committee.cfm?com=CL410000


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2012 Spring Meeting, we co-sponsoredtwo programs dealing with JOBS Act

provisions in Perspectives on RegulatoryReform for Small and Mid-Sized Com-

panies: Change is in the Air (audio ) andCurrent Securities Law Issues for SmallBusiness (audio ). Information about theSpring Meeting programs is available athere . We welcome the membership of all

business lawyers interested in federal se-curities regulation. Information regardingthe Committee is available here .

We are also very pleased that this issueof Business Law Today and our other JOBS Act initiatives represent a collabora-tive effort by a number of Business LawSection Committees. We are indebted tothe Middle Market and Small BusinessCommittee (chaired by Greg Yadley),the Private Equity and Venture CapitalCommittee (chaired by Mark Danzi),the Corporate Governance Committee (chaired by John Stout), and the StateRegulation of Securities Committee (chaired by Shane Hansen), for their extremely valuable contributions andsupport. In addition to the extraordinaryefforts by the authors of the articles inthis issue to prepare and present cogentdiscussions of the JOBS Act so soon after enactment, we also very much appreciatethe efforts of the many who commented

on the articles, including Cathy Dixon,Carol McGee, John Murphy, and AnnYvonne Walker.

Our next meetings will be held in con- junction with the ABA Annual Meeting at the Marriott Downtown in Chicago,from August 3rd through August 5th, andin Washington, D.C., at the Ritz-Carltonon November 16th and 17th. We hope tosee you there.

Best regards,Jeffrey W. Rubin

Chair, Federal Regulation of SecuritiesCommittee
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On April 5th of this year, President Obamasigned the JOBS Act . The act, techni-cally called the Jumpstart Our BusinessStartups Act, is focused speci cally onsmaller companies and is intended to easesome of the regulatory burdens imposed

by the securities laws on the ability of such companies to raise capital. Thisarticle will discuss brie y the backgroundof the JOBS Act and provide an overviewof its principal provisions.

The principal changes effected by theJOBS Act are:

the designation of companies withless than $1 billion in total an-nual gross revenues as emerginggrowth companies; such com-

panies are provided with certainaccommodations relating to their initial public offering (IPO) of equity securities and subsequentreporting obligations;

the elimination of restrictions ongeneral solicitation and advertisingin connection with Rule 506 andRule 144A offerings under the Secu-rities Act of 1933 (Securities Act);

the establishment of an offeringexemption for crowdfunding bynon-reporting U.S. companies;

the expansion of the scope of of-ferings under Section 3(b) of theSecurities Act; and

amendments to the thresholds requir-ing Section 12(g) registration andreporting under the Securities Ex-change Act of 1934 (Exchange Act).

BackgroundMany smaller companies have expressedconcerns about the cost and regulatory

burdens associated with raising capital.In the case of smaller public companies,these burdens have increased in recentyears as the Sarbanes-Oxley Act of 2002and the Dodd-Frank Wall Street Reform

and Consumer Protection Act of 2010have expanded the disclosure obliga-tions and liabilities applicable to publiccompanies. The SEC has, for many years,sought input as to appropriate means toencourage small company capital forma-tion while also assuring investor protec-tion. Pursuant to congressional mandate,since 1982, the SEC has hosted an annualGovernmentBusiness Forum on SmallBusiness Capital Formation , coordinated

by the SECs Of ce of Small BusinessPolicy. (See the reports of each Forumsince 1993 .) In 2005, the SEC created anAdvisory Committee on Smaller PublicCompanies, which issued a nal report in2006 setting forth 33 recommendations,including the elimination of general solici-tation and general advertising constraintson private placements. In September 2011,as mandated by the Dodd-Frank Act, theSEC created an Advisory Committee on

Small and Emerging Companies , whosework continues.

Despite these efforts, and a number of rule changes adopted by the SEC, manycompanies and investor groups wereconcerned that the SEC was not actingquickly enough to remove the regulatory

burdens on small businesses. Another worrisome trend was the signi cant drop-off in smaller IPOs during the past decade.This concern was highlighted by a reportissued in October 2011 by the IPO Task

Force, a group created by the Departmentof the Treasury, entitled Rebuilding the IPO On-RampPutting Emerging Com- panies and the Job Market Back on the Road to Growth .

In a very lively exchange of correspon-dence last year between CongressmanDaniel Issa, Chairman of the House Com-mittee on Oversight and Government Re-form, and SEC Chairman Mary Schapiro,Chairman Issa posed questions to the SECregarding a broad range of factors thatappeared to inhibit small company capitalformation and that may have led to thedecline of the smaller company IPO mar-ket. (See Chairman Issas March 22, 2011,letter ; Chairman Schapiros April 6, 2011,response ; Chairman Issas April 29, 2011,letter posing additional requests ; andChairman Schapiros further response .)

The legislative impetus for the JOBSAct began in 2011 as a bipartisan effort

The JOBS Act: An OverviewWhat Every Business Lawyer Should Know

By Jeffrey W. Rubin
http://www.gpo.gov/fdsys/pkg/BILLS-112hr3606enr/pdf/BILLS-112hr3606enr.pdfhttp://www.sec.gov/info/smallbus/sbforum.shtmlhttp://www.sec.gov/info/smallbus/sbforum.shtmlhttp://www.sec.gov/info/smallbus/sbforumreps.htmhttp://www.sec.gov/info/smallbus/sbforumreps.htmhttp://www.sec.gov/info/smallbus/acspc/acspc-finalreport.pdfhttp://www.sec.gov/info/smallbus/acsec.shtmlhttp://www.sec.gov/info/smallbus/acsec.shtmlhttp://www.sec.gov/info/smallbus/acsec/rebuilding_the_ipo_on-ramp.pdfhttp://www.sec.gov/info/smallbus/acsec/rebuilding_the_ipo_on-ramp.pdfhttp://www.sec.gov/info/smallbus/acsec/rebuilding_the_ipo_on-ramp.pdfhttp://www.sec.gov/info/smallbus/acsec/rebuilding_the_ipo_on-ramp.pdfhttp://democrats.oversight.house.gov/images/stories/FULLCOM/510%20future%20of%20cap%20form/2011-03-22%20DEI%20to%20Schapiro-SEC%20-%20capital%20formation%20due%204-5.pdfhttp://democrats.oversight.house.gov/images/stories/FULLCOM/510%20future%20of%20cap%20form/2011-03-22%20DEI%20to%20Schapiro-SEC%20-%20capital%20formation%20due%204-5.pdfhttp://www.sec.gov/news/press/schapiro-issa-letter-040611.pdfhttp://www.sec.gov/news/press/schapiro-issa-letter-040611.pdfhttp://pogoarchives.org/m/er/2011-04-29%20DEI%20to%20Schapiro%20-%20add'l%20questions%20on%20capital%20formation.pdfhttp://pogoarchives.org/m/er/2011-04-29%20DEI%20to%20Schapiro%20-%20add'l%20questions%20on%20capital%20formation.pdfhttp://www.sec.gov/news/press/schapiro-issa-letter-052511.pdfhttp://www.hoganlovells.com/jeffrey-rubinhttp://www.hoganlovells.com/jeffrey-rubinhttp://www.sec.gov/news/press/schapiro-issa-letter-052511.pdfhttp://pogoarchives.org/m/er/2011-04-29%20DEI%20to%20Schapiro%20-%20add'l%20questions%20on%20capital%20formation.pdfhttp://pogoarchives.org/m/er/2011-04-29%20DEI%20to%20Schapiro%20-%20add'l%20questions%20on%20capital%20formation.pdfhttp://www.sec.gov/news/press/schapiro-issa-letter-040611.pdfhttp://www.sec.gov/news/press/schapiro-issa-letter-040611.pdfhttp://democrats.oversight.house.gov/images/stories/FULLCOM/510%20future%20of%20cap%20form/2011-03-22%20DEI%20to%20Schapiro-SEC%20-%20capital%20formation%20due%204-5.pdfhttp://democrats.oversight.house.gov/images/stories/FULLCOM/510%20future%20of%20cap%20form/2011-03-22%20DEI%20to%20Schapiro-SEC%20-%20capital%20formation%20due%204-5.pdfhttp://www.sec.gov/info/smallbus/acsec/rebuilding_the_ipo_on-ramp.pdfhttp://www.sec.gov/info/smallbus/acsec/rebuilding_the_ipo_on-ramp.pdfhttp://www.sec.gov/info/smallbus/acsec/rebuilding_the_ipo_on-ramp.pdfhttp://www.sec.gov/info/smallbus/acsec/rebuilding_the_ipo_on-ramp.pdfhttp://www.sec.gov/info/smallbus/acsec.shtmlhttp://www.sec.gov/info/smallbus/acsec.shtmlhttp://www.sec.gov/info/smallbus/acspc/acspc-finalreport.pdfhttp://www.sec.gov/info/smallbus/sbforumreps.htmhttp://www.sec.gov/info/smallbus/sbforumreps.htmhttp://www.sec.gov/info/smallbus/sbforum.shtmlhttp://www.sec.gov/info/smallbus/sbforum.shtmlhttp://www.gpo.gov/fdsys/pkg/BILLS-112hr3606enr/pdf/BILLS-112hr3606enr.pdf


