The U.S. Securities and Exchange Commission (the “Commission”) has proposed new rules implementing Section 3(b)(2) of the Securities Act of 1933, as amended (the “Securities Act”), pursuant to the mandate under Title IV of the Jumpstart Our Business Startups (“JOBS”) Act. Also known as Regulation A+, the proposed rules intend to help smaller companies get better access to capital by expanding upon the existing Regulation A.
Under the existing Regulation A, eligible non-reporting U.S. and Canadian companies can conduct oﬀerings of securities up to $5 million in a 12-month period through a limited “mini-registration” process that exempts them from the more onerous registration requirements under the Securities Act and the post-oﬀering reporting requirements under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). In addition, Regulation A oﬀerings are considered to be public oﬀerings and securities sold pursuant to Regulation A have the beneﬁt of being freely transferable in contrast to securities sold in private oﬀerings under Regulation 4(a)(2) or Regulation D under the Securities Act. However, Regulation A oﬀerings have never been widely used for a number of reasons, including the $5 million oﬀering size limit and the requirement to comply with state securities (“Blue Sky”) laws.
The proposed rules seek to reform the limitations on Regulation A by building on the existing structure. Speciﬁcally, the proposed rules create two tiers of oﬀerings: Tier 1 and Tier 2. Tier 1 oﬀerings would largely preserve the existing Regulation A framework and allow eligible non-reporting U.S. and Canadian companies to conduct oﬀerings of securities up to $5 million in a 12-month period, including up to $1.5 million for secondary sales. Tier 2 oﬀerings would expand the oﬀering limit to $50 million in a 12-month period, with up to $15 million for secondary sales.
Under the proposed rules, Tier 1 and Tier 2 oﬀerings would generally be subject to the same basic requirements with regard to eligibility, manner of oﬀering and provisions regarding solicitation of interests (what is widely referred to as “testing the waters”). However, Tier 1 and Tier 2 oﬀerings would diﬀer in certain key respects. In general, Tier 2 oﬀerings (given their greater oﬀering amount limit) would be subject to stricter requirements than Tier 1 oﬀerings with regard to ongoing reporting, limitations on investment amounts by each individual investor and auditing standards, as summarized in the table below. More signiﬁcantly, however, the proposed rules would preempt Blue Sky laws for Tier 2 offerings and thus allow oﬀering participants to streamline their oﬀering process.
Review of the Comment Letters
The Commission received over 80 comment letters from the public during the 60-day comment period that ended on March 24, 2014. The comment letters discussed various issues relating to the proposed rules, and the following oﬀers a short summary of some of the key issues and arguments that may impact the usefulness of the proposed Regulation A amendments for issuers.
Comments Regarding Preemption of Blue Sky Laws
On the same day as the proposed rules were released, William F. Galvin, the Secretary of the Commonwealth of Massachusetts, submitted a comment letter indicating that he was “dismayed and shocked” that the Commission sought to preempt Blue Sky laws, and he labeled the proposed rules to be “anti-investor.” Similar comment letters strongly objecting to the preemption of the Blue Sky laws were submitted from various state securities regulators, secretaries of state and the North American Securities Administrators Association (“NASAA”).
The various comment letters objecting to the preemption of the Blue Sky laws were primarily based on two arguments: a policy argument regarding protection of investors and a legal argument challenging the authority of the Commission to preempt Blue Sky laws. Under the policy argument, various state securities regulators and oﬃcials indicated that state oversight of Regulation A oﬀerings is crucial given their “predominantly local and regional character” and pointed out that the Commission has been unable to eﬀectively protect investors in connection with Rule 506 oﬀerings. Furthermore, many also argued that the preemption of Blue Sky laws is unnecessary given the development of a “new coordinated, multi-state review program” within NASAA’s framework. In particular, NAASA indicated that this new system would ease the regulatory burden of issuers by facilitating state reviews through a one-stop electronic ﬁling process.
The state securities regulators and oﬃcials also challenged the Commission’s statutory authority to preempt Blue Sky laws for Regulation A oﬀerings. Congress had permitted securities sold pursuant to oﬀerings limited to “qualiﬁed purchasers” to be preempted from Blue Sky laws under Section 18 of the Securities Act while leaving the task of deﬁning such term to the Commission. Under the proposed rules, the Commission has deﬁned “qualiﬁed purchasers” to include (1) all oﬀerees in any Regulation A oﬀering (including Tier 1 oﬀerees) so that issuers may test the waters and conduct post-ﬁling communications with potential investors without being submitted to state requirements and (2) all purchasers in any Tier 2 oﬀering. The comment letters objected to the Commission’s deﬁnition of “qualiﬁed purchasers” by arguing that the intention of Congress was to deﬁne qualiﬁed investors based on the “investors’ characteristics,” such as “investor sophistication, high ﬁnancial resources, or any other indicator of risk bearing ability” rather than by type of transaction being conducted.
