The Jumpstart Our Business Startups Act (or “JOBS Act”) was signed into law on April 5, 2012. Its intent was to stimulate job growth by making it easier and less expensive for smaller businesses, such as start-ups and entrepreneurial companies, to raise capital. However, due to delay in enactment of rules required to effectuate key provisions, its implementation remains uncertain.
Highlights of the JOBS Act’s key provisions include:
- Reporting Companies. Increase of threshold at which a privately-held company is required to register with the Securities and Exchange Commission (“SEC”) to become a publicly reporting company under the Securities Exchange Act of 1934 from (i) 500 shareholders of record and total assets of $1 million to (ii) either 2,000 shareholders, or 500 shareholders who do not qualify as “accredited investors” pursuant to Rule 501 of Regulation D of the Securities Act of 1933, as amended (the “Securities Act”), and assets of $10 million.
- Crowdfunding. Mandate to the SEC to enact rules creating a new exemption from registration to allow crowdfunding for small offerings up to $1 million within any 12-month period. Conditions to the crowdfunding exemption include: (1) annual cap on aggregate amount an individual can invest in crowdfunded offerings, tiered based upon net worth or annual income; (2) use of internet funding portal registered with the SEC; and (3) review or audit of the issuer’s financial statements, depending on offering size.
UPDATE: The SEC missed its initial deadline to enact crowdfunding rules by the end of 2012. Until crowdfunding rules have been adopted, it is unlawful to make any offers or sales of securities claiming reliance on the crowdfunding exemption.
- Emerging Growth Companies. Reduction of costs, regulations and burdens of going public for emerging growth companies or “EGCs” (companies with gross annual revenue of less than $1 billion), which permit EGCs to phase in the full panoply of securities regulations over a longer period of time.
- Small Offerings. Mandate to the SEC to enact rules creating a new exemption for small issue offerings of up to $50 million. Although the JOBS Act contains terms and conditions applicable to the proposed small issue exemption, we won’t know the full scope of the exemption until the SEC adopts rules of implementation.
- General Solicitation. Mandate to the SEC to amend Rule 506 of Regulation D of the Securities Act to permit general solicitation or general advertising (collectively referred to as “General Solicitation”) in connection with Rule 506 offerings, provided that all purchasers of the securities are accredited investors, and the issuer takes reasonable steps to verify that purchasers are accredited investors using methods to be determined by the SEC.
UPDATE: The SEC released its proposed rules regarding General Solicitation on August 29, 2012 (See SEC Release No. 33-9354). There has been little progress since the proposed rules were released. The proposed rules are described below.
Proposed Rules Regarding General Solicitation
Issuers claiming exemption under Rule 506 are currently prohibited from engaging in General Solicitation. General Solicitation is not defined in federal securities laws or regulations. Rule 502 of Regulation D provides some examples of General Solicitation, such as newspaper and magazine ads, television and radio broadcasts, and seminars whose attendees were invited using such means. SEC interpretative letters and releases along with issued decisions in administrative actions provide additional guidance (e.g., use of publicly available websites constitutes General Solicitation).
Under the proposed rules, issuers would be permitted to use General Solicitation to offer securities in Rule 506 offerings, provided that (1) the issuer takes reasonable steps to verify that purchasers are accredited investors, and (2) all purchasers are (or are reasonably believed by the issuer at the time of sale to be) accredited investors.
- Rule 501 of Regulation D of the Securities Act includes several categories of accredited investors. A natural person may qualify as an accredited investor based upon net worth or income.
The SEC has not proposed specific verification methods that an issuer must use, rationalizing that this provides necessary flexibility in light of the numerous ways an investor can qualify as accredited. Whether the verification steps taken are reasonable is an objective determination, based on the facts and circumstances of the transaction. The factors issuers are to consider when determining the reasonableness of the verification steps include:
- The type of purchaser and the category of accredited investor the purchaser claims to be. For example, the status of a purchaser claiming accredited investor status by virtue of its status as a registered broker-dealer can be verified on the FINRA BrokerCheck website. This differs from the steps that would be deemed reasonable to confirm that a natural person is an accredited investor based on net worth or income.
- The amount and type of information the issuer has about the purchaser. The more information the issuer has that indicates a purchaser is an accredited investor, the fewer steps needed to verify accredited investor status, and vice versa. This information may include:
- publicly available information contained in government filings or industry publications indicating sufficient income or net worth;
- third party information that provides reasonably reliable evidence, such as Forms W-2 for a natural person claiming accredited status due to income levels;
- verification of accredited investor status by third parties, such as accountants, attorneys and broker-dealers, provided the issuer has a reasonable basis to rely on such third-party verification.
- The nature of the offering. This includes:
- The manner in which the purchaser was solicited to participate in the offering. The more widely disseminated an offering is, the more rigorous of a verification process is required. For example, investor self-verification (checking the accredited investor box on an investor questionnaire or certification of accredited investor status in a subscription document) is insufficient to satisfy the verification requirement for an offering conducted through a publicly available website, a widely disseminated email or social media.
- The terms of the offering, such as a minimum investment amount. The higher the minimum investment amount, the greater the likelihood that only accredited investors would be able to meet it.
Despite the flexibility afforded by a facts and circumstances verification test, without definite rules and guidelines, it is difficult to know with any certainty whether an issuer has met the verification requirement. Until the SEC provides further guidance, once the rules are enacted, issuers should err on the side of caution by requiring as much information from purchasers as they can reasonably request.
Regardless of the particular steps taken, an issuer should retain adequate records that document the steps taken to verify that each purchaser was an accredited investor at the time of purchase. The issuer has the burden of proving that it is entitled to the claimed exemption from registration.
An issuer can still elect to conduct a Rule 506 offering without General Solicitation. The JOBS Act verification requirement does not apply to such offerings. However, in light of the lack of clear guidance about what constitutes General Solicitation, if an issuer is uncertain if it (or any person acting on its behalf) has engaged in General Solicitation, it should consider taking reasonable steps to verify the accredited investor status of its purchasers.
Although the JOBS Act was passed 9 months ago, its implementation remains questionable. The two items of greatest importance to smaller businesses will not become effective until the SEC enacts certain rules to implement applicable provisions of the JOBS Act. Despite mandates to enact rules relating to General Solicitation and crowdfunding by the end of 2012, the SEC has not yet enacted any such rules, and the proposed rules regarding General Solicitation are subject to change.
We will continue to monitor developments in SEC rulemaking as well as clarifications and guidance. If you wish to discuss details of the JOBS Act, please contact your Davis & Kuelthau attorney.