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to increase the ability of small businessesto raise capital. The bill introduced to theHouse (then called the Reopening Ameri-can Capital Markets to Emerging GrowthCompanies Act of 2011) was limited to

bene ts for emerging growth companies, but was later expanded to cover a number of other matters. The legislation thatultimately resulted from these efforts wassupported by many in the technology andventure capital communities, includingGoogle and the National Venture CapitalAssociation, and many entrepreneurs, andwas passed by Congress as the JOBS Actat the end of March. In his signing state-ment , President Obama characterized the

bill as follows:Heres whats going to happen because of this bill. For business owners who want

to take their companies to the next level,this bill will make it easier for you to go public. And thats a big deal because go-ing public is a major step towards expand-ing and hiring more workers. Its a bigdeal for investors as well, because publiccompanies operate with greater oversightand greater transparency.

And for start-ups and small businesses,this bill is a potential game changer.Right now, you can only turn to alimited group of investorsincluding

banks and wealthy individualsto getfunding. Laws that are nearly eight de-cades old make it impossible for othersto invest. But a lot has changed in 80years, and its time our laws did as well.Because of this bill, start-ups and small

business will now have access to a big,new pool of potential investorsname-ly, the American people. For the rsttime, ordinary Americans will be ableto go online and invest in entrepreneursthat they believe in.

Although it received widespread sup-

port from the business community, theJOBS Act was not without its critics,who questioned the relaxation of impor-tant investor protections. In a letter toCongress dated March 13, 2012 (prior to

nal approval by Congress), SEC Chair -man Schapiro expressed concern that anumber of provisions should be addedor modi ed to improve investor protec -

tions, and also noted that the rulemakingtime limits imposed on the SEC in thelegislation were not achievable. Further, anumber of securities regulators and inves-tor advocacy groups expressed concernsabout the potential for fraud and investor exploitation that could result from therelaxed regulatory requirements. Some of these concerns, including some concernsabout crowdfunding, were re ected in the

nal version of the JOBS Act. One of theharshest critics, former New York Gover -nor Elliot Spitzer (referring to the provi-sions of the JOBS Act that removed cer-tain restrictions on research at the time of

public offerings) said, It is a bad sequelto a bad movie. It shouldnt be called theJOBS Act. It should be called the BringFraud Back to Wall Street Act.

Time will tell whether the JOBS Actachieves its objective of expandingcapital-raising opportunities for smaller companies without compromising impor-tant investor protections. Although manyof the JOBS Act provisions are prescrip-tive, the SEC is charged with signi cantrulemaking obligations, and the SECsability to implement these provisionswhile preserving investor protections maywell determine how the JOBS Act will beassessed a few years from now. In order toassist it with the rulemaking process, the

SEC has (as it did in connection with theDodd-Frank Act) invited public comments prior to the publication of its proposedrules. The comments submitted may in u -ence the rules that the commission pro-

poses. The opportunity to help shape notonly the nal rules but also the proposalscan have a signi cant impact on the rulesthat are ultimately adopted. Particularly inview of the very abbreviated rulemakingdeadlines, informed and helpful commentswill assist the SEC to understand theimplications of the proposed rulemaking,

including an identi cation of unantici - pated consequences that may result fromthe adoption of proposed rules.

Even though many of the JOBS Act pro-visions are not yet effective, the SEC hasreceived many questions from the publicrelating to particular JOBS Act issues. Inan effort to be responsive to these inqui-ries, the Division of Corporation Finance

has created a web page setting forth itsguidance on these matters. Among other things, the staff of the division has issueda number of frequently asked questions regarding JOBS Act provisions.

The JOBS ActPrincipal ProvisionsAlthough the other articles in this issue willaddress the provisions of the JOBS Act inmore detail, it may be helpful here to reviewsome of the major JOBS Act provisions. Thefollowing are summaries of major provi-sions rather than detailed descriptions.

Title IEmerging Growth CompaniesEffective upon enactment on April 5th, theJOBS Act creates a new category of com-

pany, an emerging growth company,that is eligible for certain accommodationsin connection with its IPO of equity andits subsequent Exchange Act reporting.This has been characterized as creating atransitional IPO on-ramp for such com-

panies. An emerging growth company (or EGC) means an issuer that has total an-nual gross revenues of less than $1 billion.Once within the EGC category, an EGCremains so until the earliest of:

the last day of its scal year duringwhich it had total annual grossrevenues of $1 billion or more;

the last day of its scal year follow -ing the fth anniversary of the dateof its rst sale of its common equitysecurities pursuant to an effectiveSecurities Act registration statement;

the date on which it has, during the previous 3-year period, issued morethan $1 billion of nonconvertibledebt; or

the date it becomes a large accelerat-ed ler (generally requiring one year of Exchange Act reporting history and

an aggregate worldwide market valueof its voting and non-voting commonequity held by its non-af liates of $700 million or more).

EGCs are entitled to a number of accom-modations:

an EGC can submit a draft equityIPO registration statement to the
http://thomas.loc.gov/cgi-bin/query/z?c112:H.R.3606http://thomas.loc.gov/cgi-bin/query/z?c112:H.R.3606http://www.whitehouse.gov/the-press-office/2012/04/05/remarks-president-jobs-act-bill-signinghttp://www.whitehouse.gov/the-press-office/2012/04/05/remarks-president-jobs-act-bill-signinghttp://www.aicpa.org/Advocacy/Issues/DownloadableDocuments/404b/3-13-12_SEC_Chm_Schapiro_Letter_to_Johnson.pdfhttp://www.aicpa.org/Advocacy/Issues/DownloadableDocuments/404b/3-13-12_SEC_Chm_Schapiro_Letter_to_Johnson.pdfhttp://sec.gov/spotlight/jobsactcomments.shtmlhttp://sec.gov/divisions/corpfin/cfjobsact.shtmlhttp://sec.gov/divisions/corpfin/cfjobsact.shtmlhttp://sec.gov/spotlight/jobsactcomments.shtmlhttp://www.aicpa.org/Advocacy/Issues/DownloadableDocuments/404b/3-13-12_SEC_Chm_Schapiro_Letter_to_Johnson.pdfhttp://www.aicpa.org/Advocacy/Issues/DownloadableDocuments/404b/3-13-12_SEC_Chm_Schapiro_Letter_to_Johnson.pdfhttp://www.whitehouse.gov/the-press-office/2012/04/05/remarks-president-jobs-act-bill-signinghttp://www.whitehouse.gov/the-press-office/2012/04/05/remarks-president-jobs-act-bill-signinghttp://thomas.loc.gov/cgi-bin/query/z?c112:H.R.3606http://thomas.loc.gov/cgi-bin/query/z?c112:H.R.3606


