The Jumpstart Our Business Startups Act (the “JOBS Act”) became law in April with a goal of improving access to capital markets and easing compliance burdens for newer and smaller public companies. Among other things, the JOBS Act eases the registration and reporting requirements, in some cases significantly so, for those companies that meet the definition of an “emerging growth company” or “EGC” and may significantly facilitate the burdens of going and being public that have increased consistently since the adoption of the Sarbanes-Oxley Act in 2002. In part, the JOBS Act is intended to promote an “IPO on-ramp” that has been a goal of the U.S. Treasury Department, the SEC and a cross-section of industry participants over the past several years.
Certain provisions of the JOBS Act became effective when the act was signed into law, while others require substantive rulemaking by the SEC and other regulators. However, even the provisions that were automatically implemented have created some uncertainty as to applicability and application. To help issuers start taking advantage of these provisions, the Securities and Exchange Commission’s Division of Corporation Finance has published additional guidance for emerging growth companies on the provisions of the JOBS Act, along with instructions regarding the confidential submission process.
This bulletin provides a brief overview of the regulatory changes for companies that qualify as emerging growth companies under the JOBS Act and a description of some of the guidance and developments since the law took effect.
Emerging growth company
An “emerging growth company” is an issuer whose initial public offering was or will be completed after Dec. 8, 2011, and had total annual gross revenues of less than $1 billion during its most recently completed fiscal year. An issuer’s EGC status terminates on the earliest of:
- The last day of the first fiscal year of the issuer during which it had total annual gross revenues of $1 billion or more;
- The last day of the fiscal year of the issuer following the fifth anniversary of the date of the issuer’s initial public offering;
- The date on which such issuer has issued more than $1 billion in non-convertible debt1 during the prior three-year period determined on a rolling basis; or
- The date on which the issuer is deemed to be a “large accelerated filer” under the Exchange Act, which means, among other things, that it has a public float in excess of $700 million.
A number of the companies that have filed registration statements on Form S-1 since the JOBS Act took effect have identified themselves as emerging growth companies. In each instance, the issuer has made affirmative disclosures related to its status as an emerging growth company, in accordance with guidance from the Division of Corporation Finance, which requests that EGC issuers identify themselves as an emerging growth company on the cover page of the prospectus. Each issuer has also included a risk factor describing the reporting obligations to which, as emerging growth companies, they are exempt under the JOBS Act and describing as a risk the possibility that the reduced reporting requirements will make their common stock less attractive to investors. Reporting companies that are EGCs may also want to consider including disclosure about how and when they may lose the EGC status and become subject to the standard disclosure requirements.
Confidential submissions
An emerging growth company may now submit a registration statement and preliminary prospectus confidentially in draft form for review prior to making a public filing.2 This non-public submission process is intended to allow an emerging growth company to protect confidential information while obtaining more certainty as to whether it will ultimately complete its offering, particularly in light of the relaxation of certain pre-filing, or “gun-jumping,” restrictions discussed in greater detail below. Since the confidential submission of the draft registration statement is not considered “filed” for purposes of Section 5 of the Securities Act, it need not be signed, nor must it include consents of auditors or other experts, although it is required to include the auditor’s report to the financial statements. Likewise, strict liability for statements contained in a prospectus will not apply to confidential submissions, although of course to the extent any such information were used in connection with an offer or sale, the provisions of Sections 12(a)(2) of the Securities Act and 10(b) of the Exchange Act would continue to apply. The Division of Corporation Finance has indicated that the filing must be “substantially complete,” and that the staff will comment on these filings in accordance with its standard practices applicable to publicly filed registration statements and prospectuses.
Items for which confidential treatment will be sought should be identified, in part to alert the SEC to material for which a confidential treatment request will be made so that they do not reference that information in comments or other communications that may later be made public, but the confidential treatment request and related materials need not be filed until the initial public filing of the registration statement. Due to the confidential nature of the filing, the EGC must not issue any press release or make any other disclosure that a confidential submission has been made or that a public filing or commencement of an offering is planned.
