June 2012

Chairman Issa’s recent letter to SEC Chairman Schapiro raises interesting questions regarding the initial public offering process.  A number of the communications-related issues may well be addressed if the SEC and FINRA were to provide additional guidance regarding the research rules.  But, the truth of the matter is that even if banks were to receive additional clarity regarding the effect of the JOBS Act on existing FINRA and NYSE research rules, and on the application of the JOBS Act emerging growth company research provisions to those firms that remain subject to the global research settlement, it still might not be enough to promote more research coverage, or to encourage circulation or broader dissemination of research.  Even when the SEC has reformed offering communications, market participants understandably have proceeded quite cautiously and have been reluctant to take advantage of the additional flexibility provided by regulatory changes.  For example, in 2005, as part of Securities Offering Reform, the SEC implemented significant changes to the offering communications framework.  The SEC introduced the concept of free writing prospectuses and encouraged use of FWPs to communicate useful information to investors.  The fact of the matter is that most FWPs are used for a limited (and quite conventional) purpose:  to convey final pricing terms.  We have regularly reviewed the number of FWPs filed with the SEC and the purposes of these FWPs.  When there was a securitization market, market participants often used FWPs to convey certain information about asset-backed securities.  It may be somewhat counterintuitive, but the SEC was encouraging the SEC to be bolder than the industry was prepared to be.  Why, given additional flexibility, would banks shy away from using FWPs for other purposes?  Participants in the securities markets have become more careful about making use of regulatorily-sanctioned communications for fear of liability.  Permitting pre-deal research reports on EGCs, or encouraging broader dissemination of research in the “quiet period” without recognizing the litigious environment in which we operate may, we fear, not accomplish all that much.

If you were holding off on plans for an Independence Day barbeque in anxious anticipation of the SEC rules lifting the ban on general solicitation and general advertising in Rule 506 offerings under Title II of the JOBS Act, you can go ahead and buy the hot dogs and charcoal. As I noted in the blog last week, Title II’s 90-day deadline for SEC rulemaking is fast approaching, and there has been no sign of proposed or interim final rules in the making. In testimony this morning before the House Subcommittee on TARP, Financial Services and Bailouts of Public and Private Programs of the Oversight and Government Reform Committee, SEC Chairman Mary Schapiro is telling lawmakers that the 90-day rulemaking timetable is “not achievable,” and therefore the SEC will not meet that JOBS Act rulemaking deadline.  Nonetheless, Chairman Schapiro indicates that “the staff has made significant progress on a recommendation and economic analysis, and it is my belief that the Commission will be in a position to act on a staff proposal in the very near future.”  Does that mean hold off on your Labor Day barbeque plans? It is hard to say.

Prior to enactment of the JOBS Act, Section 12(g) of the Exchange Act required issuers to register a class of equity securities with the SEC if, on the last day of the issuer’s fiscal year, such class of securities was held of record by 500 or more record holders and the company had total assets of more than $10 million.  After a company registers under Section 12(g), all of the reporting requirements under the Exchange Act apply; therefore, a company would need to file annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and proxy statements on Schedule 14A, and certain persons would be required to report transactions on Forms 3, 4, and 5 and Schedules 13D and 13G.  Historically, a company could deregister a class of equity securities under Section 12(g) when such class of equity securities was held of record by fewer than 300 persons, or by fewer than 500 persons and the total assets of the issuer had not exceeded $10 million on the last day of each of the issuer’s three most recent fiscal years.  Title VI of the JOBS Act, “Capital Expansion,” amends Section 12(g)(1)(B) of the Exchange Act, and requires that a bank holding company register under the Exchange Act not later than 120 days after the last day of its first fiscal year ended on which its total assets exceed $10 million and on which it has a class of equity security (other than an exempted security) held of record by 2,000 or more persons.  Title VI the JOBS Act also permits banks and bank-holding companies to suspend registration under Section 12(g) if the number of holders of record falls below 1,200 persons.  Banks are already taking advantage of this new flexibility and filing to deregister, which will result, over time, in significant cost savings for these institutions.  Of course, many of these same institutions may be facing higher compliance and legal costs as they attempt to address the requirements of the Dodd-Frank Act.  If Ben Franklin were alive today, he might want to footnote his aphorism about a penny saved being a penny earned.  He just wasn’t focused on compliance costs.

