June 19 will be the effective date for amendments to Regulation A under the Securities Act of 1933 recently adopted by the SEC. The amendments implement a mandate under the Jumpstart Our Business Startups Act (JOBS Act) that directed the SEC to adopt rules exempting offerings of up to $50 million of securities annually from Securities Act registration. The new offering regime, christened “Regulation A+” by some, represents an attempt by Congress to revive a moribund exemption by overhauling the existing rules to increase access to capital for smaller companies. Among other benefits, the amended regulation is expected to open public markets for offerings of up to $50 million at reduced costs.
The prior rules permitted unregistered public offerings of up to $5 million of securities in a 12-month period under the small offering exemption from registration provided by Securities Act Section 3(b). The new rules update the exemption under Section 3(b)(1) (as Section 3(b) has been redesignated) and new Section 3(b)(2) added by the JOBS Act by authorizing two “tiers” of offerings. “Tier 1” consists of offerings of up to $20 million in a 12-month period, while “Tier 2” consists of offerings of up to $50 million in a 12-month period. In a significant departure from the prior Regulation A exemptive scheme, the new rules preempt state “blue sky” registration and qualification requirements for Tier 2 offerings.
The amendments to Regulation A and related rules and forms are described in the SEC’s 453-page adopting release (No. 33-9741), which was issued on March 25.
Regulation A provides a simplified capital-raising process for smaller companies. The pre-amended version permitted an issuer to make unregistered public offerings of up to $5 million of securities in any 12-month period, including no more than $1.5 million of securities offered by the issuer’s securityholders. The prior exemption required the issuer to file in paper form with the SEC an offering statement on Form 1-A containing an offering circular that resembled an abbreviated version of the prospectus used in registered offerings. An offering statement filed under Regulation A is subject to SEC staff review and must be “qualified” by the SEC, but qualification does not trigger Exchange Act reporting obligations for the issuer.
Offerings under Regulation A are public offerings, with no prohibition on general solicitation and general advertising. Securities sold under Regulation A are not “restricted securities” under the Securities Act, and as a result are not subject to the resale limitations that apply to securities sold in small offerings under Rule 505 of Regulation D or private offerings under Securities Act Section 4(a)(2) and Rules 506(b) and 506(c) of Regulation D.
Issuers in recent years have rarely utilized Regulation A. A report to Congress by the U.S. Government Accountability Office (GAO) attributed the reluctance of issuers to use the exemption to the requirement to file an offering statement with the SEC, the need to comply with state “blue sky” laws, and the overall cost of Regulation A compared to offering alternatives.
Although the JOBS Act imposed a number of specific requirements for an enhanced version of Regulation A, it also afforded the SEC discretion to adopt additional terms and conditions. Some of the new requirements, such as those relating to issuer eligibility and filing and qualification of an offering statement, apply to both Tier 1 and Tier 2 offerings. Those requirements generally are based on provisions of the prior exemption, but in some cases have been updated by the SEC in light of current practice in registered offerings. Other provisions contained in the new rules, such as the requirement to provide audited financial statements (which is mandated by the JOBS Act) and the requirement to undertake ongoing reporting (which is permitted, but not required, by the JOBS Act), apply only to Tier 2 offerings.
In its rulemaking, the SEC amended Rules 251 through 263 of Regulation A, revised Form 1-A and adopted four new forms.
Scope and basic requirements
Ineligible companies. Under the new rules, the exemption will continue to be available to companies organized and having their principal place of business in the United States or Canada. As is the case under prior Regulation A, the following companies will not be able to rely on the exemption:
- Public companies subject to the ongoing reporting requirements of the Exchange Act
- Companies registered or required to be registered under the Investment Company Act of 1940 (including business development companies)
- “Blank check” development stage companies that (1) have no specific business plan or purpose or (2) have indicated that their business plan is to engage in a merger or acquisition with an unidentified company or companies
- Issuers of fractional undivided interests in oil or gas rights, or similar interests in other mineral rights
The SEC has added new categories of ineligible companies:
- Companies that have failed to file with the SEC the ongoing reports required by the new rules during the two years immediately before their filing of a new Regulation A offering statement
- Companies that are or have been subject to an order by the SEC denying, suspending or revoking the registration of a class of securities under Exchange Act Section 12(j) (for failure to comply with any Exchange Act provisions, rules and regulations) that was entered within five years before the filing of the Regulation A offering statement
As discussed below, the new rules also align the existing Regulation A “bad actor” rules with the parallel disqualifications set forth in Rule 506(d) of Regulation D for private offerings conducted in reliance on Rule 506.