The emerging growth company must file its registration statement and prospectus publicly, including auditors’ and experts’ consents, along with the initial confidential submission and all amendments thereto, at least 21 days before commencing its IPO road show.3 Comment letters relating to the nonpublic submissions will be made public in the same manner applicable to public filings, generally 60 days after the registration statement is declared effective (or withdrawn).
The Electronic Data Gathering, Analysis, and Retrieval system (Edgar) is not yet set up to receive the submissions, so the Division of Corporation Finance has implemented a secure e-mail system to allow the staff to receive draft registration statements and to correspond securely with companies about confidential draft submissions. The instructions can be found at http://www.sec.gov/divisions/corpfin/cfannouncements/cfsecureemailinstructions.pdf
Changes to gun-jumping restrictions
In order to allow an emerging growth company to gauge investor interest prior to making a public filing, the issuer or any person authorized to act on its behalf, including an underwriter or prospective underwriter, may now engage in oral or written communications with potential investors that are qualified institutional buyers (“QIBs”) or institutional accredited investors (but not retail accredited investors) prior to the filing of a registration statement. These communications need not be filed and are not considered prospectuses, although the SEC may ask to have copies of such communications provided to them as part of the comment process. Before the changes in the regulations, such communications were prohibited prior to the company having filed a registration statement, and under most circumstances the registrant was required to file the communications with the SEC as a free writing prospectus. The JOBS Act changes are intended to allow an EGC to discuss a potential offering with institutional investors in order to “test the waters” prior to subjecting itself to the public exposure or expense involved in filing a registration statement.
The staff has taken the position that test-the-waters communications need not be treated as an IPO “road show,” which has especially positive implications for an EGC when considered in light of the confidential submission process for IPO registration statements described above. Note, however, that if an issuer were to have meetings or other communications that meet the definition of "road show" and did not fall within the test-the-waters communications, then the 21-day filing requirement would be triggered based on the timing of such meetings. Similarly, no public announcement about the offering, such as a Rule 134 press release or similar communication, may be made during the confidential submission process.
Research reports about emerging growth companies
The JOBS Act also amends the Securities Act to exempt from the definition of an “offer” the publication or distribution by a broker or dealer of research reports about an emerging growth company that proposes to engage, or is or has engaged, in a registered public offering, even if the broker or dealer is participating or will participate in the registered offering. This is intended to allow greater visibility in the market for emerging growth companies that have completed or that are engaged in registered offerings by increasing the amount of information available on the newly public company through research reports. Prior to this rule change, analysts that were affiliates of an underwriter were not permitted to issue research reports for 40 days following the initial public offering, or for the 15 days before and after anticipated expiration of a lock-up period.
Despite the amendment to the Securities Act, though, there may be a limit to publication of research reports by participating broker/dealers in the near term as certain FINRA rules remain in place that limit the amount of reporting that FINRA members who are analysts can do with regard to offerings where an affiliate is one of the underwriters. Both the SEC and FINRA are expected to issue additional rules relating to this section of the JOBS Act.
Analyst restrictions
The JOBS Act also provides that in connection with an IPO of an emerging growth company (i) SEC and FINRA regulations may not restrict investment bankers from arranging for communications between research analysts and potential investors who are evaluating an investment banking transaction, and (ii) SEC and FINRA regulations may not restrict research analysts from participating in communications with the management team of an emerging growth company that is also attended by investment banking personnel. These changes effectively reverse restrictions imposed on such interactions in 2002 and 2003 following the adoption of the Sarbanes-Oxley Act. However, those investment bankers whose firms remain subject to the Global Settlement, which restricts investment banking personnel from arranging meetings between analysts and investors and from participating in most three-way meetings with analysts, investment bankers and company management, will still remain subject to the restrictions of that order. In addition, several FINRA rules prohibiting such practices, including Rules 2210 and 2711, appear not to be superseded by the JOBS Act and so a similar FINRA prohibition may remain in place unless and until FINRA revises those rules. As a result, the initial impact of this provision of the JOBS Act may be more limited.
