On May 23, 2016, the House passed H.R. 4139, the Fostering Innovation Act, by voice vote.  The bill had passed the House Financial Services Committee on March 2, 2016.

H.R. 4139 proposes to extend the temporary auditing exemption for emerging growth companies for five years, in order for EGCs to comply with Section 404(b) of the Sarbanes-Oxley Act.  This bill serves as a way of alleviating the burdensome costs that smaller public companies incur when having to comply with Section 404(b).  This would, in turn, allow these companies to focus their resources on growth, rather than on these compliance costs.

Financial Services Committee Chairman Jeb Hensarling commented on the passing of this and other bills and stated: “I believe most of us would agree that our economy works better for all Americans when small businesses can focus on creating jobs rather than navigating bureaucratic red tape.”

While H.R. 4139 passed with strong bipartisan support, Investor Advocate Rick Fleming had urged members of Congress to vote against it.  In a letter to Speaker of the House, Paul Ryan, and to Minority Leader, Nancy Pelosi, Fleming warned that passing H.R. 4139 would “chip away” at the protections set in place by Sarbanes-Oxley, ones set in place as a “second set of eyes” in order to prevent another scandal that would affect American investors.  Additionally, Fleming states that H.R. 4139 would further compound the complexity of U.S. securities laws/reporting requirements  by creating another category of issuer.

The Commission announced that it approved interim final rules implementing two provisions of the FAST Act, adopted in December, that revise financial reporting forms for emerging growth companies and smaller reporting companies.

The Congressionally mandated rules revise Forms S-1 and F-1 to provide that as long as emerging growth companies’ registration statements include all required financial information at the time of the offering, they will be allowed to omit certain historical period financial information prior to the offering. In addition, the rules revise Form S-1 to allow smaller reporting companies to use incorporation by reference for future filings the companies make under the federal securities laws after the registration statement becomes effective. The interim final rules also include a request for comment on whether the rules should be expanded to include other registrants or forms. The rules will become effective when published in the Federal Register and the public comment period will remain open for 30 days following their publication.

Link to press release: https://www.sec.gov/news/pressrelease/2016-6.html

Link to interim rules: https://www.sec.gov/rules/interim/2016/33-10003.pdf

A reminder that the new equity research rules, contained in FINRA Rule 2241, became fully effective on December 24, 2015.  The equity research rules, among other things, revise the quiet periods applicable to member firms during which member firms may not publish or distribute equity research reports.  As a reminder, the new quiet periods (which were effective as of September) are now:

  • 10 days following an IPO for participating member firms;
  • 3 days following a follow-on offering for member firms that act as managers or co-managers; and
  • No quiet period in relation to the expiration, waiver or termination of a lock-up agreement entered into in connection with a public offering.

The quiet periods do not apply to research related to IPOs or follow-on offerings for EGCs.  Also, member firms may publish research concerning a company the securities of which are actively traded in compliance with the Rule 139 safe harbor.

At the end of last week, the House Financial Services Committee approved two bills, H.R. 3623 and H.R. 4164.

H.R. 3623, titled the Improving Access to Capital for Emerging Growth Companies Act, was introduced by Stephen Fincher (R-TN). H.R. 3623 builds on the successes of Title I of the JOBS Act, which created a new class of publicly traded companies known as Emerging Growth Companies (EGCs). The bill reduces burdensome Securities and Exchange Commission (SEC) registration and disclosure requirements to help EGCs access the capital markets more efficiently, streamline the Initial Public Offering process and allow EGCs to deploy their assets to grow and create jobs. Most significantly, the bill would reduce the 21-day period (during which a confidential submission must be made public) to 15 days.

H.R. 4164, titled the Small Company Disclosure Simplification Act, was introduced by Robert Hunt (R-VA).  H.R. 4164 provides a voluntary exemption for all EGCs and other issuers with annual gross revenues under $250 million from the SEC’s onerous requirements to file their financial statements in an interactive data format knows as eXtensible Business Reporting Language (XBRL). The bill also requires the SEC to conduct a cost-benefit analysis on the XBRL requirement and report to Congress within one year after enactment. H.R. 4164 allows small businesses to spend more time focusing on expanding and creating jobs rather than on redundant SEC compliance requirements.

Practical Law recently published a round-up of 2013 IPOs, which includes useful statistics on the use of various JOBS Act accommodations, industry trends, selling stockholder participation, and exchange listing.

In summary, 81.4% of issuers filed as EGCs and 69.4% submitted their registration statements confidentially.  As PLC notes, only 22 or 14.8% of EGC issuers chose not to avail themselves of the confidential submission process.  To view the full report, click here.

An issuer that is considering or that has commenced an initial public offering (“IPO”) should take special care to familiarize itself with the communications rules applicable to offerings.

First, an issuer should keep in mind that communications may be viewed as impermissible “gun jumping” activities designed to condition the market for the issuer’s securities.  Second, the issuer should bear in mind that it remains liable for oral communications, and the Commission may require that certain information included in interviews, for example, be incorporated into an issuer’s prospectus.  Communications should therefore be closely controlled and vetted by counsel.

Title I of the JOBS Act expands permissible communications during a securities offering by amending the Securities Act to permit an Emerging Growth Company (“EGC”), or any person authorized to act on behalf of an EGC to “test-the-waters” by engaging in oral or written communications with potential investors that are QIBs or institutions that are accredited investors to determine whether such investors might have an interest in a contemplated securities offering.


Test the waters communications may take place before an EGC makes a confidential submission of its IPO registration statement, while the confidential submission is being reviewed, once an issuer has publicly filed, or at any other point in the offering cycle.


The objective of this provision was to enable EGCs to gauge investor interest earlier in the process, and, thereby, determine whether to move forward with their offerings.  As a result, test the waters communications are not considered “offers” and would not be viewed as “gun jumping.”


