No Easy A: SEC Proposes Rules For Regulation A+

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In the last of its major rulemaking proposals under the JOBS Act, on December 18, 2013, the U.S. Securities and Exchange Commission (SEC) voted to publish proposed rules to modify and develop Regulation A, the so-called (and little-used) “small offering exemption.” The new proposal is required by the Jumpstart Our Business Startups Act of 2012 (JOBS Act) and will be open for a 60-day comment period. The proposed rules would modify and expand Regulation A, which currently exempts from SEC registration offerings of securities of up to $5 million within a 12-month period. The new Regulation A will increase this maximum to $50 million, and allow for the first time for state securities law pre-emption in certain circumstances when offering more than $5 million and following the Tier 2 protocol, as described below.

Congress’s goal in requiring expansion of Regulation A, dubbed by many market observers as Regulation A+, was to enable small businesses to raise capital without SEC registration and as a viable, potentially more compelling alternative to accredited investors Regulation D private placements and public crowdfunding.1 Like public crowdfunding, Regulation A securities are not private placements and therefore are not restricted. Also like public crowdfunding, current public companies cannot use Regulation A to raise capital.

The Two Tiers of Regulation A+ (and the Potential Third Tier)

Under the new proposed rules, Regulation A+ would allow for an exemption from registration for two tiers of offering:

  • Tier 1: Up to $5 million in any 12-month period, including no more than $1.5 million sold by selling shareholders. Tier 1 offerings would still require approval from state regulators (i.e., there is no federal securities law pre-emption for these smaller offerings).
  • Tier 2: Up to $50 million in any 12-month period, including no more than $15 million sold by selling shareholders. Tier 2 offerings would be exempt from state securities laws and the burdens of preparing filings and obtaining approvals in numerous states, but are subject to investment limitations, enhanced disclosure and ongoing reporting obligations.
    Additionally, each tier would have modified issuer eligibility requirements, content and filing requirements for offering statements and ongoing reporting requirements for issuers.

Scope of Regulation A+

Certain issuers would be excluded from being able to use Regulation A+, including current public filers (and those who were public filers in the past two years), and certain “bad boys” - issuers that are or have been subject to any SEC order pursuant to Section 12(j) of the Securities Exchange Act of 1934, as amended, entered within five years before the filing of the offering statement. Additionally, asset-backed securities (as defined in Regulation AB) would be excluded as eligible securities and, in a Tier 2 offering, an investor would be limited to investing no more than 10 percent of the greater of annual income or net worth.

Confidential Submissions and 'Testing the Waters' Materials

You would be forgiven if you did a double-take when reading the Regulation A+ release and thought you had stumbled on an IPO frequently asked questions list. As with current Regulation A, an “offering circular” must be prepared and filed with the SEC. The SEC can review and provide comments, similar to the IPO process. As with IPOs for “emerging growth companies,” the SEC will allow confidential filings and reviews for Regulation A+ offerings. The offering circular, which must be publicly filed not later than 21 days before qualification (also similar to the IPO public S-1/F-1 filing 21 days before roadshow standard), modifies the structure allowable under Regulation A, and allows for a narrative disclosure format for the offering circular. Offering circulars will look more like prospectuses and less like RFP responses.

Qualification of the offering circular requires action by the SEC through an order. All issuers will need to file balance sheets for the two most recently completed fiscal year ends (or applicable shorter periods of existence) and Tier 2 offerings will require the inclusion of audited financial statement in their offering circulars.

Regulation A+ would also allow (and in some cases require) modern filing conveniences, such as electronic filing and “access equals delivery” delivery requirements.

Also similar to IPOs for “emerging growth companies,” under both Tier 1 and Tier 2 offerings, issuers would be permitted to “test the waters” with prospective investors before and/or after the filing of the offering circular. However, any materials used in testing the waters after publicly filing the offering circular should be preceded by or be accompanied by a preliminary offering circular or contain a notice providing instructions regarding how potential investors may obtain the most current preliminary offering circular. Remember that as “exempt securities,” Regulation A offerings are exempt from the “no offers until filing” requirements of Section 5 of the Securities Act.

Ongoing Reporting and State Securities Laws Pre-Emption

Issuers conducting a Tier 1 offering will be required to electronically file an exit report (on Form 1-Z) with the SEC no later than 30 calendar days after termination or completion of a qualified Regulation A offering (to provide information about sales in such offerings and to update certain issuer information). No other ongoing reporting is required of Tier 1 issuers. State laws must be observed as they are today.

Issuers conducting a Tier 2 offering must electronically file with the SEC annual, semi-annual and current event updates. Tier 2 issuers also may be required to provide special financial reports to provide information to investors in between the time the financial statements are included in its Form 1-A and the first periodic report after qualification of the offering statement. Tier 2 issuers may exit the Regulation A reporting regime, after completing reporting for the fiscal year in which an offering statement was qualified, by filing an exit form, provided such securities of each class to which the offering statement relates are held of record by fewer than 300 persons (also the public company deregistration standard), and offers or sales made in reliance on a qualified Regulation A offering statement are not ongoing.

State securities law registration and qualification requirements for securities offered or sold to “qualified purchasers” (defined as all offerees of securities in a Regulation A offering and all purchasers in a Tier 2 offering) are pre-empted.

Potential Third Tier

In connection with the proposed rules, an SEC commissioner has stated that, subject to public comments, if any, and further consideration by the SEC, the final rules may include an intermediate third tier, which may cover Regulation A offerings of between $10 million to $15 million, pre-empt state blue sky laws and have less-extensive continuing disclosure obligations than Tier 2 offerings. Maybe this will be called Tier 1½.