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staff of the SEC for a con dentialnonpublic review, provided that itwill be required to le the draft reg -istration statement and all amend-ments with the SEC not later than 21days before the EGCs road show.

an EGC can test the waters for a proposed public offering beforeand after ling a registration state -ment, provided that the test thewaters communications are madeonly to QIBs and institutional ac-credited investors;

an EGC only needs to present twoyears of audited nancial state -ments and managements discus-sion and analysis (MD&A) in aSecurities Act registration state-

ment in connection with an IPOof its common equity and, in aSecurities Act registration state-ment and Exchange Act reports,needs to present selected nancialdata only as far back as the earliestaudit period presented;

an EGC can elect not to complywith any new or revised nancialaccounting standard that has adifferent effective date for publicand non-public companies until the

date that non-public companies arerequired to comply;

an EGC may comply with theexecutive compensation disclosurerequirements applicable to smaller reporting companies, and need not

prepare a compensation discus-sion and analysis; in addition, suchcompanies are not required to seek say on pay or say on parachutevotes from shareholders;

an EGC need not provide auditor attestations to internal control re-

ports, or comply with any PCAOBrule requiring mandatory audit rmrotation or any supplement to anauditors report to provide ad-ditional information regarding theaudit and the nancial statements(auditor discussion and analysis);

an EGC need not obtain an auditreport on its internal control over

nancial reporting; and

the SECs rules with respect to the preparation, publication, or distri- bution of research reports regarding

an EGC that is the subject of a proposed public offering of its com-mon equity are relaxed, even if the

broker or dealer is participating inthe offering, and certain restrictionswith respect to security analystcommunications and post-offeringcommunications are relaxed.

It should be noted that EGCs may,if they so elect, opt to comply with therequirements applicable to companies thatare not EGCs.

In addition to the above provisions,Title I requires the SEC to conduct a studywith respect to the impact the trading andquoting of securities in penny increments(decimalization) has had on IPOs and onthe liquidity for small and middle capital-ization company securities, and to reportits results to Congress on or before July4, 2012 (90 days after enactment). TheSEC is also required to conduct a reviewof Regulation S-K to determine how theregulation can be updated to modernizeand simplify the registration process and

reduce the costs and other burdens associ-ated with those requirements for EGCs.The SEC is required to submit its reportto Congress, setting forth speci c recom -mendations, by October 2, 2012 (180 daysafter enactment).

Title IIElimination of General Solicita-tion and General Advertising RestrictionsThe JOBS Act requires the SEC, on or

before July 4, 2012, to revise Rule 506and Rule 144A under the Securities Actto provide that the prohibition againstgeneral solicitation and general advertis-ing does not apply to Rule 506 offerings,

provided that all purchasers are accred-ited investors, or to Rule 144A offerings,

provided that securities are only sold to persons the seller (and any person act-ing on behalf of the seller) reasonably

believes is a quali ed institutional buyer (QIB). The SEC is also required to adopt

rules that require the issuer to take reason -able steps to verify that the purchasersof securities in Rule 506 offerings areaccredited investors, using such methodsas the SEC shall determine. (Note that thecurrent de nition of accredited investorin Rule 501 means any person who comeswithin any of the categories set forth inthe de nition, or who the issuer reason -ably believe comes within any of suchcategories, at the time of the sale.) Title IIalso provides an exemption from broker or dealer registration with respect to securi-ties offered and sold pursuant to Rule 506if all the person does is maintain a plat-form or mechanism for offering, selling,

purchasing, or negotiating securities or that permits general solicitation or generaladvertising, subject to certain condi-tions with respect to the activities of such

person. The provisions of Title II will not become effective until the SEC completesits required rulemaking.

Title IIICrowdfundingCrowdfunding is the raising of capital,which may involve the use of the Internet,from a large number of investors whoseindividual investments are limited. TitleIII of the JOBS Act will, following adop-tion of implementing rules by the SEC ,

permit crowdfunding by U.S.-organized

issuers, subject to a number of conditions.Among other things:

the aggregate amount sold to allinvestors by the issuer, includingamounts sold by the issuer pursuantto crowdfunding during the 12-month

period preceding the transaction, maynot exceed $1 million;

the aggregate amount sold to anysingle investor by the issuer, in-cluding amounts sold by the issuer

pursuant to crowdfunding during

the 12-month period preceding thetransaction, may not exceed:

The greater of $2,000 or 5 percent of the annual incomeor net worth of the investor,if either the annual income or net worth of the investor is lessthan $100,000; and
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10 percent of the annualincome or net worth of theinvestor, not to exceed a maxi-mum aggregate of $100,000, if either the annual income or networth of the investor is equalto or more than $100,000;

the transaction must be conductedthrough an intermediary (a broker or a funding portal); and

the issuer is required to:

comply with certain disclosureand SEC ling obligations;

comply with certain limita-tions on advertising the termsof the offering;

comply with certain limitationson compensating promoters;

le a report on the issuersresults of operations and a

nancial statement not lessthan annually with the SECand disclose such informationto investors; and

comply with any other require-ments the SEC may prescribe.

Title III provides for a private right

of action by an investor against anissuer for negligent misrepresenta-tion (Section 12(a)(2) of the Securi-ties Act);

the securities purchased in a crowd-funding transaction are subject toa one-year restriction on resales,subject to certain exceptions;

the SEC is required to adopt rulesto disqualify issuers from offeringsecurities in crowdfunding trans-actions, and brokers and funding

portals from effecting or participat-ing in crowdfunding transactions,if they have been subject to certainsecurities-related or regulatorysanctions; and

the crowdfunding exemption pre-empts state securities law regis-

tration requirements, but speci -cally preserves state enforcementauthority.

Although concerns have been expressedas to whether the crowdfunding provisions

provide adequate investor protections, ina letter to the president referred to in aWhite House release relating to the JOBSAct, a consortium of crowdfunding com-

panies committed to appropriate regula-tion of the industry, including an industrystandard Investors Bill of Rights.

Title IVSecurities Act Section 3(b) AmendmentsThe JOBS Act expands the scope of theexemptions from registration under Sec-tion 3(b) of the Securities Act, permittingthe SEC to exempt up to $50 millionof securities offered and sold within a12-month period in reliance on the newexemption. This increase responded tocriticisms regarding the limitations of current Regulation A and Rule 504, whichhave not been widely used. Under the new

provision, among other things:

the securities eligible for the newexemption are limited to equity,debt, debt convertible or exchange-able into equity, and guarantees of such securities;

the securities may be offered andsold publicly, and are not deemedto be restricted securities;

any person offering or selling thesecurities is subject to civil liabilityunder Section 12(a)(2) of the Secu-rities Act;

the issuer may test the waters bysoliciting interest in the offering

prior to ling any offering state -ment with the SEC;

the issuer will be required to leaudited nancial statements with theSEC annually, and will be subject tosuch periodic disclosure obligationsas the SEC may determine;

the SEC is authorized to adoptother terms, conditions, or require-

ments, including offering statement preparation, ling, and distributionrequirements; in addition, the SECmay provide disquali cation provi -sions for persons subject to certainsecurities-related or regulatorysanctions; and

the securities will be treated as cov-ered securities, thereby pre-emptingstate securities registration require-ments if they are offered and soldon a national securities exchangeor offered or sold to a quali ed

purchaser (as yet to be de ned bythe SEC pursuant to Section 18 of the Securities Act).

