Ze’ev Eiger

Marty Dunn

David Lynn

Alfredo Silva

Alexa Belonick

IFLRinternational Financial Law Review

JOBS Act Quick StartA brief overview of the JOBS Act2018 Update

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JOBS Act Quick Start 2018 update 1

Morrison & Foerster Corporate Finance | Capital Markets Group

Morrison & Foerster’s lawyers advise issuers, agents and underwriters in a broad range of domestic andinternational private and public financings. Our experience spans the continuum, from privateplacements and PIPEs to IPOs and debt offerings. Morrison & Foerster has over 1,000 lawyers in 16offices worldwide. The firm is consistently ranked as one of the most active securities firms in the USand Asia, and represents issuers and underwriters in hundreds of securities offerings raising over $100billion each year.

Contacts

Ze’ev EigerPartnerzeiger@mofo.com

Marty DunnSenior Counselmdunn@mofo.com

David LynnPartnerdlynn@mofo.com

Alfredo SilvaPartnerasilva@mofo.com

Alexa BelonickAssociateabelonick@mofo.com

© Morrison & Foerster and Euromoney Institutional Investor 2018. All rights reserved.

About the authors

2 JOBS Act Quick Start 2018 update

We are Morrison & Foerster — a global firm of exceptional credentials. Our clients include some of thelargest financial institutions, investment banks, Fortune 100, and technology and life sciences companies.The Financial Times has named the firm to its lists of most innovative law firms in Northern America andAsia every year that it has published its Innovative Lawyers Reports in those regions. Our lawyers arecommitted to achieving innovative and business-minded results for our clients, while preserving thedifferences that make us stronger. The firm also has a long history of commitment to the communitythrough providing pro bono legal services, including litigating for civil rights and civil liberties, improvingpublic education for poor children, advocating for veterans, promoting international human rights,winning asylum for the persecuted, and safeguarding the environment.

About Morrison & Foerster

JOBS Act Quick Start 2018 update 3

About the authors 1About Morrison & Foerster 2Introduction 5

CHAPTER 1

The IPO on-ramp 15

CHAPTER 2

The IPO process 27

CHAPTER 3

Applying Title I to other transactions 40

CHAPTER 4

Private offerings 43

CHAPTER 5

Crowdfunding 56

CHAPTER 6

Regulation A+ 68

CHAPTER 7

Exchange Act registration thresholds 79

CHAPTER 8

Research 84

CHAPTER 9

Other capital formation discussions 95

Appendix A 104Appendix B 107Appendix C 110

Contents

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Many market participants were taken bysurprise by the enactment of the JumpstartOur Business Startups (JOBS) Act. TheJOBS Act, HR 3606, was passed by the

United States House of Representatives on March 8 2012.On March 22, the Senate passed HR 3606 with anamendment to Title III (providing for the crowdfundingexemption with enhanced investor protections). OnMarch 27, the House of Representatives accepted theSenate’s amendment, and on April 5, President Obamasigned the JOBS Act into law.1 To many, this may soundlike a quick path for legislation, especially when consideredin the context of a Congress that seemed virtuallydeadlocked and unable to reach the consensus required totake action on pressing issues. When considered closelyand in context, however, it becomes clear that the Act wasthe culmination of an at least year-long bipartisan effort inboth the House and Senate to address concerns aboutcapital formation and unduly burdensome Securities andExchange Commission (SEC) regulations.

The JOBS Act affects both exempt and registeredofferings, as well as the reporting requirements for certainpublic issuers. A centrepiece of the Act is an initial publicoffering (IPO) on-ramp approach for a class of emerginggrowth companies (Title I), with confidential SEC staffreview of draft IPO registration statements, scaleddisclosure requirements, no restrictions on test-the-waterscommunications with qualified institutional buyers(QIBs) and institutional accredited investors before andafter filing a registration statement, and fewer restrictionson research (including research by participatingunderwriters) around the time of an offering. In addition,the JOBS Act directs the SEC to amend its rules to: • eliminate the ban on general solicitation and general

advertising in Rule 506 offerings when sales are only toaccredited investors, along with comparable changes toRule 144A (Title II);

• establish a small offering exemption for crowdfunding(Title III); and

• create a new exemption for offerings up to $50 million(Title IV).The JOBS Act also raises the holder-of-record threshold

for mandatory registration under the Securities ExchangeAct of 1934, as amended (the Exchange Act) (Titles V andVI). In the chapters that follow, we discuss each of thesemeasures in greater detail, but before we do so, it isimportant to understand the concerns that led legislatorsto act in concert to adopt the JOBS Act.

The lifecycle for emerging companies in the USFor a long time in the US, a company’s financing lifecyclewas generally fairly predictable. A growing companyusually financed its business through investments fromfriends and family, then perhaps from angel investors, andfinally, if the company was successful, from venture capitalfirms. Given the application of section 5 of the SecuritiesAct of 1933, as amended (the Securities Act)2 to publicofferings of securities, a company was required to limititself to conducting small rounds of financing, relying onvarious available exemptions from the registrationrequirements of the Securities Act, and to target principallysophisticated institutional investors. The securities that acompany sold in these private, or exempt, offerings wereclassed as restricted securities, which means that thesecurities had never been offered pursuant to a registrationstatement and were subject to certain transfer restrictions.After various successful private financing rounds, thecompany’s management and venture investors would beginto consider an IPO. Once a company was an SECreporting issuer, it became subject to a comprehensiveregulatory framework. Although this regulatoryframework may have imposed requirements that seemedonerous (at the time), being a public company offereddistinct benefits. Once public, a company generally hadmany more financing opportunities. Already publiccompanies relied on raising additional capital to financetheir growth through follow-on public offerings,underwritten by one or more investment banks. From timeto time, an already public company also might conduct aprivate placement or other exempt offering as part of anoverall financing plan. Over time, as the capital markets inthe US have undergone changes and as regulations haveevolved, the cost-benefit calculus for many companies haschanged. Many companies have concluded that going

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Introduction

public might not be the most desirable liquidity event andremaining private longer or considering acquisitionalternatives might be more appealing. A bit of backgroundon the securities regulatory framework will help illustratewhy the analysis changed for many companies.

Securities regulatory frameworkA privately held company (or a company that does nothave securities that are publicly traded in the US), whetherdomestic or foreign, that would like to access the USmarkets first must determine whether it is willing tosubject itself to the ongoing securities reporting anddisclosure requirements, as well as the corporategovernance requirements that are part and parcel ofregistering securities for a public offering in the US. Anissuer may conduct a public offering in the US byregistering the offering and sale of its securities pursuant tothe Securities Act, and also by registering its securities forlisting or trading on a US securities exchange pursuant tothe Exchange Act.3 Instead, an issuer may choose to accessthe US capital markets by offering its securities in anoffering exempt from the registration requirements of theSecurities Act. Finally, a private company that elects topostpone, or seeks to avoid, becoming a public companymay become subject to SEC reporting obligationsinadvertently if it has: total assets exceeding $10 million asof the last day of its fiscal year, and a class of equitysecurities held of record by either 2,000 persons or 500persons who are not accredited investors (for banks,savings and loan holding companies, and bank holdingcompanies, a class of equity securities held of record by2,000 or more persons), whether or not that class of equitysecurities is listed on a national securities exchange.

Section 5 of the Securities Act sets forth the registrationand prospectus delivery requirements for securitiesofferings.4 In connection with any offer or sale of securitiesin interstate commerce or through the use of the mails,section 5 requires that a registration statement must be ineffect and a prospectus meeting the prospectusrequirements of section 10 of the Securities Act must bedelivered before sale.5 This means that the Securities Actgenerally requires registration for any sale of securities,although it also provides exemptions or exclusions fromthis general registration requirement. The purpose of theSecurities Act is to ensure that an issuer provides investorswith all information material to an investment decisionabout the securities that it is offering. The registration andprospectus delivery requirements of section 5 requirefilings with the SEC and are intended to protect investorsby providing them with sufficient information about theissuer and its business and operations, as well as about the

offering, so that they may make informed investmentdecisions. These apply to offerings that are made to thegeneral public (regardless of the sophistication of theofferees). The SEC presumes that distributions notinvolving public offerings (or widespread distributions) donot raise the same public policy concerns as offerings madeto a limited number of offerees that have access to the samekind of information that would be included in aregistration statement. That information can be conveyedby providing disclosure or by ensuring that the offereeshave access to the information. There are a number ofregulatory restrictions on communications for issuers thatundertake a public offering, given that the SEC always hasemphasised that the prospectus should be the principaldocument used by investors in making their investmentdecisions.

IPO and Exchange Act registrationIn connection with an IPO of securities, an issuer mustprovide extensive information about its business andfinancial results. The preparation of the registrationstatement is time-consuming and expensive. Once thedocument is filed with the SEC, the SEC staff will reviewit closely and provide the issuer with detailed comments.The comment process may take as long as 60 to 90 daysonce a document has been filed with, or submitted to, theSEC. Once all of the comments have been addressed andthe SEC staff is satisfied that the registration statement isproperly responsive, the registration statement may beused in connection with the solicitation of offers topurchase the issuer’s securities. Depending upon the natureof the issuer and the nature of the securities being offeredby the issuer, the issuer may use one of various forms ofregistration statement. Once an issuer has determined toregister its securities under the Securities Act, the issuerusually will also apply to have that class of its securitieslisted or quoted on a securities exchange, and inconnection with doing so will register its securities underthe Exchange Act. The Exchange Act imposes two separatebut related obligations on issuers: registration obligationsand reporting obligations. If an issuer becomes subject tothe reporting requirements of the Exchange Act, the issuerremains subject to those requirements until, in the case ofexchange-listed securities, those securities are delisted, or,in the case of securities listed by reason of the issuer’s assetsize and number of record holders, the issuer certifies thatit meets certain requirements.

Once an issuer conducts an IPO in the US or has a classof securities listed or traded on a national securitiesexchange, the issuer will be generally subject to thereporting requirements of the Exchange Act. Issuers that

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have undertaken an IPO or that are SEC-reportingcompanies also will become subject to many other rulesand regulations.

Over time, the regulatory burdens for public companieshave increased. In 2002, following a series of widelyreported corporate scandals involving fraudulentaccounting practices and governance abuses, the USadopted legislation affecting all public companies, theSarbanes-Oxley Act of 2002.6 It imposed a broad series ofrequirements relating to corporate governance, enhancedpublic disclosure, and the imposition of civil and criminalpenalties for wrongdoing. Sarbanes-Oxley and itsassociated rules:• require that CEOs and CFOs certify the accuracy and

completeness of their companies’ periodic reports andimpose criminal penalties for false certification;

• require the establishment and regular evaluation ofdisclosure controls and procedures, and internal controlover financial reporting designed to ensure the accuracyand completeness of the information reported to theSEC and for the preparation of financial statements;

• require the establishment by all listed companies of anindependent audit committee;

• require the disgorgement of compensation by CEOs andCFOs following an accounting misstatement that resultsfrom misconduct;

• impose limitations on trading by officers and directorsduring retirement plan blackout periods;

• prohibit the extension of credit to related parties; and• require the SEC to review a registrant’s filings once every

three years.Although relief from compliance with certain of these

requirements was provided to smaller companies, increasedcompliance costs and increased liability may have had achilling effect on IPOs.

To (or not to) go publicMany commentators have noted that, over time, the UScapital markets have become less competitive and thenumber of companies seeking to go public has declined.For example, prior to the enactment of the JOBS Act, incommunications from Congressman Darrell Issa,chairman of the House Committee on Oversight andGovernment Reform, to Mary Schapiro, chairman of theSEC (discussed further below), Issa noted that the numberof IPOs in the US plummeted from an annual average of530 during the 1990s to about 126 since 2001, with only38 in 2008 and 61 in 2009.7 The number of companieslisted on the main US exchanges peaked at more than7,000 in 1997 and, as of the date of the letter, had beendeclining to about 4,000.8 Meanwhile, the letter cited that

the value of transactions in private-company shares hadgrown, almost doubling in 2010 to $4.6 billion fromabout $2.4 billion in 2009, and was expected to increase to$6.9 billion for 2011.9 Other reports published during thesame time period cited similar statistics and highlightedthat smaller companies were disproportionately affected,with most IPOs that completed involving largercompanies and a significant offering size. Althoughcommentators would have been ready to stipulate that thenumber of IPOs had declined, there would be littleagreement regarding the causes for the decline. Quite anumber of different theories have been advanced toexplain this phenomenon. Academics active in this areahave grouped the theories into two broad categories: first,those attributing the decline to regulatory overreach; andsecond, those attributing the decline to changes in theecosystem or market structure changes.

Many studies indicate that companies are waiting longerto go public as a result of anticipated costs associated withSarbanes-Oxley compliance, as well as the additional costsassociated with being a public company. For example, apublic company must incur costs for directors and officersinsurance, director compensation (especially auditcommittees), and disclosure controls and SEC reportingcosts. Foreign issuers may be wary of the increased liabilitythat comes with being an SEC-reporting company, as wellas of the litigious environment in the US. Many executiveofficers of privately-held companies also are concernedthat going public will limit their flexibility. As officers of apublic company, they are required to make very difficultdecisions, including decisions regarding financialreporting, accounting estimates, and accounting policies,while they are subject to more scrutiny and more risk as aresult of their choices. Given the prospect of shareholderlitigation and other litigation concerns, theirdeterminations become fraught with risk. Earningspressure and the need to respond to many constituencies(such as research analysts, large institutional holders, andaggressive hedge fund holders) may affect the decision-making processes. This may inhibit their desire to take riskand may lead them to be more conservative than theyotherwise would be. A survey found that, in fact, theprincipal reason given by senior managers of privately-heldcompanies for remaining private is that they would like topreserve decision-making control.10 In addition, actuallyconducting an IPO will be time-consuming and expensivegiven the disclosure and financial statement requirements.

Over time, more financing alternatives have developedfor issuers. An issuer could choose to avail itself of one ofthe exemptions from registration and conduct privateofferings. There have been many regulatory changes that

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have provided greater legal certainty as to the availability ofprivate offering exemptions, such as the safe harbourscontained in Regulation D, especially Rule 506. In largemeasure, as a result of these changes, a number of securitiesoffering methodologies involving exempt offerings havedeveloped and become increasingly popular. Many of theseoffering methodologies have come to resemble the processused for public distributions of securities. Investors havebecome more receptive to participating in privateplacements and owning so-called restricted securities as thelimitations on hedging or transferring restricted securitieshave been relaxed. More different types of investors arewilling and eager to participate in private placementsundertaken by promising companies. These now include,in addition to venture capital funds, private equity funds,family offices, sovereign wealth funds, insurancecompanies, pension funds, and cross-over funds. Morerecently, private secondary markets have developed thatprovide liquidity opportunities for holders of the securitiesof private companies to sell their positions.

Other commentators and academics note that a varietyof market structure changes may be the cause of or maycontribute to the decline of IPOs, especially smallercompany IPOs. During the 1990s and early 2000s,consolidation in the investment banking sector led to thedisappearance of many boutique or speciality investmentbanks that had as their focus financing transactions forsmaller companies. Some commentators point to the dropin bid-ask spreads that took place following decimalisationin 2001. In 2003, as a result of the fallout from the dot-com boom, rules and regulations were adopted thatimposed restrictions on research analyst coverage andrequired the separation of research and investmentbanking activities. The burdensome regulations imposedsignificant compliance costs on investment banks withresearch activities and changed the nature of researchcoverage. As a result, the fewer, larger investment banksthat remained after industry consolidation focused theirresources on covering fewer companies (usually givingpreference to larger, well-capitalised companies). Thesevarious factors seemed to change the economics associatedwith smaller company IPOs and tend to favour IPOs bylarger, more established companies. Also, the viewdeveloped that larger companies, with a longer trackrecord and more predictable earnings histories, makebetter public companies or are better able to function aspublic companies.

SEC developmentsThe SEC has tried to keep pace with changes in the capitalmarkets and has consistently introduced reforms that

sought to balance investor protection needs with the needto provide issuers with access to capital. Since the early1980s, the SEC has undertaken a number of steps tofacilitate capital formation. The SEC has, among otherchanges, created and modified the integrated disclosuresystem, instituted and expanded the continuous anddelayed offerings processes, permitted the electronicsubmission of most SEC filings, and generally tried toaccommodate the needs of both large and small issuers. In2005, the SEC undertook a series of changes related tosecurities offerings and offering-related communications,referred to as securities offering reform. Although thisreform benefited principally the largest and mostsophisticated issuers (well-known seasoned issuers orWKSIs), the changes also expanded the range ofpermissible communications, even during IPOs.

In December 2004, the SEC established the AdvisoryCommittee on Smaller Public Companies to ‘assist theSEC in evaluating the current securities regulatory systemrelating to disclosure, financial reporting, internal controls,and offering exemptions for smaller public companies.’11

The Advisory Committee charter stated that its objectivewas ‘to assess the impact of the current regulatory systemfor smaller companies under the securities laws of theUnited States and to make recommendations forchanges.’12 The Advisory Committee considered the effectof many new regulatory requirements on smaller publiccompanies, as well as capital-raising alternatives for smallercompanies. In 2006, it issued its final report, containing33 recommendations, many of which focused on capitalformation, including a recommendation that a new privateoffering exemption from the Securities Act registrationrequirements be adopted that would not prohibit generalsolicitation and advertising for transactions withpurchasers that do not need all the protections of SecuritiesAct registration requirements. The Advisory Committeenoted that the ban on general solicitation in a privateoffering resulted in excessive concern about the offereewho may never actually purchase securities, rather than onprotection of the actual investors. The AdvisoryCommittee also noted that, given the pace of technologicalchange, the ban had become outmoded and limited issuersfrom using the internet and other tools to communicatewith potential investors. This was not the first time that arecommendation had been made to ease the prohibitionon general solicitation. In 2007, practitioners that weremembers of an American Bar Association Committeesubmitted a letter to the SEC containingrecommendations for a comprehensive overhaul of thesecurities laws governing the private placement ofsecurities.13 The letter cited problems with the private

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offering process that impacted capital formation. In May2007, the SEC approved publication of eight releasesdesigned to update and improve federal securitiesregulations that significantly affect smaller publiccompanies and their investors. Ultimately, the holdingperiod requirements under Rules 144 and 145 wereshortened, making restricted securities more liquid, andsmaller public companies gained limited access to the useof shelf registration statements.

Although all of these reforms modernised the securitiesoffering process, streamlined communicationsrequirements, and addressed certain of the concerns relatedto private or exempt offerings, the reforms did not squarelyaddress the IPO process, nor did they address many of thethorniest issues arising in exempt offerings.

Proposed changes post-Dodd-Frank In the aftermath of the financial crisis, and followingadoption of the Dodd-Frank Wall Street Reform andConsumer Protection Act (generally known simply as theDodd-Frank Act) in 2010, there was renewed focus on theeffect of regulation on the competitiveness of the UScapital markets and on entrepreneurship and emergingcompanies. As attention in the US turned to promotingeconomic activity, the dialogue related to regulatoryburdens and their effect on capital formation took on anew sense of urgency.

Issa-Schapiro correspondenceOn March 22 2011, House Committee on Oversight andGovernment Reform chairman Issa sent a letter to SECchairman Schapiro. The letter raised concerns aboutwhether the current securities regulatory framework had anegative impact on capital formation, leading to the dearthof IPOs in the United States, as well as the extent to whichSEC regulations potentially limited other capital-raisingactivities by small and emerging companies.14 The letterfrom Issa also sought specific information regardingeconomic studies conducted by the SEC staff in theseareas, along with information concerning theconsideration of costs and benefits in connection withSEC rulemakings. Issa’s letter discussed these statistics andraised questions about five topics: the decline of the USIPO market, the communications rules in connection withsecurities offerings, the 499 shareholder cap under section12(g) of the Exchange Act, organisational considerations,and new capital-raising strategies.

In her response dated April 6 2011, Schapiro stated shehad requested that the SEC staff take a fresh look at theagency’s rules in order to develop ideas for the SEC aboutways to reduce the regulatory burdens on small business

capital formation in a manner consistent with investorprotection.15 Schapiro outlined a number of new SECinitiatives in her response, including SEC staff review of (i)the restrictions on communications in initial publicofferings; (ii) whether the general solicitation ban shouldbe revisited; (iii) the number of shareholders that triggerpublic reporting, including questions regarding the use ofspecial purpose vehicles; and (iv) the regulatory questionsposed by new capital-raising strategies, such ascrowdfunding. Schapiro also indicated that the SEC was inthe process of forming a new Advisory Committee onSmall and Emerging Companies, which was subsequentlyconvened.

Decline of the IPO market in the USIssa’s letter cited statistics about the declining US IPOmarket and asked whether the SEC had evaluated thereasons for such a decline. The letter asked whether thepossible reasons for the decline included increasinglycomplex SEC regulations; costs associated withcompliance with the Sarbanes-Oxley Act; the uncertaintygenerated by the pending rulemakings under the Dodd-Frank Act; the risk of class-action lawsuits; or theexpansion of regulatory, legal, and compliance burdens.16

The letter also cited examples of the IPOs of Google andGoDaddy.com that were delayed and cancelled,respectively, as evidence of overly burdensomecommunications rules. In her response, Schapiro discussedvarious reasons for the decline in the IPO market, such aseach company’s own situation and market factors at thetime of the contemplated IPO. Schapiro stated that it isdifficult to determine why a company decides to undertakean IPO or declines to do so. The costs associated withconducting an IPO and becoming a public reportingcompany factor into the decision as to whether to conductan IPO. Schapiro stated that the SEC had lowered thesecosts in recent years and that, in 2010, approximately 40%of first-time registrants were smaller reporting companies.Similarly, in 2010, nearly half of registered offeringsconducted by first-time registrants were for offerings of lessthan $10 million. In a discussion about the challengesfaced by early-stage growth companies, Schapiro pointedout that such companies have greater difficulty raisingcapital because of the lack of disclosure on a regular basis,smaller and more variable cash flows, a smaller asset base,and a larger percentage of intangible assets.

Schapiro also stated that while there are studies thatshow that the number of US IPOs had declined,17 otherstudies conducted by SEC staff members indicate that forthe period 1995–2007, the US market’s share of globalIPOs in terms of total dollar proceeds and average dollar

JOBS Act Quick Start 2018 update 9

proceeds was much higher than those of the UK and HongKong.18 The other reason for companies to favour an IPOin the European markets is that the underwriters’ spread issignificantly lower than in the US. For example, the grossspread in the US for an offering size between $25 millionand $100 million is approximately seven percent, while inEurope it would be approximately four percent for asimilar offering.

The impact of the communications rulesIn his letter, Issa indicated that the communication rulesgoverning the offerings of securities potentially conflictwith the promotion of disclosure and transparency and theFirst Amendment. He requested an explanation for thepotential harm to a non-accredited investor that mayrealistically result from the receipt of an advertisement byan issuer of unregistered securities that is targeted ataccredited investors (qualified institutional buyers orQIBs). In her response, Schapiro described thecommunications rules that apply to registered andunregistered offerings. Under the Securities Act, forregistered offerings, an issuer’s ability to communicatevaries depending on the three phases of the registrationprocess called the pre-filing period, quiet period, and thepost-effective period.19 During the pre-filing period beforefiling a registration statement, an issuer may not offersecurities.20 During the quiet period (or waiting period), anissuer can make oral offers but cannot make written offersother than through a prospectus that complies with section10 of the Securities Act.21 In the post-effective period, anissuer can sell and deliver securities as long as a finalprospectus that complies with section 10(a) of theSecurities Act accompanies or precedes the delivery of thesecurities.

Schapiro discussed the offering reforms adopted in 2005that liberalised an issuer’s ability to communicate duringofferings.22 She also clarified that had these rules beeneffective when Google and Salesforce.com conducted theirIPOs, the SEC would not have imposed a cooling-offperiod to address gun-jumping concerns. Schapiro’s letterpoints out that with respect to offerings not registeredunder the Securities Act, issuers relying on section 4(a)(2)of the Securities Act or its safe harbour, Rule 506 ofRegulation D, generally are not allowed to use a generalsolicitation or advertising to attract investors to theiroffering. In addition, the SEC adopted Rule 155, anothersafe harbour, that allows companies to abandon a publicoffering and instead raise money through a privateoffering. Schapiro recognised that some view the generalsolicitation ban as a significant burden on capital raisingand may be unnecessary, as offerees who might be located

through general solicitation and who might not purchasethe securities would not be harmed.23 Others, however,support the solicitation ban on the grounds that it helpsprevent securities fraud by making it more difficult forfraudsters to attract investors or unscrupulous issuers tocondition the market.24

The 499 shareholder cap Issa raised concerns about the 499 shareholder cap undersection 12(g) of the Exchange Act as being a fundamentalroadblock to private equity capital formation. The letterwent on to cite the case of the Facebook equity issuance inwhich the 499 person threshold would have beenovercome by grouping multiple shareholders into singleentities. He questioned whether the use of special purposevehicles (SPVs) for the purposes of facilitating investmentsin private companies resulted in disjointed or illiquidmarkets and prevented price discovery.

In her letter, Schapiro stated that Rule 12(g) of theExchange Act was enacted by Congress in 1964 and thatthe securities markets have changed significantly sincethen. The section requires a company to register itssecurities with the SEC within 120 days after the last dayof its fiscal year if, at the end of the fiscal year, the securitiesare held of record by 500 or more persons and thecompany has total assets exceeding $10 million. Schapiropointed out that today, the vast majority of shares of publiccompanies are held in nominee or so-called street nameand, as a result, individual shareholders are not countedbecause the securities are not held of record by thoseindividuals. Conversely, in private companies, shareholdersgenerally hold their shares directly, or of record, and thusthose companies may exceed the 499 shareholder limitunder Rule 12(g), which would require them tocommence reporting. Schapiro stated in her letter that theissue of how holders are counted and how many holdersshould trigger registration will need to be examined.

In his letter, Issa also raised concerns about Rule 12g5-1(b)(3) of the Exchange Act. That rule states that if anissuer knows that the form of holding securities of recordis primarily used to circumvent section 12(g), thebeneficial holders will be deemed the record owners.Noting that this rule has been invoked sparingly, Schapirostated that this rule is not meant to create uncertainty forissuers, but rather is intended to prevent issuers fromcircumventing the registration requirements.

Schapiro also noted that Congress has provided the SECwith broad authority, in sections 12(h) and 36 of theExchange Act, to make exemptions with respect to thesection 12(g) registration requirements, and that section12(g) of the Exchange Act also allows the SEC to define

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the terms held of record and total assets. Therefore, theSEC has the requisite authority to revise the shareholderthreshold if it concludes that doing so is not inconsistentwith the public interest or protection of investors.

New capital-raising strategiesThe letter from Issa raised questions regardingcrowdfunding, singling out that approach as a possiblenew method of capital formation that has gainedpopularity. Schapiro stated that she understandscrowdfunding to be a new method of capital formationwhereby groups of people pool money, typically smallindividual contributions, to support an effort by others toaccomplish a specific goal. Initially, such arrangements didnot trigger securities law issues because there was no profitparticipation. Schapiro noted, however, that interest inoffering an ownership interest in a developing business andan opportunity for a return on investment capital isgrowing. She provided an example of crowdfunding asdescribed to the staff as an offering of up to a maximum of$100,000 of equity securities of a company, withindividual investments capped at $100. She noted thatproponents of this approach to capital formation seek aregistration exemption, and the SEC has been exploringseveral approaches to address this.25 In considering whetherto grant an exemption from registration for sucharrangements, Schapiro stated that the SEC wouldconsider, for example, its experience with Securities ActRule 504, which was revised in 1999 due to concernsabout fraud in the market. The widespread use of theinternet for capital raising presents additional challenges inthis area.

Legislative and other effortsAt more or less the same time that these exchanges weretaking place, legislative efforts were moving forward thatcontemplated other changes to the capital formationprocess for smaller and emerging companies.Representative David Schweikert introduced the SmallCompany Capital Formation Act of 2011 in the US Houseof Representatives, which sought to amend the RegulationA offering threshold from $5 million to $50 million forpublic offerings by smaller companies.26 The SmallCompany Formation Act was introduced after hearings onthe topic of capital formation were held in December2010, during which industry representatives expressedsupport for Regulation A reform as well as other changesto the capital formation process.

During the same session of Congress, other individualbills were introduced that would have increased thethreshold for mandatory registration for all companies

under the Exchange Act from 500 persons holding equitysecurities of record to 1,000 persons, and that would haveamended section 12(g) of the Exchange Act by raising theregistration threshold from 500 to 2,000 record holders ifthe issuer is a bank or a bank holding company.27

Representative Patrick McHenry introduced legislationthat would have added a crowdfunding exemption underboth section 4 of the Securities Act and section 12(g) ofthe Exchange Act. Representative Kevin McCarthyintroduced legislation to amend section 4(a)(2) of theSecurities Act to state specifically that general solicitationand general advertising would not affect the availability ofthe private placement exemption to registration undersection 5 of the Securities Act, and to direct the SEC toremove the prohibition against general solicitation andadvertising for securities issued under Rule 506 ofRegulation D, provided that all purchasers of the securitiesare accredited investors and that the issuer took reasonablesteps set forth by the SEC to ascertain that the holder isindeed an accredited investor. Of course, these individuallegislative proposals were the precursors to the JOBS Act.

In March 2011, the US Treasury Department convenedthe Access to Capital Conference to ‘gather insights fromcapital markets participants and solicit recommendationsfor how to restore access to capital for emerging companies– especially public capital through the IPO market.’ At thisconference, a small group of professionals representingbroad sectors of the IPO market decided to form the IPOTask Force to examine the challenges that emerginggrowth companies face in pursuing IPOs, and to providerecommendations for restoring effective access to thepublic markets for emerging growth companies.

The Task Force published its report, titled Rebuildingthe IPO On-Ramp, in October 2011.28 In the report, theTask Force noted that after achieving a one-year high of791 IPOs in 1996, the US IPO market severely declinedfrom 2001 to 2008, averaging only 157 IPOs per yearduring that period, with a low of 45 in 2008, with IPOsby smaller companies showing the steepest declines. Thereport presents a nuanced view of the causes of thisdecline, pointing to a series of regulatory and marketstructure changes. The report notes that these changeshave coalesced and, as a result, have had the effect ofdriving up costs for smaller companies looking to gopublic; constraining the amount of information availableto investors about such companies; and shifting theeconomics of investment banking away from long-terminvesting in such companies and toward high-frequencytrading of large-cap stocks, thus making the IPO processless attractive to, and more difficult for, smaller companies.The report made four principal recommendations to the

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Treasury Department: providing an on-ramp (or phasingin of disclosure requirements) for smaller companies thatcomplete IPOs; improving the availability and flow ofinformation for investors before and after an IPO;lowering the capital gains tax rate for investors whopurchase shares in an IPO and hold these shares for aminimum of two years; and educating issuers about how tosucceed in the new capital markets environment. The TaskForce stressed that these recommendations purport only toadjust the scale of current regulations, not change the focuson investor protection.

In December 2011, legislation, titled the ReopeningAmerican Capital Markets to Emerging GrowthCompanies Act of 2011, was introduced that incorporatedmany of the recommendations included in the Task Forcereport, including a proposal to amend section 2(a) of theSecurities Act and section 3(a) of the Exchange Act bycreating a new category of issuer called an emerginggrowth company and exempting these emerging growthcompanies, at least initially, from certain requirements.This legislation formed the basis of much of Title I of theJOBS Act.

The legislative efforts received a boost when, in January2012, President Obama expressed support for a number ofthese initiatives. During his State of the Union address, thePresident emphasised the need to foster innovation andencourage start-ups and small businesses. On January 312012, the President released the Startup AmericaLegislative Agenda to Congress, which reflected supportfor an increase in the offering threshold in Regulation A, a‘national framework’ for crowdfunding, and the adoptionof an IPO on-ramp. Shortly thereafter, the individuallegislative initiatives referenced above coalesced into asingle legislative proposal.

The JOBS Act and the IPO marketIn the years following enactment of the JOBS Act, the IPOmarket in the US has improved. Market participantsattribute the health of the US IPO market largely to overallimproved economic conditions. Growing US companiescontinue to debate whether to pursue an IPO or to deferan IPO and rely on private placements to raise capital. Inpart, the ability to submit an IPO registration statementconfidentially and the ability to test the waters with certaininstitutional investors has made it easier for manyprospective IPO issuers to explore the IPO alternative.According to published statistics, 2014 was the best yearsince 2000 for the number of US IPOs and the grossproceeds raised through IPOs. In 2014, there were 297IPOs, which raised $85.61 billion. However, 2015 and2016 were marked by volatility and many companies chose

to delay their IPOs. In 2015, 170 IPOs were completed,accounting for approximately $30 billion in aggregategross proceeds. In 2016, 117 IPOs were completed,accounting for approximately $21.9 billion in aggregategross proceeds. In the first half of 2017, 89 IPOs werecompleted, accounting for approximately $24.6 billion inaggregate gross proceeds. During the same period, we haveborne witness to the phenomenon of unicorns, or privatelyheld companies with a market value of at least $1 billion.Many successful private companies have found that theycan raise substantial amounts in private placementscompleted at attractive valuations made to largeinstitutional investors, often including the same types ofinstitutions that historically would have investedprincipally or exclusively in IPOs or in publicly heldcompanies.

While it is difficult to attribute the number of IPOsdirectly to the JOBS Act, market participants andlegislators were encouraged by IPO activity in the earlyyears following the Act’s adoption. Also, the continueddecline in the number of US public companies has ledmany legislators to advocate extending various provisionsof the JOBS Act to a broader array of companies, as well asto undertake other initiatives designed to promote capitalformation. As we discuss further in Chapter 9, some ofthese proposals were recommended by the SEC’s AdvisoryCommittee on Smaller Public Companies or by othersmall business groups. A number of enhancements to theJOBS Act and other securities law -related measures foundtheir way into a highway and transportation infrastructurebill as riders. This legislation, which is titled the FixingAmerica’s Surface Transaction Act (the FAST Act), wasenacted on December 4 2015.29 The US Congress and theSEC continue to evaluate additional measures that mayspur IPO activity.

In the chapters that follow, we provide a summary of themain provisions of the JOBS Act and a discussion of theireffect on capital formation.

12 JOBS Act Quick Start 2018 update

1 Jumpstart Our Business Startups Act, Pub. L. No.112-106.

2 Securities Act of 1933, 48 Stat. 74 (May 27 1933),codified at 15 USC § 77a et seq.

3 Securities Exchange Act of 1934, 48 Stat. 881 (June6 1934), codified at 15 USC § 78a et seq.

4 15 USC § 77e.5 15 USC § 77e(b).6 Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204,

116 Stat. 745 (codified in various sections of 15U.S.C. and 18 U.S.C.), § 301, 302, 404, 406, 407and 906.

7 See www.lexissecuritiesmosaic.com/resourcecenter/Issa.041211.pdf

8 See id.9 See http://online.wsj.com/article/

SB10001424052748704630004576249182275134552.html?KEYWORDS=%22new+stock+rules%22

10 See James C. Brau & Stanley E. Fawcett, InitialPublic Offerings: An Analysis of Theory and Practice,61 J. FIN. 399 (2006), available athttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=530924

11 Securities Act Release No. 33-8514, 87 S.E.C.Docket 1138 (February 28 2006); Exchange ActRelease No. 34-50864, 84 S.E.C. Docket 1340(December 16 2004).

12 Advisory Committee on Smaller Public Companies,Charter, available athttp://sec.gov/info/smallbus/acspc.shtml

13 Letter from Keith F. Higgins, Chair, ABACommittee on Federal Regulation of Securities, toJohn W. White, Director, Division of CorporationFinance (March 22, 2007), available atwww.abanet.org/buslaw/committees/CL410000pub/comments/20070322000000.pdf

14 See www.knowledgemosaic.com/resourcecenter/Issa.041211.pdf

15 See www.sec.gov/news/press/schapiro-issa-letter-040611.pdf

16 Dodd-Frank Wall Street Reform and ConsumerProtection Act (codified at § 12 U.S.C. § 5301 etseq.).

17 See, eg, D. Weild and E. Kim, A Wake Up Call forAmerica, Grant Thornton LLP (2009); Committeeon Capital Markets Regulation, Continued Erosionin Competitiveness of the U.S. Equity Markets

(2009).18 See C. Caglio, K. Weiss Hanley and Marietta-

Westberg, Going Public Abroad: The Role ofInternational Markets for IPOs (February 2011).

19 The Securities Act does not state when the pre-filingperiod begins. The SEC has stated that an issuer willbe in registration at least from the time it beginspreparing the related registration statement or thetime it has reached an understanding with anunderwriter, even if all the terms or conditions of theunderwriting arrangement have not been agreedupon. See Release No. 33-5009, Publication ofInformation Before or After the Filing and EffectiveDate of a Registration Statement Under the SecuritiesAct of 1933 (October 7 1969); Release No. 33-5180,Guidelines for Release of Information by Issuers WhoseSecurities Are in Registration (August 16 1971).

20 See Securities Act § 5(c).21 See Securities Act § 5(b)(1).22 See Release No. 33-8591, Securities Offering Reform

(July 19 2005), available at www.sec.gov/rules/finaI/33-8591.pdf

23 See, eg, Final Report of the Advisory Committee onSmaller Public Companies to the U.S. Securities andExchange Commission (April 23 2006),www.sec.gov/info/smallbus/acspc/acspc-finalreport.pdf; Joseph McLaughlin, How the SECStifles Investment - and Speech, The Wall StreetJournal (February 3 2011). Concerns about the scopeof the Commission’s rules on general solicitation andadvertising have been raised by the participants inthe annual SEC Government-Business Forum onSmall Business Capital Formation. See 2009 AnnualSEC Government-Business Forum on Small BusinessCapital Formation Final Report (May 2010),available at www.sec.gov/info/smallbus/gbfor28.pdf

24 See Pinter v Dahl, 486 U.S. 622, 644 (1988) (‘Thepurchase requirement clearly confines §12 liability tothose situations in which a sale has taken place.Thus, a prospective buyer has no recourse against aperson who touts unregistered securities to him if hedoes not purchase the securities.’).

25 For example, crowdfunding was discussed at theSEC’s November 2010 Forum on Small BusinessCapital Formation. Participants in the Forumrecommended that the SEC consider implementing anew exemption from Securities Act registration for

JOBS Act Quick Start 2018 update 13

ENDNOTES

crowdfunding, which would include offerings of upto $100,000 and a cap on individual investments notto exceed $100. In January 2011, representativesfrom the Division of Corporation Finance’s Office ofSmall Business Policy met with a group from theSmall Business & Entrepreneurship Council, whichadvocated an exemption from registrationrequirements for crowdfunding offerings meetingspecific requirements. In addition, the Office ofSmall Business Policy and other members of theDivision of Corporation Finance Staff discussedcrowdfunding with representatives from the NorthAmerican Securities Administrators Association, theorganisation of state securities regulators, at aconference held on March 28 2011.

26 HR 1070, available at ww.gpo.gov/fdsys/pkg/BILLS-112hr1070ih/pdf/BILLS-112hr1070ih.pdf

27 Note that this change merely puts into the statutethe current requirements of SEC rules under Sections12(g) and 15(d).

28 Available at www.sec.gov/info/smallbus/acsec/rebuilding_the_ipo_on-ramp.pdf

29 Fixing America’s Surface Transportation Act (Pub. L.No. 114-94).

14 JOBS Act Quick Start 2018 update

Title I of the JOBS Act establishes a new processand disclosure regime for initial public offerings(IPOs) by a new class of companies referred toas emerging growth companies (EGCs). As

discussed in the Introduction, Title I of the JOBS Act wasenacted based on the recommendations of the Task Force,which sought ways to improve the offering process as ameans of encouraging more IPOs in the United States. Astruly the centrepiece of the JOBS Act, Title I contemplates,for those companies that qualify as EGCs, confidentialSEC staff review of draft IPO registration statements,scaled disclosure requirements, no restrictions on test-the-waters communications with qualified institutional buyers(QIBs) and institutional accredited investors before andafter filing a registration statement, and fewer restrictionson research (including research by participatingunderwriters) around the time of an offering. Because TitleI was retroactively effective to December 9 2011 for issuersthat qualified as EGCs, it has had the most significantimpact to date on the regulation of capital formationtransactions.

Given the immediate effectiveness of Title I of the JOBSAct, the SEC staff provided interpretive guidance in theform of frequently asked questions that are posted on theSEC’s website. The FAQs were initially issued on April 162012 and were updated on May 3 2012, September 282012 and December 21 2015.1 These FAQs are not rules orregulations of the SEC, but rather reflect the views of thestaff of the SEC’s Division of Corporation Finance.

The definition of EGCIn order to qualify for the IPO on-ramp contemplated byTitle I of the JOBS Act, an issuer must qualify as an EGC,which is determined for the purpose of the reporting,accounting, auditing and corporate governance breaks thatthe company may use if it went public through a registeredsecurities offering on or after December 9 2011, and for anIPO at any time during the process when the EGC ismaking use of the Title I provisions.

The revenue testAn EGC is defined for purposes of Title I as an issuer

(including a foreign private issuer) with total annual grossrevenues of less than $1.07 billion (originally $1 billion,but amended by the SEC due to inflationary adjustmentrequired to occur every five years) during its most recentlycompleted fiscal year.2 The SEC indicates that the phrase‘total annual gross revenues’ means total revenues of theissuer (or a predecessor of the issuer, if the predecessor’sfinancial statements are presented in the registrationstatement for the most recent fiscal year), as presented onthe income statement in accordance with US generallyaccepted accounting principles (GAAP).3 If a foreignprivate issuer is using International Financial ReportingStandards (IFRS) as issued by the International AccountingStandards Board (IASB) as its basis for presentation, thenthe IFRS revenue number is used for this test.4 Because anissuer must determine its EGC status based on revenues asexpressed in US dollars, the SEC staff indicates that aforeign private issuer’s conversion of revenues should bebased on the exchange rate as of the last day of the fiscalyear.5 For financial institutions, the SEC has indicated thattotal annual gross revenues should be determined in themanner consistent with the approach used for determiningstatus as a ‘smaller reporting company,’ which looks to allgross revenues from traditional banking activities. For thispurpose, a financial institution must include all grossrevenues from traditional banking activities. Bankingactivity revenues include interest on loans and investments,dividends on investments, fees from loan origination, feesfrom trust and investment services, commissions, brokeragefees, mortgage servicing revenues, and any other fees orincome from banking or related services. Revenues do notinclude gains and losses on dispositions of investmentportfolio securities (although it may include gains ontrading account activity if that is a regular part of theinstitution’s activities).6

By way of example, the SEC indicates that, in applyingthe revenue test for determining EGC status, a calendaryear-end issuer that would like to file a registrationstatement for an initial public offering of common equitysecurities in January 2013 (which would present financialstatements for 2011 and 2010 and the nine months endedSeptember 30 2012 and 2011) should look to its most

JOBS Act Quick Start 2018 update 15

CHAPTER 1

The IPO on-ramp

recently completed fiscal year, which would be the mostrecent annual period completed, regardless of whetherfinancial statements for the period are presented in theregistration statement. In this example, the most recentannual period completed would be 2012.7

Applicability of the December 9 2011 effective dateAn issuer can qualify as an EGC if it first sold its commonstock in a registered offering on or after December 9 2011.The SEC has indicated that this eligibility determination isnot limited to initial public offerings that took place on orbefore December 8 2011, in that it could also include anoffering of common equity securities under an employeebenefit plan on Form S-8, as well as a selling shareholder’sregistered secondary offering.8 The SEC notes that justhaving a registration statement go effective on or beforeDecember 8 2011 is not a bar to EGC status, as long as nocommon equity securities were actually sold off of theregistration statement on or before December 8 2011.9

Qualification for EGC statusThe SEC has indicated that asset-backed issuers andregistered investment companies do not qualify as EGCs;however, business development companies could qualify.10

To date, the SEC staff has allowed business developmentcompanies and exchange traded commodity pools to beconsidered EGCs. The SEC may determine, through thecourse of its review process or otherwise, that otherparticular types of issuers are not EGCs for the purposes ofTitle I of the JOBS Act.

Previously public issuersAn issuer that succeeds to a predecessor’s Exchange Actregistration or reporting obligations under Rules 12g-3 and15d-5 will not qualify for EGC status if the predecessor’sfirst sale of common equity securities occurred on or beforeDecember 8 2011, as the predecessor was not eligible forthat EGC status.11

The SEC has addressed the EGC status of an issuer thatwas once an Exchange Act reporting company but is notrequired to file Exchange Act reports.12 The SEC notes thatsuch an issuer can take advantage of the benefits of EGCstatus, even though its initial public offering of commonequity securities occurred on or before December 8 2011.In this regard, the SEC indicates that if an issuer wouldotherwise qualify as an EGC but for the fact that its initialpublic offering of common equity securities occurred on orbefore December 8 2011, and such issuer was once anExchange Act reporting company but is not required to fileExchange Act reports, then the SEC would not object ifsuch issuer takes advantage of all of the benefits of EGC

status for its next registered offering and thereafter, until ittriggers one of the disqualification provisions in sections2(a)(19)(A)-(D) of the Securities Act. This position is notavailable to an issuer that has had the registration of a classof its securities revoked pursuant to Exchange Act section12(j). The SEC goes on to note that, based on the particularfacts and circumstances, the EGC status of an issuer may bequestioned if it appears that the issuer ceased to be areporting company for the purpose of conducting aregistered offering as an EGC. The SEC recommends thatissuers with questions relating to these issues should contactthe Division of Corporation Finance’s Office of the ChiefCounsel.

