On Thursday, March 8, 2012, the House of Representatives passed the Jumpstart Our Business Startups Act, H.R. 3606 (the ―JOBS Act‖),1 which, if passed in similar form by the Senate and signed into law by the President, would significantly alter certain aspects of the Securities Exchange Act of 1934, as amended (the ―Exchange Act‖), and the Securities Act of 1933, as amended (the ―Securities Act‖), that are important to issuers of securities, including privately offered investment funds.
Among other things, the JOBS Act would: (1) increase the number of security holders an issuer may have before being required to make filings with the Securities and Exchange Commission (the ―SEC‖); and (2) permit general solicitation and general advertising in connection with an offering of securities under Rule 506 of Regulation D under the Securities Act, provided that all purchasers of such securities are ―accredited investors‖ as defined in Rule 501.2 The President as well as both the Majority and Minority Leaders of the Senate have expressed support for the substance of the JOBS Act.3
Not discussed herein are provisions of the JOBS Act that would create the following new categories of issuers that would be subject to limited regulatory regimes: (1) issuers with less than $1 billion in total annual gross revenue, which would be called ―emerging growth companies,‖ (2) issuers seeking numerous small (i.e., up to $10,000) individual investments, a style of fundraising that is sometimes referred to as ―crowdfunding,‖ and (3) issuers that raise less than $50 million per year.
Amendments to Section 12(g) of the Exchange Act
Currently, pursuant to Section 12(g) of the Exchange Act and the rules promulgated thereunder by the SEC, an issuer that has total assets exceeding $10 million and a class of equity security (other than an exempted security) held of record by 500 or more persons generally must register its securities under the Exchange Act.4 As a consequence, private investment funds relying on Section 3(c)(7) of the Investment Company Act of 1940, as amended (the ―ICA‖), that seek to avoid registration of securities under the Exchange Act typically limit the number of holders of record of their interests to 499.5
Section 501 of the JOBS Act would amend Section 12(g) of the Exchange Act, such that only issuers having total assets exceeding $10 million and a class of equity security (other than an exempted security) held of record by either 2,000 persons, or 500 persons who are not accredited investors, would be required to register the securities under the Exchange Act.6 The appropriate threshold for the number of holders of record was the subject of some debate. For example, an earlier version of the JOBS Act included a threshold of 1,000 persons, regardless of accredited investor status.7 The final version reflects a compromise permitting up to 1,500 accredited investors in addition to 500 investors that may or may not be accredited investors.
Section 302 of the JOBS Act would exclude from the definition of the term ―held of record‖ persons who purchase securities through ―crowdfunding.‖ Section 502 would further exclude from the definition persons who receive securities pursuant to an employee compensation plan in transactions exempted from registration under the Securities Act. Section 503 of the JOBS Act would direct the SEC to adopt a safe harbor for issuers to determine whether holders of their securities fit within the exclusion for employee compensation plan securities recipients.
Pursuant to Rule 12g5–1(b)(3) under the Exchange Act, if an issuer knows or has reason to know that the form of holding securities of record is used primarily to circumvent Section 12(g), the beneficial owners of the securities shall be deemed to be the record owners of such securities. Section 504 of the JOBS Act would direct the SEC to examine its authority to enforce Rule 12g5–1 to determine if new enforcement tools are needed to enforce subsection (b)(3) thereof. The House rejected a proposed amendment to the JOBS Act that would have directed the SEC to conduct a study as to whether the term ―held of record‖ should be changed to mean ―beneficial owner‖ and to change the test if it found that doing so was in the public interest.8 Had this amendment been adopted, it would have raised uncertainty for issuers, including private investment funds, because if the SEC had used such authority to adopt a beneficial owner test, issuers may have been required to ―look through‖ their direct investors to include potentially many indirect investors in determining whether they were required to register their securities under the Exchange Act.
Amendments to Rule 506 of Regulation D Under the Securities Act
Rule 506 of Regulation D under the Securities Act provides a safe harbor from the requirement for an issuer to register the issuance of its securities under the Securities Act if the issuer sells securities only to accredited investors and not more than 35 non-accredited investors in a transaction that otherwise satisfies Regulation D. Rule 502(c) of Regulation D provides that, in connection with an offer or sale made pursuant to Regulation D, neither the issuer nor any person acting on its behalf shall offer or sell the securities by any form of general solicitation or general advertising.
