On December 18, 2013, pursuant to Section 401 of the Jumpstart Our Business Startups Act, the Securities Exchange Commission unanimously approved new proposed rules creating an additional exemption from registration requirements for public offerings of up to $50 million in a 12-month period. The new rules, commonly referred to as Regulation A+, are designed to address the problems with current Regulation A, which one commissioner characterized as “low, slow, costly and burdensome – a toxic stew of impediments.” The comment period is open for 60 days.
- The Proposal - Overview
The proposed rules create a two-tiered framework for the new Regulation A, leaving the old Regulation A exemption essentially intact as Tier 1, and creating a Tier 2 exemption for offerings up to $50 million, including no more than $15 million on behalf of selling securityholders. Because of the higher threshold, Regulation A+ filings will also require additional reporting requirements, but unlike Regulation A offerings, they will not be subject to state blue sky laws. Companies can decide whether to proceed with an offering of up to $5 million under Tier 1 or Tier 2.
- Old Regulation A Summary
Regulation A offerings 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 of 1933 and, therefore, are not subject to the limitations on resale that apply to securities sold in private offerings. Current Regulation A exempts public offerings below a $5 million annual threshold, including no more than $1.5 million on behalf of selling securityholders, from registration, subjecting them instead to SEC qualification. Under this qualification process, the SEC staff reviews an offering circular, which on average takes approximately eight months, in much the same way as it would review a registration statement. However, qualification of a Regulation A offering statement does not trigger reporting obligations under the Securities Exchange Act of 1934.
Despite these apparent benefits, from 2009 through 2012, only 19 Regulation A offerings were qualified, while there were approximately 27,500 offerings of up to $5 million under Regulation D and 373 registered offerings of up to $5 million during the same period. The drop in the use of Regulation A has been attributed to several possible causes, including the relatively low threshold for offerings and the costs and burdens of complying with state Blue Sky laws.
- The Old and the New of Regulation A
For the most part, the framework of Regulation A as it currently exists will be preserved under the proposed rules. This means that existing provisions involving issuer eligibility, offering circulars, “testing the waters,” and bad actor disqualifications will remain. Additionally, the SEC will still review and qualify offering statements, and Tier 1 offerings will continue to require state blue sky approvals.
The proposed rules update Regulation A (Tier 1) in several important ways. First, the rules allow companies to submit draft offering statements for non-public SEC review before filing. Second, companies will be allowed to use so-called “testing the waters” solicitation materials both before and, as proposed, after they file the offering statement. Finally, the process will be modernized by requiring electronic filing of offering materials. Each of these new components of Regulation A will also apply to Tier 2 offerings.
Regulation A currently requires issuers to file updates reporting sales and termination of sales with the SEC every six months after qualification of the offering, until 30 calendar days after the termination or completion of the offering or the final sale under that offering, on Form 2-A. Under the proposed rules, Tier 1 issuers will be required to file a Form 1-Z exit report to provide information about sales and to update certain issuer information only after the termination or completion of the offering.
- The New Tier 2: Additional Requirements
Under the proposed rules, Tier 2 offerings will be permitted for up to $50 million in unrestricted securities. The proposed rules also eliminate the current prohibition on affiliate resales which prohibit such resales unless the issuer has had net income from continuing operations in at least one of its last two fiscal years. Because the higher threshold and the non-restricted nature of the securities creates a greater opportunity for fraud, the proposal includes three new investor protection mechanisms.
First, a Tier 2 issuer will be required to include audited financial statements in their offering circulars. Second, potential investors will be limited to investing in an amount of securities up to ten percent of the greater of the investor’s annual income or net worth. This part of the proposal will require issuers to make investors aware of the investment limits, but issuers can rely on investor representations of compliance. Third, companies issuing securities under Tier 2 will be required to electronically file annual and semiannual ongoing reports and current event updates that will be similar to those required for public company reporting.
The proposed rules allow for a termination or suspension of a Tier 2 issuer’s ongoing reporting obligations if the number of record holders of the class of securities to which the Regulation A offering statement relates falls below 300 persons or suspension upon registration of a class of securities under Section 12 of the Exchange Act or registration of an offering of securities under the Securities Act. Issuers conducting Tier 2 offering may exit the Regulation A reporting regime at any time by filing a Form 1-Z exit report after completing reporting for the fiscal year in which the offering statement was qualified, so long as the securities of each class to which the offering statement relates are held of record by fewer than 300 persons and offers or sales made in reliance on a qualified Regulation A offering statement are not ongoing. Finally, Tier 2 companies will be required to include in their first annual report after termination or completion of an offering, or in their Form 1-Z exit report, information about sales in the terminated or completed offering and update certain issuer information.
- Regulation A Eligibility
The exemptions under Regulation A will be available to companies organized in and with their principal place of business in the United States or Canada. It will not be available to companies:
- that are already SEC reporting companies;
- that are investment companies;
- without a specific business plan or purpose, or whose stated business plan or purpose is to engage in merger or acquisition with an unidentified company (in other words, blank check companies and SPACs);
- seeking to offer and sell asset-backed securities or fractional undivided interests in oil, gas, or other mineral rights;
- that have failed to file the ongoing reports required by the proposed rules during the preceding two years;
- that are or have been subject to an SEC order revoking the company’s registration under the Exchange Act in the previous five years; and
- that are disqualified under “bad actor” disqualification rules1.
- State Blue Sky Laws and Regulation A
The major roadblock for companies interested in the Regulation A exemption has been the required compliance with state blue sky laws. The proposed rules would preempt state regulation for Tier 2 offerings. Tier 1 offerings would still be subject to state registration and qualification requirements.
The SEC is also looking into alternatives to preempting state blue sky laws. The most notable alternative was suggested by the North American Securities Administrators Association (“NASAA”). NASAA proposed a coordinated review program in which filings would be made in one place and distributed electronically to the states, and a lead examiner would be appointed to serve as the primary point of contact for all state reviews. The program is designed to make state blue sky law compliance easier, less costly, and less time consuming, and could make Tier 1 offerings more popular. The SEC has requested comments on its proposal to preempt state law for Tier 2 offerings.
The proposed rules aim to strike a balance between enhancing access to capital for small business while ensuring important investor protections are in place. If the proposed rules are adopted unchanged, questions will remain as to whether this will increase the use of Regulation A in light of the remaining problematic Regulation A provisions relating to state securities law compliance for purchasers in Tier 1 offerings and the ongoing reporting regime for Tier 2 offerings.