On the other hand, numerous commenters strongly supported the Commission’s approach. One commenter argued that the Commission should in fact “include any oﬀeree or purchaser of any security issued under Regulation A” in the deﬁnition of “qualiﬁed purchasers” and thereby preempt Blue Sky laws for all Regulation A oﬀerings in order to protect issuers seeking to raise smaller amounts of capital. Others also supported the Commission’s approach by indicating that adopting a deﬁnition of “qualiﬁed purchasers” that is equivalent to “accredited investors” would make the preemption of Blue Sky laws for an oﬀering be premised on sales only to accredited investors, as in the case of Rule 506 oﬀerings. Given the various disclosure requirements under Regulation A, such a deﬁnition would make Regulation A oﬀerings less attractive compared to Rule 506 oﬀerings. In the alternative, a few commenters also raised questions as to whether NASAA’s coordinated review program would indeed be able to reduce time and expenses as intended.
Comments Regarding Eligibility
While the comment letters have largely been dominated by the issue regarding preemption of Blue Sky laws, other issues have been brought up as well. In particular, several commenters argued for the expansion of eligibility. One commenter urged the Commission to also allow all shell companies, blank check companies, special purposes acquisition companies and foreign private issuers to utilize Regulation A oﬀerings. Speciﬁcally, the commenter indicated that allowing shell and blank check companies to make Regulation A oﬀerings, subject to certain additional requirements, “would help create new public vehicles with cash to provide a speedier and less costly process for a company to go public and raise capital.” The commenter also argued that there is no reason why foreign private issuers should not be able to utilize Regulation A oﬀerings given that they “already can go public with reduced disclosure as a foreign private issuer, with no dollar limit on oﬀerings or investment limit for investors.” Other commenters also supported expanding the eligibility to foreign private issuers and shell companies as well as non-reporting business development companies. In addition, a few commenters also proposed that public micro-cap companies with a non-aﬃliate ﬂoat less than $250 million should be eligible to use Regulation A oﬀerings.
Comments Regarding Offering and Investment Limits and Secondary Sales
A number of letters also commented on the issue of oﬀering and investment limits. For example, one commenter recommended increasing the oﬀering limit for Tier 2 oﬀerings to $100 million per year or $50 million without the 12-month time limit and removing all investment limits for accredited investors. Other commenters proposed adjusting the method of calculating the oﬀering limit so that the aggregate oﬀering price of the underlying security should only be included in the $50 million limitation during the 12-month period in which such security is ﬁrst convertible, exercisable or exchangeable. Several focused more on modifying the limitations on secondary sales for Tier 2 oﬀerings by arguing that “potential investors will be more likely to invest in privately held emerging companies if they have a reasonable range of post-oﬀering liquidity opportunities,” while a few recommended eliminating the secondary sale limitations for Tier 2 oﬀerings altogether. The underlying thought in all of these comment letters was that relaxing or eliminating the restrictions on secondary sales would improve liquidity and thereby incentivize potential investors to invest in smaller emerging companies.
Comments Regarding Disclosure Requirements
Most commenters generally reacted positively to the proposed disclosure requirements, with many arguing for the reduction or scaling back of disclosure requirements for both the oﬀering statement and, in the case of Tier 2 oﬀerings, ongoing reporting obligations. A few commenters provided speciﬁc comments on improving the disclosure process, such as eliminating Model B and using a scaled back version of Form S-1 for the purposes of the oﬀering statement, given that many advisers engaged by the oﬀerees would be familiar with Form S-1 and the related Regulation S-K disclosure rules.
In addition, several commenters proposed a further scaled back disclosure approach for both the oﬀering statement and ongoing reports that is contingent on the issuer’s size and sophistication and/or the size of the oﬀering. These commenters argued that such an approach would motivate issuers to turn to Tier 2 oﬀerings as an alternative to a fully registered IPO. Many commenters also requested that the Commission simplify the transition process from a Regulation A issuer to full reporting status under the Exchange Act by using Form 8-A instead of Form 10, as they viewed the current requirement to ﬁle a full Form 10 as being duplicative and overly burdensome.
