The SEC Expands Its Registration Exemption for Smaller Companies
As required by Title IV of the Jumpstart Our Business Startups (“JOBS”) Act, the Securities and Exchange Commission (“SEC”) has adopted new rules that update and expand its Regulation A small issuer registration exemption. In this regard, the JOBS Act directed the SEC to adopt rules exempting offerings of up to $50 million annually from the registration requirements of the Securities Act of 1933, as amended. According to the SEC, the new rules (now known as Regulation A+) are intended to facilitate smaller companies’ access to capital and to provide investors with more investment choices. Regulation A+ is expected to go into effect by early June 2015.
Regulation A+ Fundamentals
The final rules preserve, with some modifications, existing provisions regarding issuer eligibility, offering statement contents, testing the waters, and “bad actor” disqualification. Regulation A+ will now require that offering documents be filed on the Electronic Data Gathering, Analysis, and Retrieval system (EDGAR), but will also allow a confidential submission and review of the initial filing, similar to the rules enacted by the SEC for public offerings by “emerging growth companies” under the JOBS Act. In addition to revising Form 1-A, the SEC also adopted four new forms that will be relevant for certain issuers offering securities under Regulation A+: Form 1-K (annual report), Form 1-SA (semiannual report), Form 1-U (current report), and Form 1-Z (exit report).
Offering Limitations and Requirements. Regulation A+ provides a two-tiered registration exemption for U.S. and Canadian companies that are not SEC reporting companies to raise up to $50 million in a 12-month period. Regulation A only provided small issuers with an exemption for up to $5 million in any 12-month period.
- Tier 1 will permit offerings of securities up to $20 million in a 12-month period, with not more than $6 million offered by selling security-holders that are affiliates of the issuer.
- Tier 2 will permit offerings of securities up to $50 million in a 12-month period, with not more than $15 million offered by affiliated selling security-holders, subject to more disclosure requirements than Tier 1 offerings, but generally exempt from state blue sky regulations.
Issuers may choose the Tier that best suits their needs. The new rules also impose an aggregate limit on the amount of securities that shareholders (including non-affiliates) can sell at the time of an issuer’s first Regulation A offering (or within the following 12 months), to no more than 30 percent of the particular offering. After this 12-month period, however, secondary sales by non-affiliates are not limited except by the particular Tier’s maximum offering amount.
For quick reference, click here to see a chart comparing the various elements of Tier 1 and Tier 2 offerings.
Ineligible Issuers. The Regulation A+ exemption is not available for some issuers, including shell companies, certain investment companies, and companies that are already SEC-reporting issuers, issuers of asset-backed securities and oil and gas or mineral interests, and issuers disqualified under the “bad actor” rules or who have failed to comply with certain Regulation A requirements in the past. The exemption also is not available to issuers that have had their registration previously revoked pursuant to a Section 12(j) order under the Securities Exchange Act of 1934 that was entered into within five years before the filing of the offering statement.
Disclosure and Filing Requirements. Both Tier 1 and Tier 2 offerings require the filing of an offering statement on Form 1-A with the SEC, which contains certain required information, including the offering circular. In this regard, Regulation A+ offering statements must be “qualified” by the SEC (akin to a registration statement being declared “effective”), before sales may be made. The final rules, however, impose different disclosure requirements for each Tier, with more disclosure required for Tier 2 offerings, including:
- Audited financial statements in the offering materials.
- Tier 2 issuers will become subject to an ongoing reporting obligation and must file annual reports (Form 1-K) and semi-annual reports (Form 1-SA) with the SEC, as well as current reports (Form 1-U) upon the occurrence of certain events and exit reports (Form 1-Z) for some period of time after the offering is completed. The reporting requirement generally may be terminated after filing a Form 1-K for the year in which the offering terminates if the issuer has fewer than 300 shareholders of record and has filed all other required reports. Regulation A currently does not require issuers to file any ongoing reports with the SEC.
- Though Tier 2 (and Tier 1) offerings may include non-accredited investors, non-accredited investors in a Tier 2 offering will be limited to investing no more than 10 percent of either their net worth or annual income, whichever is greater.