Eligible securities. The exemption will be available for offerings of equity securities, debt securities and debt securities convertible into or exchangeable for equity interests, including guarantees of these securities. The final rules thus clarify that warrants and convertible equity securities are eligible for the exemption. The rules exclude asset-backed securities from the list of eligible securities.
Offering limits. Regulation A is now divided into two tiers:
- Tier 1 encompasses offerings of up to $20 million of securities in a 12-month period, including no more than $6 million on behalf of selling securityholders that are affiliates of the issuer. The $20 million offering limitation is a significant increase from the $5 million Tier 1 offering limitation originally proposed by the SEC.
- Tier 2 extends to offerings of up to $50 million of securities in a 12-month period, including no more than $15 million on behalf of selling securityholders that are affiliates of the issuer. As discussed below, Tier 2 offerings will be subject to investment limitations, enhanced disclosure requirements and ongoing reporting obligations.
A company may elect to proceed under Tier 1 or Tier 2 for offerings of less than $20 million.
Sales by selling securityholders in an issuer’s initial Regulation A offering, as well as in any subsequently qualified Regulation A offering within the first 12-month period following the date of qualification of the initial offering, are limited to a maximum of 30% of the total offering price.
Investment limitations. For Tier 1 offerings, the new rules do not restrict the amount of offered securities that may be purchased by any investor. For Tier 2 offerings, the SEC has limited the amount of securities that a non-accredited investor may purchase to (1) no more than 10% of the greater of annual income or net worth, for natural persons, or (2) no more than 10% of the greater of annual revenue or net assets, for entities. The investment limitation will not apply to securities that will be listed on a national securities exchange upon qualification of the offering.
The accreditation calculations for natural persons must be made in accordance with the methods used to determine the accredited investor status of such persons under Rule 501 of Regulation D. An issuer will be permitted to rely on an investor’s representation of compliance with the investment limitation unless the issuer has actual knowledge that the representation is false.
Qualification, communications and offering process
The amendments modernize the qualification, communications and offering process provisions under Regulation A in part to reflect similar provisions of the Securities Act registration process, including by requiring electronic filing of offering materials with the SEC via EDGAR.
Qualification. The new rules alter the qualification process under the prior Regulation A to ensure that the SEC staff has a chance to review and comment on the offering statement before it is qualified. Under the prior rules, an offering statement that did not include a delaying notation on the cover of the form when it was filed would have been qualified without SEC action on the 20th calendar day after filing. The new rules eliminate this process and require every qualification to occur by SEC order.
Form and content of offering statement. The disclosure requirements under the new rules largely follow the existing offering statement requirements and organization of Form 1-A, with some modifications. The form previously required (and will continue to require) the inclusion of financial statements and descriptions of the issuer’s business operations, financial condition and intended use of investor funds.
Part I. Part I of Form 1-A requires basic information regarding the issuer, its eligibility, the offering details, the jurisdictions where the securities will be offered, and recent sales of unregistered securities. The information contained in Part I will be publicly available on EDGAR as an online data cover sheet but not otherwise required to be distributed to investors.
Part II. Part II of the prior Form 1-A provided companies with three options for the narrative disclosure presented in the offering statement for distribution to investors: Model A; Model B; and Part I of Form S-1 under the Securities Act. The SEC has now eliminated the Model A disclosure option, which permitted presentation of information in a question-and-answer format.
The SEC has retained the option of Model B disclosure, which will be presented in an “offering circular,” and updated this format to prescribe disclosure more akin to the disclosure required of smaller reporting companies in a prospectus for a registered offering. The changes in some cases require additional information, such as more detailed disclosure in the management’s discussion and analysis (MD&A) section of the offering circular, but in other cases reduce the amount of required disclosure, such as by requiring a description of the company’s business for a period of three years, rather than the five years previously required. In a change from the SEC’s rule proposal, the offering circular for a Tier 1 offering will require only group-level executive compensation disclosure for the most recent fiscal year for the three highest paid executive officers or directors, while a Tier 2 offering circular will require individual disclosure of the three highest paid executive officers or directors.
