Overview
On December 18, 2013, the U.S. Securities and Exchange Commission (“SEC”) issued rule proposals to amend Regulation A, implementing an important part of Title IV of the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). The JOBS Act required the SEC to adopt rules (1) permitting offerings of up to $50 million of securities within a 12-month period; (2) requiring issuers to file audited financial statements with the SEC; and (3) requiring any additional terms, conditions or requirements that the SEC may prescribe in the public interest or for investor protection purposes.

Very few issuers use the existing Regulation A exemption,[1] due in part, to the low dollar amounts that can be raised in light of the current ceiling of $5 million per 12-month period and the relatively burdensome requirements (such as SEC staff review of the offering statement) that need to be complied with under Regulation A. In addition, Regulation A offerings must currently comply with state securities laws, including merit review in certain states.[2]

The rule proposals are generally additive to existing Regulation A. The SEC proposes to expand Regulation A into two tiers: Tier 1 for offerings up to $5 million in a 12-month period, and Tier 2 for offerings up to $50 million in a 12-month period. With respect to secondary sale transactions, the rule proposals would permit Tier 2 offerings to include up to $15 million of securities by selling securityholders, which would be aggregated with primary offerings by issuers when calculating the $50 million maximum amount of securities during any given 12-month period.[3]

The revisions to Regulation A could provide private companies with another means of raising significant amounts of capital from a broader group of investors without having to undertake the more burdensome and expensive registered offering process, i.e., IPOs. As proposed, revised Regulation A would effectively constitute a “registration-lite” form of securities offering, due to the SEC’s approach of modelling Regulation A disclosures and offering practices on the registered offering framework. Accordingly, revised Regulation A may ultimately serve as a middle ground between private placements and registered offerings. However, revised Regulation A, as proposed, would also require issuers in Tier 2 offerings to prepare and file ongoing reports after the offering, which will result in issuers incurring ongoing additional costs, such as legal, accounting and printer fees, until they are able to exit the Regulation A reporting system. If these ongoing reporting requirements are adopted substantially as proposed, issuers will presumably take into consideration the burdens of ongoing reporting when deciding whether to undertake a Tier 2 offering under proposed Regulation A.

Rule Proposals

Disclosure in Offering Statements
Under existing Regulation A, an issuer is required to file and qualify an offering statement with the SEC, which is subject to review by the SEC staff. The JOBS Act provides the SEC with the authority to determine the form and content of offering statements, including the inclusion of audited financial statements. As a general matter, the SEC proposes to make offering circular disclosure “more akin” to what is currently required in prospectuses for registered offerings by smaller reporting companies but with more limited disclosure required in certain areas.

With respect to offering statement disclosure, the SEC has proposed continuing to use Form 1-A’s existing three-part framework, updated and revised in accordance with the JOBS Act. Part I of Form 1-A would be revised to include, among other things, information regarding the issuer, certification that the issuer meets issuer eligibility criteria, certification that no “bad actor” disqualifying events have occurred and information regarding the offering. Part II is proposed to be revised to eliminate the existing “Model A” option, which is a question-and-answer disclosure format, on the basis that this format does not effectively disclose information in a clear and understandable manner. Instead, the SEC proposes to update and revise existing “Model B” in accordance with Title IV of the JOBS Act as well as developments in disclosure requirements that have occurred in the registered offering context. Model B is proposed to be updated by clarifying existing Management’s Discussion and Analysis (“MD&A”) requirements to more closely resemble MD&A requirements applicable to Form S-1 registration statements filed by smaller reporting companies. Other existing scaled disclosure requirements in Model B would generally be retained, including executive compensation information for the three highest paid officers and directors, disclosure regarding 10%+ beneficial owners of voting securities and description of the issuer’s business. Issuers would also continue to be permitted to comply with Part II of Form 1-A by providing narrative disclosure that is required by Part I of Form S-1.

