JOBS Act creates new class of IPOs – and new problems

October 2014

IN THIS ISSUE

— JOBS Act, Meant to Spur Investment, Also Created New Secrecy Layers
— Piecing Together Typical IPO Information Shielded by the JOBS Act

GREETINGS!

Welcome to the October edition of our newsletter! In this issue, we’ll examine how reporting provisions for initial public offerings (IPOs) of a certain size, part of a 2012 bill meant to encourage funding of smaller companies, can create information gathering hurdles for potential investors.

JOBS ACT, MEANT TO SPUR INVESTMENT, ALSO CREATED NEW SECRECY LAYERS

In early 2012, Congress passed the Jumpstart Our Businesses and Startups (JOBS) Act, which President Obama signed into law that April. The bill eased securities regulations, including allowing companies with less than $1 billion in annual revenue to be exempt from certain Sarbanes-Oxley requirements. More than two years after the bill became law, that provision — which allows companies under the threshold to file IPOs “confidentially,” meaning that the filing, and any correspondence about it, is not accessible to media outlets (or researchers) until the “roadshow” prior to the actual trading of the company’s stock. Further, companies only need to provide two years of financial statements, versus the typical three years.

The benefit for companies is obvious: they can “test the waters” to gauge interest in a filing, and quietly withdraw the registration if the response isn’t as good as hoped (which is in contrast to some high-profile IPOs which were withdrawn, in very public fashion, after failing to generate interest.) From a due diligence perspective, however, problems arise: while a supposedly ‘secret” IPO is unlikely to remain that way for long, the prospectuses and other information that it typically filed prior to an IPO adds valuable information for potential investors, including management’s assessment of the risks their company faces, as well as information about management executives themselves.

PIECING TOGETHER TYPICAL IPO INFORMATION SHIELDED BY THE JOBS ACT

Despite the secrecy created by JOBS Act provisions, certain records can be pieced together through other sources. Key management, for instance, is often listed in corporate records filed at the state level, and smaller businesses often report certain financial information to third parties, such as Dun & Bradstreet or Experian, to build a credit history. Companies that use collateral to borrow from banks typically submit Uniform Commercial code filings; while these don’t include the amount borrowed, they often include collateral that can tell you about the company’s assets and operations. News articles about the company expanding to new markets, opening new facilities or hiring new people can also help assess its ability to prosper going forward.

In short, certain parts of the JOBS Act spurred investment at the cost of transparency. While this can create new issues for a fraud examiner to overcome, it should not dissuade your clients from doing their homework prior to making a smaller investment in what could be the next big thing.