This interpretation seeks to address EGC status for thosecompanies that were taken private through private equity ormanagement buyouts with the expectation of a liquidityevent or exit through an IPO in the future, which havemade up a relatively significant portion of the IPO marketin recent years.

Losing EGC statusStatus as an EGC is maintained until the earliest of:• the last day of the fiscal year in which the issuer’s total

annual gross revenues are $1.07 billion or more; • the last day of the issuer’s fiscal year following the fifth

anniversary of the date of the first sale of common equitysecurities of the issuer pursuant to an effectiveregistration statement under the Securities Act (for adebt-only issuer that never sold its common equitypursuant to an Exchange Act registration statement, thisfive-year period will not run);

• any date on which the issuer has, during the prior three-year period, issued more than $1 billion innon-convertible debt; or

• the date on which the issuer becomes a ‘large acceleratedfiler,’ as defined in the SEC’s rules.13

With regard to the $1 billion debt issuance test, the SEChas indicated that the three-year period covers any rollingthree-year period, which is not in any way limited tocompleted calendar or fiscal years.14 The SEC also notedthat it reads non-convertible debt to mean any non-convertible security that constitutes indebtedness (whetherissued in a registered offering or not), thereby excludingbank debt or credit facilities.15 The debt test references debtissued, as opposed to issued and outstanding, so that anydebt issued to refinance existing indebtedness over thecourse of the three-year period could be counted multipletimes. The SEC has indicated, however, that the staff willnot object if an issuer does not double count the principalamount from a private placement and the principal amountfrom the related Exxon Capital or A/B exchange offer.16 For

16 JOBS Act Quick Start 2018 update

issuers that engage in securitisation transactions, debtsecurities issued in securitisation transactions may becounted toward the debt test to the extent that the issuerconsolidates the securitisation trust on its balance sheet.

The SEC also addressed two specific examples and howthe EGC status of the issuer would be determined in theevent of an acquisition or reverse merger.17

• In Example 1, Company A acquires Company B forcash or stock, in a forward acquisition. Company A isboth the legal acquirer and the accounting acquirer.

• In Example 2, Company C undertakes a reverse mergerwith Company D, an operating company. Company Dis presented as the predecessor in the post-transactionfinancial statements.

In each example, the companies’ fiscal year is the calendaryear; the transactions occur on September 30 2012; andFAQ 24, which relates to succession of Exchange Actobligations, is not implicated. In determining whetherCompany A and Company C trigger any of thedisqualifications from the definition of EGC in section2(a)(19)(A), (B), (C) or (D) (referenced above), the SECstaff notes the following framework:

Timing of the EGC determinationSecurities Act Rule 401(a) provides that ‘the form andcontents of a registration statement and prospectus shallconform to the applicable rules and forms as in effect on

the initial filing date of such registration statement andprospectus,’ and applies to registration statements at theinitial filing date, not at the time that a registrationstatement is submitted for confidential review.18 Therefore,an issuer must qualify as an EGC at the time of submissionin order to use the confidential review process for aregistration statement, or any amended submission of theregistration statement. If an issuer loses EGC status whilethe SEC staff is reviewing the registration statement on aconfidential basis, then the issuer must file the registrationstatement and all of the draft submissions in order toproceed with the review process. When the EGC files theregistration statement, the issuer’s EGC status is retainedwhile that registration statement is in registration byoperation of Securities Act Rule 401(a). With regard to theuse of the permitted test-the-waters communications underSecurities Act section 5(d) (discussed below), an issuer mustdetermine whether it qualifies as an EGC at the time itengages in the test-the-waters communications. In thisregard, the SEC has noted that if the issuer later loses itsEGC status by the time the registration statement is filed,then the issuer would not retroactively lose the ability toutilise prior test-the-waters communications.19

EGC grace periodThe FAST Act amends the Securities Act in order toprovide a grace period permitting an issuer that qualified as

JOBS Act Quick Start 2018 update 17

$1.07 billion annual revenuetest

Five-year anniversary test

$1 billion issued debt during previous three years test

Large accelerated filer test

Example 1:forward acquisition

In 2012, look to Company A’s revenuesfor 2011.

In 2013, look to Company A’s revenuesfor 2012, which will include Company B’srevenues from October 1 2012.

Look to Company A’s date of first sale.

Look to Company A’s debt issuances,which will include Company B’s debtissuances from October 1 2012.

At December 31 2012, look to CompanyA’s market value at June 30 2012.

At December 31 2013, look to CompanyA’s market value (which will includeCompany B’s) at June 30 2013.

Example 2:reverse merger

In 2012, look to Company D’s revenuesfor 2011.

In 2013, look to Company D’s revenuesfor 2012, which will include Company C’srevenues from October 1 2012.

Look to Company C’s date of first sale.

Look to Company D’s debt issuances,which will include Company C’s debtissuances from October 1 2012.

At December 31 2012, look to CompanyC’s market value at June 30 2012.

At December 31 2013, look to CompanyC’s market value (which will includeCompany D’s) at June 30 2013.

an EGC at the time it made its first confidential submissionof its IPO registration statement and subsequently duringthe IPO process ceases to be an EGC to continue to betreated as an EGC through the earlier of: the date on whichthe issuer consummates its IPO pursuant to thatregistration statement, or the end of the one-year periodbeginning on the date the company ceases to be an EGC.20

Benefits available to EGCsWhen an issuer qualifies as an EGC, it may take advantageof a number of benefits in connection with its IPO andsubsequent public reporting and corporate governance.These benefits are designed to facilitate the public offeringprocess, promote communications in and around the timeof the IPO, and allow the EGC to ease into certain publicreporting, accounting, auditing, and corporate governancerequirements.

EGC communicationsTitle I of the JOBS Act provides EGCs, or any other personthey authorise, the flexibility to engage in oral or writtencommunications with QIBs and institutional accreditedinvestors in order to gauge their interest in a proposedoffering, whether before or following the first filing of anyregistration statement, subject to the requirement that nosecurity may be sold unless accompanied or preceded by aSecurities Act section 10(a) prospectus.21 This provisionallows an EGC to test the waters for a potential IPO bycommunicating with investors and gauging their potentialinterest in the offering.22 An EGC can use the test-the-waters provision with respect to any registered offerings thatit conducts while qualifying for EGC status. There are noform or content restrictions on these communications, andthere is no requirement to file written communicationswith the SEC. In the course of reviewing the registrationstatements of an EGC, the SEC staff has requested theEGCs submit any written test-the-waters materials to theSEC, so that the SEC staff can determine whether thosematerials would provide any guidance as to informationthat should be included in the prospectus.

The SEC has addressed the interplay of these test-the-waters communications, and the requirements of ExchangeAct Rule 15c2-8(e).23 Rule 15c2-8(e) requires that a broker-dealer make available a copy of the preliminary prospectus(before the effective date) for a registered offering ofsecurities before soliciting orders from customers. If readbroadly, the prohibitions of Rule 15c2-8(e) might constrainthe types of activities that are permissible during test-the-waters discussions. The FAQs note that while the JOBS Actdoes not amend Rule 15c2-8(e) (that is, the JOBS Act doesnot modify the meaning of the term ‘solicit’), an EGC or a

financial intermediary acting on the EGC’s behalf mayengage in discussions with institutional investors to gaugetheir interest in purchasing EGC securities before the EGChas filed its registration statement with the SEC and afterthe EGC has filed its registration statement. During thisperiod, the underwriter may discuss price, volume andmarket demand and solicit non-binding indications ofinterest from customers. Soliciting such a non-bindingindication of interest, in the absence of other factors, wouldnot constitute a solicitation for purposes of Rule 15c2-8(e).

The JOBS Act also permits a broker-dealer to publish ordistribute a research report about an EGC that proposes toregister an offering under the Securities Act or has aregistration statement pending, and the research report willnot be deemed an offer under the Securities Act, even if thebroker-dealer will participate or is participating in theoffering. Further, no SRO or the SEC may adopt ormaintain any rule or regulation prohibiting a broker-dealerfrom publishing or distributing a research report or makinga public appearance with respect to the securities of anEGC following an offering or in a period before expirationof a lock-up.24 These provisions are discussed in greaterdetail in Chapter 8.

Confidential review process for EGC IPO registrationstatementsTitle I provides that the SEC’s staff must review all EGCinitial public offering registration statementsconfidentially.25 Title I provides that an EGC mayconfidentially submit a draft registration statement for anIPO for non-public review, provided that the initialconfidential submission and all amendments are publiclyfiled with the SEC no later than 21 days before the issuer’scommencement of a road show.26 The FAST Act amendedthis requirement and reduced the 21-day period to a 15-dayperiod.27 The SEC requires that confidential draftregistration statements and amendments be submittedthrough the SEC’s electronic filing system (known asEDGAR) using submission form types DRS and DRS/A,respectively. No filing fee is due at the time of submittingthe draft registration statement.28

A confidential submission of a draft registrationstatement is not required to be signed by the registrant orby any of its officers or directors, nor is it required toinclude the consent of auditors and other experts, as it isnot filed with the SEC.29 While Securities Act section6(e)(1) requires that the initial confidential submission andall amendments thereto be publicly filed with the SEC notlater than 15 days before the date on which the issuercommences a road show, the SEC notes that upon publicfiling, the previous confidential submissions are not

18 JOBS Act Quick Start 2018 update

required to be signed and do not require consents.30

The SEC expects that any registration statementsubmitted for confidential review will be substantiallycomplete at the time of initial submission, including asigned audit report and the required exhibits (however, theregistration statement itself is not required to be signed orto include the consent of auditors and other experts). TheSEC will defer review of any draft registration statementthat is materially deficient.31

The confidential submission of a draft registration doesnot constitute the filing of a registration statement for thepurposes of the prohibition in Securities Act section 5(c)against making offers of a security in advance of filing aregistration statement.32

Test-the-waters communications and the now 15-day filingrequirementThe JOBS Act amended Securities Act section 6(e) toprovide that confidential registration statementsubmissions must be publicly filed with the SEC at least 21days before the issuer conducts a road show. As notedabove, this period has now been reduced to 15 days. Theterm road show is defined as ‘an offer…that contains apresentation regarding an offering by one or more membersof the issuer’s management…and includes discussion of oneor more of the issuer, such management, and the securitiesbeing offered.’33 Given the breadth of this definition, theSEC has addressed the issue of whether the test-the-waterscommunications under Securities Act section 5(d) that arediscussed above could be considered a road show for thepurposes of triggering this public filing requirement.34

The SEC has noted that in a traditional underwrittenpublic offering where test-the-waters communications arenot used, the road show could be easily identified as ‘thosemeetings traditionally viewed as the road show when theemerging growth company and underwriters begin activelymarketing the offering.’ Under these circumstances, theEGC would be able to estimate when it expects to beginthat road show, and then publicly file the registrationstatement and all of the confidential submissions at least 15days before that date. Because Securities Act section 5(d)specifically contemplates test-the-waters communicationstaking place before filing a registration statement, and inthe interest of reading the provisions in a consistent fashion,the SEC will not object if an EGC does not treat test-the-waters communications conducted in reliance on SecuritiesAct section 5(d) as a road show for purposes of SecuritiesAct section 6(e). The SEC notes, however, that if an issuerwere to have meetings or other communications that meetthe definition of a road show and which do not fall withinthe test-the-waters communications contemplated by

section 5(d), then the public filing requirement would betriggered based on the timing of such meetings. If an EGCdoes not conduct a traditional road show and does notengage in activities that would come within the definitionof a road show, other than test-the-waters communicationsthat comply with Securities Act section 5(d), the SEC staffindicates that the issuer’s registration statement andconfidential submissions should be filed publicly no laterthan 21 days (and now, presumably, 15 days) before theanticipated date of effectiveness of the registrationstatement.35

As we discuss further in Chapters 2 and 9, in June 2017,the SEC staff announced a new policy effective July 2017that essentially extends the confidential submission processto all issuers while keeping the EGC process unchanged.The SEC will review a draft initial registration statementunder the Securities Act, and related revisions on anonpublic basis. Similarly, the SEC also will now review adraft registration statement of a class of securities undersection 12(b) of the Exchange Act. None of the otheraccommodations available to EGCs were extended to non-EGCs.

Registration statement disclosure for EGCsThe SEC has indicated that an EGC must identify itself asan EGC on the cover page of the prospectus.36 In addition,SEC staff comments on EGC registration statements haverequested the following disclosures: • a description of how and when a company may lose

EGC status; • a brief description of the various exemptions that are

available to an EGC, such as exemptions from Sarbanes-Oxley section 404(b) and the say-on-pay/say-on-goldenparachute provisions; and

• the EGC’s election under section 107(b) of the JOBSAct for extended transition to new or revised accountingstandards.

The SEC staff requests that if the EGC has elected to optout of the extended transition period for new or revisedaccounting standards, then it must include a statement thatthe election is irrevocable. If the EGC has elected to use theextended transition period, then risk factor disclosure mustexplain that this election allows an EGC to delay theadoption of new or revised accounting standards that havedifferent effective dates for public and private companiesuntil those standards apply to private companies. The SECstaff also requests that the EGC state in the risk factors that,as a result of this election, the EGC’s financial statementsmay not be comparable to issuers that comply with publicissuer effective dates. A similar statement is also requestedin the EGC’s critical accounting policy disclosures in

JOBS Act Quick Start 2018 update 19

MD&A.An EGC is required to present only two years of audited

financial statements in its initial public offering registrationstatement.37 An EGC may also limit its MD&A to onlycover those audited periods presented in the auditedfinancial statements. The SEC has indicated that,notwithstanding Securities Act section 7(a)(2)(A)’sreference to ‘any other’ registration statement, the SEC staffwill not object if an EGC presenting two years of auditedfinancial statements limits the selected financial dataincluded in its initial public offering registration statementto only two years.38 For financial statements required underRules 3-05 and 3-09 of Regulation S-X under the SecuritiesAct (Regulation S-X), the SEC staff will not object if onlytwo years of financial statements are provided in theregistration statement, even if the significance tests result ina requirement to present three years of financial statementsfor entities other than the issuer.39 The SEC staff has furthernoted that it will not object if an issuer presents the ratio ofearnings to fixed charges required by Item 503(d) ofRegulation S-K under the Securities Act (Regulation S-K)for the same number of years for which it provides selectedfinancial data.40

The FAST Act also amended the financial informationrequirement for EGCs. As a result of the FAST Actamendments, an EGC may omit historical financialinformation for certain periods otherwise required byRegulation S-X at the time of filing or confidentialsubmission, if the EGC reasonably believes the informationwill not be required to be included at the time of thecontemplated offering.41 In December 2015, the SEC staffprovided guidance on this change, clarifying that theaccommodation applies to all historical financialinformation required to be presented pursuant toRegulation S-X, including, for example, financialstatements for an acquired company. In August 2017, theSEC staff provided additional guidance on the omission ofinterim information, providing this illustration:

For example, consider a calendar year-end ECG thatsubmits a draft registration statement in November 2017and reasonably believes it will commence its offering inApril 2018 when annual financial information for 2017will be required. This issuer may omit from its draftregistration statements its 2015 annual financialinformation and interim financial information related to2016 and 2017. Assuming that this issuer were to firstpublicly file in April 2018 when its annual information for2017 is required, it would not need to separately prepare orpresent interim information for 2016 and 2017. If thisissuer were to file publicly in January 2018, it may omit its2015 annual financial information, but it must include its

2016 and 2017 interim financial information in thatJanuary filing because that interim information relates tohistorical periods that will be included at the time of thepublic offering.

An EGC may comply with the executive compensationdisclosures applicable to a smaller reporting company asdefined in the SEC’s rules, which means that an EGC needprovide only a Summary Compensation Table (with threerather than five named executive officers and limited to twofiscal years of information), an Outstanding Equity AwardsTable, and a Director Compensation Table, along withsome narrative disclosures to augment those tables. EGCsare not required to provide a Compensation Discussion andAnalysis, or disclosures about payments upon terminationof employment or change in control.42

Disclosure, corporate governance, accounting and auditingreliefTitle I of the JOBS Act provides relief from a number ofrequirements for EGCs following an initial public offering.An EGC will not be subject to the say-on-pay, say-on-frequency or say-on-golden parachute vote required by theDodd-Frank Act and the SEC rules, for as long as the issuerqualifies as an EGC.43 An issuer that was an EGC, but lostthat status, will be required to comply with the say-on-payvote requirement as follows: in the case of an issuer that wasan EGC for less than two years, by the end of the three-yearperiod following its IPO; and for any other issuer, withinone year of having lost its EGC status.44 An EGC also is notsubject to any requirement to disclose the relationshipbetween executive compensation and the financialperformance of the company, or any requirement todisclose the CEO’s pay relative to the median employee’spay (should either such requirements ever be proposed andadopted by the SEC pursuant to the Dodd-Frank Act).45

Under section 107(b) of the JOBS Act, an EGC will notbe required to adopt any update to FASB’s AccountingStandards codification after April 5 2012 that has differenteffective dates for public companies and private companiesthat are not ‘issuers’ under section 2(a) of Sarbanes-Oxley,until those standards apply to private companies. Underthis provision, EGCs are able to take advantage of theextended transition period contemplated in those limitedsituations where there is a different effective date specifiedfor private companies. If a new or revised accountingstandard does not apply at all to private companies, then notransition would be permitted for EGCs, or if anaccounting standard applies to both public and privatecompanies, but provides for the same effective date for bothtypes of companies, then no transition would be permittedfor EGCs. Section 107(b)(1) of the JOBS Act provides that

20 JOBS Act Quick Start 2018 update

an EGC ‘must make such choice at the time the companyis first required to file a registration statement, periodicreport, or other report with the Commission’ and to notifythe SEC of such choice. The SEC has noted that EGCsshould notify the SEC staff of the issuer’s choice at the timeof the initial confidential submission, and if an EGC isalready in registration or subject to Exchange Act reporting,then the statement must appear in its next amendment tothe registration statement or in its next periodic report.46

Section 107(b)(2) provides that any decision to optout ofthe extended transition period for complying with new orrevised accounting standards is irrevocable; however, theSEC allows an EGC that opted into the extended transitionperiod provision to subsequently opt out, as long as itcomplies with the applicable provisions of the JOBS Actand discloses its opting-out in the first periodic report orregistration statement following the decision to do so.

An EGC is not subject to any potential rules or standardsrequiring mandatory audit firm rotation or a supplement tothe auditor’s report that would provide additionalinformation regarding the audit of the company’s financialstatements (auditor discussion and analysis), should suchrequirements ever be proposed or adopted by the PublicCompany Accounting Oversight Board (PCAOB). Anyother new auditing standards adopted by the PCAOB willnot apply to EGC audits unless the SEC determines thatsuch requirement is necessary and appropriate for investorprotection.47

An EGC is not subject to the requirement for an auditorattestation of internal controls pursuant to section 404(b)of Sarbanes-Oxley. The EGC is subject to the requirementthat management establish, maintain, and assess internalcontrol over financial reporting, once that is phased-in fora issuer conducting an IPO after the first year.48

Other than the provisions for extended transition to newor revised accounting standards discussed above, an EGCmay decide to follow only some of the scaled disclosureprovisions and corporate governance breaks available forEGCs.49

The SEC will not object if a foreign private issuer thatqualifies as an EGC complies with the scaled disclosureprovisions available to EGCs to the extent relevant to theform requirements for foreign private issuers.50

Required studiesThe JOBS Act requires that the SEC conduct a number ofstudies. Under Title I, within 90 days of enactment of theAct, the SEC was required to present to Congress thefindings of a study that examines the impact ofdecimalisation on initial public offerings and the impact ofthis change on liquidity for small- and mid-cap securities.

If the SEC determined that securities of emerging growthcompanies should be quoted or traded using a minimumincrement higher than $0.01, the SEC may, by rule, notlater than 180 days following enactment of the Act,designate a higher minimum increment between $0.01 and$0.10.51 Also under Title I, within 180 days of enactment,the SEC was required to present to Congress its findingsand recommendations following a review of Regulation S-K that is intended to analyse current registrationrequirements and determine whether these requirementscan be updated, modified or simplified in order to reducecosts and other burdens on EGCs.52

DecimalisationOn July 20 2012, the SEC delivered to Congress the reportrequired by section 106 of the JOBS Act.53 The study notesthe observations of the IPO Task Force regarding thechanging market structure and economics arising from theshift to decimal stock quotes, which point toward anegative impact on the economic sustainability of sell-sideresearch and the greater emphasis placed on liquid, verylarge capitalisation stocks at the expense of smallercapitalisation stocks. The SEC’s study takes a three-prongedapproach to examining the issues: (i) reviewing empiricalstudies regarding tick size and decimalisation; (ii)participation in, and review of materials prepared inconnection with, discussions concerning the impact ofmarket structure on small and middle capitalisationcompanies and on IPOs as part of the SEC AdvisoryCommittee on Small and Emerging Companies; and (iii) asurvey of tick-size conventions in foreign markets.

The SEC concluded that decimalisation may have beenone of a number of factors that have influenced the IPOmarket, and that the existing literature did not isolate theeffect of decimalisation from the many other factors. TheSEC also noted that markets have evolved significantlysince decimalisation was implemented over a decade ago,and that other countries have used multiple tick sizes ratherthan the one-size-fits-all approach implemented in the US.Based on the observations reported in the study, the SECrecommends that the Commission should not proceed withspecific rulemaking to increase tick sizes, but should ratherconsider additional steps that may be needed to determinewhether rulemaking should be undertaken, which mightinclude soliciting the views of investors, companies, marketprofessionals, academics and others on the broad topic ofdecimalisation and the impact on IPOs and the markets. InMay 2015, the SEC approved a proposal by the nationalsecurities exchanges and the Financial Industry RegulatoryAuthority (Finra) for a two-year tick-size pilot program thatwill have as its objective assessing whether wider tick sizes

JOBS Act Quick Start 2018 update 21

enhance market quality for the securities of small capcompanies. The pilot programme will run for at least twoyears and will include stocks of companies with $3 billionor less in market capitalisation, an average daily tradingvolume of one million shares or less, and a volume-weighted average price of at least $2 for every trading day.

Regulation S-KOn December 23 2013, the SEC delivered to Congress thereport required by section 108 of the JOBS Act.54 The SECwas mandated to review Regulation S-K in the context ofthe new class of issuers referred to in the JOBS Act asEGCs. In connection with this review, the SEC staff choseto consider the background of the development ofdisclosure requirements and potential recommendations forrevisiting disclosure requirements in a broad manner. TheSEC staff reviewed, among other things, Regulation S-K,SEC releases and comment letters on SEC regulatoryactions pertaining to Regulation S-K. The SEC staff alsoreviewed public comments that were submitted regardingsection 108 of the JOBS Act. In light of the focus of themandate in section 108 of the JOBS Act, the SEC staff didnot review two subparts of Regulation S-K, Regulation ABand Regulation M-A.

The SEC staff noted that while the study conducted inconnection with the section 108 report serves as animportant starting point, further information gatheringand review is warranted in order to formulate specificrecommendations regarding specific disclosurerequirements. The SEC staff stated that ‘input from marketparticipants is needed to facilitate the identification of waysto update or add requirements for disclosure that is materialto an investment or voting decision, ways to streamline andsimplify disclosure requirements to reduce the costs andburdens on public companies, including emerging growthcompanies, ways to enhance the presentation andcommunication of information and to understand howtechnology can play a role in addressing any of these issues.’In addition, the SEC staff noted in the report thateconomic analysis is necessary to inform any reevaluation ofdisclosure requirements.

The SEC staff recommended the development of a planto review systematically the SEC’s disclosure requirementsfor public companies, including Regulations S-K and S-X,and the related rules concerning the presentation anddelivery of information. Among the factors that will beconsidered in the review are disclosure requirementsdeveloped through SEC interpretations, as well externalfactors that may have contributed to the length andcomplexity of filings and the costs of compliance (e.g., SECenforcement actions and judicial opinions). After

conducting this detailed review, the SEC staff would makespecific recommendations for proposed rule and formchanges.

The SEC staff has identified two alternative frameworksfor structuring such a review: a comprehensive approachand a targeted approach. The SEC staff believes that anysuch review could be more effective if it were to:• emphasise a principles-based approach as a critical aspect

of the disclosure framework;• evaluate the appropriateness of current scaled disclosure

requirements and whether further scaling would beappropriate for EGCs or other categories of issuers;

• evaluate methods of information delivery andpresentation, through both the EDGAR system andother means; and

• consider ways to present information that would improvethe readability and navigability of disclosure documents,as well as discouragement of repetition and the disclosureof immaterial information;The SEC’s Division of Corporation Finance is engaged in

its disclosure effectiveness review. As part of this review, theDivision is considering the disclosure requirements inRegulation S-K and Regulation S-X, and assessing whethersuch requirements are outdated, repetitive, or can otherwisebe revised in order to improve disclosures made by publiccompanies. In April 2016, the SEC moved forward in itsreview of Regulation S-K requirements by issuing aConcept Release requesting comment on the business andfinancial disclosures that public companies provide in theirExchange Act filings. The Concept Release did notcomment specifically on the other disclosure requirementsof Regulation S-K, such as corporate governance orcompensation-related items, or the required disclosures forforeign private issuers, business development companies orother types of registrants. During 2016, the SEC requestedcomment through four other releases.

The FAST Act included a few provisions requiring theSEC to take actions within 180 days of the statute’senactment to permit issuers to submit a summary page onForm 10-K that cross-references related disclosuresincluded throughout the form. It also required a revision ofRegulation S-K in order to further scale or eliminaterequirements to ease the burden on EGCs, acceleratedfilers, smaller reporting companies and other smallerissuers, while still providing all material information toinvestors and to eliminate provisions of Regulation S-K,required for all issuers, that are duplicative, overlapping,outdated or unnecessary, and for which the SECdetermines no further study is necessary to determine theefficacy of such revisions to Regulation S-K. The FAST Actalso requires the SEC to conduct another study (this time

22 JOBS Act Quick Start 2018 update

within 360 days of the statute’s enactment) to determinehow to best modernise and simplify Regulation S-K in amanner that reduces the costs and burdens to issuers whilestill providing all material information. In November2016, the SEC Staff released its ‘Report on Modernizationand Simplification of Regulation S-K,’ as required by theFAST Act addressing specific recommendations tomodernize and simplify the Regulation S-K requirements.In October 2017, the SEC proposed for commentamendments to Regulation S-K to implement therecommendations made in its 2016 report.

JOBS Act Quick Start 2018 update 23

24 JOBS Act Quick Start 2018 update

Appendix ADISCLOSURE AND RELATED REQUIREMENTS

Before the JOBS Act

• three years of audited financial statements;• two years of audited financial statements for

smaller reporting companies; and• selected financial data for each of five years

(or for life of issuer, if shorter) and any interimperiod included in the financial statements.

• no confidential filing for US issuers; and• confidential filing for FPIs only in specified

circumstances.

Limited ability to test the waters

• auditor attestation on effectiveness of internalcontrols over financial reporting required insecond annual report after IPO; and

• non-accelerated filers not required to comply.

Must comply with applicable new or revisedfinancial accounting standards

• must comply with executive compensationdisclosure requirements, unless a smallerreporting company (which is subject toreduced disclosure requirements); and

• upon adoption of SEC rules under Dodd-Frank will be required to calculate anddisclose the median compensation of allemployees compared to the CEO.

• must hold non-binding advisory stockholdervotes on executive compensationarrangements; and

• smaller reporting companies are exempt fromsay-on-pay.

Under the JOBS Act

• two years of audited financial statements; • certain financial statements may be omitted

from confidential submissions and filings ifthese will not be required to be included atthe time of consummation of the IPO;

• not required to present selected financialdata for any period before the earliest auditedperiod presented in connection with an IPO;and

• within one year of IPO, EGC would reportthree years of audited financial statements.

EGCs (including FPIs that are EGCs) maysubmit a draft IPO registration statement forconfidential review before public filing, providedthat such submission and any amendments arepublicly filed with the SEC not later than 15days before the EGC conducts a road show.

EGCs, either before or after filing a registrationstatement, may test the waters by engaging inoral or written communications with QIBs andinstitutional accredited investors to determineinterest in an offering.

Transition period for compliance of up to fiveyears

• not required to comply with any new orrevised financial accounting standard untilsuch standard applies to companies that arenot subject to Exchange Act public companyreporting; and

• EGCs may choose to comply with non-EGCaccounting standards but may not selectivelycomply.

• may comply with executive compensationdisclosure requirements by complying withthe reduced disclosure requirementsgenerally available to smaller reportingcompanies;

• exempt from requirement to calculate anddisclose the median compensation of allemployees compared to the CEO; and

• FPIs entitled to rely on other executivecompensation disclosure requirements.

Exempt from requirement to hold non-bindingadvisory stockholder votes on executivecompensation arrangements for one to threeyears after no longer an EGC

Financialinformation in SECfilings

Confidentialsubmissions ofdraft IPOregistrationstatement

Communicationsbefore and duringoffering process

Auditor attestationon internal controls

Accountingstandards

Executivecompensationdisclosure

Say-on-pay

JOBS Act Quick Start 2018 update 25

1 Frequently Asked Questions of General Applicabilityon Title I of the JOBS Act (April 16 2012, May 32012 and September 28 2012), available atwww.sec.gov/divisions/corpfin/guidance/cfjjobsactfaq-title-i-general.htm (SEC Title I FAQs).

2 Securities Act § 2(a)(19), 15 USC 77b(a).3 SEC Title I FAQs, supra note 1 at Question 1.4 Id.5 Id.6 SEC Title I FAQs, supra note 1 at Question 23,

referencing section 5110.2(c) of the Division ofCorporation Finance Financial Reporting Manual,available at www.sec.gov/divisions/corpfin/cffinancialreportingmanual.pdf

7 SEC Title I FAQs, supra note 1 at Question 51.8 SEC Title I FAQs, supra note 1 at Question 2.9 Id.10 SEC Title I FAQs, supra note 1 at Questions 19-21.11 SEC Title I FAQs, supra note 1 at Question 24.12 SEC Title I FAQs, supra note 1 at Question 54.13 Securities Act § 2(a)(19), 15 USC 77b(a).14 SEC Title I FAQs, supra note 1 at Question 17.15 Id.16 SEC Title I FAQs, supra note 1 at Question 18.17 SEC Title I FAQs, supra note 1 at Question 47.18 SEC Title I FAQs, supra note 1 at Question 3.19 Id.20 Section 71002 of the FAST Act, amending Section

6(e)(1) of the Securities Act.21 JOBS Act §105(c), amending Securities Act § 5, 15

USC 77e.22 Without the availability of the test-the-waters

provisions in Securities Act § 5(d), an issuer couldpotentially be deemed to be ‘gun-jumping’ whencommunicating with investors about an actual orpotential offering, based on the timing and nature ofsuch communications.

23 Frequently Asked Questions About Research Analystsand Underwriters (August 22 2012), available atwww.sec.gov/divisions/marketreg/tmjobsact-researchanalystsfaq.htm, at Question 1.

24 Sections 105(c) and 105(d) of the JOBS Act.25 Section 106(a) of the JOBS Act, amending Securities

Act section 6, 15 USC 77(f ). A foreign private issuerthat qualifies as an EGC may opt to use the Divisionof Corporation Finance’s policy titled Non-PublicSubmissions from Foreign Private Issuers if they meet

the circumstances that the Division has outlined inthat policy, available atwww.sec.gov/divisions/corpfin/internatl/nonpublicsubmissions.htm

26 For this purpose, the term road show is defined inSecurities Act Rule 433(h)(4).

27 Section 71001 of the FAST Act.28 Frequently Asked Questions on the Confidential

Submission Process for Emerging GrowthCompanies (April 10 2012), available atwww.sec.gov/divisions/corpfin/guidance/cfjumpstartfaq.htm (SEC Confidential SubmissionFAQs) at Question 5.

29 SEC FAQs, supra note 1 at Question 52.30 Id.31 SEC Confidential Submission FAQs, supra note 26,

Question 7.32 SEC Confidential Submission FAQs, supra note 26,

Question 6.33 Securities Act Rule 433(h)(4).34 SEC Confidential Submission FAQs, supra note 26,

Question 8.35 SEC Confidential Submission FAQs, supra note 26,

Question 9.36 SEC Title I FAQs, supra note 1, Question 4.37 Securities Act § 7(a)(2)(A), 15 USC 77g(a)(2)(A).38 SEC Title I FAQs, supra note 1 at Question 11. The

SEC would not object if an issuer that has lost itsEGC status does not present, in subsequently filedregistration statements and periodic reports, selectedfinancial data or a ratio of earnings to fixed chargesfor periods before the earliest audited periodpresented in its initial Securities Act or Exchange Actregistration statement. See SEC Title I FAQs, supranote 1 at Question 50.

39 SEC Title I FAQs, supra note 1 at Question 16.40 SEC Title I FAQs, supra note 1 at Question 27.41 Section 71003 of the FAST Act.42 JOBS Act §102(c).43 Exchange Act § 14A(e), 15 USC 78n-1(e).44 Id.45 See Dodd-Frank Act § 953(b)(1).46 SEC Title I FAQs, supra note 1 at Question 13.47 JOBS Act § 104, amending Sarbanes-Oxley Act §

103(a)(3).

ENDNOTES

26 JOBS Act Quick Start 2018 update

48 JOBS Act § 103, amending Sarbanes-Oxley Act §404(b).

49 JOBS Act § 107.50 SEC Title I FAQs, supra note 1 at Question 8.51 JOBS Act § 106(b).52 JOBS Act § 108.53 Report to Congress on Decimali ation (July 2012),

available atwww.sec.gov/news/studies/2012/decimali ation-072012.pdf.

54 Report on Review of Disclosure Requirements inRegulation S-K (December 2013), available atwww.sec.gov/news/studies/2013/reg-sk-disclosure-requirements-review.pdf

As we discussed in the Introduction, there areimportant considerations to be analysed inconnection with pursuing an IPO. Even givenmany changes in the capital markets, and the

improved liquidity of private or restricted securities, thereare significant advantages to be gained as a result of beinga public company. Aside from the immediate capital-raising opportunity of the IPO, which may be valuable toan issuer that cannot access private capital, going publicwill create a liquid public market for the issuer’s securities.The issuer’s security holders will have an opportunity tomonetise their investment in the company. The issuer alsowill have an acquisition currency and be able to use itsstock as consideration in a strategic transaction. After itsIPO, the issuer also will have many more capital-raisingalternatives. All of these advantages will have to be weighedcarefully against the costs of undertaking an IPO, as wellas the burdens and expense of life as a public company. Abit of this calculus has been made easier for companies thatqualify as EGCs. An EGC has the opportunity to pursuean IPO through an initial confidential submission process.Should the issuer determine that the market will not bereceptive to the offering, or that other alternatives are moreappealing, it can withdraw from the IPO process withoutthe stigma of a failed deal. In addition, an EGC maybenefit from the disclosure accommodations madeavailable by the JOBS Act. As a public company, an EGCalso will have the opportunity to ease into many corporategovernance requirements. This phase-in approach mayresult in important cost-savings for an EGC. Also, theEGC will have the benefit of getting accustomed to life asa public company and adding additional staff or retainingservice providers before it has to comply with some of themore burdensome requirements.

In addition to changing some of the dynamics thatmight figure into an issuer’s decision-making about anIPO, the JOBS Act also has changed the IPO process itselffor EGCs. Below, we discuss briefly the IPO process andhighlight a number of the most important decisions thatan EGC should consider, and conclude by discussing theopportunities for an issuer that qualifies as a foreign privateissuer (FPI), arising from the JOBS Act.

Pre-IPO planningEven though an EGC will have an opportunity to submitits IPO registration statement through the confidentialsubmission process, and proceed on a confidential basiswithout a public filing, the issuer will still have toundertake a fair bit of planning before committing toproceed with a filing.

Most companies will have to make legal and operationalchanges before proceeding with an IPO. A companycannot wait to see if its IPO is likely to be successful beforeimplementing most of these changes. Many corporategovernance matters, federal securities law requirements(including Sarbanes-Oxley), as well as applicable securitiesexchange requirements must be met when the IPOregistration statement is publicly filed, or the issuer mustcommit to satisfy them within a set time period.

A company proposing to list securities on an exchangeshould review the differing governance requirements ofeach exchange, as well as their respective financial listingrequirements, before determining which exchange tochoose. Similarly, an issuer will want to consider whetherto retain additional senior management or enter intoemployment agreements with key executive officers andsystematise its compensation practices. An issuer must alsoaddress other corporate governance matters, includingboard structure, committees and member criteria, related-party transactions, and director’s and officer’s liabilityinsurance. The company should undertake a thoroughreview of its compensation scheme for its directors andofficers as well, particularly its use of equity compensation.The issuer also will want to review all prior securitiesissuances for compliance with federal and state securitieslaws, including the limits of Rule 701.

Primary and secondary offeringsAn IPO may consist of the sale of newly issued shares bythe company (a primary offering), or a sale of alreadyissued shares owned by shareholders (a secondary offering),or a combination of these. Underwriters may prefer aprimary offering because the company will retain all of theproceeds to invest in its business. However, many IPOsinclude secondary shares, either in the initial part of theoffering or as part of the 15% over-allotment option

CHAPTER 2

The IPO process

JOBS Act Quick Start 2018 update 27

28 JOBS Act Quick Start 2018 update

granted to underwriters. Venture capital and private equityshareholders view a secondary offering as their principalrealisation event. An issuer also must consider whether anyof its shareholders have registration rights that couldrequire the issuer to register shareholder shares for sale inthe IPO.

Cheap stockCheap stock describes options granted to employees of apre-IPO company during the 18 to 24 months before theIPO where the exercise price is deemed (in hindsight) to beconsiderably lower than the fair market value of the sharesat grant date. If the SEC determines (during the commentprocess) that the company has issued cheap stock, thecompany must incur a compensation expense that willhave a negative impact on earnings. The earnings impactmay result in a significant one-time charge at the time ofthe IPO as well as going-forward expenses incurred overthe option vesting period. In addition, absent certainlimitations on exercisability, an option granted with anexercise price that is less than 100% of the fair marketvalue of the underlying stock on the grant date will subjectthe option holder to an additional 20% tax pursuant tosection 409A of the Internal Revenue Code.

The dilemma that a private company faces is that it isunable to predict with certainty the eventual IPO price. Agood-faith pre-IPO fair market value analysis can yielddifferent conclusions when compared to a fair marketvalue analysis conducted by the SEC in hindsight based ona known IPO price. There is some industry confusion as tothe acceptable method for calculating the fair market valueof non-publicly traded shares and how much deviationfrom this value is permitted by the SEC. Companies oftenaddress this cheap stock concern by retaining anindependent appraiser to value their stock options. It nowappears, however, that most companies are using one ofthe safe-harbour methods for valuing shares prescribed inthe section 409A regulations.

Governance and board membersEven with the accommodations available to an EGC, acompany still must comply with significant corporategovernance requirements imposed by the federal securitieslaws and regulations and the regulations of the applicableexchanges, including with regard to the oversightresponsibilities of the board of directors and itscommittees. A critical matter is the composition of theboard itself. All exchanges require that, except underlimited circumstances, a majority of the directors be“independent” as defined by both the federal securitieslaws and regulations and exchange regulations. In

addition, boards should include individuals withappropriate financial expertise and industry experience, aswell as an understanding of risk management issues andpublic company experience. A company should begin itssearch for suitable directors early in the IPO process evenif it will not appoint the directors until after the IPO iscompleted. The company can turn to its large investors aswell as its counsel and underwriters for referencesregarding potential directors.

The Sarbanes-Oxley and the Dodd-Frank Acts requirepublicly traded companies to implement corporategovernance policies and procedures that are intended toprovide minimum structural safeguards to investors.Certain of these requirements are phased in after the IPO.Again, quite a number of these requirements will beapplicable to an EGC and should be carefully considered.Key provisions include:• prohibition of most loans to directors and executive

officers (and equivalents thereof );• the CEO and CFO of a public company must certify

each SEC periodic report containing financialstatements;

• adoption of a code of business conduct and ethics fordirectors and senior executive officers;

• required real time reporting of certain material eventsrelating to the company’s financial condition oroperations;

• disclosure of whether the company has an auditcommittee financial expert serving on its auditcommittee;

• disclosure of material off-balance sheet arrangementsand contractual obligations;

• audit committee approval of any services provided to thecompany by its audit firm, with certain exceptions for deminimis services;

• whistleblower protections for employees who comeforward with information relating to federal securitieslaw violations;

• compensation disgorgement provisions applicable to theCEO and CFO upon a restatement of financial resultsattributable to misconduct; and

• the exchanges’ listing requirements contain relatedsubstantive corporate governance requirementsregarding independent directors; audit, nomination, andcompensation committees; and other matters.

Selecting the underwritersA company will identify one or more lead underwritersthat will be responsible for the IPO. A company generallychooses an underwriter based on its industry expertise,including the knowledge and following of its research

JOBS Act Quick Start 2018 update 29

analysts, the breadth of its distribution capacity, and itsoverall reputation. A company should consider theunderwriter’s commitment to the sector and itsdistribution strengths. For example, does the investmentbank have particularly strong research coverage. Does ithave a retail distribution network, or is it focused oninstitutional distribution? Is its strength domestic, or doesit have foreign distribution capacity? The company maywant to include a number of co-managers in order tobalance the underwriters’ respective strengths andweaknesses. In recent years, the trend has been towardincluding a significant number of co-managers andmanagers in IPOs. The number of syndicate members willdepend, to some extent, on the size of the IPO.

A company should keep in mind that underwriters haveat least two conflicting responsibilities: to sell the IPOshares on behalf of the company (and/or the sellingshareholders) and to recommend to potential investorsthat the purchase of the IPO shares is a suitable and aworthy investment. In order to better understand thecompany – and to provide a defence in case theunderwriters are sued in connection with the IPO – theunderwriters and their counsel are likely to spend asubstantial amount of time performing business, financial,and legal due diligence in connection with the IPO andmaking sure that the prospectus and any other offeringmaterials are consistent with the information provided.The underwriters will market the IPO shares, set the price(in consultation with the company) at which the shareswill be offered to the public, and, in a so-called firmcommitment underwriting, purchase the shares from thecompany and then re-sell them to investors. In order toensure an orderly market for the IPO shares, after theshares are priced and sold, the underwriters are permittedin many circumstances to engage in certain stabilisingtransactions to support the stock.

The IPO process The public offering process is divided into three periods:• the pre-filing period between determining to proceed

with a public offering and the actual SEC filing of theregistration statement; the company is in the quietperiod and subject to potential limits on publicdisclosure relating to the offering;

• the waiting or pre-effective period between the SECfiling date and the effective date of the registrationstatement; during this period, the company may makeoral offers, but may not enter into binding agreementsto sell the offered security; and

• the post-effective period between effectiveness andcompletion of the offering.

The registration statementA registration statement contains the prospectus, which isthe primary selling document, as well as other requiredinformation, written undertakings of the issuer and thesignatures of the issuer and the majority of the issuer’sdirectors. It also contains exhibits, including basiccorporate documents and material contracts. UScompanies generally file a registration statement on FormS-1. Most non-Canadian foreign private issuers use aregistration statement on Form F-1, although other formsmay be available. There are special forms available tocertain Canadian companies.

The prospectusThe prospectus describes the offering terms, theanticipated use of proceeds, the company, its industry,business, management and ownership, and its results ofoperations and financial condition. Although it isprincipally a disclosure document, the prospectus also iscrucial to the selling process. A good prospectus sets forththe investment proposition.

As a disclosure document, the prospectus functions as aninsurance policy of sorts in that it is intended to limit theissuer’s and underwriters’ potential liability to IPOpurchasers. If the prospectus contains all SEC-requiredinformation, includes robust risk factors that explain therisks that the company faces, and has no materialmisstatements or omissions, investors will not be able torecover their losses in a lawsuit if the price of the stockdrops following the IPO. A prospectus should not includepuffery or overly optimistic or unsupported statementsabout the company’s future performance. Rather, it shouldcontain a balanced discussion of the company’s business,along with a detailed discussion of risks and operating andfinancial trends that may affect its results of operations andprospects.

SEC rules set forth a substantial number of specificdisclosures required to be made in the prospectus. Inaddition, federal securities laws, particularly Rule 10b-5under the Exchange Act, require that documents used tosell a security contain all the information material to aninvestment decision and do not omit any informationnecessary to avoid misleading potential investors. Federalsecurities laws do not define materiality; the basic standardfor determining whether information is material iswhether a reasonable investor would consider theparticular information important in making an investmentdecision. That simple statement is often difficult to applyin practice.

An issuer should be prepared for the time-consumingdrafting process, during which the issuer, underwriters,

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and their respective counsel work together to craft theprospectus disclosure.

Financial informationThe IPO registration statement for an EGC must includeaudited financial statements for the last two fiscal years;financial statements for the most recent fiscal interimperiod, comparative with interim financial information forthe corresponding prior fiscal period (may or may not beaudited depending on the circumstances); and incomestatement and condensed balance sheet information forthe last two years and interim periods presented.

