Washington Delivers Relief to Community Bank Capital Raising Initiatives - Part II
On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups (or JOBS) Act. The JOBS Act includes a number of dramatic changes to the federal securities laws. It represents the most significant relaxation of initial public offering and public company reporting requirements to be enacted in many years. It also includes revisions intended to facilitate, and reduce the expense of, access to capital through unregistered offerings of securities. A number of these changes may have particular importance for community banks and their holding companies, as those institutions continue to face heightened needs for capital and can benefit significantly from any easing of access to capital raising opportunities.
This alert continues our discussion of those provisions of the JOBS Act that have particular relevance to community banks. Our last alert dealt specifically with the JOBS Act's impacts on registration and de-registration thresholds under the Securities Exchange Act of 1934 and its loosening of certain rules concerning public offerings. A copy of that alert is available here. This alert deals specifically with the JOBS Act's provisions on a new classification of reporting companies — "emerging growth companies" and the so-called "crowdfunding" exemption. These additional reforms will help community banks tap the capital markets for growth capital. Healthy banks in particular will find the liberalization of the rules governing capital raising beneficial as they assess long-term growth opportunities.
Emerging Growth Companies
The JOBS Act creates a new classification of SEC reporting companies called emerging growth companies (or EGCs) that will enjoy reduced regulatory and compliance burdens. The JOBS Act defines an EGC as a company that had total annual gross revenues of less than $1 billion (subject to inflationary adjustment by the SEC every five years) during its most recently completed fiscal year. A company retains such status until the earliest of (1) the last day of the issuer's fiscal year during which it had total annual gross revenues of $1 billion or more (as the threshold is indexed for inflation); (2) the last day of the issuer's fiscal year following the fifth anniversary of the issuer's IPO; (3) the date on which the issuer has, during the previous three-year period, issued more than $1 billion in non-convertible debt; and (4) the date on which the issuer is deemed to be a large accelerated filer under the Exchange Act (i.e., a $700 million public float). An issuer that sold its common stock in an IPO prior to December 8, 2011 is not eligible to be an EGC.
EGC status for banks or bank holding companies would hold a number of benefits under the JOBS Act. First, the JOBS Act relaxes the initial public offering process for EGCs in the following ways that promise to reduce expenses and compliance burdens:
- Reduced Financial Statement Requirements — an EGC would be required to include only two years (as opposed to the three years generally required) of audited financial statements in its IPO registration statement. In any other registration statement, an EGC would not be required to provide selected financial data for any period prior to the earliest audited period presented in its IPO registration statement (as opposed to the previous five years). An EGC's MD&A will only need to cover the periods for which financial statements are included in the registration statement.
- Confidential Registration Statement Filing — an EGC would be permitted to submit a draft of its IPO registration statement for review by the SEC staff on a confidential, nonpublic basis provided that the registration statement and all amendments are publicly filed at least 21 days before the date on which the issuer conducts its road show.
- Pre-Filing Marketing — an EGC (or any person authorized to act on its behalf) may "test the waters" or meet with or communicate in writing with qualified institutional buyers and institutional accredited investors to gauge investor interest in its securities and offering either prior to or following the time the EGC files its IPO registration statement.
In addition to relaxing the IPO process, the JOBS Act also reduces the reporting and compliance burdens that are imposed on EGCs following the completion of an IPO. In particular, the JOBS Act limits the reporting obligations of an EGC, for as long as the company remains an EGC, as follows:
- Compliance with Section 404(b) of Sarbanes-Oxley — An EGC will not be required to provide an auditor attestation of internal controls pursuant to Section 404(b) of Sarbanes-Oxley, although under Section 404(a) of Sarbanes-Oxley, the EGC's management will be required to establish, maintain and assess internal controls and the EGC's CEO and CFO will be required to provide the compliance certifications required under Sarbanes-Oxley.
- Executive Compensation Disclosures — An EGC will not be required to provide the full range of executive compensation disclosures required of other domestic reporting companies under Item 402 of Regulation S-K and instead is permitted to comply with the standards applicable to small business reporting companies.
- Say-on-Pay Vote — An EGC will not be required to hold the advisory votes on say-on-pay, say-on-frequency or approval of golden parachute payments required of other public companies until the end of the third year following the EGC's IPO or within one year of having lost its EGC status. In addition, for as long as it remains an EGC, it will not have to comply with the disclosures required under the Dodd-Frank Act with respect to (1) the relationship between executive compensation and the issuer's financial performance, and (2) the ratio between CEO and median employee compensation.
- Compliance with New Accounting Standards — An EGC will not be required to comply with any new or revised financial accounting standard until the date that such accounting standard becomes applicable to private companies.
