As we have noted in prior Bulletins, pursuant to Section 5 of the Securities Act of 1933 (Securities Act) and state securities laws, any offer and sale of a security must be registered with the Securities and Exchange Commission (SEC) and any applicable state securities regulators, or exempt from such registration. Currently, SEC rules under Regulation A of the Securities Act provide an exemption from registration for offerings by certain issuers of up to $5 million, including $1.5 million on behalf of selling securityholders, in any 12-month period. This exemption requires the preparation of an offering statement on Form 1-A that must be filed with and qualified by the SEC (or automatically 20 days after the delaying amendment is removed) and is subject to staff review and comment. The offering circular included in the offering statement, which is similar to a prospectus included in a registered offering, must be distributed to potential investors in the Regulation A offering. Securities sold in Regulation A offerings are not restricted securities and may be freely resold.
Pursuant to the Jumpstart our Business Startups (JOBS) Act passed in 2012, the SEC has proposed amendments to Regulation A that retain the option for offerings of up to $5 million in a new Tier 1 of Regulation A and provide a new exemption from Securities Act registration for offerings of up to $50 million, including $15 million by selling securityholders, in any 12-month period in a new Tier 2. The provisions governing Tier 1 offerings would remain largely the same as under current Regulation A, with a few modifications discussed further below. The most important distinctions between Tier 1 and Tier 2 are that (i) Tier 2 offerings would not be subject to registration or qualification under state securities laws and (ii) issuers that conduct a Tier 2 offering would become subject to ongoing SEC reporting requirements. As under current Regulation A, both Tier 1 and Tier 2 offerings would be unregistered public offerings without any restriction on the nature of offerees or investors and would permit general solicitation and advertising subject to the requirements of the amended rules. In addition, securities sold under both Tier 1 and Tier 2 would continue to count towards the stockholders of record threshold for registration and reporting under the Securities Exchange Act of 1934 (Exchange Act).
The amendments would preempt state securities laws for all purchasers in a Tier 2 offering and all offerees in a Regulation A offering. Therefore, compliance with the registration provisions of state securities laws would only be required with respect to purchasers in a Tier 1 offering, to the extent an exemption from registration is not available in the applicable state(s). We discuss below certain other provisions of the proposed amendments.
General; Issuer Eligibility; Investment Limits
Under the proposed rules, Tier 1 and Tier 2 offerings would remain limited to U.S. and Canadian companies not subject to the reporting requirements of the Exchange Act. Companies currently prohibited from using Regulation A, including companies registered or required to be registered under the Investment Company Act of 1940, companies with no business plan or whose only business plan is to merge with or acquire unidentified companies (blank check companies) and issuers of fractional undivided interests in oil or gas rights or similar interests in other mineral rights, would remain so. Companies with, or that have certain insiders and offering participants with, certain criminal convictions or that are subject to certain bars or orders would be disqualified from conducting a Regulation A offering under revised “bad actor” provisions of Rule 262, which the SEC proposes to amend, consistent with the JOBS Act, to track the bad actor disqualifications applicable to private placements conducted under Regulation D (including, in lieu of disqualification, disclosure of bars or orders imposed prior to the effective date of the new rules that are not disqualifying events under current Rule 262).
In addition, issuers that (i) have not filed all required ongoing reports triggered by a prior Tier 2 offering during the two years preceding the filing of the offering statement or (ii) are or have been subject to an SEC order denying, suspending or revoking the registration of a class of securities for failure to comply with the provisions of the Exchange Act or the rules and regulations thereunder within five years before filing the offering statement, would be ineligible to conduct a Regulation A offering. Further, consistent with the JOBS Act, Regulation A offerings would be limited to equity securities, debt securities and debt securities convertible into equity securities; the SEC also proposes to exclude asset-backed securities from Regulation A offerings.
Finally, under the proposed rules investors in a Tier 2 offering would be limited to investing no more than 10% of the greater of their annual income or net worth.
The proposed amendments would require that Regulation A offering statements be filed electronically through the SEC’s EDGAR filing system instead of in paper as under current Regulation A, although similar to the process for emerging growth companies filing a Form S-1 registration statement, the amended rules would provide an option for non-public review of draft offering statements.