An issuer and its underwriters have considerable latitude in structuring their discussions.  For companies in certain sectors, like biotech, where there are complex technologies, a regulatory pathway, etc., a bank may want to set up meetings early in the process so investors can become familiar with the company’s “story.”  In other sectors, it may be preferable to wait until the issuer has gone through at least one or two rounds of comments from the Commission before meetings with investors are scheduled.

What materials are used?

Depending on the stage at which discussions are held, written materials may or may not be used.  If written materials are used, the issuer and its counsel and the underwriter and its counsel must review the materials and approve their use.  The materials must be consistent with the registration statement disclosure and may consist of a slide deck or the draft registration statement.  Written materials should not be left behind.  Materials should not contain information beyond what is provided in the registration statement (i.e., no projections).

The Commission will ask whether test the waters materials were used and will request copies of the materials.  The issuer is liable for statements made in such materials.

If no written materials are used, the working group should agree on a script.

Can orders be obtained?

The underwriter cannot solicit orders during such meetings.  It can only gauge interest and obtain nonbinding indications of interest.

Private versus public

It is important to remember that during such meetings, an investor may manifest interest in investing in the company.  If the issuer intends to complete a private offering prior to completion of the IPO or concurrently with the IPO, the issuer and financial intermediary should be clear with investors as to the type of offering in which they are being asked to participate.  A number of considerations will need to be taken into account—for example, pricing of the securities sold in the private placement; class of securities; “cheap” stock type issues; etc.

Implications for dual-track transactions

In the past, when an issuer was contemplating a dual track IPO/M&A process, the applicable restrictions on communications (pre-filing, and while in registration), made it difficult for the issuer to pursue actively M&A opportunities, because the issuer had to wait until fairly late in the offering process to pursue such conversations.  The additional flexibility for communications during the pre-filing and registration phase will facilitate dual-track discussions.

In a recent speech delivered at a Futures Industry Association conference (see full text here: http://www.sec.gov/News/Speech/Detail/Speech/1370540289361), Commissioner Gallagher raised the possibility of a venture exchange.  Commissioner Gallagher addressed broader market structure issues in his remarks; however, he devoted a substantial portion of the speech to the benefits that might be associated with a venture exchange for equity securities of smaller companies.  Gallagher noted that a historic one-size fits all regulatory approach may have made the public markets inhospitable for small and emerging companies.  Commissioner Gallagher noted that the SEC’s Advisory Committee on Small and Emerging Companies has recommended that the SEC facilitate a marketplace for the securities of small and emerging companies, or a “venture exchange.”  Gallagher noted that the SEC is working with the securities exchanges to facilitate a pilot program that would permit smaller companies to choose to use a wider tick size; however, he observed that a venture exchange might provide a better answer for smaller companies.  He pointed to examples in Canada and the UK (presumably the AIM).  In the U.S., this idea has not progressed though.  The BX Venture Market, which has real qualitative listing standards, was approved by the SEC, but not as a “national securities exchange.”  This means that securities listed on the BX Venture Market would not be deemed “covered securities” (exempt from state blue sky requirements).  Without preemption, a listing on such a venture market would not be meaningful for a smaller emerging company.

Gallagher also touched on a topic that Chair White has addressed several times recently—disclosure requirements.  Gallagher noted that it is important for regulators to be “willing to consider setting aside the one-size-fits-all approach in favor of more tailored requirements for different-sized companies.”  Might the pendulum be swinging back to phased disclosures?  Certainly the SEC’s proposed crowdfunding rules demonstrated a willingness to tailor disclosure requirements, but are we ready to return to the days of the SB forms?  And, in the absence of express requirements that would compel issuers to limit their disclosures (for example, requiring small issuers to identify only the ten most significant risks affecting their business results), will market participants heed the call to focus on only the most pertinent disclosures?

In a recent speech (see http://www.sec.gov/news/speech/2013/spch041913laa.htm), SEC Commissioner Aguilar addressed the “scale back” of disclosures in connection with the JOBS Act, and the role of institutional investors in the capital markets.  Commissioner Aguilar cited a paper noting that institutional investors were better at avoiding the worst-performing investors—presumably based on their analysis of financial information made available by public companies.  He noted that the JOBS Act reduces the amount of information required to be made public by emerging growth companies.  This raises a number of interesting questions.  The accommodations available to EGCs under Title I of the JOBS Act relate principally to scaled back executive compensation disclosures.  Would more fulsome executive compensation disclosures be helpful or informative to investment decisions? It is unlikely that more robust compensation disclosures would be essential to an investment analysis.  Title I also permits EGCs to present two years of financial information in their filings.  Perhaps it could be argued that two rather than three years of data would make a difference to an initial investment analysis; however, there is no data yet that would substantiate whether there is a measurable difference to institutional investor decisions based on the availability of a third year of data.  Before concluding that the relatively modest scaled disclosures available to EGCs pose an issue, should we consider whether institutional investors simply have resources to conduct their own analysis, and have access to information (often from investment banks) that is not available to retail investors?

Practical Law Company (PLC) recently published a useful survey (online version accessible here: http://us.practicallaw.com/7-522-8947?q=&qp=&qo=&qe) of the compensation practices adopted by 52 emerging growth companies, or EGCs.  Of those surveyed, 41 EGCs disclosed their post offering director compensation policies.  Of these, 40 will pay annual retainer fees to directors, generally in cash.  The amounts of the annual retainer payments were reported to vary from $10,000 to $120,000.  The survey also noted that, of the 41 EGCs that disclosed their policies, 27 are not paying meeting fees, and 14 pay meeting fees generally.  The survey provides additional details regarding compensation for committee meetings that may be of interest to EGCs.