August 04, 2015
Securities Law Alert
Author(s): Theodore Ghorra
The JOBS Act was signed into law in August 2012 and the Securities and Exchange Commission has since toiled to implement rules that facilitate capital formation and promote investor protection, including the SEC’s most recent adaptation found under Regulation A+.
The Jumpstart Our Business Startups (JOBS) Act was signed into law in August 2012 and the Securities and Exchange Commission has since toiled to implement rules that facilitate capital formation and promote investor protection, as directed by the JOBS Act, by re-vamping sections of the federal securities laws to become more business-friendly. Title IV of the JOBS Act gives the SEC the authority to perform this function, and it has taken its role seriously by recently adopting amendments to the existing exemptions known as Regulation A, increasing the dollar limits on offerings and simultaneously relaxing certain administrative requirements.
The SEC’s newest exemption from the registration requirements of the Securities Act, Regulation A+, went into effect on June 19, 2015, and implements substantial updates to the seldom-used Regulation A The goal of these updates is to improve access to capital for smaller companies through revisions to Regulation A. The previous version of Regulation A had a $5 million limit on offerings, required an onerous review process and was subject to state Blue Sky laws.
In contrast, the newly revamped Regulation A (now referred to as “Regulation A+”) allows for substantially larger offerings of up to $20 million or $50 million, depending on the issuer’s choice of two tiers—see below for further discussion—in any 12-month period.
Regulation A+ creates a two-tiered system for offerings. Tier 1 retains many of the features of the original Regulation A, but increases the limit on offerings to $20 million (in a rolling 12-month period). Under the amended rule, the exemption is available for sales by existing shareholders, though subject to tighter limits. In Tier 1, no more than $6 million may be offered by selling security-holders that are affiliates of the issuer. Importantly, Tier 1 also remains subject to state Blue Sky laws and is subject to the same disclosure requirements as Regulation A, as discussed in further detail below. The issuer, if the offer is for an amount of $20 million and under, may elect to proceed under either Tier. Tier 2 is available for offerings of up to $50 million (in a rolling 12-month period), of which no more than $15 million may be offered by selling security-holders that are affiliates of the issuer. In trying to balance the needs of providing existing stockholders access to liquidity, on the one hand, and helping companies to raise capital, on the other hand, the SEC limited the amount of securities that selling stockholders may sell in such issuer’s first Regulation A+ offering and any other Regulation A+ offering qualified within one year of the first offering to no more than 30% of the aggregate price of such offering in both Tier 1 and Tier 2.
To be eligible for Regulation A+, companies must be organized with a principal place of business in the United States or Canada. Securities offered must be equity, debt, convertible debt or guarantees thereof. Bad actors are disqualified from participating, similar to the prohibition on such participants in Rule 506(d). Regulation A+ is not available to several types of companies, including Exchange Act registrants other than voluntary reporters; registered investment companies; business development companies; blank check companies; companies that were subject to, but missed filing Regulation A reports within the past two years; asset-backed securities or fractional undivided interests in oil, gas and other mineral rights (but REIT securities are eligible); or resales for more than 30% of the aggregate offering price of an initial Regulation A offering.
Both tiers of Regulation A+ offerings require offering statements (disclosure documents) and allow companies to submit such draft offering statements for confidential treatment/review by the SEC staff. Disclosure documents are required 48 hours prior to the delivery of point of sale disclosures, unless the issuer is current on its Tier 2 ongoing reporting obligations. Updates and supplements are required during the pendency of the offering and are subject to a 21-day SEC review period. Disclosure documents must include balance sheets and related financial statements for the previous two fiscal year ends, dated not more than nine months before the date of the nonpublic submission. For Tier 2 issuers, financial statements must be audited under AICPA or PCAOB standards. Issuers providing interim financials must submit statements covering at least a six-month time frame. Other required information is similar to that which is contained in a registered offering prospectus and the electronic filing of offering materials is required.
Tier 1 and Tier 2 both require ongoing reporting maintenance. Tier 1 requires issuers to file limited updates to issuer and offering information within 30 days of termination or completion of an offering. Tier 1 also requires issuers to provide updates for sales and termination of sales every six months for ongoing offerings, as well as updating disclosure documents while an offering is ongoing. Tier 2 requires issuers to update information when an offering is terminated or completed. Additionally, Tier 2 requires issuers to file special financial reports for periods between the most recent period included in a qualified offering statement and the first required periodic report, as well as annual reports, semiannual reports and current event reports (this is akin to SEC requirements for reporting companies). Tier 2’s ongoing reporting requirements also satisfy 15c2-11 broker requirements, thereby allowing securities to be listed over the counter. Reporting obligations under the Tier 2 regime are suspended if the issuer becomes an Exchange Act filer.
One attractive feature of Regulation A+ is that it is open to both accredited and non-accredited investors, with the following distinctions: while Tier 1 offerings do not have dollar limitations for individual investors, Regulation A+ does place a dollar limit on the amounts that may be invested by non-accredited investors for Tier 2 offerings. For Tier 2 offerings, individual non-accredited investors are constrained to 10% of their annual income or net worth, whichever is greater. Similarly, non-accredited entity investors are limited to purchasing no more than 10% of their annual revenue or net assets at the end of the previous fiscal year, whichever is greater. These dollar limits do not apply to securities listed on a national securities exchange. There is no limit to the number of non-accredited investors who may participate in Tier 1 or Tier 2, so long as a Tier 2 issuer retains the services of a transfer agent and meets the “smaller reporting company” requirements in Section 12(g) of the Exchange Act.