Section 201(a)(1) of the JOBS Act would direct the SEC to revise Rule 506 to provide that the prohibition against general solicitation or general advertising in Rule 502(c) shall not apply to offers and sales of securities made pursuant to Rule 506, provided that all purchasers of such securities are accredited investors. In addition, the SEC would be directed to require issuers relying on Rule 506 (as revised) to take reasonable steps to verify that purchasers are accredited investors, with the verification methods to be determined by the SEC. If this provision becomes law, it will remain to be seen if the SEC would require more than the customary representations issuers typically require from investors in a Regulation D offering. In a parallel change, Section 201(b)(2) of the JOBS Act would amend Section 4 of the Securities Act by adding a new paragraph (b) providing that ―[o]ffers and sales exempt under [Rule 506] . . . shall not be deemed public offerings under the Federal securities laws as a result of general advertising or general solicitation.‖
Section 3(c)(1) and Section 3(c)(7) of the ICA, which contain the exemptions from registration under the ICA generally relied on by private investment funds, currently prohibit a fund seeking to rely on Section 3(c)(1) or Section 3(c)(7) from making or proposing to make a ―public offering‖ of its securities. The SEC has indicated that offerings compliant with the prohibition on general solicitation or general advertising under Regulation D are not public offerings for purposes of Section 3(c)(1) and Section 3(c)(7) of the ICA.9 Section 201(b)(2) of the JOBS Act, which states that ―[o]ffers and sales exempt under [Rule 506] . . . shall not be deemed public offerings under the Federal securities laws as a result of general advertising or general solicitation‖ (emphasis added), would appear to include the ICA.10 As a result, if the JOBS Act becomes law, and this language is retained in the final bill, it appears that if a private investment fund engaged in an offering that complied with Rule 506, it would not be deemed to have engaged in a ―public offering‖ that would preclude reliance on Section 3(c)(1) or Section 3(c)(7) of the ICA even if it engaged in general advertising or general solicitation.11
Footnotes
1 H.R. 3606, 112th Cong. (2012), available at http://www.gpo.gov/fdsys/pkg/BILLS-112hr3606eh/pdf/BILLS-112hr3606eh.pdf .
2 Section 201(a)(2) of the JOBS Act also includes a parallel amendment that would permit general solicitation and general advertising in connection with securities offered under Rule 144A under the Securities Act, provided that securities are sold only to persons that the seller and any person acting on its behalf reasonably believe are ―qualified institutional buyers‖ as defined in Rule 144A.
3 See Press Release, Sen. Mitch McConnell, McConnell Statement on Passage of House Bipartisan JOBS Act (Mar. 8, 2012); Statement of Administration Policy on H.R. 3606—Jumpstart Our Business Startups Act, Office of Mgmt. & Budget, Exec. Office of the President (Mar. 6, 2012); Press Release, Sen. Harry Reid, Reid: Senate Will Move Forward with Small Business Jobs Bill (Feb. 28, 2012).
4 Under Rule 12g3–2(a) under the Exchange Act, securities of any class issued by ―any foreign private issuer‖ are exempt from registration if the class has fewer than 300 holders resident in the United States.
5 In order to rely on Section 3(c)(1) of the ICA, private investment funds must restrict the number of their investors to no more than 100 beneficial owners; thus, Section 12(g) is usually less of a concern.
6 Pursuant to Section 601 of the JOBS Act, the number of holders of record permitted with respect to issuers that are banks or bank holding companies as defined in the Bank Holding Company Act of 1956 would be limited to 2,000 persons without registration regardless of the accredited investor status of such persons, and the Section 12(g) registration requirement would terminate for such issuers when the number of holders of record falls below 1,200 persons (rather than 300 persons, which is the threshold applicable to other issuers).
7 See 158 CONG. REC. H1278–79 (daily ed. Mar. 8, 2012) (statement of Rep. Miller).
8 See id. at H1280 (statement of Rep. Capuano).
9 See Privately Offered Investment Companies, Investment Company Act Release No. 22,597 n.5, [1997–1997 Transfer Binder] Fed. Sec. L. Rep. (CCH) 85,929 (Apr. 3, 1997); STARS & STRIPES GNMA Funding Corp., SEC No-Action Letter, [1986–1987 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 78,303 (Apr. 17, 1986).
10 See 15 U.S.C. § 78c(a)(47) (2006). See also 17 C.F.R. § 270.38a–1(e)(1) (2011).
11 A prior version of Title II of the JOBS Act would have amended Section 4(2) of the Securities Act, which exempts transactions by an issuer not involving any ―public offering‖ from the registration requirement under the Securities Act, to provide that the exemption can be satisfied ―whether or not such transactions involve general solicitation or general advertising.‖ See 158 CONG. REC. H1260–61 (daily ed. Mar. 7, 2012) (statement of Rep. McCarthy); STAFF OF H. COMM. ON FIN. SERVS., RULES COMMITTEE PRINT 112-17, TEXT OF H.R. 3606, THE REOPENING AMERICAN CAPITAL MARKETS TO EMERGING GROWTH COMPANIES ACT OF 2011, at 19 (Comm. Print Feb. 27, 2012), available at http://docs.house.gov/billsthisweek/20120305/CPRT-112-HPRT-RU00-HR3606Floor_xml.pdf . The approach reflected in the final version of the JOBS Act appears to mean (more clearly than the prior approach did) that an offering that complies with Regulation 506 is not a public offering for purposes of Section 4(2) of the Securities Act as well as Section 3(c)(1) or Section 3(c)(7) of the ICA.
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