This article was authored by Alex Bafi, Partner, and Dinesh Banani, Senior Associate at Herbert Smith, an international law firm. |
This e-bulletin discusses the aspects of the JOBS Act most likely to impact foreign private issuers, including non-US investment funds. Certain provisions of the JOBS Act, including those in relation to the relaxation of standards for Emerging Growth Companies, are effective immediately. Other provisions will require further rulemaking, guidance and interpretation from the US Securities and Exchange Commission (the "SEC") in the coming weeks and months.
The objectives of the JOBS Act are ambitious, but it remains to be seen to what extent the regulatory changes adopted by the JOBS Act will be reflected in practice.(1)
1. Emerging Growth Companies
1. Emerging Growth Companies
The JOBS Act establishes a new category of issuer, the Emerging Growth Company ("EGC"), which the JOBS Act defines as a company with annual gross revenues of less than $1 billion during its most recently completed fiscal year. The JOBS Act aims to significantly reduce the regulatory burden on EGCs, with the aim of encouraging greater use of the US capital markets by these companies, particularly by way of US SEC-registered equity initial public offerings ("IPOs").
The SEC has indicated that foreign private issuers who fall under the definition of an EGC are eligible to utilize all the regulatory accommodations that are available to a US-domestic EGC under the JOBS Act. Issuers who elect to be treated as EGCs can also choose to take advantage of certain reforms while foregoing others.(2)
Key Provisions in Relation to Emerging Growth Companies (EGCs)
The key elements of the JOBS Act relating to EGCs include:
Confidential treatment of draft IPO registration statements. The JOBS Act enables an EGC to submit its draft IPO registration statement to the SEC on a confidential basis prior to the initial public offering date3 so long as a public filing is made at least 21 days prior to the roadshow for the offering. Once a public filing of the registration statement is made, it must include the initial confidential submission and all amendments thereto.(4)
A foreign private issuer should be able to use these new confidential submission procedures if it qualifies as an EGC, even if it is currently not permitted to use the SEC's existing confidential review procedures created specifically for foreign private issuers.(5) Conversely, foreign private issuers who do not qualify as EGCs may, if they are eligible, and subject to the SEC's approval, continue using the existing confidential review procedures for foreign private issuers to submit their draft registration statements. However, a foreign private issuer that takes advantage of any other EGC-related accommodation under the JOBS Act cannot, at the same time, make a confidential submission under the existing foreign private issuer procedures. In that situation, a foreign private issuer will be required to publicly file its confidential submission (and all amendments thereto) at least 21 days before its roadshow.
Test-the-waters communications. In relation to US public offerings, companies and other offering participants are prohibited from making (i) oral or written offers before filing a registration statement with the SEC and (ii) written offers without a statutory prospectus, subject to exceptions for free writing prospectuses in certain cases and other limited communications. The JOBS Act creates an additional exception to this general prohibition by permitting an EGC and anyone acting on its behalf, at any time before or after the public filing of the IPO registration statement, to engage in oral or written communication with any Qualified Institutional Buyer (“QIB”) and with any institutional accredited investor in order to ascertain the level of interest in an IPO among such investors. The SEC has referred to such pre-IPO marketing as "test-the-waters communications".
A company must determine whether it qualifies as an EGC each time it undertakes any test-the-waters communications. Companies that have submitted draft registration statements on a confidential basis will also need to ensure that any test-the-waters communications do not constitute a roadshow (which cannot occur until 21 days after a public filing of the IPO registration statement) by strictly limiting such communications to QIBs and/or institutional accredited investors during the time before a roadshow is permitted. Any statements, whether written or oral, made in connection with any test-the-waters communications should not be considered exempt from potential liability under Section 12(a)(2) of the U.S. Securities Act of 1933 (the "Securities Act") or the anti-fraud provisions of Rule 10b-5 under the Exchange Act.
Financial Reporting.An EGC is permitted to provide two, rather than three, years of audited financial statements in its IPO prospectus, and the selected financial data and management's discussion and analysis (MD&A) sections of the IPO prospectus may cover only those two years.
