New rules enhance IPO accommodations under the JOBS Act and provide private resale exemption.
On December 4, US President Barack Obama signed the Fixing America’s Surface Transportation Act (the FAST Act or the Act, H.R. 22) into law. Although the Act primarily is designed to provide long-term funding certainty for surface transportation, Division G (Financial Services) of the Act contains several provisions that implicate the federal securities laws. These provisions include amendments to the Jumpstart Our Business Startups Act (JOBS Act), a new statutory exemption for private resale of securities, and provisions that relate to the recent pronouncements by the Securities and Exchange Commission (SEC) regarding modernization and simplification of public disclosures.
Title LXXI of the Act contains certain provisions applicable to initial public offerings (IPO) by emerging growth companies (EGC) under the JOBS Act.
Simplified Financial Statement Disclosure
Section 71003 of the Act permits EGCs to omit financial statements in registration statements for historical periods as required by Regulation S-X in an IPO if (i) the EGC reasonably believes that such financial statements will not be required to be included in the registration statement at the time of the offering and (ii) the EGC amends the registration statement to include all then-required financial statements before distributing a preliminary prospectus. This provision potentially can reduce significantly the cost associated with financial audit and accelerate the timeframe for completing the initial registration statement in an IPO.
For example, if a calendar-year company plans to file or submit its first registration statement during the third quarter of 2015, the current SEC rules require the company to provide audited financial statements for 2013 and 2014 in the initial filing. Under this new provision, the company may omit the 2013 financial statements in the first filing if it plans to price the IPO in April 2016 and amend the registration statement to include audited financial statements for 2014 and 2015 before pricing.
In addition, SEC guidance indicates that the EGC is not permitted to omit interim financial statements for a period that will be included within the required financial statements that cover a longer interim or annual period at the time of the offering, where the shorter period will not be presented separately at that time. For instance, in the above example, the company will not be permitted to omit interim financial statements for the nine-month period in 2015 in the initial filing, even though such interim financial statements may be replaced by the annual audited financial statements for 2015 at the time of pricing. Furthermore, SEC guidance provides that EGC may omit financial statements of other entities from its filing or submission, provided that it reasonably believes that such financial statements will not be required at the time of the offering.
This provision becomes effective on January 3, 2016; however, the SEC has indicated that it will not object if companies avail themselves of this provision prior to that date.
Reduced Time Period for Public Filing Prior to IPO Roadshow
Previously, an EGC was required to publicly file its registration statement, including all previously submitted confidential drafts, within 21 days of the commencement of roadshow in an IPO. Section 71001 of the Act shortens this time period to 15 days, which should provide EGCs with more flexibility to coordinate and strategize their marketing efforts with the public filing of the IPO. This provision became effective on December 4 and is applicable to EGCs with pending IPOs prior to the effective date.
Grace Period for Change in EGC Status
Section 71002 of the Act amends section 6(e) of the Securities Act of 1933, as amended (Securities Act) to provide that, if a company subsequently ceases to be an EGC after the time that it submits or files a registration statement, it will continue to be treated as an EGC until the earlier of (i) the date on which the EGC completes its IPO or (ii) the end of the one-year period beginning on the date that the company ceased to have EGC status. This provision also became effective on December 4. The amendment provides certainty that companies can rely on all of the EGC accommodations under the JOBS Act throughout the entire IPO process, even if it exceeds the EGC threshold prior to pricing the IPO.