Form 1-A has been revised to consist of three parts. Part I is a fillable form that includes basic information regarding the issuer, its eligibility, the offering details, the jurisdictions where the securities will be offered and previous sales of unregistered securities. Part II contains the actual offering circular distributed to investors, with financial statements, a description of the issuer’s business, material risks, use of proceeds disclosure, an MD&A type discussion, executive officer and director biographical and compensation information, beneficial ownership information, related party transactions disclosure and a description of the offered securities. Part III contains exhibits and related materials that now may be incorporated by reference from exhibits that were previously filed on EDGAR.
Tier 1 and Tier 2 issuers must file balance sheets and other required financial statements as of the two most recently completed fiscal year ends (or for such shorter time as they have been in existence). Moreover, U.S. issuers are required to prepare financial statements in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”), while Canadian issuers may use U.S. GAAP or International Financial Reporting Standards (“IFRS”) as adopted by the International Accounting Standards Board (“IASB”).
State Preemption for Tier 2 Offerings. One of the most significant concerns regarding the use of the Regulation A exemption had been the requirement to comply with state securities or blue sky laws. In contrast, securities sold under Rule 506 of Regulation D are treated as “covered securities” for purposes of Section 18 of the Securities Act and thus exempted from state regulation. The absence of that treatment for Regulation A offerings has made it an unattractive option for most issuers in the past.
Regulation A+ provides for the preemption of state securities law registration and qualification requirements for securities offered or sold to qualified purchasers in Tier 2 offerings. Tier 1 offerings will remain subject to SEC requirements, as well as to registration and qualification requirements of any state in which its investors reside; although issuers may use the coordinated review program developed by the North American Securities Administrators Association to ease the regulatory burden and handle the state review process more efficiently. States will, of course, continue to have authority to require filing of offering materials and enforce antifraud provisions in connection with any Tier 2 offering.
Solicitation of Interest (Testing the Waters). Issuers will continue to be permitted to “test the waters,” that is, deliver written selling materials to prospective investors prior to filing a compliant offering statement to determine the level of interest in the offering before incurring the often substantial legal, accounting and other costs associated with preparing the offering statement and offering circular. Materials used by an issuer to “test the waters” after it publicly files an offering statement, however, now must be accompanied by a current preliminary offering circular or contain a notice informing potential investors where and how the most current preliminary offering circular can be obtained. According to the new rules, this requirement may be satisfied by providing the URL where the preliminary offering circular or the offering statement may be obtained. These solicitation materials remain subject to the antifraud and other civil liability provisions of the federal securities laws.
The securities sold in a Regulation A+ offering are not considered “restricted securities.” As a result, sales of the securities by persons who are not affiliates of the issuer would not be subject to any transfer restrictions under Rule 144. Affiliates, of course, would continue to be subject to the limitations of Rule 144, other than the holding period requirement. The ability to resell, coupled with a broader distribution of a Regulation A+ offering, presents the potential for an over-the-counter trading market to develop should there be brokers willing to publish quotes in the securities based on current public information voluntarily provided by the issuer.
Whether Regulation A+ can achieve its stated goal of facilitating smaller companies’ access to capital depends, in large part, on how companies perceive and balance the benefits and costs of the new offering method versus other forms of financing, particularly traditional Regulation D offerings. Rule 506 of Regulation D may still be the fastest way to issue securities in unlimited quantities to an unlimited number of accredited investors, with no SEC general filing or ongoing disclosure obligations, particularly now that these private offerings may involve general solicitation and advertising under certain circumstances. Although Regulation D offerings limit the number of non-accredited investors to whom the issuer may sell, non-accredited investors will be limited in the amount they may invest (either due to Tier 2 requirements or practical limitations) and therefore are likely to be a less reliable source of funding. Moreover, the number of non-accredited investors necessary to provide the desired level of funding may result in shareholder relations problems the issuer is not equipped to handle.
Further, while the ongoing reporting requirements imposed on Tier 2 issuers are not as comprehensive as those imposed on public companies, issuers engaged in private placements under Regulation D have no ongoing reporting requirements. Small issuers engaging in Regulation A+ offerings are not likely to have the accounting resources needed to produce reports and monitor ongoing reporting requirements.
In view of the state law preemption of a Rule 506 offering, its more flexible disclosure requirements and its lack of ongoing reporting requirements, it seems likely that private placements will continue to be the exempt offerings of choice for small companies looking to raise capital.