The implementation of the statutoryamendments under Title IV is subject toSEC rulemaking.

Titles V and VI Exchange Act Section12(g) TriggersPrior to the JOBS Act, a company thathad, at the end of a scal year, over $10million in assets and a class of equitysecurities (other than exempted securities)held of record by 500 or more persons wasrequired to register the class of securi-ties under the Exchange Act. As a resultof Section 12(g) registration, a company

becomes subject to SEC reporting obliga-tions. For a number of companies, thisreporting trigger became problematic, andrisked forcing them into public companystatus prior to the time they otherwisewould have wanted to become subject tothe burdens of public company compli-ance. The JOBS Act has now amendedthese triggers. Section 12(g) now providesthat an issuer is not required to register under Section 12(g) until, at the end of a

scal year, it has over $10 million in as -sets and a class of equity securities (other than exempted securities) held of record

by either: 2,000 persons; or

500 persons who are not accreditedinvestors (as de ned by the SEC).

Importantly, Section 502 of the JOBSAct provides that, for the purpose of determining whether an issuer is required
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to register a class of equity security under Section 12(g), the de nition of held of record does not include securities held by

persons who received the securities pursu-ant to an employee compensation plan intransactions exempt from the registrationrequirements of the Securities Act (such

as pursuant to Rule 701). Although theamendments to Section 12(g) becameeffective upon enactment of the act, SECrulemaking will be necessary to determinehow some of the changes will be imple-mented. Further, the JOBS Act providesfor the SEC to exempt from Section 12(g),either conditionally or unconditionally,securities acquired pursuant to a crowd-funding offering.

With respect to banks and bank holdingcompanies, the applicable threshold hasnow been increased to 2,000 holders of record, without a further test based on thenumber of persons who are not accreditedinvestors. Although the JOBS Act did notchange the standards for deregistrationunder Section 12(g) or Section 15(d) of the Exchange Act for non-bank compa -nies, it amended the provisions applicableto banks and bank holding companies to

permit deregistration and a termination of Exchange Act reporting if the number of holders of record of a class of securities isreduced to under 1,200.

Also, in addition to requiring SEC toamend the de nition of held of recordto re ect the exclusion of securities held

by employees in exempt offerings pursu-ant to employee compensation plans asdescribed above, the SEC is required toadopt safe harbor provisions that issuerscan follow when determining whether holders of their securities fall into thisexclusion. Finally, the SEC is requiredto examine its authority to enforce theholder of record provision in ExchangeAct Rule 12g5-1 to determine if new

enforcement tools are needed to enforcethe anti-evasion provision contained in therule, and to report to Congress by August3, 2012 (120 days after enactment).

ConclusionThe SEC is currently engaged in the sig-ni cant rulemaking and studies required

by the JOBS Act, with the rst rulemak -ing (under Title II of the JOBS Act), andthe rst study (the decimalization studyunder Title I) required by July 4, 2012. Aswith all legislation intended to achieve aspeci c purpose, most securities practi -tioners eyes are keenly focused on the

implementation of the statutory provisions by the SEC, and on whether the desiredobjectives will be achieved.

Jeffrey W. Rubin is a partner of Hogan Lovells US LLP and Chair of the Federal Regulation of Securities Committee of the ABA Business Law Section. The viewsexpressed in this article are solely those of the author and do not necessarily repre-sent the views of Hogan Lovells US LLP orthe American Bar Association.
http://www.hoganlovells.com/jeffrey-rubinhttp://apps.americanbar.org/dch/committee.cfm?com=CL410000http://apps.americanbar.org/dch/committee.cfm?com=CL410000http://apps.americanbar.org/dch/committee.cfm?com=CL410000http://apps.americanbar.org/dch/committee.cfm?com=CL410000http://www.hoganlovells.com/jeffrey-rubin


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The JOBS Act signi cantly eases some of the restrictions on exempt offerings under the Securities Act of 1933 (Securities Act)and updates thresholds that would trigger reporting under the Securities ExchangeAct of 1934 (Exchange Act). In particular,the JOBS Act:

directs the SEC to eliminate the banon general solicitation and generaladvertising for certain offeringsunder Rule 506 of Regulation D,

provided that the securities aresold only to accredited investors,

and under Rule 144A offerings, provided that the securities aresold only to persons who the seller (and any person acting on behalf of the seller) reasonably believes is aquali ed institutional buyer (QIB);

establishes a new offering exemp -tion under Securities Act Section3(b), which will permit companiesto offer and sell up to $50 millionin securities in a public offeringwithin a 12-month period; and

increases the number of holdersof record of equity securities that

private companies are permitted tohave before requiring registration andreporting under the Exchange Act.

Private Offering ReformsTitle II of the JOBS Act directs the SECto permit general solicitation and gen -

eral advertising for offerings conductedunder Rule 506 of Regulation D and Rule144A of the Securities Act, provided thatRule 506 sales are made only to inves -tors who are accredited and Rule 144Aresales are made only to investors who arequali ed institutional buyers, as eachof those terms is de ned under the federalsecurities laws. Title II also provides thatgeneral solicitation and general advertis -ing will not cause a Rule 506 offering to

be deemed a public offering.

Rule 506 Offerings: The Current RegimeRule 506 is the most popular means for conducting a private offering, becauseit permits issuers to raise an unlimitedamount of money and pre-empts state se -curities laws. Generating interest in a Rule506 offering is sometimes dif cult for companies, due in part to a long-standing

prohibition against general solicitation andgeneral advertising. This prohibition hasmeant that issuers can offer securities onlyto investors with whom there is a pre-existing relationship, and that they cannot

advertise the offering in order to reach a broad group of potential investors. Somecompanies undertaking private capital-raising activities are able to access a larger group of potential investors by engaging aregistered broker-dealer who has preexist -ing relationships with such persons. Thisalternative may not be available, however,if the company is too early in its develop -

ment to interest a broker-dealer to expendthe effort to undertake an offering.

Rule 144A Offerings: The Current RegimeRule 144A, which is a popular means for conducting large private offerings, permits

nancial intermediaries to buy securi -ties from an issuer and resell them to anunlimited number of QIBs in transactionsthat comply with the conditions of Rule144A. Those QIBs can in turn trade thesecurities among themselves in transac -tions that comply with the conditions of Rule 144A. Rule 144A(d)(1) provides thatthe securities must be offered and soldonly to a QIB or an offeree or purchaser that the seller (and any person acting on

behalf of the seller) reasonably believes to be a QIB. As a result, Rule 144A currently prohibits offers to non-QIBs, thus preventing the use of any general solicitation or general advertising in connection with aRule 144A offering.

Private Offerings after the JOBS Act The amendments to Rules 506 and 144A

contemplated by the JOBS Act remainsubject to SEC rulemaking, which theJOBS Act directs the SEC to complete

by July 4, 2012. The revised rules will permit broader communications by issuersand Rule 144A sellers, allowing notice of accredited- and QIB-only offerings in anymanner, including through unrestrictedissuer or intermediary websites and social

The JOBS Act: Easing ExemptOffering Restrictions

By Elizabeth M. Dunshee and David M. Lynn
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media sites, as well as print, radio, andtelevision advertising. Until the rules areamended, however, market participantsshould continue to comply with the exist -ing rules and follow customary procedureswith respect to these offerings.