An EGC will also not be required to:
• produce an auditor's attestation report in relation to the EGC's internal controls under Section 404(b) of the Sarbanes-Oxley Act;
Research. The Act provides that the publication or distribution by a broker-dealer of a research report about an EGC that is publicly offering, or proposing to offer, equity securities will not “constitute an offer for sale or an offer to sell a security” even if the broker-dealer is participating or will participate in the offering. The Act also mandates that neither the SEC nor the Financial Industry Regulatory Authority ("FINRA") can adopt or maintain any regulations prohibiting broker-dealers from publishing research reports with respect to the securities of an EGC within any time period after the initial public offering date or before the expiration of any related lock-up arrangement, whether or not such report contains sufficient information upon which to base an investment decision. Furthermore, neither the SEC nor FINRA can adopt or maintain any regulations, in relation to an EGC's IPO, that restrict a research analyst from participating in meetings with management and other investment banking personnel associated with that research analyst.
The rule changes under the JOBS Act in relation to IPO research for EGCs appear to represent a significant relaxation of the existing standards applicable to connected research analysts and research reports. Under current rules, investment banks participating in an SEC-registered IPO cannot publish research until 40 days after the completion of the offering (and 15 days prior to and after the expiration, waiver, or termination of a lock-up agreement) and connected research analysts are not permitted to participate in meetings with management and investment banking personnel unless it is for due diligence purposes and a compliance chaperone is present. Also, given that EGC research reports at or around the time of an IPO will no longer be viewed by the SEC as an offering of securities under Section 5 of the Securities Act, prospectus liability under Section 12(a)(2) of the Securities Act should not apply to such research reports (though the anti-fraud provisions of Rule 10b-5 under the Exchange Act would continue to apply).
The Chairman of the SEC, Mary Schapiro, has been openly critical of the research-related rule changes under the JOBS Act and, at this stage, it is unclear to what extent the existing practice of research analysts covering US-registered IPOs will change. It should be noted that some of the existing restrictions on research analysts are not directly affected by the JOBS Act, including the restriction on participating in efforts to solicit investment banking business, the prohibition on discussions between research analysts and investment bankers regarding the content of the research report and the requirement that research analysts certify that the views they express in their research reports accurately reflect their personal views. It is also unlikely that investment banks still subject to the Global Research Settlement can utilize all the reforms afforded by the JOBS Act without amendments to, or an SEC or FINRA rule that supersedes specific provisions of, that settlement.
Cessation of EGC Status An issuer that is an EGC as of the first day of the most recent fiscal year in which its annual gross revenue was less than $1 billion will maintain its status as an EGC until the earliest of:
1. The last day of the fiscal year of the issuer during which it had total annual gross revenues of $1 billion or more;
Potential Impact on Foreign Private Issuers It remains to be seen whether foreign private issuers that qualify as EGCs will seek to undertake SEC-registered IPOs as a result of the JOBS Act. Enabling EGCs to obtain confidential SEC review of draft IPO registration statements, engage in test-the-waters communications, and benefit from reduced financial reporting obligations, and removing certain restrictions in respect of connected analyst research, have the potential to be significant accommodations to EGCs. However, foreign private issuers also consider many other factors when deciding where to list or publicly offer their securities. Moreover, in the case of a foreign private issuer that would qualify as an EGC and is considering a concurrent listing in the US and another jurisdiction, the securities rules of the other jurisdiction, regardless of the JOBS Act, may require disclosure of three years of audited financial information, and may also require the EGC's auditors to assess its internal controls and procedures at or around the time of the IPO.
The JOBS Act does not significantly change the landscape for liability (and potential litigation) under the US securities rules. This has historically been a major consideration for foreign private issuers when approaching the US capital markets. As noted above, any material misstatements or omissions, whether written or oral, made in connection with any test-the-waters communications should not be considered exempt from potential liability under Section 12(a)(2) of the Securities Act or the anti-fraud provisions of Rule 10b-5 under the Exchange Act. The anti-fraud provisions of Rule 10b-5 will also apply to any IPO research reports relating to EGCs. The potential liability associated with test-the-waters communications and research reports will also be a concern to the underwriters of such offerings. If they choose to undertake these activities in connection with SEC-registered offerings, underwriters will need to adopt procedures to ensure that any IPO research reports or test-the-waters communications do not contain any material misstatements or omissions and are consistent with the proposed disclosure in the IPO prospectus. The underwriters may also seek to have any test-the-waters communications covered by the representations, undertakings and disclosure indemnity in the underwriting agreement with the issuer.
