Later this week President Obama is expected to sign into law the Jumpstart Our Business Startups Act (the JOBS Act), which was passed by large majorities of both the US House of Representatives and the US Senate in March. The stated intent of the JOBS Act is in part to stimulate capital raising exercises in the United States, which are perceived to be an engine for the growth of business and in turn spur job creation, by reducing capital raising costs for emerging businesses and providing them with more freedom to solicit investors. Notwithstanding this apparent domestic focus, most of the provisions of the JOBS Act are not expressly limited to US companies.
In this briefing we explore some of the provisions of the JOBS Act that may be of interest to non-US companies considering whether or not to access the US capital markets. In particular, the JOBS Act:
- eases the US initial public offering process for emerging growth companies and their on-going reporting and related obligations for up to five years;
- eliminates prohibitions on general advertising and general solicitation in connection with Rule 144A offerings and certain other private placements; and
- raises the numerical shareholder threshold for registration and on-going public reporting obligations for companies not otherwise subject to those requirements.
The implementation of parts of the JOBS Act will require interpretations and rulemakings by the US Securities and Exchange Commission (the SEC) and its staff, as well a certain self-regulatory organizations, and consequently we believe the ultimate impact of the new law on existing capital raising practices will depend on the outcome of that process. In that regard, it is worth noting that the SEC’s Chairman, Mary L. Schapiro, in a letter to certain members of the Senate, identified several provisions in the JOBS Act that raise significant investor protection concerns. As a consequence, we expect there will be significant focus on such concerns as part of the rulemaking process and, of course, cannot predict with certainty the final outcome of that process.
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Emerging Growth Company IPOs
The JOBS Act contains a number of provisions intended to encourage emerging growth companies to access the US public securities markets. A company is considered to be an emerging growth company and will continue to be considered one until the earliest of:
- the last day of the fiscal year during which it had total annual gross revenues of at least US$1 billion;
- the last day of the fiscal year following the fifth anniversary of the initial public offering of its common equity in the United States;
- the date on which it has, during the previous three-year period, issued more than US$1 billion in non-convertible debt; or
- the date on which it is considered to be a “large accelerated filer” under the US Securities Exchange Act of 1934, as amended (the Exchange Act), a classification which includes companies with a worldwide public float of $700 million or more.
Emerging growth company status will not be available retrospectively to companies who sold common shares in an IPO on or before 8 December 2011, the date on which the relevant legislation was first introduced in the US House of Representatives.
Relief relating to IPOs. The JOBS Act establishes a number of accommodations to encourage emerging growth companies to access the US public capital markets by reducing the costs and other burdens associated with being a public company in the United States. In summary, these include:
- Reduced financial information requirements. An emerging growth company will be permitted to include two years of audited financial statements in its IPO registration statement (rather than the typically required three years) under the US Securities Act of 1933, as amended (the Securities Act). Likewise, it will not be required to present selected financial data in accordance with the SEC’s rules for periods prior to the earliest audited period included in the registration statement (rather than the five years of data typically required).
- Confidential submissions. An emerging growth company will be permitted to submit its IPO registration statement and amendments on a confidential basis for review by the SEC’s staff in advance of public filing, provided that any such submissions are publicly filed at least 21 days before any “road show” in connection with the IPO.
- Expanded permitted marketing. An emerging growth company and persons acting on its behalf will be permitted to have oral and written communications with qualified institutional buyers (QIBs) and institutional accredited investors either before or after the filing of its registration statement. Other companies would remain subject to much more stringent restrictions on communications in relation to US public offerings.
We believe all these accommodations should be welcomed by non-US companies and should address some of the costs, risks and issues currently associated with the intentionally transparent nature of the US IPO process. The reduced financial information requirements for emerging growth companies have obvious advantages for any eligible company. They may also give rise to somewhat surprising situations where the financial statement requirements for a US offering (at least in terms of periods covered) may be less onerous than those of the company’s home market.
On 8 December 2011, the SEC staff narrowed its policy that previously allowed non-US companies to submit registration statements and amendments on a confidential basis in connection with their first-time registration with the SEC. While under the narrowed policy a non-US company that is listed or is concurrently listing its securities on a non-US securities exchange (among others) generally continues to be allowed to submit its first time registration statement on a confidential basis, the JOBS Act extends a similar accommodation to all emerging growth companies and therefore could be of benefit to a number of other non-US companies. The confidential review process clearly provides the eligible companies with significant advantages in terms of the timing of the public announcement of their offering and in dealing with the rigorous preparation process for a US IPO outside of the public view. However, there are two notable differences between the SEC’s existing confidential treatment policy for certain non-US companies and the one contemplated by the JOBS Act: (i) under the latter all previous confidential submissions will have to be publicly filed retrospectively and (ii) that filing must be made at least 21 days in advance of the IPO road show, neither of which is the case with the former.