Early on, the issuer should identify any problemsassociated with providing the required financial statementsin order to seek necessary accommodation from the SEC.These statements must be prepared in accordance with USGAAP or International Financial Reporting Standards(IFRS) as adopted by the International AccountingStandards Board (IASB), as they will be the source ofinformation for Management’s Discussion and Analysis ofFinancial Condition and Results of Operations (MD&A).The SEC will review and comment on the financialstatements and the MD&A. The SEC’s areas of particularconcern include: revenue recognition; businesscombinations; segment reporting; financial instruments;impairments of all kinds; deferred tax valuationallowances; compliance with debt covenants; fair value;and loan losses.

The pre-filing periodThe pre-filing period begins when the company and theunderwriters agree to proceed with a public offering.During this period, key management personnel willgenerally make a series of presentations covering thecompany’s business and industry, market opportunities,and financial matters. The underwriters will use thesepresentations as an opportunity to ask questions andestablish a basis for their due diligence defence.

From the first all-hands meeting forward, all statementsconcerning the company should be reviewed by thecompany’s counsel to ensure compliance with applicablerules. Communications by an issuer more than 30 daysbefore filing a registration statement are permitted as longas they do not reference the securities offering. Statementsmade within 30 days of filing a registration statement thatcould be considered an attempt to pre-sell the publicoffering may be considered an illegal prospectus, creating agun-jumping violation. This might result in the SEC’sdelaying the public offering or requiring prospectusdisclosures of these potential securities law violations. Pressinterviews, participation in investment banker-sponsored

conferences, and new advertising campaigns are generallydiscouraged during this period.

In general, at least four to six weeks will pass between thedistribution of a first draft of the registration statementand its filing with the SEC. To a large extent, the length ofthe pre-filing period will be determined by the amount oftime required to obtain the required financial statements.

The waiting periodResponding to SEC comments on the registration statementThe SEC targets 30 calendar days from the registrationstatement filing date to respond with comments. The SECreview process has not changed much as a result of theJOBS Act, although the issuer should anticipate that it willreceive comments from the SEC staff regarding its EGC-related disclosures. Once the registration statement issubmitted, a team of SEC staff members is assigned toreview the filing. The team consists of accountants andlawyers, including examiners and supervisors. The SEC’sobjective is to assess the company’s compliance with itsregistration and disclosure rules.

It is not unusual for the first SEC comment letter tocontain a significant number of comments to which theissuer must respond both in a letter and by amending theregistration statement. However, in recent years, there hasbeen a general decline in the number of comments issuedby the SEC staff, resulting in a shorter review process.

The SEC’s principal focus during the review process ison disclosure. In addition to assessing compliance withapplicable requirements, the SEC considers the disclosuresthrough the eyes of an investor in order to determine thetype of information that would be considered material.The SEC’s review is not limited to the registrationstatement. The staff will closely review websites, databases,and magazine and newspaper articles, looking in particularfor information that the staff thinks should be in theprospectus or that contradicts information included in theprospectus.

It is easy to anticipate many of the matters that the SECwill raise during the comment process. The SEC makes thecomment letters and responses from prior reviews availableon its website, so it is possible to determine the mosttypical comments arising during the IPO process forsimilarly-situated companies. Overall, the SEC staff looksfor a balanced, clear presentation of the informationrequired in the registration statement. Some of the mostfrequent comments raised by the SEC staff on disclosure,other than the financial statements, include:

Front cover and gatefold: Has the EGC includeddisclosure on the front cover identifying itself as an EGC?Given that a number of issuers that are EGCs have

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completed their IPOs, an EGC pursuing an IPO mayreview its filings and see the type of language that the SECstaff expects to see on the cover page. For an issuer thatchooses to use artwork, the SEC staff will consider whetherthe artwork presents a balanced presentation of thecompany’s business, products, or customers.

Prospectus summary: Is the presentation balanced?Again, in the summary section, the SEC staff will expect tosee a brief discussion that identifies that the issuer is anEGC and is electing to rely on certain accommodationsavailable to EGCs.

Risk factors: Are the risks specific to the company anddevoid of mitigating language? The SEC also will expect tosee certain risk factors relating to the issuer’s status as anEGC.

Use of proceeds: Is there a specific allocation of theproceeds among identified uses and, if funding acquisitionsis a designated use, are acquisition plans identified?

Selected financial data: Does the presentation of non-GAAP financial measures comply with SEC rules?

MD&A: Does the discussion address known trends,events, commitments, demands, or uncertainties,including the impact of the economy, trends with respectto liquidity, and critical accounting estimates and policies?

Business: Does the company provide support forstatements about market position and other industry orcomparative data? Is the disclosure free of, or does itexplain, business jargon? Are the relationships withcustomers and suppliers, including concentration risk,clearly described?

Underwriting: Is there sufficient disclosure aboutstabilisation activities (including naked short selling), aswell as factors considered in early termination of lockupsand any material relationships with the underwriters?

Exhibits: Do any other contracts need to be filed basedon disclosure in the prospectus?

After the SEC has provided its initial set of comments,it is much easier to determine when the registrationprocess is likely to be completed and the offering can bemade. In most cases, the underwriters prefer to delay theoffering process and to avoid distributing a preliminaryprospectus until the SEC has reviewed at least the firstfiling and all material changes suggested by the SEC staffhave been addressed by the Company and its counsel in aresponsive amendment.

Preparing the underwriting agreement, comfort letter andother documentsDuring the waiting period, the company, the underwritersand their counsel, and the company’s independent auditorwill negotiate a number of agreements and other

documents, particularly the underwriting agreement andthe auditor’s comfort letter.

The underwriting agreement is the agreement pursuantto which the company agrees to sell, and the underwritersagree to buy, the shares and then sell them to the public;until this agreement is signed, the underwriters do nothave an enforceable obligation to purchase the offeredshares. The underwriting agreement is not signed until theoffering is priced. In the typical IPO, the underwriters willhave a ‘firm commitment’ to buy the shares once they signthe underwriting agreement.

Underwriters’ counsel will submit the underwritingagreement, the registration statement, and other offeringdocuments for review to Finra, which is responsible forreviewing the terms of the offering to ensure that theycomply with Finra requirements. An IPO cannot proceeduntil the underwriting arrangement terms have beenapproved by Finra.

In the comfort letter, the auditor affirms itsindependence from the issuer and the compliance of thefinancial statements with applicable accountingrequirements and SEC regulations. The auditor also willnote period-to-period changes in certain financial items.These statements follow prescribed forms and are usuallynot the subject of significant negotiation. Theunderwriters will also usually require that the auditorundertake certain agreed-upon procedures in which itcompares financial information in the prospectus (outsideof the financial statements) to the issuer’s accountingrecords to confirm its accuracy.

Marketing the offeringDuring the waiting period, marketing begins. Before theJOBS Act, it was the case that the only written salesmaterials that could be distributed during this period werethe preliminary prospectus and additional materials knownas free writing prospectuses, which must satisfy specifiedSEC requirements. Binding commitments cannot be madeduring this period. The underwriters will receive indicationsof interest from potential purchasers, indicating the pricethey would be willing to pay and the number of shares theywould purchase. Once SEC comments are resolved, or it isclear that there are no material open issues, the issuer andunderwriters will undertake a two- to three-week road show,during which company management will meet withprospective investors.

Once SEC comments are cleared and the underwritershave assembled indications of interest for the offeredsecurities, the company and its counsel will request thatthe SEC declare the registration statement effective at acertain date and time, usually after the close of business of

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the US securities markets on the date scheduled for pricingthe offering.

The post-effective periodOnce the registration statement has been declared effectiveand the offering has been priced, the issuer and themanaging underwriters execute the underwritingagreement, and the auditor delivers the final comfort letter.This occurs after pricing and before the opening of tradingon the following day. The issuer then files a finalprospectus with the SEC that contains the final offeringinformation.

On the second or third business day following pricing,the closing occurs, the shares are issued, and the issuerreceives the proceeds. The closing completes the offeringprocess. Then, for the following 25 days, aftermarket salesof shares by dealers must be accompanied by the finalprospectus or a notice with respect to its availability. Ifduring this period there is a material change that wouldmake the prospectus misleading, the issuer must file anamended prospectus.

SPECIAL JOBS ACT-RELATEDCONSIDERATIONS

Confidential submissionsAs explained in Chapter 1, an EGC may make aconfidential submission of its registration statement,provided that the initial confidential submission and allamendments are publicly filed with the SEC no later than15 days before the commencement of the issuer’s roadshow.

Although an EGC may submit confidentially, and aconfidentially-submitted draft registration statement is notrequired to be signed by the issuer and its officers ordirectors, nor is it required to contain a signed auditors’consent, the confidential submission should be a completeregistration statement. The SEC may decide not to reviewa draft submission that is deemed incomplete or materiallydeficient. This will just slow down the IPO process.Moreover, the issuer and its advisers should understand, asnoted above, that the initial confidential submission willbecome publicly available. As a result, the issuer, itsadvisers and the entire working group should approach thepreparation of a confidential submission with the samerigour as they would approach the preparation of aregistration statement that will be publicly filed andavailable to all, including the issuer’s competitors.

There are few, if any, disadvantages to the confidentialsubmission process. An issuer will be able to make aconfidential submission and proceed with the review

process without the glare of publicity, and without havingcompetitors become aware of the proposed offering. Theissuer will have greater flexibility to control the timing ofthe offering. If the market seems inhospitable to anoffering, the issuer may decide to delay the process and willnot subject itself to public scrutiny for doing so. If theissuer needs to withdraw the filing, again, it will be able todo so without the stigma associated with a failed orwithdrawn offering.

An issuer and its bankers and advisers may not, however,have as much insight into the IPO market given theconfidential filing process. For example, bankers may notbe aware of competitors (that are EGCs) that also arepursuing IPOs because the competitors also may beproceeding with their offerings on a confidential basis.Often having information about other companies in theIPO queue may be important because it may factor intodecisions on timing of marketing the deal, as well asdecisions regarding valuation.

Often an issuer will decide to pursue a dual-trackapproach, whereby it will decide to undertake an IPO andalso consider M&A alternatives. The IPO filings oftenserve to make acquisitive competitors that may beinterested in new opportunities aware of the issuer and theissuer’s performance. It may be more difficult to pursue adual-track strategy during the confidential submissionprocess. Of course, an issuer that is relying on theconfidential submission process may choose to make anannouncement regarding its intentions to pursue an IPO,and a few companies have issued such press releases. Sincethe confidentiality obligation rests with the SEC, and notwith the issuer, a press release of this sort is permissible,although it should be considered carefully given that itundoes many of the benefits associated with theconfidential process.

Marketing the offeringSection 5(c) of the Securities Act prohibits offers of asecurity before a registration statement is filed. While gun-jumping can be a serious concern, the 2005 safe harbourscreated by Securities Offering Reform have providedconsiderable guidance to companies about this issue.Further, the ability of EGCs to test-the-waters beforefiling, together with the elimination of the ban on generalsolicitation in connection with certain private placementsalso effected by the JOBS Act, have also significantlyreduced concerns about gun-jumping. In addition, theconfidential submission of a draft registration does notconstitute the filing of a registration statement for thepurposes of the prohibition in Securities Act section 5(c)against making offers of a security in advance of filing a

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registration statement.1

Section 5(b)(1) prohibits written offers other than bymeans of a prospectus that meets the requirements ofsection 10 of the Securities Act, such as a preliminaryprospectus. The bans are designed to prohibitinappropriate marketing, conditioning or hyping of thesecurity before all investors have access to publicly availableinformation about the company so that they can makeinformed investment decisions. From the first all-handsorganisational meeting forward, all statements concerningthe company should be reviewed by the company’s counselto ensure compliance with applicable rules.

Testing the watersThe JOBS Act provides an EGC or any other person, suchas its underwriter, that it authorises to act on its behalfwith the flexibility to engage in oral or writtencommunications with QIBs and institutional accreditedinvestors in order to gauge their interest in a proposedoffering, whether before (irrespective of the 30-daycommunications safe harbour) or following the first filingof any registration statement, subject to the requirementthat no security may be sold unless accompanied orpreceded by a section 10(a) prospectus.

An EGC may use the testing-the-waters provision withrespect to any registered offerings that it conducts while itqualifies for EGC status. There are no form or contentrestrictions on these communications, and there is norequirement to file written communications with the SEC.The SEC staff will ask to see any written test-the-watersmaterials during the course of the registration statementreview process to determine whether those materialsprovide any guidance as to information that the SEC staffbelieves should be included in the prospectus.

The JOBS Act does not amend section 5(b)(1) of theSecurities Act, which requires that written offers mustinclude the information required by section 10. Therefore,in order to make written offers, an EGC or a foreignprivate issuer must first file (not just submit) itsregistration statement with the SEC and have apreliminary prospectus available, irrespective of theexpected commencement of the road show. In the pre-filing period, test-the-waters communications must belimited to QIBs and institutional investors, since even anEGC cannot make offers to the public until it files theregistration statement publicly.

Before engaging in any test-the-waters discussions, anEGC should consult with its counsel and coordinateclosely with the underwriter. As noted above, during thecomment process, the SEC staff will ask whether the issuerengaged in testing the waters, and will want to see any

written materials used for this purpose. In addition, as wediscuss below, issuer’s counsel and the underwriter and itscounsel will want an opportunity to review and commenton the material. Any written materials used for thispurpose should be consistent with the informationincluded in the issuer’s registration statement. An issueralso will want to be certain that the issuer is not sharingany information that may be deemed confidential in thecourse of these discussions. An investor approached duringthis phase generally will not want to be in possession of anyinformation that will remain confidential, and that may bematerial, even following the issuer’s IPO. In addition, asdiscussed further below, an issuer will be required to makecertain representations and warranties to the underwritersin the underwriting agreement relating to any test-the-waters activities and materials.

Many companies contemplating an IPO in the US,especially foreign private issuers, were surprised by therestrictions on offering related communications imposedby SEC regulations. Critics noted that thesecommunications restrictions limited an issuer’sopportunity to reach potential investors early in theprocess and, therefore, an issuer was forced to incursignificant expense in pursuing an IPO and might not haveany information about the level of investor interest andpotential valuations until the road show. In otherjurisdictions, especially in Europe and Asia, issuers and thefinancial intermediaries acting on their behalf haveconsiderably more flexibility. Often in European or Asianofferings, a lead or cornerstone investor might be securedearly in the offering process. As a result of these concerns,the ability to conduct test-the-waters communications waswell received. To the extent that EGCs are benefiting fromthe enhanced flexibility, more often than not, the test-the-waters conversations are taking place shortly before thecommencement of the road show, and not early in theoffering process.

It is also important to remember that the test-the-watersflexibility still is more limited than the approach that maybe familiar to foreign private issuers. As noted in Chapter1, during the test-the-waters phase an EGC may engage indiscussions with institutional investors but the EGC andthe underwriter cannot obtain a purchase commitment.The underwriter may discuss price, volume and marketdemand and solicit non-binding indications of interestfrom customers.

Private offerings during the IPO processAn issuer may need to raise capital while it is pursuing anIPO. Historically, there was some concern aboutundertaking concurrent offerings. An issuer that had

34 JOBS Act Quick Start 2018 update

publicly filed a registration statement had to considercarefully with its counsel whether the public filingconstituted a general solicitation that precluded the issuerfrom availing itself of the private placement exemption tocomplete a financing during the pendency of its IPO. Forsome time, practitioners relied on existing no-action letterguidance that was somewhat narrowly construed aspermitting a concurrent private placement to QIBs and toa handful of institutional accredited investors.2 This fairlylimited approach was modified over time and a moreexpansive view was expressed by the SEC first in 2007 andconfirmed in a Compliance and Disclosure Interpretation.3

The C&DI, confirming the guidance in the SEC’s 2007release, provides that:

‘Under appropriate circumstances, there can be a side-by-side private offering under Securities Act section[4(a)(2)] or the Securities Act Rule 506 safe harbor witha registered public offering without having to limit theprivate offering to qualified institutional buyers and twoor three additional large institutional accreditedinvestors, as under the Black Box (June 26, 1990) andSquadron, Ellenoff (Feb. 28, 1992) no-action lettersissued by the Division, or to a company’s key officers anddirectors, as under our so-called “Macy’s” position.4’

The SEC also clarified that a company can make a validprivate placement if the investors are identified by meansother than the registration statement.

Given this viewpoint, and even without considering therelaxation of the prohibition on general solicitation inrespect of certain Rule 506 offerings, it is clear that anEGC could either during the confidential phase or afterthe public filing of its registration statement contactinstitutional investors and discuss a potential privatefinancing. It is easy to envision that a test-the-watersconversation may morph into a discussion with aninstitutional investor about a potential private placement.An EGC should take care to be clear in its conversationswith potential investors, and ensure that any potentialinvestors understand whether they are participating in aprivate placement transaction, and purchasing securitiesthat will be restricted securities, and not expressing aninterest in participating in the IPO.

The JOBS Act has contributed to a further blurring ofthe lines between private placements and public offeringsgiven the relaxation of the prohibition against generalsolicitation and the introduction of exemptions for certainlimited offerings pursuant to Regulation A andcrowdfunding.

Flipping from confidential to publicIn a typical IPO, the issuer will continue to work with itscounsel during the waiting period in order to address theSEC staff ’s comments on its filing, and also concurrentlywork on finalising various ancillary agreements, includingthe underwriting agreement and lock-up agreements. Theunderwriter and its counsel usually recommend that anissuer wait to finalise, and print a preliminary prospectusor red herring until the issuer and its counsel haveresponded to and addressed all of the significant commentsraised by the SEC staff during the review process. Thisensures that the issuer will not have to recirculate itspreliminary prospectus as a result of any change arisingduring the review process. The underwriter will wait tocommence the road show until the preliminary prospectusis prepared.

In the case of an EGC IPO, there may be an additionaldynamic to be considered. An EGC that is relying on theconfidential submission process may want to considerwhen to make its first ‘public’ filing. As discussed inChapter 1, and above, an EGC is required to file publiclywith the SEC at least 15 days before the commencementof the issuer’s road show. The EGC may want to make apublic filing before that for a variety of reasons, however.The EGC may want to file publicly earlier in the process,perhaps after it has undergone one or two amendments, inorder to have it known to competitors or to strategicinvestors that the company is proceeding with an IPO andto make the registration statement available freely. Thismay be helpful if the issuer is contemplating a dual-trackapproach. It may be helpful in order to permit theunderwriter to interest institutional investors inpreliminary test-the-waters type discussions. Someinstitutional investors may be reluctant to commit the timeand resources to meeting with a company or evaluating apotential investment if they believe that the offering is in avery preliminary stage. An EGC will want to consult withcounsel and consider carefully its decision to transitionfrom a confidential process to a public process.

Disclosures and other accommodationsWe noted that one of the principal benefits of the IPO on-ramp approach is that an EGC may choose to rely on someof the disclosure accommodations made available by TitleI of the JOBS Act. An EGC may choose to present onlytwo years of audited financial information (and only twoyears of summary and selected financial data, as well as anabbreviated MD&A discussion) in its registrationstatement. An EGC and its counsel will want to considerwhether the EGC will want to present information for athird year although it is not required. In some cases, the

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underwriter will have strong views regarding theinformation that should be presented in the registrationstatement. For example, the underwriter may take the viewthat the issuer’s competitors that are already SEC-reportingcompanies provide financial information for a longerperiod and it will be important to investors that the EGCprovide comparable information. The underwriter maybelieve that institutional investors in that industry sectormay demand three years of financial information. It maybe the case that there are important trends in either theissuer’s business and results of operations or in the industryas a whole that make it important to present three years ofinformation in order to ensure that an investor will be ableto evaluate all of the information that may be deemedmaterial to an investment decision, including, perhaps,trends in the issuer’s business or in the industry.

EGCs also have the option of relying on the smallerreporting company scaled disclosure requirements forexecutive compensation. This means, for example, that anEGC could omit a Compensation Discussion and Analysissection and present only a summary compensation table.An EGC may decide to include more substantial executivecompensation disclosures in its future filings. An EGCshould consult with its counsel, as well as with theunderwriter, regarding these disclosures.

An EGC also will have to decide whether it will opt outof the extended transition period provided for an EGC tocomply with new or revised accounting standards. AnEGC’s decision in this regard is irrevocable and will haveto be disclosed in its registration statement. Here, again,the issuer will want to consider this decision carefully anddiscuss it with its counsel and its auditors. The underwritermay also have a view.

Underwriting agreementsUnderwriting agreements have been revised to addressJOBS Act changes. An underwriting agreement for anEGC will contain representations and warranties by theEGC regarding its status as an EGC at each of the relevanttimes (when it made its confidential submission with theSEC, when it undertook any test-the-waterscommunications, on the date of execution of theunderwriting agreement, and so on). The EGC will beasked to represent that it has not engaged in any test-the-waters communications other than with QIBs orinstitutional accredited investors, and except as agreedwith the underwriters. To the extent that it has distributedwritten test-the-waters materials, the EGC will be asked tomake certain representations regarding the accuracy ofthose materials. Similarly, the EGC will be asked to makecertain covenants to the underwriters, which will include

an agreement to notify the underwriters if, at any timebefore the later of the time when a prospectus is requiredto be delivered in connection with the offering, and thecompletion of the lock-up period, the issuer no longerqualifies as an EGC. In addition, the lock-up languageapplicable to an EGC also will be revised to account forthe quiet period changes included in the JOBS Act.

FOREIGN PRIVATE ISSUERSOur discussions have focused on US domestic issuers;however, foreign issuers that are considering accessing theUS capital markets will have available to them almost all ofthe benefits of the JOBS Act. A foreign issuer must choosebetween undertaking a public offering in the US, whichwould have the result of subjecting the issuer to ongoingsecurities reporting and disclosure requirements, andundertaking a limited offering that will not subject theissuer to US reporting obligations. A public offering in theUS offers distinct advantages for foreign issuers. The USpublic markets remain among the most active and deepestequity markets in the world. In recent years, however,many foreign issuers may have been discouraged by theregulatory burdens associated with being a US reportingcompany, including those imposed by the Sarbanes-Oxleyand the Dodd-Frank Acts. For foreign issuers that qualifyas EGCs, the IPO on-ramp process has made the US morehospitable.5

An FPI is any issuer (other than a foreign government)incorporated or organised under the laws of a jurisdictionoutside of the US, unless more than 50% of the issuer’soutstanding voting securities are held directly or indirectlyby residents of the US, and any of the following applies: (i)the majority of the issuer’s executive offices or directors areUS citizens or residents; (ii) the majority of the issuer’sassets are located in the US; or (iii) the issuer’s business isprincipally administered in the US.5 An FPI may becomesubject to US securities law reporting requirements eitherby conducting a public offering in the US by registeringthe offering and sale of its securities pursuant to theSecurities Act, or by listing a class of its securities on a USnational securities exchange through registration pursuantto the Exchange Act or becoming subject to the ExchangeAct requirements if a class of its equity securities is held ofrecord by 2,000 or more persons or 500 non-accreditedinvestors.

Important benefits are available to FPIs. For example, anFPI may exit or deregister its securities more easily than adomestic US issuer. An FPI must test its qualification onlyonce a year, and, should it fail to qualify as an FPI, it hassix months to transition to the US domestic reportingsystem. US domestic issuers generally must file their

36 JOBS Act Quick Start 2018 update

annual reports on Form 10-K within three monthsfollowing the end of their fiscal year. By contrast, an FPImust file its annual report on Form 20-F within fourmonths of the fiscal year covered by the report. This allowsan FPI slightly more time to prepare the requiredinformation. An FPI has no legal obligation to filequarterly reports. By contrast, US domestic issuers mustfile a quarterly report on Form 10-Q. Unlike a USdomestic issuer, an FPI has no legal obligation to file proxysolicitation materials on Schedule 14A or 14C inconnection with annual or special meetings of its securityholders. An FPI has no legal obligation to establish anaudit committee. The securities exchanges generallyprovide alternative corporate governance requirements forlisted FPIs, which are less burdensome than those for listedUS domestic issuers. An FPI is exempt from the SEC’sdisclosure rules for executive compensation on anindividual basis, but is required to provide certaininformation on an aggregate basis. An FPI may prepare itsfinancial statements in accordance with IFRS as issued bythe IASB without reconciliation to US GAAP.

An FPI may submit its initial registration statement ona confidential basis to the SEC staff if it is listed or isconcurrently listing its securities on a non-US securitiesexchange, it is being privatised by a foreign government, orit can demonstrate that the public filing of the initialregistration statement would conflict with the law of anapplicable foreign jurisdiction. An FPI may separately usethe confidential registration statement review proceduresavailable to an EGC, if it qualifies as an EGC. An FPI canqualify to be treated as an EGC if it has total grossrevenues of under $1 billion during its most recentlycompleted fiscal year. Total annual gross revenues meanstotal revenues as presented on the income statement underUS GAAP or IFRS as issued by the IASB, if used as thebasis of reporting by an FPI. If the financial statements ofan FPI are presented in a currency other than US dollars,total annual gross revenues for purposes of determiningwhether an FPI is an EGC should be calculated in USdollars using the exchange rate as of the last day of themost recently completed fiscal year.

An FPI seeking to raise capital by selling securities (orADRs) in the US must file a registration statement onForm F-1 with the SEC. The registration statement onForm F-1 requires significant disclosure about the foreignissuer’s business and operations, and is similar to, but lessonerous than, the Form S-1 that most US issuers use fortheir IPOs. The SEC staff has made clear that an FPI thatqualifies as an EGC and that is using a Form F-1 may availitself of all of the disclosure accommodations available todomestic EGCs. An FPI that is an EGC also may avail

itself of all other benefits available to domestic EGCs,including the governance related accommodations, theability to test-the-waters, and the flexibility to have broker-dealers publish or distribute research reports about thecompany.

A foreign issuer also may decide to access the US capitalmarkets through an exempt offering, such as an offering toQIBs or an offering made in reliance on section 4(a)(2) orRule 506. Once the SEC rulemaking relating to therelaxation of the prohibition on general solicitation isfinalised, foreign issuers will be able to benefit from greatercommunications flexibility in connection with Rule 506and Rule 144A offerings.

MARKET TRENDS RELATING TO JOBSACT ACCOMMODATIONSSince the JOBS Act took effect on April 5 2012, there havebeen a number of trends in the IPO market. Companieselecting EGC status come from many industries, althoughthe largest groups of EGC IPO issuers are from thebiotech/pharmaceuticals, technology, real estate, andhealthcare industries. FPIs also are taking advantage ofTitle I (approximately 26% of all EGC issuers in 2016 andapproximately 27% of all EGC issuers in 2017). Standarddisclosure has been developed by the IPO marketregarding the election of EGC status and the chosen IPOon-ramp accommodations. In addition, there have been anumber of trends with respect to the IPO on-rampaccommodations chosen by EGC issuers, which wedescribe below.

Confidential submissionsAn EGC may submit its IPO registration statementconfidentially in draft form for SEC staff review, providedthat the initial confidential submission and allamendments are publicly filed with the SEC within 15days prior to the commencement of the EGC’s roadshow.The confidential submission process permits an EGC tocommence the SEC review process without publiclydisclosing sensitive strategic, proprietary, and financialinformation. In addition, in the case of adverse marketconditions, weak investor demand in response to testing-the-waters communications, or regulatory concerns, anEGC may withdraw its draft registration statement andterminate the IPO process without ever making a publicfiling, thus removing a potential disincentive tocommencing an IPO and permitting the immediatepursuit of a private placement or an M&A transactioninstead.

The confidential submission process has beenparticularly popular among EGCs and has gained market

JOBS Act Quick Start 2018 update 37

acceptance. The vast majority of EGCs that priced an IPOsince the JOBS Act took effect (well over 95%) haveconfidentially submitted at least one draft registrationstatement prior to publicly filing and the majority ofEGCs have submitted at least two draft registrationstatements prior to making their first public filing. Muchof the discussion related to the confidential submissionprocess has been focused on the timing of moving from theconfidential submission to the first public filing, which isoften based on having the 15-day period run in order tomeet the IPO roadshow schedule and the desire to pursuea dual-track IPO and M&A strategy.

The confidential submission process appears thus far tobe used primarily to keep the IPO process secret fromcompetitors and the market without having to disclosesensitive strategic, proprietary, and financial information.However, not all EGCs have availed themselves of theconfidential submission process. Some EGCs have forgonethe process based on the belief that a public filing helpsattract bidders in the case of a dual-track IPO and M&Astrategy. However, a small number of EGCs engaged in adual-track IPO and M&A strategy have, for strategicreasons, used the confidential submission process andpublicly announced the confidential submission in aSecurities Act Rule 135 compliant press release (in order toavoid gun-jumping).

Testing-the-waters communications andresearch coverageTesting-the-waters communications and research practicescontinue to evolve. The decision whether, when, and howto use testing-the-waters communications is being madeon a case-by-case basis by EGC issuers and theirunderwriters. When testing-the-waters communicationshave been used, they have been used mainly for ‘meet themanagement’ presentations. With respect to researchpractices, although analysts employed by participatingbroker-dealers may publish research on EGCs earlier thancurrently allowed for non-EGCs, robust pre-deal researchin connection with EGC IPOs has not emerged. In fact,most offering participants have been voluntarily restrictingresearch publication for an agreed period following EGCIPOs (typically 25 days).

Reduced financial statements and selectedfinancial dataTaking advantage of the scaled financial disclosures hasgained some market acceptance, with more than half of allEGCs electing to provide only two years of auditedfinancial statements rather than three years. The decisionto take advantage of the scaled financial disclosures though

is being made on a case-by-case basis, depending onwhether the extra year of financial statements is needed tounderstand the EGC’s story (less important in the case ofa biotechnology or development stage company) or showinvestors the EGC’s longer-term trends and historicalgrowth trajectory (more important for a company with anoperating history).

Extended transition for new or revised GAAPaccounting pronouncementsEGCs are not required to comply with new or revisedGAAP accounting pronouncements until thosepronouncements apply to private companies, giving EGCsa longer transition than public companies in situationswhere a different effective date exists for a GAAPaccounting pronouncement specified for privatecompanies. However, a significant majority of EGCs havenot taken advantage of this extended transition period forcompliance with new or revised GAAP accountingpronouncements because it might create an unfavourablecomparison with competitors, and the EGC’s IPOregistration statement must still satisfy the relevantRegulation S-X requirements.

Scaled executive compensation disclosuresEGCs are permitted to provide scaled executivecompensation disclosure under the requirements generallyavailable to smaller reporting companies. As a result, anEGC may: (1) omit the detailed Compensation Discussionand Analysis (CD&A); (2) provide compensationdisclosure covering the top three (including the CEO),rather than the top five, executive officers for a period oftwo years as compared to three years; and (3) omit four ofthe six executive compensation tables required for largercompanies. Over 70% of EGC IPO issuers from 2012through June 2017 that otherwise would have beenrequired to include traditional executive compensationdisclosures (ie issuers other than FPIs, externally managedReits, commodity pools, etc) elected to take advantage ofthe reduced disclosure, with many omitting the CD&Asection and including only a Summary CompensationTable and Outstanding Equity Awards Table coveringthree rather than five named executive officers and limitingthe tabular disclosures to two years.

Exemption from auditor attestation report EGCs are exempt from the requirements under Sarbanes-Oxley section 404(b) to have an auditor attest to thequality and reliability of the company’s internal controlover financial reporting, and the exemption remains validfor so long as the company retains its EGC status. In

38 JOBS Act Quick Start 2018 update

contrast, all other newly public companies, regardless ofsize, generally have until their second annual report toprovide the auditor attestation report, and smaller publiccompanies (generally those with a public float of less than$75 million) are permanently exempted. Almost all EGCshave indicated that they intend to take advantage of (orreserve the right to do so in the future) the exemption fromproviding the auditor attestation report under Sarbanes-Oxley section 404(b).

JOBS Act Quick Start 2018 update 39

1 SEC Confidential Submission FAQs, supra note 26,Question 6.

2 See, eg, Division of Corporation Finance no-actionletters to Black Box Incorporated (June 26 1990)and Squadron Ellenoff, Pleasant & Lehrer (February28 1992).

3 The SEC’s integration guidance can be found in theRegulation D Proposing Release, Revisions ofLimited Offering Exemptions in Regulation D, 33-8828 (August 3 2007), available atwww.sec.gov/rules/proposed/2007/33-8828.pdf atpp. 52-56. See also the SEC Staff ’s Compliance andDisclosure Interpretations – Securities Act Sections(last updated November 26 2008), Question 139.25.

4 See, eg, C&DI – Securities Act Sections, Question139.25.

5 Rule 3b-4(c) of the Securities Exchange Act of 1934,as amended [hereinafter Exchange Act]. An FPI ispermitted to assess its status as an FPI once a year onthe last business day of its second fiscal quarter,rather than on a continuous basis, and may availitself of the FPI accommodations, including use ofthe FPI forms and reporting requirements, beginningon the determination date on which it establishes itseligibility as an FPI. If an FPI determines that it nolonger qualifies as an FPI, it must comply with thereporting requirements and use the forms prescribedby US domestic companies beginning on the firstday of the fiscal year following the determinationdate. SEC Release No. 33-8959. Note that if an FPIloses its status as an FPI it will be subject to thereporting requirements for a US domestic issuer, andwhile previous SEC filings do not have to beamended upon the loss of such status, all futurefilings would be required to comply with therequirements for a US domestic issuer. FinancialReporting Manual, Division of Corporation Finance,Topic 6120.2, available atwww.sec.gov/divisions/corpfin/cffinancialreportingmanual.shtml. Also note that ifan FPI is reincorporated as a US entity, a registrationstatement on a domestic form (Form S-4) will berequired for the exchange of shares with the new USdomestic issuer. Id. at Topic 6120.8.

ENDNOTES

40 JOBS Act Quick Start 2018 update

While Title I of the JOBS Act is largelyfocused on capital raising transactions,there is nothing in the JOBS Act or in theSEC’s interpretations to suggest that the

IPO on-ramp provisions in Title I should not also apply inthe context of other transactions conducted by EGCspursuant to a Securities Act registration statement. TheSEC’s Division of Corporation Finance has providedguidance in the form of frequently asked questionsindicating that EGCs may rely on certain of the disclosure,communications and confidential submission benefits forEGCs in the context of merger and exchange offertransactions.1 An overriding principle of the guidance inthese FAQs is that an EGC which avails itself of the TitleI provisions in the context of an exchange offer or a mergermust comply with all of the pre-existing applicable rulesfor tender offers and proxy solicitations, which might, insome cases, conflict with the more liberal communicationsapproach contemplated by Title I of the JOBS Act. TheSEC staff has also provided guidance regarding the EGCstatus of issuers that are spun off from SEC reportingissuers.

Availability of test-the-waters communications As discussed in Chapter 1, Title I of the JOBS Act providesEGCs, or any other person authorised to act on theirbehalf, the flexibility to engage in oral or writtencommunications with QIBs and institutional accreditedinvestors in order to gauge their interest in a proposedoffering, whether before or following the first filing of anyregistration statement, subject to the requirement that nosecurity may be sold unless accompanied or preceded by aprospectus.2 An EGC could use this test-the-watersprovision with respect to any registered offerings that itconducts while it qualifies for EGC status. There are noform or content restrictions on these communications, andthere is no requirement to file written communicationswith the SEC (although the SEC staff requests that writtencommunications be submitted to them when they reviewan EGC’s registration statement).

The SEC has confirmed that an EGC may use test-the-waters communications with QIBs and institutional

accredited investors pursuant to Securities Act section 5(d)in connection with an exchange offer or merger.3 Inaddition, the SEC staff notes that an EGC must make allrequired filings under the Exchange Act for any writtencommunications made in connection with, or relating to,the exchange offer or merger. In this regard, the SEC notesthat the JOBS Act did not amend the exchange offer ormerger requirements under the Exchange Act, such asfilings required under Exchange Act Rules 13e-4(c), 14a-12(b), and 14d-2(b), for pre-commencement tender offercommunications and proxy soliciting materials inconnection with a business combination transaction.

Confidential draft registration statementsubmissionsAs discussed in Chapter 1, Title I added paragraph (e) tosection 6 of the Securities Act to provide that the SECmust review all EGC initial public offering registrationstatements confidentially, if an EGC chooses to submit adraft registration statement to the SEC. An EGC mayconfidentially submit a draft registration statement for aninitial public offering for non-public review, provided thatthe initial confidential submission and all amendments arepublicly filed with the SEC no later than 15 days (reducedfrom 21 days) before the issuer’s commencement of a roadshow.4

The SEC has indicated that an EGC may use theconfidential submission process in section 6(e) of theSecurities Act to submit a draft registration statement foran exchange offer or a merger that constitutes its initialpublic offering of common equity securities.5 If an EGCuses the confidential submission process to submit a draftregistration statement for an exchange offer or merger thatconstitutes its initial public offering of common equitysecurities, the SEC notes a number of obligations underthe Securities Act and Exchange Act with respect to thetransaction.

If an EGC does not commence its exchange offer beforethe effectiveness of the registration statement, the EGCmust publicly file the registration statement (including theinitial confidential submission and all amendmentsthereto) at least 15 days before the earlier of the

CHAPTER 3

Applying Title I to other transactions

JOBS Act Quick Start 2018 update 41

commencement date of the road show, if any, or theanticipated date of effectiveness of the registrationstatement. This applies in the case of all exchange offersthat do not use early commencement, including those thatdo not qualify for early commencement under theprovisions of Rules 13e-4(e)(2) and 14d-4(b) regardinggoing-private transactions and roll-up transactions.

An EGC that commences its exchange offer beforeeffectiveness of the registration statement pursuant toSecurities Act Rule 162 must publicly file the registrationstatement (including the initial confidential submissionand all amendments thereto) at least 15 days before theearlier of: the commencement date of the road show, if any,or the anticipated date of effectiveness of the registrationstatement, but no later than the date of commencement ofthe exchange offer in light of the filing requirement underExchange Act Rules 13e-4(e)(2) and 14d-4(b).

For the early commencement of exchange offers subjectonly to Regulation 14E, an EGC must file its registrationstatement at least 15 days before the earlier of thecommencement date of the road show, if any, or theanticipated date of effectiveness of the registrationstatement, but no later than the date of commencement ofthe exchange offer.

An EGC must also make the required filings underSecurities Act Rule 425 (unless it is relying on theSecurities Act section 5(d) provision for test-the-waterscommunications) and Exchange Act Rules 13e-4(c) and14d-2(b) for pre-commencement tender offercommunications. An EGC must also file the tender offerstatement on Schedule TO on the date of commencementof the exchange offer under Exchange Act Rules 13e-4(b)and 14d-3(a), as applicable.

In a merger where the target company is subject toRegulation 14A or 14C and the registration statement ofthe EGC acquirer includes a prospectus that also serves asthe target issuer’s proxy or information statement, theacquirer must publicly file the registration statement(including the initial confidential submission and allamendments thereto) at least 15 days before the earlier ofthe date of commencement of the road show, if any, or theanticipated date of effectiveness of the registrationstatement. In addition, the acquirer must make therequired filings under Securities Act Rule 425 (unless it isrelying on the Securities Act section 5(d) provision for test-the-waters communications) and Exchange Act Rule14a-12(b) for any soliciting material, as applicable.6

Following the extension in June 2017 of the SEC staff ’sconfidential review policy, the SEC will also accept draftregistration statements submitted prior to the end of thetwelfth month following the effective date of an issuer’s

initial Securities Act registration statement or an issuer’sExchange Act section 12(b) registration statement fornonpublic review. This extension is helpful to EGCs thatseek to conduct a follow-on offering prior to becomingeligible to file a shelf registration statement.

Financial statement requirementsThe SEC has stated that if a target company which doesnot qualify as a ‘smaller reporting company’ is to beacquired by an EGC that is not a shell company and willpresent only two years of its financial statements in itsregistration statement for the exchange offer or merger, theSEC will not object if, in the registration statement filedfor the merger or exchange offer, the EGC presents onlytwo years of financial statements for the target company.7

Spin-offsThe SEC has also addressed the EGC status of an issuer inthe context of spin-offs and similar transactions. Incircumstances where a public parent issuer decides to spinoff a wholly-owned subsidiary, register an offer and sale ofthe wholly-owned subsidiary’s common stock for an initialpublic offering, or transfer a business into a newly-formedsubsidiary for purposes of undertaking an IPO of thatsubsidiary’s common stock, the subsidiary would notnecessarily trigger any of the disqualification provisions insections 2(a)(19)(A)-(D) of the Securities Act, and wouldthus be considered an EGC if it had less than $1.07 billionin revenues during its most recently completed fiscal year.8

This analysis is focused on whether the issuer, and not itsparent, meets the EGC requirements. The SEC notes that,based on the particular facts and circumstances, the EGCstatus of an issuer under these circumstances may bequestioned if it appears that the issuer or its parent isengaging in a transaction for the purpose of converting anon-EGC into an EGC, or for the purpose of obtainingthe benefits of EGC status indirectly when it is not entitledto do so directly. The SEC recommends that issuers withquestions relating to these issues should contact theDivision of Corporation Finance’s Office of the ChiefCounsel.

42 JOBS Act Quick Start 2018 update

1 Frequently Asked Questions of General Applicabilityon Title I of the JOBS Act (April 16 2012, May 32012 and September 28 2012), available atwww.sec.gov/divisions/corpfin/guidance/cfjjobsactfaq-title-i-general.htm (SEC Title I FAQs).

2 JOBS Act §105(c), amending Securities Act § 5, 15USC 77e.

3 SEC Title I FAQs, supra note 1 at Question 42.4 For this purpose, the term ‘road show’ is defined in

Securities Act Rule 433(h)(4).5 SEC Title I FAQs, supra note 1 at Question 43.6 SEC Title I FAQs, supra note 1 at Question 44.7 SEC Title I FAQs, supra note 1 at Question 45.8 SEC Title I FAQs, supra note 1 at Question 53.

ENDNOTES

JOBS Act Quick Start 2018 update 43

Title II of the JOBS Act directs the SEC toeliminate the ban on general solicitation andgeneral advertising for certain offerings underRule 506 of Regulation D under the Securities

Act (Rule 506), provided that the securities are sold onlyto accredited investors, and offerings under Rule 144Aunder the Securities Act (Rule 144A), provided that thesecurities are sold only to persons who the seller (orsomeone acting on the seller’s behalf ) reasonably believes isa QIB.

Rule 506 is the most popular means for conducting aprivate offering because it permits issuers to raise anunlimited amount of money and pre-empts state securitieslaws. In recognition of concerns about restrictions oncommunications in private offerings, Title II of the JOBSAct directs the SEC to revise Rule 506 to provide that theprohibition against general solicitation or generaladvertising in Rule 502(c) of Regulation D shall not applyto offers and sales of securities made pursuant to Rule 506,provided that all purchasers of the securities are accreditedinvestors, and to require that issuers using generalsolicitation or general advertising in connection with Rule506 offerings take reasonable steps to verify that purchasersof securities are accredited investors, using methods to bedetermined by the SEC. Under the SEC’s existingdefinition, an accredited investor is a person who fallswithin one of the categories specified in the definition, ora person who the issuer reasonably believes falls within oneof those categories. With respect to Rule 144A, Title II ofthe JOBS Act directs the SEC to revise the rule to providethat securities may be offered to persons other than QIBs,including by means of general solicitation or generaladvertising, provided that the securities are sold only topersons that the seller (or someone acting on the seller’sbehalf ) reasonably believes is a QIB. The JOBS Actspecifies that any offering made pursuant to Rule 506 thatuses general advertising or general solicitation will not bedeemed a public offering.

Title II of the JOBS Act also specifies that persons whomaintain certain online or other platforms to conduct Rule506 offerings that will use general advertising or generalsolicitation will not, by virtue of this activity, be required

to register as a broker or a dealer pursuant to Exchange Actsection 15, provided that enumerated conditions aresatisfied. In order to qualify for this exemption, such aplatform must not receive transaction-basedcompensation, take possession of customer funds orsecurities, or be subject to an Exchange Act statutorydisqualification.

On July 10 2013, the SEC adopted final rules asdirected by Title II of the JOBS Act to eliminate the banon general solicitation and general advertising for certainofferings under Rule 506 and offerings under Rule 144A.The final rules became effective September 23 2013.

Rule 506 of Regulation DRule 506 is considered a safe harbour for the privateoffering exemption of section 4(a)(2) of the Securities Act.Rule 506 has proven to be an attractive means forconducting private offerings, because an issuer using it canraise an unlimited amount of money. Prior to adoption ofthe SEC’s final rules, the conditions for using Rule 506were as follows:• The issuer cannot use general solicitation or advertising

to market the securities. • The issuer may sell its securities to an unlimited number

of accredited investors and up to 35 other purchasers. Allnon-accredited investors, either alone or with apurchaser representative, must be sophisticated: theymust have sufficient knowledge and experience infinancial and business matters to make them capable ofevaluating the merits and risks of the prospectiveinvestment.

• An issuer must decide what information to give toaccredited investors, so long as it does not violate theantifraud prohibitions of the federal securities laws, withnon-accredited investors receiving disclosure documentsthat are generally the same as those used in registeredofferings, and if the issuer provides information toaccredited investors, it must make this informationavailable to non-accredited investors as well.

• The company must be available to answer questionsfrom prospective purchasers.

