Reed Smith partner, Gerry DiFiore Discusses Major Implications of Washington’s JOBS Act

Gerry DiFiore, partnered with the global law firm of Reed Smith is specialized in securities law on emerging growth companies. He recently co-authored a paper on the Jobs Act and the implications for companies and what it means for entrepreneurs in the management of fast-growing businesses.



Click below for full audio interview and see transcript that follows.

Brett Johnson:     Welcome, Brett Johnson in New York with OneMedRadio. Today, I’m with the Gerry DiFiore who’s partnered with the global law firm of Reed Smith. Mr. DiFiore is specialized in securities law folks on emerging growth companies for over 20 years including 4 years at the SEC. He recently co-authored a paper on the Jobs Act and the implications for companies and what it means for entrepreneurs in the management of fast-growing businesses. Thanks for joining us today, Gerry.

Gerry DiFiore:   Thanks, Brett. Thanks for having me. I appreciate it.

BJ:   So from an entrepreneur’s point of view or the management of a fast-growing company, I heard a lot of the Jobs Act. What is it from a practical point of view? What is it really mean for me?

GD:   I think that the provisions of the Jobs Act that are meaningful for fast-growing private companies are all contained in what I call the IPO ramp-up provisions. That part of the Jobs Act provides a cleaner, simpler path towards public offerings for companies that are called or defined as emerging growth companies. Emerging growth companies under the act are those companies that have revenues of less than a billion dollars and don’t have a public float of an excess of $700 million.

The provisions of the Jobs Act that are beneficial for these types of emerging growth companies come across a number of sectors.

First of all, there’s a phase of a lot of the owner’s requirements of Sarbanes-Oxley and Dodd Frank that are not immediately applicable. Emerging growth companies only need 2 years of audited financial statements and MBNA rather than a longer period of time. The executive compensation disclosures are mitigated and what’s called the CD&A, the Compensation Disclosure and Analysis requirements under Dodd Frank, are, again, eliminated for 5 years. There’s no requirement for merchant growth companies to comply with the say on pay requirements of the Dodd Frank Act.

A couple of other areas of relaxation include the elimination of the Sarbanes-Oxley 404 financial control auditor at the station, which is going to be a big problem for smaller companies, and there’s no rotation requirement for the auditors.

Let me mention one other thing Brett, then you can poke me with some questions. Another benefit of the Jobs Act is that the SEC will permit registration statements for IPOs by merging growth companies to be filed in drift form on a confidential basis. That’s a big departure from current practice where a registration statement is filed and immediately available for everyone to view. So this is to give companies an opportunity to work with the stay up on a private basis, a confidential basis until they get it right, and then at a later date when they’re getting closer to meaningfully being able to go public giving access to the public to those documents.

BJ:  Interesting. So in a sense, emerging growth company, you’re pretty much under billion revenues. You’re pretty much talking about most companies so this really applies to any, almost any company. The last point you mentioned sounds like it’s going to be a situation now where you won’t have as many of these offerings being pulled. From a significant number of people from file registrar, and then they don’t do the offering.

GD:    Well, I think that the dynamics of that are impacted by things beyond just the Jobs Act provisions. There are big companies that file offerings, or you know, seasoned companies that are larger that might be in this category, that might pull the offering for marketing reasons, and so it has nothing really to do with whether or not they got comments they didn’t like from the staff, that they didn’t want the world to know about.

BJ:     But it does enable them to get all this stuff done, and then I don’t have to wait 6 months before they get their comments back from the NCC. I mean they get it all ready to go, and if they want to pull the trigger then they can pull the trigger and go.? Is that the benefit in this?

GD:  I’m not sure. I think that the nature of the sequence back and forth with the commission is exactly the same. You file, you get comments. You respond to comments, you re-file. You get more comments, you re-file. You keep going – The ping pong ball goes back and forth. It’s just that in the early stages of the back and forth, it’s done without the world watching.

GD:  That’s the only difference, but the nature of the process with the commission of review, comment, refilling is exactly the same. And it’s not any faster. It’s not going to be any faster.

BJ:   Is the cost essentially of going public going to be reduced in a meaningful fashion?

GD:   In a meaningful fashion, not materially. I would say no. Here is how I would answer that question. It’s still going to be costly to go through the process. Some companies will be ready to be going public sooner because the financial statement requirements are less burdensome, but as a general rule, the cost of preparing a registration statement for an emerging growth company that complies with the modified rules will not be meaningfully less than to do a registration statement for a company that has to comply with all the rules.