Putting it All Together: Regulation A+, Public Crowdfunding and Regulation D Rule 506

The SEC’s press release fact sheet for the proposed rules and the proposed rule amendments release identify and recognize the rarity of Regulation A offerings compared to Regulation D exemptions and registered offerings, and that the issues in cost and complexity make Regulation A less practical than other Securities Act exemptions, such as Regulation D, and registered offerings.2

Regulation A

Regulation D
(of up to $5 million)

Public Offerings
(of up to $5 million)

From 2009 through 2012

19 qualified offerings for a total offering amount of approx. $73 million

Approx. 27,000 offerings for a total offering amount of approx.$25 billion

373 offerings for a total offering amount of approx. $840 million

In 2012

8 qualified offerings for a total offering amount of approx. $34.5 million

Approx. 7,700 offerings for a total offering amount of approx. $7 billion

52 offerings for a total offering amount of approx. $132 million

In considering the use of Regulation A+, eligible issuers will likely consider: (A) a Regulation A+ cost-benefit analysis, relating the benefit of an up to $50 million capital raise in a 12-month period (for Tier 2) against the cost for the ongoing filing and compliance requirements of Regulation A+, and (B) a comparative analysis against potential additional exemptions allowable by current securities laws, including public crowdsourcing and Regulation D. We take a closer look at Regulation A+ (Tiers 1 and 2) vs. public crowdfunding vs. Regulation D private placements below (checkboxes indicate our view of most preferable or least restrictive or costly):

Feature

Public Crowdfunding

Regulation A+
(Tier 1)

Regulation A+
(Tier 2)

Regulation D Rule 506 (4(a)(2))

Maximum Total Raised

$1 million per 12 month period

$5 million per 12 month period; including up to $1.5 million for selling shareholders

$50 million per 12 month period; including up to $15 million for selling shareholders

Unlimited

þ

Number of Investors

Unlimited but subject to maximum total raised

Unrestricted

þ

Unrestricted

þ

Unlimited accredited investors; up to 35 non-accredited investors unless soliciting (if soliciting- 0 non-accreds)

þ

Investment Per Investor

Restricted by income/net worth

Unrestricted

þ

Restricted by income/net worth

Unrestricted

þ

Investor Disclosure

Required, must be filed with SEC

Required, must be filed with SEC

Required, must be filed with SEC

Not required if all accredited investors; Form D filing proposed

þ

Intermediary Required

Yes – broker/dealer or funding portal

No

þ

No

þ

No

þ

Subject to ongoing SEC reporting following raise

Yes, at least annually, possibly more frequently

No; as long as exit report is filed not later than 30 calendar days after termination or completion

Yes; audited financials filed annually; annual, semi-annual, current reporting required

May file exit report, so long as issuer meets certain qualifications

No

þ

Disclosure Liability

Yes, full disclosure liability with a knowledge exception

Yes, full disclosure liability with a knowledge exception

Yes, full disclosure liability with a knowledge exception

Only anti-fraud liability

þ

Shares restricted

Yes, for one year

No

þ

No

þ

Yes, for public companies most can sell under Rule 144 after six months

State Filing

Possibly, depends on future rules by state

Not exempt from state securities law registration and qualification

Exempt from state securities law registration and qualification if sold to “qualified purchasers,” defined to include all offerees in a Regulation A offering and all purchasers in a Tier 2 offering

Usually no if only offering to accredited investors

þ

Advertising and general solicitation

Not allowed

"Testing the waters" permitted before filing; general solicitation permitted after qualification

þ

"Testing the waters" permitted before filing; general solicitation permitted after qualification

þ

Allowed if sales are made only to accredited investors and issuer takes reasonable steps to verify accredited status

Can public cos., foreign issuers, investment companies and exempt inv. companies issue

No

Yes, but limited

Yes, but limited

Yes

þ

The comment period for the proposed rules will expire 60 days after their publication in the Federal Register.

Pepper Points

  • The new rules create a two-tier system under Regulation A+, each with different modified requirements for eligibility, content and filing of offering statements and ongoing reporting requirements for issuers; the first tier allowing for up to $5 million in any 12-month period and the second tier allowing for up to $50 million in any 12-month period.
  • Subject to public comment, the SEC may consider a potential third (intermediary) tier, with similarly intermediary requirements for eligibility, content and filing of offering statements and ongoing reporting requirements for issuers.
  • Public comments will likely identify whether the balance struck by the SEC in increasing the amount of money allowed to be raised under Regulation A+ and the requirements of state securities laws/federal securities laws; ongoing filing, compliance and reporting requirements; and eligibility allowances is adequate.
  • Time will tell whether the final rules in the implementation of Regulation A+ are successful in enticing small companies to use Regulation A+ as opposed to alternative public crowdfunding or Regulation D exemptions for raising capital.

Endnotes

1 For more information about Regulation D and recently proposed rules, please see: https://www.jdsupra.com/legalnews/sec-relaxes-ban-on-advertising-and-solic-57154/.

For more information about crowdfunding and recently proposed crowdfunding rules, please see: http://www.pepperlaw.com/publications_article.aspx?ArticleKey=2776; and http://www.pepperlaw.com/pdfs/Korn_Crowdfunding112712_Slides.pdf.

2 Information regarding recent IPO trends can be found at: http://www.pepperlaw.com/publications_article.aspx?ArticleKey=2800.