On March 25, 2015, the U.S. Securities and Exchange Commission (the “SEC”) adopted final rules amending Rules 251 through 263 (“Regulation A”) under the U.S. Securities Act of 1933, as amended (the “Securities Act”). The final rules go into effect on June 19, 2015 and updated and expanded the exemption from registration under existing Regulation A for certain U.S. and Canadian issuers. While this development is only applicable to North American issuers, we think it is of interest as most jurisdictions are looking for less burdensome ways for small and medium-sized enterprises to access capital.
Prior to the enactment of the Jumpstart Our Business Startups Act (the “JOBS Act”) in 2012, then-Section 3(b) of the Securities Act and Regulation A provided an exemption from Securities Act registration. The exemption applied to offerings of up to $5 million in any 12-month period, including no more than $1.5 million in secondary sales by selling security-holders, by U.S. and Canadian issuers that were not: (i) U.S. Securities Exchange Act of 1934, as amended (“Exchange Act”) reporting companies; (ii) investment companies, including business development companies; (iii) blank check companies (i.e., development stage companies that have no specific business plan or purpose or have indicated that their business plan is to engage in a merger or acquisition with an unidentified company or companies); (iv) issuers of fractional undivided interests in oil or gas rights or similar interest in other mineral rights; or (v) issuers disqualified by Regulation A’s “bad actor” provisions. Securities issued under Regulation A were not considered “covered securities” under Section 18(b) of the Securities Act and were therefore subject to state qualification and registration requirements. For that reason, and the $5 million/12-month cap limitation, Regulation A has not been a widely used exemption.
Section 401 of the JOBS Act added Section 3(b)(2) to the Securities Act, which directs the SEC to adopt rules exempting offerings of up to $50 million annually from the registration requirements of the Securities Act.
Tier 1 and Tier 2 Exemptions
SEC’s new rules, often referred to as “Regulation A+,” divides the exemption from registration into two tiers. An issuer of $20 million or less of securities may elect to proceed under either Tier 1 or Tier 2.
- Offering Parameters. Tier 1 offerings consist of securities offerings of up to $20 million in a 12-month period through sales to an unlimited number of accredited and non-accredited investors, with no limits on the amount that non-accredited investors may invest.
- Secondary Sales. Secondary sales by all selling security-holders are limited to no more than 30 percent of the aggregate offering price of the issuer's initial Regulation A+ offering and to 30 percent of any subsequent Regulation A+ offerings for the first year following the initial Regulation A+ offering. Secondary sales by security-holders that are affiliates of the issuer in any offering made after the first year following the issuer's initial offering are limited to $6 million in a 12-month period.
- Reporting Requirements. Generally, companies using the Tier 1 exemption will not have to provide audited financial statements or ongoing reports to the SEC.
- Blue Sky Laws. Under Tier 1, Regulation A+ does not provide for preemption of any state securities laws and therefore Tier 1 offerings will be required to comply with applicable state registration and review requirements. This requirement may significantly affect the use of Tier 1 offerings.
- Offering Parameters. Tier 2 offerings consist of securities offerings from up to $50 million in a 12-month period through sales to an unlimited number of accredited and non-accredited investors; however, non-accredited investors in Tier 2 offerings may only invest 10% of the greater of their annual income or net worth (for a natural person) or the greater of annual revenue or net assets at fiscal year-end (for a non-natural person) with these limitations not applying to a purchaser who qualifies as an accredited investor under Rule 501 of Regulation D or to the sale of securities that will be listed on a national securities exchange upon qualification.
- Secondary Sales. Sales by all selling security-holders are limited to no more than 30 percent of the aggregate offering price of the issuer's initial offering and to 30 percent of any subsequent offerings for the first year following the initial offering. Secondary sales by security-holders that are affiliates of the issuer in any offering made after the first year following the issuer's initial offering are limited to $15 million in a 12-month period.
- Reporting Requirements. Unlike a registration statement that has been declared effective by the SEC, the qualification of a Regulation A+ offering statement does not require an issuer to comply with the annual and quarterly reporting requirements of the Exchange Act but Tier 2 issuers are required to have their financial statements audited and must file some ongoing periodic reports. Regulation A+ qualified securities are, however, eligible to be listed on a national securities exchange pursuant to Section 12 of the Exchange Act. If a Regulation A+ issuer lists securities, it will become subject to the annual and quarterly reporting requirements of the Exchange Act, but would be treated as an emerging growth company for disclosure purposes. If the issuer is conducting a Tier 2 offering and plans to simultaneously list the securities on a national securities exchange, the financial statements must be audited in accordance with PCAOB auditing standards and by an auditor that is registered with the PCAOB.
- Blue Sky Laws. Regulation A+ provides for preemption of state securities laws under Tier 2.
The expanded exemptions provided by Regulation A+ are only available to companies organized and with their principal place of business in the United States or Canada. Regulation A+ is not available to: (i) companies subject to the ongoing reporting requirements of Section 13 or 15(d) of the Exchange Act; (ii) companies required to register with the SEC under the Investment Company Act of 1940 including business development companies (which invest in other businesses); (iii) blank check companies; (iv) issuers of fractional undivided interests in oil or gas rights, or similar interests in other mineral rights; (v) issuers that are required to, but that have not filed ongoing reports with the SEC during the two years preceding the filing of a current Regulation A offering statement (or for shorter periods as required by rule); (vi) issuers that are or have been subject to an order by the SEC denying, suspending or revoking the registration of a class of securities pursuant to Section 12(j) of the Exchange Act entered within five years prior to filing of an offering statement; and (vii) issuers subject to “bad actor” disqualification.
The SEC specifically declined to exclude all shell companies or issuers of penny stock. There will also be no restrictions on the size of a company that can use Regulation A+.
Regulation A+ maintains the same eligible securities as Regulation A (i.e., equity securities, debt securities and debt securities convertible or exchangeable into equity interests, including any guarantees of such securities), but clarifies that all securities convertible or exchangeable into equity interests are eligible under Regulation A+ while explicitly excluding asset-backed securities, as defined in Regulation AB.
Solicitation of Interest (Testing the Waters)
The new Regulation A+ permits issuers to “test the waters” (i.e., solicit indications of interest in a potential offering) with all potential investors and use solicitation materials both before and after the offering statement is filed (and before making actual sales). Testing the waters only allows the issuer to directly notify specific investors and obtain their indications of interest in a potential offering. The SEC has stated that this should enable issuers to determine potential market interest in their securities before incurring costs of preparing and filing an offering statement under Regulation A+.
For the Final Rules, please click here.
Massachusetts and Montana have moved to block Regulation A+ in consolidated court actions. These two states are asking that the new Regulation A+ be vacated because it is arbitrary, capricious and not in accordance with the Administrative Procedures Act, the Securities Act and other law.