On December 18, 2013, the Securities and Exchange Commission (the “SEC”) released proposed rules to amend Regulation A to provide for the offering of up to $50 million in securities. Regulation A is a quasi-public offering process intended to allow established companies that are not yet ready to go public an avenue for advertising and selling securities. Recently, however, the utility of Regulation A has become extremely limited due to its current $5 million cap. The SEC rulemaking amends Section 3(b) of the Securities Act of 1933 (the “Securities Act”) and was mandated by Congress in Title IV of the Jumpstart Our Business Startups Act (the “JOBS Act”).
Current Regulation A
Currently, Regulation A (or “Reg A”) permits non-public companies to publicly offer securities for proceeds of up to $5 million, subject to certain conditions. Reg A is available to US and Canadian entities that are not either (i) development stage companies with no business plan or (ii) investment companies registered under or required to be registered under the Investment Company Act of 1940. Reg A can be used by an issuer to conduct a primary offering of its securities or to conduct a secondary offer of securities for the benefit of selling stockholders, though only $1.5 million can be sold in a secondary offering. An issuer relying on Reg A must file an offering statement, or disclosure circular, with accompanying financial statements, but is not subject to any further company-related reporting requirements. In addition, issuers must comply with state securities laws, requiring the issuer and its legal team to satisfy an exemption from registration and file the attendant state disclosures.
Increasingly in the last decade, Reg A has fallen out of favor because (i) compliance with the reporting and state filing requirements has become increasingly expensive and (ii) Regulation D offerings, with the continued streamlining of federal and state filing exemptions, have become increasingly efficient. Essentially, the prospect of raising $5 million through Reg A no longer justifies the associated costs.
Proposed Amendment to Regulation A
The SEC’s proposed rules split Reg A into two tiers, with (i) Tier 1 maintaining Reg A largely in its current form with the $5 million offering cap; and (ii) Tier 2 permitting offerings of up to $50 million, including no more than $15 million in secondary sales by selling stockholders, with a corresponding set of heightened disclosure requirements. The following is not intended to be an exhaustive list of the changes to Reg A under these proposed rules, but rather an attempt to capture the areas of greatest impact.
Proposed rule changes that apply to both Tier 1 and Tier 2
- Additional “bad actor” limitations, disqualifying issuers that have not complied with SEC reporting requirements or that have been subject to SEC orders denying, suspending or revoking the registration status of a class of securities
- Asset-backed securities are no longer eligible for Reg A offerings
- Reg A offerings do not integrate with crowdfunding offerings
- Changes to the form offering statements as well as SEC opportunity to review and comment before declaring their effectiveness
New rules applying only to Tier 2
- Audited financial statements must be provided in an offering circular
- Additional ongoing reporting obligations requiring annual, semi-annual, current and special financial reports
- Investors may not purchase securities in an amount greater than 10% of the their net worth or annual income
- Securities offered pursuant to Tier 2 will not be subject to state securities laws
The proposed rules are an attempt by Congress to create new avenues for access to capital for companies that are not prepared for a traditional IPO. Over the last few decades, the cost of an IPO and operating as a reporting company have become prohibitively expensive for medium-size companies. In contrast, offerings under Regulation D, particularly Rule 506, have continued to be an attractive avenue for raising capital, despite the restricted nature of the securities offered, limitations on general solicitation (though these, too, have recently been relaxed under certain circumstances) and investor accreditation requirements.
The newly proposed Tier 2 of Reg A has the potential to fill the capital raising void left between going public and conducting completely private offerings. Tier 2 promises to allow companies to raise significant capital through solicited offers, all while being subject to a less burdensome reporting regime and without the burdens of registering their securities under Section 5 of the Securities Act. The increased secondary sales limit in Tier 2 also has the potential to provide significantly more liquidity for stockholders, especially when compared with the “restricted securities” offered pursuant to Regulation D offerings. Lastly, Tier 2’s preemption of state securities laws removes a significant barrier hindering the traditional use of Reg A.
The SEC is taking comments on the proposed rules until the middle of February, but is expected to finalize these rules in substantially the same form as proposed sometime in the spring or summer of 2014. Of all the JOBS Act related SEC rulemaking in the past few months relating to offerings of unregistered shares (final rules on Rule 506(c) in September and proposed rules on Regulation Crowdfunding in October), these proposed rules may have the most significant impact on capital raising markets. The opportunity to use general solicitation of securities, the potential for liquidity, the predictability of the reporting requirements and the $50 million offering cap have fueled optimism that Tier 2 of Regulation A may develop into a viable tool to fill the large capital fundraising vacuum that exists between limitations involved in Regulation D private offerings and the prohibitive costs of going public.