Financial disclosure
Prior to the JOBS Act, companies looking to go public were required to include three years of audited financial statements, along with a Management’s Discussion and Analysis (“MD&A”) covering those periods, and five years of selected financial information. The JOBS Act permits emerging growth companies to elect whether to include as little as two years of audited financial statements and selected financial data, along with a correspondingly reduced MD&A section. Issuers considering such an offering should consider, and should discuss with their underwriters or prospective underwriters, whether to avail themselves of this amendment wholly or in part. Specifically, the issuer should consider whether the benefits of reduced disclosure burden, and presumably reduced audit and auditors’ consent costs, is worth the risk of a perception that the issuer’s financials are not “ready for prime time.”
Once public, emerging growth companies will continue to enjoy some of the benefits of the reduced financial reporting and auditing requirements applicable to their IPO. Specifically, emerging growth companies will not be required to provide selected financial data in their annual reports for any period prior to the earliest audited period presented in connection with their first registration statement under the Securities Act or the Exchange Act that became effective. Emerging growth companies will, however, be required to provide three years of audited financial statements in their annual reports unless they qualify as a smaller reporting company. In addition, all XBRL requirements will still apply to EGCs.
As mentioned above, while the disclosure requirements for emerging growth companies have been reduced under the JOBS Act, it is not clear yet how investors will react to the new disclosure. Most public issuers that have taken advantage of the exemptions to the reporting obligations afforded by the JOBS Act have elected to include a risk factor in the prospectus addressing the potential impact the reduced disclosure could have on the trading market for its stock and resulting volatility. In addition, prospectus-liability and anti-fraud statutes and rules will continue to apply, including Securities Act Sections 11(a) and 12(a)(2) and Exchange Act Section 10(b), so companies will need to include all disclosure relevant to prevent materially misleading disclosure or omission of a material fact which may necessitate disclosure beyond that required under the new rules applicable to EGCs.
Executive compensation disclosure and governance
Emerging growth companies are permitted under the JOBS Act to omit the “Compensation Discussion & Analysis” section in their disclosure materials. EGCs also may avail themselves of “smaller reporting company” disclosure requirements for executive compensation, which require two years, rather than three, of executive compensation information for executive officers. EGCs following the smaller company reporting requirements also need to report compensation data only for the principal executive officer and two other most highly paid executive officers, rather than for the principal executive officer, principal financial officer and the three other most highly paid executive officers applicable to other registrants. Further, EGCs will be entitled to omit certain disclosures to be required under the Dodd Frank Act, including (i) the ratio comparing the median of total annual compensation for employees to the total annual compensation of the CEO, and (ii) the relationship between executive compensation the company paid to named executive officers and the company’s financial performance.4
In addition to these reduced executive compensation disclosure requirements, an EGC need not hold the shareholder advisory votes on “say-on-pay,” “say-on-frequency” and “say-on-golden parachutes” promulgated under the Dodd-Frank Act.
As with the reduced financial statement requirements, although EGCs are entitled to provide the more limited compensation disclosure required of smaller reporting companies, some may elect to provide more than the required disclosure. In some cases, companies that are now permitted to omit these disclosures had already filed proxy statements prior to the adoption of the JOBS Act, so adopting a scaled-back disclosure in the next filing, while allowed, may be seen as a reversion from precedent. It remains to be seen whether ECGs will avail themselves of these disclosure exemptions, especially where a precedent had been established. In any event, once a registrant no longer qualifies as an emerging growth company, it must phase in such disclosures, with the timing of implementation of certain disclosures dependent on how long it qualified as an emerging growth company.
