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What Is The Jobs Act

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 9 minute read

On March 27, 2012, the House and Senate enacted H.R. 3606, the Jumpstart Our Business Startups Act (JOBS), and on April 5, 2012, President Obama signed it into law. Economists are divided on whether or not the Act would really increase jobs, but it will simplify the way for private enterprises to enter public markets during their expansion phase.

Private investors, who had been afforded some safeguards under previous securities regulations, are expected to bear the brunt of these improvements. A lot of people have pointed out that the minor benefits to a select number of businesses, investment managers, and broker-dealers aren’t worth the increased danger of fraud and scams to the general public.

The bill’s backers claim that JOBS “would assist small businesses in raising money, expanding their operations, and generating private sector employment opportunities for Americans.” The purpose of JOBS is twofold: to encourage funding for startups and to exclude smaller publicly listed firms from the Sarbanes-Oxley Act’s reporting requirements, which have been criticized as being too onerous.

After the collapse of Enron on July 29, 2002, Congress passed Sarbanes-Oxley to impose stringent regulations on the accounting and reporting of financial results by public companies and to extend criminal and civil liability to boards of directors, management, and public accounting firms for noncompliance. Many of the safeguards for investors provided by Sarbanes-Oxley have been repealed by the JOBS Act.

What Does the JOBS Act Include?

Many of the JOBS Act’s most important features originated in smaller, bipartisan proposals that were ultimately incorporated into the larger legislation. A few of the most crucial clauses are as follows:

  1. The formation of a “Emerging Growth Company”

A new type of stock issuer, known as an emerging growth company (EGC), was established by the Act and is now subject to SEC rules for the next five years. Privately held companies with annual revenues of less than $1 billion are eligible for EGC status, which they can keep for up to five years or until their revenues reach $1 billion, whichever comes first. The Act defines an EGC as:

  • Currently mandated laws that allow shareholders to vote on CEO remuneration packages do not apply.
  • Provides only two years of audited financial statements for an IPO, rather than the current three.
  • Does not need to retain an outside auditor to issue a report attesting to the effectiveness of internal controls over financial reporting in accordance with Sarbanes-Oxley.
  • Analysts’ research reports can now be made available to potential investors or the public both before and after an IPO, a practice that previously was banned to prevent analysts from being coerced into giving positive evaluations of securities for which their companies had underwritten.
  1. Allowance of Advertising and General Solicitations of Potential Investors

No “advertisement, article, notice, or other communication published in any newspaper, magazine, or similar media, or broadcast by television or radio, and any seminar or meeting whose attendees have been invited by any general solicitation or general advertising” may be used by a securities issuer after August 5, 2003.

The Access to Financing for Job Creators Act (JOBS), first passed by the House as H.R. 2940 in November 2011, removes the prohibition on broad solicitation or advertising for Regulation D private placements, which are commonly utilized by small businesses to acquire capital.

  1. Provision for “Crowdfunding”

Since its initial passage in the House as H.R. 2930, The Entrepreneur Access to Capital Act, the bill has been changed in the Senate to make it possible for businesses to openly seek investors from two distinct categories.

  • For those with a $100,000 yearly income or net worth, the maximum investment allowed is the greater of $2,000 or 5% of that amount.
  • If your yearly income or net worth is more than $100,000, you can invest up to 10% of the bigger amount.

It is not necessary to register with the SEC in order to file an offering document with the agency. Companies can raise up to $1 million yearly, provided that the broker-dealers sponsoring the offering are SEC-registered. Any securities purchased under this provision must be held by the purchaser for a period of at least one year.

Accredited investors, as specified by Rule 501 of Regulation D, are no longer necessary thanks to JOBS. An “accredited investor” is defined as a person who either has a net worth over $1 million (not including the value of their primary residence) or who has had an annual income of over $200,000 in each of the two years prior to the offering, with a reasonable expectation of the same level of income in the offering year.

  1. Regulation A relaxed the rules for initial public offerings (IPOs).

H.R. 1070 By amending SEC Regulation A, the House’s 2011 Small Firm Capital Formation Act makes it possible for a company to raise up to $50 million with only audited financial statements and an SEC-approved streamlined registration and offering circular.

When a company goes public in this way, it avoids having to comply with federal and state securities (or “blue sky”) rules. The issuing and sale of securities inside a state are governed by that state’s “blue sky legislation.”

  1. Delayed Registration and Reporting

H.R. 2167, often known as the Private Company Flexibility and Growth Act, or the “Facebook rule,” increases the threshold of shareholders at which registration with the SEC is necessary from 500 to 2,000. All stock grants to workers are excluded. With this clause, a growing business is not compelled to go public too soon, allowing it to keep its private status.

  1. Increase in Community Bank Shareholder Limits

Under H.R. 4088, The Capital Expansion Act, the threshold at which community banks and holding corporations must register their securities with the SEC rises from 500 to 2,000.

The JOBS Act’s Impact

The JOBS Act is contentious for the same reasons that many proposals introduced in Congress are. Notable businesspeople including Steve Case, ex-CEO of AOL, and the U.S. Chamber of Congress, as well as The Wall Street Journal and the majority of Republicans, support it. SocialTables’ Washington, DC-based creator Dan Berger put it this way: “Investing in companies has been restricted to the rich for the longest time, but with crowdfunding, the process will allow more entrepreneurs access to cash and more people the potential to strike gold.”