• Certain financial statement requirements to the extent

CHAPTER 4

Private offerings

44 JOBS Act Quick Start 2018 update

that non-accredited investors are permitted toparticipate.

• Purchasers receive restricted securities. Issuers making use of the Rule 506 exemption do not

have to file a registration statement with the SEC, but theymust file a Form D after they first sell their securities.Form D is a brief notice that includes the names andaddresses of the issuer’s owners and promoters andinformation concerning the offering.

For the purposes of Regulation D, an accredited investorincludes:• a bank, insurance company, registered investment

company, business development company, or smallbusiness investment company;

• an employee benefit plan, within the meaning of theEmployee Retirement Income Security Act, if a bank,insurance company, or registered investment advisermakes the investment decisions, or if the plan has totalassets in excess of $5 million;

• a charitable organisation, corporation, or partnershipwith assets exceeding $5 million;

• a director, executive officer, or general partner of thecompany selling the securities;

• a business in which all the equity owners are accreditedinvestors;

• a natural person who has individual net worth, or jointnet worth with the person’s spouse, that exceeds $1million at the time of the purchase, excluding the valueof the primary residence of such person;

• a natural person with income exceeding $200,000 ineach of the two most recent years or joint income with aspouse exceeding $300,000 for those years and areasonable expectation of the same income level in thecurrent year; or

• a trust with assets in excess of $5 million, not formed toacquire the securities offered, whose purchases asophisticated person makes.Prior to the adoption of the SEC’s final rules, Rule 506

did not include any bad actor limitations with respect tothe issuer, its affiliates and offering participants. Bad actordisqualification provisions were mandated pursuant tosection 926 of the Dodd-Frank Act. We describe the badactor limitations adopted by the SEC below.

Rule 144ARule 144A is a safe harbour exemption from theregistration requirements of section 5 of the Securities Actfor certain offers and sales of qualifying securities bycertain persons other than the issuer of the securities. Rule144A is available only for resales of qualifying securities.Prior to the adoption of the SEC’s final rules, the

exemption applied to re-offers and re-sales of securities toQIBs. The securities eligible for resale under Rule 144A aresecurities of US and foreign issuers that are not listed on aUS securities exchange or quoted on a US automatedinter-dealer quotation system. Rule 144A also providesthat re-offers and re-sales in compliance with the rule arenot distributions and that the reseller is therefore not anunderwriter within the meaning of section 2(a)(11) of theSecurities Act. A reseller that is not the issuer, anunderwriter, or a dealer can rely on the exemptionprovided by section 4(a)(1) of the Securities Act. Resellersthat are dealers can rely on the exemption provided bysection 4(a)(3) of the Securities Act.

SEC rulemaking under Title II of the JOBS ActDiscussion related to relaxing the ban on generalsolicitation has been going on since the early 1990s.Speeches and statements by SEC staff members over theyears have commented on, and acknowledged, the need torevisit private placement exemptions in light of changes incommunications patterns. The legal community also hasgiven close consideration to these questions, going as farback as the late 1990s and early 2000s. In 2001, theAmerican Bar Association’s Committee on the FederalRegulation of Securities submitted a comment letter to theSEC that suggested relaxation of the ban on generalsolicitation. At around the same time, the American BarAssociation’s Task Force for the Review of the FederalSecurities Laws also proposed that a private offering wouldqualify for an exemption from registration based on theeligibility of the purchasers of the securities and therestrictions on re-sales, and not on the number of offerees.The Advisory Committee on Smaller Public Companies,formed in 2004, advocated a relaxation of the ban ongeneral solicitation. In 2007, the SEC proposed arelaxation of the ban on general solicitation in the contextof private offerings to a new category of large accreditedinvestors.1 As mentioned above, in July 2013, the SECissued final rules amending Rule 506 and Rule 144A;2 andthe final rules became effective on September 23 2013.

Final rules eliminating the prohibition againstgeneral solicitation and general advertising inRule 506 and Rule 144A offeringsThe final rules eliminate the prohibition against generalsolicitation and general advertising contained in Rule502(c) of Regulation D with respect to offers and sales ofsecurities made pursuant to Rule 506, provided that allpurchasers are accredited investors. The final rules requirethat for offerings involving the use of general solicitation,issuers take reasonable steps to verify that the purchasers of

JOBS Act Quick Start 2018 update 45

the securities are accredited investors. The final rules alsoprovide that securities may be offered pursuant to Rule144A to persons other than qualified institutional buyers,provided that the securities are sold only to purchasers thatthe seller (or someone acting on the seller’s behalf )reasonably believes is a qualified institutional buyer. TheSEC staff also has issued guidance in the form ofcompliance and disclosure interpretations (CD&Is)relating to the Rule 506(c) and Rule 144A amendments.3

Eliminating the prohibition against general solicitationThe SEC’s final rules implement a bifurcated approach toRule 506 offerings. An issuer may still choose to conducta private offering without using general solicitationpursuant to Rule 506(b). Under new Rule 506(c), generalsolicitation and general advertising are permitted so longas: • The issuer takes reasonable steps to verify that the

purchasers of the securities are accredited investors. • All purchasers of securities are accredited investors,

either because they come within one of the enumeratedcategories of persons that qualify as accredited investorsor the issuer reasonably believes that they qualify asaccredited investors, at the time of the sale of thesecurities.

• The conditions of Rules 501, 502(a), and 502(d) ofRegulation D are satisfied.4

The SEC noted that the exemption applies only toofferings made pursuant to the safe harbour provided byRule 506(c), and it does not apply to offerings relying onthe Securities Act section 4(a)(2) exemption in general.5 Asa result, in a transaction made pursuant to Rule 506(c), thesection 4(a)(2) exemption is not available. Section 4(a)(2)remains available in Rule 506(b) offerings.

The SEC also confirmed that the effect of section 201(b)of the JOBS Act is to permit privately offered funds(including private equity funds and hedge funds, amongothers) to make a general solicitation under amended Rule506 without losing the ability to rely on the exclusionsfrom the definition of an investment company availableunder section 3(c)(1) and 3(c)(7) of the InvestmentCompany Act of 1940, as amended (the InvestmentCompany Act).6

Reasonable steps to verify accredited investor statusThe SEC indicated in the final rules that reasonable effortsto verify investor status will be a fact-based objectivedetermination based on the SEC’s prior principles-basedguidance. New Rule 506(c) does not mandate any specificprocedure that issuers must follow to be assured that thesteps they have taken to verify that the purchasers of their

securities are accredited investors are reasonable. In theadopting release, the SEC stated that ‘[w]hether the stepstaken are “reasonable” will be an objective determinationby the issuer (or those acting on its behalf ), in the contextof the particular facts and circumstances of each purchaserand transaction.’7 The SEC noted that reasonable efforts toverify investor status may differ depending on the facts andcircumstances, and the SEC indicated that it may beappropriate to consider the nature of the purchaser, thenature and amount of information about the purchaser,and the nature of the offering, as follows:• The nature of the purchaser. The SEC describes the

different types of accredited investors, including broker-dealers, investment companies or business developmentcompanies, employee benefit plans, and wealthyindividuals and charities.

• The nature and amount of information about thepurchaser. Simply put, the SEC states that ‘the moreinformation an issuer has indicating that a prospectivepurchaser is an accredited investor, the fewer steps itwould have to take, and vice versa.’8

• The nature of the offering. The nature of the offeringmay be relevant in determining the reasonableness ofsteps taken to verify status: issuers may be required totake additional verification steps to the extent thatsolicitations are made broadly, such as through a websiteaccessible to the general public, or through the use ofsocial media or email. By contrast, less intrusiveverification steps may be required to the extent thatsolicitations are directed at investors that are pre-screened by a reliable third party. The SEC stated that these factors are interconnected,

and the more indicia that are in evidence that an investorqualifies as an accredited investor, the fewer steps the issuermust take to verify status. The SEC noted that issuersshould retain adequate records to document theverification process.

In response to the concerns of many commenters on theproposed rules, in new Rule 506(c), the SEC added thefour following specific non-exclusive methods of verifyingaccredited investor status for natural persons that will bedeemed to meet the reasonable steps to verify requirement:• a review of IRS forms for the two most recent years and

a written representation regarding the individual’sexpectation of attaining the necessary income level forthe current year;

• a review of bank statements, brokerage statements,statements of securities holdings, certificates of deposit,tax assessments, and appraisal reports by independentthird parties in order to assess assets, and a consumerreport or credit report from at least one nationwide

46 JOBS Act Quick Start 2018 update

consumer reporting agency in order to assess liabilities;• a written confirmation from a registered broker-dealer, a

registered investment adviser, a licensed attorney, or acertified public accountant that such person or entityhas taken reasonable steps to verify that the person is anaccredited investor within the prior three months andhas determined that the person is an accredited investor;and

• with respect to any natural person who invested in anissuer’s Rule 506(b) private placement as an accreditedinvestor prior to the effective date of new Rule 506(c)and remains an investor of that issuer, for any Rule506(c) offering conducted by the same issuer, an issuercan obtain a certification from the person at the time ofsale in the new offering that he or she qualifies as anaccredited investor.9

Because an issuer has the burden of demonstrating thatits offering is entitled to an exemption from the SecuritiesAct registration requirements, regardless of the steps anissuer takes to verify accredited investor status, the SECstated that ‘it will be important for issuers and theirverification service providers to retain adequate recordsregarding the steps taken to verify that a purchaser was anaccredited investor.’10

The SEC has received inquiries asking whether the SECstaff would provide guidance, presumably on a case-by-case basis, confirming that a specified principles-basedverification method constitutes reasonable steps forpurposes of Rule 506(c).11 The SEC has indicated that thenotion of the SEC staff reviewing and approving specificverification methods seems somewhat contrary to the verypurpose of a principles-based rule and will not provide anyadditional guidance.12 Further, the SEC has expressed theview that this is an area where issuers and other marketparticipants have the flexibility to think about innovativeapproaches for complying with the verificationrequirement of Rule 506(c) and use the methods that bestsuit their needs, and the SEC will not be quick to secondguess decisions that issuers and their advisers make in goodfaith that appear to be reasonable under thecircumstances.13

Reasonable belief The SEC confirmed the view that Congress did not intendto eliminate the existing reasonable belief standard in Rule501(a) of Regulation D or for Rule 506 offerings. Itconfirmed that if a person were to supply false informationto an issuer claiming status as an accredited investor, theissuer would not lose the ability to rely on the proposedRule 506(c) exemption for that offering, provided theissuer ‘took reasonable steps to verify that the purchaser

was an accredited investor and had a reasonable belief thatsuch purchaser was an accredited investor.’14

Form D amendments The SEC also amended Form D to add a separate checkbox for issuers to indicate whether they are claiming anexemption under Rule 506(c).15 Meredith Cross, formerdirector of the SEC’s Division of Corporation Finance,noted at the open meeting for the proposed rules that itwas the SEC staff ’s intention to form a multi-divisionaltask force to monitor these offerings as a means of gaininginsight into market practices.

Final amendment to Rule 144A As amended, Rule 144A(d)(1) only requires that securitiessold in reliance on the rule be sold to a QIB, or to a personthat the seller and any person acting on behalf of the sellerreasonably believes is a QIB.16 The SEC also amended Rule144A to eliminate references to offer and offeree.17 TheSEC also noted that the general solicitation now permittedby Rule 144A will not affect the availability of the section4(a)(2) exemption or Regulation S for the initial sale ofsecurities by the issuer to the initial purchaser.18

The SEC also clarified that for ongoing Rule 144Aofferings that commenced before the effective date of thenew rules, offering participants will be entitled to conductthe portion of the offering following the effective date ofthe new rules using a general solicitation, without affectingthe availability of Rule 144A for the portion of the offeringthat occurred prior to the effective date.19

Integration with offshore offerings The SEC addressed the interplay between concurrentofferings made outside the US in reliance on Regulation Sand inside the US made in reliance on Rule 506 or Rule144A where there is a general solicitation or generaladvertising. Of particular concern is the requirement inRegulation S that there be no directed selling efforts in theUS.

The SEC reaffirmed its position that an offshore offeringconducted in compliance with Regulation S would not beintegrated with a concurrent domestic unregisteredoffering that is conducted in compliance with Rule 506 orRule 144A, even if there is a general solicitation or generaladvertising. This position is consistent with the SEC’sviews regarding integration of concurrent offshoreofferings made in compliance with Regulation S andregistered domestic offerings.

JOBS Act Quick Start 2018 update 47

Disqualification of felons and other bad actorsfrom Rule 506 offerings On July 10 2013, the SEC adopted amendments to rulespromulgated under Regulation D to implement section926 of the Dodd-Frank Act.20 The amendments add badactor disqualification requirements to Rule 506, whichprohibit issuers and others, such as underwriters,placement agents, directors, executive officers, and certainshareholders of the issuer from participating in exemptsecurities offerings, if they have been convicted of, or aresubject to court or administrative sanctions for, securitiesfraud or other violations of specified laws. Theamendments were originally proposed on May 25 2011.21

In light of concerns raised by investor and consumeradvocates that the relaxation of the prohibition againstgeneral solicitation in certain Rule 506 offerings wouldlead to an increased incidence of fraud, the SEC tookaction on the bad actor provisions at the same time as itpromulgated the final Rule 506 amendments. The finalrules (collectively, the bad actor rule) became effective onSeptember 23 2013.

The new disqualification provisions apply to all Rule506 offerings, regardless of whether general solicitation isused. Section 926 of the Dodd-Frank Act requires the SECto adopt rules that would make the Rule 506 exemptionunavailable for any securities offering in which certainfelons or other bad actors are involved. The new provisionsgenerally track those in section 926 of the Dodd-Frank Actand Rule 262 of Regulation A under the Securities Act(Regulation A). Since the final rule became effective, theSEC staff has provided additional guidance on variousinterpretative matters in various series of CDIs as discussedbelow. Although it was anticipated that the relaxation ofthe prohibition against general solicitation in certain Rule506 offerings and Rule 144A offerings would have asignificant effect on the exempt offering market, at least inthe short-term, the bad actor disqualification provisionshave had a more immediate impact on offering practices.Issuers and financial intermediaries have had to establishpolicies and procedures and revise documentation in orderto address these provisions.

Covered personsThe disqualification provisions in Rule 506(d)(1) apply tothe following covered persons:• the issuer and any predecessor of the issuer;• any affiliated issuer;• any director, executive officer, other officer participating

in the offering, general partner, or managing member ofthe issuer;

• any beneficial owner of 20% or more of any class of the

issuer’s outstanding voting equity securities, calculatedon the basis of voting power;

• any promoter (as defined in Rule 405) connected withthe issuer in any capacity at the time of the sale;

• any investment manager of an issuer that is a pooledinvestment fund;

• any person that has been or will be paid (directly orindirectly) remuneration for solicitation of purchasers inconnection with such sale of securities (a compensatedsolicitor);

• any general partner or managing member of any suchinvestment manager or compensated solicitor; or

• any director, executive officer, or other officerparticipating in the offering of any such investmentmanager or compensated solicitor or general partner ormanaging member of such investment manager orcompensated solicitor.22

In the case of financial intermediaries likely to beinvolved in a private placement under Rule 506, ratherthan referring to underwriters, the rules apply to ‘anyperson that has been or will be paid (directly or indirectly)remuneration for solicitation of purchasers (compensatedsolicitors).’23

Rule 506(d)(3) provides that the disqualificationprovisions do not apply to events relating to any affiliatedissuer that occurred before the affiliation arose if theaffiliated entity is not (i) in control of the issuer or (ii)under common control with the issuer by a third partythat was in control of the affiliated entity at the time ofsuch events.

Two key changes from the categories of covered personsdiscussed in the proposing release are the inclusion in Rule506(d)(1) of executive officers (ie those performing policy-making functions) of the issuer and the compensatedsolicitor, instead of just officer, and a change to 20% from10% shareholders of the issuer.

Disqualifying eventsThe final rule includes eight categories of disqualifyingevents. They are:• criminal convictions;• court injunctions and restraining orders;• final orders (as defined in Rule 501(g) of Regulation D)

of certain state regulators (such as securities, banking,and insurance) and federal regulators, including the USCommodity Futures Trading Commission (CFTC);

• SEC disciplinary orders relating to brokers, dealers,municipal securities dealers, investment advisers, andinvestment companies and their associated persons;

• certain SEC cease and desist orders;• suspension or expulsion from membership in, or

48 JOBS Act Quick Start 2018 update

suspension or barring from association with a memberof, a securities self-regulatory organisation (SRO);

• SEC stop orders and orders suspending a Regulation Aexemption; and

• US Postal Service false representation orders.24

A discussion of each of these categories appears below.Criminal convictions. Rule 506(d)(1)(i) provides for

disqualification of any covered person who has beenconvicted of any felony or misdemeanour in connectionwith the purchase or sale of any security, involving themaking of any false filing with the SEC, or arising out ofthe conduct of the business of an underwriter, broker,dealer, municipal securities dealer, investment adviser, orpaid solicitor of purchasers of securities. The rule includesa five-year look-back period for criminal convictions ofissuers, their predecessors, and affiliated issuers, and a ten-year look-back period for other covered persons.25

Court injunctions and restraining orders. Similar toRule 262 of Regulation A, Rule 506(d)(1)(ii) disqualifiesany covered person from relying on the exemption for asale of securities if such covered person is subject to anyorder, judgment, or decree of any court of competentjurisdiction, entered within five years before such sale,that, at the time of such sale, restrains or enjoins suchperson from engaging in or continuing any conduct orpractice (i) in connection with the purchase or sale of anysecurity, (ii) involving the making of a false filing with theSEC, or (iii) arising out of the conduct of business of anunderwriter, broker, dealer, municipal securities dealer,investment adviser, or paid solicitor of purchasers ofsecurities.26

Final orders of certain regulators. Final orders ofregulatory agencies or authorities are covered by Rule506(d)(1)(iii). That section disqualifies any covered personwho is subject to a final order of: a state securitiescommission (or an agency or officer of a state performinglike functions); a state authority that supervises orexamines banks, savings associations, or credit unions; astate insurance commission (or an agency or an officer of astate performing like functions); an appropriate federalbanking agency; the Commodity Futures TradingAssociation (CFTC); or the National Credit UnionAdministration. The order must be final and:

(A) at the time of such sale, bar the person from:• associating with an entity regulated by such commission,

authority, agency, or officer; • engaging in the business of securities, insurance, or

banking; and • engaging in savings association or credit union activities;

or (B) constitutes a final order based on a violation of any

law or regulation that prohibits fraudulent, manipulative,or deceptive conduct entered within ten years of such sale.

In a change from the proposing release, the rule alsoadded CFTC final orders as disqualification triggers. Inadding CFTC final orders, the SEC noted that the CFTC(rather than the SEC) has authority over investmentmanagers of pooled investment funds that invest incommodities and certain derivative products. The SECreasoned that, absent adding CFTC final orders as adisqualifying trigger, regulatory sanctions against thoseinvestment managers would not likely triggerdisqualification.27

Final orders. Rule 501(g) of Regulation D defines a‘final order as a written directive or declaratory statementissued by a federal or state agency described in [Rule506(d)(1)(iii)] under applicable statutory authority thatprovides for notice and an opportunity for a hearing,which constitutes a final disposition or action by thatfederal or state agency.’28 The definition is based on theFinra definition.

Fraudulent, manipulative, or deceptive conduct. Rule506(d)(1)(iii)(B) provides that disqualification must resultfrom final orders of the relevant regulators that are ‘basedon a violation of any law or regulation that prohibitsfraudulent, manipulative, or deceptive conduct.’ Despitethe suggestions of commenters, the SEC did not define‘fraudulent, manipulative, or deceptive conduct,’ did notexclude technical or administrative violations, and did notlimit Rule 506(d)(1)(iii) to matters involving scienter.29

SEC disciplinary orders. Currently under Rule262(b)(3), issuers and other covered persons that aresubject to an SEC order entered pursuant to sections15(b), 15B(a), or 15B(c) of the Exchange Act, or sections203(e) or (f ) of the Investment Advisers Act of 1940 (theAdvisers Act), are disqualified from relying on theexemption available under Regulation A under theSecurities Act. Under the cited provisions of the ExchangeAct and the Advisers Act, the SEC has the authority toorder a variety of sanctions against registered brokers,dealers, municipal securities dealers, and investmentadvisers, including the suspension or revocation ofregistration, censure, placing limits on their activities,imposing civil money penalties, and barring individualsfrom being associated with specified entities and fromparticipating in the offering of any penny stock.

The SEC has historically required disqualificationperiods to run only for as long as an act is prohibited orrequired to be performed pursuant to an order. Therefore,censures are not disqualifying and a disqualification basedon a suspension or limitation of activities expires when thesuspension or limitation expires. Rule 506(d)(1)(iv)

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codifies this position, but removes the reference to section15B(a) of the Exchange Act. No look-back period wasadded to the rule.30

Certain SEC cease and desist orders. Although notrequired by section 926 of the Dodd-Frank Act, the SECadded an additional disqualification trigger, using itsexisting authority previously used to create bad actorprovisions. Under Rule 506(d)(1)(v), an offering will bedisqualified if any covered person is subject to any order ofthe SEC entered within five years before such sale that, atthe time of such sale, orders the person to cease and desistfrom committing or causing a future violation of: (i) anyscienter-based anti-fraud provision of the federal securitieslaws, including, without limitation, section 17(a)(1) of theSecurities Act, section 10(b) of the Exchange Act and Rule10b-5 thereunder and section 206(1) of the Advisers Act,or any other rule or regulation thereunder; or (ii) section 5of the Securities Act. Note that the disqualificationprovision for section 5 of the Securities Act does notrequire scienter, which is consistent with the strict liabilitystandard imposed by section 5.31

Suspension or expulsion from SRO membership orassociation with an SRO member. Rule 506(d)(1)(vi)disqualifies any covered person that is suspended orexpelled from membership in, or suspended or barredfrom association with a member of, an SRO, for any act oromission to act constituting conduct inconsistent with justand equitable principles of trade. This provision does notinclude a look-back period.32

SEC stop orders and orders suspending theRegulation A exemption. Rule 506(d)(1)(vii) imposesdisqualification on an offering if a covered person has filed(as a registrant or issuer), or was named as an underwriterin, any registration statement or Regulation A offeringstatement filed with the SEC that, within five years beforesuch sale, was the subject of a refusal order, stop order, ororder suspending the Regulation A exemption, or is, at thetime of such sale, the subject of an investigation orproceeding to determine whether a stop order orsuspension order should be issued.33

US Postal Service false representation orders. Thefinal disqualification provision is enumerated in Rule506(d)(1)(viii), which disqualifies any covered person thatis subject to a US Postal Service false representation orderentered within five years preceding the sale of securities, oris, at the time of such sale, subject to a temporaryrestraining order or preliminary injunction with respect toconduct alleged by the US Postal Service to constitute ascheme or device for obtaining money or property throughthe mail by means of false representations.34

Reasonable care exceptionRule 506(d)(2)(iv) creates a reasonable care exception thatwould apply if an issuer can establish that it did not knowand, in the exercise of reasonable care, could not haveknown that a disqualification existed because of thepresence or participation of a covered person. Thereasonable care exception helps preserve the intendedbenefits of Rule 506 and avoids creating an undue burdenon capital-raising activities, while giving effect to thelegislative intent to screen out felons and bad actors.35

In order to rely on the reasonable care exception, theissuer would need to conduct a factual inquiry, the natureof which would depend on the facts and circumstances ofthe issuer and the other offering participants. In such aninquiry, an issuer would need to consider various factors,such as the risk that bad actors present, the presence ofscreening and other compliance mechanisms, the cost andburden of the inquiry, whether other means used to obtaininformation about the covered persons is adequate, andwhether investigating publicly available information isreasonable.36

Transition issuesAlthough the look-back provisions of Rule 506(d) reachback to disqualifying events prior to the effectiveness of therule, Rule 506(d)(2)(i) provides that disqualification willnot arise as a result of triggering events that occurred priorto the date of the amendments. However, Rule 506(e)requires written disclosure to purchasers, at a reasonabletime prior to the sale, of matters that would have triggereddisqualification except that they occurred prior to the rule’seffective date. This disclosure requirement applies to allRule 506 offerings, regardless of whether purchasers areaccredited investors. Failure to make such disclosures willnot be an ‘insignificant deviation’ within the meaning ofRule 508 of Regulation D; consequently, relief under thatrule will not be available for such failure.37

The SEC staff has provided additional guidance on theapplication of the rule through various CD&Is, includingthose issued on November 13 2013, December 4 2013,January 3 2014 and January 23 2014.38

Proposed amendmentsRegulation D and Form DAlso in July 2013, the SEC issued proposed rules forcomment that would impose a number of investorprotection measures in connection with Rule 506(c)offerings.39 These include a proposed amendment to Rule503 of Regulation D in order to implement additionalcompliance requirements relating to the filing of a FormD. In connection with a Rule 506(c) offering, an issuer

50 JOBS Act Quick Start 2018 update

would be required to file a Form D not later than 15calendar days from the commencement of generalsolicitation efforts. In addition, in order to provide theSEC with more information regarding these types ofofferings, the issuer would be required to file a finalamendment to the Form D within 30 days after thecompletion of such an offering. Along the same lines, inorder to make additional information available to the SEC,the proposal would revise Form D in order to requestadditional information in the context of Rule 506(c)offerings. The SEC also proposed an amendment to Rule507 of Regulation D in order to promote compliance withthe Form D filing requirement by implementing certaindisqualification provisions where the issuer and its affiliatesfailed to comply with Form D filing requirements. TheSEC would have the authority to grant waivers upon ashowing of good cause by the issuer. The proposal alsoincluded the introduction of a new Rule 509 of RegulationD, which would require an issuer engaging in a Rule506(c) offering to include certain legends on any writtengeneral solicitation materials. The required legends wouldalert potential investors of the type of offering, that theoffering is available only to certain investors, and that theoffering may involve certain risks. The proposal also wouldrequire that for a temporary period of two years, issuersmust file with the SEC any written solicitation materials.These materials would not be available to the public. Theproposal also solicited comment on the definition ofaccredited investor and on whether there should beadditional requirements relating to the communicationsused in general solicitation.

Private funds and Rule 156 The SEC proposed to require private funds making Rule506(c) offerings to file written general solicitationmaterials with the SEC on a temporary basis. The SECalso proposed to amend Rule 156 under the Securities Act,the anti-fraud rule that applies to sales literature ofregistered investment companies. The rule amendmentswould apply the guidance to sales literature of privatefunds making general solicitations under Rule 506.

Rule 156 under the Securities Act prevents registeredinvestment companies from using sales literature that ismaterially misleading in connection with the offer and saleof securities. The comment period for the proposed ruleshas closed, and it is not clear whether the proposed ruleswill be adopted, or if adopted, the form in which the SECwill adopt them.

The SEC’s proposed rules were quite controversial. As ofthe date of this writing, no further action has been takenrelating to these proposed rules.

Impact of Rule 506 amendments on broker-dealers, investment advisers, CPOs and CTAsThe amendments to Rule 506 affect issuers, as well asbroker-dealers, investment advisers, commodity pooloperators (CPOs), and commodity trading advisers(CTAs). Registered broker-dealers often act asintermediaries that facilitate Rule 506 offerings, whileinvestment advisers (including CPOs and CTAs) organiseand sponsor pooled investment funds that conduct Rule506 offerings in an issuer capacity. Broker-dealers,investment advisers, CPOs, and CTAs may be affecteddirectly or indirectly by the amendments to Rule 506 inseveral ways, which we describe below.

Bad actor ruleSEC disciplinary orders relating to broker-dealers,municipal securities dealers, investment advisers, andinvestment companies and their associated personsconstitute disqualifying events under the bad actor rule.The scope of the bad actor rule has also been expanded byusing the term investment manager rather than investmentadviser. This is meant to ensure that control persons ofpooled funds that deal in instruments other than securities,such as commodities, real estate, and certain derivatives,are covered persons and subject to disqualification underthe bad actor rule. This revision recognised that, unlikeoperating companies making Rule 506 offerings, mostpooled investment funds engaging in Rule 506 offeringsfunction through their investment managers and theirpersonnel and have few, if any, employees. Broker-dealersand other registered persons that participate in privateplacements will have to implement compliance policiesand procedures in order to permit them to be in a positionto represent to any issuers with which they are working ona Rule 506 offering that they are not ‘bad actors.’ In theaftermath of the financial crisis, a number of financialinstitutions were subject to governmental orders that areconsidered disqualifying events. These financialinstitutions have had to seek waivers from the SEC inorder not to be disqualified from participating in privateplacements.

An issuer may rely on Rule 506’s exemption even if thereis a disqualification as to a covered person, such as abroker-dealer, if the issuer can demonstrate that it did notknow and, in the exercise of reasonable care, it could nothave known about the disqualification at the time of thesale of securities. Although issuers are generally required toexercise that reasonable care and conduct associated factualinquiries themselves, when a registered broker-dealer actsas placement agent, it may be sufficient for the issuer tomake inquiries concerning the relevant set of covered

JOBS Act Quick Start 2018 update 51

officers and controlling persons and to consult publiclyavailable databases concerning the past disciplinary historyof the relevant persons.

Use of general solicitationExisting Finra rules governing offering-relatedcommunications take on greater significance with the wideravailability of general solicitation in private placements. Thisincludes Finra Rule 5123 (requiring Finra members sellingsecurities issued by non-members in certain privateplacements to file the private placement memorandum,term sheet, or other offering documents with Finra within15 days of the date of the first sale of securities) and FinraRule 2210 (establishing pre-approval, filing, content, andrecord retention requirements with respect tocommunications with retail investors). Furthermore, bothbroker-dealers and investment advisers participating inofferings made by issuers relying on Rule 506(c) willcontinue to be subject to Finra and SEC rules generallyprohibiting false or untrue statements. Broker-dealersparticipating in offerings made by issuers relying on Rule506(c) would continue to be subject to Finra rules regardingcommunications with the public, which, among otherthings: (1) generally require all member communications tobe based on principles of fair dealing and good faith, to befair and balanced, and to provide a sound basis forevaluating the facts in regard to any particular security ortype of security, industry, or service; and (2) prohibit broker-dealers from making false, exaggerated, unwarranted,promissory, or misleading statements or claims in anycommunications. As a result, it may be difficult to advertiseeffectively while still complying with these Finra rules.Concerns regarding these Finra rules has led many broker-dealers to recommend against use of Rule 506(c) by theirissuer clients.

In addition, while CPOs are generally required toregister with the CFTC and comply with its rules, certainexemptions are available under CFTC Regulations 4.7(b)and 4.13(a)(3) for CPOs who offer and accept investmentsonly from accredited investors and other qualified personswithout marketing to the public. As a result of theambiguity arising from the CFTC regulations, many fundsrefrained from relying on Rule 506(c) offerings. InSeptember 2014, the staff of the CFTC issued exemptiverelief in CFTC Letter No. 14-116, addressing CFTCRegulations 4.13 and 4.7 for CPOs that rely on the JOBSAct and use general solicitation or general advertising.40

The relief requires the CPO to affirmatively notify theCFTC that it will be using general solicitation or generaladvertising and to provide certain representations, but it isself-effectuating. Market participants, however, expected

broader relief that would have amended the regulations,covered other relevant CFTC rules and regulations, andprovided relief to CTAs. CPOs and CTAs also are subjectto the advertising regulations promulgate under Part 4 ofthe CFTC’s Regulations and disclosure documents used byCPOs to market interests in their securities must besubmitted to the National Futures Association (NFA) forreview.

Investor verificationAn issuer may verify that its investors are accredited by,among other ways, obtaining written confirmation from aregistered broker-dealer, an SEC-registered investmentadviser, a licensed attorney, or a certified public accountantthat such person or entity has taken reasonable stepswithin the prior three months to verify that the purchaseris an accredited investor and has determined that suchpurchaser is an accredited investor. The rationale behindthis provision is that these third parties are all subject tovarious other regulatory, licensing, and examinationrequirements.

Matchmaking sites Matchmaking sites have come to play a more significant rolein capital formation in recent years. A matchmaking sitegenerally relies on the internet in order to match orintroduce potential investors to companies that may beinterested in raising capital. However, in order to avoid therequirement to register as a broker-dealer, a matchmakingsite will limit the scope of its activities. Under section 3(a)(4)of the Exchange Act, a broker is defined as any person thatis ‘engaged in the business of effecting transactions insecurities for the account of others.’ The SEC has noted thata person ‘effects transactions in securities if he or sheparticipates in such transactions ‘at key points in the chainof distribution,’ and that a person is engaged in the businessif he or she receives transaction-related compensation, holdshimself out ‘as a broker, as executing trades, or as assistingothers in completing securities transactions.’41 Thedetermination as to whether an entity is acting as a broker iscomplex. The SEC closely considers many criteria and thespecific facts and circumstances. Generally, though, the SEChas attributed great significance to whether the personreceives transaction-based compensation. Given that actingas an unregistered broker-dealer would be met with seriousconsequences, many matchmaking sites sought further SECguidance. Prior to the enactment of the JOBS Act, the SECstaff issued several no-action letters to matchmaking sitesthat sought relief from the requirement to register as broker-dealers. The no-action letter relief generally was conditionedon the requirement that the matchmaking site: (1) not

52 JOBS Act Quick Start 2018 update

provide any advice, endorsement, analysis, orrecommendation about the merits of securities; (2) notreceive compensation that is contingent on the outcome orcompletion of any securities transaction (transaction-basedcompensation); (3) not participate in any negotiationsrelated to securities transactions; (4) not have any role ineffecting securities trades; (5) not receive, transfer, or holdany investor funds or securities; and (6) not hold itself outas a broker-dealer.42

Section 201(b) of the JOBS Act provides further legalcertainty. Pursuant to this section, in the absence of otheractivities that would require registration, a matchmakingsite is exempt from the requirement to register as a broker-dealer if, in connection with Rule 506 offerings: (1) it doesnot receive compensation based on the purchase or sale ofsecurities; (2) it does not handle customer funds orsecurities; and (3) it is not a bad actor. A matchmaking sitemay maintain ‘a platform or mechanism that permits theoffer, sale, purchase, or negotiation of or with respect tosecurities, or permits general solicitations, generaladvertisements, or similar or related activities by issuers ofsuch securities, whether online, in person, or through anyother means.’43 A matchmaking site also may provideancillary services in connection with Rule 506 offerings,which include ‘due diligence services, in connection withthe offer, sale, purchase, or negotiation of such security, solong as such services do not include, for separatecompensation, investment advice or recommendations toissuers or investors;’ and ‘the provision of standardizeddocuments to the issuers and investors, so long as suchperson or entity does not negotiate the terms of theissuance for, and on behalf of, third parties and issuers arenot required to use the standardized documents as acondition of using the service.’ This provision applies onlyto the activities of matchmaking sites in Rule 506offerings. Although many articles in the popular press referto the use of the internet to offer securities in Rule 506offerings to accredited investors as crowdfunding oraccredited investor crowdfunding, it is important to notethat the transactions taking place on such sites do not relyon the exemption under section 4(a)(6) of the SecuritiesAct and Regulation Crowdfunding for crowdfundedofferings, and that the exemption from broker-dealerregistration would not be available for crowdfundedofferings or for Regulation A offerings.44 Crowdfundedofferings must be conducted by either a registered broker-dealer or a registered funding portal.

In order to provide additional guidance relating tomatchmaking sites, the SEC staff issued guidance in theform of Frequently Asked Questions.45 Also, in March2013, the SEC’s Division of Trading and Markets (the

Division) provided the first no-action relief fromregistration as a broker-dealer after the issuance of theJOBS Act in a letter to FundersClub (FundersClub) andFundersClub Management (FC Management).46 In theletter, the SEC staff indicated that the Division would notrecommend enforcement action under section 15(a)(1) ofthe Exchange Act if FundersClub and FundersClubManagement operated a platform through which itsmembers could participate in Rule 506 offerings.FundersClub identifies start-up companies in which itsaffiliated fund will invest, and then posts informationabout the start-up companies on its website so that theinformation is only available to FundersClub members,who are all accredited investors. The FundersClubmembers may submit non-binding indications of interestin an investment fund which relies on Rule 506 to conductthe offering. When a target level of capital is reached, theindication of interest process is closed, and FundersClubreconfirms investors’ interest and accredited investor statusand negotiates the final terms of the investment fund’sinvestment in the start-up company. Members maywithdraw their indications of interest at any time. In thisprocess, FundersClub and FundersClub Management donot receive any compensation, however someadministrative fees are charged. FundersClub andFundersClub Management intend to be compensatedthrough their role in organising and managing theinvestment funds (at a rate of 20% or less of the profits ofthe investment fund, but never exceeding 30%). The SECstaff notes in the no-action letter that FundersClub’s andFundersClub Management’s current activities appear tocomply with section 201 of the JOBS Act, in part becausethey and each person associated with them receive nocompensation (or the promise of future compensation) inconnection with the purchase or sale of securities.However, once FundersClub, FundersClub Management,or persons associated with them receive compensation orthe promise of future compensation, as described in theirincoming letter, they will no longer be able to rely onsection 201 of the JOBS Act. The SEC staff issued similarno-action relief to AngelList, another matchmaking site.47

These letters are narrowly focused and do not addresswhether other registrations (such as registration as aninvestment adviser) would be required to be obtained.Also, the letters do not address or comment on any issuesrelated to general solicitation or the means by whichinvestors are identified or contacted. Given the popularityof matchmaking sites, an issuer may consider using such aservice in connection with a proposed Rule 506 offering.The issuer and its counsel should familiarise itself with thebusiness model and the operations of the matchmaking

JOBS Act Quick Start 2018 update 53

site. It will be essential for the issuer to understand whetherthe site is relying on the exemption under section 201 ofthe JOBS Act, or whether it is a registered broker-dealer,and the functions or services that the site will provide inconnection with the financing. In addition, the issuer alsowill need to understand whether the activities of the siteare organised in a manner that would constitute a generalsolicitation, requiring the issuer to rely on Rule 506(c) forits exemption and thereby triggering a need to conductadditional investor verification.

Guidance from the SEC staff on general solic-itation and related issuesAfter the adoption of the final rules relaxing theprohibition against general solicitation for Rule 506(c)offerings, there was considerable debate regarding the typesof communications that would constitute a generalsolicitation. For years, market participants had functionedwithout a precise definition for the term generalsolicitation. It was understood that the SEC wouldinterpret the term broadly and that the term wouldencompass communications relating to an offering ofsecurities that were not directed at specific individuals orentities with which the issuer or a financial intermediaryacting on the issuer’s behalf had a pre-existing substantiverelationship. Over the years, the staff of the SEC hadprovided guidance regarding the types of activities thatwere sufficient to establish a relationship prior to anoffering of securities being made. In any event, manyissuers and investors did not want to be deemed, by virtueof their communications, to be engaged in Rule 506(c)offerings, which would require that they undertakeadditional investor verification procedures. Also, manyissuers were interested in using matchmaking platforms inorder to assist them with Rule 506(b) offerings. Perhaps asa result of these developments, the staff of the SEC’sDivision of Corporation Finance provided guidance in theform of a number of C&DIs that reaffirmed longstandingprinciples relating to the types of communications thatwould or would not be viewed as constituting a generalsolicitation.48 The SEC staff clarified that communicationsthat are directed to persons with whom the issuer or itsagent has a pre-existing substantive relationship also wouldnot be considered to be a general solicitation. Of course,by contrast, unrestricted communications relating to anoffering made using the internet would constitute ageneral solicitation. The C&DIs also reiterate thatregularly released factual business communications wouldnot be considered a general solicitation. Persons other thanregistered broker-dealers and investment advisers can havea pre-existing relationship with a prospective offeree.

Presentations at business plan competitions, demo days orventure fairs and the like should be evaluated andconsidered based on the facts and circumstances. If there isno mention made of a securities offering or the attendeesare known to the issuer or confirmed to be sophisticatedinvestors, one might conclude that there is no generalsolicitation.

Most matchmaking sites limit their advertising orsolicitation activities, or primarily rely on Rule 506(b)offerings made to investors with whom they have a pre-existing substantive relationship. In order to ensure thattheir offerings are made in compliance with Rule 506(b),these sites generally rely on guidance issued by the SECstaff in various no-action letters, including the IPONet no-action letter issued to a broker-dealer and its affiliate.49

Under the conditions described in IPONet, the SEC staffconcluded that no general solicitation or advertising wasinvolved because of the established principle that ‘a generalsolicitation is not present when there is a pre-existing,substantive relationship between an issuer, or its broker-dealer, and the offerees.’ The SEC staff considered thesufficiency of the qualification process implemented by anon-broker-dealer website operator that solicited investorinterest in hedge funds in the no-action letter issued toLamp Technologies Inc.50 Lamp imposed a 30-day waitingperiod from the time that an investor was first grantedaccess to the restricted site and the first investment. TheSEC staff noted that this was a satisfactory means ofsatisfying the no general solicitation requirement solely inthe context of offerings of private hedge funds. The SECinterpretive guidance and the IPONet and Lamp no-action letters provide a roadmap for using internet-basedcommunications in the context of an exempt offering ofsecurities. In the above-mentioned C&DIs, the SEC staffreaffirmed this guidance and noted that the 30-day periodmay not be a hard and fast requirement. The SEC staff alsoissued a no-action letter in which it passed upon certainmethods used by a platform-based sponsor in order toestablish a substantive relationship with potential investorsin venture capital funds.51 The no-action letter issignificant in that it extends the prior guidance relating toreliance by an issuer on the pre-existing relationshipformed by a broker-dealer with its clients to a registeredinvestment adviser. Also, the no-action letter makes clearthat in order to establish a pre-existing substantiverelationship, a registered person or other intermediarymust not only obtain information about a prospectiveinvestor’s financial sophistication and status, but it alsomust have the means to, and must, verify this information.

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1 SEC Release No. 33-8828 (August 3 2007), availableat www.sec.gov/rules/proposed/2007/33-8828.pdf

2 SEC Release Nos. 33-9415 (July 10 2013), availableat www.sec.gov/rules/final/2013/33-9415.pdf

3 See www.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm

4 Supra note 3, at 20.5 Id. at 12.6 Id. at 47.7 Id. at 20, 28-29.8 Id. at 31.9 Id. at 35.10 Id. 28-29.11 See speech of Keith F. Higgins, Director, Division of

Corporation Finance, titled ‘Keynote Address at the2014 Angel Capital Association Summit’ (March 282014), available at www.sec.gov/News/Speech/Detail/Speech/1370541320533#.U2PsBBnD-Hs

12 Id.13 Id.14 Id. at 44.15 Id. at 45.16 Id. at 56.17 Id. at 55.18 Id.19 Id. at 57.20 SEC Release No. 33-9414 (July 10 2013), available

at www.sec.gov/rules/final/2013/33-9414.pdf21 SEC Release No. 33-9211 (May 25 2011), available

at www.sec.gov/rules/proposed/2011/33-9211.pdf22 Supra note 19, at 13.23 Id. at 29.24 Id. at 30.25 Id. at 33.26 Id. at 36.27 Id. at 39.28 Id. at 49.29 Id.30 Id. at 52.

31 Id. at 54.32 Id. at 59.33 Id. at 60.34 Id. at 61.35 Regulation D already has a provision, Rule 508,

under which insignificant deviations from the terms,conditions, and requirements of Regulation D willnot result in the loss of the exemption if the personrelying on the exemption can show that: (i) thefailure to comply did not pertain to a term,condition, or requirement directly intended toprotect that individual or entity; (ii) the failure tocomply was insignificant with respect to the offeringas a whole; and (iii) a good faith and reasonableattempt was made to comply. The SEC does notbelieve that Rule 508 of Regulation D would covercircumstances in which an offering was disqualifiedunder Rule 506(d).

36 Supra note 19, at 62.37 Id. at 73.38 See www.sec.gov/divisions/corpfin/

guidance/securitiesactrules-interps.htm39 SEC Release Nos. 33-9416 (July 10 2013), available

at www.sec.gov/rules/proposed/2013/33-9416.pdf41 See SEC Denial of No-Action Request to Oil-N-Gas,

Inc. (June 8 2000); SEC Denial of No-ActionRequest to Progressive Technology Inc. (October 112000); and SEC Denial of No-Action Request to 1stGlobal, Inc. (May 7 2001).

42 See Angel Capital Electronic Network, SEC No-Action Letter (October 25 1996); E-Media, LLC,SEC No-Action Letter (December 14 2000); SwissAmerican Securities, Inc. and Streetline, Inc., SECNo-Action Letter (May 28 2002); The InvestmentArchive, LLC, SEC No-Action Letter (May 142010); Roadshow Broadcast, LLC, SEC No-ActionLetter (May 6 2011); and S3 Matching TechnologiesLP, SEC No-Action Letter (July 19 2012).

ENDNOTES

JOBS Act Quick Start 2018 update 55

45 See Frequently Asked Questions About theExemption from Broker-Dealer Registration in TitleII of the JOBS Act, available atwww.sec.gov/divisions/marketreg/exemption-broker-dealer-registration-jobs-act-faq.htm

46 See FundersClub Inc. and FundersClub ManagementLLC, SEC No-Action Letter (March 26 2013).

47 See AngelList LLC, SEC No-Action Letter (March 282013).

48 Compliance and Disclosure Interpretations (C&DIs),Securities Act Rules (updated August 6 2015),questions 256.23 to 256.32, available atwww.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm

49 See IPONet, SEC No-Action Letter (July 26 1996).50 See Lamp Technologies, Inc,. SEC No-Action Letter

(May 29 1997).51 See Citizen VC, Inc., SEC No-Action Letter (August

6 2015).