Internal controls attestation
One of the JOBS Act provisions that is most likely to result in an immediate cost savings to EGCs is that an EGC need not provide an auditor’s attestation report pursuant to Section 404 of the Sarbanes-Oxley Act. This exemption should not be perceived as a panacea, because an EGC must still provide management’s report on the effectiveness of internal controls, the CEO and CFO are still required to provide certifications regarding their internal controls for annual and quarterly reports, and the registrant must of course maintain in place sufficient internal controls as to provide a reasonable assurance of accuracy and completeness in its financial reporting. However, the widely reported increases in audit fees driven in large part by the Section 404 requirements had been identified as a significant disincentive to smaller companies considering public offerings, so this exemption is intended to help increase IPO activity in the United States.
Audit standards
Under the JOBS Act, emerging growth companies are not required to comply with any new or revised financial accounting principles until they are required to be adopted by all private companies. However, the SEC has made clear that this is an all-or-nothing election: an EGC must either opt to wait to adopt all such principles until adoption is required by private companies or it must adopt all accounting principles when required of public companies without taking the exemption offered to EGCs. In addition, from and after such time as the company elects to be treated as a non-EGC public company for purposes of adopting new accounting standards, the company cannot subsequently elect to seek the exemption offered to EGCs with respect to adoption of new accounting principles.
If any future rules are adopted that call for mandatory audit firm rotation or an “auditor discussion & analysis,” which has been proposed by the Public Company Accounting Oversight Board, emerging growth companies also will be exempt from those rules. Perhaps most significantly, emerging growth companies are exempt from the Sarbanes-Oxley Act requirement that a public company’s auditor attest to and report on management’s assessment of the effectiveness of the company’s internal controls for financial reporting. However, as discussed above, the registrant’s management must still provide its report and conclusions regarding internal controls and, where required, must provide certification of those internal controls on annual and quarterly reports filed with the SEC.
Exchange Act registration thresholds
The JOBS Act also relaxed, in two important ways, the registration requirement for private companies (whether or not they qualify as an EGC), relaxing the Exchange Act’s former requirement to register upon reaching 500 holders of equity securities. First, an issuer need not register until it has a class of equity securities held by 2,000 or more shareholders of record or 500 shareholders of record who are non-accredited investors. Second, and just as importantly for many companies, securities issued under employee benefit plans are excluded from the computation of the number of holders for the purposes of the Exchange Act’s registration requirement.
Review of Regulation S-K
Lastly, in addition to the changes outlined above, the JOBS Act also requires the SEC to conduct a review of Regulation S-K. The SEC is to report back to Congress within 180 days following the enactment of the JOBS Act with rulemaking proposals that seek to modernize and simplify the registration process and reduce the costs and other burdens of these rules for emerging growth companies. The SEC’s report, as well as developments or further guidance relating to the matters described above, may result in further changes to the IPO process. The SEC is currently seeking comment on the rules and regulations impacted by the JOBS Act as part of their rulemaking process. For more information on the comments being sought and how to submit your own, please see the SEC’s website at http://www.sec.gov/spotlight/jobsactcomments.shtml
FOOTNOTES
1 While the SEC has said it will not object to omitting debt securities issued in A/B exchange offerings from the total amount of non-convertible debt issued in the last three years, in general all non-convertible debt, whether publicly or privately issued, issued in the prior three years is counted toward the $1 billion limit, even if the debt is no longer outstanding as of the measuring date. Note also that this measurement is done at the time of determining EGC status, not as of the end of the prior fiscal year.
2 The registrant need not pay the associated registration fee until the registration statement is first publicly filed.
3 The Staff has stated that the commencement of the road show will continue to be measured in accordance with Rule 433(h)(4), which defines a “road show” as an offer (other than a statutory prospectus or a portion of a statutory prospectus filed as part of a registration statement) that contains a presentation regarding an offering by one or more members of the issuer’s management … and includes discussion of one or more of the issuer, such management, and the securities being offered.” Thus a communication that includes an offer to sell or solicits an offer to buy would fall outside the “testing-the-waters” exception.
4 These rules have yet to be promulgated even for companies that are not EGCs or smaller reporting companies.