The JOBS Act directs the SEC to reviseRule 506 to provide that the prohibitionagainst general solicitation or general ad -vertising in Rule 502(c) shall not apply tooffers and sales of securities made pursu -ant to Rule 506, provided that all purchas -ers of the securities are accredited inves -tors. Under the SECs existing de nition,an accredited investor is a person whofalls within one of the categories speci -

ed in the de nition, or a person whomthe issuer reasonably believes falls withinone of those categories. The revised rulesmust further require that issuers utilizinggeneral solicitation or general advertisingin connection with Rule 506 offerings takereasonable steps to verify that purchasersof securities are accredited investors, us -ing methods to be determined by the SEC.With respect to Rule 144A, the rule asrevised must provide that securities may

be offered to persons other than QIBs,including by means of general solicitationor general advertising, provided that thesecurities are sold only to persons that theseller and any person acting on behalf of

the seller reasonably believe is a QIB.The JOBS Act also provides certain in -termediaries with greater latitude to assistwith Rule 506 offerings, without requir -ing registration of those intermediaries as

broker-dealers. Speci cally, such third- parties will not be required to register as broker-dealers solely because they operatewebsites or other platforms that facilitatethe offer, sale, purchase, or negotiation of or with respect to securities, or that permitgeneral solicitation or general advertisingin connection with Rule 506 offerings,

or that provide ancillary services such asdue diligence or standardized documenta -tion, provided that such third-parties: (1)receive no compensation in connectionwith the purchase or sale of the securities;(2) do not hold investor funds or securitiesin connection with the transaction; and(3) are not subject to statutory bad actor

disquali cation provisions.Once the SECs rules are in place, a

practice of broadly disseminated an -nouncements of Rule 506 and Rule 144Aofferings is likely to develop. It may

become more common for issuers touse third-party matching and marketing

platforms in order to facilitate these of -ferings. Until the new rules are effective,issuers and intermediaries must continueto comply with current regulations.

The Federal Regulation of SecuritiesCommittee of the Business Law Sec -tion of the American Bar Associationhas submitted a pre-rulemaking com -ment letter regarding the elimination of general solicitation and general advertis -ing restrictions in connection with Rule506 and Rule 144A transactions, whichis available here . Other pre-rulemakingcomment letters relating to Title II of theJOBS Act are available here .

No Fraud Allowed Although the JOBS Act relaxes restric -tions on the audience for communica -tions, it does not eliminate anti-fraudrules. Issuers and intermediaries mustcontinue to ensure that communicationsdo not contain material misstatements or omissions that could subject them to li -ability in connection with the offering.

A New Small Public OfferingExemptionIn addition to easing restrictions on

private capital-raising efforts as discussedabove, the JOBS Act establishes a newexemption pursuant to new subparagraph(2) of Section 3(b) of the Securities Act.The JOBS Act gives the SEC signi cantlatitude in crafting this new exemption,and in many ways it appears to be similar to current Regulation A, which permits

private companies to conduct small public

offerings without registration. Somecommentators have referred to this newexemption as Regulation A+.

Regulation A Offerings: The Current RegimeToday, Regulation A provides some ad -vantages over a private offering, because

it permits limited solicitations of interest(sometimes referred to as testing thewaters) and purchasers receive securitiesthat are not restricted securities under federal securities law. In addition, Regula -tion A calls for less extensive disclosurethan a traditional initial public offeringand, although a very successful public of -fering under Regulation A could result inthe company having a number of holdersof record that would require registrationunder Section 12(g) of the ExchangeAct following the end of the scal year,Regulation A does not in and of itself trig -ger ongoing periodic reporting obligationsunder the Exchange Act. Regulation Ahas, however, fallen out of favor becauseof the $5,000,000 limit on aggregate con -sideration to be received for securities of -fered thereunder, including no more than$1,500,000 of securities offered by sellingshareholders, in any 12-month period. Inaddition, companies relying on RegulationA must comply with state regulations inevery state where the offering occurs.

The New Small Offering ExemptionTitle IV of the JOBS Act directs the SECto establish an exemption for offerings of up to $50,000,000, without a maximum for selling shareholders, in any 12-month pe -riod. In order to maintain the utility of the

new exemption, the JOBS Act requires theSEC to consider adjustments to the dollar limitation every two years. Companies will

be permitted to offer equity securities, debtsecurities, and debt securities convertible or exchangeable into equity interests, includ -ing any guarantees of such securities.

Although the new exemption would nottrigger required periodic reporting under the Exchange Act pursuant to SecuritiesAct Section 15(d), it will, among other things, subject a company to the civilliability provisions of Section 12(a)(2) of

the Securities Act and require the lingwith the SEC of annual audited nancialstatements. Through rulemaking, the SECmay also require that the company lewith the SEC and distribute to potentialinvestors an offering statement, and mayrequire the company to le additional

periodic disclosures.
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Like existing Regulation A, the newexemption will allow for solicitations of interest (testing the waters) and pur -chasers in such offerings will receive se -curities that are not restricted securities.In addition, securities offered under thisexemption will be considered coveredsecurities under the National SecuritiesMarket Improvements Act of 1996 (NS -MIA), and therefore not subject to statesecurities registration and quali cationrequirements, but only if the securitiesare offered or sold on a national securitiesexchange (which would require ExchangeAct registration under Section 12(b) of the Exchange Act), or offered or sold to aquali ed purchaser, which is a term yetto be de ned by the SEC.

Stay Tuned for RulemakingThere is no timeframe within which theSEC is required to adopt regulationsimplementing so-called Regulation A+.The most controversial aspect of Title IVis likely to be the scope of the state law

pre-emption. The JOBS Act directs theU.S. Comptroller General to complete astudy by early July 2012 (three monthsafter enactment) regarding the impact of state laws regulating securities offeringson Regulation A offerings.

Increases in Exchange Act Registra-tion TriggersWhile the amendments described abovewill be useful for capital-raising by

private companies, their bene ts would be muted in the absence of an increase tothe mandatory Exchange Act registrationtriggers that permits companies to stay

private longer. Accordingly, the JOBS Actincreases the number of holders of recordof a companys equity securities thatare permitted before the company mustregister under the Exchange Act and begin

public reporting.

Section 12(g): Before the JOBS Act Before the JOBS Act, a company wasrequired to register under Section 12(g) of the Exchange Act and begin the periodicreporting process if, at the end of its scalyear, the company had at least $10 million

in assets and a class of equity securitiesheld of record by 500 or more persons.Under this provision, nancing roundsand equity compensation arrangements ledmany private companies either to becomesubject to public disclosure rules long

before they were ready to go public, or toengage in share buy-backs or other meansto avoid or delay registration.

Relief from Exchange Act RegistrationThe JOBS Act raises the Section 12(g)registration thresholds and thereby im -

proves the utility of the JOBS Act capitalformation provisions. As amended, Sec -tion 12(g) will now require registration if,at the end of its scal year, a company hasat least $10 million in assets and a class of equity securities held of record by either (1) 2,000 persons, or (2) 500 persons whoare not accredited investors. Banks and

bank holding companies are not requiredto register unless they have, at the end of the scal year, at least $10 million in as -sets and a class of equity securities held of record by 2,000 or more persons.