BJ:  Okay, let’s move on to sort of the endorsement as you’re seeing. You pay for OD emergence of secondary trading markets in securities of private is yours, which effectively in some sense, maybe sort of illuminates or delays the need to become a public offering. Is that a safe statement?

GD:  I think that the provisions dealing with these trading platforms that may be facilitating a placement of securities or the re-sell of private securities to the extent of the commission is going to bless these crowd funding platforms.

If those things function the way people are hoping they will function that will create more liquidity with private companies and I think it will not obviate the need for raising capital because those provisions do not facilitate raising capital. Those provisions simply allow an existing shareholder to sell shares in a private company, some new shareholder.

The money doesn’t go to the company. The money goes to the shareholder. What that’s going to do is to make it more palatable for share holders, for investors to take risks early on because they may believe that with these platforms in place, they have a pathway to an exit of their shares before the company goes public.

BJ:      I see. Okay, so that could be quite significant in terms of appeal of people buying shares in companies by the companies.

GD:     It would be significant for the investors and the companies would probably argue that because there could be some more liquidity in private company shares that might make later-stage investors more willing to come in and play. I think that that would remain to be seen, but that’s – I think that that’s the thought process.

BJ:    Okay, so that wouldn’t be. As you look at the broad brush on this, how do you feel about what’s positive about it, what’s negative about it? What do you like? What don’t you like?

GD:     I like the IPO ramp-up provisions. I think that they’re well thought out and they’re really trying to address an important need in the marketplace. There are also a couple of studies that are being mandated by the act. One of those studies asks for the commission to review the impact of what’s called the decimalization because there are some commentators that have said that the early-stage IPOs of younger companies that were prevalent 10 or 15 years ago don’t happen anymore because the markets are too tight meaning the spreads for stocks are so narrow that dealers can’t make markets in those stocks and make money.

So this decimalization study may show that an inadvertent consequence of decimalization has meant the crowding out of dealers who will play in the smaller company marketplace, and it’s the part of those dealers that has made it difficult for small companies to go public. So it’s going to be interesting to see what that decimalization study shows.

BJ:    In fact, there’s been 43% drop in the listings of publicly-listed stocks over the last 14 years, and many attribute that to decimalization, and you know, the computers entering the business where people used to do this training. Is that true?

GD:    Yeah, I think that the fact that you don’t have a dealer marketplace that’s vibrant anymore because dealers cannot afford to commit the capital to create liquidity for these smaller companies, and with the dealers out of the market, there’s no incentive for Goldman Sachs, you know, and Morgan Stanley to be playing with companies with a $200 million market cap or a $100 million market cap. So without the smaller players, there’s no platform. There’s no infrastructures to support the companies, and without the infrastructure, those companies aren’t going to go public. So yeah, I think it’s interesting.

BJ:       What’s your read on when these studies are going to get done, and when they’re going to conclude, and when is all this going to happen?

GD:     I don’t remember when a decimalization study is due. It might be due either 6 months or 9 months after adoption of the act, and I can’t really speculate on what will come of it since I don’t know what the study is going to conclude. My own personal view would be that, you know, if the study does conclude that decimalization has been a cause for part of this problem, it will be nice to think that Congress might try to do something about it. We’ll see.

BJ:    Let’s skip ahead to another interesting piece that’s gotten some attention that is crowdfunding, and this idea of people using the internet to gather small amounts of money from thousands and thousands of investors now, what does that mean big picture for let’s say an early stage, healthcare like science company?

GD:   I think that the crowdfunding provisions have limited utility except in the context of companies that have a lot of inherent hype about them and that are easily understood by large numbers of people. The crowdfunding provisions have several different types of limits that apply to them. There’s limits that apply to the company, and so money raised at the company, you know, for a company can now exceed a million dollars in a 12-month period.

There is also individual investor limitations that are quite low that are a function of the investor’s individual level of income or net worth. And then there are provisions on financial disclosure requirements that are not zero that are imposed and requirements on the portals where, you know, the crowdfunding portals that are going to be making these offerings.

And so the portal requirements are actually going to be quite vigorous because what’s happening here is – the statute is placing the burden of compliance away from the issuer, which is where the securities laws generally place the burden, and moving the burden in the crowdfunding context to the portal. By putting that burden on the portal, depending upon how the rules play out, it’s likely to make a lot of what the proponents of crowdfunding thought they might get, not there. They’re going to be taken away. And that’s because when the commission wants to regulate the portal requirements, they’re going to make it very difficult for the portals to make this simple because they’re going to impose the burdens on the portals.