56 JOBS Act Quick Start 2018 update

Title III of the JOBS Act addressescrowdfunding, an outgrowth of social mediathat provides an emerging source of fundingfor a variety of ventures. Crowdfunding works

based on the ability to pool money from individuals whohave a common interest and are willing to provide smallcontributions for a venture. Given the difficulty in relyingon existing exemptions from registration for crowdfundingefforts involving the offer and sale of securities, Title III ofthe JOBS Act amended section 4(a) of the Securities Act toadd a new paragraph (6), which provides for a newcrowdfunding exemption from SEC registration (subjectto rulemaking by the SEC), as well as pre-emption fromstate Blue Sky laws.

Crowdfunding can be used to accomplish a variety ofgoals (such as raising money for a charity or other causes ofinterest to the participants), but when the goal is of acommercial nature and there is an opportunity forcrowdfunding participants to participate in the venture’sprofits, it is likely that federal and state securities laws willapply. Absent an exemption from registration with theSEC, or registering the offering with the SEC,crowdfunding efforts that involve the offer and sale ofsecurities are in all likelihood illegal. In addition to SECrequirements, those seeking capital through crowdfundingneed to be aware of state securities laws, which includevarying requirements and exemptions. By crowdfundingthrough the internet, a person or venture can be exposedto potential liability at the US federal level, in all fiftystates, and potentially in foreign jurisdictions.

Existing exemptions present some problems for personsseeking to raise capital through crowdfunding. RegulationA requires a filing with the SEC and disclosure in the formof an offering circular, which would make conducting acrowdfunding offering difficult. The Regulation Dexemptions generally would prove too cumbersome (withthe possible exception of Rule 504), and a private offeringapproach or the intrastate offering exemption isinconsistent with widespread use of the internet forcrowdfunding.

The potential illegality of crowdfunding effortsinvolving the offer and sale of securities was demonstrated

in the SEC enforcement action In the matter of MichaelMigliozzi II and Brian William Flatow,1 which the SECbrought against two individuals in connection with theirefforts to allegedly raise small contributions using theinternet in order to purchase Pabst Brewing Company for$300 million. Migliozzi and Flatow settled the proceeding,consenting to a cease and desist order relating to thealleged violation of the registration provisions of theSecurities Act. The order indicates that Migliozzi andFlatow established the BuyaBeerCompany.com websiteand then used Facebook and Twitter to advertise thewebsite. They sought pledges from participants in thecrowdfunding effort, and in return participants were toldthat if the $300 million necessary to purchase Pabst wasraised, the participants would receive a crowdsourcedcertificate of ownership, as well as an amount of beer of avalue equal to the money invested. While no monies wereever collected from the crowdfunding participants whomade the pledges, the SEC alleged that Migliozzi andFlatow nonetheless violated the registration provisions ofthe federal securities laws by offering the security (in thiscase, the crowdsourced certificate of ownership) withoutregistering the offer with the SEC or having an exemption,such as the private placement exemption, available for theoffer.

In recent years, crowdfunding advocates have requestedthat the SEC consider implementing an exemption fromregistration under the federal securities laws forcrowdfunding efforts. For example, a rulemaking petitionsubmitted by the Sustainable Economies Law Centersuggested that the SEC exempt crowdfunding offerings ofup to $100,000, with a cap on individual investments notto exceed $100.2 Also, following an SEC Forum on SmallBusiness Capital Formation, the Small Business &Entrepreneurship Council submitted commentssuggesting that the SEC adopt a small business offeringexemption for offerings of less than $1 million with a limiton the amount any one individual could contribute to nomore than 10% of the previous year’s stated income of theissuer or up to $10,000 per individual. Before enactmentof Title III of the JOBS Act, the SEC was consideringwhether to implement an exemption for crowdfunding, in

CHAPTER 5

Crowdfunding

addition to a variety of other measures to encourage capitalformation.

When HR 3606 was originally adopted in the House ofRepresentatives, the bill included Title III, titledEntrepreneur Access to Capital. This Title provided for anexemption from registration under the Securities Act forofferings of up to $1 million, or $2 million in certain caseswhen investors were provided with audited financialstatements, provided that individual investments werelimited to $10,000 or 10% of the investor’s annualincome. The exemption was conditioned on issuers andintermediaries meeting a number of specific requirements,including notice to the SEC about the offering and theparties involved with the offering, which would be sharedwith state regulatory authorities. The measure would havepermitted an unlimited number of investors in thecrowdfunding offering and would have pre-empted statesecurities regulation of these types of offerings (except thatstates would be permitted to address fraudulent offeringsthrough their existing enforcement mechanisms). TheHouse measure also contemplated that the issuer wouldstate a target offering amount, and a third-party custodianwould withhold the proceeds of the offering until theissuer has raised 60% of the target offering amount. Theprovision also contemplated certain disclosures andquestions for investors and provided for an exemptionfrom broker-dealer registration for intermediaries involvedin an exempt crowdfunding offering.

After it was adopted, the House crowdfunding measuredrew a significant amount of criticism, with much of thatcriticism focused on a perceived lack of investorprotections. In a letter to the Senate leadership, then SECchair Mary Schapiro noted that ‘an important safeguardthat could be considered to better protect investors incrowdfunding offerings would be to provide for oversightof industry professionals that intermediate and facilitatethese offerings’ and also noted that additional informationabout companies seeking to raise capital throughcrowdfunding offerings would benefit investors.

In the Senate, an amendment to HR 3606 that wassubmitted by Senator Merkley and approved by the Senateprovided additional investor protections for exemptcrowdfunding offerings. Many of these protections presentdifficulties as market participants seek to make use of theJOBS Act crowdfunding exemption.

TITLE III OF THE JOBS ACTTitle III of the JOBS Act addresses crowdfunding byproviding an exemption from registration provided that: • The aggregate amount sold to all investors by the issuer,

including any amount sold in reliance on the

crowdfunding exemption during the 12-month periodpreceding the date of the transaction, is not more than$1.07 million.

• The aggregate amount sold to any investor by the issuer,including any amount sold in reliance on thecrowdfunding exemption during the 12-month periodpreceding the date of the transaction, does not exceed: - the greater of $2,200 or five percent of the annual

income or net worth of the investor, as applicable, ifeither the annual income or the net worth of theinvestor is less than $107,000; or

- 10% of the annual income or net worth of aninvestor, as applicable, not to exceed a maximumaggregate amount sold of $107,000, if either theannual income or net worth of the investor is equalto or more than $107,000.

• The transaction is conducted through a registeredbroker or funding portal that complies with therequirements of the exemption.

• The issuer complies with a number of specificinformational and other requirements specified underthe exemption. All of the amounts above have been adjusted for

inflation.

Requirements as to intermediariesAn exempt crowdfunding offering must be made throughan intermediary that has registered with the SEC as abroker or as a so-called funding portal. Funding portals arenot be subject to registration as a broker-dealer but aresubject to an alternative regulatory regime with oversightby the SEC and the Financial Industry RegulatoryAuthority (Finra). A funding portal is defined as anintermediary for exempt crowdfunding offerings that doesnot:• offer investment advice or recommendations;• solicit purchases, sales, or offers to buy securities offered

or displayed on its website or portal; • compensate employees, agents, or other persons for such

solicitation or based on the sale of securities displayed orreferenced on its website or portal;

• hold, manage, possess, or otherwise handle investorfunds or securities; or

• engage in other activities as the SEC may determine byrulemaking. A crowdfunding intermediary must provide specified

disclosures to investors and take other steps related to theoffering oriented toward investor protection, such as:• ensuring that all offering proceeds are only provided to

issuers when the amount equals or exceeds the targetoffering amount and allowing for cancellation of

JOBS Act Quick Start 2018 update 57

commitments to purchase in the offering;• ensuring that no investor in a 12-month period has

invested in excess of the limit described above in allissuers conducting exempt crowdfunding offerings;

• taking steps to protect privacy of information; • not compensating promoters, finders, or lead generators

for providing personal identifying information ofpersonal investors;

• prohibiting insiders from having any financial interest inan issuer using that intermediary’s services; and

• meeting any other requirements that the SEC mayprescribe.

Requirements as to issuersIssuers also must meet specific conditions in order to relyon the exemption, including making filings with the SECand providing to investors and intermediaries informationabout the issuer (including financial statements, whichwould be reviewed or audited depending on the size of thetarget offering amount), its officers, directors, and greaterthan 20% of shareholders, and risks relating to the issuerand the offering, as well specific offering information, suchas the use of proceeds for the offering, the target amountfor the offering, the deadline to reach the target offeringamount, and regular updates regarding progress towardreaching the target. A crowdfunding issuer will also besubject to reporting requirements after the offering.Securities sold in crowdfunding offerings are not restrictedsecurities, but they are subject to transfer restrictions forone year following the sale.

The SEC’s rules adopted under Title III also prohibitissuers from advertising the terms of the exempt offering,other than to provide notices directing investors to thefunding portal or broker, and require disclosure ofamounts paid to compensate solicitors promoting theoffering through the channels of the broker or fundingportal.

A purchaser in a crowdfunding offering could bring anaction against an issuer for rescission in accordance withsection 12(b) and section 13 of the Securities Act, as ifliability were created under section 12(a)(2) of theSecurities Act, in the event that there are materialmisstatements or omissions in connection with theoffering.

The crowdfunding exemption is only available fordomestic issuers that are not reporting companies underthe Exchange Act and that are not investment companies,or as the SEC otherwise determines is appropriate. Badactor disqualification provisions similar to those requiredunder Regulation A are also applicable to crowdfundingofferings.

The Title III exemption pre-empts state securities lawsby making exempt crowdfunding securities coveredsecurities; however, some state enforcement authority andnotice filing requirements are retained. State regulation offunding portals will also be pre-empted, subject to limitedenforcement and examination authority.

Proposed rulesOn October 23 2013, the SEC issued its proposedrulemaking, referred to as Regulation Crowdfunding, toimplement the crowdfunding exemption.3 The proposalacknowledged that regulation of these offerings requiresadapting disclosure-based principles and the existingapproach to broker-dealer regulation and oversight to anentirely new public offering rubric.

Regulation Crowdfunding consisted of five subpartstotaling 20 individual rules under new section 4(a)(6) ofthe Securities Act. As discussed above, Title III of theJOBS Act is quite prescriptive, so the SEC’s proposed rulesfollowed closely the statutory requirements. Nonetheless,commenters reacted quite harshly to the SEC’s proposedrules, noting that the proposed disclosure requirements,financial statement requirements, and ongoing reportingrequirements would be too burdensome especially whenconsidered in light of the small amounts that can be raisedunder Regulation Crowdfunding.

Final rulesIn October 2015, two years after the release of theproposed rules, the SEC adopted final crowdfundingrules.4 These rules became effective in May 16, 2016. TheSEC’s Form Funding Portal became effective on January29, 2016 so that entities that seek to register as fundingportals could begin the process. Below, we summarise theprincipal requirements of Regulation Crowdfunding. Rulereferences are to those under Regulation Crowdfunding.

Limit on capital raised Consistent with the statutory limitations, Rule 100(a)provides that an issuer may sell up to $1.07 million in any12-month period to investors in an offering made pursuantto the exemption. Of course, an issuer may considerconducting other exempt offerings in close proximity withits crowdfunded offering. In calculating the amounts soldfor purposes of the threshold, amounts sold by a predecessoror by an entity under common control with the issuer areaggregated with the amounts sold by the issuer.

Individual investment limitsThe SEC modified the investor limits from those includedin its proposed rules. The final rules make clear that the

58 JOBS Act Quick Start 2018 update

individual investor limit is an aggregate limit, whichapplies to all investments made by the individual over a12-month period in crowdfunded offerings and not to aspecific offering. An investor will be limited to investing:• the greater of: $2,200 or five percent of the lesser of the

investor’s annual income or net worth if either annualincome or net worth is less than $107,000; or

• ten percent of the lesser of the investor’s annual incomeor net worth, not to exceed an amount sold of $107,000,if both annual income and net worth are $107,000 ormore.As we discuss below, the issuer can rely on the

intermediary’s calculation of the investment limit;provided that the issuer does not have knowledge that theinvestor has exceeded, or would exceed, the investmentlimits as a result of participating in the issuer’s offering.

Offering through an intermediaryAn issuer is only able to engage in an offering through aregistered broker-dealer or through a funding portal, andan issuer can only use one intermediary for a particularoffering or concurrent offerings made in reliance on theexemption. The offering must be conducted online onlythrough the intermediary’s platform so that the crowd hasaccess to information, and there is a forum for an exchangeof information among potential offering participants. Aplatform is defined as ‘a program or application accessiblevia the internet or other similar electronic communicationmedium through which a registered broker or a registeredfunding portal acts as an intermediary in a transactioninvolving the offer or sale of securities in reliance onSection 4(a)(6) of the Securities Act.’

Eligible issuersThe ability to engage in crowdfunding is not available toall issuers. By statute, the following issuers cannot rely oncrowdfunding transactions under section 4(a)(6):• issuers not organised under the laws of a state or territory

of the US or the District of Columbia;• issuers already subject to the Exchange Act reporting

requirements;• investment companies as defined in the Investment

Company Act of 1940 or companies that are excludedfrom the definition of investment company underSection 3(b) or 3(c) of the Investment Company Act;and

• any issuer that the SEC, by rule or regulation,determines appropriate.The final rules also exclude:

• issuers disqualified from relying on Section 4(a)(6), orbad actors

• issuers that have sold securities in reliance on section4(a)(6) and have failed, to the extent required, to makerequired ongoing reports required by RegulationCrowdfunding during the two-year period immediatelypreceding the filing of the required new offeringstatement; and

• any issuer that is a development-stage company that hasno specific business plan or purpose, or has indicatedthat its business plan is to engage in a merger oracquisition with an unidentified company or companies.

Disclosure requirementsThe statute sets out a number of required disclosures inany Section 4(a)(6) offering. An issuer that elects to engagein a crowdfunding offering must comply with disclosurerequirements, including: an initial disclosure about theoffering on Form C, amendments to Form C to reportmaterial changes (Form C-A), periodic updates on theoffering on Form C-U and ongoing annual filings until afiling obligation is terminated. The annual filing must bemade on Form C-AR and a termination notice on FormC-TR.

Form CThe Form C would be filed with the SEC, and theintermediary would post the filing or provide a link to thefiling for investors. The Form C must include disclosuresrelating to the issuer’s business, officers, directors andcontrol persons, use of proceeds, capital structure, andfinancial results, as discussed below in more detail. Inmany respects, the Form C requirements resemble thosefor Form 1-A used in connection with Regulation Aofferings. The final Form C also includes an optionalQ&A format that issuers may elect to use to providecertain disclosures.

Basic issuer information is required, including: theentity name, the form of entity, the jurisdiction offormation, formation date, address, website, number ofemployees, the issuer’s website on which an investor canfind the issuer’s annual report, and the date by which suchreport will be made available, whether the issuer or anypredecessor previously failed to comply with the ongoingreporting requirements of Regulation Crowdfunding. Inaddition, the form must disclose certain basic informationabout the intermediary, including: the intermediary’s SECfile number and Finra CRD number and fees being paid tothe intermediary, expressed either as a dollar amount or asa percentage of the offering amount, and a description ofthe intermediary’s financial interests in the transaction andin the issuer. In addition, the form requires a narrativediscussion that addresses, among other things, the use of

JOBS Act Quick Start 2018 update 59

proceeds, the offering size, offering price, the issuer’sbusiness, a discussion of the issuer’s results of operations,management and executive compensation, beneficialownership, capital structure, related party transactions,and risks associated with an investment in the issuer’ssecurities.

Financial statement requirementsIn a change from the proposed rules, the final rules providesome accommodations with respect to financial statementrequirements depending upon the target offering size andfor first-time issuers. Based on target offering size, therequirements (updated for inflation) are as follows:• $107,000 or less: the amount of total income, taxable

income, and total tax or equivalent line items, asreported on the federal tax forms filed by the issuer forthe most recently completed year (if any), certified bythe principal executive officer of the issuer, and thefinancial statements of the issuer, also certified by theprincipal executive officer. If financial statements of theissuer are available that have either been reviewed oraudited by a public accountant independent of theissuer, then these financial statements must be providedinstead of the materials described in the precedingsentence.

• More than $107,000.01 and less than $535,000:financial statements of the issuer reviewed by a publicaccountant independent of the issuer. If financialstatements of the issuer are available that have beenaudited by a public accountant independent of theissuer, the issuer must provide those instead of thereviewed statements.

• More than $535,000 to $1.07 million: financialstatements of the issuer audited by a public accountantindependent of the issuer; provided, however, that forissuers that are first-time issuers, offerings that have atarget offering amount of more than $535,000 but notmore than $1.07 million, financial statements of theissuer reviewed by a public accountant independent ofthe issuer. If audited statements are available, those mustbe provided instead.Financial statements must be prepared in accordance

with US GAAP. Audited financial statements must beconducted in accordance either with American Institute ofCertified Public Accountants (AICPA) standards (referredto as US GAAS) or Public Company AccountingOversight Board (PCAOB) standards. These requirementsare similar to those applicable for Tier 1 offerings madeunder Regulation A. A signed audit report mustaccompany audited financial statements.

Other required filingsAn issuer is required to amend its Form C disclosures usingForm C/A for any updates or material changes. An issueralso is required to file progress updates with the SEC on aForm C-U. An issuer that completes a crowdfundedoffering must file with the SEC and post on its website anannual report on Form C-AR along with financialstatements of the issuer certified by its principal executiveofficer within 120 days of the end of the issuer’s fiscal year.The annual report is required to contain the sameinformation required in the offering statement, asdescribed above.

Termination of reportingAn issuer must file with the SEC a Form C-TR toterminate its reporting obligation within five days of thedate on which it becomes eligible to do so. An issuer canterminate its ongoing reporting requirements upon theearliest to occur of the following:• The issuer is required to file reports under the Exchange

Act.• The issuer has filed at least one annual report and has

fewer than 300 holders of record.• The issuer has filed at least three annual reports and has

total assets that do not exceed $10 million.• The issuer or another party purchases or repurchases all

of the securities issued pursuant to section 4(a)(6),including any payment in full of debt securities or anycomplete redemption of redeemable securities.

• The issuer liquidates or dissolves in accordance withstate law.

Offering amount and offering mechanicsIn connection with a proposed offering, the final rulescontemplate that the issuer include in its disclosures adiscussion of the target or maximum amount to be raised,and a discussion of the subscription or offering process.The description of the subscription process must disclosethat investors can cancel their investment up to 48 hoursprior to the deadline identified in the offering materials,but if an investor does not cancel the investment, then theinvestor’s funds will be released to the issuer upon closing.The intermediary will notify investors when the targetoffering amount has been met, and if the target offeringamount is not met, then no securities will be sold, and allfunds will be returned to investors. If the target offeringamount is met prior to the deadline identified in theoffering materials, the issuer must provide five days’advance notice before closing the offering early. If aninvestor does not reconfirm the investment commitmentafter a material change is made to the offering and

60 JOBS Act Quick Start 2018 update

disclosed on Form C-A, the investment will be cancelled,and the issuer must return the funds to the investor.

Types of securities offeredThe final rules do not limit the types of securities that maybe offered in reliance on section 4(a)(6). An issuer mayoffer debt securities in a crowdfunded offering. An offeringof debt securities is exempt from the requirement toqualify an indenture under the Trust Indenture Act of1939, as amended (the Trust Indenture Act) given that anyoffering exempted by section 4 of the Securities Act isexempt from the Trust Indenture Act requirements.However, the final rules do not include a specificexemption from Trust Indenture Act requirements forcrowdfunded offerings.

Status of securitiesSecurities sold in a crowdfunded offering pursuant to theexemption would be subject to transfer restrictions.Pursuant to Rule 501, securities issued in a crowdfundedoffering cannot be transferred by a purchaser for one yearfrom the date of purchase, except for transfers to: theissuer; an accredited investor; a family member of thepurchaser or in estate type transfers; and third parties in anSEC-registered offering. The statute exempts securitiessold in section 4(a)(6) offerings from the Exchange Actholder of record count for the purposes of determining ifregistration of a class of equity securities is required undersection 12(g) of the Exchange Act. An issuer will berequired to establish a means for tracking its shareholders.This may require an early-stage company to engage theservices of a transfer agent or other similar service providerin order to monitor its security holders.

IntegrationAn offering made pursuant to the section 4(a)(6)exemption will not be integrated with another exemptoffering that precedes the crowdfunded offering or thattakes place concurrently or subsequently. The issuer mustensure that it has satisfied all of the conditions for theexemption that it is claiming for each such offering. If theissuer is conducting a Rule 506(c) offering (using generalsolicitation), it must ensure that the Rule 506(c) offereeswere not solicited by means of the communications usedfor the crowdfunded offering.

Restrictions on advertising and promotionThe final rules limit the ability of the issuer, as well as theability of others acting on the issuer’s behalf, to advertise.Rule 204 sets out the information that may be included inan offering notice. The adopting release notes that this

notice is intended to be similar to tombstone adspermitted under Securities Act Rule 134. The issuer wouldbe able to communicate with potential crowdfundinginvestors if the communications occur through theplatform; however, it should be clear to potential investorswhich platform communications are being made by theissuer or on the issuer’s behalf. The final rules do not limitan issuer from being able to continue to engage in regularbusiness communications so long as the issuer does notdisclose information about the offering, except aspermitted in an offering notice. However, the final rules donot contain an express safe harbor for regularly releasedbusiness information.

Promoter compensationRule 205 prohibits an issuer from compensating, orcommitting to compensate, directly or indirectly, a personfor advertising or promoting a section 4(a)(6) offeringthrough the intermediary’s platform, unless the issuer takesreasonable steps to ensure that the person clearly disclosesthe receipt (past and prospective) of compensation eachtime that such person makes a promotionalcommunication. A founder or employee of the issuer thatengages in promotional activities on the issuer’s behalfthrough the intermediary’s platform would be required todisclose in each posting that he or she is engaging in thoseactivities on the issuer’s behalf.

IntermediariesTitle III of the JOBS Act provides that a crowdfundedoffering must be made through an intermediary that iseither a registered broker-dealer or a funding portal. Theintermediary is intended to function as a gatekeeper and,in this role, protect investors from fraud. The SEC’s finalrules establish a regulatory framework for theseintermediaries. As discussed below, in the case of fundingportals, the regulatory framework is a scaled back versionof the framework applicable to broker-dealers. We discussthe final rules in the sequence of an offering and thenprovide an overview of the registration, compliance, andother requirements applicable to intermediaries.

Conducting a crowdfunded offeringAs discussed above, the final rules require that an offeringbe made only through one intermediary.

Financial interests in issuerRule 300 prohibits directors, officers, or partners (orothers having a similar status or performing a similarfunction) of an intermediary from having any financialinterest in an issuer using its services and prohibits such

JOBS Act Quick Start 2018 update 61

persons from receiving a financial interest in an issuer ascompensation for the service provided to or for the benefitof the issuer in connection with the offering. Anintermediary cannot have a financial interest in an issuerthat is using the intermediary’s platform, unless:• The intermediary receives the financial interest from the

issuer as offering compensation.• The financial interest consists of securities of the same

class and having the same terms as those sold in theoffering. A financial interest in an issuer means a direct or indirect

ownership of, or economic interest in, any class of theissuer’s securities.

Measures to reduce risk of fraudUnder Rule 301, an intermediary must have a reasonablebasis to believe that the issuer is in compliance withrelevant regulations and has an established means to keepaccurate records of holders of the securities it offers. Anintermediary could reasonably rely on the issuer’srepresentations, absent knowledge or other informationthat would suggest that the representations are not true.

An intermediary must deny access to an issuer if it has areasonable belief that the issuer or its offering wouldpresent a potential for fraud. An intermediary would berequired to deny access to its platform to an issuer if theintermediary has a reasonable belief that the issuer, or anyof its directors, officers or 20% of its beneficial owners issubject to a disqualification under Rule 503. Anintermediary must conduct a background and securitiesenforcement regulatory history check on each issuer whosesecurities are to be offered by the intermediary, as well ason each of its officers, directors (or any person occupyinga similar status or performing a similar function), and 20%of its beneficial owners.

Account openingUnder Rule 302, no intermediary or associated person mayaccept an investment commitment until the investor opensan account with the intermediary and the intermediaryobtains consent to electronic delivery of materials. Anintermediary is required to deliver certain information toeach investor, including educational materials, byelectronic message with links to information posted on theintermediary’s website.

Educational materialsRule 302 requires that, in connection with establishing anaccount, an intermediary deliver educational materials inplain English. Any revised materials must be madeavailable to all investors before accepting any additional

investment commitments or effecting any furthercrowdfunded transactions. The rule sets out the topics thatmust be addressed in the educational materials. Anintermediary also is required to inform investors thatdisclosure is required regarding any past or prospectivecompensation paid to a promoter. An intermediary alsomust disclose the compensation it will receive inconnection with crowdfunded offerings.

Issuer informationUnder Rule 303, an intermediary must make available tothe SEC and potential investors, not later than 21 daysprior to the first day on which securities are sold to anyinvestor, any information provided by the issuer underRules 201 and 203(a). The information must be madepublicly available on the intermediary’s platform in amanner that reasonably permits a person accessing theplatform to save, download, or store the information; thisinformation must be made publicly available on theintermediary’s platform for a minimum of 21 days beforeany securities are sold in the offering, during which timethe intermediary may accept investment commitments;and this information, including any additionalinformation provided by the issuer, must remain publiclyavailable on the intermediary’s platform until the offer andsale is completed or cancelled. An intermediary cannotrequire any person to establish an account with theintermediary in order to receive this information.

Investor qualificationsSecurities Act section 4A(a)(8) imposes an obligation onintermediaries to make sure no investor exceeds thestatutory investment limitations. The final rulesimplement this requirement by providing that, beforepermitting an investor to make an investmentcommitment on its platform, an intermediary must have areasonable basis to believe that the investor satisfies theinvestment limitations discussed above. The final rulesallow reasonable reliance on an investor’s representation tothis effect.

Investor’s acknowledgment of risksSecurities Act section 4A(a)(4) requires an intermediary toensure that each investor reviews the educational materials,positively affirms that the investor understands that he orshe is risking the loss of the entire investment and that theinvestor could bear such a loss, and answer questionsdemonstrating an understanding of the level of riskinvolved in startups. As discussed above, educationalmaterials must be provided at the account opening.

62 JOBS Act Quick Start 2018 update

Rule 303 requires that an intermediary, each time beforeaccepting an investment commitment, obtain from theinvestor a representation that the investor has reviewed theintermediary’s educational materials, and understands thatthe entire investment may be lost and can bear the risk ofloss. The intermediary also must ensure, each time beforeaccepting an investment commitment, that each investoranswers questions demonstrating their understanding thatthere are restrictions on the investor’s ability to cancel aninvestment commitment and obtain a return of his or herinvestment, that it may be difficult for the investor to resellthe securities, and that the investor should not invest anyfunds in a crowdfunding offering unless he or she canafford to lose the entire amount of his or her investment.

Communication channelsRule 303 requires an intermediary to provide, on its platform,channels through which investors can communicate with oneanother and with representatives of the issuer about offeringsmade available on the intermediary’s platform, subject tocertain conditions. This is intended to provide a centralisedand transparent means for members of the public to sharetheir views and to communicate with the issuer. Theintermediary cannot participate in the communications;however, the intermediary can set rules regarding the postingsor remove postings that use offensive language.Communications should be available for public viewing, butthe intermediary would only be able to permit those personswho have opened accounts with it to post comments. Witheach post, a person must disclose whether such person is apromoter or affiliate of the issuer and whether it has been orwill be compensated. The intermediary must keep records ofthese communications.

Notice of investment commitmentAn intermediary, upon receipt of an investmentcommitment from an investor, must promptly give or sendto the investor a notification disclosing: the dollar amountof the commitment, the price of the securities (if known),the name of the issuer, and the date and time by which theinvestor may cancel the investment commitment.Notification would be required to be provided by email orother electronic media and to be documented inaccordance with applicable recordkeeping rules.

Maintenance and transmission of fundsSecurities Act section 4A(a)(7) requires that anintermediary ‘ensure that all offering proceeds are onlyprovided to the issuer when the aggregate capital raisedfrom all investors is equal to or greater than a targetoffering amount.’ An intermediary that is a registered

broker must comply with established requirements underExchange Act Rule 15c2-4 for the maintenance andtransmission of investor funds.Investor funds must be heldin escrow until the specified contingency occurs (ie, thetargeted amount or the minimum amount is raised) andthen the funds would be promptly transmitted to a bank,which has agreed in writing to hold such funds in escrowfor the investors and to transmit or return such fundsdirectly to the issuer or to investors, as the case may be.Proceeds are to be transmitted to the issuer only if thetarget offering amount is met or exceeded.

Because a funding portal cannot receive or handle anyfunds, it would be required to direct investors to transmitmoney or other consideration directly to a qualified thirdparty (a registered broker-dealer, a bank, or a credit union)that serves as an escrow agent. A funding portal mustpromptly direct transmission of funds from the qualifiedthird party to the issuer when the aggregate amount ofinvestment commitments from all investors is equal to orgreater than the target amount of the offering and thecancellation period for each investor has expired, but noearlier than 21 days after the date on which theintermediary makes publicly available on its platform theinformation required to be provided about the issuer andthe offering. A funding portal must direct the return offunds to an investor when an investment commitment hasbeen cancelled or the offering is terminated or cancelled.

Confirmation of transactionAt or before the completion of a transaction, theintermediary is required to give or send each investor anotification, similar to a confirmation, disclosing: thetransaction date, the type of security, the price and numberof securities purchased, the number of securities sold bythe issuer in the transaction, the price at which thesecurities were sold, certain specified terms of the security(for example, if it is a debt or callable security), and thesource and amount of any remuneration received or to bereceived by the intermediary in connection with thetransaction, whether from the issuer or other persons. Thisnotification must be by email or other electronic mediaand subject to recordkeeping rules.

Completion of offerings, cancellations andreconfirmationsInvestors have an unconditional right to cancel aninvestment commitment for any reason until 48 hoursprior to the deadline identified in the issuer’s offeringmaterials. Thereafter, an investor cannot cancel anyinvestment commitments made within the final 48 hours(except in the event of a material change to the offering, as

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discussed below). If an issuer reaches the target offering amount prior to

the deadline identified in its offering materials, it mayclose the offering once the target offering amount isreached, provided that: the offering will have remainedopen for a minimum of 21 days; the intermediary providesnotice about the new offering deadline at least five businessdays prior to the new offering deadline; investors are giventhe opportunity to reconsider their investment decisionand to cancel their investment commitment until 48 hoursprior to the new offering deadline; and at the time of thenew offering deadline, the issuer continues to meet orexceed the target offering amount.

If there is a material change to the terms of the offering,or the information provided by the issuer regarding theoffering, the intermediary must give or send to anypotential investors who have made investmentcommitments notice of the material change. This muststate that the investor’s investment commitment will becancelled unless the investor reconfirms his or hercommitment within five business days of receipt of thenotice. If the investor fails to reconfirm his or herinvestment within those five business days, theintermediary, within five business days thereafter, mustprovide or send the investor a notification disclosing thatthe investment commitment was cancelled, the reason forthe cancellation and the refund amount that the investorshould expect to receive, and direct the refund of investorfunds.

Finally, if an issuer does not complete an offeringbecause the target is not reached or the issuer decides toterminate the offering, the intermediary, within fivebusiness days, must give or send to each investor whomade an investment commitment a notificationdisclosing: the cancellation of the offering, the reason forthe cancellation, and the refund amount that the investorshould expect to receive. It must also direct the refund ofinvestor funds and prevent investors from makinginvestment commitments with respect to that offering onits platform.

Intermediary registration and other requirementsAn intermediary must be registered as a broker-dealer withthe SEC under section 15(b) of the Exchange Act or afunding portal registered with the SEC in accordance withthe requirements of Rule 400. They must also be amember of a national securities association registeredunder section 15A of the Exchange Act, which is Finra.

Additional requirements on funding portalsThe SEC has established a streamlined registration processunder which a funding portal would register with the SECby filing a form, Form Funding Portal, with informationconsistent with, but less extensive than, the informationrequired for broker-dealers on Form BD. A funding portalregisters by completing a Form Funding Portal, whichincludes information concerning: the funding portal’sprincipal place of business, legal organisation, anddisciplinary history, if any; business activities, includingthe types of compensation the funding portal has receivedand disclosure of its disciplinary history, if any; Finramembership with any other registered national securitiesassociation; and the funding portal’s website address(es) orother means of access. A funding portal’s registrationbecomes effective the later of: (1) 30 calendar days after thedate that the registration is received by the SEC; or (2) thedate the funding portal is approved for membership inFinra. In order to promote transparency, all such FormsFunding Portal will be available publicly.

Non-US funding portalsEntities domiciled or organided outside of the US (non-resident funding portals) are able to act as funding portals;however, they are subject to additional requirements.There must be an information-sharing arrangement inplace between the SEC and the competent regulator in thejurisdiction under the laws of which the nonresidentfunding portal is organised, or where it has its principalplace of business. In addition, a nonresident fundingportal would be required to have an agent for service ofprocess in the US, as well as an opinion of counseladdressing the ability of the applicant to provide the SECand any national securities association of which it is amember with prompt access to its books and records, andto submit to onsite inspection and examination by theSEC and the relevant national securities association. Thenonresident funding portal also would be required toconsent that service of any civil action brought by, ornotice of any proceeding before, the SEC or any nationalsecurities association of which it is a member, inconnection with the funding portal’s investment-relatedbusiness, may be given by registered or certified mail to thenonresident funding portal’s contact person at the mainaddress or mailing address indicated on the form.

Exemptions from broker-dealer registration and safe harboursBut for the exemption from registration for fundingportals that Congress directed in the JOBS Act, a fundingportal would be required to register as a broker under theExchange Act. The SEC’s final rules exempt an

64 JOBS Act Quick Start 2018 update

intermediary that is registered as a funding portal from therequirement to register as a broker-dealer under theExchange Act, although a funding portal would remainsubject to the full range of the SEC’s examination andenforcement authority. A funding portal cannot:• offer investment advice or recommendations;• solicit purchases, sales, or offers to buy the securities

displayed on its platform;• compensate employees, agents, or other persons for such

solicitations based on the sale of securities displayed orreferenced on its platform; or hold, manage, possess, orotherwise handle investor funds or securities.In addition, the final rules set out certain permitted

activities of a funding portal, such as: providing a channelfor investors to communicate about an offering,highlighting particular offerings made through its fundingportal based on objective criteria, advising issuers on theoffering structure, paying for referrals subject to certainconditions, entering into arrangements with broker-dealers, and limiting the offerings made through itsplatforms based on particular criteria without risk of beingdeemed to provide investment advice.

Compliance policies and proceduresA funding portal is required to implement written policiesand procedures designed to achieve compliance withapplicable regulations. A funding portal will be required tocomply with the same privacy rules (Regulation S-P,Regulation S-AM, and Regulation S-ID) applicable tobroker-dealers. A funding portal is subject to the SEC’sexamination and inspection authority. Also, a fundingportal is subject to recordkeeping requirements in order toensure that there is an audit trail for all crowdfundingtransactions and communications.

Bad actor provisionsRule 503 sets out bad actor disqualification provisions.The Section 4(a)(6) exemption is not available for a sale ofsecurities if the issuer, a predecessor of the issuer, anaffiliated issuer, any director, officer, general partner ormanaging member of the issuer, a beneficial owner of 20%or more of the issuer’s outstanding voting equity securities,any promoter or solicitor, or any general partner, director,officer, or managing member of any such solicitor issubject to a statutory disqualification.

Finra rulesAs discussed above, intermediaries must be registered withFinra. Final Finra rules (Rules 100, 110, 200, 300, 800,900, and 1200), referred to as the Funding Portal Rulesbecame effective January 29 2016.5 The rules reflect an

attempt to streamline regulatory requirements in light ofthe limited scope of activities of a funding portal whilemaintaining investor protection provisions. The Finrarules are summarised below.• Rule 100 provides that funding portals and their

associated persons are subject to Finra’s bylaws.• Rule 110 outlines the membership application process

(MAP), which is based on the NASD’s Rule 1010 Seriesbut is abridged. Finra must make a decision onmembership within 60 days of the filing of amembership application (Form FP-NMA). Rule 110establishes standards for membership, including: (a)ability to comply with all applicable laws and regulationsof the SEC and Finra; (b) contractual arrangementssufficient to initiate operations; (c) supervisory systemsthat are sufficient; (d) evidence of direct and indirectfunding; and (e) a recordkeeping system. Rule 110permits membership interviews to take place by video,streamline the appeals process, and narrow the eventsinvolving a change of control of the member that requireFinra approval. Rule 110 also sets out a fidelity bondrequirement.

• Rule 200 requires funding portals to observe highstandards of commercial honour and just and equitableprinciples of trade. Rule 200(b) prohibits a portal fromeffecting any transaction in, or inducing the purchase orsale of, any security by means of, or by aiding orabetting, any manipulative or fraudulent device. Rule200(c) tracks Finra Rule 2210 on advertising andrequires that funding portal communications be fair andbalanced and prohibits the use of false and misleadingstatements and statements that predict futureperformance.

• Rule 300 requires funding portals to: establish writtenpolicies and procedures and supervisory systemsreasonably designed to achieve compliance with allapplicable rules.

• Rule 800 provides that information about fundingportals and associated persons provided to Finra,including information about disqualifying events, willbe made public.

• Rule 900 addresses codes of procedure, including theprocess for eligibility proceedings for a person to remainassociated with a portal despite the existence of astatutory disqualification.

• Rule 1200 addresses arbitration procedures for customerand industry disputes.

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66 JOBS Act Quick Start 2018 update

Appendix AINTERMEDIARY COMPARISON

Regulatory environment

Conduct of business

Costs

Availability ofcrowdfunding exemption

Broker-dealer

Well-established SEC and Finra rulesregarding registration and ongoing obligations

Handling customer funds and securities,making investment recommendations,compensated for sales of securities etc

Significant registration costs, as well asongoing compliance costs. A broker-dealermay receive transaction-based compensation

Available for issuers using broker-dealer’splatform

Funding portal

New SEC and Finra rules regardingregistration and ongoing obligations

Restrictions on activities traditionallyconsidered to be those activities characteristicof broker-dealer status

Less burdensome ongoing obligations, thuslower costs involved. Funding portal cannotreceive transaction-based compensation

Available for issuers using funding portal’splatform

JOBS Act Quick Start 2018 update 67

1 SEC Release No. 33-9216 (June 8 2011).2 Sustainable Economies Law Center, Petition for

Rulemaking, Petition No. 4 -605, available atwww.sec.gov/rules/petitions/2010/petn4-605.pdf

3 SEC Release No. 33-9470 (October 23 2013).4 SEC Release No. 33-9974 (October 30 2015).5 Finra Regulatory Notice 16-06 (January 2016).

ENDNOTES

As we discuss in Chapter 4, in order to raisecapital most issuers rely on exemptions fromregistration adopted pursuant to section 4 ofthe Securities Act. There are, however, a

number of other exemptions from registration that may beavailable to issuers. Section 3(b) of the Securities Actauthorises the SEC to adopt rules and regulationsexempting securities from registration if the SEC finds thatregistration ‘is not necessary in the public interest and forthe protection of investors by reason of the small amountinvolved or the limited character of the public offering.’One of the exemptions that the SEC adopted pursuant tosection 3(b) of the Securities Act is Regulation A.1

Historically, pursuant to Regulation A, issuers that werenot SEC-reporting companies were able to raise up to $5million in offering proceeds through sales of theirsecurities in interstate offerings without complying withthe registration requirements of the Securities Act.2

Regulation A also provided controlling stockholders, aswell as non-affiliates, an opportunity to sell theirunregistered securities. A Regulation A offering is not aprivate offering; in fact, a Regulation A offering is oftenreferred to as a mini-registration. Regulation Aincorporated a number of conditions that in certainrespects resembled the registration requirements of section5 of the Securities Act. For example, in order for an issuerto avail itself of the exemption, it must: prepare and filewith the SEC an offering statement for the SEC’s reviewand approval;deliver the offering statement to prospectiveinvestors; and file periodic reports of sales after completionof the offering.

The requirements for the offering statement were not asonerous as those applicable to a section 10 prospectus.However, due to the low offering threshold, and without acorresponding state blue sky exemption for securitiesoffered in Regulation A offerings, prior to the enactmentof the JOBS Act, Regulation A did not provide a viablecapital-raising approach. Rule 506 of Regulation D, whichhas no offering threshold, became the most commonlyused exemption from registration.

Regulation A reform had been considered a number oftimes over the course of the last few years. However, it was

not until 2011 and 2012 that legislative efforts to amendthe offering exemption took shape. As discussed below,these legislative proposals, if passed, would have raised theoffering threshold and modernised existing Regulation A.Ultimately, however, many of these concepts wereincorporated into Title IV of the JOBS Act, titled SmallCompany Capital Formation. Title IV of the JOBS Actamends section 3(b) of the Securities Act, increasing thedollar threshold for a Regulation A-style offering, but didnot actually amend then existing Regulation A.

History of Regulation A and Regulation AreformRegulation A was enacted during the Great Depression topromote capital formation for small businesses. One of theSEC’s primary purposes in adopting Regulation A was toprovide a simple and efficient process by which smallbusinesses could raise limited amounts of capital, whileensuring that investors had access to current information.When originally enacted, section 3(b) authorised the SECto exempt only small issues involving offerings of$100,000 or less. Over time, this dollar threshold wasadjusted. In 1980, the small issue exemption was increasedby Congress to $5 million.3 The SEC did not actuallyincrease the threshold until 1992, however.4 In July 1992,the SEC adopted a number of small business-relatedinitiatives that included significant amendments toRegulation A.5 These changes were intended to facilitate‘access to the public market for start-up and developingcompanies and...[to reduce] the costs for small businessesto undertake to have their securities traded in the publicmarkets.’6 The amendments increased the thresholdamount to $5 million in any 12-month period, includingno more than $1.5 million in non-issuer resales. Also, theamendments permitted issuers to use a simplifieddisclosure document and to test the waters beforepreparing the mandated offering circular. The SEC alsoextended the safe harbour provisions for forward-lookingstatements to statements made in a Regulation A offeringcircular or any written material submitted to the SEC.Finally, the SEC clarified that an issuer would not beprecluded from relying on the exemption if it had

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CHAPTER 6

Regulation A+

endeavoured in good faith to comply with the terms,conditions, and requirements of Regulation A.Theavailability of Regulation A was conditioned upon meetingcertain substantive and procedural requirements.7

There had been various efforts to amend Regulation A.Commentators noted that, while over the years theoffering threshold had been increased to $5 million, thedollar amount had not kept pace with changes related tocapital formation. In 2009, the recommendation to raisethe dollar threshold made it into the final report of theSEC’s Government-Business Forum on Small BusinessCapital Formation.8 Increasing the Regulation A dollarthreshold was also discussed at the SEC’s Government-Business Forum on Small Business Capital Formation in2010.9

Statistics demonstrated that the offering threshold ofRegulation A was too low and did not align with marketrealities.10 In connection with a hearing before the HouseCommittee on Financial Services in December 2010,regarding increasing the Regulation A offering thresholdfrom $5 million to $30 million, William R Hambrecht,chairman and CEO of WR Hambrecht + Co, stated that,‘according to public records, since 2005 there have onlybeen 153 Regulation A filings and of those 153, anastoundingly low number of 13 have actually priced.’11

Following the financial crisis, concerns about theavailability of capital for smaller, emerging companiesintensified, which led, in March 2011, to the introductionof legislation that would have increased the Regulation Aoffering threshold, titled the Small Company CapitalFormation Act.12 In introducing the proposed legislation,Schweikert, vice-chairman of the House Financial ServicesSubcommittee on Capital Markets and GovernmentSponsored Enterprises, said: ‘Taking a small businesspublic is an important, but expensive process that requiresmillions in underwriting costs...Raising the Regulation Athreshold to $50 million is one way to lower those costsand promote economic growth and job creation. At a timewhen so many small businesses are in need of capital, thisis a common sense proposal that will make our capitalmarkets more vibrant and competitive.’13

As discussed in the Introduction, the Small CompanyCapital Formation Act was part of a broader effort toaddress US job creation and economic competitivenessand to amend or repeal certain sections of the Dodd-FrankWall Street Reform and Consumer Protection Act.14

Industry representatives testified in support of theproposed Regulation A reform,15 as exemplified bytestimony from David Weild, then a senior adviser ofGrant Thornton, who provided an analysis of thedevastating decline in numbers of small IPOs,

demonstrating that small businesses and entrepreneurscould not access the capital they needed to grow and createjobs.16 Weild applauded the Small Company CapitalFormation Act as the beginning of an initiative to revivethe small IPO market. In June 2011, the HouseCommittee on Financial Services approved an amendmentto the Small Company Capital Formation Act, whichprovided that ‘the Commission shall require an issuer tofile audited financial statements with the Commissionannually’ (our emphasis).17 Title IV of the JOBS Actincorporates this reporting requirement in the context ofthe section 3(b)(2) exemption that it references. Thelegislation was met with strong bipartisan support. InNovember 2011, the House of Representativesoverwhelmingly approved the Small Company CapitalFormation Act of 2011 by a vote of 421 to one.Companion legislation was introduced in the Senate inSeptember 2011 by Senators Jon Tester and Pat Toomey.But for a few minor differences, the Senate bill wassubstantially similar to the Small Company CapitalFormation Act. Ultimately, the changes that werecontemplated in these bills were incorporated into theJOBS Act, albeit with some modifications.

