After clearing a last minute hurdle described below, newly revised Regulation A, dubbed Regulation A+, became effective on June 19, 2015. The revised regulation under the Securities Act is designed to facilitate the development of a mini-IPO market for smaller U.S. and Canadian companies to offer their shares publicly without the full responsibilities of SEC registration. In order for this endeavor to succeed, Regulation A+ must:
- survive (as it most likely will) a court challenge by state securities regulators in Massachusetts and Montana;
- offer, for at least some companies, an effective alternative to offerings under Rules 506(b) or (c) or Rule 144A under the Securities Act; and
- stimulate investor interest (and foster investor confidence) in both primary and secondary markets.
Some Background on Regulation A+
Regulation A+ results from a JOBS Act-mandated overhaul of prior Regulation A, a little used exemption from Securities Act registration which required both SEC review of the offering document and state Blue Sky qualification. Old Regulation A offerings could not exceed $5 million, a virtually unworkable cap for this type of offering. Regulation A securities, however, could be publicly offered and resold without a holding period.
New Regulation A+ creates two tiers of offerings, with Tier 2 being potentially the more interesting and innovative. Under Tier 2, companies may “qualify” offerings of up to $50 million of their securities in any 12-month period made to an unlimited number of accredited and unaccredited investors. The amount that may be purchased by any single unaccredited investor, however, is limited by the regulation. Companies may also qualify secondary sales by their affiliates in an amount up to 30% of the first Tier 2 offering and up to $15 million per year in subsequent years. The qualification process requires the submission and SEC review of a detailed offering statement that includes two years of audited financial statements. (While it is difficult to predict how market standards will evolve, a reading of the disclosure rules suggests that the offering circular will have less disclosure than a typical IPO prospectus but more disclosure than a typical private placement memorandum.) The company must wait for SEC review and qualification of the offering statement, but the offering is exempt from state Blue Sky review.
After a Tier 2 offering, the company becomes, in effect, a mini-reporting company, required to submit to the SEC annual and semi-annual reports, as well as current reports of significant events. These reports, like the offering statement itself, can be viewed by the public on EDGAR. The requirements are analogous to, but less burdensome than, the basic periodic reporting requirements applicable to smaller reporting companies, except that reporting is done on a semi-annual rather than quarterly basis. There are no rules governing the solicitation of proxies or requiring insider transaction reports. Tier 2 companies can exit from the reporting regime on essentially the same terms as public companies exit SEC reporting requirements. So long as the company continues to comply with Tier 2 reporting requirements, its shares can be traded in the over-the-counter market. A Tier 2 company may also list on an exchange if it registers its shares under the Securities Exchange Act (in which case the company becomes subject to Securities Exchange Act reporting requirements).
Tier 1 of Regulation A+ is more like the old Regulation A, with the important exception that companies may now offer up to $20 million of their securities in any 12 month period pursuant to Tier 1. Offerings may be made to an unlimited number of accredited and unaccredited investors, with no limitation on the amount that may be sold to unaccredited investors. Secondary sales by affiliates may constitute up to 30% of the first Tier 1 offering and up to $6 million per year in subsequent years. The offering statement submitted to the SEC for review and qualification is similar to, but slightly less detailed than. the one required for a Tier 2 offering, and financial statements need not be audited. The offering is not exempt from Blue Sky qualification, which means that the company must potentially file for review in each state where offers are made. The North American Securities Administrators Association (NASAA) has developed a coordinated review process, which might make this less onerous than it seems.
Tier 1 companies do not have continuing reporting obligations, after the filing of a report on the completion of the offering. Like Tier 2 securities, Tier 1 securities are not “restricted securities” under Rule 144 under the Securities Act, meaning they can be freely sold by non-affiliates. Without the availability of current financial and other information, however, it may not be possible to trade Tier 1 securities in over-the-counter markets.
A Last Minute Hurdle and an Ongoing Challenge from State Securities Regulators
State securities regulators have strongly opposed the Tier 2 exemption from state securities law review and have argued that the SEC did not have the power to create this exemption. On June 16, 2015, the SEC refused to stay the implementation of Regulation A+ during the pendency of litigation in the U.S. Court of Appeals for the D.C. Circuit, where the Montana state auditor and commissioner of Securities and Insurance, together with the Massachusetts Secretary of the Commonwealth, seekto challenge the preemption of state review. Although the D.C. Circuit could still side with the state commissioners, it is more likely that it will eventually uphold the SEC’s position in this case.
Is Regulation A+ an Effective Alternative to Other Exemptions or an IPO?
Why go through the process of Tier 1 or Tier 2 qualification if you can raise money from accredited investors under Rule 506(b) or (c) under the Securities Act? As long as investors are willing to provide financing on reasonable terms in private markets, Rule 506(b) or (c) will be the way to go. But despite a frothy market in private company shares and the billion dollar valuations of certain tech company “unicorns,” many smaller companies have difficulty finding financing on acceptable terms in private markets. Regulation A+ requires more work on the preparation of the offering and more compliance effort afterwards, at least for Tier 2, but may expose companies to a different market. Regulation A+ allows companies to offer freely tradable stock to their investors. Regulation A+ also allows them to approach individual retail investors (both accredited and unaccredited), who are often not included in private markets. Tier 2 gives companies and investors many of the benefits of a publicly traded stock, with less cost and less regulatory burden.
Will Regulation A+ Gain Market Acceptance?
The technical advantages of Regulation A+ will not be very helpful if investors are not interested in buying securities in Tier 1 or Tier 2 offerings, or they find no liquidity in the trading markets when they wish to resell the securities they have purchased. Of course only time will tell whether an attractive market will develop for Regulation A+ securities. One hopeful sign is the announcement by the OTC Markets Group Inc. on June 12, 2015 that it would adopt rules for the OTCQX and OTCQB trading platforms to include trading in the securities of Tier 2 companies. In the case of the OTCQX, the company would also have to file quarterly (not just semi-annual) reports, make timely announcements of material events and meet Public Company Accounting Oversight Board (PCAOB) audit standards on an ongoing basis. Other positive signs are announcements from various broker-dealer firms of their interest in the Regulation A+ market. But ultimately the success or failure of Regulation A+ offerings over the next few years will determine how investors view this market.