So my view is that when you look at the portal requirements, you know, that they have to register with an SRO. They have to provide investors with disclosures and educational materials. They have to, you know, take measures that reduce the risk of fraud. They have to regular the receipt and holding of investors money. They have to ensure that the investors do not exceed their applicable limits, the investment limitations, and they can’t be compensation for promoters or finders. All of those things that now have to be regulated by the portal and to be done on a relatively thin margin. It’s going to make it very hard. I think it’s possible that some portals will emerge at being able to figure out how to do this, but if you look at the impact of this in the broad brush, I don’t think there’s a lot there. I think where there is opportunity, perhaps more than in the crowdfunding context is in something that you have not asked about.

BJ:   The general solicitation rules?

GD:   Exactly, exactly.

BJ:  I was just about to ask you that. What about the general solicitation rule?

GD:   The lifting of the general solicitation band is a seismic shift and the philosophy of regulation of private offerings in the United States. The SEC has, you know, steadfastly refused to lift that prohibition in the context of private offerings, and now, the Jobs Act is going to permit general solicitation so long as the participants are limited to accredited investors.

BJ:    And so basically, historically, you couldn’t really get out and promote and tell people about your company and that you’re raising capital — your quiet period and all sorts of restrictions I guess, and now, can just get up and tell everyone as much as you want whenever you want?

GD:    Well see, the rules that the SEC has to promulgate under the general solicitation band eliminate – the elimination of the band are going to be coming out on the summer, and I think everyone will be anxious to see exactly how they work, but certainly, you know, opening the lines of communication and allowing solicitation is going to make it a lot easier for people to get the word out about interesting companies.

BJ:   Uh-huh. So that actually is a very, very big change. Will you say that’s the biggest change and the most meaningful change in the Jobs Act?

GD:    I would say it’s the most meaningful change for most private companies because most private companies are not going to go public. Most private companies are going to get private financing and a very small percentage of those companies will end up on the IPO on-ramp, but many of them will start down with private financing and then may ultimately grow and be acquired by another company, which is acquired by another company, which is acquired by another company, and then that snowball will go public. I think that the general solicitation band is going to reach more companies than any other provision of the Jobs Act.

BJ:  Interesting.

GD:   There’s another provision of the Jobs Act which will be interesting to see how it plays out, and that deals with changes to the nature of what’s called Regulation A.

Regulation A is an SEC regulation defining what has traditionally been called a limited public offering or sometimes called an exempt public offering. Regulation A is not oftentimes used. It’s very, very sparsely used because it’s hard to work and because it edifies million dollar offering size limitation.

So the Jobs Act has raised the offering size limitation for a Regulation A limited public offering from $5 million to $50 million, and it’s also going to permit sort of – I think that when you combine it with the General Solicitation Prohibitions, it’s going to allow people to make solicitations for this type of an offering. And so that’s a big enough dollar amount to actually make going through regulatory hurdles of Regulation A worth doing.

The other thing that would have to happen in order to make this work nicely is the coordination with the States to the Blue Sky Laws has to change. In other words, Regulation A is an exempt public offering under Section 3B of the 33 Act, and because it’s under that section of the 33 Act, there is no authority for excluding the review of state regulators from the offering like there is for a 42 private place into accredited investors. And so an offering of common stock by a private company to accredited investors is considered a coverage security under an – It’s exempt from State Law Regulation, but a Regulation A offering would not be. So what the SEC have to do is find a way to pre-empt state regulation mayor to make that a meaningful pay as way, but I think that may be something that’s going to be talked about.

BJ:   And do you think they actually will do that?

GD:   I don’t know. I don’t know. I mean in my 25 years of practicing law, I think I’ve done maybe one Regulation A offering. When I was on the staff of the SEC, I think, you know, I heard of one or two Regulation A offerings in 4 years. I mean literally, there’s been a hundred of them in a hundred years. So it’s just not used because it doesn’t fit. It’s kind of like – I don’t know – its like a square peg in a round hole. It just doesn’t fit with the regulatory regime. There’s nobody who’d want to go through the trouble to do it for $5 million bucks.

BJ:   Interesting. Well, it’ll certainly be very interesting to see how all of these I guess rules that the SEC now have to promulgate will shape and will affect the environment for companies raising money in the coming months and years.

Thanks so much for joining us today, Gerry.

GD:   Absolutely. It’s my pleasure.

BJ: So that was Gerry DiFiore who have partnered with the global law firm of Reed Smith. He’s spent his career in the securities law and told us today a little bit about the impact of the Jobs Act. Thanks for joining us, Brett Johnson, OneMedRadio, signing off.

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