Impact on Rule 144A and Regulation S Global Offerings Given the considerations discussed above, it is also unclear to what extent market practice for global concurrent offerings under Rule 144A/Regulation S will change as a result of the EGC reforms under the JOBS Act. The disclosure in offering documents for Rule 144A/Regulation S offerings has generally tended to follow the standards for US-registered offerings. Given the relaxation of requirements in respect of EGCs, it is possible that the disclosure standards in Rule 144A/Regulation S offerings could change accordingly by allowing for two, rather than three, years of audited financial statements, particularly in the case of offerings by issuers who would have been eligible to conduct an SEC-registered offering as an EGC. However, this practice may not be adopted consistently as (i) local disclosure requirements and/or stock exchange rules may require more stringent financial reporting and disclosure requirements than what is required under the JOBS Act and (ii) foreign private issuers (and their underwriters) may decide to disclose additional financial information in their Rule 144A/Regulation S offering document to ensure that the disclosure, and the material trends discussed therein, are not materially misleading and do not contain material omissions.
It also remains to be seen whether current market practice in Rule 144A/Regulation S global offerings to avoid sending IPO and (subject to certain exemptions) other research into, or to conduct minimal, if any, pre-marketing activity in, the US will change in light of the JOBS Act. Given that the US liability risks associated with these activities remain largely unchanged, the desire to minimize potential liability under Rule 10b-5 of the Exchange Act is likely to remain an important factor in determining the extent to which market practice changes in these respects.
2. Communications with Potential Investors in US Private Placements
Removal of Ban on General Solicitation and General Advertising
The JOBS Act mandates changes to the rules that govern the conduct of US private placements by requiring the SEC to amend Rule 506 of Regulation D and Rule 144A under the Securities Act to eliminate the prohibition on "general solicitation and general advertising" for offerings conducted under those rules. Rule 506 will be amended so that the prohibition on general solicitation and general advertising does not apply to offers and sales of securities made under that rule, provided that every purchaser is an Accredited Investor ("AI") and the issuer takes reasonable steps to verify that purchasers of the securities are AIs (using such methods as determined by the SEC). Rule 144A will be amended so that securities sold under that rule may be offered to persons other than QIBs, including by way of general solicitation and general advertising, provided that the securities are sold only to persons that the seller and any person acting on its behalf reasonably believes are QIBs. The SEC must adopt these amendments no later than 90 days after the enactment of the JOBS Act.
The JOBS Act has also amended Section 4 of the Securities Act to clarify that offers and sales exempt under the revised Rule 506 of Regulation D will not be deemed "public offerings" under the US federal securities laws as a result of general solicitation and general advertising. This clarification is likely to be relevant for foreign investment funds who currently rely on the Section 3(c)(1) or 3(c)(7) exemptions from registration under the Investment Company Act of 1940 and want to undertake a private placement under the revised Rule 506 of Regulation D. The exemptions under Sections 3(c)(1) and 3(c)(7) provide that such funds cannot make, or propose to make, a public offering of their securities in the US.
The JOBS Act does not amend the exemption from registration under Section 4(2) of the Securities Act.8 Until the SEC provides further guidance, issuers conducting private placements pursuant to Section 4(2) (but not in accordance with Rule 506 of Regulation D or Rule 144A) are likely to continue to rely on current market practice, which would involve extending offers only to a limited number of sophisticated investors in the US (without conducting any general solicitation or general advertising).
The amendments to Rule 506 of Regulation D and Rule 144A also do not affect the anti-fraud provisions of Rule 10b-5 under the Exchange Act.
Potential Impact on Foreign Private Issuers
Foreign private issuers often sell securities in a concurrent offering in reliance on Rule 144A for offers and sales to US QIBs and Regulation S for "offshore" offers and sales made in other jurisdictions. Regulation S prohibits directed selling efforts, which is broadly defined to include any activities that have, or can reasonably be expected to have, the effect of conditioning the market in the US for the securities being offered.
The JOBS Act does not direct the SEC to amend Regulation S and, at the moment, the prohibition on directed selling efforts remains in place. As a result, the prohibition on directed selling efforts under Regulation S could limit the utility of lifting the ban on general solicitation and general advertising, especially in situations where issuers and underwriters want to undertake widespread marketing activity in the US in reliance on the revised Rule 144A (or the revised Rule 506 of Regulation D) and concurrently offer securities outside the US in reliance on Regulation S. At this stage, it remains unclear how the SEC will change the definition, or its interpretation of, directed selling efforts in this context.
