The SEC has proposed rules to institute Title IV of the Jumpstart Our Business Startups Act (JOBS Act) and add an exemption from registration under Section 3(b) of the Securities Act of 1933, as amended. These rules, commonly referred to as “Regulation A+,” were proposed on December 18, 2013 and can be found here. The SEC may finalize the rules on Regulation A+ in the near term, but this likely will occur after a number of Dodd-Frank rulemaking initiatives are docketed.
Regulation A+ is designed to improve upon Regulation A. Currently, Regulation A allows companies to sell up to $5 million of securities to investors over a rolling 12-month period. The compliance costs of Regulation A are high, as companies must comply with state laws in each state where funds are sought. Accordingly, offerings under Regulation A have been infrequent over a sustained period, as many companies have opted towards more user-friendly alternatives like Regulation D, which preempts state securities law and allows for multiple exemptions from registration, including Rule 506, which can be effected without regard to a maximum offering limit. The high cost of compliance under Regulation A and the $5 million offering limit are often cited as deterrents to more frequent usage. See, for instance, a report by the U.S. Government Accountability Office.
The proposed Regulation A+ would create two different tiers. Much like the current Regulation A, Tier 1 would allow companies to sell up to $5 million of securities to accredited and unaccredited investors over a rolling 12-month period, including up to $1.5 million on behalf of selling security-holders. Tier 2 would allow companies to sell up to $50 million of securities to accredited and unaccredited investors over a rolling 12-month period, including up to $15 million on behalf of selling security-holders. Companies could choose whether to proceed under either Tier, but Tier 2’s higher proceeds limit comes with a cost to individual investors, as the Tier 2 rules would prohibit purchases of securities worth more than 10% of the greater of an investor’s annual income and net worth. This individual investment limit is based upon existing standards of income and net worth for “accredited investors.” Regulation A+ would also allow companies to “test the waters” of the general public before making an offering – that is, before or after filing an offering statement, companies could communicate with potential investors to assess their interest in an offering.
While Regulation A+ may represent a practical response to the market’s qualms with existing Regulation A, one key issue is under hot debate: the proposed preemption of state qualification and registration requirements for Tier 2 offerings. Federal preemption, as currently proposed, would allow offerings of any amount up to $50 million to forego state securities laws. The North American Securities Administrators Association and several Congressional leaders have opposed the preemption on legal grounds, claiming that the preemption conflicts with the JOBS Act. Several U.S. Senators submitted a comment letter to this effect in August 2014. The JOBS Act gives the SEC authority to provide exemptions from state Blue Sky laws when securities are sold on a national exchange or to qualified purchasers. Opponents of the preemption claim that Regulation A+ ignores the requirement that potential purchasers be qualified, but proponents claim that preemption is valid under the JOBS Act as it defines “qualified purchasers” to be “all purchasers in a Tier 2 offering.”
Proponents of the currently proposed Regulation A+ will largely look to the popularity of Regulation D and the infrequent utilization of Regulation A as proof that federal preemption is necessary for Regulation A+ to provide capital raising benefits. Proponents, including many in the investment community, advocate the benefits to individual businesses and the overall economy of easier access to capital and greater liquidity through Regulation A+. Opponents of the currently proposed Regulation A+, including certain regulators, will point to the need for investor protection and the risks arising from this emerging market. If included in the final rule, the preemption would certainly lighten the compliance burden believed to have discouraged many from offering under Regulation A. The challenge facing the SEC will be assuring more risk-averse parties (including certain members of Congress) that the other investor protections of Regulation A+ are robust enough to justify federal preemption.
The premise of Regulation A+ is operably strong – midsize companies thirsting for capital could complete a “mini-IPO” and access up to $50 million without the more extensive costs and regulatory requirements associated with a full S-1 IPO under the current system. Post-offering reporting obligations and costs would be reduced under Regulation A+, as compared to current reporting rules. Ongoing reporting will enable (1) Regulation A+ investors to achieve immediate resale liquidity after an offering and (2) ongoing secondary trading by market participants. If the final rules preempt state law, Regulation A+ should garner popular usage and alter the landscape of small and mid-market securities offerings. If the final rules do not provide for preemption, Regulation A+ will “jumpstart” little and in time will join Regulation A on the shelf as a dusty, red-tape bookend.