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JOBS Act 2.0

by contributor Dan Lonkevich  |  Published July 1, 2013 at 3:12 PM

House Republicans are in the early stages of developing a sequel to the Jumpstart Our Business Startups Act, dubbed JOBS Act 2.0, which probably will involve tinkering further with scaled disclosure requirements for emerging growth companies as well as several new measures.

At the same time, lawmakers are waiting somewhat impatiently for the Securities and Exchange Commission to finalize its rulemaking agenda from the first JOBS Act. That agenda includes rules for ending the ban on general solicitation, rules for Regulation A+ offerings and rules for crowdfunding.

Newly appointed SEC Chairwoman Mary Jo White has testified before the House Financial Services Committee and has been meeting with a number of lawmakers to assure them that the SEC is working diligently on its JOBS Act rulemaking.

"We're literally two years behind," said Rep. David Schweikert, R-Ariz., who was one of the architects of the original JOBS Act. Lawmakers are "very intent" on seeing that the SEC finishes its JOBS Act rulemaking, he said.

"I'm going to give Mary Jo White a little bit of space," Schweikert said. "She gave me an hour of her time today. She's smart but there's going to be a learning curve."

Although Schweikert is no longer on the House Financial Services Committee, he has remained committed to the plight of small-cap companies and has been working behind the scenes with lawmakers on the committee to revive interest in further legislative fixes.

The top priorities of JOBS Act 2.0 "won't be known until the SEC reaches a decision on a rules set," Schweikert said.

"I have great interest in crowdfunding and Reg A, but we won't know what to do until the SEC finishes its work," he said. "That will be the trigger. Until then, we're grinding through little concepts to improve capital raising for the small-cap market."

In the meantime, Rep. Scott Garrett, R-N.J., who chairs the House Capital Markets Subcommittee, is spearheading JOBS Act 2.0. Garrett has already held one hearing to identify problems not fixed by the JOBS Act and plans another.

Maggie Seidel, an aide to Garrett, said it is still too early to say what measures may be included in JOBS Act 2.0.

The first pillar of JOBS Act 2.0 appears to be some sort of legislation to allow companies to experiment with wider tick sizes. Advocates for larger tick sizes say they are needed to provide an incentive for market makers to trade and raise money for small-cap and microcap companies and provide aftermarket support such as research.

The move to decimalize stock prices on U.S. markets in 2001 deprived market makers of this revenue source, which many in the small-cap market blame for the steep reduction in the number of initial public offerings and the sharp drop in the number of small-cap-focused investment banks. The number of IPOs, which averaged about 900 a year before decimalization, has since dropped to about 100 a year.

Rep. Sean Duffy, R-Wis., is planning to introduce legislation to create an optional pilot program to allow emerging growth companies to choose a wider tick size.

Duffy wasn't available for comment on the timing of his bill or other aspects of JOBS Act 2.0. Cassie Smedile, an aide to Duffy, said the House Republican efforts to draft JOBS Act 2.0 were still in the early stages.

Schweikert introduced his own tick size bill on May 13, which has the backing of Reps. Mick Mulvaney, R-S.C., and Ed Perlutter, D-Colo.

His bill would allow companies with public floats of less than $500 million and average daily trading volumes of less than 500,000 shares to have their securities quoted at increments of either 5 or 10 cents.

In addition to his tick size bill, Schweikert also has been developing legislative ideas to streamline the process of going public and to make it easier for emerging growth companies to raise money in Regulation A offerings.

For example, Schweikert would like to streamline the IPO process for companies that use a Dutch auction pricing method for their initial share sales.

In a Dutch auction, the price of the offering is set after taking in all bids and determining the highest price at which the total offering can be sold. Investors place bids for the amount they are willing to buy and at what price.

Dutch auctions are thought to be more democratic than other methods of pricing IPOs, especially in popular offerings, said Jack Hogoboom, a partner with the law firm of Lowenstein Sandler LLP in Roseland, N.J.

Typically, retail investors can't get access to the hottest IPOs, which are snapped up by institutional investors because of their buying power. A Dutch auction process might bring retail investors back into IPOs.