It is important to note that, throughout the precedingfew years, when commentators were considering amendingRegulation A to increase the dollar threshold and addressstate blue sky matters, the proposals had as theirunderlying premise that smaller issuers that were not SEC-reporting companies would be able to conduct one ormore Regulation A offerings and elect either to remainnon-reporting issuers, or voluntarily seek to have theirsecurities listed and quoted on a national securitiesexchange (thereby becoming SEC-reporting companies)and use Regulation A as an alternative to a traditional IPO.The notion of an IPO on-ramp, or scaled approach toIPOs for emerging growth companies, had not yet beenproposed.

Title IV of the JOBS ActTitle IV of the JOBS Act does not amend existingRegulation A. Instead, section 401 of the JOBS Actamends section 3(b) of the Securities Act by adopting anew section (b).

Pursuant to the new section 3(b)(2), the SEC isauthorised to promulgate rules or regulations creating anexemption that is substantially similar to the existingRegulation A. An issuer would be able to offer and sell upto $50 million in securities within a 12-month period inreliance on the exemption. The issuer may offer equitysecurities, debt securities, and debt securities convertible orexchangeable for equity interests, including any guarantees

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of such securities. The securities sold pursuant to theexemption will be offered and sold publicly (withoutrestrictions on the use of general solicitation or generaladvertising) and will not be considered restricted securities.The issuer may test the waters or solicit interest in theoffering before filing any offering statement with the SEC,subject to any additional conditions or requirements thatmay be imposed by the SEC. The civil liability provisionin section 12(a)(2) of the Securities Act applies to anyperson offering or selling such securities.

The securities will be considered covered securities forpurposes of the National Securities Market ImprovementAct of 1996 (Nsmia), (and not subject to state securitiesreview,) if: the securities are offered and sold on a nationalsecurities exchange; or the securities are offered or sold toa qualified purchaser as defined under the Securities Act.18

These provisions are more limited than those originallycontained in the standalone Regulation A legislation.During consideration of the Regulation A legislation, itbecame clear that perhaps the only significant source ofcontroversy regarding modernising Regulation A related tostate blue sky qualification. State securities regulators,through the North American Securities AdministratorsAssociation (Nasaa), expressed concerns about thepotential for fraud and abuse related to offerings for smallcompanies, including offerings completed pursuant toRegulation A. Nasaa opposed certain aspects of theproposals to modernise the regulation of these offeringsthat would involve broader state blue sky pre-emption.19

The SEC will require that the issuer file audited financialstatements with the SEC annually. The SEC may imposeother terms, conditions, or requirements deemed necessaryfor investor protection, including a requirement that theissuer prepare and file electronically with the SEC anddistribute to prospective investors an offering statementand any related documents, including a description of theissuer’s business and financial condition, its corporategovernance principles, the intended uses of proceeds, andother appropriate matters. The SEC also may require anissuer that relies on the exemption to make available toinvestors and file with the SEC periodic disclosures. Thebad actor disqualification provisions applicable for theexemption shall be substantially similar to thedisqualification provisions contained in the regulationsadopted pursuant to section 926 of the Dodd-Frank Act(which looks to the bad actor disqualification provisions incurrent Regulation A).

Not later than two years after enactment and every twoyears thereafter, the SEC shall review the offering thresholdand report to the Committee on Financial Services of theHouse of Representatives and the Committee on Banking,

Housing, and Urban Affairs of the Senate on its reasons fornot increasing the dollar amount.

Required study on blue sky lawsSection 402 of the JOBS Act requires that the ComptrollerGeneral must conduct a study of the impact of state bluesky laws on offerings made under Regulation A. Withinthree months of enactment of the Act, the ComptrollerGeneral must deliver the report to the Committee onFinancial Services of the House of Representatives and theCommittee on Banking, Housing, and Urban Affairs ofthe Senate. The study titled Factors that May Affect Trendsin Regulation A Offerings was delivered in July 2012.20

The study notes that there are a number of factors thatcontributed to the lack of utility of the Regulation Aexemption, and highlighted the time and expenseassociated with state blue sky compliance. The studyconcluded that without pre-emption of the state blue skyrequirements, Regulation D would continue to be used infavour of Regulation A.

Proposed rulesIn December 2013, the SEC proposed rules to carry outthe rulemaking mandate of Title IV of the JOBS Act. Theproposed rules both retained and modernised theframework of current Regulation A by expanding it intotwo tiers based on offering amount. Generally, theproposed rules were well received and commentatorsfocused principally on some of the financial statement andongoing reporting requirements. In addition, the SEC’sproposed rules fueled a debate among regulators, marketparticipants, and commentators regarding the pre-emptionof state blue sky requirements for Tier 2 Regulation Aofferings, and whether such pre-emption would hurtinvestors or is necessary to ensure the widespread use of theoffering exemption. On one hand, commentatorsexpressed concern that for Regulation A to be a workableexemption, it must attract issuers that might otherwisechoose more opaque exemptions for their capital-raisingneeds. This may include Rule 506 offerings to accreditedinvestors where there are no disclosure requirements, noinvestment limits, and no ongoing reporting obligations.In contrast, Tier 2 Regulation A offerings provideenhanced investor protections. Furthermore, even withcoordinated state review, an issuer faced with a range ofcapital-raising alternatives would not choose a Tier 2Regulation A offering if state review were necessary. Onthe other hand, consumer protection advocates noted thatwithout state review of Tier 2 Regulation A offerings,investors will lose an important safeguard. In addition,Nasaa and certain other commentators asserted that such

70 JOBS Act Quick Start 2018 update

pre-emption arguably contravened the intent of Congressto have section 3(b)(2) apply to qualified purchasers(defined on the basis of sophistication and financialwherewithal and not simply the type of transaction beingconducted) and securities offered and sold on a nationalsecurities exchange (which are already exempt from bluesky laws).21

Final rulesIn March 2015, the SEC voted unanimously to adopt finalrules to implement the rulemaking mandate of Title IV ofthe JOBS Act by adopting amendments to Regulation A.The final rules provide an exemption for US and Canadiancompanies that are not required to file reports under theExchange Act to raise up to $50 million in a 12-monthperiod. The final rules create two tiers: Tier 1 for smallerofferings raising up to $20 million in any 12-monthperiod; and Tier 2 for offerings raising up to $50 million.The rules also make the exemption available, subject tolimitations on the amount, for the sale of securities byexisting stockholders. The rules modernise the existingframework under Regulation A by, among other things,requiring that disclosure documents be filed on EDGAR,allowing an issuer to make a confidential submission withthe SEC, permitting certain test-the-waterscommunications, and disqualifying bad actors. The finalrules impose different disclosure requirements for Tier 1and Tier 2 offerings, with more disclosure required for Tier2 offerings, including audited financial statements. Tier 1offerings will be subject to both SEC and state blue skypre-sale review. Tier 2 offerings are subject to SEC, but notstate blue sky pre-sale review; however, investors in Tier 2offerings are subject to investment limits (except whensecurities are sold to accredited investors or are listed on anational securities exchange) and Tier 2 issuers are requiredto comply with periodic filing requirements, whichinclude a requirement to file current reports upon theoccurrence of certain events, semi-annual reports andannual reports. The final rules also provide a means for anissuer in a Tier 2 offering to concurrently list a class ofsecurities on a national exchange through a short-formForm 8-A, without requiring the filing of a separateregistration statement on Form 10. The final rules becameeffective on June 19 2015.

Eligible issuersRegulation A is available to issuers organised in and havingtheir principal place of business in the US or Canada.Certain issuers are ineligible to offer or sell securities underRegulation A, including: an issuer that is an SEC-reportingcompany; a blank check company; any investment

company registered or required to be registered under theInvestment Company Act (this includes businessdevelopment companies); and any entity issuing fractionalundivided interests in oil or gas rights, or similar interestsin other mineral rights. The exemption also is not availableto: issuers that have not filed with the SEC the ongoingreports required by Regulation A during the two yearsimmediately preceding the filing of a new offeringstatement; issuers that have had their registration revokedpursuant to an Exchange Act section 12(j) order that wasentered into within five years before the filing of theoffering statement; and certain bad actors.

Eligible securitiesThe securities that may be offered under Regulation A arelimited to equity securities including warrants, debtsecurities, and debt securities convertible into orexchangeable into equity interests, including anyguarantees of such securities. The final rule excludes asset-backed securities.

Offering limitationsAs noted above, an issuer can choose a Tier 1 or a Tier 2offering. Under Tier 1, an issuer may offer and sell up to$20 million in a 12-month period, of which up to $6million may constitute secondary sales (except as notedbelow). Under Tier 2, an issuer may offer and sell up to$50 million in a 12-month period, of which up to $15million may constitute secondary sales (except as notedbelow). In the issuer’s initial Regulation A offering and anysubsequent Regulation A offering in the following 12months, the selling securityholder component cannotexceed 30% of the aggregate offering. In addition, the finalrules distinguish between sales by affiliates and sales bynon-affiliates. Following the expiration of the first yearfollowing an issuer’s initial qualification of a Regulation Aoffering statement, the limit on secondary sales falls awayfor non-affiliates only.

Investment limitationTo address potential investor protection concerns, the finalrules impose an investment limit for Tier 2 offerings. Theinvestment limit does not apply to accredited investors anddoes not apply if the securities are to be listed on a nationalsecurities exchange at the consummation of the offering;otherwise a non-accredited natural person is subject to aninvestment limit and must limit purchases to no more than10% of the greater of the investor’s annual income and networth, determined as provided in Rule 501 of RegulationD (for non-accredited, non-natural persons, the 10% limitis based on annual revenues and net assets).

JOBS Act Quick Start 2018 update 71

Integration of offeringsA Regulation A offering will not be integrated with (1)prior offers or sales of securities, or (2) subsequent offers orsales of securities that are: registered under the SecuritiesAct, except as provided in Rule 255(e); made in reliance onRule 701; made pursuant to an employee benefit plan;made in reliance on Regulation S; made pursuant tosection 4(a)(6) of the Securities Act (ie crowdfundedofferings); or made more than six months after thecompletion of the Regulation A offering. The final rulealso addresses abandoned offerings in much the same waythat these are handled by Rule 155, with a 30-day coolingoff period. The SEC also reaffirmed guidance that wasincluded in the proposing release, which is consistent withthe guidance regarding integration provided in SECRelease No. 33-8828 (August 3 2007).

Exchange Act thresholdThe final rule provides a limited exemption for securitiesissued in a Tier 2 offering from the section 12(g) holder ofrecord threshold where the issuer is subject to, and currentin its, Regulation A periodic reporting obligations. Inorder to benefit from this conditional exemption, an issuermust retain the services of a transfer agent and meetrequirements similar to those in the smaller reportingcompany definition (public float of less than $75 millionor, in the absence of a public float, revenues of less than$50 million, in the most recently completed fiscal year).An issuer that exceeds the section 12(g) threshold will havea two-year transition period.

Filing and delivery requirementsRegulation A offering statements must be filed onEDGAR. Form 1-A has been amended to consist of threeparts: Part I, which is an XML-based fillable form withbasic issuer information; Part II, which is a text file thatcontains the disclosure document and financial statements;and Part III, which is a text file that contains exhibits andrelated materials. Periodic reports and any otherdocuments required to be submitted to the SEC inconnection with a Regulation A offering must be filed onEDGAR. The final rules adopt an access equals deliverymodel for Regulation A final offering statements. In thecase where a preliminary offering statement is used to offersecurities to potential investors and the issuer is not alreadysubject to the Tier 2 periodic reporting requirements, anissuer and participating broker-dealer are required todeliver the preliminary offering statement to prospectivepurchasers at least 48 hours in advance of sales.

Non-public reviewAn issuer may submit an offering statement for non-publicreview by the SEC. Consistent with the original Title I on-ramp provision available for EGCs, should an issuer optfor confidential review, the offering statement must befiled publicly not less than 21 calendar days beforequalification of the offering statement. The timing, in thecase of a Regulation A offering, is not tied to an issuer’sroad show, but rather to the qualification of the offeringstatement.

Form 1-AAn issuer that seeks to rely on Regulation A must file andqualify an offering statement. The offering statement isintended to be a disclosure document that providespotential investors with information that will form thebasis for their investment decision. A notice ofqualification is similar to a notice of effectiveness in anSEC-registered offering. Part I of the offering statementrequires certain basic information regarding the issuer, itseligibility, the offering details, the jurisdictions where thesecurities will be offered, and sales of unregisteredsecurities. Part II contains the narrative portion of theoffering statement and requires: disclosures of basicinformation about the issuer; material risks; use ofproceeds; an overview of the issuer’s business; an MD&Atype discussion; disclosures about executive officers anddirectors and compensation; beneficial ownershipinformation; related party transactions; and a descriptionof the offered securities. This is similar to Part I of Form S-1, and an issuer can choose to comply with Part I of FormS-1 in connection with its offering statement. However,the disclosure requirements of Form 1-A are scaled.

Tier 1 and Tier 2 issuers must file balance sheets andother required financial statements as of the two mostrecently completed fiscal year ends (or for such shortertime as they have been in existence). US issuers arerequired to prepare financial statements in accordance withUS GAAP. Canadian issuers may use US GAAP or IFRS asadopted by the IASB. As with EGCs, an issuer may electto delay implementation of new accounting standards tothe extent such standard permit delayed implementationby non-public business entities. The election is a one-timeelection and must be disclosed.

The financial statements for an issuer in a Tier 1 offeringare not required to be audited. However, if a Tier 1 issueralready obtained an audit of its financial statement forother purposes and such audit was performed inaccordance with US GAAS or the PCAOB standards andthe auditors meet the independence standards, then theaudited financial statements must be filed.

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The financial statements for an issuer in a Tier 2 offeringare required to be audited. The audit firm must satisfy theindependence standard, but need not be PCAOB-registered. The financial statements may be audited inaccordance with either US GAAS or PCAOB standards.An issuer in a Tier 2 offering that seeks to have a class ofsecurities listed on a national securities exchangeconcurrent with the Regulation A offering must includefinancial statements prepared in accordance with PCAOBstandards by a PCAOB-registered firm.

Continuous offeringsThe final rule continues to permit continuous or delayedofferings in certain instances, such as: securities offered orsold on behalf of selling security holders; securities offeredunder employee benefit plans; securities pledged ascollateral; securities issued upon conversion of otheroutstanding securities or upon the exercise of options,warrants, or rights, etc.; and securities that are part of anoffering that commences within two calendar days afterthe qualification date, will be offered on an continuousbasis, may continue to be offered for a period in excess of30 days from the date of initial qualification, and will beoffered in an amount that, at the time the offeringstatement is qualified, is reasonably expected to be offeredand sold within a period of two years from the initialqualification date. The offerings permitted underRegulation A are limited in the same manner as underRule 415 under the Securities Act; as such, delayedofferings would not be permitted under Regulation A.

Offering communicationsAn issuer engaged in a Regulation A offering hassubstantial flexibility regarding offering communications.An issuer must file solicitation materials with the SEC.Solicitation materials used after an offering statement isfiled must be accompanied by the offering circular orinclude a link to the offering statement. Solicitationmaterials will be subject to certain legends.

Ongoing reporting requirementsThe final rules impose new ongoing reporting obligationsfor certain offerings. Tier 1 issuers are required to providecertain information about their Regulation A offerings ona new form, Form 1-Z. Issuers in Tier 2 offerings aresubject to an ongoing reporting regime. Similar to theongoing reporting regime that the SEC proposed inconnection with issuers that conduct crowdfundedofferings, Tier 2 issuers are required to file:• annual reports on Form 1-K;• semi-annual reports on Form 1-SA;

• current reports on Form 1-U; • special financial reports on Form 1-K and Form 1-SA;

and• exit reports on Form 1-Z.

Form 1-K requires: disclosures relating to the issuer’sbusiness and operations for the preceding three fiscal years(or since inception if in existence for less than three years),related party transactions, beneficial ownership, executiveofficers and directors, and executive compensation;MD&A; and, two years of audited financial statements.Form 1-K is required to be filed within 120 calendar daysof the issuer’s fiscal year-end. The semi-annual report onForm 1-SA is similar to a Form 10-Q, although it is subjectto scaled disclosure requirements. Form 1-SA is required tobe filed within 90 days after the end of the first six monthsof the issuer’s fiscal year-end, commencing immediatelyfollowing the most recent fiscal year for which fullfinancial statements were included in the offeringstatement or, if the offering statement included six-monthinterim financial statements for the most recent full fiscalyear, then for the first six months of the following fiscalyear. A current report on Form 1-U is required toannounce: fundamental changes in the issuer’s business;entry into bankruptcy or receivership proceedings;material modifications to the rights of security holders;changes in accountants; non-reliance on audited financialstatements; changes in control; changes in key executiveofficers; and sales of 10% or more of outstanding equitysecurities in exempt offerings. Form 1-U must be filedwithin four business days of the triggering event. An exitreport on Form 1-Z is required to be filed within 30 daysafter the termination or completion of a Regulation Aoffering.

Rule 15c2-11, Rule 144, and Rule 144AA Tier 2 issuer’s periodic reports will satisfy Exchange ActRule 15c2-11 broker-dealer requirements relating to theobligation to review information about an issuer inconnection with publishing quotations on any facilityother than a national securities exchange. However,contrary to commenters’ requests, the final rule does notestablish that these reports would constitute currentinformation for purposes of Rule 144 and Rule 144Aunder the Securities Act. A Tier 2 issuer that voluntarilysubmits quarterly information in a form consistent withthat required for semi-annual information would be ableto satisfy the reasonably current information and adequatecurrent public information requirements.

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Tier 2 offering with concurrent Exchange ActregistrationThe final rules facilitate the ability of a Tier 2 issuer tovoluntarily register a class of Regulation A securities underthe Exchange Act. In the absence of the relief provided inthe final rules, an issuer that completed a Regulation Aoffering and sought to list a class of securities on a nationalsecurities exchange would have had to incur the costs andthe timing delays associated with preparing and filing aseparate registration statement on Form 10. The final rulepermits a Tier 2 issuer that has provided disclosure in PartII of Form 1-A that follows Part 1 of Form S-1 (or forReits, Form S-11) to file a Form 8-A to list its securities ona national securities exchange. Of course, thereafter, theissuer would be subject to Exchange Act reportingrequirements. An issuer that enters the Exchange Actreporting regime in this manner will be an EGC.

Termination or suspension of Tier 2 disclosureobligationsTier 2 issuers are permitted to terminate or suspend theirongoing reporting obligations on a basis similar to theprovisions for suspension or termination of reportingrequirements for SEC-reporting companies. A Tier 2 issuerthat has filed all required ongoing reports for the shorter of(1) the period since the issuer became subject to suchreporting obligations or (2) its most recent three fiscalyears and the portion of the current year preceding thedate of filing Form 1-Z (termination or exit form) ispermitted to suspend its reporting obligations at any timeafter completing reporting for the fiscal year in which theoffering statement was qualified. This suspension ispermitted if the securities of each class to which theoffering statement relates are held of record by fewer than300 persons and offers or sales made in reliance on aqualified offering statement are not ongoing. Further, theRegulation A ongoing reporting requirements would beautomatically suspended if an issuer registers a class ofsecurities under section 12 of the Exchange Act.

Bad actor disqualification provisionsThe final rule includes bad actor disqualificationprovisions that are largely consistent with those includedin Rule 506(d) of Regulation D.

State securities law requirementsAs discussed above, one of the most significant concernsregarding the use of the Regulation A exemption has beenthe requirement to comply with state securities or blue skylaws. At the time the new rules were proposed, there wasno coordinated review process by the states for Regulation

A offerings. Although Nasaa has introduced a coordinatedreview process for Regulation A offerings, the SEC notedthat the coordinated review process is relatively new and itremains largely untested. The final rules provide that Tier1 offerings will remain subject to state securities lawrequirements. Consistent with the proposed rules, Tier 2offerings will not be subject to state review if the securitiesare sold to qualified purchasers or, as provided by statute inthe JOBS Act, listed on a national securities exchange. Thefinal rule defines the term qualified purchaser in aRegulation A offering to include all offerees and purchasersin a Tier 2 offering. States will, of course, continue to haveauthority to require filing of offering materials and enforceanti-fraud provisions in connection with a Tier 2 offering.

Securities Act liabilitySellers of Regulation A securities would have liabilityunder section 12(a)(2) of the Securities Act in respect ofoffers or sales made by means of an offering statement ororal communications that include a material misleadingstatement or omission. While an exempt offering pursuantto Regulation A is excluded from the operation of section11 of the Securities Act, those offerings are subject to theanti-fraud provisions under the federal securities laws.

Character of the securities sold in a Regulation A offeringThe securities sold in a Regulation A offering are notconsidered restricted securities under Securities Act Rule144. As a result, sales of the securities by persons who arenot affiliates of the issuer are not be subject to any transferrestrictions under Rule 144. Affiliates, of course, continueto be subject to the limitations of Rule 144, other than theholding period requirement. This is important to an issuerthat would like an active trading market to develop for itssecurities following completion of a Regulation A offering.However, the issuer’s securities may not be listed or quotedon a national securities exchange without registrationunder section 12 of the Exchange Act, and, as a result,there may not be a liquid market for the securities.

Finra reviewFor any public offering of securities, Finra Rule 5110prohibits Finra members and their associated persons fromparticipating in any manner unless they comply with thefiling requirements of the rule.22 Finra Rule 5110 alsocontains rules regarding underwriting compensation. Rule5110(b) requires that certain documents and informationbe filed with and reviewed by Finra, and these filing andreview requirements apply to securities offered underRegulation A.23 In September 2015, Finra issued Notice toMembers 15-32 providing guidance regarding the Finra

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filing requirements and review process for Regulation Aofferings.

Considerations in conducting a Regulation AofferingAdvantagesAn exempt offering, including, for example, a RegulationD offering, is subject to several limitations, and a registeredpublic offering may be too time-consuming and costly foran issuer. Using Regulation A to offer securities mayprovide an issuer with an offering format that is similar toa registered offering, but may be more efficient. Whilethere are many similarities between an offering statementand a prospectus, the preparation of an offering statementis generally simpler particularly for an issuer that has had alimited operating history. An offering statement is lessdetailed than a prospectus for a registered offering. As aresult, it is typically less costly for an issuer to conduct aRegulation A offering. The costs associated with externaladvisers, such as counsel and auditors, also will be lower inconnection with a Regulation A offering. Also,management time devoted to the preparation of theoffering statement will be less.24 The review processundertaken by SEC staff may be somewhat shorter thanthe review and comment process in connection with a fullregistration. A registration statement on Form S-1 wouldalways be subject to complete review by the SEC staff inconnection with an issuer’s initial public offering. Timingis often the most important determinant of success for anoffering. Inability to initiate an offering during afavourable market window may result in the issuer notbeing able to conduct an offering at all. Regulation A mayprovide flexibility to the issuer in this respect.

No limitation on offereesRegulation A does not impose any limitations on offerees.In contrast to Rule 506 of Regulation D, Regulation Adoes not limit the number of offerees or investors that canparticipate in an offering, nor does it impose anyrequirement that offerees be accredited or sophisticatedinvestors.

Nature of securitiesSecurities offered and sold pursuant to Regulation A areoffered publicly and are not restricted securities. Thesecurities may be traded in the secondary market(assuming that there is a secondary market) after theoffering. As a practical matter, the securities likely willtrade in the over-the-counter (OTC) market unless theissuer has taken steps to list the class of securities on anexchange. No holding period applies to the holder of

securities purchased in a Regulation A offering. Because anissuer may remain a non-reporting company aftercompletion of a Regulation A offering, there may not bean active secondary market. If a smaller company choosesto list a class of securities on a major exchange, it willbecome subject to Exchange Act reporting as well as to thegovernance requirements under the securities laws andunder the rules of the exchange.25 Certain institutionalinvestors have limitations on the amount that they mayinvest in restricted securities. These restrictions generallywould not apply to investments in securities issuedpursuant to Regulation A; however, to date, mostinstitutional investors have been wary of participating inRegulation A offerings.

Testing the waters, advertising, and generalsolicitationThe ability to test the waters in connection with aRegulation A offering may make a Regulation A offeringmore appealing than a Regulation D offering, even withthe relaxation of the prohibition on general solicitation forcertain offerings made pursuant to Rule 506 of RegulationD.

DisadvantagesDollar thresholdAlthough there are many significant benefits associatedwith a Regulation A offering, the $50 million thresholdundermines the benefits and reduces the utility of theexemption when compared to Rule 506.26 Often, an issuerwill look to engage an underwriter to assist withstructuring and marketing the offering. Similar to aregistered offering, the underwriting effort may be on abest-efforts or a firm commitment basis. The recenthistory of Regulation A shows that it is unlikely that a largewell-established broker dealer will underwrite a RegulationA offering. With the current offering threshold of $50million, participating in a Regulation A offering may notprovide most broker-dealers with sufficient financialincentive. Many of the Regulation A offerings since theamendments became effective have been conductedwithout a financial intermediary.

Requirement of state registrationOfferings made pursuant to Tier 1 of Regulation A mustsatisfy state blue sky laws in each state where the offeringis to take place. An offering likely will trigger a meritreview in those states that are merit review states (unlesswaivers can be obtained), which may cause delays inqualifying Regulation A offerings. By comparison,offerings of securities listed on major exchanges

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(NASDAQ and NYSE) have been exempt from statereview since 1996 pursuant to the Nsmia. Similarly,securities offered pursuant to Rule 506 of Regulation D areexempt from state securities registration requirements.27

Considering the alternativesMany clients have asked us why an issuer might choose torely on Regulation A if the issuer could rely on Rule 506of Regulation D. An exempt offering, including, forexample, a Regulation D offering, may still be subject toseveral limitations that may not be appealing to an issuer,and a registered public offering may still be too time-consuming and costly. Using the new Regulation A to offersecurities can provide an issuer with an offering formatthat is similar to a registered offering with certainaccompanying advantages. It might be especially appealingfor an issuer to consider this type of offering as a precursorto an IPO. An issuer will be required to prepare andfurnish certain offering disclosures in connection with aRegulation A offering, while there are no informationrequirements associated with a Rule 506 offering. Inpractice, however, most issuers will prepare somedisclosure materials to share with prospective investors,even in a Rule 506 offering. An issuer may want topreserve the opportunity to approach investors that are notaccredited, and may do so in connection with a RegulationA offering. To date, many issuers that are consumerproducts companies have found Regulation A offeringsappealing as affinity offerings that allow the issuers toreach their existing customer base.

A non-reporting company may choose to undertake aRegulation A offering or a Regulation D offering andremain below the shareholder threshold for requiredExchange Act reporting. If it were to do so, a market for itssecurities may or may not develop. A non-reportingcompany that undertakes a Regulation A offering may alsouse the offering as an IPO.

Further guidance on Regulation AShortly following the effective date of the final rules, theSEC published a Small Entity Compliance Guide toprovide market participants with an overview of theregulation. The staff of the SEC also published C&DIs onvarious aspects of the regulation. Among other things,these C&DIs noted that Regulation A could be applied inthe context of merger transactions involving stockconsideration. In July 2015, the SEC’s Office of InvestorEducation and Advocacy issued an Investor Bulletin thathighlights the differences from an investor’s perspectivebetween a Tier 1 and a Tier 2 offering, including thedisclosure and ongoing reporting requirements and the

investment limitation for Tier 2 offerings.

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JOBS Act Quick Start 2018 update 77

1 Securities Act Release No. 66, 1933 WL 28878(November 1 1933).

2 Regulation A consists of Rules 251 through 263. 17CFR §§ 230.251–.263, hereinafter cited by rulenumber.

3 See Pub. L. No. 96-477, § 301, 94 Stat. 2275, 2291(1980).

4 See Small Business Initiatives, Securities Act ReleaseNo. 6949, 1992 WL 188930 (July 30 1992).

5 See Small Business Initiatives, Securities Act ReleaseNo. 6949, 1992 WL 188930 (July 30 1992).

6 See id. at *2.7 See generally Rules 251–63. 17 CFR §§ 230.251–

.263.8 See 2009 Annual SEC Government-Business Forum

on Small Business Capital Formation 17 (2009).9 See 29th Annual SEC Government-Business Forum

on Small Business Capital Formation, Record ofProceedings (November 18 2010) (statement ofDavid Hirschmann, President and CEO of theCenter for Capital Markets Competitiveness at theUS Chamber of Commerce).

10 See Statement of William R. Hambrecht, Chairman& Chief Exec. Officer, WR Hambrecht + Co.)(‘According to public records, since 2005 there haveonly been 153 Reg A filings and of those 153, anastoundingly low number of 13 have actuallypriced.’).

11 See A Proposal to Increase the Offering Limit UnderSEC Regulation A: Hearing Before the H. Comm.on Fin. Servs., 111th Cong. 32 (2010) (preparedstatement of William R. Hambrecht, Chairman &Chief Exec. Officer, WR Hambrecht + Co.).

12 See Small Company Capital Formation Act of 2011,HR 1070, 112th Cong. (1st Sess. 2011).

13 See press release issued by the House FinancialServices Committee, available athttps://financialservices.house.gov/news/documentsingle.aspx?DocumentID=247737

14 Pub. L. No. 111-203, 124 Stat. 1376 (July 21 2010)[hereinafter Dodd-Frank].

15 See generally Legislative Proposals to Promote JobCreation, Capital Formation, and Market CertaintyBefore the Subcomm. on Capital Markets and Gov.Sponsored Enterprise of the H. Comm. on Fin.Servs., 112 Cong. 24 (2011).

16 Legislative Proposals to Promote Job Creation,

Capital Formation, and Market Certainty Before theSubcomm. on Capital Markets and Gov. SponsoredEnterprise of the H. Comm. on Fin. Servs., 112Cong. 24 (2011) (prepared statement of DavidWeild, Senior Advisor, Grant Thornton LLP).

17 Amendment to the Amendment in the Nature of aSubstitute to HR 1070 Offered by Mr. Ackerman,no. 1a (emphasis added), available athttp://financialservices.house.gov/UploadedFiles/062211hr1070ackermanam.pdf. As originallyproposed, the legislation provided that the SEC mayrequire an issuer to file audited financial statementswith the SEC and distribute such statements toprospective investors.

18 National Securities Market Improvement Act of1996, Pub. L. No. 104-290, 110 Stat. 3435(October 11 1996). NSMIA pre-empts statequalification and registration requirements forcovered securities, which includes issuer offerings ofsecurities listed on NASDAQ or the NYSE andsecurities exempt from registration under federalsecurities law, including pursuant to rulespromulgated under section4(a)(2) of the SecuritiesAct. Currently, there is no definition under theSecurities Act of a qualified purchaser. The SECwould be required to adopt a definition.

19 See Letter from David S. Massey, North CarolinaDeputy Securities Administrator, NASAA President,to Spencer H. Bachus, Chair., House FinancialServices Committee, et al. (June 15 2011), availableat www.nasaa.org/wp-content/uploads/2011/07/6-15-11-NASAA_Comment_Letter_HR1070_HR1082.pdf

20 See study, available atwww.gao.gov/assets/600/592113.pdf

21 See letter from William F. Galvin, Secretary of theCommonwealth of Massachusetts, to the SEC(December 18 2013), available atwww.sec.gov/comments/s7-11-13/s71113-1.pdf

22 See FINRA Rule 5110.23 See NASD Notice to Members 92-28 (May 1992);

see also NASD Notice to Members 86-27 (April1986).

24 The SEC has emphasised this advantage in the past.See, eg, Securities Act Release No. 5977, 1978 WL196028, at *2 (September 11 1978).

25 An issuer may choose to prepare and file a Form 10

ENDNOTES

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to register one or more classes of securities undersection 12 of the Exchange Act with the SEC.

26 See A Proposal to Increase the Offering Limit UnderSEC Regulation A: Hearing Before the H. Comm.on Fin. Servs., 111th Cong. 10 (2010) (statement ofMichael Lempres, Asst. Gen. Counsel, SVB FinancialGroup) (‘The impetus behind the creation ofregulation A was very good one. Unfortunately, inrecent years, as you’ve been hearing, regulation A hasnot proved to be a useful capital raising vehicle forsmall issuers. It was used only a total of 78 timesduring the 10-year period between 1995 and 2004.An average of eight filings a year with the maximumamount of $5 million each really proves theirrelevance of regulation A in today’s economy. It’ssimply not a viable vehicle as currently structured.’).

27 Rule 504 of Regulation D was promulgated undersection 3(b) of the Securities Act and does not pre-empt state securities law requirements. However,most states have adopted changes to their statesecurities laws that essentially duplicate theprovisions of Regulation D.

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Before enactment of the JOBS Act, Exchange Actsection 12(g) required registration of a class ofan issuer’s equity securities if, as of the last dayof the issuer’s fiscal year, the issuer had more

than $10 million in assets and the class of equity securitieswas held of record by 500 or more persons.1 Once thesethresholds were crossed, an issuer would have to registerthe class of equity securities within 120 days of the end ofthe fiscal year, and then begin filing current and periodicreports with the SEC.2 The definition of held of record forthese purposes counts as holders of record only personsidentified as owners on records of security holdersmaintained by the company, or on its behalf, in accordancewith accepted practice. An issuer could only deregister aclass of equity securities under section 12(g) when suchclass of equity securities is held of record by fewer than 300persons, or by fewer than 500 persons and the total assetsof the issuer has not exceeded $10 million on the last dayof each of the issuer’s three most recent fiscal years.Exchange Act section 12(g) was originally enacted out ofconcern that issuers who were not listed on a nationalsecurities exchange could nonetheless be widely held andtraded over the counter, and therefore disclosure should beavailable to investors through SEC registration andreporting.

Leading up to the JOBS Act changes to the ExchangeAct registration/deregistration thresholds, concerns wereraised about the fact that the 500 -person held-of-recordthreshold had not been revisited since 1964. Theseconcerns focused on the fact that issuers sometimes werecompelled to go public sooner than they might haveotherwise by virtue of the mandatory registrationprovisions in section 12(g), and the possibility of SECregistration and reporting could serve to discourage privatecompanies from raising capital and using equity awards tocompensate their employees. At the same time, concernswere expressed about issuers going dark and ceasing theirSEC reporting by bringing the number of holders ofrecord below the deregistration threshold. As a result ofthis dialogue, a variety of proposals were advanced relatingto possible amendments to section 12(g) registrationthresholds. Some of these proposals sought to reduce the

number of issuers required to report pursuant to theExchange Act, for example, by raising the shareholderthreshold,3 by excluding employees or by excludingaccredited investors, QIBs or other sophisticated investorsfrom the calculation.4 The SEC also received a rulemakingpetition requesting that the SEC revise the held -of -recorddefinition to look through record holders to theunderlying beneficial owners of securities in order toprevent issuers from ceasing to report under certaincircumstances.5 Before April 5 2012, the SEC wasconducting a comprehensive study of these issues and wasactively considering the various proposals.

Raising the registration and deregistrationthresholds in Titles V and VIAs amended by Titles V and VI of the JOBS Act, ExchangeAct section 12(g) now requires registration of a class ofequity securities if, at the end of its fiscal year, an issuer hasat least $10 million in assets and a class of equity securitiesheld of record by either 2,000 persons, or 500 persons whoare not accredited investors. Banks6 and bank holdingcompanies7 are not required to register under the ExchangeAct unless they have, at the end of the fiscal year, at least$10 million in assets and a class of equity securities held ofrecord by 2,000 or more persons. The FAST Act furtheramended Exchange Act section 12(g) so that savings andloan holding companies are treated similarly to banks andbank holding companies. Under Exchange Act section12(g)(4) before the enactment of the JOBS Act, an issuercould deregister a class of equity securities when either theissuer had $10 million or less in assets and the class ofequity securities was held by fewer than 500 holders ofrecord, or the class of equity securities was held by fewerthan 300 holders of record. The JOBS Act increased the300 persons held-of-record threshold in Exchange Actsection 12(g)(4) only with respect to banks and bankholding companies, raising that threshold from 300 to1,200 persons. The JOBS Act did not increase the 300persons held-of-record threshold for deregistration forissuers that are not banks or bank holding companies.

Under the JOBS Act, Exchange Act section 12(g)(5) wasamended to provide that the term held of record does not

CHAPTER 7

Exchange Act registration thresholds

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include ‘securities held by persons who received thesecurities pursuant to an employee compensation plan intransactions exempted from the registration requirementsof section 5 of the Securities Act.’ The SEC was directedby the JOBS Act to amend the Rule 12g5-1 definition ofheld of record in order to reflect this amendment to thestatute. The SEC also was directed to adopt safe harbourrules for issuers to follow in determining whether holdersof their securities had received the securities pursuant to‘an employee compensation plan in transactions that wereexempt from the registration requirements of section 5 ofthe Securities Act of 1933,’ and to provide that securitiessold in exempt crowdfunding offerings will also not beincluded in determining whether registration is requiredunder section 12(g).

On April 11 2012, the Division of Corporation Financeissued Frequently Asked Questions on Changes to theRequirements for Exchange Act Registration andDeregistration, which confirmed that the Title V and TitleVI provisions raising the Exchange Actregistration/deregistration thresholds were, for the mostpart, immediately effective, thereby providing issuers withthe ability to avoid registration in 2012 and going forwardand, specifically with regard to bank holding companies, toterminate their registration/reporting obligation.8

In Frequently Asked Question 4, the SEC noted that ifa bank holding company with a class of equity securitiesheld of record by fewer than 1,200 persons as of the firstday of the current fiscal year has a registration statementthat is updated during the current fiscal year pursuant toSecurities Act section 10(a)(3), but under which no saleshave been made during the current fiscal year, then thebank holding company may be eligible to seek no-actionrelief to suspend its section 15(d) reporting obligation. TheStaff has been granting these no-action letters.9

In Frequently Asked Question 5, the SEC noted that anissuer (including a bank holding company) may excludepersons who received securities pursuant to an employeecompensation plan in Securities Act–exempt transactions,whether or not the person is a current employee of theissuer. While section 503 of the JOBS Act directs theCommission to adopt ‘safe harbor provisions that issuerscan follow when determining whether holders of theirsecurities received the securities pursuant to an employeecompensation plan in transactions that were exempt fromthe registration requirements of section 5 of the SecuritiesAct of 1933,’ in the SEC’s view the lack of a safe harbourdoes not affect the application of Exchange Act section12(g)(5).

Required studyThe SEC was required to examine its authority to enforceRule 12g5-1 to determine if new enforcement tools arerequired to enforce the anti-evasion provision contained in(b)(3) of the rule, and to provide recommendations toCongress within 120 days of the enactment of the JOBSAct. On October 16 2012, the SEC staff published theresults of this mandated study, concluding that thestatutes, rules and procedures as currently formulatedprovide the Division of Enforcement with sufficient toolsto investigate and bring a case for section 12(g) violationsbased on section 12g5-1(b)(3).10

Final rulesAs mentioned above, section 503 of the JOBS Act requiredthe SEC to revise the definition of held of record toexclude, from the section 12(g)(1) holder-of-recordcalculation, persons who received the securities pursuantto an employee compensation plan in transactionsexempted from the registration requirements of section 5of the Securities Act.

In May 2016, the SEC adopted final rules pursuant tothe JOBS Act, which, among other things, amendedExchange Rule 12g-1. As amended, an issuer is required toregister a class of equity securities pursuant to Section12(g)(1) if, on the last day of its most recent fiscal year:• The issuer had total assets exceeding $10 million.• The class of equity securities was held of record by

greater than (i) 2,000 persons or (ii) 500 persons whoare not accredited investors, as defined under Rule501(a), determined as of such date rather than at thetime of the sale of the securities.

• In the case of a (i) bank, (ii) savings and loan holdingcompany or (iii) bank holding company, the class ofequity securities was held of record by greater than 2,000persons.The SEC further amended Rule 12g-1 to provide that

the term accredited investor (for purposes of section12(g)(1)) is defined within Rule 501(a) under theSecurities Act as any person: (i) who comes within one ormore of the categories of investors specifically listed inRule 501(a); or (ii) whom the issuer reasonably believescomes within any such category. An issuer’s reasonablebelief depends on the facts and circumstances surroundingthe determination. Accordingly, under amended Rule 12g-1, an issuer will need to determine whether priorinformation provides a basis for a reasonable belief that theholder continues to be an accredited investor as of the lastday of the fiscal year.

The final rules also amended the definition of held ofrecord in Exchange Act Rule 12g5-1 to exclude certain

securities held by persons who received them pursuant toemployee compensation plans; and established a non-exclusive safe harbor for issuers to assess whether holders ofrecord received securities pursuant to an employeecompensation plan in transactions exempt from thesection 5 registration requirements.

For purposes of determining whether an issuer isrequired to register a class of equity securities pursuant tosection 12(g)(1) of the Exchange Act, the issuer mayexclude from the definition of held of record securities thatare:• held by persons who received the securities pursuant to

an employee compensation plan in transactions exemptfrom, or not subject to, the section 5 registrationrequirements (now Rule 12g5-1(a)(8)(i)(A)); or

• held by persons who received the securities in atransaction exempt from, or not subject to, the section 5registration requirements from the issuer, a predecessorof the issuer or an acquired company in substitution orexchange for excludable securities under Rule 12g5-1(a)(8)(i)(A), as long as the persons were eligible toreceive securities pursuant to Rule 701(c) under theSecurities Act at the time the excludable securities wereoriginally issued (now Rule 12g5-1(a)(8)(i)(B)).Pursuant to the safe harbour:

• An issuer may deem a person to have received securitiespursuant to an employee compensation plan if the plan,and the person who received the securities pursuant tothe plan, satisfies the plan and participant conditions ofRule 701(c).

• An issuer may, solely for purposes of section 12(g), deemthe securities to have been issued in a transaction exemptfrom, or not subject to, the section 5 registrationrequirements if the issuer had a reasonable belief at thetime of issuance that the securities were issued in such atransaction.In its final rules, the SEC included restricted stock units

in its rulemaking to satisfy the amendment to section12(g)(5) of the Exchange Act to exclude from held ofrecord securities held by persons who received thesecurities pursuant to an employee compensation plan intransactions exempted from the registration requirementsof section 5. Issuers may rely on the safe harbor to assesswhether holders of record received securities pursuant toan employee compensation plan in transactions exemptfrom the section 5 registration requirements.

Companies remaining private longerWhether or not intended, these changes brought about bythe JOBS Act have made it easier for privately heldcompanies to remain private longer. In recent years, many

market participants and policymakers have sounded acautionary note in pointing to the decline in the numberof US. public companies. According to a speech given bySEC chairman Jay Clayton, the total number of listedcompanies in 1996 was about 8,100, compared toapproximately 4,300 in 2016, or a nearly 50% decline in adecade. On average, most issuers that do move forwardwith IPOs tend to be quite different than theirpredecessors. These companies have been in existenceapproximately nine to 11 years and have significantlyhigher market capitalisations at the time that theyundertake their IPOs. Promising privately held companieshave found that it may be more efficient to raise capital insuccessive private rounds of financing. Given theproliferation of investors, including private equity funds,hedge funds, family offices, sovereign wealth funds, andcross-over funds, willing and eager to invest in thesecurities of privately held companies, there has beenrelatively little impetus for companies to considerundertaking public offerings. The JOBS Act rules wediscuss in this chapter certainly have allowed privately heldcompanies to continue to conduct successive privatecapital raises without worrying about crossing the Section12(g) Exchange Act threshold. Of course, the decision todefer an IPO may be attributed to any number of otherfactors.

JOBS Act Quick Start 2018 update 81

82 JOBS Act Quick Start 2018 update

Appendix ASHAREHOLDER TRIGGERS

Total assets at fiscal year-end thattrigger reporting requirement ifshareholder trigger is breached

Total number of holders of recordthat triggers reporting

Total number of holders of recordto exit reporting

Effectiveness

Companies other than banks,BHCs and SLHCs

$10 million

2,000 holders of recordOR

500 non-accredited holders ofrecord

300 or fewer holders of record

Immediately effective

Banks, BHCs and SLHCs

$10 million

2,000 holders of record

1,200 or fewer holders of record

For banks, BHCs and SLHCs, at theend of the issuer’s first fiscal year

following enactment of the JOBS Act

JOBS Act Quick Start 2018 update 83

1 These thresholds were set forth in Exchange Act §12(g)(1) and Exchange Act Rule 12g-1. Whensection 12(g) was enacted in 1964, the assetthreshold was set at $1 million. The asset thresholdwas most recently increased to $10 million in 1996.SEC Release No. 34-37157 (May 1 1996), availableat www.sec.gov/rules/final/34-37157.txt

2 In addition, section 16 reporting and short-swingliability apply to insiders; beneficial ownershipreporting applies to significant stockholders; theSEC’s proxy rules apply to the issuer; and the variousSarbanes-Oxley Act and Dodd-Frank Act provisionsapply as a result of Exchange Act section 12(g)registration.

