Emerging Growth Companies: You Have Been Warned

In order to try to boost the number of companies going public, the recently enacted JOBS act provides for certain procedural and reporting advantages for "Emerging Growth Companies," which are defined in the Act as companies within five years of their IPO and with revenues less than $1 billion. A number of companies planning IPOs are already taking advantage of the new provisions. But at the same time, those same companies are warning investors that their status as Emerging Growth Companies may itself be a risk of which investors should be aware.

As discussed at greater length here, the JOBS Act contains a number of IPO "on ramp" procedures designed to ease the process and burdens of the "going public process" for Emerging Growth Companies (EGCs). The "on ramp" advantages are intended to ease the going public process. For example, EGCs can elect to submit their IPO registration statement for SEC review on a confidential, nonpublic basis, although the registration statement must be publicly filed at least 21 days before the IPO roadshow.

The Act also provides for reduced disclosure and reporting burdens for EGCs for as long as five years after an IPO - as long as the company continues to meet the definitional requirements. For example, an EGC will not be subject to Section 404(b) of the Sarbanes Oxley Act requiring an outside auditor's attestation report on the company's internal controls. Similarly, an EGC would be exempt from the requirements under the Dodd-Frank Act to hold shareholder advisory votes on executive compensation and on golden parachutes.

Since the enactment of these provisions, a number of commentators have noted that while these JOBS Act provisions may serve the laudable goal of easing the IPO process, these provision also introduce risks for investors. Nor are these remarks just coming from sideline commentators. Indeed many of the most specific warnings are coming from the companies themselves.

In her May 15, 2012 CFO.com article entitled "A New Risk Factor: The JOBS Act" (here), Sarah Johnson reports that for many of the companies taking advantage of the JOBS Act IPO on-ramp provisions, the fact that the companies are relying in the JOBS Act "is itself a risk factor." Her article notes that in recent days, at least 13 companies "have warned investors in their prospectuses filed with the Securities and Exchange Commission that the JOBS Act's breaks on SEC rules could actually be a turnoff." By way of example, she quotes Cimarron Software's recently filed S-1, in which the company states that "we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors."

In a May 14, 2012 post on his CorporateCounsel.net blog entitled "JOBS Act: EGC Status as a Risk Factor" (here), Broc Romanek takes a detailed look at one of the recent IPO filings, the S-1 that LegalZoom filed in connection with its proposed initial public offering. He notes that right on the cover page of the filing, the company warns that "we are an 'emerging growth company' under the federal securities laws, and will be subject to reduced public company reporting requirements." Among other things, the company notes in its filing that it will be taking advantage of the JOBS Act reporting exemptions as long as the company qualifies to do so, adding that "we cannot predict if investors will find our common stock less attractive because we rely on these exemptions." The company further notes that "if some investors find our common stock less attractive as a result, there may be less active trading for our common stock and our stock price may be more volatile."

These disclosures not only have the virtue of warning investors that the companies' status as emerging growth companies may make their stock less attractive. The warnings may, according to one commentator quoted in the CFO.com article, provide "cheap insurance" that could help the company if it later runs into trouble. As the commentator noted, if the emerging growth company is later sued, the company can say "We warned you that there weren't auditors looking independently at this."

These emerging growth companies advisory statements may indeed represent good precautionary disclosure. But it is fair to ask whether the cautionary statements go quite far enough. It is one thing to say that the company's reduced reporting requirements may make the company's stock less attractive. What the companies don't seem to be saying, at least not directly, is that the reduced reporting requirements could make their reported financial results less reliable. As a plaintiff's lawyer quoted in the CFO.com article notes, the emerging growth companies' precautionary disclosure may forewarn that their stock may not trade as high or as frequently as it might otherwise, but they are not saying that as a result of the reduced reporting requirements you "may get a nasty surprise" when the company no longer qualifies for the exemptions.

All of which says that while companies are now just trying to adjust to the newly enacted IPO process and reporting provisions, we will have to wait to see how all of this plays out in the securities litigation arena. For now, the companies taking advantage of the new rules do seem to be recognizing that while the new processes do present certain advantages, they do involve possibly increased risks as well.

The one thing that is certain is that because of the JOBS Act's broad definition of "emerging growth companies," a very larger percentage of companies going public will be eligible to take advantage of the new rules. Indeed, according to one report, of the 113 companies that went public in 2011, only 15 (or 13%) would not have qualified for the JOBS Act's IPO on-ramp procedures.

In other words, the disclosure issues discussed above, and the related liability concerns, could be an issue for a significant number of companies. Indeed, if the JOBS Act achieves its fundamental goals, these considerations could be a concern for an increasingly larger number of companies.  

Delaware Seminar on Corporate and LLC Law: On Tuesday May 22, 2012, I will be participating in a panel the Delaware State Bar Association Corporate Law Section's annual "Recent Developments in Delaware Corporate and Alternative Entity Law" seminar. The seminar will be co-chaired by Francis Pileggi of the   Eckert Seamans firm and also the author of the Delaware Corporate and Commercial Litigation Blog, and his law partner Kevin F. Brady and R. Montgomery Donaldson of the Montgomery McCracken Walker & Rhoads firm. Pileggi's recent post on his blog about the event can be found here

The panel I will be participating in is entitled "Corporate Law Updates Via Blogs," and my fellow panelists will include Doug Batey of the Stoel Rives law firm and the author of theLLC Law Monitor blog; University of Illinois Law Professor Christine Hurt, of  The Conglomerate blog; and Boston College Law Professor Brian Quinn, of  The M&A Law Prof blog. Batey's recent blog post about our upcoming panel can be found here.