The expansion of permitted marketing in relation to QIBs and institutional accredited investors also has obvious advantages in terms of permitting a company to test the waters on a confidential basis, although no doubt market participants will consider the need to develop practices to address potential antifraud liability in connection which such activities. In addition, to the extent the non-US company already has a listing in its home jurisdiction or in an international market such as London or Hong Kong, there will be “wall crossing” type issues that will need to be considered.
All that said, for many non-US companies a major concern in accessing the US capital markets is potential securities fraud liability and in particular the possibility of class actions by US shareholders. None of the reforms provided for in the JOBS Act meaningfully reduces this inherent risk associated with being a public company in the United States.
Relief relating to reporting requirements. The JOBS Act also eases the on-going reporting and related obligations for an emerging growth company for up to its first five years as a US public company. In particular, the statute grants an emerging growth company:
- relief from the auditor attestation report requirements of the Sarbanes-Oxley Act of 2002.
- relief from any rules of the PCAOB requiring mandatory audit firm rotation or a supplement to the auditor’s report.
- relief from certain executive compensation disclosure requirements, including new disclosures required by Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act relating to the ratio between a CEO’s total compensation and the median total compensation for all other company employees; however, whether or not these new disclosure requirements will apply to non-US companies at all will ultimately be determined by the SEC in a proposed rulemaking expected possibly later this spring.
- relief from rules requiring non-binding shareholder advisory votes on executive compensation for up to six years from their IPO; however, non-US companies are generally not subject to these requirements in any event.
Relief from the auditor attestation report requirement, in particular, is a significant concession, with meaningful cost savings implications for virtually all eligible companies. This requirement was perhaps one of the most hotly contested elements of Sarbanes-Oxley because of its cost implications for US public companies. Of course, that relief only will last for up to five years. Moreover, most of the other on-going reporting and related requirements and risks associated with being a public company in the United States that generally apply to non-US companies will continue to apply to them.
Relief relating to research. Although the use of research in connection with initial public offerings is common in many jurisdictions outside of the United States, currently investment banks may not publish research in advance of US initial public offerings. In addition, current US rules restrict research during the 40 days following an initial public offering and around the time of the expiration of lock-up agreements. The JOBS Act seeks to end these restrictions in relation to emerging growth companies, so, for example, an investment bank will be permitted to publish research related to an emerging growth company prior to the initial public offering of that company (even if the investment bank is participating or will participate in the distribution of the offering). It also will ease rules prohibiting research analysts from participating in meetings with the emerging growth company that are also attended by investment banking employees, although how this will work in practice remains to be seen given the historical basis for those rules.
Significantly, the JOBS Act implements this by providing that research will not constitute “an offer for sale or offer to sell a security” for purposes of the definition of “prospectus” and certain related provisions of the Securities Act. However, this approach does not appear to provide relief from potential liability under the general securities fraud provision under Section 10(b) of the Exchange Act (and Rule 10b-5 thereunder) if it can be established that the investment bank acted recklessly or with the requisite intent. Given this, as well as the reputational risk inherent in the activity, it is to be seen whether investment banks in the United States will be prepared to commence this practice and if so on what basis, particularly in pre-IPO the context.
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The JOBS Act also provides that the SEC must amend its rules to provide that the prohibition against “general solicitation” or “general advertising” in private offerings shall not apply to offers and sales of securities made pursuant to:
- Rule 144A, provided that the securities are sold only to persons that the seller and any person acting on behalf of the seller reasonably believe is a qualified institutional buyer; or
- Rule 506 of Regulation D, provided that all purchasers of the securities are accredited investors. The company will be required to take reasonable steps to verify that purchasers of the securities are accredited investors.
The SEC will have 90 days from enactment to amend its rules to effect these changes.