Google Inc. is one of the few companies to go public through a Dutch auction. Hogoboom said Dutch auctions have failed to catch on since Google in 2004, because they are complicated. Streamlining the process for Dutch auctions might make them more popular, he said.

Schweikert said he also would like to expand short form S-3 "baby shelf" registrations to allow small companies current in their filings for two years to file for a primary offering rather than on the more extensive and burdensome Form S-1.

Schweikert's fix would extend S-3 baby shelf registrations to companies with public floats of less than $75 million, which are permitted to raise only one-third of their public float. This limit has prevented the smallest companies that need the most help from availing themselves of the reduced disclosure requirements of the S-3.

In addition, Schweikert said he would like to foster a more active market in Reg A offerings, by requiring emerging growth companies to register Reg A shares on the short form 8-A.

Smaller companies could register Reg A offerings on a Form 8-A and use it, or an S-3, to go public later. Registrations under an 8-A filing would be much less intensive than under an S-1 filing. The idea would be to reduce the cost of filing an S-1, which can run as high as $3 million to $4 million, by at least half.

Because an 8-A filing also would be less time consuming than an S-1, it also could bring down opportunity costs.

Schweikert also is seeking to amend Reg A+ to pre-empt state securities laws.

The original JOBS Act created a securities exemption for so-called Reg A+ offerings and increased the amount that could be raised to $50 million in a calendar year. The SEC was supposed to write the rules for Reg A+ and has yet to do so.

Schweikert also would like to make it easier for public companies not covered by the JOBS Act to deregister and become private again so they can go public once more as emerging growth companies.

Currently, only companies with annual revenue of less than $1 billion that went public after Dec. 8, 2011, are eligible to become emerging growth companies under the JOBS Act and so enjoy its reduced disclosure requirements. That leaves a number of substantially similar companies to face much more disclosure requirements simply because they were public before the JOBS Act.

Provisions of the JOBS Act allow emerging growth companies to make only two years of audited financial statements available to investors, instead of the three years that other companies have to disclose when they go public.

Emerging growth companies also don't need to have auditors attest to the reliability of the companies' internal controls over financial reporting, as other companies do under Section 404 of the Sarbanes-Oxley Act.

Emerging growth companies also don't need to disclose as much information about executive compensation, and are exempt from requirements to hold nonbinding advisory votes on executive compensation and to seek shareholder approval for golden parachute payments.

In answers to frequently asked questions, the SEC has expressed hostility to public companies deregistering to later go public again as emerging growth companies.

Schweikert also would like to change the original law's crowdfunding provisions to liberalize the limits for real estate deals.

The current $1 million cap on crowdfunding deals makes it of limited use in most real estate deals, which are typically much larger.

Currently, crowdfunding is only allowed for companies that seek money from accredited investors and the SEC is still drafting rules to allow them to seek money from unaccredited investors.

Real estate crowdfunders have raised some equity using Reg A and have been getting around the limit by tranching their deals. In addition to a small equity crowdfunding round, they also do a round of mezzanine financing.

Raising the crowdfunding limit for real estate deals from $1 million to $5 million would enable real estate crowdfunders to finance deals as large as $100 million through tranching.

Other ideas for tinkering with equity crowdfunding would be to free portals from having to verify the net worth of people who invest less than $1,000.

Schweikert also would like to allow for a grace period for companies after they lose their emerging growth company status. Currently, emerging growth companies lose their status after five years or if their market value has surpassed $1 billion.

Other fine-tuning Schweikert has in mind would involve increasing the number of unaccredited shareholders a private company could have before it had to become a fully reporting company.

Currently, companies must become fully reporting once they have 2,000 total shareholders or 500 unaccredited shareholders.

Some companies owned by multigeneration families, many of whose members are unaccredited, have been bumping up against the limits on unaccredited shareholders.

In addition, Schweikert would increase the threshold for using equity to compensate employees from $5 million to $10 million to take into account inflation.

"I'm encouraged people are talking about these issues, especially the expansion of S-3 shelf registration," said John Borer, the head of investment banking at Benchmark Co. "Reform of S-3 would really be helpful."

