On December 18, 2013, the SEC published its proposal to modify Regulation A. The SEC is proposing to expand Regulation A into two tiers: Tier 1, for offerings of up to $5 million; and Tier 2, for offerings of up to $50 million. The proposed rules also seek to modernize the Regulation A filing process to create additional flexibility and streamline compliance for Regulation A issuers. This post provides an overview of the key provisions of the SEC’s proposal.
I. Scope of Exemption
The SEC is proposing to retain the existing issuer eligibility requirements that companies be organized in, and have their principal place of business inside, the United States or Canada. Under the proposal, the exemption would not be available to the following companies:
Exchange Act reporting companies (existing exclusion);
Investment companies (existing exclusion);
Blank check companies (existing exclusion);
Issuers disqualified under the “bad actor” provisions of Rule 262 (existing exclusion);
Issuers of fractional undivided interests in oil or gas rights or other mineral rights (existing exclusion);
Issuers that have not filed with the SEC ongoing reports during the two years immediately preceding the filing of a new offering statement (new exclusion); or
Issuers that are the subject to an order by the SEC denying, suspending or revoking the registration of a class of securities pursuant to Section 12(j) of the Exchange Act that was entered within five years before the filing of the offering statement (new exclusion).
Under the proposed rules, Regulation A would apply to offerings of equity securities, debt securities and debt securities convertible or exchangeable into equity interests, including any guarantees of such securities. Asset-backed securities will remain ineligible for Regulation A offerings.
Offering Limitations and Secondary Sales
Tier 1 (same as existing offering) – Up to $5 million with no more than $1.5 million by selling securityholders
Tier 2 – Up to $50 million with no more than $15 million by selling securityholders
The proposed rules eliminate the limitations on affiliate resales where the issuer had no net income from continuing operations in at least one of its last two fiscal years.
The proposed rules contain new investment limitations. For a Tier 2 offering an investor is limited to purchasing securities with a purchase price of no more than 10% of the greater of the investor’s annual income and net worth. Issuers would not be required to verify individual income and net worth and could rely on investor representations of compliance.
II. Offering Statement
The proposed rules update Regulation A to require electronic filing of offering statements on the EDGAR System. A From 1-A would be developed that is a fill-in-the-blank form similar to Form D and then other disclosure documents and exhibits would be attached. Ongoing reports would also be filed electronically. The SEC is also proposing an access equals delivery model for Regulation A final offering circulars. The SEC also proposes to allow the non-public submission of draft offering statements by issuers of Regulation A securities.
The SEC Proposes to maintain Form 1-A’s existing three-part structure – Part 1 (Notification, Part II (Offering Circular), and Part III (Exhibits). Part I would be updated to be an online XML-Based fillable form that would be publicly available on EDGAR but not otherwise required to be distributed to investors. Part II would be updated to eliminate Model A (the Q-and-A format) as a disclosure option and to update and retain Model B as a disclosure option and to continue to permit issuers to rely on Part I of Form S-1 to satisfy the disclosure obligations of Part II of Form 1-A. The primary update to Model B would be to propose disclosure similar to that of smaller reporting companies. The proposed rules would maintain the existing financial statement requirements for Tier 1 Offerings but require issuers in Tier 2 to include audited financial statements.
III. Testing the Waters
The SEC’s professed approach to the proposed rules relating to testing the waters (solicitations of interest for an offering before the commencement of the offering) was based on the idea that the current regulations are inconvenient at best, especially for smaller issuers, and that even for larger issuers the current rules don’t work as well as they could or should. The Commission’s proposals relating to testing the waters are most easily described by reference to applicable current requirements:
Rule 254 currently requires that issuers must submit all materials used in test-the-waters solicitations to the SEC no later than the date the materials are first used; under the proposed rules, the materials need only be filed with the initial public filing or filing for non-public review, thus eliminating the filing requirement altogether for issuers that test the waters and, as a result, elect not to pursue an offering.
Current Rule 254 prohibits sales until 20 days after the last use or publication of materials in test-the-waters solicitations; the proposed rules would excise this provision and add a provision requiring that at least 21 calendar days must pass between the filing of the preliminary offering circular and qualification of the offering.
Current Rule 254 requires issuers to cease testing the waters after the filing of the preliminary offering statement; under the proposed rules, test-the-waters solicitations would be permitted both before and after the initial filing. Solicitations after the filing of a preliminary offering statement would need to include either a copy of the current preliminary offering circular or a URL to the current preliminary offering circular. In addition, issuers would be responsible for providing material offering circular updates to the recipients of test-the-waters solicitations, but those updates could be provided via distribution of a URL.
IV. Regulation A Reporting Obligations
Reduced Reporting for Tier I Issuers
Tier I issuers will be required to file certain summary information about the Regulation A offering on Part I of new Form I-Z within 30 days after the completion or termination of the Regulation A offering. This is actually a reduction in the reporting burden for Tier I issuers, as the current rules require similar information to be reported every six months after qualification and within 30 days after termination or completion of the offering.