Importantly, the de nition of hold -ers of record will also be amended toexclude securities held by persons whoreceived the securities in exempt transac -tions under an employee compensation

plan, or pursuant to the JOBS Act crowd -

funding exemption (see Crowdfunding:Its Practical Effect May Be Unclear UntilSEC Rulemaking is Complete ). Sincethese are two of the most likely avenuesfor the issuance of securities to non-accredited investors, a company could

potentially have a signi cant number of non-accredited investors that will not becounted against the 500 holder-of-recordlimit (or the 2,000 holder-of-record limitfor banks and bank holding companies)described above. It remains to be seenhow dif cult it will be for nonpublic com -

panies to monitor the accredited investor status of their shareholders. Except for

banks and bank holding companies, thederegistration thresholds under Sections12(g) and 15(d) of the Securities Act havenot been amended.

The SEC has posted an initial series of frequently asked questions regarding

implementation of the amendments toSection 12(g).

ConclusionThe JOBS Act aims to afford signi cantlymore latitude for capital-raising efforts,

particularly for private companies. As theSEC develops its rules under the JOBS Act,it will have to balance the need to promotecapital formation with the goal of protect -ing investors. Ultimately, we can expect tosee a much more public private offeringmarket, and perhaps new alternatives to thetraditional initial public offering.

Elizabeth M. Dunshee is an associate with Fredrikson & Byron, P.A., in Minneapolis. David M. Lynn is a partner of Morrison& Foerster LLP at the rms Washington, D.C., of ce. The views expressed in thisarticle are those of the authors and do not necessarily represent the view of theirrespective law rms or the American Bar Association.
http://apps.americanbar.org/buslaw/blt/content/2012/05/article-03-taku.shtmlhttp://apps.americanbar.org/buslaw/blt/content/2012/05/article-03-taku.shtmlhttp://apps.americanbar.org/buslaw/blt/content/2012/05/article-03-taku.shtmlhttp://www.sec.gov/divisions/corpfin/guidance/cfjjobsactfaq-12g.htmhttp://www.sec.gov/divisions/corpfin/guidance/cfjjobsactfaq-12g.htmhttp://www.fredlaw.com/bios/attorneys/dunsheeelizabethhttp://www.mofo.com/David-Lynn/http://www.mofo.com/David-Lynn/http://www.fredlaw.com/bios/attorneys/dunsheeelizabethhttp://www.sec.gov/divisions/corpfin/guidance/cfjjobsactfaq-12g.htmhttp://www.sec.gov/divisions/corpfin/guidance/cfjjobsactfaq-12g.htmhttp://apps.americanbar.org/buslaw/blt/content/2012/05/article-03-taku.shtmlhttp://apps.americanbar.org/buslaw/blt/content/2012/05/article-03-taku.shtmlhttp://apps.americanbar.org/buslaw/blt/content/2012/05/article-03-taku.shtml


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President Obama signed the JumpstartOur Business Startups Act (known as theJOBS Act) into law on April 5, 2012. Onehighly anticipated provision of the JOBSAct, Title III, is entitled Capital Rais-ing Online While Deterring Fraud andUnethical Non-Disclosure Act of 2012or the CROWDFUND Act. Title IIIenables crowdfunding, or the ability tosell securities in small amounts to a largenumber of investors.

Whether or not the crowdfunding provi-sions will have a signi cant impact onsmall business fundraising is yet to be de-termined. Despite the buzz among entre-

preneur communities, various restrictionsmay make crowdfunding impractical for companies raising money and the inter-mediaries that facilitate the process. Mostimportantly, the crowdfunding provisionsof the JOBS Act are not yet effective. OnApril 23, 2012, the SEC published guid-ance reminding issuers that any offers or sale of securities purporting to rely on thecrowdfunding exemption would be unlaw-ful under federal securities laws until the

SEC adopts new rules.

Crowdfunding Prior to the JOBS ActCrowdfunding is not a new concept. TheInternet has made it easier for individu-als and organizations to raise money for charitable purposes, political campaigns,artists seeking support from fans and vari-ous other projects. In 2005, Kiva launched

a micro- nance platform that allows people to lend small amounts of moneyto entrepreneurs in developing areas. Thislending model was further re ned, and

peer-to-peer lending companies like Pros- per emerged in 2006 and Lending Clubemerged in 2007. More recently, com-

panies like Kickstarter have emerged toenable the public to fund creative projectsranging from independent lms, videogames, and food projects.

Prior to the JOBS Act, crowdfundingsuffered from some several legal limita-tions. First, crowdfunding involving thesale of securities triggers the prohibitivelyexpensive registration requirements of theSecurities Act of 1933, as generally noexemptions are available in many crowd-funding models. Second, websites thatfacilitate crowdfunding may be subject toregulation as brokers.

As a result, current crowdfunding plat-forms have generally developed businessmodels designed to avoid characterizationas a sale of a security. Some companiesutilize pure donation models. Companies

like Kiva that provide micro-loans withoutinterest and do not take commissions arearguably not offering securities becausethere is no expectation of pro t on the

part of the investors. Other companieslike Kickstarter offer rewards or facilitatethe pre-purchase of products. At the other extreme, because the SEC has taken the

position that interest-bearing notes are

securities, companies like Prosper andLending Club have registered their offer-ings with the SEC.

Under pressure from Congress, the SECagreed to review its regulations and their effect on capital formation in spring 2011.Crowdfunding received a boost when theObama administration endorsed crowd-funding in September 2011. Although theSEC has the authority to exempt crowd-funding from the registration require-ments of the Securities Act and to exemptintermediaries from registration as broker-dealers, Congress has forced the SEC totake action. The House of Representatives

passed a crowdfunding bill in November 2011 and crowdfunding bills were intro-duced in the Senate in November 2011and December 2011 that resulted in thecrowdfunding provisions of the JOBS Act.

Crowdfunding under the JOBS ActTitle III of the JOBS Act amends Sec-tion 4 of the Securities Act by adding anew paragraph (6), and requires the SECto promulgate related rules to create an

exemption from registration that permits a private company to sell securities in smallamounts to large numbers of investors thatare not accredited over a 12-month period.

Under the crowdfunding provisions,the aggregate dollar amount of securitiesthat an issuer can sell in a crowdfundingtransaction is limited to $1 million (lessthe aggregate amount of securities sold

Crowdfunding: Its Practical Effect May Be UnclearUntil SEC Rulemaking is Complete

By Yoichiro Taku
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under other exemptions) over a 12-month period. In addition, the amount an issuer can sell to an individual investor in any12-month period is limited to the maxi-mum of:

the greater of $2,000 or 5 percent

of the annual income or net worthof an investor, if either the inves-tors net worth or annual income isless than $100,000; and

10 percent, not to exceed $100,000,of annual income or net worth of an investor, if either the investorsannual income or net worth is equalto or greater than $100,000.

Securities sold pursuant to the crowd-funding provisions are not transferable bythe purchaser for one-year from the date

of purchase, unless the securities are trans-ferred to the issuer, an accredited investor,in a registered offering, or to family of the purchaser. The securities may also besubject to such other limitations as may bedetermined by the SEC.

Requirements on IntermediariesAn issuer must sell the securities in acrowdfunding offering through a broker or funding portal, which is required toregister with the SEC and other applicableself-regulatory organizations.

These intermediaries need to meet a se-ries of speci c and restrictive requirementsto be determined by the SEC. For example,intermediaries will be required to:

provide investors with certaininformation (such as disclosuresrelated to risks and other investor education materials);

ensure that investors review theinvestor-education information, af-

rm their understanding of the risksand answer questions demonstrat-ing an understanding of the risks;

take measures to reduce the risk of fraud, including conducting back-ground checks on of cers, direc -tors, and holders of more than 20

percent of the shares of issuers;

make available to the SEC and potential investors the disclosurerequired to be provided by issuersnot later than 21 days prior to the

rst day on with securities are sold;

ensure that offering proceeds

are provided to the issuer onlywhen the target offering amountis reached or exceeded and allowinvestors to cancel their commit-ments;

ensure that no investor in a12-month period has purchasedsecurities pursuant to the crowd-funding exemption that exceed the

per-investor limits in the aggre-gate;

take steps to ensure the privacy of information collected from inves-tors;

not compensate promoters, nders,or lead generators for providingthe intermediary with the personalidentifying information of any

potential investor; and

prohibit its directors, of cers, or partners from having a nancial in -terest in an issuer using its services.