3. Registration Thresholds under the US Exchange Act
The JOBS Act has also amended Section 12(g) of the Exchange Act to increase the threshold number of shareholders required before a company must register its equity securities under the Exchange Act. Currently, non-reporting U.S. companies must file an Exchange Act registration statement regarding a class of equity securities within 120 days of the last day of its fiscal year if, on that date, the number of its record holders is 500 or greater, and the issuer’s total assets exceed $10 million. An issuer other than a bank or bank holding company must now register a class of equity securities under the Exchange Act if, on the last day of its fiscal year, (i) it has equity securities held of record by at least either (A) 2,000 persons or (B) 500 persons who are non-AIs and (ii) its total assets exceed US$10 million.(9)
The JOBS Act has not amended Rule 12g3-2(a) under the Exchange Act, which exempts foreign private issuers with fewer than 300 holders resident in the United States from Exchange Act registration (though it is possible that the SEC will make corresponding changes to Rule 12g3-2(a) to conform with the amendments to Section 12(g)). The JOBS Act also does not affect Rule 12g3-2(b), which exempts a foreign private issuer from Exchange Act registration if, among other requirements, the issuer furnishes certain material information regarding its business in English on its website on an ongoing basis.
Potential Impact on Foreign Private Issuers
Many foreign private issuers are exempt from Exchange Act registration under Rule 12g3-2(b) and, as a result, the amendments to Section 12(g) are not expected to have an impact on the exempt status of those issuers. However, for foreign private issuers that currently rely on the exemption under Rule 12g3-2(a) (which would typically include Section 3(c)(7) private funds), conforming amendments that the SEC may make to this Rule, when considered together with the amendments to Rule 506 of Regulation D, could allow these funds to offer and sell their securities to a wider pool of qualified purchasers in the United States.(10)
2 However, as discussed below, an EGC who chooses to avail itself of the exemption from compliance with new or revised accounting standards may not selectively take advantage of this exemption by complying with some, but not all, new or revised standards.
3 "Initial public offering date" under the JOBS Act is the date of the first sale of common equity securities of an issuer pursuant to an effective registration statement under the US Securities Act of 1933.
4 Consistent with the SEC's existing policy for all issuers, comment letters relating to the registration statement and the EGC's responses remain confidential until no earlier than 20 days after the effective date of the IPO registration statement.
5 On 8 December 2011 the SEC indicated that it will generally not permit a foreign private issuer to use the confidential review process created expressly for foreign private issuers if such foreign private issuer proposes to list its securities only on a US exchange. A foreign private issuer proposing to undertake concurrent listings on a US exchange and a foreign exchange should, unless indicated otherwise by the staff of the SEC, be able to continue using these confidential review procedures. (See Herbert Smith LLP Corporate e-Bulletin, "US SEC limits availability of confidential review process for initial registration statements of foreign private issuers", 19 December 2011.)
6 The SEC has clarified that the term "new or revised" financial accounting standards refers to any update by the US Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.
7 An issuer becomes a "large accelerated filer" when (i) the worldwide market value of its outstanding common equity in the hands of non-affiliates is in aggregate equal to or greater than $700 million (as measured on the last day of the issuer's fiscal year); (ii) the issuer has been publicly reporting to the SEC for at least 12 months; and (iii) the issuer has filed at least one annual report with the SEC; and (iv) the issuer is not eligible to use the requirements for smaller companies set out under the Exchange Act for its annual and quarterly reports.
8 The JOBS Act does, however, renumber Section 4(2) of the Securities Act as Section 4(a)(2) as a result of the other amendments to Section 4 discussed in this e-bulletin.
9 Further, the JOBS Act excludes certain categories of holders from the definition of "holder of record", including holders receiving securities via employee compensation plans in transactions exempted from registration under the Securities Act. For banks and bank holding companies, the holder of record threshold is 2,000 persons, with no limit on the number of non-AIs.
10 Operators of private funds trading commodity interests and that rely on certain exemptions from regulation promulgated by the Commodity Futures Trading Commission ("CFTC") should be mindful that the JOBS Act only applies to the "federal securities laws" and that restrictions on general solicitation and general advertising under the CFTC rules may still be applicable to such funds.
Other Voices: The JOBS Act and its impact on foreign private issuers
Thursday, May 17, 2012