Our panel should afford the panelists an opportunity to reflect and comment upon the blogging process and experience. Along those lines, in an interesting May 18, 2012 post entitled "What Then is Blogging" (here),   Dick Cassin of the indispensable The FCPA Blog sets out some of his views and thoughts about blogs and blogging. (Thanks to Cassin for quoting one of my prior blog posts).

Looking for Life in All the Wrong Places?: A May 18, 2012 Wall Street Journal article entitled "Searching a Billion Planets for Life" (here) describes scientists' efforts to write a recipe for "perfect planet"-that is, a place that is "not too cold, not too hot, not too toxic and chemically suitable for life as we know it" as a way to aid in the search for "potentially habitable alien worlds."

The challenge for the scientists is that the process of trying to come up with the recipe leaves them "grappling with the nature of life itself." Perhaps the most fundamental problem is that the analysis depends on presumptions "based on life as we know it" - that is, life on Earth.

The potential limitations of this Earth-biased analysis are revealed most dramatically just by looking at what has happened in recent years to our knowledge about life on Earth. Through a series of interesting discoveries, our awareness of the range of conditions in which life on Earth can thrive has expanded far beyond what was previously thought possible.

An interesting article in the May/June 2012 issue of The Economist's Intelligent Life magazine entitled "Some Like it Very Hot" (here) takes a look at the scientific advances that have revealed the teeming existence of "hyper-resilient microbes," organisms that can survive "levels of heat, cold, pressure, radiation and salt or acid concentrations that previously would have been thought fatal to all living things." These previously unknown organisms, now known as extremophiles, have been found deep beneath the sea floor; in the depths of Mexican caverns; in the core of nuclear reactors; in hydrothermal vents on the sea bed; and are constantly being discovered in ever more unlikely and seemingly inhospitable environments.

Among many other things, these discoveries show that "life can sustain itself in many more environments than was previously thought possible." This realization not only has enormous implications for the study of life on Earth; it has also given new life to the "idea that life is dispersed throughout the universe and is disseminated on meteorites or asteroids." Or to put it another way, "the bandwidth of survivable environments - and therefore, forms of life, has broadened enormously."

The implication for scientists hoping to increase their chances of finding life beyond Earth by narrowing their search only to the "perfect planets," may be that by narrowing their search, they may actually diminish their chances of finding outside our planet. But on the positive side, the likelihood that life outside of earth might exist and someday might actually be discovered both seem to have increased significantly.

Personally, I find all of this quite fascinating and even exciting. The possibility that life in the universe is not rare but could actually be quite common and even widely dispersed represents an entirely new way of looking at things. Instead of the Earth as a lone life-bearing vessel whirling through an empty, heartless void, it could instead be one of countless places where life is thriving. Of course, the possibility that life elsewhere might be merely microbial might not satisfy the most febrile science fiction fantasies. It would of course be much more exciting if there seemed to be a greater likelihood of discovery of intelligent life beyond earth. But it may be too much to hope for, to expect to find intelligent life beyond earth. After all, think of how hard it is to find intelligent life on our own planet.  

In Case You Missed It: For the second weekend in a row, a major European soccer title has been determined in a last-minute come from behind victory. Last Sunday, it was Manchester City scoring two goals in stoppage time in their final game of the season to capture the English Premier League crown. This Saturday, Chelsea, playing against Bayern Munich on the German team's home field, won the UEFA Champions League club team title in almost equally dramatic fashion, winning in a penalty kick shootout.

Bayern Munich had many chances to put the game away, and seemingly had the game won when they finally scored on a Thomas Müeller header in the 82nd minute. But then with just two minutes left in regulation, on Chelsea's first corner kick of the game, Didier Drogba scored on a header to tie the game. As regulation time expired the game went into extra time (a thirty minute overtime period).

Drogba's fine goal to tie the game looked like it might have been naught when early in extra time he committed a foul by tripping Franck Ribèry in the penalty area. It seemed like another golden opportunity for Bayern Munich to put the game away, but Chelsea's goalie, Petr ČechArjen Robben's penalty kick. The 30-minute period ended with the teams still tied, setting up a penalty kick shootout. , stopped

Bayern Munich once again appeared to have the advantage as its goalie, Manuel Neuer, stopped the first Chelsea penalty kick from Juan Mata. After each team had attempted three penalty kicks, Bayern had made all three of its attempts, while Chelsea had only made two. Bayern substitute, Ivica Olic  then missed his team's fourth shot while Ashley Cole made the next shot for Chelsea, bringing the two teams even. On Bayern Munich's fifth and final shot, Bastian Schweinsteiger , who looked as if taking the penalty kick was about the last thing in the world he wanted to do, hit the post. Drogba, looking calm and confident, smashed his kick into the corner of the net, securing Chelsea's improbable victory. The game-winner might be the 34-yearold Drogba's last act for Chelsea, as his contract with the team expires this summer.

It was a great game, although the Bayern Munich fans are not the only ones unhappy about the outcome. Tottenham Hotspurs, who finished fourth in the English Premier League and therefore otherwise qualified for the UEFA Champtions League competition, were dispossessed of the spot by Chelsea's win. Chelsea, which didn't otherwise qualify for the Champions league (since they finished sixth in the Premier League), secured an automatic spot in next year's Champions League competition with their win on Saturday. Since only four teams from each participating country can compete, that meant that Chelsea's win forced Tottenham out of its spot.

With all of this great end of season soccer just completed, it is even more exciting to look forward to the Euro 2012 national team championship competition, which kicks off on June 8, 2012 in Poland and Ukraine. 

Read other items of interest from the world of directors & officers liability, with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.

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