Prosper or perish?

New appeal

The JOBS Act vastly reduces the regulatory burdens on small and medium-sized companies going public in the US

Joshua Zimmerman, Sanjeet Malik and Richard Mo of Milbank explain

The New York Stock Exchange (NYSE), Nasdaq and global investment banks consistently tout the benefits of US listings to Indian technology, media and telecommunications companies and their investors: demonstrably higher initial valuations; best-in-class research coverage; US-listed shares as an unparalleled acquisition currency; exits for private equity and venture capital investors on attractive terms; and, perhaps most important, sustained access to the world’s deepest capital market.

But in recent years these pitches have fallen flat as companies and their investors fret over the disadvantages of US listings. These include multimillion-dollar costs to comply with obscure internal controls requirements and a regulatory process for initial public offerings that mandates full public exposure long before an IPO has any assurance of success. The regulatory burden for US public companies appeared to increase with every major dip in US equity markets, making London listings look increasingly attractive by comparison.

Now president Barack Obama, with broad bipartisan support, seeks to make the US capital markets once again the leading destination for listing foreign and domestic companies. The recent passage of the US Jumpstart Our Business Startups (JOBS) Act significantly reduces the regulatory burden for small and medium-sized companies going public in the US.

Exemptions for a new class of companies

The JOBS Act defines a new class of companies called emerging growth companies (EGCs) – newly public companies with less than US$1 billion in annual gross revenues, as calculated using US generally accepted accounting principles (GAAP) or international financial reporting standards. The act then exempts EGCs from a host of IPO and ongoing reporting requirements.

The JOBS Act streamlines the US IPO process for EGCs in two major ways. First, the requirement to provide audited historical financial statements has been reduced from three years to two (but if an EGC already provides three years of financials to another exchange, the third year will still need to be provided as part of the US IPO process). Second, the legislation permits EGCs to submit a draft IPO registration statement to the US Securities and Exchange Commission (SEC) on a confidential basis for SEC review, provided a public SEC filing is made at least 21 days prior to the IPO roadshow.

Testing the waters

EGCs may also test the waters for their IPOs by communicating with certain large institutional investors to gauge investor interest before committing to an IPO by publicly filing a registration statement with the SEC. Testing the waters represents a major break from the traditional SEC approach, which strictly prohibits even oral offers of securities until after an IPO registration statement has been publicly filed.

Confidential SEC submissions coupled with the ability to test the waters should help an EGC delay the disclosure of sensitive information to the market and avoid publicly committing to an IPO until after it is reasonably confident that its IPO has a decent shot at success.

Relaxed reporting obligations

EGCs are also exempt from certain SEC ongoing reporting obligations for up to five years after listing (referred to as the “on-ramp” period). The most significant exemption is from the requirement to provide an annual auditor attestation report on internal controls over financial reporting, under section 404(b) of the US Sarbanes Oxley Act. The SEC estimates that Sarbanes Oxley attestation reports cost US public companies roughly US$2 million on average annually, so the exemption from 404(b) represents considerable cost savings.

The JOBS Act also exempts EGCs from some of the more controversial regulations concerning executive compensation, including the requirement to give shareholders an advisory vote on executive compensation (the so-called “say-on-pay”) and the requirement to disclose the ratio of CEO-to-worker compensation. In addition, an EGC that prepares its financial statements using US GAAP is exempt from complying with new or revised US GAAP pronouncements applicable to public companies until the standard becomes mandatory for private companies as well.

Maintaining EGC status

To qualify for these exemptions post-listing, a company must remain an EGC. A company loses its EGC status on the earliest of: (1) the last day of the fiscal year during which it had annual gross revenues of US$1 billion or more; (2) the last day of the fiscal year following the fifth anniversary of its IPO; (3) the date on which it has, during the previous three-year period, issued more than US$1 billion in non-convertible debt; and (4) the date on which it becomes a “large accelerated filer” (at least 12 months of SEC reporting history and a minimum US$700 million public float).

At the conclusion of the on-ramp period, former EGCs are deemed to be sufficiently large and seasoned to comply with section 404(b) of Sarbanes Oxley and the other requirements from which they were previously exempt. Moreover, EGCs, like larger US public companies, remain subject to periodic SEC review of their registration statements and must comply with the vast majority of the reporting obligations and other requirements mandated by the SEC rules and Sarbanes Oxley.

The JOBS Act is one of the most significant revisions to the US securities laws since the passage of Sarbanes Oxley a decade ago. Indian companies and their investors who have dismissed US listings as too expensive and burdensome may want to take another look.

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Joshua Zimmerman is a partner at Milbank’s Hong Kong office, Sanjeet Malik is a counsel at the firm’s Singapore office, and Richard Mo is an associate at Milbank in New York.