On April 5, 2012, President Obama signed into law the JOBS Act which makes fundamental changes to the way capital will be raised by large and small public and private companies. Companies with up to $1 billion in annual revenues face fewer regulatory requirements in their IPOs and five years thereafter. Private placements of securities will be able to be publicly advertised and investors can be generally solicited. Companies can use the Internet and social media to raise up to $1 million every 12 months. Companies can use Regulation A to register an offering of up to $50 million in any 12-month period, up from $5 million. Private companies will no longer have to register under the Securities Exchange Act of 1934, as amended (the Exchange Act) until they have 2,000 shareholders of record, up from the previous limit of 500. The full text of the JOBS Act can be found here. Each of these changes is discussed below.

Emerging Growth Companies
Title I of the JOBS Act creates a new class of company known as Emerging Growth Companies, (EGCs) which are companies that have gross annual revenues of up to $1 billion, as indexed for inflation every five years, for its most recently completed fiscal year. These EGCs may remain EGCs until the earliest to occur of:

1. The last day of the fiscal year during which it had total annual gross revenues of $1 billion;
   
   
2. The last day of the fiscal year following the fifth anniversary of the date of its first sale of common equity securities pursuant to a public registration statement;
   
   
3. The date on which the EGC has, during the previous three-year period, issued more than $1 billion in non-convertible debt securities; or
   
4. The date on which the EGC is deemed to be a “large accelerated filer” as defined in Rule 12b-2 of the Exchange Act. A “large accelerated filer” has a public float of at least $700 million.
   

EGCs are permitted to conduct an IPO without complying with a number of current rules, including some under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act) and the Sarbanes-Oxley Act of 2002 (SOX). These include:

1. Provision of only two years of audited financial statements in a registration statement for its IPO rather than the current three years required of other companies (other than “smaller reporting companies”);
   
   
2. Exemption from providing selected financial data pursuant to Item 301 of Regulation S-K for any period prior to the audited financial statements provided in its IPO registration statement for any subsequent registration statement;
   
   
3. Exemption from compliance with new or revised financial accounting standards until the date that non-public companies are required to comply with such standards;
   
   
4. Exemption from the auditor’s attestation on management’s report on internal controls under SOX Section 404(b);
   
   
5. Exemption from the requirement to rotate auditors or any auditor discussion and analysis once adopted by the Public Company Accounting Oversight Board ( PCAOB), unless the SEC determines otherwise;
   
   
6. Exemption from current requirements for non-binding shareholder votes on “say-on-pay” and “say-on-golden parachutes,” as well as rules on CEO-employee pay ratios and pay versus performance disclosures yet to be proposed under the Dodd-Frank Act; and
   
   
7. Provision of the reduced executive compensation disclosure permitted to smaller reporting companies (three executives rather than five and two years rather than three years), as well as an exemption from providing the compensation discussion and analysis (CD&A).
   

Additionally, EGCs can:

1. Submit to the SEC of a confidential draft registration statement for its IPO prior to filing it publicly so long as the draft is submitted at least 21 days prior to the date on which the company conducts a road show;
   
   
2. Have research analysts not only publish research reports on an EGC even if the affiliated investment bank is participating in the EGC’s IPO, but also to participate in communications with management where other investment bankers are present and lifting the restrictions on investment bankers publishing and distributing research reports or making public appearances in connection with the sale of securities during post-IPO quiet periods; and
   
   
3. “Test the waters” prior to filing a registration statement with the SEC so long as the potential investors are institutional accredited investors (pursuant to Rule 501(a) of Regulation D or qualified institutional buyers (pursuant to Rule 144A of the Securities Act of 1933, as amended (the “Securities Act”)).
   

EGCs can also decide to “opt-in” to the more comprehensive disclosure requirements applicable to issuers that are not EGCs; however, if an EGC determines to “opt-in” to compliance with new or revised financial accounting standards for which it was exempted pursuant to the JOBS Act, an EGC must:

1. Make such choice at the time it is first required to file a registration statement, periodic report or other report required by Section 13 of the Exchange Act and notify the SEC of its choice to do so;
   
   
2. Must comply with all such standards to the same extent as non-EGCs; and
   
   
3. Must continue to comply with such standards to the same extent that a non-EGC is required to do so for so long as the issuer remains an EGC.
   

A company can become an EGC so long as its first sale of equity securities pursuant to an effective registration statement occurred after December 8, 2011.

