Source: Jim Verdonik, Ward and Smith PA and Knox Proctor (also Ward and Smith)
The Jumpstart our Business Startups (“JOBS”) Act was a bipartisan effort to create jobs by making it easier for start-up companies to deal with securities laws when raising capital. It was signed by the President on April 5, 2012. Most of the Act’s provisions require the Securities and Exchange Commission (“SEC”) to enact rules to implement those provisions before they become effective.
Did you ever buy a Christmas toy for your children that had on the box the dreaded words: “Some Assembly Required?”
If so, then you will understand the current status of the JOBS Act several years after passage:
– Some parts appear to work as intended.
– Some parts seem to be missing.
– We have some extra parts that don’t appear to belong anywhere.
– The assembly instructions were not written by native English speakers.
The excitement of unwrapping the present wears off if there is a long assembly process with bumps in the road.
If you cannot get your Christmas gift assembled and in full working order before Christmas dinner, you begin to wonder:
– Is the product defective?
– Are you just a dysfunctional assembler?
The three year delay in implementing major parts of the JOBS Act is caused in part by both poor design and an assembler that would really rather be doing something else.
Let’s talk about our reluctant assembler first.
The SEC missed all the statutory deadlines for proposing rules. So far only one of the SEC’s proposed rules has become effective. That’s an impressive delay strategy success rate. A football team trying to hold onto a lead that is winding down the clock could learn a lot from the SEC. But the SEC is fighting a losing battle. The Internet and Social Media won’t disappear. There is no two minute signal before the game ends. The influence of Internet and Social Media grow stronger as these tools permeate our lives while the SEC’s delay and out dated interpretation of the securities laws seem more foolish day after day. Recently, the SEC had to surrender to Twitter by permitting issuers that use Twitter or any other technology that limits the space you can use to link to other documents that contain required SEC legends that are too long to fit the technology space limitations. For example, Twitter’s 140 character limit.
Temporary delays can be put in the past.
The primary issue is that some of the SEC’s proposed rules (or statements about what the SEC thinks the JOBS Act means) threaten to so substantially limit the practical usefulness and cost efficiency of some JOBS Act offerings that the purposes of the JOBS Act may not be achieved.
Not all the JOBS Act’s problems can be blamed on a reluctant SEC. The SEC has been able to take positions that frustrate the purposes of the JOBS Act, because the statute contains a number of ambiguities. In other instances, Congress built in to the statute provisions that make the JOBS Act very cost inefficient for businesses that are trying to raise capital.
Part of the problem was just poor draftsmanship. But the other driving force was that Congress was split between two goals: increasing the efficiency of capital raising by small to mid-sized businesses to defend against allegations by critics that investor protection is being abandoned. Investor protection forces in Congress contributed substantially to the confusing language and unreasonable conditions, which the SEC is relying on to create restrictive rules.
Before we leave the subject of investor protection, let us remember that the JOBS Act did not change any anti-fraud rules. What was fraud before the JOBS Act remains fraud after the JOBS Act. The primary purpose of JOBS Act is to allow information to be disseminated into the market using 21st Century technology that most people use every day for both business and in their personal lives.
Yes, new technologies will be used to commit fraud. But old media and personal contacts were also used to commit fraud. No system is perfect as long as fools and their money are soon parted. But any system that tries to always protect us from our foolish selves will unnecessarily interfere with the ability of honest businesses to raise capital.
If we do not change the definition of fraud, advocates of change in securities laws should remember that more information delivered to more people faster and cheaper in the open where everyone can see it is the best anti-fraud investor protection system.
Before we review the current status of the JOBS Act and existing and proposed implementation rules, we should note that Congressional Committees are working on changes to the JOBS Act. Some of these changes are required to clarify ambiguous language in the original JOBS Act. Other changes are necessary to offset SEC interpretations of the JOBS Act and implementation rules that threaten to negate many of the JOBS Act’s intended benefits.
Notwithstanding our criticisms of some unnecessary restrictions, we should note that the JOBS Act has already helped many issuers raise capital. Rule 506 (c) offerings that use general solicitations are growing in number and size. Likewise, many issuers have benefitted from the new confidentiality and other rules that govern IPOs and 1934 Act reporting by emerging growth companies. These are substantial beneficial changes that should not be overlooked in our zealousness to make capital raising regulations reasonable and cost efficient in light of 21st Century technology and communications tools and practices.
Although we are giving an updated overview of JOBS Act developments, it is important to note that most of the provisions in the JOBS Act are not yet effective. We will provide a further update when all final regulations are in place. Note that you will need to consult with a knowledgeable securities lawyer before you try to take advantage of any of these provisions.
Overview of the JOBS Act
The JOBS Act is a wide ranging piece of legislation that amends multiple sections of both the Securities Act of 1933 and the Securities Exchange Act of 1934. Some Sections of the JOBS Act became operative when the statute was enacted. Other Sections of the JOBS Act instructed the Securities and Exchange Commission to write rules implementing these sections.
