JOBS Act reduces filings for county IPOs, but critics worry about diminishing oversight

In the past two weeks, a Sonoma County high-tech developer and a winery have filed plans to take their companies public and raise millions of dollars from investors.

They have something in common beyond their geography.

Truett-Hurst, a Healdsburg wine company, and Cyan Inc., a Petaluma technology firm, both chose to file as "emerging growth companies," a new category that was created under the JOBS Act -- short for Jumpstart Our Business Startups.

Enacted a year ago, the JOBS Act was designed to ease companies' access to capital markets by making it less expensive and onerous to comply with the regulations required of public companies. It was pushed by Silicon Valley venture capitalists, who argued it would spur economic growth by enabling companies to raise the funds they need to expand and create new jobs.

But critics say the JOBS Act hasn't accomplished that goal. They say it risks eroding important protections that were put in place after the Enron scandal by reducing the amount of information public companies have to file with regulators, and by relieving companies of requirements like giving shareholders a say on executive compensation and "golden parachutes."

The Council of Institutional Investors, a nonprofit association of pension funds, endowments and foundations with combined assets that exceed $3 trillion, warned investors that they would find significant erosion of mandatory disclosures and shareowner rights when dealing with companies that filed as "emerging growth companies."

But backers of the act like Bill Hambrecht, whose San Francisco firm WR Hambrecht + Co. is underwriting Truett-Hurst's public filing, say something needed to be done to simplify the IPO process to help smaller, venture-backed companies access capital markets in a way that isn't cost-prohibitive.

"The motivation of the JOBS Act was to allow smaller companies to go public," said Hambrecht, who is a co-owner at Truett-Hurst. "And the rationale was pretty simple. There's been thousands and thousands of small companies started by VC investors and angel investors . . . and for the last decade, about 95 percent of them would end up -- when they came to going public or selling out -- would end up selling out."

Companies backed by venture capitalists reach a point when they have to pay back their original investors, Hambrecht explained. They're often faced with the decision to either raise money from the public through an IPO or to sell the company to a larger competitor. Those that choose the IPO route typically create jobs, while those swallowed up by a merger typically contract because of staff redundancies, Hambrecht said.

"If you look at Apple and Google and people like that, the real expansion in job creation came after they went public," said Hambrecht, whose investment banks helped underwrite both of those companies' IPOs.

A year after the JOBS Act went into effect, nearly three quarters of all companies that filed IPOs identified themselves as emerging growth companies, according to an analysis by Latham & Watkins, a law firm that was instrumental in drafting the legislation. The firm found that 184 companies took advantage of the relaxed rules.

Big small companies

Proponents say the law was designed to help smaller companies. But a company can qualify with up to $1 billion in annual revenues. And some of the companies that have filed as emerging growth companies include so-called "shell companies" that don't have any assets but are designed to serve a business purpose such as check writing or creating a tax haven, according to media reports.

"There wasn't a lot of strong basis for determining the definition and the amounts," said Jeff Mahoney, general counsel of the Council of Institutional Investors. "That was not something that there was a lot of deep thought about as to where the line should be drawn."

So far, almost 85 percent of the companies that filed as emerging companies in the last year had less than $250 million in annual revenues, according to a report by Latham & Watkins.

Mary Shapiro, who was chairwoman of the Securities and Exchange Commission when the act passed, opposed many provisions of the law. She said the definition of an emerging growth company was so broad that it would eliminate important protections for investors in even very large companies.

The companies that have filed also aren't necessarily new, Mahoney said.

"We've seen some companies that have been in existence for a long time, like Manchester United, the soccer club," Mahoney said. "They registered as an emerging growth company. I think they've been in existence for hundreds of years."

Relaxed filing requirements

About half of the filers took advantage of the ability to provide less financial information, and included two years of audited financial statements instead of three, the Latham & Watkins report said.

"You're looking for records that are not readily at hand," said Tony Richmond, a Menlo Park-based partner at Latham & Watkins. "It costs money, it requires work, it takes time, and those are all three things growth companies have limited resources on."