Elimination of Prohibition on General Solicitation and General Advertising
Title II of the JOBS Act provides that, so long as all purchasers in a Regulation D, Rule 506 offering are accredited investors, there are no more prohibitions on general solicitation and general advertising of such securities offerings. In addition, there are no prohibitions on general solicitation and general advertising in a Rule 144A offering so long as all purchasers are qualified institutional buyers. Neither a Rule 506 offering nor a Rule 144A offering will be considered a public offering by virtue of a general solicitation or general advertising so long as the issuer has taken reasonable steps to verify that purchasers are either accredited investors or qualified institutional buyers, respectively. The JOBS Act requires the SEC to revise its rules within 90 days after the date of enactment. The SEC, as part of its rulemaking, will have to determine what “reasonable steps” will be required from issuers to verify a purchaser’s status as either an accredited investor or a qualified institutional buyer.

In addition, with respect to a Rule 506 offering, a person need not register as a broker or dealer pursuant to Section 15 of the Exchange Act:

1. for maintaining a platform or mechanism, either online, in person or through any other means, that permits the offers, sales, purchases or negotiations of or with respect to securities or permits the general solicitation or advertising of securities or related activities by issuers;
   
   
2. where such person or an associated person co-invests in such securities or
   
   
3. where such person or an associated person provides ancillary services with respect to such securities.
   

Ancillary services are defined in the JOBS Act to include (1) due diligence services in connection with the offer, sale, purchase, or negotiation of such security so long as there is no separate compensation, investment advice, or recommendations to issuers or investors and (2) the provision of standardized documents to issuers and investors so long as such person does not negotiate the terms of the issuance of the securities for or on behalf of third parties and issuers are not required to use the standardized documents as a condition of using any such services. The exemption from registration as a broker or dealer also requires that such person and each person associated with such person:

1. receives no compensation in connection with the purchase or sale of the security;
   
   
2. does not have possession or customer funds or securities in connection with the purchase or sale; and
   
   
3. is not subject to statutory disqualification pursuant to Section 3(a)(39) of the Exchange Act.
   

Section 4(2) of the Securities Act provides for exemption from registration for “any transaction by an issuer not involving a public offering.” The JOBS Act did not address any issues with respect to “manner of offering” limitations outside of Rule 506, which is a safe-harbor provision under Section 4(2) of the Securities Act.

Capital Raising Online While Deterring Fraud and Unethical Non-disclosure Act of 2012 (Otherwise Known as “Crowdfunding”)
Title III of the JOBS Act creates a new transactional exemption within Section 4 of the Securities Act. New Section 4(6) will permit companies to use the internet and social media to sell up to $1 million of securities within any 12-month period to an unlimited number of investors. However, the amount sold to any investor by an issuer cannot exceed:

1. the greater of $2,000 or five percent (5%) of the investor’s annual income or net worth, so long as such investor’s annual income or net worth is less than $100,000; or
   
   
2. if the investor’s annual income or net worth is equal to or more than $100,000, ten percent (10%) of the investor’s annual income or net worth, not to exceed a maximum aggregate amount of $100,000 of securities sold.
   

Any crowdfunding transaction must be conducted through a broker or funding portal and the issuer must comply with certain filing and disclosure requirements, including:

1. the names of directors and officers and each person holding more than 20% of the shares of the issuer;
   
   
2. a description of the business of the issuer and the anticipated business plan of the issuer;
   
   
3. depending on the size of the target offering amount, a description of the financial condition of the issuer including either (1) the income tax returns of the issuer for the most recently completed year and the financial statements of the issuer certified by the principal executive officer; (2) financial statements reviewed by an independent public accountant; or (3) audited financial statements;
   
   
4. a description of the stated purpose and intended use of the proceeds of the offering;
   
   
5. the target offering amount, the deadline to reach the target offering amount and regular updates regarding the progress of the issuer in reaching the target offering amount;
   
   
6. the price or method of determining the price to the public of the securities; provided, that prior to sale, each investor receives, in writing, the final price, and all required disclosures and has a reasonable opportunity to rescind its commitment to purchase the securities;
   
   
7. a description of the ownership and capital structure of the issuer, including the terms of the securities being issued as well as all other classes of securities outstanding, as well as the risks to purchasers related to minority ownership, corporate actions (including dilution), transactions with related parties, and sale of the company or its assets; and
   
   
8. such other information as the SEC prescribes for the protection of investors and in the public interest.
   

Issuers may not advertise the terms of the offering except through notices that direct investors to the funding portal or broker. Issuers also may not compensate, directly or indirectly, any person to promote its offering other than in accordance with rules to be prescribed by the SEC. An issuer must also, not less than annually, provide investors reports regarding its results of operations and financial statements and file such reports with the SEC.

Securities purchased pursuant to the exemption in Section 4(6) are restricted securities and may not be transferred for at least one year following the date of purchase, except to the issuer, an accredited investor, a family member, or in connection with death or a divorce or pursuant to a resale offering registered with the SEC. Offerings under the crowdfunding exemption will be “covered securities” pursuant to Section 18(b)(4) of the Securities Act and not subject to regulation under state securities laws, other than notice filing requirements. In addition, issuers and their directors, officers, principal executive officers, principal financial officer, controller, and any person who offers or sells securities will be subject to the anti-fraud provisions in offering documents or oral communications in connection with the sale of securities and will be subject to civil liability for any violations of such anti-fraud provisions.