Borer described the way the S-3 works currently as "nonsensical." Companies with a public float of less than $75 million can't use the S-3 unless they are listed on an exchange. Most of the companies of that size aren't listed on an exchange.

"Companies that aren't S-3 eligible have to file an S-1, which is far more arduous and they also can't incorporate [filings] by reference," he said.

And "the one-third rule is nonsensical," he said. "A company that's $76 million can raise 500% of its float, but a $75 million company can only raise a third. It's not logical."

While Borer said he's never been an advocate for Reg A offerings, he said the ideas Schweikert is floating could make a huge difference, especially if state blue sky laws are pre-empted and short-form 8-A enables companies to avoid the filing requirements of an S-1.

"Reg A is supposed to be an exemption from registration, yet they're making them go through 99% of the filing requirements," he said. "If they make it so they're not reviewing the offering documents, that could make a huge difference."

Kent Womack, a professor of finance at the Rotman School of Management at the University of Toronto, said in an e-mail that most of what Schweikert is proposing makes sense and is likely to have more benefit than costs.

"The only thing uneconomic in my opinion is tick size, where he must be listening too closely to the boutique investment bankers," Womack said. "It's very clear that companies are discouraged by the time and cost of regulation, and so this initiative has the right flavor to it."

David Weild, a former Nasdaq Stock Market vice chairman who also has conducted and written extensive research on market structure obstacles to small-cap capital formation, said in an e-mail that exemptions from state blue sky requirements were "essential" to ensuring that Reg A+ is broadly used.

"Extending shelf registration benefits to all companies is the fair and democratic thing to do," said Weild, who is now chief executive of Weild & Co., a New York-based boutique investment bank. "There are many, many things that conspire to harm small companies. This is one."

Weild said another harm not covered by Schweikert's ideas for JOBS Act 2.0 is the ability of the Depository Trust & Clearing Corp. to refuse to provide electronic delivery of small-company shares, which kills the market for such stocks.

"Any company that is making regular disclosures to the SEC should be DTCC eligible," Weild said.

The Financial Industry Regulatory Authority "should not block solicitation in these names, which can seem arbitrary at times, and I hear some firms won't take shares from a private placement without a separate opinion of counsel," he said. "Why is an investor going to buy private placement shares if, after the company is public, Schwab is going to require the investor to get a separate opinion that may cost thousands of dollars, just to deposit the shares?"

Weild said that, in his opinion, the provisions that favor Dutch auction pricings should be extended to all pricings including book builds. "Why not let the issuers choose?" he said.

Finally, he said Congress should call for a complete new stock market focused on the needs of small-cap companies and their ecosystem and possibly cause separate divisions at the SEC and Finra to make it work for smaller broker-dealers, investors in small companies and smaller issuers.

"The needs of these entities, so critical to U.S. economic growth, are consistently lost in the dominance of large-cap interests -- whether investors, [high-frequency traders, alternative trading systems], indexers, exchanges or bulge-bracket firms," he said.

Congress needs "to fix the overarching governance of equities markets through and through," he said. "The U.S. needs a horizontally integrated, small and emerging company infrastructure to compete for the next millennium."

For his part, Hogoboom described Schweikert's ideas for JOBS Act 2.0 as disappointing because they fail to address issues that could really make a difference to the small-cap equity financing market.

If lawmakers really want to help, Hogoboom said, they should legislatively force the SEC's hand on general solicitation and Reg A+.

Lawmakers also should liberalize the broker-dealer rules to allow people to act as finders on private placements, get rid of the one-third limitation on the baby shelf rule and allow companies that are public to incorporate filings by reference, he said.

Tags: crowdfunding | David Schweikert | Depository Trust & Clearing Corp. | DTCC | Dutch auction | House Capital Markets Subcommittee | House Financial Services Committee | IPO | JOBS Act 2.0 | Jumpstart Our Business Startups Act | Mary Jo White | Reg A | S-1 | S-3 | Scott Garrett | SEC | Securities and Exchange Commission

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