Annual, Semi-Annual, and Current Reports for Tier II Issuers
Under the proposed rules, Tier II issuers would be required to file four types of reports: an annual report on Form 1-K, a semi-annual report on Form 1-SA, a report of certain updates on Form I-U, and a report notifying the Commission of the termination of ongoing reporting obligations on Form I-Z. Each of the reports is briefly described below:
Form 1-K: There are two parts to proposed Form 1-K. Part I consists of the summary offering information that is already required of Regulation A issuers under Form 2-A, which will be retired. Part II consists of narrative disclosure about the issuer’s business operations, related party transactions, beneficial ownership of securities by insiders, identities and bios of officers, directors, and key employees, executive compensation data, and MD&A of the issuer’s liquidity, capital resources, and results of operations. In addition to the narrative disclosure, Part II of Form 1-K also requires two years of audited financial statements. While Part I of Form 1-K is basically a reformatting of information that is already required to be disclosed on current Form 2-A, the requirements of Part II are new requirements not present in current regulation A. Tier II issuer’s will also use Form 1-K to file audited financial statements for the issuer’s last completed fiscal year, to be filed no later than 120 calendar days after qualification of the offering statement, if the offering statement did not include such financials.
Form 1-SA: The semi-annual reports required of Tier II issuers will be similar to Form 10-Q in that they will primarily consist of financial statements and MD&A, but disclosure relating to quantitative and qualitative market risk, controls and procedures, updates to risk factors, and defaults on senior securities will not be required. In addition, events that would otherwise require a Form 1-U filing (discussed below) can be disclosed on Form 1-SA. Tier II issuers would also use Form 1-SA to file semi-annual financial statements (which can be unaudited) for the first six months of the issuer’s fiscal year within 90 calendar days after qualification of the offering statement if the offering statement did not include such financial statements.
Form 1-U: Tier II issuers will be required to file current reports of certain types of events on Form 1-U. This filing is similar to an 8-K filing, and it incorporates certain elements of items 1.01, 1.02. and 2.01 of Form 8-K. While the trigger for the 8-K depends on materiality, the trigger for Form 1-U depends on a “fundamental change” standard. Form 1-U must be filed within four business days of the occurrence of the following events: fundamental changes in the nature of the issuer’s business, bankruptcy or receivership, material modification of securityholders’ rights, Changes in the certifying accountant, non-reliance on previous financial statements or audit reports, change in control, departure of key officers, and unregistered sales of 5% or more of outstanding equity securities. The SEC has anticipated the obvious question: what is a fundamental change? The Commission is soliciting comments on what exactly should constitute a fundamental change, but provides in the proposing release that fundamental changes would include “major and substantial changes in the issuer’s business or plan of operations or changes reasonably expected to result such changes, such as significant acquisitions or dispositions, or the entry into or termination of a material definitive agreement that has or will result in major and substantial changes to the nature of an issuer’s business or plan of operations.”
Termination or Suspension of Ongoing Reporting for Tier II Issuers
Tier II issuers can elect to terminate their ongoing reporting obligations by filing Form 1-Z, provided that: 1) the issuer has been current on its Regulation A filings for the last three years (or since commencement of Regulation A reporting, if more recent than three years ago); 2) the securities of each class to which the Regulation A offering relates are held of record by fewer than 300 persons; and 3) offers or sales made in reliance on a qualified offering are not ongoing.
Coordination and Effects of Tier II Reporting Regime
Since the ongoing reporting obligations of Tier II issuers are analogous to a miniature version of the Exchange Act reporting requirements, there are several areas where the SEC is soliciting comments relating to coordination or effects of Tier II ongoing reporting under Regulation A. For example, the Commission wonders whether Regulation A reporting should make an issuer eligible to file the 8-A short form registration statement (currently available to issuers who are already subject to Sections 13 or 15(d) of the Exchange Act) in connection with the registration of securities under Section 12 of the Exchange Act. In the proposing release, the Commission also wonders about the implication for the satisfaction of broker-dealer obligations under Rule 15c2-11 and the effect of Regulation A reporting when a Tier II issuer becomes subject to Exchange Act reporting.
V. Insignificant Deviations from a Term, Condition, or Requirements
Although the SEC is not currently proposing any amendments to Rule 260 (which generally provides that an insignificant deviation from a term, condition, or requirement of Regulation A will not result in a loss of exemption), the Commission is soliciting comments on whether the list of Regulation A requirements that are always considered “significant to the offering as a whole” should be altered.
VI. Bad Actor Disqualification
The SEC proposes to amend Rule 262 to include bad actor disqualification provisions in substantially the same form as recently adopted under Rule 506(d), but without the categories of covered persons specific to fund issuers, which would not be eligible to use Regulation A under the proposal. Under the proposal, offerings that would have been disqualified from reliance on Regulation A under Rule 262 as currently in effect would continue to be disqualified. Triggering events that are not currently covered by Rule 262—namely, the events specified in proposed Rule 262(a)(3) and 262(a)(5)—and that pre-date effectiveness of any rule amendments would not cause disqualification, but would be required to be disclosed on a basis consistent with new Rule 506(e).
VII. Relationship with State Securities Laws
The proposal provides that offers and sales of Tier 2 securities under revised Regulation A would preempt state blue sky requirements. Only offers of Tier 1 securities would preempt state blue sky requirements.