We discussed above that the fundamental purpose of the JOBS ACT was to unleash the power of 21st Century communications systems in capital raising. The JOBS Act also tries to make it less burdensome for smaller companies to become publicly-held and remain publicly-held. Conversely, the JOBS Act allows smaller businesses to remain private even if they have a relatively large number of shareholders.
The following table summarizes the primary provisions of the JOBS Act as well as their current regulatory status and some of the primary issues related to using these provisions.
|JOBS ACT SECTION||DESCRIPTION||CURRENT STATUS AND ISSUES|
|Section 201(a)||Rule 506 Private Offerings General Solicitation and Advertising –– Allows general solicitation and advertising of Rule 506 (c) private offerings that are exempt from registration, if an issuer takes reasonable steps to verify that all investors are “accredited investors.”
|Initial SEC Rules approved July 10, 2014 in Release No. 33-9415;34-69959 and became effective September 23, 2014.
SEC proposed additional rules on July 10, 2013 in Release No. 33-9416; 34-69960
The initial SEC rules represent a fair attempt to implement Congressional intent to promote capital-raising.
Investor verification rules are being implemented without undue burdens and both the number and size of Rule 506 (c) offerings are growing month by month as more people recognize the benefits.
Proposed SEC rules regarding changes to SEC Form D and filing all communications with the SEC on the date they occur impose impractical burdens that will make it difficult and more expensive for young businesses to comply with the rules thereby exposing companies to liability risk.
|Section 201 (c)||Broker-Dealer Registration Exemption – Affords exemptions from the requirement to register as a broker under Section 15 (a) (1) of the Exchange Act to technology platform operators and people who co-invest in issuers.
|Became effective immediately.
SEC has not proposed any rules, but the SEC has issued statements in FAQs that indicate the SEC believes technology platforms that sell securities in Rule 506 offerings can only be operated by registered broker-dealers and venture capital funds.
The primary legal issue is whether technology platform operators should be treated like (i) media outlets or telecommunications system operators who provide technology enabled services that permit others to offer and sell securities or (ii) as a broker who actually effects offers and sales of securities.
Should technology platform operators be treated more like Merrill Lynch or more like Comcast or Verizon or the Wall Street Journal?
Sections 301 to 305
|Crowdfunding” –– Allows companies to obtain limited investments (up to $1 million per issuer per year and up to $10,000 per investor per year) from the general public (both accredited and non-accredited investors) without registration, but through strictly regulated crowdfunding platforms.
Rules regulate both the issuers raising capital and crowdfunding platform operators.
|SEC proposed rules on October 23, 2013 in Release No.33-9470; 34-70741.
Rules not yet effective.
Primary issues with rules include”
– Requiring reviewed and audited financial statements increases offering expenses to a high percentage of the $1 million annual limit per issuer.
– Requiring annual filings with the SEC creates ongoing expense and loss of confidentiality for issuers.
– Limits in fees operators can charge and ownership of issuers by platform operators limits operator profits.
– Limiting off-platform communications by issuers impedes the sales efforts.
– Prohibiting platform operators from making recommendations limits usefulness to investors who seek to find the best investment opportunities.
Section 501 to 504
|Exchange Act Triggers – Increases the maximum number of record shareholders that, when exceeded, trigger registration and ongoing reporting requirements under the ’34 Act.||Rules are working as intended.|
|TITLE IV Sections
401 to 402
|“Small Offerings –– Regulation A+” –– Provides exemptions for certain smaller offerings of securities.
Primary change is to create different rules for (1) offerings up to $5 million and (ii) offerings up to $50 million (including $15 million of shareholder e-sales). Also exempts the offering from certain state securities laws.
Regulation A offerings were limited to $5 million and most issuers utilized the more flexible Rule 506 offerings, which has always provided exemption from certain state securities laws.
Advantages of Regulation A compared to Rule 506 offerings include the ability to sell to persons who are not accredited investors and the securities investors receive are not “restricted securities,” which makes re-sale easier if there is a trading market.
|SEC proposed rules on December 13, 2013 in Release No.33-9497; 34-71120
Not yet effective.
Primary issue will be whether Regulation A can compete with: the flexibility of Rule 506 (c) offerings or the traditional IPO process.
May be most useful for small public companies that have some trading volume, because the securities are not restricted.
|Title I Sections 101 to 108||“IPO On-Ramp” –– Grants relief for “Emerging Growth Companies” in initial public offerings (“IPOs”) and in their subsequent reporting and compliance obligations.||Currently effective and has been utilized by most companies that have done IPOs since it became effective.|
We will address each of these provisions summarized above in greater detail in this article in the order listed in the table.
For a comparison between the new rules and other securities exemptions, check out my blog post:
Note re: Jim Verdonik, Author – You can reach me atJFV@WardandSmith.com or JimV@eLearnSuccess.com. Or you can check out my eLearning course at http://www.elearnsuccess.com/start.aspx?menuid=3075or http://www.youtube.com/user/eLearnSuccessor or you can purchase my books at http://www.amazon.com/Jim-Verdonik/e/B0040GUBRW. I’m an attorney with Ward and Smith PA. I also write a column about business and law for American Business Journals, have authored multiple books and teach an eLearning course for entrepreneurs.
About Scale Finance
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