The SEC will continue to permit issuers to forgo the Model B disclosures and deliver investors an offering circular containing the alternative narrative disclosures required in Part I of Form S-1.
The new rules maintain the existing financial statement requirements of Part F/S of Form 1-A for Tier 1 offerings, which do not require financial statements to be audited unless the company already has obtained an audit of its financial statements for other purposes. In the case of Tier 2 offerings, however, the new rules require companies to include audited financial statements in accordance with the financial statement requirements of Article 8 of Regulation S-X and generally as if the issuer were a “smaller reporting company” under SEC rules.
Confidential submission. Under either Tier 1 or Tier 2, companies whose securities have not previously been sold pursuant to a qualified offering statement under Regulation A or an effective Securities Act registration statement may submit draft offering statements for non-public SEC staff review before filing, as in the case of an IPO of an “emerging growth company.” The initial non-public submission, all non-public amendments to that submission and all correspondence with the staff regarding the submission would have to be publicly filed as exhibits to the offering statement not less than 21 calendar days before the offering statement is qualified. The timing requirements for filing would not turn on whether or when the issuer plans to conduct a road show, which governs the first public filing date for an emerging growth company’s IPO registration statement.
Testing the waters. The new rules liberalize the prior rules governing “testing the waters,” which is the solicitation process followed by an issuer to obtain indications of interest from prospective investors. The prior rules permitted an issuer to test the waters before it filed an offering statement, so long as the issuer submitted all solicitation materials to the SEC no later than the time the materials were first used. Under the prior rules, issuers had to cease using testing-the-waters solicitation materials after the initial filing of the offering statement with the SEC, and then were prohibited from making sales under Regulation A until 20 calendar days after the last publication or delivery of the solicitation materials.
Issuers now will be permitted to use solicitation materials to test the waters both before and after the offering statement is publicly filed, so long as they comply with rules on filing and disclaimers. Materials used to test the waters after public filing of an offering statement, however, will be required to include a preliminary offering circular or contain a notice informing potential investors where and how they can obtain the most current preliminary offering circular. The issuer will have to submit or file the solicitation materials as exhibits when the offering statement is either submitted for non-public review or publicly filed, but will no longer be required to submit the materials at or before the time of first use. Unlike the rules governing registered offerings by emerging growth companies, the new rules will not limit testing-the-waters solicitations to communications with qualified institutional buyers (QIBs) and institutional accredited investors.
Delivery of disclosure documents. Under the new rules, the preliminary offering circular must be delivered at least 48 hours before any sale unless the issuer is subject to, and current in, its Tier 2 ongoing reporting obligation. Where the issuer is subject to, and current in, a Tier 2 ongoing reporting obligation, the issuer and any offering intermediaries will only be required to comply with the general delivery requirements for offers. In all instances, a final offering circular must be delivered within two business days after a sale. The SEC has adopted the “access equals delivery” approach followed in registered offerings, so that the delivery requirements for the final offering circular will be satisfied when the document is filed via EDGAR. The new rules require issuers and intermediaries, not later than two business days after a sale, to provide purchasers with a notice containing a link to the final offering circular on EDGAR and contact information for a purchaser to request a final offering circular.
Ongoing SEC reporting
Before the amendments, Regulation A required companies to file a Form 2-A with the SEC every six months after qualification of the offering to report sales and to make a final filing within 30 calendar days after the termination or completion of the offering. Form 2-A has now been rescinded, but the new rules continue to require all companies to file with the SEC the information generally disclosed in that form, in an EDGAR filing on a new Form 1-Z or (for Tier 2 companies only) on a new Form 1-K that would be made only after the company terminates or completes the offering.
No other ongoing SEC reporting will be required of Tier 1 issuers. Companies conducting Tier 2 offerings, however, will be subject to a new, continuing reporting regime. Tier 2 companies will be required to file annual reports via EDGAR on a new Form 1-K, which will include, among other information, disclosures about the company, the offering, the company’s business, related-person transactions, beneficial ownership of securities and executive compensation, as well as two years of audited financial statements and MD&A. Tier 2 companies also will have to file semi-annual updates on a new Form 1-SA (an abbreviated version of Form 10-Q), current event reports on a new Form 1-U (an abbreviated version of Form 8-K), and notices to the SEC of the suspension of their ongoing reporting obligations on a new Form 1-Z. Companies conducting a Tier 2 offering also may be required to provide investors with special financial reports between the time the financial statements are included in the Form 1-A and the date of the first semi-annual report after qualification of the offering statement.