Many Democrats, Bloomberg and New York Times editorial boards, Consumer Federation of America, AARP, former SEC chairs, state security commissioners, and security law experts have all spoken out against JOBS, arguing that it goes too far in dismantling the safeguards for investors that inspired the passage of the Sarbanes-Oxley Act in 2002 and the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010.

For Forbes author John Wasik, “crowdfunding might make the boiler room frauds of the 1980s appear like petty parking fines.” Former SEC Chief Accountant Lynn Turner has stated that the bill “would be better called as the Bucket-Shop and Penny-Stock Fraud Reauthorization Act of 2012.”

Both supporters and detractors of the JOBS Act have laid out the potential upsides and downsides of the legislation.

Benefits

  1. To put it another way: more funding for startups equals more new businesses and more people finding employment. As a result of simplified processes and reduced costs, more startups may be established and existing businesses can expand their staff. As a result of JOBS, companies no longer have to submit paperwork as frequently or wait for clearance from regulators to register with the SEC. This means there will be a rise in the number of businesses going public. Bill Sahlman, a professor at Harvard Business School, says, “When you cut the cost of doing something, more of it gets done.” That is the basic idea behind the JOBS Act, and it makes perfect economic sense.
  2. Growth in the amount of money put into new businesses. There is a huge increase in the sums available for investments in startups. Crowdfunding and other methods that don’t limit communication with potential investors make it possible for startups to reach out to a wider pool of capital. Private offers formerly could only attract affluent individuals with a minimum net worth of $1 million. But because to JOBS, anyone with a positive net worth can participate in a private placement and invest money.
  3. It’s open to a wider range of potential financiers now. Now, private placements of equity are available to smaller investors. Historically, only small groups (no more than 35 investors), investors with a special link to the firm issuing the securities, or authorized investors were allowed to put money into non-private beginning businesses. Those restrictions are nullified by JOBS.
  4. It is now easier for businesses to maintain their secrecy. By raising the threshold at which a company is required to register with the SEC from 500 to 2,000 shareholders, privately held businesses can improve their finances without having to go public until it is in their best interest to do so.
  5. Employees can be compensated using stock options. If a private company decides to delay an initial public offering, the company can now grant stock options as a form of compensation. For instance, many software firms with less than $10m in assets have a high proportion of their workforce compensated in stock options rather than cash.
  6. Companies can increase employee stock ownership without incurring additional costs from mandatory registration and reporting by excluding employee ownership from the shareholder computation.
  7. The financial sector might improve. Owners of small businesses, especially those who were struck hard by the recent economic downturn, often lament the difficulty of gaining access to necessary funding. Banks have increased their credit requirements and internal attention on balance sheet reforms in response to loan losses. A boost in capital gives banks more strength to extend credit.

Risks

  1. It’s expected that frauds and other forms of trying to scam investors would increase. The freedom to openly seek investors and the crowdfunding feature are the most controversial features of the JOBS Act because of less regulatory monitoring. Many federal and state securities authorities are concerned that the lowered bar would make it easier for fraudsters to take advantage of the public, particularly the elderly who may not have the financial literacy to assess the merits of a private offering. This would cause a scandal on a national scale, somewhat unlike the ones involving Bernie Madoff or Alan Stanford. Put simply, JOBS undermines the protections afforded to individual investors ever since the Securities Act of 1933 was enacted in the wake of the 1929 stock market crisis. Some market watchers foresee a return to the 1920s-style “boiler room” operations, in which high-pressure salesmen use sophisticated robot telephone banks to prey on the trusting and cause them to lose their life savings without fear of repercussions from the authorities. Regardless of the conclusion, it’s apparent that investors are taking on more risk and should do their homework before putting money into any investment.
  2. Potentially More Startups Will Fail. Experts in the business world tend to agree that it’s not a lack of funds that causes small businesses to fail, but rather, owner-expectations that are too high and management that isn’t up to par. Because of the reduction in the difficulty of gaining access to finance, an increase in the number of ill-conceived businesses led by people who lack even the most fundamental business management abilities is likely.
  3. In the end, the JOBS Act may not accomplish much. The JOBS Act, according to their logic, will have the unintended consequence of reducing investment and the number of startups being established. While testifying before the Senate Committee on Banking, Housing, and Urban Affairs, University of Florida finance professor Jay Ritter said that “by making it easier to raise money privately, creating some liquidity without being public, restricting information that shareholders have access to, restricting the ability of public market shareholders to constrain managers after investors contribute capital, and driving out capital, the net effect of the public market is to encourage private capital formation.” John Coates, a professor at Harvard Law School, shared his concerns about the proposed regulations in the same committee, saying that they will “not only produce front-page controversies, but diminish the exact thing they are being touted to increase: employment development.”

Bottom Line

On April 5, 2012, the president signed the new Act into law, and legislators from both parties are claiming victory for their efforts to reduce red tape and cut wasteful spending on administration. Securities regulators at the federal and state levels are figuring out how best to safeguard investors in light of potential complaints about the lack of their past monitoring. 

Meanwhile, con artists, scammers, and dishonest brokers are jumping with joy at the prospect of targeting a big, untapped pool of ignorant investors with their quick-rich schemes. Many people will learn for the first time about the predatory and prey-like world of private placements.

When dealing with people who claim to have found “lightning in a bottle” or an “assured, safe return,” a prudent investor proceeds with care, examining every assertion, confirming facts, and authenticating credentials. Even if failure is the more typical consequence of an endeavor, the former tends to receive more attention and remain in memory for longer.

Remember that the ancient gambler’s adage, “The quickest way to save your money is to fold it over and put it in your pocket,” is sound advice.

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