3 See, eg, Comment Letter from American BankersAssociation to SEC (November 12 2008), available atwww.sec.gov/rules/petitions/4-483/4483-21.pdf

4 See, eg, 2009 Annual SEC Government-BusinessForum on Small Business Capital Formation FinalReport (May 2010), available atwww.sec.gov/info/smallbus/gbfor28.pdf

5 Petition from Lawrence Goldstein to SEC (February24 2009), available atwww.sec.gov/rules/petitions/2009/petn4-483-add.pdf. See also Petition for Commission Action toRequire Exchange Act Registration of Over-the-Counter Equity Securities (July 3 2003), available atwww.sec.gov/rules/petitions/petn4-483.htm

6 Under Exchange Act section 12(i), banks do notregister their securities or file reports with the SEC.

7 The term bank holding company is defined in theBank Holding Company Act of 1956.

8 Frequently Asked Questions on Changes to theRequirements for Exchange Act Registration andDeregistration (April 11 2012), available atwww.sec.gov/divisions/corpfin/guidance/cfjjobsactfaq-12g.htm.

9 See, eg, Peoples Financial Services Corp. (August 162012); Central Virginia Bankshares, Inc. (August 82012); AB&T Financial Corporation (July 27 2012);Botetourt Bankshares, Inc. (July 24 2012); FirstOttawa Bankshares (July 23 2012); PotomacBancshares, Inc. (July 23 2012); Skagit StateBancorp, Inc. (July 20 2012); TouchmarkBancshares, Inc. (July 17 2012).

10 Report on Authority to Enforce Exchange Act Rule12g5-1 and Subsection (b)(3) (October 15 2012),available at www.sec.gov/news/studies/2012/authority-to-enforce-rule-12g5-1.pdf

ENDNOTES

84 JOBS Act Quick Start 2018 update

The regulation of capital markets research,having undergone significant change prior tothe JOBS Act, was further revised throughJOBS Act rules. In 2003, as a result of legal

and regulatory developments adopted in the fallout fromthe dot-com boom, the business of research coveragechanged quickly and fundamentally. These changes werebrought about as a result of the entry by a number ofinvestment banking firms into the Global ResearchAnalyst Settlement (the Global Settlement), the adoptionof SRO rules relating to research, and the promulgation bythe SEC of Regulation AC. The Global Settlementaddressed the most serious perceived conflicts betweeninvestment banking and research departments during thedotcom boom and required implementation of variousprophylactic measures by investment banking firms thatprovided research coverage, including separating bankingand research structurally and physically, requiring achaperone to monitor communications between the two,and requiring analyst compensation be determinedindependently and not be based on banking revenues.Regulation AC was designed to ensure research analystindependence and integrity by requiring that researchanalysts certify the truthfulness of the views expressed inresearch reports and public appearances. The rules adoptedby the NASD (Finra’s predecessor) and NYSE followedalong the same lines and also addressed the timing ofresearch reports in connection with offerings. In additionto imposing significant compliance burdens, together, theGlobal Settlement and the rules and regulations relating toresearch also brought about a significant cultural shift andchanged fundamentally the role of research analysts andthe business of research coverage. In part, as a result ofthese changes, research coverage for smaller companiesdeclined. As noted in the IPO Task Force Report in 2011,the lack of research coverage adversely impacted tradingvolumes, company market capitalisations, and the totalmix of information available to market participants.1 Inorder to promote capital formation by EGCs, the IPOTask Force Report recommended that policymakersconsider the existing restrictions on research and adoptmeasures to encourage additional research coverage of

EGCs in order to improve the flow of information. Title Iof the JOBS Act addresses certain of the concerns raised bythe IPO Task Force Report by implementing a number ofchanges to the restrictions on the timing of, and on thepublication of, research reports relating to EGCs. Asdiscussed below, however, the JOBS Act does not addressthe research safe harbours contained in the Securities Act,nor does it address the regulations that mandate theseparation of research and investment banking functions.In order to put the JOBS Act research-related changes incontext, below we have provided a summary of the rulesand regulations governing the research function and therelease of research reports.

The regulatory framework applicable toresearchThe rules and regulations that apply to the relationshipbetween the research and investment banking departmentsof an investment banking firm include: Finra Rule 2241(for equity research, which incorporates prior NASD Rule2711 and NYSE Rule 472); Finra Rule 2242 (for debtresearch); SEC Regulation AC (Analyst Certification); andRules 137, 138, and 139 under the Securities Act. Inaddition, certain firms are bound by the terms of theGlobal Settlement.

During the dotcom boom, research analysts publishedreports recommending investments in the securities ofmany companies with which their firms had an advisory orinvestment banking relationship. In 1999, the SEC begana review of industry practices regarding the disclosure ofresearch analysts’ conflicts of interest. Committees of theUS House of Representatives and the Senate also heldhearings on research analysts’ conflicts of interests. In April2002, the SEC announced a formal inquiry into industrypractices concerning research analysts, their conflicts ofinterest and their relationships with the investmentbanking departments within their firms. Civil complaintswere filed by the SEC and other federal and stateregulatory and law enforcement authorities against thesefirms. The Global Settlement is an enforcement agreementfirst announced in December 2002 and finalised in April2003, among the SEC, NASD, the NYSE, the New York

CHAPTER 8

Research

State Attorney General, and 10 of the then-largestinvestment banking firms in the US (referred to here as thesettling firms). As part of the Global Settlement, thesettling firms agreed to several measures designed toprevent abuse stemming from pressure by investmentbankers on research analysts to provide favourable coverageof specific issuers or securities. The settling firms wererequired to separate their investment banking and researchdepartments from each other both physically and withinformation firewalls. Additionally, the budget allocationfor research was to be independent of investment banking.Research analysts were also prohibited from attending IPOpitches and road shows with investment bankers. Finally,research analysts’ previously issued ratings on issuers had tobe disclosed and made available. In addition to theseregulatory actions, each settling firm was enjoined fromviolating the statutes and rules that it was alleged to haveviolated and was also required to pay fines to theirinvestors, fund investor education, and pay forindependent third-party market research. The GlobalSettlement remains in effect, although its terms have beenmodified from time to time.

The Sarbanes-Oxley Act required the SEC to addressconflicts of interest involving research analysts andinvestment bankers. In response to Sarbanes-Oxley, theNASD and the NYSE established rules and safeguards toseparate research analysts from the review, pressure, andoversight of investment banking personnel. These rules areintended to ensure the integrity of research and to protectinvestors from being misled as a result of a failure todisclose potential conflicts of interest. In July 2003, theSEC announced the approval of a series of changes to therules affecting research analysts, generally embodied inFinra Rule 2711 and NYSE Rule 472 and referred to as theSRO rules.

The SRO rules have since been amended many times,but the most significant amendments were in November2014 and February 2015, when Finra announcedcomprehensive revisions to its research rule, including thefinalisation of new Finra Rule 2241 (for equity research),which became effective in December 2015, and new FinraRule 2242 (for debt research), which became effective inJuly 2016. Previously, Finra Rule 2711 and NYSE Rule472 applied only to research reports that included analysisof equity securities. Finra Rule 2241 retains many of theprincipal provisions of the predecessor rule, includingprovisions requiring the maintenance of separationsbetween research and banking, but adopts a moreprinciples-based approach.2 Finra Rule 2242 imposesrequirements similar to Finra Rule 2241 on debt researchdistributed to retail investors, with some modifications to

reflect the unique nature of the debt markets. Finra Rule2242 adopts a tiered approach that provides retail debtinvestors with protections similar to those provided toequity investors under Rule 2241, with modifications toreflect differences in the trading of debt securities. Finracontinues to assess whether further changes should bemade to its rules. For example, in April 2017, Finrarequested comments on Finra rules impacting capitalformation, including Finra Rules 2241 and 2242 as well asin amendments proposed in April 2017 to Rule 2241 andRule 2242 to create a limited safe harbour for eligible deskcommentary prepared by sales and trading or principaltrading personnel that may rise to the level of a researchreport.3

The Global Settlement and SRO rules address reportinglines, requiring that research and investment banking beseparate units and research not report to banking. Researchmust be physically separated from investment banking.This physical separation must be reasonably designed toensure that there will not be any intentional orunintentional flow of information between research andinvestment banking. Finra Rules 2241 and 2242 do notexpressly require physical separation between researchanalysts and investment banking personnel. However,Finra has stated that it expects physical separation exceptin ‘extraordinary circumstances where costs areunreasonable due to a firm’s size and resources.’4 Researchmust have its own resources for compliance and legalservices. In addition, the research budget may not becontrolled by investment banking, and investmentbanking personnel are prohibited from exerting anyinfluence or control over research analyst compensationand determinations.5

Both the SRO rules and Regulation AC mandate thatresearch reports include certain disclosures. Researchreports must disclose any material conflicts known notonly by research analysts but also by any associated personwith the ability to influence the content of the report. Forexample, a research report must disclose whether thesubject company has paid the firm to prepare anddistribute the research report; whether it has received, orexpects to receive, compensation from the subjectcompany within a specified time period; and whetheranalysts or other persons have a financial interest in thedebt or equity security of the subject company. RegulationAC requires a report contain prominent certificationsregarding the views expressed in the research report andattesting that the analyst’s compensation was not tied to orrelated to specific recommendations or views expressed bythe research analyst in the research report.

The Global Settlement also limits the participation of

JOBS Act Quick Start 2018 update 85

research personnel in offering related activities. Researchpersonnel may not participate in efforts to solicit businessfor investment banking, including, among other things,participating in any pitches or otherwise communicatingwith a company or prospective client for the purpose ofsoliciting investment banking business. Further, SECinterpretive guidance states that it would be inconsistentwith section I.9 of Addendum A to the Global Settlementto allow investment banking personnel to include anyinformation regarding any research analyst employed bythe firm in a pitch book or any other presentationmaterials used to solicit investment banking business.6

Under Finra Rules 2241 and 2242, a firm must restrictthe activities of research personnel that can reasonably beexpected to compromise the objectivity of researchpersonnel. Equity and debt research personnel also areprohibited from participating in pitches and othersolicitation of investment banking services transactions;however, under the JOBS Act, research personnel canparticipate in meetings with representatives of an EGC inconnection with that company’s IPO, even if investmentbanking personnel are present.7 In addition, equity anddebt research personnel are prohibited from participatingin road shows and other marketing on behalf of an issuerrelated to investment banking services. The supplementarymaterials to Finra Rules 2241 and 2242 further stipulatethat pitch materials cannot include any information aboutthe firm’s research capacity in a manner that suggests thefirm would provide, either directly or indirectly, favorableresearch. However, SEC interpretive guidance providesthat research personnel may listen (in listen-only mode) orview a live webcast of these road shows. Research personnelmay also access other widely attended presentations toinvestors from a remote location, but, if the presentation isin the firm’s building, they must be in a separate room.

The Global Settlement permits certain communicationsbetween a research analyst and an issuer in connectionwith an offering. At an issuer’s request, investment bankingpersonnel may arrange for a department of the firm otherthan research to provide the issuer access to previouslypublished reports regarding that issuer that would beavailable from other sources. Should an issuer requestinvestment banking personnel to arrange a meetingbetween the issuer and a research analyst, the investmentbankers must instruct the issuer to contact research directlyand may not notify research in advance. A research analystis permitted to attend a meeting with an issuer and answerquestions regarding the analyst’s views on the company butmay not use it as an opportunity to solicit investmentbanking business, and investment banking personnel maynot be present or participate in any of these meetings.

The SRO rules subject member firms to quiet periodsduring which they may not publish research and duringwhich analysts may not make public appearances followinginitial and secondary offerings and around thetermination, waiver, or expiration of lock-up agreements,subject to certain exceptions.

Restrictions on communications affectingresearchIn addition to these rules and regulations that affect thestructure and business of research coverage, the SecuritiesAct imposes restrictions on offering-relatedcommunications that impact the dissemination of researchreports.

A research report8 may be considered an offer or a non-conforming prospectus under the Securities Act.Information, opinions, or recommendations by a broker-dealer about securities of an issuer proposing to registersecurities under the Securities Act may constitute an offerto sell such securities, particularly when the broker-dealerparticipates in the distribution as an underwriter ormember of the selling group.9 The issuance of a researchreport in advance of a public offering could also technicallyconstitute gun-jumping (the illegal solicitation of an offerbefore a registered offering) and, as a result, a section 5violation.

Historically, the nature and content of communicationsmade around the time of a securities offering weregenerally very limited, because the SEC took an expansiveview of the concept of an offer. Under section 2(a)(3) ofthe Securities Act, an offer is defined broadly and includesevery attempt or offer to dispose of, or solicitation of anoffer to buy, a security or interest in a security, for value.10

Before an issuer filed a registration statement, all offers inany form were prohibited.11 Between the filing of theregistration statement and its effectiveness, the onlywritten offers that were permitted were those filed with theSEC and that conformed to the requirements applicable toa statutory prospectus under section 10 of the SecuritiesAct.12 After the registration statement was declaredeffective, written materials still were required to meet thesection 10 prospectus requirements. Additional offering-related materials were permitted only if a final prospectus(conforming to the section 10(a) requirements) wasdelivered before or along with the additional materials.13

These limitations did not relate to the accuracy or contentof the communications. Any violation of these rules wasconsidered gun-jumping.14 The SEC’s restrictive positionwas founded on the belief that ‘the means ofcommunications were limited and restrictingcommunications (without regard to accuracy) to the

86 JOBS Act Quick Start 2018 update

statutory prospectus appropriately balanced availablecommunications and investor protection.’15

In 2004, the SEC decided to revamp the securitiesoffering communications regime. In its release proposingthe Securities Offering Reform, the SEC stated:

‘The capital markets, in the United States and around theworld, have changed significantly since those limitations wereenacted. Today, issuers engage in all types of communications onan ongoing basis, including, importantly, communicationsmandated or encouraged by our rules under the Exchange Act.Modern communications technology, including the Internet,provides a powerful, versatile, and cost-effective medium tocommunicate quickly and broadly. [footnote omitted] Thechanges in the Exchange Act disclosure regime and thetremendous growth in communications technology are resultingin more information being provided to the market on a morenon-discriminatory, current and ongoing basis. Thus, while theinvestor protection concerns remain, the gun-jumpingprovisions of the Securities Act impose substantial andincreasingly unworkable restrictions on communications thatwould be beneficial to investors and markets and consistentwith investor protection.’ 16

As a result, as part of its 2005 Securities OfferingReform, the SEC redesigned the regulation ofcommunications in order to limit the types ofcommunications that would be deemed offers for purposesof section 5 of the Securities Act or prospectuses forpurposes of section 12(a)(2) of the Securities Act. Inconnection with Securities Offering Reform, the SECbroadened the existing safe harbours under the SecuritiesAct for certain research reports, which are contained inRules 137, 138, and 139. These safe harbours for certainresearch reports apply to all types of issuers (as opposed tothe JOBS Act’s provisions which apply only to EGCs) whomeet the requirements of Rules 137, 138 and 139. Thesafe harbours expressly exclude research reports from thedefinition of offers, offers for sale, and offers to sell17 undersection 5.18 Note that the safe harbours only apply toresearch reports distributed in advance of or during apublic offering, a Rule 144A offering or a Regulation Soffering.19 It is unlikely, however, that a research report thatmeets the requirements set forth in the safe harbourswould be considered a general solicitation in the context ofa private placement.

Rules 137, 138, and 139 are designed to protectanalysts, brokers, and dealers from general solicitation andgun-jumping violations in connection with their regularlydisseminated research reports. In the Securities OfferingReform release, the SEC recognised that certain events,including passage of Sarbanes-Oxley, Regulation AC,revisions to the self-regulatory organisation rules governing

broker-dealers, and the Global Settlement,20 had addressedthe ‘veracity and reliability’ of research reports, as well asother potential abuses associated with these reports.21 Inparticular, the SEC stated that it expects research reports‘will better disclose conflicts of interest relating to researchof which investors should be aware.’22 In light of thesedevelopments, the SEC decided it was ‘appropriate tomake measured revisions to the research rules that areconsistent with investor protection but that will permitdissemination of research around the time of an offeringunder a broader range of circumstances.’23 Rule 137 appliesto broker-dealers not participating in a registered offeringand therefore not classified as underwriters. In order not toviolate the gun-jumping provisions and solicitationprohibitions, the broker-dealer must publish the report inthe ordinary course of its business and may not receive anyconsideration from, or act under any direct or indirectarrangement with, the issuer of the securities, a sellingsecurity holder, any participant in the distribution of thesecurities, or any other person interested in the securities.Furthermore, the issuer may not be, nor have been in thepast three years: a blank cheque company,24 a shellcompany25 or a penny stock issuer.26

Rule 138 applies to broker-dealers participating in thedistribution of a different security from that beingdiscussed in the research reports. Rule 138 permits abroker-dealer that is participating in the distribution of anissuer’s securities to publish and distribute research reportsthat either: relate solely to the issuer’s common stock, debtsecurities, or preferred stock convertible into commonstock, where the offering involves solely the issuer’s non-convertible debt securities or non-convertiblenon-participating preferred stock; or relate solely to theissuer’s non-convertible debt securities or non-convertible,non-participating preferred stock, where the offeringinvolves the issuer’s common stock, debt securities, orpreferred stock convertible into common stock. In order totake advantage of Rule 138, the broker-dealer mustregularly report on the types of securities that are thesubject of the research report. The issuer involved must notbe a blank cheque company, shell company, or penny stockissuer and be either:• a reporting company (foreign or domestic) and current

in its Exchange Act filings; or• a foreign private issuer that meets all of the registrant

requirements of Form F-3 (other than the reportinghistory provisions of General Instructions IA1 andIA2(a) to Form F-3) and either: - satisfies the $75 million minimum public float

threshold in General Instruction I.B.1. of Form F-3,or

JOBS Act Quick Start 2018 update 87

- is issuing non-convertible securities other thancommon equity, and meets the provisions of GeneralInstruction IB2 of Form F-3; and either:• has its equity securities trading on a ‘designated

offshore securities market’ as defined in Rule902(b) of the Securities Act, and has had themtrading for at least 12 months; or

• has a worldwide public float of $700 million ormore.

Rule 139 applies to broker-dealers participating in theregistered distribution of the same security as thatdiscussed in their disseminated research reports. Thebroker-dealer must publish or distribute research reports inthe regular course of its business, and such publication ordistribution cannot represent either the initiation ofpublication or the re-initiation of publication. The issuermay not be a blank cheque, shell company or penny stockissuer and must: • have filed all required Exchange Act reports during the

preceding 12 months; • meet all the registrant requirements of Form S-3/F-3

(other than the reporting history provisions of GeneralInstructions IA1 and IA2(a) to Form F-3); and either: - satisfies the minimum public float threshold in

General Instruction IB1 of Form S-3/F-3; - is or will be offering non-convertible securities other

than common equity and meets the thresholdpursuant to General Instruction IB2 of Form S-3/F-3; or is

- a WKSI as defined in Rule 405 of the Securities Act,or

- a foreign private issuer that satisfies the samerequirements as for Rule 138.

Despite the above reforms, over time commentatorsnoted that the SEC’s communications rules were againoutmoded and needed to be further revised, because theyhad the effect of inhibiting more information from beingmade available to the investing public. In 2011, the IPOTask Force Report recommended that the SEC expand theexisting safe harbours in order to permit broker-dealers toinitiate coverage and distribute research on IPO issuerswithout being deemed to have offered securities throughthe research reports and include oral (in addition towritten) communications within the scope of the safeharbours.

JOBS Act Title I changesRecognising the contribution of research coverage to themarket for emerging companies, the JOBS Act attemptedto address some logistical issues relating to the diligenceactivities undertaken in connection with IPOs; however, it

did not supersede the Global Settlement. The JOBS Actalso eliminated certain quiet period restrictions onpublication of research reports in offerings by EGCs.

Research reports and offersSection 105 of the JOBS Act permits a broker-dealer topublish or distribute a research report about an EGC thatproposes to register an offering of common stock underthe Securities Act or has a registration statement pending,and the research report will not be deemed an offer undersection 2(a)(3) of the Securities Act, even if the broker-dealer will participate or is participating in the offering.Section 105(a) of the JOBS Act defines a research report as“a written, electronic, or oral communication that includesinformation, opinions, or recommendations with respectto securities of an issuer or an analysis of a security or anissuer, whether or not it provides information reasonablysufficient upon which to base an investment decision” (ouremphasis). This differs from the definition of a researchreport in the SRO rules and Global Settlement, where theinformation contained in the report must be reasonablysufficient to form the basis for an investor’s decision.Accordingly, the definition of research report for purposesof the JOBS Act would encompass nearly any written ororal communication relating to an EGC or its securitiesmade by a broker-dealer.

Section 105(a) of the JOBS Act provides that a researchreport published by a broker-dealer about an EGC that isplanning a public offering of common equity securitieswill not be considered an offer for purposes of section2(a)(10) and section 5(c) of the Securities Act. As a result,the issuance of a written research report by a broker-dealerwill not trigger a section 5 violation and would notconstitute a written offer ‘by means of a prospectus’ forpurposes of potential liability under section 12(a)(2). Bycontrast, the JOBS Act does not provide an exemptionfrom section 12(a)(2) liability for testing-the-waterscommunications under the JOBS Act but only fromsection 5. Therefore, a research report would have greaterprotection from liability under the JOBS Act than testing-the-waters materials. Whether an oral research report maybe subject to section 12(a)(2) liability is more complicated.The JOBS Act does not provide a safe harbour undersection 12(a)(2) with respect to oral research reports.Consequently, an oral research report could still result insection 12(a)(2) liability if it is deemed to constitute anoffer of a security. As a general matter, it is worth notingthat the JOBS Act has no impact on liability under Rule10b-5 or state anti-fraud laws.

88 JOBS Act Quick Start 2018 update

Research participation in certain meetingsSection 105(b) prohibits any SRO and the SEC fromadopting any rule or regulation that would restrict abroker-dealer from participating in certain meetingsrelating to EGCs. The JOBS Act also removes restrictionson who within an investment bank can arrange forcommunications between research analysts andprospective investors in connection with an EGC IPO,permitting investment bankers to be involved in thosearrangements. Further, a research analyst would bepermitted to engage in any communications with anEGC’s management when other employees of theinvestment bank, including the investment bankers, arepresent.

Under section 105(b) of the JOBS Act, an associatedperson of a broker-dealer, including investment bankingpersonnel, may arrange communications between researchanalysts and investors. This activity would include, forexample, an investment banker forwarding a list of clientsto the research analyst that the analyst could, at his or herown discretion and with appropriate controls, contact. Inturn, a research analyst could forward a list of potentialclients it intends to communicate with to investmentbanking personnel as a means to facilitate scheduling.Investment bankers can also arrange, but not participatein, calls between analysts and clients. In the past, the SEChas stated that such arranging activity, without more,would not violate Finra Rule 2711 or NYSE Rule 472,although the SEC has indicated that firms should bemindful of other provisions of the Exchange Act and theSRO Rules as well as the applicability of the GlobalSettlement.27

The JOBS Act prohibits a national securities associationor the SEC from maintaining rules restricting researchanalysts from participating in meetings with investmentbanking personnel and an EGC in connection with anEGC’s IPO. Before the enactment of the JOBS Act,research personnel were prohibited from attendingmeetings with issuer management that were also attendedby investment banking personnel in connection with anIPO, including pitch meetings. Section 105(b) of theJOBS Act permits research personnel to participate in anycommunication with the management of an EGCconcerning an IPO that is also attended by any otherassociated person of a broker, dealer, or member of anational securities association whose functional role isother than as an analyst, including investment bankingpersonnel. The SEC has interpreted this section asprimarily reflecting a Congressional intent to allowresearch personnel to participate in EGC managementpresentations with sales force personnel so that the issuer’s

management would not need to make separate andduplicative presentations to research personnel at a timewhen resources of the EGC may be limited.

The SEC stated in the SEC FAQs that researchpersonnel must limit their participation in such meetingsto introducing themselves, outlining their researchprogramme and the types of factors that they wouldconsider in their analysis of a company, and asking follow-up questions to better understand a factual statementmade by the EGC’s management. In addition, after thefirm is formally retained to underwrite the offering,research personnel could, for example, participate inpresentations by the management of an EGC to educate afirm’s sales force about the company and discuss industrytrends, provide information obtained from investingcustomers, and communicate their views.28

Under Finra Rules 2241 and 2242, research analysts areprohibited from soliciting business for the investmentbanking department, but they are not prevented fromattending a pitch meeting in connection with an IPO of anEGC that is also attended by investment bankingpersonnel; provided, however, that a research analyst maynot engage in otherwise prohibited conduct in suchmeetings.29

In the SEC’s view, section 105(b)(2) of the JOBS Actallows a firm to avoid the ministerial burdens of organisingseparate and potentially duplicative meetings andpresentations for an EGC’s management, investmentbanking personnel, and research analysts. Section105(b)(2) did not address communications whereinvestors are present together with an EGC’s management,analysts and investment banking personnel. Therefore, theSEC has taken the view that this provision of the JOBS Actdoes not affect the SRO rules prohibiting analysts fromparticipating in road shows or otherwise engaging incommunications with customers about an investmentbanking transaction in the presence of investment bankersor an EGC’s management. These rules apply tocommunications with customers and other investors anddo not depend on whether analysts, investment bankers,and an issuer are participating jointly in suchcommunications.30

The SEC FAQs confirm that Regulation AC is notaffected by the JOBS Act.31

In May 2015, Finra provided guidance on researchparticipation in certain meetings through its ResearchRules Frequently Asked Questions.32 In these FrequentlyAsked Questions, which were updated in March 2016,Finra makes clear that it regards the participation ofresearch personnel in meetings including investmentbanking personnel that relate to offerings as presenting

JOBS Act Quick Start 2018 update 89

certain risks. These risks are heightened if researchpersonnel participate in meetings before the investmentbank has been awarded a mandate to take part in theoffering. To this end, in its guidance, Finra notes it viewsan IPO in three stages, with a sliding scale of attendantrisks where an analyst communicates with an issuer: (1) apre-IPO period; (2) a solicitation period; and (3) a post-mandate period. Given the heightened risks that may bepresented in the solicitation period, wherein a researchanalyst may feel pressured to promise favourable researchor to share its views with the issuer regarding valuation,Finra member firms should consider carefully whetherresearch personnel should join meetings during suchperiod. Communications with research, and any potentialconflicts of interest, can be more effectively managed inthe pre-IPO and in the post-mandate periods.

In the Finra Research Rules Frequently AskedQuestions, Finra also provides its views regarding the SECFAQs, and, specifically, Question 4 with respect to thepermissible communications by a research analystattending an EGC IPO pitch meeting or other meetingsduring the solicitation period for an EGC IPO mandate.Finra emphasises that analysts attending such meetings arenot permitted to engage in otherwise prohibited conductor communications and cannot, for example, solicitinvestment banking business, or share views on valuationsduring the IPO pitch process. Given the sensitivity ofmany of these issues, most investment banks have chosennot to have research personnel present in pitch meetings.

Finra Rules 2241 and 2242 incorporate the guidanceprovided under the Finra Research FAQs issued in May2015.

Quiet periodsA broker-dealer participating in an issuer’s IPO is generallysubject to certain quiet periods with respect to publishingof research reports about such issuer. The publication ofresearch is generally prohibited in advance of the IPO and,once the IPO has been priced, no research can bepublished until 40 days following the offering.

Section 105 of the JOBS Act permits a broker-dealer topublish or distribute a research report about an EGC thatproposes to register an offering of common stock underthe Securities Act or has a registration statement pending,and the research report will not be deemed an “offer”under Section 2(a)(3) of the Securities Act, even if thebroker-dealer will participate or is participating in theoffering.

The JOBS Act also prohibits any national securitiesassociation (which includes Finra) or the SEC fromadopting any rule or regulation prohibiting a broker-dealer

from publishing or distributing a research report ormaking a public appearance with respect to the securitiesof an EGC within any prescribed period of time followingthe EGC’s IPO or the expiration date of any lock-upagreement. This eliminates the traditional post-IPO quietperiod for EGCs.

Finra Rule 2241 has further shortened the various quietperiods surrounding equity offerings. Specifically, a firmmust implement policies and procedures that stipulate thefollowing quiet periods: (i) a minimum of 10 days in thecase of an IPO and (ii) a minimum of three days in the caseof a secondary offering. Finra interprets the date of theoffering to be the later of either (x) the effective date of theregistration statement or (y) the first date on which thesecurities were bona fide offered to the public. Finra Rule2241 also expressly excludes from the quiet period: (i) thepublication or distribution of a research report or publicappearance following an IPO or secondary offering by anEGC, as defined under Section 3(a)(80) of the SecuritiesAct; (ii) the publication or distribution of a researchreport, or making of a public appearance, concerning theeffects of significant news or a significant event on anissuer provided that the firm’s legal or compliancepersonnel provided prior authorization before suchpublication was distributed or public appearance made;and (iii) the distribution of research reports or making of apublic appearance pursuant to Rule 139 under theSecurities Act.

Finra Rule 2241 also eliminates the quiet periods of 15days before and after the expiration, waiver or terminationof a lock-up agreement that had previously applied.

Other restrictions on researchThe JOBS Act does not affect or amend most of theexisting rules and regulations dealing with the separationof research and investment banking, even in relation toEGCs. The JOBS Act does not address or amendRegulation AC. The JOBS Act does not directly addressthe Global Settlement, and, as the Global Settlement is ajudicial order and not an SEC or Finra rule, it istechnically not affected by the enactment of the JOBS Act.It is important to remember, however, that the GlobalSettlement only affects the eight remaining settling firms.All other broker-dealers not party to the Global Settlementare able to take advantage of the self-effectuatingprovisions of the JOBS Act described above. It remains tobe seen whether the settling firms will petition the courtfor another amendment to the Global Settlement toconform to the provisions of the JOBS Act. The JOBS Actalso does not address the existing research safe harbours,and it is unclear when the SEC will amend Rules 137, 138,

90 JOBS Act Quick Start 2018 update

and 139 to address the effects of the JOBS Act. The tablein Appendix A compares the actions, as they relate toresearch and investment banking personnel, which arepermitted before and after the enactment of the JOBSAct.33

The future of researchTo date, following enactment of the JOBS Act, most firmshave proceeded cautiously in respect of research relating toEGCs. In the United States, there has not been (giventraditional restrictions on offering relatedcommunications) any history of pre-deal research. It is notclear that firms will become comfortable with pre-dealIPO research even following the JOBS Act. Firms havepublished research reports on EGCs that have completedtheir IPOs; however, generally, these research reports havebeen published at least 25 days following completion ofthe IPOs. Even firms that are not parties to the GlobalSettlement have not been quick to publish research reportsimmediately upon completion of the IPO. Over time, aspractitioners become more comfortable with the newrules, and compliance departments of investment bankingfirms are able to adapt to these new rules, market practicemay evolve. Commentators continue to emphasise theimportance of availability to retail investors of informationthat is contained in research reports. The experiences inrecent offerings have led many to advocate for additionalchanges related to research reports and to calls to requirethat any research views shared with institutional investorsor with a limited number of investors be shared morebroadly. We discuss these issues further in Chapter 9.

JOBS Act Quick Start 2018 update 91

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Appendix A

Can research personnel …

publish research reports concerningthe securities of an issuerimmediately following its IPO?

publish research reports concerningissuers that are the subject of anypublic offering of common equitysecurities (even if the firm isparticipating in the offering)?

publish research reports concerningthe securities of an issuer within 15days before and after the expiration,waiver or termination of any lock-upagreement?

participate in meetings withrepresentatives of an issuer,attended by investment bankingpersonnel?

contact potential investors in anissuer’s IPO?

make public appearancesconcerning the securities of anissuer?

solicit business for investmentbanking personnel?

engage in communications withpotential investors in the presenceof investment banking personnel?

share price targets and ratings withan issuer before the launch of adeal?

be compensated based oninvestment banking revenue?

Pre-JOBS Act

All issuers

Prohibited

Prohibited

Prohibited

Prohibited

Prohibited

Prohibited

Prohibited

Prohibited

Prohibited

Prohibited

EGC

Permitted

Permitted

Permitted

Permitted

Permitted

Permitted

Prohibited

Prohibited

Prohibited

Prohibited

Non-EGC

Prohibited

Prohibited

Permitted

Prohibited

Prohibited

Prohibited

Prohibited

Prohibited

Prohibited

Prohibited

Post-JOBS Act

JOBS Act Quick Start 2018 update 93

1 See IPO Task Force Report, available atwww.sec.gov/info/smallbus/acsec/rebuilding_the_ipo_on-ramp.pdf, at 26.

2 See Id.3 Finra Requests Comment on Finra Rules Impacting

Capital Formation, April 2017,www.finra.org/sites/default/files/notice_doc_file_ref/Regulatory-Notice-17-14.pdf; Finra RequestsComment on Proposed Limited Safe Harbor FromFinra Equity and Debt Research Rules for DeskCommentary, April 2017,www.finra.org/sites/default/files/notice_doc_file_ref/Regulatory-Notice-17-16.pdf.

4 See Finra Research Rules Frequently Asked Questions(FAQ), available at www.finra.org/industry/faq-research-rulesfrequently-asked-questions-faq

5 See Global Settlement (I)(1):www.sec.gov/litigation/litreleases/finaljudgadda.pdf;Finra Rule 2241; Finra Rule 2242.

6 See Letter to Dana G. Fleischman from James A.Brigagliano, SEC Division of Market Regulation(November 2 2004), at Question 10, available atwww.sec.gov/divisions/marketreg/mr-noaction/grs110204.htm

7 See section titled ‘Research participation in certainmeetings’.

8 A research report is defined as a writtencommunication that includes information, opinionsor recommendations with respect to securities of anissuer or an analysis of an issuer, whether or not itprovides information reasonably sufficient uponwhich to base an investment decision. Rule 137(e) ofthe Securities Act.

9 See Adoption of Rules Relating to Publication ofInformation and Delivery of Prospectus by Broker-Dealers Prior to or After the Filing of a RegistrationStatement Under the Securities Act of 1933,Securities Act Release No. 33-5101, 1970 WL 10585(November 19 1970).

10 See, eg, id. at n.88 (‘The publication of informationand publicity efforts, made in advance of a proposedfinancing which have the effect of conditioning thepublic mind or arousing public interest in the issueror in its securities constitutes an offer.’) (citingSecurities Act Release No. 33-5180, 1971 WL120474 (August 20 1971)).

11 Section 5(c) of the Securities Act, 15 USC § 77e(c).

12 Section 5(b) of the Securities Act, 15 USC § 77e(b).13 See the definition of prospectus in section 2(a)(10) of

the Securities Act, 15 USC § 77b.14 Securities Offering Reform Release, No. 33-8591,

2005, WL 1692642 (July 19 2005), at 39–40. Gun-jumping refers to the illegal solicitation of an offerbefore a registered offering.

15 Reform Release, supra note 14, at 16.16 Id. at n.55. See also id. at 41–42.17 See section 2(3) of the Securities Act.18 See Rules 137–39 of the Securities Act.19 See Rule 139(b)–(c) of the Securities Act.20 See SEC Litigation Release No. 18438 (October 31

2003).21 Reform Release, supra note 14.22 Id.23 Id. at 156. Research reports issued in reliance on Rule

137, 138, or 139 continue to be subject to theantifraud provisions of the federal securities laws,including liability under section 17(a) of theSecurities Act, section 10(b) of the Exchange Act,and Rule 10b-5 of the Exchange Act.

24 A blank cheque company is a development stagecompany that has no specific business plan orpurpose or has indicated its business plan is toengage in a merger or acquisition with anunidentified company or companies, other entity, orperson. SEC Rule 419(a)(2).

25 A shell corporation is a company that serves as avehicle for business transactions without itself havingany significant assets or operations. SEC Rule 405.

26 A penny stock issuer is a very small issuer of low-priced speculative securities. Since penny stocks aredifficult to accurately price, there are specific SECrules that must be satisfied before a broker-dealer cansell a penny stock, and the SEC does not allow theissuer to use certain exemptions from the registrationrequirements when selling their securities. ExchangeAct Rule 3a51-1.

27 Frequently Asked Questions about Research Analystsand Underwriters (August 22 2012), at Question 3,available at www.sec.gov/divisions/marketreg/tmjobsact-researchanalystsfaq.htm

28 See SEC FAQs, supra note 27 at Question 4.

ENDNOTES

29 See Finra Rules 2241(b)(2)(L) and 2242(b)(2)(L).See also SEC Release No. 34-68037 (October 112012), available atwww.sec.gov/rules/sro/finra/2012/34-68037.pdf

30 See SEC FAQs, supra note 27 at Question 5.31 See SEC FAQs, supra note 27 at Question 12.32 Finra Research Rules Frequently Asked Questions,

available at www.finra.org/industry/faq-research-rulesfrequently-asked-questions-faq.

33 This chart originally appeared in Morrison &Foerster’s Frequently Asked Questions AboutSeparation of Research and Investment Banking.

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JOBS Act Quick Start 2018 update 95

As we noted in the Introduction, the JOBS Actwas the continuation of a dialogue regardingthe impact of increased regulation andincreased disclosure requirements on capital

formation, as well as on the IPO process more specifically.While the US IPO market improved in the years followingthe JOBS Act’s implementation, largely as a result ofimproved economic conditions and, in part, as a result ofsome of the JOBS Act accommodations, in recent years theIPO market has been marked by volatility and manycompanies have chosen to delay their IPOs. Discussionsregarding measures intended to promote capital formationcontinue as regulators and commentators assess the JOBSAct’s impact.

Below, we highlight what we believe to be a few of theareas that are likely to receive substantive attention in thenear future. We have organised the discussion in two parts,focusing first on public offerings and second on exemptofferings.

The JOBS Act and initial public offeringsSix years have passed since the JOBS Act was signed intolaw to ease regulatory burdens on smaller companies andto facilitate public and private capital formation. Theprovisions related to IPOs, which have been effective sinceenactment, seek to encourage EGCs to pursue IPOs bycodifying a number of changes to the IPO process andestablishing a transitional “on-ramp” that provides forscaled-down public disclosures for EGCs. As we discuss inChapter 2, the impact of the JOBS Act on the executionof IPOs has been significant, resulting in new marketpractices that issuers and their advisers should be aware ofwhen planning an IPO.1

In 2013, the first full year after the JOBS Act’senactment, a total of 222 IPOs generated $54.9 billion ingross proceeds. This was a significant increase compared to2012, when 128 IPOs generated $42.7 billion ($26.9billion, excluding Facebook). The resurgence in IPOscontinued through 2014, with a total of 275 IPOsgenerating $85.3 billion in gross proceeds ($63.3 billion,excluding Alibaba). Since 2014, the IPO market hasgenerally cooled to pre-JOBS Act levels, with some

fluctuations. In 2015, a total of 170 IPOs generated $30billion in gross proceeds. In 2016, a total of 117 IPOsgenerated $21.9 billion in gross proceeds. In 2017, a totalof 189 IPOs generated $44 billion in gross proceeds.

While the JOBS Act may not have led to a resurgence inIPO activity, issuers have certainly taken advantage of itsscaled disclosure protections. In each year since the JOBSAct was enacted, the IPO market has been dominated byEGCs, which accounted for between approximately 80%,76%, 97%, 86% and 91% of all IPOs in 2013, 2014,2015, 2016 and 2017, respectively. Measured by totalproceeds raised, the energy, financial and healthcaresegments were the most active in 2013 and the technology,financial and energy segments were the most active in2014; however, the resurgence of the IPO market generallywas broad-based. Measured by total proceeds raised, thehealthcare, energy and financial segments were the mostactive during 2015; the finance, biotech/pharmaceuticaland energy segments were the most active during 2016;and the finance, computer software/services and biotech/pharmaceutical segments were the most active during2017.

Financial sponsors also continue to play an importantrole in the IPO market. In 2013, a total of 70 privateequity-backed IPOs generated $24.8 billion and 81venture capital-backed IPOs generated $9.6 billion. In2014, a total of 71 private equity-backed IPOs generated$25 billion and 126 venture capital-backed IPOsgenerated $35.3 billion. A total of 39 private equity-backed IPOs generated $11.3 billion and 85 venturecapital-backed IPOs generated $8.9 billion in 2015. In2016, a total of 29 private equity-backed IPOs generated$8 billion and 39 venture capital-backed IPOs generated$3.7 billion. In 2017, a total of 52 private equity-backedIPOs generated $16.4 billion and 53 venture capital-backed IPOs generated $9.2 billion.

JOBS Act 2.0?Market participants and commenters identified a numberof aspects of the JOBS Act IPO on-ramp process thatshould be streamlined, clarified or expanded to be availableto non-EGC companies. In recent years, various bills have

CHAPTER 9

Other capital formation discussions

96 JOBS Act Quick Start 2018 update

been introduced, principally in the House ofRepresentatives, which address aspects of the IPO on-rampprovisions. A number of these bills met with bipartisansupport in the House, but failed to garner the supportneeded to advance beyond that into legislation. As wediscuss in the Introduction, it was not until 2015 thatseveral of the most popular measures found their way intothe FAST Act. These included reducing the original 21-day public filing requirement for EGC IPO registrationstatements to a 15-day period, providing a grace period forEGCs that cease to qualify as EGCs while in the midst ofpursuing IPOs, and making certain modestaccommodations to the financial statement and financialinformation requirements for EGCs. We regard these asenhancements to the JOBS Act’s on-ramp provisions. Thecontinued decline in the number of US public companieshas led many commentators to advocate extending variousprovisions of the JOBS Act to a broader array ofcompanies. In June 2017, the SEC staff announced a newpolicy effective July 2017 that essentially extends theconfidential submission process for IPOs to all issuerswhile keeping the EGC process unchanged. The SEC willnow review a draft initial registration statement under theSecurities Act and related revisions on a confidential basis.Similarly, the SEC also will now review a draft registrationstatement for a class of securities under section 12(b) of theExchange Act. Confidential submission also is available formost follow-on registrations within the first year after acompany has become a reporting company. None of theother accommodations available to EGCs, however, wereextended to non-EGCs.

Other discussions relating to IPOsOffering-related communicationsIn the Introduction, we discuss an exchange ofcorrespondence in 2011 between Congressman DarrellIssa and SEC chair Schapiro relating to, among otherthings, capital formation. In those 2011 letters, Issaquestioned whether the SEC’s regulations relating tooffering-related communications had a chilling effect oncapital formation. The SEC committed to review its rulesrelating to offering related communications. The Issa-Schapiro dialogue had a second act in mid-2012. In June2012, Issa wrote a letter to Schapiro inquiring about theregulations applicable to IPOs.2 The letter specificallyaddress ‘barriers to communicating with investors’ duringthe IPO process. Issa referenced public reports that notedthat during the Facebook IPO, certain of the underwritersmay have provided institutional investors withinformation about revenue forecasts for Facebook, andquestioned whether SEC regulations relating to offering

communications had the effect of creating informationdisparities. Issa also questioned whether there weresufficient safe harbours for research reports such thatresearch analysts would be encouraged to make reportsavailable broadly, including to retail investors. In herresponse letter dated June 19 2012, Schapiro reiterated theSEC’s views that the statutory prospectus should be theprimary source of information for investors, but referred tovarious communications reforms, including SecuritiesOffering Reform in 2005, which had relaxed restrictionson communications.4 Schapiro also recognised theimportance of research reports and observed that the SEChad modernised the safe harbours for research reports.

As we discuss in Chapter 8, the JOBS Act provides greaterflexibility to publish research reports relating to EGCs.Other avenues for regulatory change to promote capitalformation outside of new legislation have also shownpromise. In early 2017, Finra launched an initiative calledFINRA360, with the objective of ensuring that Finra isoperating as the most effective self-regulatory organisation itcan be, working to protect investors and promote marketintegrity in a manner that supports strong and vibrantcapital markets. As part of this initiative, in April 2017,Finra issued a regulatory notice requesting comment on theeffectiveness and efficiency of its rules, operations andadministrative processes governing broker-dealer activitiesrelated to the capital-raising process and their impact oncapital formation, including requesting commentspecifically on Finra Rules 2241 and 2242 regarding debtand equity research as described in Chapter 8i.

As we discuss in Chapters 1 and 2, the JOBS Act alsopermits EGCs to engage in test-the-waterscommunications with QIBs and institutional accreditedinvestors before and after filing a registration statement.After the new SEC policy extending the confidentialsubmission process for IPOs to all issuers, somecommentators have speculated that an expansion of thetest-the-waters benefit may also be under consideration bythe SEC. An October 2017 US Treasury Departmentreport also recommended expanding this provision of theJOBS Act to allow all companies, not just EGCs, to testthe waters.

The structure of IPOsThe Issa letter to Schapiro also raised some fundamentalquestions regarding the structure of IPOs in the UnitedStates, where the book building process has long beenrelied upon for public offerings. As part of the bookbuilding process, underwriters will meet with institutionalinvestors and the issuer and the underwriter will conduct aroad show that will include in-person meetings with

groups of institutional investors. During the marketingprocess, the underwriters will gather informal indicationsof interest from institutional investors about the extent oftheir interest in an investment in the issuer’s securities,along with their pricing sensitivities. Over the marketingperiod, the underwriters begin to form a book of interestbased on these conversations.