The elimination of these prohibitions should be welcome as they are at times both ineffective and obstructive in the international context, as other countries often do not have similar concepts, particularly given the virtual worldwide availability of information posted on the Internet. Notwithstanding SEC rules and guidance adopted intended to address these conflicts in international offerings, some practitioners insist on putting in place publicity restrictions that at times unduly interfere with legitimate marketing activities outside the United States. That said, the usefulness of these provisions in the context of the now commonplace Rule 144A/Regulation S offering by non-US companies seeking listings in their home countries or in international markets such as London or Hong Kong will be diluted by the fact that there is no similar relaxation on the prohibition of “directed selling efforts” under Regulation S. The concern presumably being that activities now legitimately taken to promote the US private offering could also serve to generate interest in the aftermarket for the securities placed offshore. Consequently, modified guidelines relating to US publicity issues will need to be formulated as accepted practices for private offerings develop.
Likewise, consideration will need to be given to the impact of this development in relation to non-US investment companies (including so-called “inadvertent” investment companies) listing overseas but which simultaneously desire to offer and sell their securities to a limited number of US investors relying upon, for example, the exemption under Section 3(c)(7) of the Investment Company Act of 1940, which has its own private offering requirement but one that traditionally has been seen as being satisfied if there is a “good” private offering for Securities Act purposes.
The JOBS Act may well also lead (outside of the Rule 144A/Regulation S context) to renewed interest in Rule 506 of Regulation D, as opposed to reliance on the so-called “pure” private placement exemption established by Section 4(2) of the Securities Act itself, because of the flexibility potentially provided by the JOBS Act.
In addition, some of the accommodations in relation to emerging growth company IPOs discussed above may also impact practices in the context of private offerings. First, as was the case when the SEC adopted financial statements accommodations for first-time IFRS reporting companies in 2005, we would expect the reduced financial statement requirements for emerging growth companies in the US IPO context to lead to similar reduced financial statement requirements in the context of Rule 144A/Regulation S offerings, where domestic market rules or practices do not require three years of financial statements in the offering documentation. Second, it is to be seen whether any investment banks will reconsider the long-established market practice of not sharing research produced for use outside of the United States with QIBs (on a confidential basis) in the context of Rule 144A/Regulation S offerings, particularly if the issuance of pre-IPO research becomes market practice in relation to emerging growth company IPOs in the United States. Of course, there are a number of liability and reputational issues associated with this in addition to the practical difficulties of adequately controlling the distribution of any such research, which would have to be addressed.
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Increased Threshold for Registration and Reporting
The JOBS Act also increases the threshold for the registration and public reporting requirements for companies under the Exchange Act, which has recently received a great deal of attention in relation to companies such as Facebook. Currently, under the Exchange Act and related exemptive rules, a company must register a class of its equity securities with the SEC if it has total assets exceeding US$10 million and 500 or more shareholders of record. The JOBS Act increases that threshold for most companies to total assets exceeding US$10 million and either 2,000 or more shareholders or 500 or more shareholders of record who are not accredited investors.
Currently, non-US companies may also rely on Rule 12g3-2, which also provides certain exemptions from these registration and reporting requirements. Under Rule 12g3-2(a), the equity securities of a non-US company are exempt from registration if fewer than 300 holders are resident in the United States. Separately, Rule 12g3-2(b) provides an exemption for certain non-US companies who post on a public website, on an ongoing basis, information required to be made public or filed under the laws of their home country or exchange. In order to be eligible for the Rule 12g3-2(b) exemption, a company’s primary trading market must be outside of the United States. In general, a company’s primary trading market is one on which at least 55 per cent of the average daily trading volume in the company’s securities occurs.
While some non-US companies may be able to take advantage of the higher thresholds under the JOBS Act, we would suspect that most who exceed this threshold are likely to continue to rely on the overseas primary trading market exemption under Rule 12g3-2(b). Of potential interest to non-US companies that are not eligible for the 12g3-2(b) exemption but who have large numbers of US-based employees and securities-based compensation arrangements, the JOBS Act amends the definition of “held of record” to exclude securities held by persons who received them pursuant to an employee compensation plan in transactions exempted from the registration requirements of the Securities Act.
Separately, these amendments under the JOBS Act may be of interest to domestic companies in the United States who raise capital only in offshore public markets such as London’s AIM market in Category 3 Regulation S transactions. While these transactions raise a number of issues, the new threshold will give these companies additional “headroom” before they must register.
The SEC will have one year from enactment to issue rules implementing these changes.
When we refer to a “non-US company” in this briefing we are referring to a “foreign private issuer” as defined by the SEC, a term which encompasses many but not all non-US companies that are not a foreign government.
This briefing is intended to provide a general summary of these legal developments as they relate to non-US companies. It is not intended to be a full analysis of the law or its application to any particular situation.
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