The SEC is directed to establish rulesthat exempt funding portals from broker-dealer registration as long as they aresubject to the authority of the SEC, are amember of a national securities associa-tion and are subject to other requirementsthe SEC may establish.

However, in order to qualify as a fund-ing portal, the intermediary must notoffer investment advice or recommenda-tions; solicit purchases, sales, or offers to

buy the securities offered on its website;compensate persons for such solicitation

based on the sale of securities referencedon its website; hold, manage, possess, or otherwise handle investor funds or securi-ties; or engage in other activities that theSEC determines.

While separate from the crowdfunding provisions, the JOBS Act also clari edthat certain intermediaries in the fund-

raising process, such as web sites likeAngelList that facilitate introductions

between companies and investors, arenot subject to broker-dealer registration.Section 201(c) of the JOBS Act providesthat certain trading platforms involvedwith the sale of securities in a valid Rule506 private placement are not subject toregistration as a broker or dealer as longas certain conditions are met, includingthat persons receive no compensation inconnection with the purchase or sale of securities and that the platform does nothave possession of customer funds or securities in connection with the purchaseor sale of securities.

Requirements for IssuersIssuers utilizing crowdfunding must make

nancial and other information availableto both the SEC and investors, both inconnection with the offering and on anannual basis. The JOBS Act provides for atiered disclosure regime based on the sizeof the offering, including the following:

$100,000 or less: Income taxreturns for the last scal year andunaudited nancial statements cer -ti ed as accurate by the principalexecutive of cer.

$100,000 to $500,000: Financial

statements reviewed by an indepen-dent public accountant.

More than $500,000: Audited nancial statements.

As a practical matter, many early-stagestartup companies that are consideringcrowdfunding may have only been re-cently incorporated and have not yet ledtax returns. Furthermore, many startupcompanies may not yet have engagedindependent public accountants, nor haveaudited nancial statements at the time

they wish to raise funds.Among other things, the issuer must le

with the SEC and provide to investors andthe intermediary and make available to

potential investors:

basic corporate information includ-ing name, legal status, address, andwebsite;


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names of of cers and directors(and any persons occupying similar status or performing similar func-tions);

names of any holder of more than20 percent of the shares of the is-

suer; description of the business and the

anticipated business plan of theissuer;

description of the stated purposeand intended use of the proceeds of the offering;

target offering amount, deadline toreach such target amount, and regu-lar updates relating to the issuers

progress in meeting the target offer-

ing amount; the price to the public of the securi-

ties or the method for determiningthe price, and written disclosure

prior to the sale of the nal priceand all required disclosures, provid-ing investors with a reasonableopportunity to rescind the commit-ment to purchase;

description of the ownership andcapital structure of the issuer; and

such other information as the SECmay prescribe.

Issuers must le annual reports withSEC and provide to investors reports of results of operations and nancial state -ments as the SEC determines. However,many private companies wish to protectsuch sensitive nancial information andmay be disinclined from utilizing theexemption for this reason.

Furthermore, issuers may not advertisethe terms of the offering except throughnotices that direct investors to the broker or funding portal. Compensation of inter-mediaries will be subject to rules designedto ensure that recipients disclose receipt of compensation.

In addition, the JOBS Act speci callyauthorizes an investor in a crowdfundingtransaction to bring a civil action againstan issuer for material misstatements or

omissions in disclosures provided toinvestors. Such an action is subject to the

provisions of Section 12(b) and Section 13of the Securities Act.

The crowdfunding exemption will not be available to foreign companies, SECreporting companies, investment com-

panies, and companies excluded fromthe de nition of investment company byvirtue of Section 3(b) or 3(c) of the Invest-ment Company Act of 1940.

The SEC is directed to promulgatedisquali cation provisions under whichan issuer is not eligible to offer securities

pursuant to new Section 4(6) of the Secu-rities Act and brokers or funding portalsshall not be eligible to effect or participatein crowdfunding transactions.

Coordination with State Law andOther ExemptionsSecurities acquired pursuant to the crowd-funding provisions will be exempt fromregistration or quali cation under state

blue sky laws. In addition, states may notrequire a ling or a fee for crowdfund -ing securities except for the state of the

principal place of business of the issuer or the state in which purchasers of 50 percentor greater of the aggregate amount raisedare residents. However, the crowdfund-ing provisions preserve state enforcement

authority over unlawful conduct by inter-mediaries and issuers and with respect tofraud or deceit.

While the JOBS Act speci cally statesthat the crowdfunding amendments to theSecurities Act are not to be interpreted as

preventing an issuer from raising capitalthrough other methods, it is unclear in prac-tice how this will work. Private placementsconducted through Regulation Dthe mostcommon type of private offering transac-tionmay be integrated with other offeringsconducted within six months. Absent SEC

clari cation, signi cant questions regard -ing integration may inhibit a crowdfundingtransaction at the same time as an angel or venture capital-led transaction with accred-ited investors is being conducted.

In addition, the SEC is directed to issue arule to exclude persons holding crowdfund-ing securities from the shareholder thresh-

old for registration under Section 12(g) of the Securities Exchange Act of 1934.

SEC RulemakingThe crowdfunding provisions of the JOBSAct require signi cant SEC rulemaking,which is supposed to occur by December 31, 2012. In addition to speci c areas thatthe SEC is supposed to address throughrulemaking, the SEC is given wide discre-tion to prescribe various requirements onintermediaries and issuers for the protec-tion of investors and in the public inter-est. The SEC has begun accepting publiccomments on regulatory initiatives under the JOBS Act, including the crowdfunding

provisions.SEC Chairman Mary Schapiro has pub-

licly stated that the proposed rulemakingdeadlines in the JOBS Act do not providesuf cient time for the SEC to consider and adopt rules under the act. Given thesestatements, it is not clear when companiesactually will be able to take advantageof all of the provisions of the JOBS Act,including the crowdfunding provisions.Given the extensive SEC rulemakingrequired by the JOBS Act, and the inves-tor protection issues involved, it is unclear whether the SEC will meet the deadline.

Raising Capital Apart from

CrowdfundingOther provisions of the JOBS Act provideopportunities to enable capital raisingother than through crowdfunding. For example, Section 201(a)(1) of the JOBSAct directs the SEC to amend Rule 506to make the prohibition against general so-licitation or general advertising containedin Rule 502(c) inapplicable to offersand sales under Rule 506 provided thatall purchasers are accredited investors.Section 201(b) amends Section 4 of theSecurities Act to provide that offers and

sales exempt under Rule 506 as revised bySection 201 shall not be deemed publicofferings under the Federal securitieslaws as a result of general advertisingor general solicitation. Section 201(a)requires the SEC to amend both Rule 506and Rule 144A not later than 90 days after enactment of the JOBS Act. Therefore,
http://www.sec.gov/spotlight/jobsactcomments.shtmlhttp://www.sec.gov/spotlight/jobsactcomments.shtml


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after SEC rulemaking is complete, it may be easier for issuers to advertise Rule 506offerings and raise capital through the saleof securities to accredited investors.

What the Crowdfunding ProvisionsMean

First, companies should not try to utilizecrowdfunding until the SEC nalizesrulemaking. Doing so would violate thesecurities laws and, in view of the badactor provisions in the JOBS Act, may

preclude a company from subsequentlyutilizing crowdfunding to raise capital.