Under the proposed rules, the general structure of the Form 1-A offering statement would remain the same, with Part I focusing on basic information about the issuer and the offering and whether it qualifies to use Regulation A, Part II consisting of the offering circular that is provided to potential investors, and Part III, exhibits. The information in Part I would be considerably expanded, however, to provide the SEC with additional information that can be used to analyze the Regulation A market, among other things. In Part II, the “Model A” question and answer option for the offering circular disclosure would be eliminated. The “Model B” option intended to be a scaled version of the Form S-1 disclosure requirements would be updated, and the alternate option to provide disclosure required by Part I of Form S-1 would remain. The financial statements required for Tier 1 offering would remain largely the same, except balance sheets for the last two fiscal years, instead of the most recent year only, would be required. Consistent with current Form 1-A issuers conducting a Tier 1 offering would be required to provide audited financial statements only if they had been previously prepared by an independent auditor in accordance with U.S. Generally Accepted Auditing Standards or Public Company Accounting Oversight Board (PCAOB) auditing standards. Issuers conducting a Tier 2 offering, however, would be required to provide financial statements prepared generally in accordance with Article 8 of Regulation S-X applicable to smaller reporting companies audited by an independent (though not PCAOB-registered) auditor in accordance with Article 2 of Regulation S-X and PCAOB standards.
The SEC is also proposing an “access equals delivery” model for final offering circulars consistent with Rule 172 under the Securities Act for registered offerings, whereby issuers (and participating broker-dealers) could satisfy their delivery obligations for the final offering circular that is filed and available on EDGAR. This assumes, of course, that a preliminary offering circular had been delivered and would require disclosure in the preliminary offering circular (which must be provided at least 48 hours before sale) that the obligation to deliver a final offering circular may be satisfied electronically. Issuers (and participating broker-dealers) would still be required to deliver a final offering circular or a notice stating that the sale occurred pursuant to a qualified offering statement within two business days after the completion of the sale. Finally, the proposed amendments would modernize the rules for permissible continuous or delayed offerings (but not at the market offerings) under Regulation A, most notably by allowing some changes to the offering circular, and pricing information, to be included via a supplement to the offering circular instead of an amendment that must be qualified by the SEC.
Currently, Regulation A permits issuers to communicate with potential investors, with no limits on the types of investors (i.e. they need not be qualified institutional buyers or accredited investors), to gauge investor interest prior to filing the offering statement, commonly known as “testing the waters.” Under the proposal, issuers would be able to continue using test the waters communications with all potential investors before, as well as after, filing of the offering statement. Solicitations after filing, however would have to be accompanied by the current preliminary offering circular or inform potential investors where it can be obtained, and such solicitations would have to be updated if they become materially inaccurate or inadequate. Such communications would also have to be filed with the SEC and include certain proscribed legends or disclaimers.
Currently, issuers that conduct a Regulation A offering must file a Form 2-A with the SEC every six months to report sales under the offering, with a final filing due within 30 days after the end of the offering. Under the proposed amendments to Regulation A, Form 2-A would be rescinded. Instead, issuers conducting a Tier 1 offering would provide the information currently required in Form 2-A only once, on a new Form 1-Z exit report, not later than 30 days after termination or completion of the offering. Issuers conducting a Tier 2 offering would be subject to ongoing reporting requirements including: (i) filing summary information about a recently completed offering and annual reports on new Form 1-K (including a business discussion, management’s discussion and analysis (MD&A) of liquidity, capital resources and results of operations, executive compensation, audited financial statements, and other information); (ii) semiannual reports on Form 1-SA (consisting primarily of financial statements and an MD&A); (iii) current event reports on new Form 1-U to report certain enumerated events; and (iv) in certain circumstances, special financial reports on Forms 1-K and 1-SA. Issuers would be able to suspend such reporting (other than in the fiscal year their Form 1-A offering statement is qualified) using Form 1-Z if the securities of each class to which the offering statement relates is held of record by less than 300 persons, offers and sales under the offering statement are not ongoing, and they have complied with their ongoing reporting obligations. In addition, Regulation A reporting obligations would be automatically suspended if the issuer becomes subject to the Exchange Act’s periodic reporting obligations.
All such filings would be made through the SEC’s EDGAR system. Information about results of the offering would be included on Form 1-Z if the issuer had not previously included that information on a Form 1-K.
The SEC has asked for comments on all aspects of its proposal, so specifics of the amendments to Regulation A as adopted are likely to differ in some respects from the proposal. We expect, however, that the final Regulation A amendments will be substantially the same as those proposed.
The proposing release for the Regulation A amendments is available here [PDF].