Intermediaries that facilitate crowdfunding offerings will be subject to certain requirements that are intended to provide investor protection, including disqualification similar to Rule 262 of the Securities Act and registration with the SEC either as a broker-dealer or as a “funding portal,” which exempts them from broker-dealer registration. In addition, such intermediaries will be required to provide certain disclosures to ensure that investors understand the risks, including a complete loss of their investment, generally applicable to new ventures and small businesses.

For purposes of calculating the number of shareholders of record for registration pursuant to Section 12(g) of the Exchange Act, securities acquired pursuant to a crowdfunding offering are excluded.

The SEC has 270 days after the date of enactment of the JOBS Act to complete its rulemaking with respect to the provisions of Title III of the JOBS Act.

Small Company Capital Formation (Otherwise Known as the “Regulation A Amendments”)
Title IV of the JOBS Act amends Section 3(b) of the Securities Act by requiring the SEC to add, by rule or regulation, a new exempt security that provides for the following:

1. the aggregate offering amount of all securities offered and sold within the previous 12 months may not exceed $50 million;
   
   
2. such securities may be offered and sold publicly;
   
   
3. such securities will not be restricted securities;
   
   
4. Section 12(a)(2) civil liability provisions will be applicable to any person offering or selling such securities;
   
   
5. issuers may “test the waters” to solicit investor interest prior to filing an offering statement;
   
   
6. the issuer must file audited financial statements with the SEC annually; and
   
   
7. such other terms and conditions as the SEC may require, including requiring electronic filing with the SEC and disqualification for issuers or underwriters similar to the disqualification provisions required by Section 926 of the Dodd-Frank Act.
   

Only equity securities, debt securities, and debt securities convertible or exchangeable into equity securities, including guarantees of such securities may be offered pursuant to this exemption.

Any securities issued in connection with this new Section 3(b) exemption will be “covered securities” pursuant to Section 18(b)(4) of the Securities Act only if such securities are offered and sold on a national securities exchange or offered and sold to a qualified purchaser, as defined by the SEC.

It is expected that the SEC will incorporate the changes included in Title IV of the JOBS Act as an amendment to its current Regulation A rather than creating a new exempt security. There is, however, no mandated deadline for the SEC to promulgate rules to implement Title IV of the JOBS Act.

Increase in Exchange Act Reporting Thresholds
Titles V and VI of the JOBS Act amend Section 12(g) of the Exchange Act to increase the threshold for registration as a public company. Previously, Section 12(g) required an issuer to register under the Exchange Act if, on the last day of its fiscal year, it had 500 or more holders of record of a class of its equity securities and more than $10 million in total assets.

Under the JOBS Act, the $10 million asset test remains unchanged, but the new threshold for holders of record for any company that is not either a bank or a bank holding company is increased from 500 holders of record to either 2,000 holders of record or 500 holders of record who are not accredited investors. Excluded from the holder of record calculation are:

1. holders of securities acquired through the crowdfunding exemption (new Section 4(6) of the Securities Act);
   
   
2. holders of securities received under an issuer’s employee compensation plan in reliance on other exemptions from registration under the Securities Act; and
   
   
3. the current exclusion for beneficial owners who are not also record holders, such as persons who hold their securities through brokerage firms or other intermediaries.
   

Title VI of the JOBS Act also sets the threshold requirement for banks and bank holding companies at $10 million in assets and 2,000 record holders, without any requirement to distinguish between accredited and non-accredited investors.

The SEC has one year to enact rules to make the changes required by Title VI. Title V requires the SEC to revise the definition of “held of record” and to adopt safe harbor provisions for issuers to determine whether securityholders received their shares pursuant to an exempt compensation plan; however, there is no time requirement set forth in the JOBS Act to do so.

Conclusion
There are a number of fundamental changes to the way that capital will be raised by small and large, public and private companies contained in the JOBS Act. Many of the changes require rules to be promulgated by the SEC while a number of changes, such as the definition of an Emerging Growth Company, are effective immediately and relate back to December 8, 2011. Only time will tell whether these changes stimulate job growth and capital formation activities but they have fundamentally changed the landscape for many companies to raise capital in less restrictive ways and provide less protections to investors.

For further information, please contact Deborah Froling or any of our attorneys in the Corporate Group.

This client alert is for general informational purposes and should not be regarded as legal advice. Furthermore, the information contained in this memorandum does not represent, and should not be regarded as, the view of any particular client of Arent Fox LLP. Please contact your relationship partner if we can be of assistance regarding these important developments. The names and office locations of all of our partners can be obtained from our website, www.arentfox.com.