That decrease in information doesn't trouble Hambrecht, because under the JOBS Act, underwriting banks are no longer prohibited from issuing research reports about the company before and during the IPO. He says those reports are more valuable to potential investors than an additional year of historical financial information.

"Under the old system, investors got all kinds of information, but it left out something crucial," Hambrecht said. "The basic question: What is the future of the company?"

Research reports

The JOBS Act reversed a long-standing policy that prohibited analysts affiliated with the underwriting investment bank from publishing research reports about the company during the IPO process, prohibitions that came about during the scandals of the dot-com era. Now, analysts associated with the underwriters can issue reports throughout the IPO process.

"There were all kinds of examples in Enron about analysts providing reports that were highly biased and contained inaccuracies in order to boost interest in the company, and those analysts in part were compensated by the benefits that resulted from their reports," Mahoney said. "So provisions were put in place to put limits on that, and the JOBS Act rolled back some of those protections."

Most of the emerging growth companies that filed IPOs have not taken advantage of this liberty, and instead have voluntarily restricted research publication, the Latham & Watkins report said.

Changing audits

The JOBS Act also allows emerging growth companies to hold off for a period of years on the requirement that outside auditors review the company's internal financial controls, which are the procedures the company has in place to prevent fraud.

According to the Latham & Watkins report, nearly all the emerging growth companies that filed an IPO in the past year planned to delay submitting their financial controls to external audits. Some of those companies might not have been required to submit to the audits anyway. New companies have a two-year grace period, and the 2010 Dodd-Frank Act eliminated the requirement for companies with market capitalization of less than $75 million.

But the JOBS Act extended the exemption to companies as much as nine times larger, according to the Council of Institutional Investors, despite the fact that the SEC had concluded the benefits of those audits outweighed the costs.

"If you're a public company and you're accessing the public for funds, then you should have good internal controls in place . . . and one way is to have an independent party assess them," Mahoney said.

The audit requirement has remained controversial, particularly for smaller companies, said Tony Richmond, a partner with Latham & Watkins based in Menlo Park. The audits of internal financial controls are "expensive and invasive," he said.

"I think many people would debate the extent to which they are worth the cost, at least at smaller companies," Richmond said. "What matters is that the financial statements are accurate."

Higher ceilings as triggers

The JOBS Act also raised the limit on how much money companies could raise from the public before triggering full disclosures with the SEC.

Hambrecht testified before Congress on the issue of how much money a company could raise before triggering disclosures, known as the SEC's "Regulation A," arguing that the ceiling should be raised from $5 million to $30 million. He said the possibility of a quicker entry into public markets would encourage venture capitalists to invest in enterprises at earlier stages of development.

"Nobody used it in the last 10 or 15 years, because to list on an exchange, typically you have to have an offering of $15 to $20 million," Hambrecht said.

The JOBS Act raised that ceiling even further, saying companies could raise up to $50 million a year from the public while making only minimal disclosures. Consumer advocates opposed the change, saying it dramatically increased the amount of capital that companies could raise from the public without triggering the full reporting and other obligations that go with registration.

"The result could be a large and growing exemption that replaces, rather than supplements, the traditional registered public offering," the Council of Institutional Investors wrote in a report.

Impact uncertain

The JOBS Act passed through Congress quickly, pushed by AOL founder Steve Case and supported early on by President Barack Obama. Although Shapiro, the Council of Institutional Investors and other institutions like CalPERS were protesting, the law passed with minimal changes.

"There were some other fixes in the works that would have addressed many of the issues, but there wasn't sufficient support at the end to make those fixes," Mahoney said.

With all the changes that are taking place, supporters and critics of the JOBS Act both agree that there hasn't been an increase in IPOs or new jobs. That's in part due to delays at the SEC in drafting the rules to tell companies how to proceed with certain parts of the law.

"I think there's a lot of people watching the process now, a lot of people waiting to see the final rules from the SEC," Hambrecht said. "People are waiting and watching."

You can reach Staff Writer Cathy Bussewitz at 521-5276 or cathy.bussewitz@pressdemocrat.com. On Twitter @cbussewitz.

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