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Reg rageJuly 2 2012

Can US equity On-Ramp get investors on board?

The US JOBS Act is intended to boost access to public equity markets for emerging growth companies. But it has yet to win the trust of investors.
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What is it?

The Jumpstart Our Business Start-ups (JOBS) Act was passed by both houses of the US Congress in March 2012. It is the product of bipartisan efforts to address concerns that regulation, especially by the Securities and Exchanges Commission (SEC), was stifling the ability of so-called 'emerging growth companies' to stage initial public offerings (IPOs) in US markets.

What are the main provisions?

The act has six titles, of which the most important is Title I, also known as the IPO On-Ramp. This defines emerging growth companies as having less than $1bn in annual revenues and a free float of less than $700m. The act allows listed companies in this category to defer – for up to five years after listing – annual say-on-pay shareholder votes, disclosure of the linkage between executive pay and results, compliance with new accountancy standards (unless they are also applied to privately held companies) and external auditor sign-off on the companies’ internal controls.

In addition, broker-dealers will be allowed to publish research on emerging growth companies even if they are participating in their IPOs as underwriters. Title I also reduces the restrictions on pre-IPO communication with institutional investors – 'testing the waters'.

Title II eases the rules on advertising private placements to retail investors and allows the creation of online offering platforms without needing to register as brokers with the SEC. Title III facilitates 'crowdfunding' of companies through a broker or funding platform.

What do the bankers say?

Several banks testified before the US Congress in favour of this legislation. Leading hi-tech sector lender Silicon Valley Bank conducted a client survey that found 72% in favour of easing access to accredited investors to raise capital.

“The survey results are consistent with our philosophy, which has always been that individual high-growth companies may or may not deserve access to more capital, but it is certainly a good thing for the economy to eliminate artificial impediments to the flow of capital and leave the decision to a healthy market between companies and their potential investors,” says Mary Dent, head of government affairs at Silicon Valley Bank.

What do the investors say?

The US Council of Institutional Investors (CII), which represents some of the largest asset managers, public and private sector pension funds, wrote a letter to the US Congress raising concerns about Title I of the JOBS Act. The very definition of an emerging growth company is a matter of contention, with the CII’s letter pointing out that a small business forum organised by the SEC in 2010 recommended a maximum float of $250m as the definition of a small cap.

Jeff Mahoney, the CII’s general counsel, says Congressional testimony suggested that 95% of IPOs might fall under the emerging growth company definition as it currently stands. He notes that the easing of disclosure requirements appears to cut across the Dodd-Frank Act.

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“Dodd-Frank requires the SEC to write a rule on disclosing the link between pay and performance metrics, which is still being drafted. We agree with that, and deferring this requirement for certain types of company seems to contradict something that Congress previously saw as important,” says Mr Mahoney.

He is also concerned that Congress risks undermining the status of independent accounting standards boards by making its own rules on which companies must comply with which accounting standards. Finally, he warns that granting investment banks permission to publish research on companies with which they have an underwriting relationship goes too far towards unpicking the Spitzer settlement firewalls agreed after the scandals surrounding hyped technology company IPOs in the early 2000s.

However, Ms Dent argues that it is difficult to create robust trading in small company stocks without adequate research coverage. Overall, she believes the act adequately balances access to capital with investor protection.

“Growth company executives still have to attest in their filed financial statements before listing that they have adequate internal controls, and they can still be sued by investors if it turns out that those controls do not work. Removing the need for an external audit of those controls is an appropriate compromise,” says Ms Dent.

Will it make a difference?

Given the ever-present risk of litigation, the main flaw of the act may be that it is less transformational than issuers are hoping. Anna Pinedo, capital markets partner at law firm Morrison & Foerster in New York, points out that the 2005 offering reforms already allowed greater freedom for issuers and their investment banks in writing IPO prospectuses.

“Due to concerns about legal liability, those 2005 reforms did not really do what was intended. There are already signs that investment banks will proceed very cautiously this time as well, and in particular there is confusion about whether banks that signed up to the Spitzer settlement will be able to take advantage of the JOBS Act research provisions. But the section on testing the waters should be significant, and it brings the US closer into line with Europe and Asia,” she says.

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