The Securities & Exchange Commission (the “SEC”) proposed significant revisions to Regulation A on December 18, 2013, as mandated by Congress under Title IV of the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). Revised Regulation A has become known as, and is referred to here as, Regulation A+. This DechertOnPoint discusses Regulation A+’s background and key points.
Regulation A, implemented by the SEC under Section 3(b) of the Securities Act of 1933, as amended (the “Securities Act”), is an exemption from SEC registration for securities offerings of up to $5 million, including up to $1.5 million by selling securityholders, within a 12-month period. Although the SEC implemented Regulation A to help small companies raise capital, it did not eliminate all obstacles. Among other things, companies pursuing Regulation A offerings must prepare and file an offering statement with the SEC prior to offering any securities and must also comply with the registration requirements of applicable state securities laws (“blue sky laws”). The costs of compliance with these requirements – combined with the $5 million limitation on offering size – have made Regulation A offerings increasingly rare.
Congress, through the JOBS Act, has sought to revive Regulation A as a viable way for small and medium sized companies to raise capital. Specifically, Title IV of the JOBS Act required the SEC to authorize exempt offerings under Regulation A of up to $50 million of securities within a 12-month period, subject to new regulatory conditions. The SEC, based on its own investigation as well as a recent report by the U.S. Government Accountability Office on trends in Regulation A offerings, has proposed Regulation A+ to satisfy its mandate. Regulation A+ is currently open for comments, and will remain open until 60 days after its publication in the Federal Register.
Only select companies would be eligible to engage in Regulation A+ offerings. Like Regulation A, Regulation A+ is limited to companies organized and based in the United States and Canada. Moreover, Regulation A+ is unavailable to companies with a class of securities currently registered under the Securities Exchange Act of 1934 (“reporting companies”); investment companies; blank check companies; issuers of fractional undivided interests in oil, gas, or other mineral rights; private funds; and “bad actors” as defined under Rule 262 of the Securities Act (as amended by Regulation A+). Regulation A+ is available for offerings of equity securities and debt securities, including convertible or exchangeable debt securities, but not for offerings of asset-backed securities.
For eligible companies and offerings, Regulation A+ promises to modernize the regulatory process in a handful of ways. For example, it would permit companies to confidentially submit offering statements to the staff of the SEC for review before filing, introduce electronic filing and the “access equals delivery” delivery model to Regulation A offerings, and would allow issuers to engage in “testing the waters” communications with potential qualified investors before and after the filing of an offering statement. In addition to these upgrades, Regulation A+ also proposes additional changes to Regulation A, the most notable of which is the introduction of a tiered system of offerings.
Introduction of the Tiered System
As required by the JOBS Act, Regulation A+ increases the maximum eligible offering size from $5 million to $50 million by introducing a two-tiered regulatory framework. Tier 1 of Regulation A+ exclusively covers offerings of up to $5 million of securities, whereas Tier 2 of Regulation A+ covers offerings of up to $50 million of securities. In addition, the SEC has requested comment on the potential usefulness of a third, intermediate tier for offerings valued between Regulation A+’s two proposed end points with its own regulatory requirements.
Tier 1 Offerings
Current Regulation A largely lives on in Regulation A+’s first tier. Tier 1 offering limits are the same as under current Regulation A – $5 million in a 12-month period, including no more than $1.5 million by selling securityholders – and Tier 1 offerings would likewise remain subject to the registration requirements of applicable blue sky laws. Companies pursuing Tier 1 offerings would have to submit an offering statement on the revised Form 1-A to the SEC for review and approval, but would not be subject to continuing reporting requirements after their electronic submissions of an exit report with the SEC within 30 days of the termination or completion of a Tier 1 offering.