Second, crowdfunding will clearlyexpand the options available to smallcompanies seeking nancing. As someearly-stage startup companies have usedKickstarter to fund pre-sales of products,some startups may choose to use crowd-funding as an alternative to more conven-tional sources of funding.

Third, companies seeking to raise capi-tal through crowdfunding will need attor-neys involved to ensure that their corpo-rate housekeeping is in order. Companieswill need to ensure that an appropriatenumber and type of shares is authorizedand review provisions relating to votingrights, board composition, and other mat-ters that may be affected when the number of stockholders increases. In addition,

companies will need to consider whether they will want their stockholders to enter into agreements imposing restrictions onshare transfers, such as a company right of

rst refusal or IPO-related lock-up provi -sions. Furthermore, with a large number of stockholders, companies may want toreview their director and of cer indemni -

cation provisions, and consider obtainingdirectors and of cers liability insurance.

Fourth, companies will be required tomake lings with the SEC. Although these

lings will be less burdensome than the

lings required by public companies, theymay still impose burdens on the resourcesof small companies, and may subject thecompanies and their of cers and directors to

potential liability if not properly prepared.Fifth, many companies may be unable

to prepare disclosure documents in compliance with the crowdfunding provisionsof the JOBS Act. The SEC may use its

rulemaking authority to prescribe a for-mat, such as the Form 1-A Regulation Aoffering statement and the model offeringcircular contained in the form, which mayimpose a signi cant burden to raising asmall amount of money.

Sixth, the increase in number of stock-holders as a result of crowdfunding mayresult in increased administrative burdenson issuers. Stockholders may call or e-mail company personnel with ques-tions or request meetings and may seek to avail themselves of rights to attend and

participate in stockholder meetings andto inspect corporate books and records.Should litigation arise, it may be morechallenging to manage such actions asthe number of stockholders increases.In addition, if an issuer is the target of an acquisition, having a large number of stockholders may complicate securitieslaw compliance.

Seventh, companies will need to chooseintermediaries carefully. While someintermediaries websites have already

begun to prepare for crowdfunding, thetransaction fees charged by intermediarieshave not yet been determined and there isthe risk that fees will be excessive or thatunscrupulous persons will masquerade asregistered intermediaries.

Finally, it is possible that the attention

given to crowdfunding may result in moreelaborate schemes to defraud the public.Although the SEC will likely establishstrict regulations on issuers and interme-diaries, the perception that crowdfundingis legitimate may encourage unscrupulous

persons to spam the public with variousfraudulent crowdfunding opportunitiesnot in compliance with the crowdfund-ing provisions of the JOBS Act. This mayrange from fraudsters operating fraudulentintermediaries to directly soliciting invest-ments in fraudulent businesses.

Yoichiro Taku is a corporate and secu-rities partner in the Palo Alto of ce of Wilson Sonsini Goodrich & Rosati. He isthe chairman of the Angel Venture Capital Subcommittee of the ABA Business Law Sections Venture Capital and Private Equity Committee. He also maintains a

web site at http://www.startupcompa-nylawyer.com/ .
http://www.wsgr.com/wsgr/DBIndex.aspx?SectionName=attorneys/BIOS/1933.htmhttp://apps.americanbar.org/dch/committee.cfm?com=CL930001http://apps.americanbar.org/dch/committee.cfm?com=CL930001http://www.startupcompanylawyer.com/http://www.startupcompanylawyer.com/http://www.startupcompanylawyer.com/http://www.startupcompanylawyer.com/http://apps.americanbar.org/dch/committee.cfm?com=CL930001http://apps.americanbar.org/dch/committee.cfm?com=CL930001http://www.wsgr.com/wsgr/DBIndex.aspx?SectionName=attorneys/BIOS/1933.htm


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1

The JOBS Act springs from a belief thatsmaller companies are the engines of economic growth and job creation. In this

view, the decline of the smaller companyIPO market over the last decade threatensthe long-term prospects of the Americaneconomy, as smaller companies that can-not access the IPO market must either relyon private capital to nance their growthor sell themselves to larger companies.

In an effort to restore vibrancy to thesmaller company IPO market, the JOBSAct eases disclosure and other regulatoryrequirements for smaller companies inthe initial public offering process and insubsequent public reporting. The belief is

that, over the past decade, smaller compa-nies have been discouraged from entering

public markets for capital due to the costof regulatory compliance, particularlyin the wake of the Sarbanes-Oxley Actof 2002 and the Dodd-Frank Wall StreetReform and Consumer Protection Act of 2010. If we create a new on-ramp to

public markets by easing the regulatory burden for smaller companies, the think-ing goes, more of these companies willseek to go public.

In order to have a successful publiccapital market for smaller companies,however, analysts and investors have tocome to the party as well. In this regard,the JOBS Act includes test the waters

provisions to permit smaller companiesto approach institutional investors prior to and during the offering period. Morecontroversially, the JOBS Act includes

provisions relaxing restrictions on com-

munications by analysts during the offer-ing period.

Emerging Growth CompaniesDefnedThe JOBS Act creates a new category of issuerthe emerging growth compa-nythat will bene t from a lighter levelof regulation in the offering process andas a reporting company for a period of upto ve years from the date of the issuers

rst public offering. An emerging growthcompany is an issuer that:

had less than $1 billion in annualgross revenues during its mostrecently completed scal year;

made its rst sale of commonequity securities pursuant to an ef-fective registration statement withinthe last ve years (or has not yetmade a registered sale of commonequity securities);

has not issued more than $1 billionin non-convertible debt securitiesover the past three years; and

is not a large accelerated ler as

de ned in Rule 12b-2 under theSecurities Exchange Act of 1934(i.e., a seasoned issuer with at least$700 million in common equitymarket capitalization held by non-af liates).

Companies that made their rst saleof common equity securities in a regis-tered offering on or before December 8,

2011, are excluded from the de nition of emerging growth companies. The goal of the emerging growth company on-ramp,

after all, is to create new public compa-nies, not to assist those that were already public when the JOBS Act was conceived.Companies that are reporting companiesas a result of Section 12(g) under theExchange Act and have not issued sharesin a registered offering under the Securi-ties Act of 1933, and companies that have

publicly issued debt but not equity, mightnonetheless qualify as emerging growthcompanies under the JOBS Act de nition.

The $1 billion revenue ceiling for emerging growth companies is signi cant,

as a large number of companies seekingto go public are likely to have revenues of less than that amount.

On April 16, 2012, and May 3, 2012,the Division of Corporation Finance of theSecurities and Exchange Commission (SEC)

posted frequently asked questions relatingto emerging growth companies on the SECwebsite, indicating among other things thatforeign issuers are eligible to be treated asemerging growth companies so long as theyotherwise meet the requirements.

Financial Disclosures and ReportingRequirementsThe JOBS Act seeks to make the nancialreporting process easier and less expen-sive for emerging growth companies inseveral ways, re ecting the fact that the

public company accounting requirementsand accounting costs often are a substan-tial deterrent to going public.

IPO On-Ramp: The Emerging Growth Company By Bonnie J. Roe
http://www.sec.gov/divisions/corpfin/guidance/cfjjobsactfaq-title-i-general.htmhttp://www.cohengresser.com/Dev/data/attorneysIZ/RoeBonnieJ/default.pdfhttp://www.cohengresser.com/Dev/data/attorneysIZ/RoeBonnieJ/default.pdfhttp://www.sec.gov/divisions/corpfin/guidance/cfjjobsactfaq-title-i-general.htm


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