With respect to financial statements, the SEC proposes to require issuers in Tier 2 offerings to file audited financial statements in Part F/S of Form 1-A, which would include balance sheets as of the two most recently completed fiscal year ends.  The SEC proposes to continue the existing Regulation A requirement that offerings pursuant to Tier 1 would not require audited financial statements unless an audit was already obtained for other purposes, the audit was performed in accordance with U.S. generally accepted auditing standards or auditing standards of the Public Company Accounting Oversight Board (“PCAOB”) and the auditor was independent under Regulation S-X. Tier 2 issuers would be required to comply with the financial statement requirements applicable to smaller reporting companies. Offerings pursuant to Tier 2 would require audited financial statements that are audited in accordance with PCAOB standards, with an auditor that is independent under Regulation S-X.[4]

Filing/Confidential Submission of Offering Statements
The rule proposals would require issuers to file offering statements electronically on the SEC’s EDGAR system. However, issuers that have not previously sold securities pursuant to a qualified offering statement under Regulation A or an effective registration statement under the Securities Act would be able to use a confidential submission procedure with respect to the offering statement whereby issuers are able to submit confidential draft offering statements, similar to the process for draft registration statements submitted confidentially by emerging growth companies.[5] All non-public drafts of the initial submission of the offering statement and related amendments would be required to be publicly filed as exhibits to the offering statement not less than 21 calendar days before the offering statement is qualified.

Access Equals Delivery for Final Offering Circulars
Similar to the “access equals delivery” framework in registered offerings,[6] the SEC has proposed an “access equals delivery” model for final offering circulars in Regulation A offerings, which would require an issuer to include a notice in any preliminary offering circulars that the issuer may satisfy its delivery obligations for the final offering circular through electronic filing. Issuers and participating broker-dealers would be required to deliver only a preliminary offering circular to prospective purchasers at least 48 hours in advance of sale when a preliminary offering circular is used during the prequalification period to offer securities to potential investors, i.e., any persons who have indicated an interest in purchasing the securities before qualification.

Continuous or Delayed Offerings
The SEC proposes to amend Regulation A to more closely resemble registered offerings with respect to continuous or delayed offerings. In particular, the SEC proposes to clarify that continuous or delayed offerings are permitted under Regulation A, provided that issuers are current with ongoing reporting requirements at the time of sale. Continuous or delayed offerings that would be permitted include (1) securities offered or sold by securityholders; (2) securities offered or sold pursuant to a dividend or interest reinvestment plan or employee benefit plan of the issuer; (3) securities issued upon the exercise of outstanding options, warrants or rights; and (4) securities where the offering of such securities commences within two calendar days after the qualification date, will be made on a continuous basis, may continue for a period in excess of 30 days from the date of initial qualification and will be offered in an amount that, at the time the offering statement is qualified, is reasonably expected to be offered and sold within two years from the initial qualification date. “At the market” offerings would not be permitted under Regulation A. As is the case with respect to registered offerings, the SEC proposes to allow issuers to use offering circular supplements to update information in certain instances, rather than require issuers to file a post-qualification amendment to the offering circular that needs to be requalified.

Testing the Waters
Soliciting investor interest in a potential offering before the filing of an offering statement, i.e., testing the waters, is currently permitted under Regulation A.[7] The JOBS Act provides that issuers are permitted to test the waters prior to the filing of an offering statement on such terms and conditions as the SEC may prescribe. The SEC proposes to continue the ability of an issuer or any person authorized to act on behalf of an issuer to test the waters under Regulation A by permitting testing the waters communications both before and after the offering statement is filed, provided that issuers comply with filing and legend requirements.  Unlike similar testing the water provisions applicable to registered offerings for emerging growth companies, the proposed Regulation A testing the waters provisions would not restrict what types of investors can be solicited.[8] Testing the waters materials used after publicly filing the offering statement must be preceded or accompanied by a preliminary offering circular or contain a notice letting potential investors know where and how the most current preliminary offering circular can be obtained, which may be satisfied by providing the URL where the preliminary offering circular or the offering statement can be obtained on EDGAR.  Testing the waters materials will not be required to be submitted to the SEC at or before the time they are first used.  Instead, such materials would be required to be submitted or filed as an exhibit when the offering statement is submitted confidentially or filed, with updates for any substantive changes in such materials after the initial non-public submission or filing. Testing the waters materials will be required to include a specified legend or disclaimer.

