Brace for JOBS Act aftershocks

We appear to be somewhere between free market Nirvana and a Wild West nightmare. The Jumpstart Our Business Startups (JOBS) Act became law just a year ago, with rare bipartisan support in Congress and the White House. Proponents predicted that easing the rules for capital raising would unleash the animal spirits of entrepreneurial capitalism, while critics warned that some provisions potentially open the gates to fraudsters, pump-and-dump shops and stock scams.

The sky has not fallen but neither has there been an explosion of business start-ups and rising employment. The scope of the act is ambitious, mainly targeting companies under $1 bn in revenue, the so-called emerging growth companies (EGCs). But the JOBS Act provisions are far-reaching and touch not just US start-ups but companies large and small around the globe.

Some of the act’s most significant changes, such as crowd funding and allowing more communication by issuers as well as hedge funds looking for investors, could be game changers for IROs and await SEC rule making, at least until a permanent chairman is in place at the commission.

Other parts of the law went into effect immediately and altered the IPO landscape. For EGCs, several SOX requirements are eased and the pre-IPO quiet period is gone, so analysts can issue research reports even before a registration statement is filed. Companies can receive a confidential SEC review of draft registration statements before deciding to go public and can test the waters with potential investors without actually committing to an IPO.

That means a very large door has been knocked through the Chinese Wall that is supposed to separate research analysts from bankers working on an IPO, with the exception of bulge-bracket banks subject to the Global Analyst Research Settlement.

It is not only US companies that have taken advantage of the lighter restrictions, however. A handful of foreign issuers in the UK, the United Arab Emirates, Ireland, China, Luxembourg, Israel, Hong Kong, Germany and Canada have also filed IPOs under the act. And it’s not just two-guys-in-a-garage start-ups seeking to raise funds as EGCs, either.

Cerberus Mortgage Capital, a real estate investment trust controlled by an affiliate of private equity firm Cerberus Capital Management, is seeking to raise up to $150 mn to invest in mortgage-backed securities. And Milwaukee-based Artisan Partners, the $24 bn investment manager, is seeking to raise up to $250 mn in a JOBS Act IPO to restructure its balance sheet.

Private affairs

Meanwhile, the threshold that forces private firms to go public has been expanded from 500 to 2,000 shareholders. This provision could be termed the Facebook Rule: that lower limit pushed Mark Zuckerberg to rush his IPO ahead of a swelling number of employee shareholders last year, before the act was passed.

‘The reality is that IPOs are not about raising seed capital so companies can grow. An IPO is really about giving your early-stage investors a liquidity event more than anything,’ observes Tim Ryan, managing director at OTC Markets. ‘Look at Facebook: it didn’t need the money to grow the business; it needed it to pay its early investors.’

The JOBS Act enables smaller companies to raise capital more easily without having to promise early-stage investors an IPO within five years. But an IPO is not the only way to give liquidity to investors. Ryan points out that the amount of capital raised in the traditional IPO market on listed exchanges has been surpassed in recent years by alternative equity offerings.

These include Rule 506 of Regulation D private placements, which can raise capital sold only to ‘accredited investors’ (high-net-worth investors), and 144A offerings to qualified institutional buyers (QIBs) by companies not listed on US exchanges (including foreign issuers without ADRs). According to the SEC, in 2011 Reg D and 144A offerings raised $895 bn and $168 bn, respectively, compared with $984 bn raised in registered offerings.

Changes under the JOBS Act still awaiting SEC rule making could have a significant impact on these private offerings for issuers, institutional investors and IROs alike. Title II: Access to Capital for Job Creators lifts the ban on general solicitation and advertising. Talk about a changed landscape. The controversy surrounding this provision illustrates the complex rule making facing the SEC.

Imagine hedge funds advertising for new shareholders the way a mutual fund does now or bankers pitching a 144A offering in a late-night infomercial. ‘The big secret beneficiary of all this is the hedge funds,’ observes Jeff Morgan, NIRI’s CEO. ‘They get to grow to be much larger and have lots more shareholders.’

Marketing by hedge funds is one thing, and perhaps the most controversial issue. But the JOBS Act is meant to give breathing room to companies doing private offerings by lifting the ban on general solicitations as long as they sell only to accredited investors and QIBs.

Critics of Title II point out that the SEC did not specify the ‘reasonable steps’ issuers should take to ensure securities end up only with sophisticated investors. Supporters of lifting restrictions, on the other hand, worry that requiring issuers to figure out who among the investors responding to their advertisements are accredited investors would place an onerous burden on them.

New capital pools

Still, the possibility of easier general solicitation could make private offerings in the US by foreign issuers a more attractive prospect and perhaps reduce their desire to be listed on a US exchange, with all the reporting demands a listing comes with.

Title IV of the act, Small Company Capital Formation, could be one of the biggest game changers when the SEC gets around to writing rules. It proposes to expand little used Reg A offerings from a maximum of $5 mn a year in unregistered securities that typically trade in the OTC markets to $50 mn a year.

If they come into being, so-called Reg A Plus offerings could accelerate a shift to more equity financing and less reliance on debt and bank borrowing, Ryan predicts. This provision is particularly important for smaller companies, he argues, where over the past decade the sub-$50 mn IPO has virtually disappeared, in part due to changes in market structure, contraction of bid/ask spreads caused by decimalization, and the shrinking of the sell side. ‘The aftermarket support for those smaller IPOs is just not there in a meaningful way,’ he explains.

When the SEC finally completes its JOBS Act rule making, the world of investor relations will definitely look different. At a minimum, the act expands the demand for savvy capital market communication. ‘A decade from now you will see private companies grow to be much larger, with more shareholders and private company IR,’ predicts Morgan. ‘That will set the stage for better exposure and understanding of what investor relations is before they get listed on a public exchange. I don’t see it as a bad thing. I just see it as a full-cycle IR opportunity. The future of IR is bright.’