Tier 2 Offerings
Under Tier 2 of Regulation A+, the SEC has substantially expanded the scope of current Regulation A. Under Tier 2, companies can raise up to $50 million in any 12-month period, including no more than $15 million by selling securityholders, a tenfold increase over current Regulation A thresholds in both categories. In addition, the SEC has proposed to exempt Tier 2 offerings from state blue sky laws by classifying all purchasers of securities issued in Tier 2 offerings as “qualified purchasers” under Section 18(b)(3) of the Securities Act.
In exchange, the SEC has proposed requiring companies issuing securities in Tier 2 offerings to comply with a more extensive set of rules than those offering securities under Tier 1. Most notably, Regulation A+ proposes that companies that offer securities under Tier 2 be required to comply with ongoing reporting requirements and thus required to file annual, semiannual, and current reports with the SEC on new Forms 1-K, 1-SA, and 1-U, respectively. These filings would be less involved than those required of a reporting company. For example, companies filing annual reports on the new Form 1-K would be required to make more limited disclosures than reporting companies in annual reports on Form 10-K. Although Regulation A+ issuers would not be required to comply with the Securities Exchange Act’s proxy rules, they would nevertheless need to disclose on Form 1-K certain information with respect to executive compensation, beneficial ownership, and other items that a reporting company would typically include in its annual proxy statement and incorporate by reference in its annual Form 10-K filing. In addition, companies filing semiannual reports on the new Form 1-SA would not be required to make disclosures in areas such as market risk and controls and procedures, unlike reporting companies in semiannual reports on Form 10-Q, but would have to provide financial disclosures covering six months as opposed to three months. Similarly, companies that issue securities in Tier 2 offerings would only need to provide current reporting on 11 of the 26 areas on which reporting companies must report when filing current reports on Form 8-K, which would likely reduce the frequency of required Form 1-U filings.
In addition to these ongoing reporting requirements, companies pursuing Tier 2 Regulation A+ offerings would be subject to other requirements. Unlike companies pursuing Tier 1 offerings, they would be required to submit two years of audited financial statements to the SEC. Moreover, a purchaser of securities in a Tier 2 offering would be allowed to spend no more than 10% of his or her net worth or income on the securities, whereas no similar restriction applies to purchasers in Tier 1 offerings. In short, Tier 2 of Regulation A+ offers certain advantages to companies looking to raise capital, but does so in exchange for more regulation.
Under Regulation A+ companies that offer securities under Tier 2 could exit the ongoing reporting regime by filing Form 1-Z with the SEC after completing reporting for the fiscal year in which the offering statement was qualified, but only under certain circumstances. For example, a company could file an exit form only if offers or sales made in reliance on the offering statement have concluded and if fewer than 300 persons are holders of record of each class of securities offered in connection with the offering statement.
Although the SEC has sought to establish through proposed Regulation A+ “an effective, workable path to raising capital that . . . also builds in necessary investor protections,” it remains to be seen how the costs and benefits of Regulation A+ will stack up. Under proposed Regulation A+, a company that intends to list on a national exchange the securities issued through a Regulation A+ offering would need to file with the SEC the relatively more extensive Form 10, as opposed to the relatively straightforward Form 8-A, which is currently reserved for use by reporting companies. The costs associated with this process may deter companies from raising capital through offerings under Regulation A+. The SEC has invited comment on this point, and if the SEC reverses course, it could eliminate one of Regulation A+’s disadvantages. By contrast, one of Regulation A+’s key advantages over current Regulation A – the Tier 2 offering exemption from the registration requirements of applicable state blue sky laws – may be scaled back. Groups such as the North American Securities Administrator Association (“NASAA”) have strongly opposed the preemption of state law on anti-fraud grounds, and the SEC has invited further comment on this point. If the SEC eliminates the preemption component of Regulation A+ and implements instead a “streamlined state review and filing program” proposed by NASAA, a major benefit of the new regulation may be lessened. Ultimately, Regulation A+’s success will depend on how companies view its benefits and costs relative to those of the available alternatives, such as exempt offerings under Regulation D.