As the 1990s drew to a close Congress passed legislation signed by the President ensuring the deregulation of the derivatives markets. At the time CFTC Chairwoman Brooksley Born was one of the sole voices of dissent. Less than ten years that dissent proved prophetic as the most severe market crisis since the great depression unfolded. Many believe the unregulated derivative market was at its core.

Now, as markets struggle to recover from that crisis, legislation is about to be enacted which will deregulate part of the capital formation process. As in the late 1990s Congress is about to pass legislation the President says he will sign. It is called the JOBS Act, H.R. 3606.

The JOBS Act has noting to do with the President’s initiatives to create jobs. It started in the House of Representatives as H.R. 3606 titled the Jumpstart Our Business Startups Act or JOBS. It has passed in the House. It passed in the Senate with a few amendments. The legislation now goes back to the House. Whether it will create jobs remains to be seen. It clearly has everything to do with stripping away regulatory requirements in the capital formation process by amending key provisions of the securities statutes. Its main features are:

  • Emerging Growth Companies: Section 101 defines these companies as essentially issuers with total annual gross revenues of less than $1 billion. To ease the IPO process on these companies, the Act would only require two rather than three years of audited financial statements; eliminates the requirement for certain selected financial data; and authorizes pre-offering communications to “test-the-waters” with investors. It would also exempt these companies from SOX 404, “say on pay” and certain compensation disclosure requirements as well as certain new GAAP requirements and future PCAOB rules regarding auditor rotation and which modify the auditor report.
  • Private capital formation: Rule 506 of Regulation D would be amended to permit general solicitation in offerings as long as the purchasers are accredited investors. This would include Rule 144A.
  • Exchange Act reporting: The threshold for becoming subject to the reporting requirements would be raised from the current 500 shareholders of record to 2,000 provided that, in the case of any issuer other than a community bank, the threshold would also be triggered by 500 non-accredited investors. Excluded from the tabulation of shareholders of record are those who acquire their shares through the crowdfunding provisions (below) and through eligible employee compensation plans.
  • Crowdfunding: This provision, contained in Section 301, create a new registration exemption which would permit a private company to raise $1 million in twelve months or $2 million if investors are provided certain financial information if investors purchase the lesser of $10,000 or 10% of their annual net income.
  • Analysts: The Act would eliminate prohibitions which require a separation between research analysts and investment bankers who work in the same firm and the quite period on analyst reports by the underwriters of an IPO.

SEC Chairman Schapiro forwarded a letter to the Chairman of the Senate Banking committee expressing concern about the Act. Likewise, Jack Herstein, President of the North American Securities Administrators Association, and others have raised questions about the adequacy of investor protections.

SEC Commissioner Louis Aguilar published a statement presenting critical issues regarding H.R. 3606 entitled “Investor Protection is Needed For True Capital Formation” (March 16, 2012). Key points raised by Commissioner Aguilar include:

  • Transparency: True capital formation and economic growth are a function of investor confidence and access to material information. The JOBS Act undermines this by reducing transparency and investor protections while making enforcement more difficult.
  • Faulty premise: The bill is based on the theory that reducing regulatory requirements will facilitate capital formation. Yet there is considerable research which demonstrates that the contrary is true.
  • Reduced disclosures/requirements: The reduced disclosure and regulatory requirements for emerging growth companies could harm investors and “arguably, impede access to capital for emerging companies, as capital providers may not be confident that they have access to . .. “ all necessary information.
  • Reporting requirements: The provisions raising the threshold for Exchange Act reporting create exclusions which may permit a “virtually unlimited number of record shareholders, without being subject to the disclosure rules applicable to public companies.”
  • Analysts: Overriding protections regarding the separation of research analysts and investment bankers ignores the learning from the dot-com era scandals. “Investors won’t return to the IPO market, if they don’t believe they can trust it.”

Despite these objections the Act is expected to shortly become law. One can only hope that Commissioner Aguilar’s remarks do not presage the future in the same fashion as those of Ms. Born.

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