Issa questions whether this traditional book buildingapproach allows the underwriters to exercise too muchdiscretion over the IPO process, and questions whether theapproach may be fraught with conflicts that may lead toinaccurate pricing. He also wondered whether the processhas the effect of foreclosing opportunities for meaningfulretail participation in IPOs. Finally, Issa asks the SEC tocomment on whether it has considered whetheralternatives, such as auction based pricing, would be morebeneficial and potentially less subject to overpricing andconflicts of interest. In other jurisdictions, there areexamples of modified book building approaches wherespecified percentages are reserved for retail investor orders,as well as examples of auction-based approaches.Academics have devoted substantial attention toconsidering whether book building or auction-basedapproaches are beneficial to issuers and investors. In fact,Schapiro, in her response to Issa, provides a very thoroughsurvey of the leading academic literature on IPO under-pricing and the advantages and disadvantages associatedwith the book building and the auction-based models.More or less at the same time, the US Senate BankingCommittee’s Subcommittee on Securities, Insurance andInvestment held hearings examining the IPO process.Legislators had as their objective considering whether theIPO process is fair and transparent, and whether the IPOmarket operates effectively for both institutional and retailinvestors. Dr. Ann Sherman provided testimony regardingthe IPO methods used in different countries andcommented on the costs and benefits of variousapproaches, concluding that retail investors are unlikely tocontribute to more accurate IPO pricing. Sherman andother participants in the hearing did conclude that therewas unequal access to information regarding IPOs.Sherman suggested requiring issuers to make their roadshow materials publicly available. Others suggestedextending the application of Regulation FD in order tomake certain that retail investors had access to the sameinformation that was provided to institutional investors.

From time to time, the IPO process appears to undergoreview. For example, the expansion of the JOBS Actconfidential submission provisions to cover most follow-on registrations within the first year after a company hasbecome a reporting company has partially addressed

fairness in the IPO process by reducing pressure oncompanies to maximize capital raising through the IPOoffering and easing dilution to existing investors. However,at present, it is not clear that there is any impetus togenerally re-evaluate the book building approach.

Disclosure requirements and disclosureeffectivenessThe JOBS Act’s IPO on-ramp provisions attempt tostreamline the disclosure requirements for EGCsundertaking an IPO. The SEC also was mandated by TitleI of the JOBS Act to undertake a study of the disclosurerequirements set forth in Regulation S-K in order toanalyse current disclosure requirements and determinewhether these requirements can be updated, modified orsimplified in order to reduce costs and other burdens onEGCs. On December 23 2013, the SEC delivered toCongress its report, which considers potentialrecommendations for revisiting disclosure requirementsbroadly.5

Many practitioners have noted that even with the scaleddisclosure requirements applicable to smaller reportingcompanies and the disclosure accommodations madeavailable to EGCs by the JOBS Act, the SEC disclosurerequirements and disclosure practices still seem to result inincredibly detailed and lengthy IPO documents that areoften hundreds of pages long. Commentators have notedthat, for a retail investor, it may be difficult to wadethrough dense disclosures and to assess which risks aremost critical to the issuer’s future prospects and businessresults. For this reason, some commentators haveencouraged the SEC to review whether certain disclosurerequirements may be modernised or simplified.

In various speeches, SEC representatives have discussedthe SEC’s disclosure effectiveness project. The staff of theDivision of Corporation Finance has highlightednumerous areas for potential improvement, including:whether certain requirements are outdated or redundant;whether disclosure documents could be made simpler andmore user friendly through the introduction of hyperlinksor topical indices; whether disclosure requirements mightbenefit from a principles-based approach; and whether torecommend a company disclosure or core disclosureapproach in which an issuer’s basic business descriptionand other company information would be disclosed in acore document and supplemented through periodicfilings.6 In April 2016, the SEC moved forward in itsreview of Regulation S-K requirements by issuing aConcept Release requesting comment on the business andfinancial disclosures that public companies provide in theirExchange Act filings.ii The Concept Release did not

JOBS Act Quick Start 2018 update 97

comment specifically on the other disclosure requirementsof Regulation S-K, such as corporate governance orcompensation-related items, or the required disclosures forFPIs, business development companies or other types ofregistrants. During 2016, the SEC requested commentthrough four other releases.

In the absence of rule changes, the SEC has noted thatpractitioners could improve disclosures by avoidingrepetition, producing more tailored, less generic riskfactors and other disclosures and eliminating outdatedinformation.11 The SEC has identified a number of areasthat often lead to duplicative disclosures.12 For example,discussion of share-based compensation, verbatimrepetition from the notes to the financial statements in theMD&A section of an issuer’s critical accounting policies,and the follow the leader phenomenon whereby issuersinclude disclosures made by other comparable companiesin their own filings even if those disclosures may not beappropriate or as relevant.13

The FAST Act further imposed certain deadlines for theSEC’s work on the disclosure effectiveness project.Specifically, the FAST Act directs the SEC to complete itswork related to revising Regulation S-K for the purpose ofeliminating duplicative, overlapping, outdated orunnecessary requirements by no later than 180 days afterthe FAST Act’s enactment, or June 2016. The FAST Actalso requires that the SEC complete a study of RegulationS-K within 360 days after enactment, or November 2016.In November 2016, the SEC staff released its ‘Report onModernization and Simplification of Regulation S-K,’ asrequired by the FAST Act.iii In October 2017, the SECproposed for comment amendments to Regulation S-K toimplement the recommendations made in its November2016 report. The amendments can be grouped into fourprincipal categories: proposed amendments that updaterules to account for developments that have occurred sincethe rules were adopted (ie changes to Item 407 ofRegulation S-K relating to corporate governance, changesto prospectus cover page disclosure, and changes to theundertakings); proposed amendments that requireadditional disclosure or incorporation of new technology(ie Inline XBRL tagging, use of legal entity identifiers etc);proposed changes that simplify required disclosures (iechanges to Item 303 of Regulation S-K relating toMD&A); and rationalisation of disclosures that may beincorporated by reference. The proposed amendments toItem 303 of Regulation S-K include eliminating thediscussion of the earliest year of the three-year periodcovered by the financial statements included in aregistration statement if (i) that discussion is not materialto an understanding of the registrant’s financial condition,

changes in financial condition and results of operationsand (ii) the registrant has filed with the SEC its annualreport on Form 10-K or 20-F for the prior year containingMD&A covering that earlier year.

It is important to note that changes to the disclosurerequirements of Regulation S-K and Regulation S-X likelywill apply to all issuers and not just to EGCs.

Smaller reporting companies and the ‘in-betweeners’As we have noted elsewhere, over time, the SEC has donemuch to modernise its regulations relating to offeringcommunications, and also has adopted changes to improvethe capital formation process. Securities Offering Reformin 2005 simplified the offering process for the largest andmost sophisticated public companies, WKSIs, andprovided these companies with greater flexibility foroffering-related communications. Companies that areconsidered smaller reporting companies are entitled to relyon certain scaled disclosure requirements, but many ofthese scaled disclosure requirements have not beenreviewed by the SEC in some time. Many mid-sizedcompanies cannot benefit from EGC status (due to thetiming of their initial offerings of equity securities) and arelarger than smaller reporting companies and thus notentitled to scaled disclosure provisions. We refer to thesecompanies as in-betweeners. Their disclosure andreporting concerns have not been addressed. In addition,these companies have capital raising needs that also havenot been addressed by Securities Offering Reform or bythe modifications made to the eligibility requirements foruse of shelf registration statements for primary offerings.

In June 2016, the SEC proposed amendments to thedefinition of smaller reporting company that wouldexpand the number of companies that have this status.Under the proposed amendments, registrants with a publicfloat of less than $250 million would qualify as a smallerreporting company. The SEC also proposed amendmentsto the definitions of accelerated filer and large acceleratedfiler, namely to eliminate the provision in the definition ofeach category that specifically excludes registrants that areeligible to use the smaller reporting company requirementsunder Regulation S-K for annual and quarterly reports.

Capital formation issues for smaller reporting companies,as well as other mid-sized companies, continues to be a topicof discussion among market participants. For example, anindustry task force, the Equity Formation Task Force, issueda report to the US Treasury Department recommending afew additional measures to facilitate capital formation.14 TheEquity Formation Task Force appears to be a successor to theIPO Task Force whose October 2011 report to the US

98 JOBS Act Quick Start 2018 update

Treasury Department contained various recommendationsthat were eventually incorporated in the JOBS Act.15 Severalbills have been proposed in Congress to address certain ofthe issues concerning smaller reporting companies and mid-cap companies. For example, bills have been introduced thatwould amend the definition of non-accelerated filer, revisethe definition of WKSI to lower the threshold and amendthe restrictions on the use of Form S-3 by smaller reportingcompanies for primary offerings. In February 2016, Form S-1 was revised, as directed by the FAST Act, in order topermit smaller reporting companies to forward incorporate,or incorporate by reference documents filed after theeffective date of the registration statement. This measuremakes it much more cost-efficient for smaller reportingcompanies to maintain a current resale registrationstatement (or other registration statement) on Form S-1,without the need to file post-effective amendments. In lightof the legislative proposals and recommendations made bythe SEC’s Advisory Committee on Smaller and EmergingCompanies at the SEC’s Government Business Forum onSmall Business Capital Formation, additional measures willbe considered that are intended to address the needs ofsmaller reporting companies.

Accredited investor statusAs we discuss in Chapter 4, Title II of the JOBS Actrequired that the SEC implement regulations relaxing theprohibition against general solicitation and generaladvertising in connection with certain private offeringsconducted pursuant to Rule 506 under Regulation D. TheJOBS Act also required an additional measure ofverification of the investor’s status as an accredited investorin connection with any Rule 506 offering employinggeneral solicitation. Investor verification was requiredgiven that for private placements where general solicitationwas used it was possible for an issuer or a financialintermediary working on the issuer’s behalf to contactpotential investors with whom neither the issuer nor thefinancial adviser had a pre-existing relationship.Congresswoman Maxine Waters was the sponsor of anamendment to HR 2940 that created the requirement ofreasonable steps to verify, and her language was ultimatelyincluded in section 201(a)(1) of the JOBS Act. Watersexplained the rationale for her amendment as follows:

‘I am concerned about the process in which accreditedinvestors verify that they are in fact accredited. As Iunderstand it, it is currently a self-certification process.This obviously leaves room for fraud...If we are rollingback protections for our targeted audience ofsophisticated individuals, we must take steps to ensurethat those folks are in fact sophisticated.’ 16

Historically, in the US, the statutory private placementexemption, or section 4(a)(2) exemption, was available fora private offering, which was understood to be an offeringmade on a limited basis to a group of investors with whomthe issuer, or the issuer’s agent, had a pre-existingrelationship, and who were in a position to have or toobtain certain information about the issuer. An offeringmade under proposed Rule 506(c) would still beconsidered a private placement; however, it would involvean offering to investors with whom the issuer potentiallyhad no pre-existing relationship, and who might notnecessarily receive any specified information about theissuer before making their investment decision. As a result,many commentators have expressed investor protectionconcerns. Commentators have noted that there isenhanced opportunity for fraudulent practices wheregeneral solicitation is used. As a result of these concerns,many, including SEC Commissioner Aguilar, havesuggested that the SEC should revisit the definition ofaccredited investor and consider whether the definitionsufficiently identifies investors that have the requisitefinancial sophistication to fend for themselves and nothave the protections associated with registered securitiesofferings.17

Changes to the definition of accreditedinvestorOn December 21 2011, the SEC amended the accreditedinvestor standards in its rules under the Securities Act toimplement section 413(a) of the Dodd-Frank Act.18 Thechange to the net worth standard was effective uponenactment by operation of the Dodd-Frank Act on July 212010; however, section 413(a) also required the SEC torevise its Securities Act rules to conform to the newstandard.19 Rules 21520 and 501(a)(5)21 under the SecuritiesAct set forth the accredited investor standards.22 Pursuantto section 413(a) of the Dodd-Frank Act, the SEC isrequired to adjust the net worth standard for naturalpersons individually or jointly with their spouses, to “morethan $1,000,000...excluding the value of the primaryresidence.”23 Before the adoption of section 413(a), thestandard under Rules 215 and 501(a)(5) required aminimum net worth of more than $1 million, butpermitted an individual investor and his or her spouse toinclude the net equity value of their primary residence incalculating whether they qualified for accredited investorstatus.24

In amending Rules 215 and 501(a)(5) to conform to thenew standard under the Dodd-Frank Act, the SECadopted identical language in the two rules,25 definingindividual accredited investor status to require net worth

JOBS Act Quick Start 2018 update 99

in excess of $1 million, provided that ‘[t]he person’sprimary residence shall not be included as an asset.’ Thefinal accredited investor definition is consistent with theapproach taken in the proposing release with respect to thebasic treatment of the primary residence and indebtednesssecured by the primary residence.26 The final rules alsoprovide a specific provision addressing the treatment ofincremental debt secured by the primary residence that isincurred in the 60 days before the sale of securities to theindividual in the exempt offering and certain newgrandfather provisions.

The new standard discusses the treatment of mortgagedebt in calculating net worth. ‘Indebtedness that is securedby the person’s primary residence, up to the estimated fairmarket value of the primary residence at the time of thesale of securities, shall not be included as a liability.’27 Thus,under the final rules, as in the proposing release, net worthis calculated by excluding positive equity that an investormay have in its primary residence.28 The SEC believed thisapproach to be the most appropriate way to conform itsrules to section 413(a) stating ‘it reduces the net worthmeasure by the net amount that the primary residencecontributed to net worth before enactment of section413(a), which we believe is what is commonly meant by‘the value of a person’s primary residence.’29 The final rulesalso provide that any excess of indebtedness secured by theprimary residence over the estimated fair market value ofthe residence is considered a liability for purposes ofdetermining accredited investor status on the basis of networth, whether or not the lender can seek repayment fromother assets in default.30 In the SEC’s view, the full amountof the debt incurred by the investor is the most appropriatevalue to use in determining accredited investor status.31

Review and mandatory studySection 413(b) of the Dodd-Frank Act provides that fouryears after enactment, and every four years thereafter, theSEC must review the accredited investor definition asapplied to natural persons, including adjusting thethreshold, although it may not be lowered below $1million.32 Section 415 of the Dodd-Frank Act requires theComptroller General of the United States to conduct aStudy and Report on Accredited Investors examining ‘theappropriate criteria for determining the financialthresholds or other criteria needed to qualify for accreditedinvestor status and eligibility to invest in private funds.’33

The study is expected to be taken into account by the SECin future rulemakings in this area.34 On July 18 2013, theUS Government Accountability Office (GAO), which isheaded by the Comptroller General, released its reportwith respect to the accredited investor standard.35 In

addition to reviewing data in order to understand whetherthe existing criteria serves the intended purpose or whetheralternative criteria should be considered, the GAOconducted interviews with market participants. Inconnection with its study, the GAO considered whetherthere should be an investments-owned criterion added tothe accredited investor standard, or a tiered approach thatwould limit investments to a fixed percentage of anindividual’s net worth (similar to the proposed investmentlimits for crowdfunding offerings under Title III of theJOBS Act). The GAO also considered whether theaccredited investor standard should be modified tointroduce a sophistication or financial literacy prong. In itsreport, the GAO notes that market participants seemed toconsider a minimum investments-owned criterion aspracticable.

These recent changes to the accredited investor standarddid not fundamentally alter the basic premise of thedefinition – that is, net worth continues to be used as aproxy for financial sophistication, or, at least for the abilityto bear a certain measure of investment risk. However,many commenters have advocated that standards otherthan or in addition to net worth and annual income beconsidered in connection with revisions to the definitionof ‘accredited investor.’ Certain recommendations havebeen incorporated into proposed legislation.

On December 18, 2015, the staff of the SEC publishedits Report on the Review of the Definition of AccreditedInvestor as required by section 413(b)(2)(A) of the Dodd-Frank Act.36 The study suggests that, among other things,the Commission consider: leaving the current income andnet worth thresholds in place, but make these subject toinvestment limitations; creating thresholds subject toinflationary adjustments; revising the definition to allowcertain individuals to qualify as accredited investors basedon other measures of sophistication, such as education orprofessional certifications; and amending the entitydefinitions.

Information requirements and continuingreporting requirementsIn the post-JOBS Act world, there may be some disparitiesin the information requirements that arise for an issuerdepending on the securities offering exemption that theissuer chooses to rely on in connection with its capital-raising efforts. For example, following enactment of theJOBS Act, an issuer may conduct a Rule 506 offeringusing general solicitation and make sales to investors thatare verified to be accredited investors. The issuer is notsubject to any information requirements. The securitiessold in a Rule 506 offering will be covered securities. The

100 JOBS Act Quick Start 2018 update

securities also will be restricted securities. Conceivably, anissuer could conduct multiple Rule 506 offerings, and, ifthe issuer remains below the holder-of-record threshold,the issuer would remain exempt from any requirement toprovide information to security-holders. By contrast, anissuer might choose to raise modest amounts of capital incrowdfunded offerings through a funding portal or abroker-dealer made to a broader universe of potentialinvestors, provided that the issuer complies with certainlimited information requirements and thereafter makespublicly available certain limited information. Thesecurities sold in a crowdfunded offering will be restrictedsecurities. Title IV of the JOBS Act contemplates that anissuer that is not an SEC-reporting company may rely onthe new Regulation A exemption to offer securitiespublicly, which will not be restricted securities, providedthat the issuer satisfies certain information requirements.Following a Regulation A offering, the issuer may chooseto remain private, although it will have issued shares in abroad-based offering, and may be subject to certain SECreporting requirements, though these are likely to belimited. In addition, given the growth of private secondarymarkets, the securities of a private company may beactively traded through the facilities of a private secondarymarket and, provided the issuer remains under the holder-of-record threshold, it will not be subject to informationreporting requirements. There also may be issuers thathave securities that trade OTC and there may notnecessarily be robust publicly available disclosures forinvestors. Also, in recent years, the unicorn phenomenonhas received significant public attention. Privately heldcompanies may rely for years on successive rounds offinancing and achieve significant market capitalisationswhile remaining private. These companies may havedispersed shareholder bases and be well known tocustomers and institutional investors. Employees,consultants and other stakeholders in these companies mayfrom time to time have liquidity opportunities presentedto them through sales on private secondary markets.Recognising that the dynamics of capital formation mayhave changed permanently and IPOs may continue to bedeferred in favour of exempt offerings, many commenters,including certain SEC Commissioners, have noted thatattention should be devoted to promoting privatesecondary markets. Commenters also have noted thatinformation requirements should be reviewed forcompanies that have developed a market following. It islikely that this is an area on which the SEC will focus aspart of its investor protection mission.

Intrastate and regional offeringsAt the same time that the SEC adopted RegulationCrowdfunding, in October 2015 the SEC proposed rulechanges to facilitate intrastate and regional offerings thatare subject to state blue sky regulation. The SEC indicatedin the proposing release that these proposals are ‘part of theCommission’s efforts to assist smaller companies withcapital formation consistent with other public policy goals,including investor protection.’37

In October 2016, the SEC adopted final rules regardingintrastate and regional offerings, which closely follow theSEC’s proposed rules.iv The final rules amend Rule 147under the Securities Act to facilitate offerings relying uponrecently adopted intrastate crowdfunding exemptionsunder state securities laws. Rule 147 provides a safeharbour for intrastate offerings exempt from registrationpursuant to section 3(a)(11) of the Securities Act, whichexempts any security offered and sold only to personsresident within a single state or territory by an issuerresiding or incorporated in and doing business within suchstate or territory. As amended, Rule 147 will continue tofunction as a safe harbour under section 3(a)(11), thoughsection 3(a)(11) will still be available as a potentialstatutory exemption in and of itself. The final rules alsoestablish a new Securities Act exemption, designated Rule147A, that further accommodates offers accessible to out-of-state residents and companies that are incorporated ororganized out-of-state. The final rules also amend Rule504 of Regulation D to (1) increase the aggregate amountof securities that may be offered and sold in any twelve-month period from $1 million to $5 million and (2)disqualify certain bad actors from participating in Rule504 offerings. In addition, the final rules repeal Rule 505of Regulation D, which had provided a safe harbour fromregistration for securities offered and sold in any twelve-month period from $1 million to $5 million. Theamendments to Rule 147 and Rule 504 are part of theSEC’s broader effort to assist smaller companies withcapital formation consistent with other public policy goals,including investor protection.

Going forwardThe JOBS Act has been an important catalyst fordiscussions regarding the appropriate balance betweenregulation and disclosure requirements and efficient accessto the capital markets. We hope that the lively dialoguethat the JOBS Act has reignited will continue and thatthere will be continued review of disclosure requirementsand additional innovative approaches to capital-raising.

JOBS Act Quick Start 2018 update 101

102 JOBS Act Quick Start 2018 update

1 For more information, see ‘Market trends relating toJOBS Act accommodations’ in Chapter 2 (The IPOprocess).

2 Letter dated June 19 2012, available athttp://s3.documentcloud.org/documents/370607/issa-ipoletter-june2012.pdf

4 See letter at http://online.wsj.com/public/resources/documents/secipoletter0826.pdf;

i Finra Requests Comment on Finra Rules ImpactingCapital Formation, April 2017, available atwww.finra.org/sites/default/files/notice_doc_file_ref/Regulatory-Notice-17-14.pdf

5 For more information regarding the SEC’s study onRegulation S-K, see ‘Required studies – RegulationS-K’ in Chapter 1 (The IPO on-ramp).

6 See speech of Keith F. Higgins, Director, Division ofCorporation Finance, titled ‘Disclosure Effectiveness:Remarks Before the American Bar AssociationBusiness Law Section Spring Meeting’ (April 112014), available atwww.sec.gov/News/Speech/Detail/Speech/1370541479332#.U2fpdxnD-Hs

ii SEC Release No. 33-10064; 34-77599; File No. S7-06-16, available atwww.sec.gov/rules/concept/2016/33-10064.pdf

11 Id.12 See speech of Keith F. Higgins, Director, Division of

Corporation Finance, titled ‘Keynote Address at PLI– Thirteenth Annual Institute on SecuritiesRegulation in Europe’ (March 20 2014), available atwww.sec.gov/News/Speech/Detail/Speech/1370541190424#.U2f0ARnD-Hs

13 Id.iii Report on Modernization and Simplification of

Regulation S-K, November 23, 2016, available atwww.sec.gov/files/sec-fast-act-report-2016.pdf

14 See report titled ‘From the On-Ramp to the Freeway:Refueling Job Creation and Growth by ReconnectingInvestors with Small-Cap Companies (November 112013), available atwww.securitytraders.org/wp-content/uploads/2013/11/ECF-From-the-On-Ramp-to-the-Freeway-vF.pdf

15 For more information regarding the IPO Task Force,see ‘Legislative and other efforts’ in Introduction.

16 House Financial Services Subcommittee on CapitalMarkets and Government Sponsored EnterprisesHolds Markup on HR 1965, HR 2167, HR 2930,HR 2940 and a Draft Bill Concerning SmallCompanies and Regulatory Relief, 112th Cong., 1stSess. (Congressional Hearing held October 5 2011),Congressional Quarterly Transcripts at 8-9.

17 See, eg, Commissioner Luis Aguilar’s statements titled‘Increasing the Vulnerability of Investors,’ available atwww.sec.gov/news/speech/2012/spch082912laa.htm

18 Net Worth Standard for Accredited Investors,Securities Act Release No. 9287, InvestmentCompany Act Release No. 29891, 2011 WL6415435 (December 21 2011) (the Net WorthStandard Adopting Release).

19 On January 25 2011, the SEC proposedamendments to the accredited investor standards. SeeNet Worth Standard for Accredited Investors,Securities Act Release No. 9177, InvestmentCompany Act Release No. 29572, 2011 WL 231559(January 25 2011).

20 17 CFR § 230.215.21 17 CFR § 230.501(a)(5).22 Rule 501 defines the term accredited investor for

purposes of exempt and limited offerings underRules 504, 505, and 506 of Regulation D. Rule 215defines the term accredited investor under section2(a)(15) of the Securities Act, setting the standardsfor accredited investor status under section 4(5) ofthe Securities Act, formerly section 4(6), whichpermits offerings solely to accredited investors of upto $5 million, subject to certain conditions. 15 USC77d(5). Former section 4(6) of the Securities Act wasrenumbered section 4(5) by section 944 of theDodd-Frank Act.

ENDNOTES

23 Section 413(a) of the Dodd-Frank Act, Pub. L. No.111-203, § 413(a) (2010), states: ‘The Commissionshall adjust any net worth standard for an accreditedinvestor, as set forth in the rules of the Commissionunder the Securities Act of 1933, so that theindividual net worth of any natural person, or jointnet worth with the spouse of that person, at the timeof purchase, is more than $1,000,000 (as suchamount is adjusted periodically by rule of theCommission), excluding the value of the primaryresidence of such natural person, except that duringthe 4-year period that begins on the date ofenactment of this Act, any net worth standard shallbe $1,000,000, excluding the value of the primaryresidence of such natural person.’

24 See 17 CFR § 230.215(e) and § 230.501(a)(5)(2010).

25 The SEC stated: ‘so the two rules will implementSection 413(a) of the Dodd-Frank Act in the sameway.’ See Net Worth Standard Adopting Release at*4.

26 See id. at *5.27 See Rule 501(a)(5)(i)(B) (as amended).28 Id.29 Id.30 See id. at *7.31 Id. The SEC further explained ‘that is the basis on

which interest accrues under the mortgage and theamount that third parties would look to in assessingcreditworthiness.’ Id.

32 Dodd-Frank Act, § 413(b).33 Dodd-Frank Act, § 415.34 See Net Worth Standard Adopting Release at *3.35 See Report to Congressional Committees titled

‘Securities and Exchange Commission – AlternativeCriteria for Qualifying as an Accredited InvestorShould be Considered’ (July 2013), available athttp://gao.gov/assets/660/655963.pdf

36 See www.sec.gov/corpfin/reportspubs/special-studies/review-definition-of-accredited-investor-12 182015.pdf

37 See SEC Release No. 33-9470 (October 23 2013).iv See SEC Release Nos. 33-9973; 34-76319 (October

30 2015) and SEC Release Nos. 33-10238; 34-79161 (October 26 2016).

JOBS Act Quick Start 2018 update 103

104 JOBS Act Quick Start 2018 update

EMERGING GROWTHCOMPANIES (EGCS)

Qualifying as an EGC

Disqualification as anEGC

IPOs by EGCs

Ongoing disclosures/governance requirements

RESEARCH REPORTS

Permitted communications

Conflicts, separation,disclosures

REGULATION D

Rule 506 offerings

BROKER-DEALER REGISTRATION

Platforms/matching services

CROWDFUNDING

Offering threshold

EGC defined as an issuer with total gross revenues of less than $1.07 billion.1

EGC until the earliest of:(A) last day of the fiscal year during which issuer’s total gross revenues exceed $1.07 billion;2

(B) five years from IPO;(C) the date on which issuer has sold more than $1 billion in non-convertible debt; or(D) date on which issuer becomes a large accelerated filer (public float of $750 million).

• confidential submission available;• must file publicly at least 15 days (previously 21 days) before roadshow;• two years audited financials required (instead of three);• may elect to rely on certain scaled disclosures available to smaller public reporting

companies (such as for executive compensation); and• may engage in testing the waters with QIBs and IAIs.

• may opt into voluntary disclosures;• subject to phase-in for say-on-pay and say-on-golden parachute requirements;• subject to phase-in for any PCAOB mandatory rotation or modified audit report requirement;• exempt from Sarbanes-Oxley section 404(b) attestation (but subject to requirement for

management assessment of internal control requirement over financial reporting and toCEO/CFO certification requirement); and

• not required to adopt FASB standards until broadly applicable to private companies.

• research report on EGC not an offer;• research report on EGC not subject to quiet period or lock-up period restrictions; and• distribution participants may publish research before commencement of an offering, during

an offering or post offering.

• reports subject to required conflicts disclosures and certifications; and• modifies separation/chaperoning requirements in connection with certain activities for EGCs.

General advertising/general solicitation permitted in Rule 506(c) offerings provided that the issuer has a reasonable belief that purchasers are all AIs.

Not required to register as broker-dealers solely as a result of participation or involvement in Rule506 offerings that use general solicitation or general advertisement, provided that platform doesnot receive transaction-based compensation, handle customer funds or securities, or participate in documentation.

The aggregate amount sold to all investors by the issuer, including any amount sold in reliance onthe crowdfunding exemption during the 12-month period preceding the date of the transaction, isnot more than $1.07 million.3

APPENDIX A: JOBS ACT: SUMMARY OVERVIEW

JOBS Act Quick Start 2018 update 105

Investment threshold

Manner of offering

Information

Funding portals

Liability

Status of securities

Other conditions

REGULATION A

Eligible issuer

Offering threshold

Status of securities

Investment threshold

Liability

Other conditions

EXCHANGE ACTTHRESHOLD

Issuer not a bank orbank holding company2

The aggregate amount sold to any investor by the issuer, including any amount sold in reliance onthe crowdfunding exemption during the 12-month period preceding the date of the transaction,does not exceed:• the greater of $2,2004 or five percent of the annual income or net worth of the investor, as

applicable, if either the annual income or the net worth of the investor is less than $107,000; or• 10% of the annual income or net worth of an investor, as applicable, not to exceed a maximum

aggregate amount sold of $107,000,5 if either the annual income or net worth of the investor isequal to or more than $107,0006.

The transaction must be conducted through a broker or funding portal.

Information filed and provided to investors regarding the issuer and offering, including financialinformation based on the target amount offered

Funding portals are subject to SEC and SRO regulation.

Subject to Securities Act section 12(a)(2) liability

Covered securities for NSMIA

Issuers must file with the SEC and provide to investors, no less than annually, reports of theresults of operations and financial statements of the issuers.

Non-reporting issuer with principal place of business in Canada or the US; not an investmentcompany or a bad actor

Tier 1 offerings: up to $20 million within the prior 12-month period (with no more than $6 millionsold on behalf of selling stockholders);Tier 2 offerings: up to $50 million within the prior 12-month period (with no more than $15 millionsold on behalf of selling stockholders); andSEC required to review threshold and report on threshold to Congress.

Securities sold in a Tier 2 offering are covered securities for NSMIA; however, securities sold in aTier 1 offering are subject to blue sky requirements.

Non-accredited natural persons in Tier 2 offerings are subject to an investment limit and arerequired to limit purchases to no more than 10% of the greater of the investors’ net worth orannual income (for non-accredited, non-natural persons, the 10% limit is based on annualrevenues and net assets).

Subject to Securities Act section 12(a)(2) liability.

SEC empowered to impose additional conditions; Tier 2 issuers must include audited financialstatements in the offering statement and file with the SEC annual audited financial statements;rule includes detailed ongoing reporting requirements.

Becomes subject to reporting within 120 days after last day of fiscal year ended in which issuerhad:

• total assets in excess of $10 million; and• a class of equity securities (other than exempted securities) held of record by either 2,000

persons or 500 persons not AIs.

106 JOBS Act Quick Start 2018 update

ENDNOTES1 Updated for inflationary adjustments (from original threshold of $1 billion) and effective beginning April 12 2017.2 Updated for inflationary adjustments (from original threshold of $1 billion) and effective beginning April 12 2017.3 Updated for inflationary adjustments (from original amount of $1 million) and effective beginning April 12 2017.4 Updated for inflationary adjustments (from original amount of $2,000) and effective beginning April 12 2017.5 Updated for inflationary adjustments (from original amount of $100,000) and effective beginning April 12 2017.6 Updated for inflationary adjustments (from original amount of $100,000) and effective beginning April 12 2017.

Issuer is a bank or bankholding company

Held of record

REQUIRED STUDIES

Decimalisation

Regulation S-K

Blue sky laws and Regulation A

Section 12 SEC enforcement authority

Becomes subject to reporting within 120 days after last day of fiscal year ended in which issuerhad:

• total assets in excess of $10 million; and• a class of equity securities (other than exempted securities) held of record by 2,000 persons.

May deregister if class of equity securities held of record by fewer than 1,200 persons

Excludes: securities held by persons who received the securities pursuant to an employeecompensation plan in transactions exempt from registration requirements under Securities Actsection 5 and securities sold pursuant to crowdfunding exemption.

SEC, within 90 days of enactment, must report to Congress on its study of the impact ofdecimalisation on IPOs and the impact of this change on liquidity for EGCs. SEC must alsoconsider within 180 days of enactment any recommendations regarding the minimum tradingincrements for EGCs; on July 20 2012, the SEC delivered to Congress its report.

SEC, within 180 days of enactment, must report to Congress on its review of Regulation S-K andits recommendations concerning changes to S-K requirements for EGCs to simplify burdens; onDecember 23 2013, the SEC delivered to Congress its report.

Comptroller General, within three months of enactment, must report to Congress on its study ofthe impact of blue sky laws on Regulation A offerings; on July 3 2012, the Comptroller Generaldelivered to Congress its report.

SEC, within 120 days of enactment, must report to Congress on its assessment regardingadditional enforcement tools that may be needed for it to enforce anti-evasion provision inSecurities Act section 12(b)(3); on October 16 2012, the SEC delivered to Congress its report.

JOBS Act Quick Start 2018 update 107

AP

PE

ND

IX B

: SU

MM

ARY

CH

AR

T O

F EX

EM

PT O

FFE

RIN

G A

LTE

RN

ATIV

ESB

elow

we

prov

ide

a su

mm

ary

com

paris

on o

f var

ious

sec

uriti

es e

xem

ptio

ns.

Type

of

offe

ring

Sec

tion

3(a)

(11)

Rul

e 14

7

Rul

e 14

7A

Dol

lar

limit

Non

e

Non

e

Non

e

Man

ner

of o

fferin

g

No

limita

tion

othe

r tha

nto

mai

ntai

n in

trast

ate

char

acte

r of o

fferin

g.

No

limita

tion

othe

r tha

nto

mai

ntai

n in

trast

ate

char

acte

r of o

fferin

g

Gen

eral

sol

icita

tion

perm

itted

, pro

vide

d th

atsa

les

are

mad

e on

ly to

resi

dent

s of

the

stat

e or

terri

tory

in w

hich

the

issu

er is

resi

dent

. Offe

rsm

ay b

e m

ade

to o

ut-o

f-st

ate

resi

dent

s.

Issu

er a

nd in

vest

orre

quire

men

ts

Issu

er a

nd in

vest

ors

mus

tbe

resi

dent

in s

tate

. No

limita

tion

on n

umbe

r

Issu

er m

ust b

e re

side

nt in

stat

e, u

sing

‘prin

cipa

lpl

ace

of b

usin

ess’

and

juris

dict

ion

ofor

gani

satio

n to

det

erm

ine

resi

denc

y, an

d m

eet a

tle

ast o

ne ‘d

oing

busi

ness

’ req

uire

men

t.In

vest

ors

mus

t be

resi

dent

in s

tate

, usi

ng‘p

rinci

pal p

lace

of

busi

ness

’ to

dete

rmin

ere

side

ncy.

No

limita

tion

on n

umbe

r of i

nves

tors

.

Issu

er m

ust b

e re

side

nt in

stat

e, u

sing

‘prin

cipa

lpl

ace

of b

usin

ess’

tode

term

ine

resi

denc

y, an

dm

eet a

t lea

st o

ne ‘d

oing

busi

ness

’ req

uire

men

t.In

vest

ors

mus

t be

resi

dent

in s

tate

usi

ng‘p

rinci

pal p

lace

of

busi

ness

’ to

dete

rmin

ere

side

ncy.

No

limita

tion

on n

umbe

r of i

nves

tors

.

Filin

g re

quire

men

t

Non

e

Non

e

Non

e

Res

tric

tion

on r

esal

e

Sec

uriti

es m

ust r

est

with

in th

e st

ate.

Lim

its o

n re

sale

s to

pers

ons

resi

ding

with

inth

e st

ate

or te

rrito

ry o

fth

e of

ferin

g fo

r six

mon

ths.

Lim

its o

n re

sale

s to

pers

ons

resi

ding

with

inth

e st

ate

or te

rrito

ry o

fth

e of

ferin

g fo

r six

mon

ths.

Blu

e sk

y ex

empt

ion

Nee

d to

com

ply

with

stat

e bl

ue s

ky la

ws

byre

gist

ratio

n or

sta

teex

empt

ion.

Nee

d to

com

ply

with

stat

e bl

ue s

ky la

ws

byre

gist

ratio

n or

sta

teex

empt

ion.

Nee

d to

com

ply

with

stat

e bl

ue s

ky la

ws

byre

gist

ratio

n or

sta

teex

empt

ion.

108 JOBS Act Quick Start 2018 update

Type

of

offe

ring

Sec

tion

4(a)

(2)

Rul

e 50

4R

egul

atio

n D

Rul

e 50

6(b)

Rul

e 50

6(c)

Dol

lar

limit

Non

e

$5 m

illion

w

ithin

prio

r 12

mon

ths.

Non

e

Non

e

Man

ner

of o

fferin

g

No

gene

ral s

olic

itatio

n or

gene

ral a

dver

tisin

g.

No

gene

ral s

olic

itatio

n or

gene

ral a

dver

tisin

gun

less

regi

ster

ed in

ast

ate

requ

iring

use

of a

subs

tant

ive

disc

losu

redo

cum

ent o

r sol

d un

der

stat

e ex

empt

ion

for s

ales

to a

ccre

dite

d in

vest

ors

with

gen

eral

sol

icita

tion.

No

gene

ral s

olic

itatio

n or

gene

ral a

dver

tisin

g un

der

Rul

e 50

6(b)

.

Gen

eral

sol

icita

tion

perm

itted

, pro

vide

d th

atal

l pur

chas

ers

are

accr

edite

d in

vest

ors.

Issu

er a

nd in

vest

orre

quire

men

ts

Inve

stor

s m

ust m

eet

soph

istic

atio

n an

dac

cess

to in

form

atio

n te

stso

as

not t

o ne

edpr

otec

tion

of re

gist

ratio

n.

Avai

labl

e to

non

-repo

rting

com

pani

es o

nly

that

are

not i

nves

tmen

tco

mpa

nies

or b

lank

chec

k co

mpa

nies

.

Cer

tain

‘bad

act

ors’

are

disq

ualif

ied

from

parti

cipa

ting

in R

ule

504

offe

rings

.

Unl

imite

d nu

mbe

r of

accr

edite

d in

vest

ors

and

35 n

on-a

ccre

dite

din

vest

ors

that

are

soph

istic

ated

.

Und

er R

ule

506(

c), a

llpu

rcha

sers

mus

t be

accr

edite

d in

vest

ors.

Issu

er m

ust t

ake

reas

onab

le s

teps

to v

erify

accr

edite

d in

vest

orst

atus

.

Filin

g re

quire

men

t

Non

e

File

For

m D

with

the

SEC

not l

ater

than

15

days

afte

r firs

t sal

e.

Filin

g no

t a c

ondi

tion

ofth

e ex

empt

ion.

File

For

m D

with

SEC

not

late

r tha

n 15

day

s af

ter

first

sal

e.

File

For

m D

with

the

SEC

not l

ater

than

15

days

afte

r firs

t sal

e.

Res

tric

tion

on r

esal

e

Res

trict

ed s

ecur

ities

.

Res

trict

ed u

nles

sre

gist

ered

in a

sta

tere

quiri

ng u

se o

f asu

bsta

ntiv

e di

sclo

sure

docu

men

t or s

old

unde

rst

ate

exem

ptio

n fo

r sal

eto

acc

redi

ted

inve

stor

sw

ith g

ener

al s

olic

itatio

n.

Res

trict

ed s

ecur

ities

.

Res

trict

ed s

ecur

ities

.

Blu

e sk

y ex

empt

ion

Nee

d to

com

ply

with

stat

e bl

ue s

ky la

ws

byre

gist

ratio

n or

sta

teex

empt

ion.

Nee

d to

com

ply

with

stat

e bl

ue s

ky la

ws

byre

gist

ratio

n or

sta

teex

empt

ion.

No

need

to c

ompl

y w

ithst

ate

blue

sky

law

s.

No

need

to c

ompl

y w

ithst

ate

blue

sky

law

s.

JOBS Act Quick Start 2018 update 109

Type

of

offe

ring

Tier

1R

egul

atio

n A

Tier

2R

egul

atio

n A

Reg

ulat

ion

Cro

wdf

undi

ng

Dol

lar

limit

$20

milli

onw

ithin

prio

r 12

mon

ths,

but

no

mor

e th

an $

6m

illion

by

sell-

ing

secu

rity

hold

ers.

$50

milli

onw

ithin

the

prio

r12

mon

ths,

but

no m

ore

than

$15

milli

on b

yse

lling

secu

rity

hold

ers.

Up

to

$1.0

7 m

illion

ina

12-m

onth

perio

d.

Man

ner

of o

fferin

g

‘Tes

ting

the

wat

ers’

perm

itted

bef

ore

and

afte

r filin

g Fo

rm 1

-A.

Sal

es p

erm

itted

afte

rFo

rm 1

-A q

ualif

ied.

‘Tes

ting

the

wat

ers’

perm

itted

bef

ore

and

afte

r filin

g Fo

rm 1

-A.

Sal

es p

erm

itted

afte

rFo

rm 1

-A q

ualif

ied.

Offe

ring

mus

t be

mad

eso

lely

thro

ugh

a pl

atfo

rm.

Issu

er a

nd in

vest

orre

quire

men

ts

Issu

er m

ust b

e el

igib

leis

suer

.N

o in

vest

or re

quire

men

t.

Issu

er m

ust b

e el

igib

leis

suer

.

No

inve

stor

requ

irem

ent;

how

ever

, inv

esto

rs w

hoar

e na

tura

l per

sons

and

are

not a

ccre

dite

din

vest

ors

are

subj

ect t

oan

inve

stm

ent l

imit.

Issu

ers

that

are

not

repo

rting

com

pani

es, n

otfu

nds,

and

not

sub

ject

todi

squa

lific

atio

n.

Filin

g re

quire

men

t

File

test

-the-

wat

ers

docu

men

ts, F

orm

1-A

,an

y sa

les

mat

eria

l and

repo

rt of

sal

es a

nd u

se o

fpr

ocee

ds w

ith th

e S

EC.

File

test

-the-

wat

ers

docu

men

ts, F

orm

1-A

,an

y sa

les

mat

eria

l and

repo

rt of

sal

es a

nd u

se o

fpr

ocee

ds w

ith th

e S

EC.

Issu

er s

ubje

ct to

ong

oing

repo

rting

requ

irem

ents

.

Req

uire

s th

e pr

epar

atio

nof

a F

orm

C, w

hich

rese

mbl

es a

For

m 1

-A.

Res

tric

tion

on r

esal

e

Not

rest

ricte

d se

curit

ies.

Not

rest

ricte

d se

curit

ies.

Sec

uriti

es s

old

in a

nof

ferin

g ar

e su

bjec

t to

certa

in tr

ansf

erre

stric

tions

for

one

year

.

Blu

e sk

y ex

empt

ion

Sub

ject

to s

tate

blu

e sk

yla

ws

rega

rdin

g pr

e-of

ferin

g re

view

, filin

g, a

ndan

ti-fra

ud.

Not

sub

ject

to s

tate

blu

esk

y la

ws

rega

rdin

g pr

e-of

ferin

g re

view

; how

ever

,su

bjec

t to

stat

e bl

ue s

kyfil

ing

and

anti-

fraud

requ

irem

ents

.

No

need

to c

ompl

y w

ithst

ate

blue

sky

law

s.

110 JOBS Act Quick Start 2018 update

AP

PE

ND

IX C

: EG

C IP

O P

RO

CES

S

The

SEC

mus

t rev

iew

the

draf

t reg

istra

tion

stat

emen

ton

a c

onfid

entia

l bas

is

An

EGC

may

rem

ain

in th

eco

nfid

entia

l rev

iew

pro

cess

until

requ

ired

to fi

le F

orm

S-1

,w

ith th

e S

EC is

suin

g co

m-

men

ts a

nd th

e EG

C re

spon

d-in

g w

ith d

raft

subm

issi

ons

The

Form

S-1

and

all

prio

rco

nfid

entia

l sub

mis

sion

sm

ust b

e fil

ed 1

5 da

ys b

efor

eth

e ro

ad s

how

Afte

r filin

g th

e Fo

rm S

-1, t

hepr

oces

s is

the

sam

e as

a p

re-

JOB

S A

ct IP

O

An

EGC

or a

ny o

ther

per

son

auth

oris

ed b

y th

e EG

C c

an te

st th

e w

ater

s in

com

mun

icat

ions

with

QIB

s an

d in

stitu

tiona

l acc

redi

ted

inve

stor

s be

fore

or

durin

g th

e IP

O.

Bro

ker-d

eale

rs, i

nclu

ding

thos

e pa

rtici

patin

g in

the

IPO

, can

pub

lish

rese

arch

befo

re, d

urin

g or

afte

r the

IPO

with

out t

he re

sear

ch b

eing

dee

med

an

offe

run

der t

he S

ecur

ities

Act

.

File

S-1

Sub

mit

draf

t S-1

Roa

d sh

owS

-1ef

fect

ive