We’re reggae fans, and fans of Reg A.  Chances are you may be more familiar with the offbeat rhythms of reggae, than with Regulation A.  Regulation A was intended to allow smaller businesses, including banks and bank-holding companies, access to the capital markets without subjecting them to the high costs associated with registered public offerings.  However, the relatively low $5 million threshold and potential need to comply with state blue sky laws has made Regulation A unappealing.  It was, as Jimmy Cliff sings, “A Hard Road to Travel.”  Title IV of the JOBS Act amends Section 3(b) of the Securities Act, by increasing the dollar threshold for a Regulation A-style offering (referred to as Reg A+ offerings).  Pursuant to Section 3(b)(2), an issuer will be able to offer and sell up to $50 million in securities within a 12-month period in reliance on the exemption.  The securities sold pursuant to the exemption will be offered and sold publicly (without restrictions on the use of general solicitation or general advertising) and will not be “restricted securities.”  The securities will be considered “covered securities” for NSMIA purposes (and not subject to state securities review) if:  the securities are offered and sold on a national securities exchange, or the securities are offered or sold to a “qualified purchaser” as defined under the JOBS Act.  A Reg A offering would provide a perfect capital-raising approach for an emerging company.  In fact, proposals to amend Reg A preceded the IPO “on-ramp” concept and the JOBS Act by at least 18 months.  Given that Reg A would provide a relatively simple capital formation approach, it is a shame that legislators did not include a timeline for Reg A rulemaking by the SEC.  Experience would suggest that the SEC will focus first on meeting the deadlines for rulemaking included in the JOBS Act, and address Reg A in due course.  While there may be “Many rivers to Cross” in order to get to a workable Reg A, we are hopeful that attention will turn to regulations that help operating companies and actually promote job creation.

Title II of the JOBS Act directs the SEC to revise Rule 506 of Regulation D to provide that the prohibitions against general solicitation or general advertising in Rule 502(c) do not apply to offers and sales of securities made pursuant to Rule 506, provided that all purchasers of the securities are accredited investors.  The revised rules must further require that issuers utilizing general solicitation or general advertising in connection with Rule 506 offerings take reasonable steps to verify that purchasers of securities are accredited investors, using methods to be determined by the SEC.  Rule 144A also must be revised to provide that securities may be resold to persons other than QIBs, including by means of general solicitation or general advertising, 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 QIB.  The JOBS Act specifies that any offering made pursuant to Rule 506 that uses general advertising or general solicitation will not be deemed a “public offering.”  Title II’s contemplated changes to Rule 506 of Regulation D and Securities Act Rule 144A require SEC rulemaking, which the JOBS Act indicates must be completed within 90 days of enactment.

With the 90-day deadline coming up soon on July 4th, the question on the minds of many is whether the SEC will meet this deadline, and if so, how the rules will be adopted within such a tight timeframe.  To date, the SEC has received over 30 comment letters regarding Title II under its “advance” comment process, expressing a variety of views on the implementation of the Title II directive.  The SEC has not yet proposed any rule changes, and it if does so in the near term it would have to provide for a comment period that we think would need to be at least 30 days, which at this point makes adoption of final rule changes outside of the rulemaking deadline contemplated by the Act.

Another alternative that the SEC might be considering is adopting an interim final temporary rule, which is a course that the SEC has taken in the past when faced with circumstances calling for quick regulatory action.  Generally, the Administrative Procedure Act requires an agency to publish a notice of a proposed rulemaking in the Federal Register.  This requirement does not apply, however, if the SEC “for good cause finds…that notice and public procedure are impracticable, unnecessary, or contrary to the public interest.”  Further, the APA also generally requires that an agency publish an adopted rule in the Federal Register 30 days before it becomes effective.   This requirement does not apply, however, if the agency finds good cause for making the rule effective sooner.  Against this backdrop, the SEC could adopt interim final temporary rule changes, while also soliciting comment on those interim final rules.  Then, at a later time, after the deadline has been met, the SEC could go back and address comments in a subsequent rulemaking.

It seems more likely that the SEC will continue preparing proposed rules, and issue them as soon as it can, even if the proposed rules and/or the final rules are released after the JOBS Act deadline.  This is because the notion of verifying accredited investor status is potentially controversial, and the SEC would likely get some benefit from soliciting comment on proposed rule changes.  Moreover, the Title II deadline does not have any “teeth,” in the sense that the provisions do not become automatically operative once the deadline has passed, so that, much like with the Dodd-Frank Act deadlines, the SEC could proceed at its own pace regardless of Congressional expectations.  It should be noted in this regard that the SEC has outstanding proposals to integrate bad actor disqualification provisions into Rule 506, which the Dodd-Frank Act prescribed were to be adopted last summer.  It remains unclear whether the SEC will want to take up all of these changes to Rule 506 at the same time.

Welcome to the MoFo Jumpstarter blog, where we will cover the implementation of the Jumpstart Our Business Startups (JOBS) Act.  It was signed into law by President Obama on April 5, 2012.  In over two months since enactment of the JOBS Act, we have observed a whole new process for conducting initial public offerings by emerging growth companies (EGCs) blossoming, as EGCs have begun taking advantage of the confidential SEC review process, reduced disclosure burdens and more flexible communications around the time of the offering.  We have noted a distinct air of caution among issuers and underwriters concerning the communications aspects of the JOBS Act, in particular the use of the “testing-the-waters” provisions and the ability for broker-dealers to publish research at and around the time of the offering.  We will comment on these and other implementation considerations in this blog as the JOBS Act’s provisions are rolled out over the next year.  We hope you’ll stay tuned, share your thoughts, and provide feedback.