The Jumpstart Our Business Startups Act And Its Impact On Equity Research Analysts

1. OVERVIEW

   On Thursday April 5, 2012, President Obama signed the Jumpstart Our Business Startups Act (the "JOBS Act") into law, adopting measures designed to facilitate both public and private capital formation. The legislation is intended, in part, to encourage "emerging growth companies" (companies with less than $1 billion in revenue) ("EGCs") to go public. As enacted, the JOBS Act significantly liberalizes the regulations governing research analysts and their coverage of these companies. The purpose of this memorandum is to provide an overview of the impact of the JOBS Act on the regulatory scheme governing equity research analysts and the potential liability arising from the issuance of pre-deal research.

   In short, under the JOBS Act, the publication of pre-deal research regarding an offering by an EGC is now expressly permitted. However, although the JOBS Act breaks new ground by permitting pre-deal research on EGCs, the standards for imposing liability under Section 17 of the Securities Act and Section 10(b) of the Exchange Act with respect to pre-deal research reports are consistent with traditional standards governing post-deal research reports. As described in greater detail below, where research analysts publish good faith reports accompanied by meaningful cautionary language, it will be difficult for plaintiffs to successfully prosecute a claim based on the opinions contained in the research reports.

   1. Emerging Growth Companies

      The JOBS Act defines EGCs as having total annual gross revenues of less than $1 billion for their most recently completed fiscal year. An EGC will retain its status until the earlier of: (i) the last day of the fiscal year during which the company had total annual gross revenues of $1 billion or more, (ii) the last day of the fiscal year following the fifth anniversary of the date of the company's initial public offering, (iii) the date on which the EGC has issued more than $1 billion in non-convertible debt during the previous three-year period, or (iv) the date on which the company qualifies as a "large accelerated filer" (a company that has been reporting for at least a year, has an unaffiliated public float of at least $700 million, and has filed at least one annual report).

      If a company's IPO occurred on or before December 8, 2011, then it would not qualify as an EGC. A company can determine not to avail itself of the benefits conferred on EGCs under the JOBS Act.

   2. The Existing Regulatory Landscape

      In the post-Enron and WorldCom regulatory environment, research analysts have become subject to a strict set of rules intended to prevent perceived conflicts of interest from impairing research coverage. In 2002, Congress passed the Sarbanes-Oxley Act. SOX Section 501 directed the SEC, or (at the SEC's discretion) the NASD and NYSE, to promulgate rules designed to address potential conflicts of interest that may arise when research analysts recommend equity securities.

      Also in 2002, the NASD promulgated Rule 2711, which establishes research "blackout periods" — specified periods of time following an initial public offering, a secondary offering or the release or termination of a lock-up agreement, after which a manager or co-manager of the offering may not publish research with respect to the company making the offering. Rule 2711 also prohibits research analysts from participating in efforts to solicit investment banking business; prohibits research analysts from participating in road shows related to an investment banking transaction; and bars research analysts from communicating with a current or prospective customer in the presence of investment bankers or company management about an investment banking transaction.

      In 2003, the SEC adopted Regulation AC, which requires research analysts to certify that the opinions expressed in their reports accurately reflect their personal views, and to disclose whether their compensation is in any way tied to the positions adopted in their reports.

      Finally, in late 2003, following investigations by federal and state regulatory authorities, a number of prominent Wall Street banks entered into the Global Research Analyst Settlement (the "Research Settlement"). The terms of the Research Settlement, which are reflected in a federal court judgment for each of the settling banks, are similar to certain of the provisions of NASD Rule 2711 concerning conflicts. However, the Research Settlement differs from Rule 2711 in that it imposes stricter firewalls between the research and investment banking departments of a firm, and requires chaperoning of most communications between those departments by the firm's internal legal or compliance staff.

2. RESEARCH REPORTS ON EGCS UNDER THE JOBS ACT

   Section 105 of the JOBS Act significantly reduces, but does not eliminate, the constraints imposed upon research analysts with respect to research coverage of EGCs.

   1. Pre-Deal Research Reports

      The JOBS Act now permits research analysts to issue pre-deal research reports regarding EGCs.1 Section 2(a)(3) of the Securities Act generally prohibits the publication of pre-deal research reports because they would be considered an unauthorized offer for sale or offer to sell a...