The legislation enjoyed unusually strong bipartisan support in the House, passing 390 to 23 on March 8th, and continues to attract accolades from many in the venture capital and startup communities, as evidenced by the ubiquitous #JOBSAct hashtag. Notable tech figures like superangel Ron Conway and AOL co-founder Steve Case join Senate Republicans and the Wall Street Journal in their outspoken support for the bill. Recent days, however, have seen intense opposition from those who argue that the act invites fraud and promotes "boiler room" operations via excessive deregulation. The New York Times editorial board and SEC chairwoman Mary Schapiro have each expressed their opposition (along with Forbes contributor John Wasik).
It seems to me that many of those tweeting their support for the bill or, on the other hand, reflexively reacting against deregulation don't fully grasp the major impacts of H.R. 3606. So rather than dive headlong into the debate, I've decided to put together a (hopefully) helpful summary of the act's key provisions. Here's what the JOBS Act actually does:
Legalizes Equity-Based Crowdfunding
In case you're tempted to assure me that crowdfunding is already legal (Kickstarter!), please hold on a moment. Those who use Kickstarter to raise funds cannot seek equity investment, they can only solicit donations or pre-sell their products. Because of these restrictions, donors don't expect to make a return on their investment, they only hope to preorder a nifty gadget or fund a worthy project. This is a long-winded way of saying that Kickstarter does not, and is not legally allowed to, help companies issue securities (a financial instrument representing value).
The JOBS Act would actually open up the market for something like a Kickstarter for equity funding. In this scenario, Average Joe (i.e. a non-accredited investor) can chip in up to 10% of his annual income or $10,000 (whichever is less) in return for a small stake in a startup. Like any other investor, Joe would hope to fund the company's growth so that his stake increases in value over time. According to the bill, companies seeking crowdfunding investment would need to file with the SEC and restrict this method of financing to $1 million a year, or $2 million if they release audited financial statements.
Raises Cap on Private Shareholders From 500 to 2000
Currently, private companies with over 500 shareholders and $10 million in assets face a number of difficulties that often compel them to go public. Young companies that attract talent with stock options quickly find themselves at the brink of this limit, potentially forcing them to enter the public markets before they're ready. The JOBS Act, as passed by the House, would raise this shareholder cap to 2000. Private secondary market companies like SecondMarket and Sharespost would benefit substantially from this reform, as it would likely lead to a larger, more robust market for the shares of private companies.
Introduces "Emerging Growth Companies"
This is perhaps the most contentious piece of the JOBS Act. By introducing a new category of publicly-held companies known as an "emerging growth companies", the bill seeks to exempt businesses with under $1 billion in revenue from certain regulations associated with going public. Notably, companies governed under this category only need to produce two years of audited financial statements when filing for an IPO (normal rules require three years); they are exempted from Dodd-Frank rules giving shareholders a non-binding vote on executive compensation; and are freed from the requirement of hiring an outside auditing firm to check internal financial controls.
For many of the bill's opponents, the most troubling part of the JOBS Act is found in language that frees up ostensibly objective Wall Street analysts to tout the stocks of their investment banking departments' clients.
Here, it may actually be worth taking a look at the bill itself. It prohibits:
... the SEC and any registered national securities association from adopting or maintaining any conflict-of-interest rule or regulation in connection with an initial public offering of the common equity of an emerging growth company that restricts: (1) which associated persons (based on functional role) of a broker, dealer, or member of a national securities association may arrange for communications between a securities analyst and a potential investor; or (2) a securities analyst from participating in any communications with the management of an emerging growth company that is also attended by any other associated person of a broker, dealer, or member of a national securities association whose functional role is other than as a securities analyst.
This section of the bill effectively repeals key parts of Sarbanes-Oxley that were designed to prevent securities analysts from becoming mouthpieces for their investment banking divisions.
Raises Limit of "Regulation A" Offerings From $5 Million to $50 Million
These "mini-public offerings" currently allow companies raising less than $5 million to dodge certain disclosure requirements typically associated with an IPO. The key attraction here is that companies who file under Regulation A do not have to issue the periodic reports to shareholders that are expected of conventional publicly-held companies. The JOBS Act will extend Regulation A exemptions for companies raising up to $50 million.
Allows for General Solicitation in "Regulation D" Offerings
Regulation D (of the Securities Act of 1933) allows companies to avoid costly SEC registration for certain securities offerings. The House bill expands this exemption to allow for general solicitation, meaning that companies and their brokers can advertise the merits of their stock to the general public. While only accredited individuals can invest in Regulation D securities, critics balk at the thought of giving brokers any room to aggressively solicit securities to unsuspecting investors (i.e. the elderly).
Like most pieces of legislation, the JOBS Act is, in many ways, a regrettable amalgam of loosely related ideas and reforms. Taken separately, many of these proposals are wonderful, and should have been implemented long ago. Others, I'm afraid, dubiously ride the coattails of a worthy intention: expanding access to capital for growing companies and entrepreneurs. Do the benefits outweigh the risks?
That's not yet a question I'm ready to answer.
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