Reports issued under the Tier 2 reporting regime would satisfy the obligation of broker-dealers under Exchange Act Rule 15c2-11 to review specified information about the issuer and its security before publishing a quotation for the security. The SEC has determined that the information in these required reports will not satisfy the current public information requirement of Securities Act Rule 144 because they are semi-annual and not quarterly filings. A Tier 2 issuer that is current in its reporting under Regulation A, however, could voluntarily provide quarterly financial information on a Form 1-U and satisfy the current public information requirement under Rule 144 for the entire year.
A Tier 2 company will be able to exit the reporting regime after it files all required reports for the fiscal year in which its offering statement was qualified, so long as:
- Securities of each class to which the offering statement related are held of record by fewer than 300 persons (or fewer than 1,200 persons if the issuer is a bank or a bank holding company)
- Offers or sales in reliance on Regulation A are not ongoing
Exchange Act registration
The new rules permit a Tier 2 issuer to use a short-form process to register a class of Regulation A securities under the Exchange Act, such as in connection with the listing of the securities on a national securities exchange. The Tier 2 issuer may register its securities by filing a short-form Form 8-A in conjunction with the qualification of a Form 1-A. Only issuers that follow the Part I of Form S-1 disclosure model in the offering will be permitted to use Form 8-A. Previously, an issuer that completed a Regulation A offering and sought to list a class of securities on a national securities exchange would have had to prepare and file a separate long-form registration statement on Form 10 under the Exchange Act.
Bad actor disqualification
The SEC amended the existing “bad actor” provisions of Regulation A to bring them into line with those adopted under Rule 506 of Regulation D and described in the SEC Update we issued on July 26, 2013. The bad actor rules generally disqualify securities offerings from reliance on Regulation A (or in some instances require the issuer to make disclosures) if the issuer or other persons (such as underwriters, placement agents, or directors, officers or significant shareholders of the issuer) have been convicted of, or are subject to court or administrative sanctions for, securities fraud or other violations of specified laws. An issuer would not lose the benefit of the Regulation A exemption if it could show that it did not know, and in the exercise of reasonable care could not have known, of the existence of a disqualification.
Preemption of state securities laws
In its adopting release, the SEC cited the GAO’s findings that the lack of preemption of state “blue sky” laws under prior Regulation A might have contributed to the lack of use of the exemption. The new rules provide that state securities-law requirements will be preempted for Tier 2 offerings. The SEC believes that investors should be adequately protected by the substantial investor protections applicable to those offerings without the involvement of state securities authorities. The preemption was effected by adopting a definition of “qualified purchaser” for purposes of Securities Act Section 18(b)(3) that includes any person to whom securities are offered or sold in a Tier 2 offering. States will continue to have authority to require filing of offering materials and enforce anti-fraud provisions in connection with a Tier 2 offering.
Tier 1 offerings will remain subject to state securities-law requirements.
The amendments to Regulation A are intended to revive the exemption to provide smaller businesses seeking capital with a practical alternative to the registered offering process and to securities-based crowdfunding transactions and Regulation D offerings. Issuers relying on the enhanced Regulation A would not have to comply with such proposed public crowdfunding limitations as the low maximum investment threshold, the use of a broker-dealer or funding portal intermediary in the offering process, and restrictions on transfers of issued shares. Issuers under the amended regulation also would not have to contend with accredited investor qualification requirements and restrictions on transfers of issued shares that apply to private offerings conducted in reliance on Rule 506(b) or Rule 506(c) of Regulation D. A liberalized Regulation A, however, will not eliminate all significant regulatory burdens on smaller issuers, which will include ongoing SEC reporting requirements for Tier 2 issuers and the application of state “blue sky” requirements for Tier 1 offerings. Companies will need to evaluate with their counsel and financial advisers the advantages and disadvantages of using the amended regulation compared to capital-raising alternatives.