Comments on Section 12(g) Thresholds
A few commenters also objected to the fact that the proposed rules would not exempt Regulation A oﬀerings from the “holder of record” threshold under Section 12(g) of the Exchange Act. These commenters pointed out that a Tier 2 offering, coupled with the restrictions on maximum investment amount, is by design likely to result in many non-accredited investors holding the securities of the issuer. Furthermore, issuers that often do not have adequate resources would be faced with the diﬃcult task of monitoring and limiting the number of holders of securities in order to maintain an exemption from the reporting requirements under Section 12(g). In order to address the potential chilling eﬀect that this may cause, some commenters proposed partial exemptions for Tier 2 oﬀerings depending on the issuer’s non-aﬃliate market capitalization or compliance with ongoing reporting requirements and also suggested adopting transition periods for issuers that have crossed the Section 12(g) threshold.
While much depends on what comments the Commission decides to incorporate into its ﬁnal rules, Regulation A under the current proposed rules may nevertheless be useful for small emerging companies that require access to capital for growth but are not yet prepared to conduct a full-scale IPO. Companies that may have otherwise sought to conduct a Regulation D private oﬀering may now want to conduct a Regulation A oﬀering given that the securities oﬀered under Regulation A are unrestricted and have the potential to attract a larger number of investors. It is also possible that Regulation A may become a cost-eﬀective initial step for a smaller company that is seeking to be listed on a national securities exchange as a fully reporting public company, especially if the Commission amends the proposed rules to further facilitate the transition as requested in some of the comment letters.
On the other hand, however, Regulation A oﬀerings under the current proposed rules may not be as attractive to issuers that are either very small or suﬃciently mature and sophisticated to conduct a full IPO. Issuers seeking to raise less than $5 million a year under Tier 1 would not, as is currently the case under the existing rules for Regulation A, be exempt from Blue Sky laws. In the alternative, smaller issuers seeking to conduct a Tier 2 oﬀering may ﬁnd the various disclosure requirements to be overly burdensome. For instance, the oﬀering statement on Form 1-A requires disclosures similar to Form S-1 as well as audited ﬁnancial statements under PCAOB standards. While the issuer does have a choice between using a narrative disclosure or providing the information required on Part I of Form S-1 and may limit the Form S-1 disclosure as it is applicable to smaller reporting companies (“SRCs”) if it qualiﬁes as an SRC, the issuer is likely to require additional assistance from outside legal counsel and auditors. The continuing periodic disclosure obligations, which are largely scaled back versions of the Exchange Act reporting requirements, may also be too costly for an issuer, especially if the issuer is seeking to raise over $5 million but signiﬁcantly less than $50 million.
For an issuer that deems itself to be suﬃciently experienced and is considering eventually listing on a national securities exchange, conducting a fully registered IPO may be a more attractive option, especially if it seeks to raise amounts closer to the $50 million limit. Such issuers would have to take into consideration the already signiﬁcant requirements for conducting Tier 2 oﬀerings and the fact that it would have to largely duplicate its work by ﬁling a Form 10 when it makes its decision to become a full reporting company. Issuers may view the incremental costs of conducting a fully registered IPO as a reasonable price for avoiding the various restrictions under Regulation A and the possibility of incurring additional costs at a later date.
In the end, a well-designed Tier 2 oﬀering framework, if adopted, may allow many small to mid-sized companies to obtain better access to the public markets and act as a possible stepping stone to eventually list on a national securities exchange. In a recent speech, SEC Commissioner Luis Aguilar noted that a goal of the SEC is to have a “form of Regulation A that is utilized more frequently than its predecessor because it provides an eﬀective way for small companies to raise capital and because, importantly, it provides appropriate investor protection.” In order for such potential to be realized, however, the rules would have to maximize the beneﬁts of a Tier 2 offering over private oﬀerings while reducing costs compared to a fully registered IPO. As noted in the numerous comment letters, this might involve, among other things, making the A well-designed Tier 2 oﬀering framework, if adopted, may allow many small to mid-sized companies to obtain better access to the public markets and act as a possible stepping stone to eventually list on a national securities exchange. securities oﬀered under Tier 2 more liquid by modifying the limits governing secondary sales and investment, maintaining the preemption of Blue Sky laws, and reducing costs by adopting an appropriate disclosure framework that addresses investor protection concerns without being overly burdensome. How the Commission will respond to the comment letters remains to be seen, but hopefully it will take some of these comments into account in the ﬁnal rules release.