Although the statutory exemption under section 4(a)(2) of the Securities Act is well-established for private placement of securities by issuers, no comparable statutory provision exists for private resales of securities by security holders. Rule 144 and Rule 144(A) provide two resale exemptions under section 4(a)(1) of the Securities Act, but they impose additional limitations and obligations that may render them unavailable. For example, Rule 144 requires a certain holding period by the seller and current public information about the issuer before the resale and imposes additional restrictions on affiliates of issuers, such as volume limitation, manner of sales, and filing of Form 144 with the SEC. Rule 144A is only applicable to offers to “qualified institutional buyers” (QIBs) of securities not of the same class as securities listed on a US national securities exchange or quoted on an over-the-counter market. Instead, selling stockholders generally rely on what is known as the “4(a)(1½)” exemption for unlimited private resales to purchasers that are not QIBs. The 4(a)(1½) exemption is based on a mosaic of SEC guidance, case laws, and general practices that have developed over time. As a result, these private resales carry inherent uncertainty and often involve higher costs associated with the requirement for obtaining a legal opinion. Section 76001 of the Act removes this uncertainty by creating a nonexclusive safe harbor in a new section 4(a)(7) of the Securities Act, which codifies the main elements of the 4(a)(1½) exemption.
A selling stockholder may rely on the new exemption under section 4(a)(7) if the following conditions are met:
Additionally, for the resale of securities of issuers not subject to SEC reporting requirements, certain information must be delivered to prospective purchasers, including the following:
Securities acquired under section 4(a)(7) are considered “restricted securities” and cannot be transferred in the absence of another exemption under the Securities Act. In addition, securities sold under the exemption are “covered securities” within section 18 of the Securities Act, therefore federal preemption applies and no “blue sky” qualifications will be required under state securities laws.
Although section 4(a)(7) provides a clear exemption for private resales that will certainly be welcomed, it remains unclear as to whether it will be widely adopted. In particular, the section 4(a)(7) information requirements appear to be more extensive and stringent than those required under Rule 144A and Regulation D, therefore some market participants may continue to rely on other exemptions, such as Rule 144, Rule 144A, or even the “section 4(a)(1½) exemption” in certain circumstances, given that section 4(a)(7) is a nonexclusive safe harbor. On the other hand, section 4(a)(7) may be useful for secondary sales of private company securities to natural persons who are accredited investors, because it provides certainty in the exemption and preemption of state blue sky laws. This is particularly useful to affiliates of issuers that may be subject to more stringent resale restrictions under Rule 144.
Title LXXII of the Act includes the following provisions, applicable to all reporting issuers.
Summary Page for Form 10-K
Section 72001 of the Act requires the SEC to issue rules that allow issuers to include a summary page in their annual reports on Form 10-K, provided that each item in the summary contains a cross-reference to material elsewhere in Form 10-K.
Improvement of Regulation S-K
Section 72002 of the Act requires the SEC to revise Regulation S-K to (i) further scale or eliminate requirements relating to EGCs, accelerated filers, smaller reporting companies, and other smaller issuers and (ii) eliminate duplicative, overlapping, outdated, or unnecessary provisions.
Study on Modernization and Simplification of Regulation S-K
Section 72003 of the Act requires the SEC to conduct a study of Regulation S-K requirements for the purposes of modernizing and simplifying disclosure requirements, emphasizing a facts-and-circumstances approach (i.e., no boilerplate or static disclosure requirements), and determining how best to deliver and present information while discouraging repetitious information and disclosure of immaterial information. A report on this study, in coordination with the Investor Advisory Committee and the Advisory Committee on Small and Emerging Companies, is due to Congress by December 4, 2016, with rules to follow 360 days from the date of the report to the Congress.
Small Company Simple Registration
Section 84001 of the Act requires the SEC to amend Form S-1 to allow smaller reporting companies to incorporate by reference any documents that it subsequently files with the SEC after the effective date of Form S-1. Currently, incorporation by reference in Form S-1 is only permitted for information filed prior to the filing of Form S-1. The new rule is particularly useful for smaller reporting companies that are not eligible to file shelf registration statements on Form S-3, because it enables them to keep a resale registration statement on Form S-1 current by satisfying its ongoing SEC reporting obligations without having to file any posteffective amendment to Form S-1. This provision requires SEC rulemaking by January 18, 2016.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
Timothy J. Corbett
John F. Hartigan
Steven M. Cohen
Special thanks to associate Celia A. Soehner for helping prepare this LawFlash.