- PCAOB Rules Regarding Auditor Rotation — An EGC will not be subject to any of the potential future rules requiring mandatory audit firm rotation or a supplement to the auditor's report that would require the auditor to provide additional information regarding the audit of the company's financial statements.
The JOBS Act also significantly changes current law and rules with respect to behavior of investment banks and analysts in connection with research reports and other activities concerning offerings by EGCs. Additionally, the SEC, within 180 days of enactment of the JOBS Act, is required to present to Congress its findings and recommendations following a review of Regulation S-K that is intended to comprehensively analyze the current registration requirements of Regulation S-K and determine whether these requirements can be updated to "modernize and simplify" the registration process and reduce costs and other burdens on EGCs.
The provisions concerning EGCs were effective upon enactment of the law.
An additional (and somewhat controversial) aspect of the JOBS Act is a new exemption from registration for capital raising transactions utilizing "crowdfunding." "Crowdfunding" is a term used to describe the collective effort of people who network and pool their money and other resources together, usually via the Internet, to support a common interest or to support efforts initiated by other people or organizations. Crowdfunding can be used to accomplish a variety of goals, from supporting charities, to funding political campaigns, to raising capital for commercial ventures. When crowdfunding is used for commercial goals and there is an opportunity for crowdfunding participants to share in the venture's profits, federal and state securities laws begin to apply.
The crowdfunding portions of the JOBS Act amend Section 4 of the Securities Act to create a new Section 4(6) exemption (the "crowdfunding exemption"). Pursuant to this new exemption, issuers will be able to publicly offer and sell, without registration under the Securities Act, securities in "crowdfunding" transactions, subject to the following restrictions: (1) the aggregate amount sold to all investors, including any amount sold in reliance on the exemption during the 12-month period preceding the date of the transaction, is not more than $1 million; and (2) the aggregate amount sold to any investor, including any amount sold in reliance on the exemption during the 12-month period preceding the date of the transaction, does not exceed (a) the greater of $2,000 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 $100,000; and (b) ten percent of the annual income or net worth of the investor, as applicable, up to a maximum of $100,000, if either the annual income or net worth of the investor is $100,000 or more.
The JOBS Act requires the SEC to issue rules implementing the crowdfunding provisions not later than 270 days after enactment. In addition, not later than 270 days after enactment, the SEC is required to establish disqualification provisions under which an issuer or an intermediary would not be eligible to participate in a transaction in reliance on Section 4(6), based on the disciplinary history of the issuer or intermediary. Thus, the exact procedures and requirements for undertaking one of these transactions are yet to be determined. However, the JOBS Act has outlined certain requirements that the SEC is charged with implementing.
Any company seeking to utilize the exemption must meet certain issuer-specific requirements, including (1) filing with the SEC and providing to investors and the relevant broker or funding portal certain detailed information about the issuer and the investment opportunity; (2) avoiding any advertisement of the terms of the offering, except for notices directing investors to the funding portal or broker; (3) not compensating or committing to compensate any person to promote the offerings through communication channels not permitted by SEC rules; (4) at least annually, file with the SEC and provide to investors reports of the results of operations and financial statements of the issuer, as required by SEC rules; and (5) complying with such other requirements as the SEC may, by rule, prescribe.
The securities may only be issued through a registered broker-dealer or "funding portal" over the Internet that complies with certain additional requirements, including (1) registration with the SEC or applicable self-regulatory organizations, (2) public disclosures as SEC rules may require; (3) actions to ensure and validate review and understanding of investor education information, (4) filing with the SEC and potential investors any information provided by the issuer in connection with crowdfunding transaction; (5) prohibiting its insiders from having any financial interest in the issuer using its services; and (6) certain other actions as required by SEC rules aimed at ensuring compliance with the requirements of the exemption and investor protection.
Any securities issued pursuant to the new crowdfunding exemption will be subject to transfer restrictions and any investor who purchases a security in such a transaction may bring an action against the issuer for rescission or damages as a result of any alleged material misstatement or omission. The JOBS Act preempts state securities laws by making exempt crowdfunding securities "covered securities;" however, some state enforcement authority and notice filing requirements are retained. State regulation of funding portals is also preempted, subject to limited enforcement and examination authority.
These changes brought about by the JOBS Act, together with those discussed in our last alert, promise to loosen regulatory burdens on community banks and bank holding companies and thus expand capital raising opportunities for such institutions that remain in desperate need of additional capital. Both the sources of new capital and the means and methods by which such capital can be tapped have the potential for significant expansion for financial institutions. Although the exact parameters of some of the changes brought about by the JOBS Act will continue to emerge and evolve, financial institutions have reason to be optimistic about this altered regulatory landscape.
A copy of the JOBS Act is available at http://www.govtrack.us/congress/bills/112/hr3606/text#.