Ongoing Reporting
The JOBS Act requires issuers using revised Regulation A to provide annual audited financial statements on an ongoing basis and provides the SEC with the authority to determine whether other additional ongoing information is required. The SEC proposes to require issuers to continue disclosing information reporting sales and termination of sales made under Regulation A only after termination or completion of the offering on proposed new Form 1-Z not later than 30 calendar days after termination or completion. In addition, for Tier 2 issuers, the SEC proposes to require ongoing reporting in filings made on EDGAR in the form of annual reports on proposed new Form 1-K (required to be filed within 120 calendar days after the issuer’s fiscal year-end), semiannual reports on proposed new Form 1-SA (required to be filed within 90 calendar days after the end of the issuer’s second fiscal quarter), current event reporting on proposed new Form 1-U (required to be filed within four business days after the occurrence of certain events) and notices relating to the suspension of ongoing reporting obligations on Part II of proposed new Form 1-Z. Form 1-K would contain information regarding the business operations of the issuer for the last three fiscal years; transactions with related persons, promoters and certain control persons; beneficial ownership of executive officers, directors and 10%+ owners; identities and disclosure relating to directors, executive officers and significant employees; executive compensation information for the three highest paid officers or directors; MD&A for the two most recently completed fiscal years; and two years of audited financial statements.  Form 1-SA would serve as a semiannual update and contain information primarily consisting of financial statements and MD&A. Similar to current Form 8-K requirements for reporting companies, Form 1-U would be required upon the occurrence of certain events, including fundamental changes to the nature of the issuer’s business, bankruptcy, changes in the issuer’s certifying accountant and departures of the principal executive officer, principal financial officer or principal accounting officer.

Ongoing reporting for Tier 2 issuers is proposed to be suspended at any time after completion of reporting for the fiscal year in which the offering statement was qualified if (1) the securities of each class to which the offering statement relates are held of record by fewer than 300 persons; (2) offers or sales made in reliance on a qualified offering statement are not ongoing; and (3) the issuer is current in its ongoing reports required by Regulation A for the shorter of (i) the period since the issuer become subject to the reporting obligation or (ii) its most recent three fiscal years and the portion of the current year preceding the date of filing of proposed new Form 1-Z. The obligation to file ongoing reports would be suspended upon the filing of a notice with the SEC on proposed new Form 1-Z.

Bad Actor Disqualification
The SEC proposes to amend existing Rule 262 to include bad actor disqualification provisions that are substantially similar to those in recently adopted Rule 506(d), except that amended Rule 262 would not include categories of covered persons specific to fund issuers, which would not be eligible to use Regulation A under the rule proposals. Accordingly, if the issuer or other relevant persons, including placement agents and officers and directors of the issuer, have been convicted of, or are subject to court or administrative sanctions for, securities fraud or other specified violations, then securities offerings by the issuer would be disqualified.

Preemption of State Securities Laws
Importantly, state securities regulation is proposed to be preempted with respect to Tier 2 offerings. Section 18(b)(4)(D) of the Securities Act, which was added by the JOBS Act, provides that securities sold pursuant to proposed amended Regulation A are “covered securities” for purposes of Section 18 if they are offered or sold on a national securities exchange or offered and sold to a “qualified purchaser,” as defined by the SEC.  The SEC proposes to define “qualified purchasers” in a Regulation A offering as all offerees of securities and all purchasers in a Tier 2 offering. The SEC is of the view that the total package of investor protections in the rule proposals permit the preemption of state securities law registration and qualification requirements for securities offered or sold to “qualified purchasers.” Perhaps not surprisingly, state securities regulators have expressed concerns about the SEC’s proposal to preempt the states in connection with Tier 2 offerings.[9]

Investment Limitation
Regulation A does not currently have limitations on the amount of securities that an investor can purchase in a Regulation A offering. In light of the increase in the annual offering limits to $50 million and the commensurate investor risk of increased losses, the rule proposals include a proposed limit on the amount of securities that an investor can purchase to 10% of the greater of the investor’s annual income and net worth.

Liability
Regulation A offerings would continue to be subject to liability under Section 12(a)(2) of the Securities Act, as well as Section 10(b) and Rule 10b-5 under the Securities Exchange Act of 1934.

Request for Comment
The SEC has requested public comment on the rule proposals for a 60-day period following the publication of the rule proposals in the federal register. The proposing release is available here: http://www.sec.gov/rules/proposed/2013/33-9497.pdf.

Notes:

[1] The proposing release indicates that from 2009 through 2012, there were 19 qualified Regulation A offerings, raising a total amount of approximately $73 million.