Regulation A+ offers several substantial benefits to issuers. Both Tiers allow a company or its representative to “test the waters” both before and after an offering statement has been filed, and may do so with all potential investors (not only QIBs, as is the case for registered offerings of emerging growth companies), as long as solicitation materials used after publicly filing the offering document are preceded or accompanied by a preliminary disclosure document (that is, if an offering is later qualified for sale and the offering takes place, the confidentially submitted documents and all correspondence between the issuer and the SEC will need to be publicly filed, although confidential treatment requests may be made to the SEC). Regulation A+ allows for low printing and mailing expenses. Offerings under Regulation A+ may be quicker than taking a company public through a traditional IPO, but depend on the coordinated review and state Blue Sky clearance if made under Tier 1 (which is still required for Tier 1 offerings, which may delay an offering rather than streamline it). Similarly, Regulation A+ allows greater flexibility in offerings, as the offerings may be continuous or delayed. There are also no SEC filing fees for Regulation A+ offerings.
Importantly, Regulation A+ is not integrated with other offerings when the other offerings are: (1) not within six months of completion of the Regulation A offering, (2) registered under the Exchange Act, (3) made in reliance on Rule 701, (4) made pursuant to an employee benefit plan, (5) made in reliance on Regulation S, or (6) made under 4(a)(6) of the Exchange Act.
Tier 2 bestows additional benefits to the issuer. Tier 2 preempts state Blue Sky laws, and allows issuers to simultaneously use Form 8-A to register a class of securities under the Exchange Act in order to achieve a stock exchange listing Under Tier 2, securities can be conditionally exempted from Exchange Act requirements if certain public float and procedural requirements are met. Tier 2 has fewer ongoing reporting requirements than Exchange Act registration. For example, fewer items need to be reported on Form 8-K within four business days, semiannual unaudited financials must be reported instead of the Exchange Act’s quarterly required financials, Tier 2 securities are not subject to Exchange Act proxy rules and less onerous executive compensation disclosure is required.
While Regulation A+ offers many benefits to issuers, several potential drawbacks may limit the new regulation’s appeal. Although Tier 2 preempts Blue Sky laws, Tier 1 does not. The SEC qualification process for offerings under Regulation A+ remains lengthy and cumbersome, similar to filing a registration statement on Form S-1. This reduces the incentive to offer under Regulation A+ rather than take a company public. Even though the ongoing reporting requirements for Tier 2 issuers are less rigorous than registration under the Exchange Act, such issuers must still adhere to substantial reporting requirements. Penny stock concerns and the significant limitations for convertible securities further reduce the appeal of Regulation A+ offerings.
Regulation A+ has several additional consequences. Securities sold under Regulation A+ can now be listed over the counter even without issuer involvement, which may change practices with respect to registration rights. Regulation A+ offerings are unrestricted securities and, therefore, freely tradable and may be listed or quoted upon registration under Section 12 of the Exchange Act; however, no liquid market currently exists for these securities at present.
Further, if liquidity is not a paramount concern of the issuer or the investor, then perhaps an offering under Regulation D (“Reg D”), in the alternative, may be preferable, given that Reg D offerings do not require ongoing reporting requirements or the preparation of an offering statement or SEC or state regulatory review and approval. Further, offerings made under Reg D are not limited as to size, unlike the caps set forth in Regulation A+.
Regulation A+ provides Broker-Dealer’s (“BDs”) another product to offer to issuers and investors. For the most part, private placements via Reg D offerings have been the purview of accredited and institutional investors—thus, limiting investment outside of these types of investors. Further, Reg D offerings carry with them a lack of investor liquidity and a high reward for high risk profile—which, as a practical matter, limit these types of investments to a relatively small pool of potential investors.
As mentioned earlier in this article, Regulation A+ places few restrictions on accredited investors, and the potential liquidity of these investments means that as markets grow, a larger investor pool can choose to invest in deals with little current return, but with larger up side, and have the ability to sell the security to mitigate risk (assuming a broader and viable market develops for non-listed Regulation A+ securities).
Similar to other offerings exempt from the Securities Act registration requirements, Regulation A+ offerings do not subject participants to Section 11 liability; however, federal securities laws would apply, including Sections 12(a)(2) and 17 of the Securities Act, Section 10(b) of the Exchange Act and Rule 10 b-5. Therefore, underwriters participating in a Regulation A+ offering will likely require a level of diligence and disclosure comparable to that required in registered offerings.
Finally, filings with FINRA and payments of related fees will be necessary in Regulation A+ offerings in which a FINRA member participates, and FINRA’s compensation rules will apply to such members. If underwritten, a 15% over-allotment option should be factored into a Tier 2 offering, thus reducing the maximum raise to approximately $43.5 million.
Regarding BDs, this new regime simply adds another tool to the alternative finance options that BDs now currently have in their arsenal for issuers and investors alike.
It will be interesting to see the impact of Regulation A+, and the SEC has indicated that its staff will conduct a study on the impact of offerings under both Tiers regarding capital formation and investor protection no later than five years after its adoption. While many questions remain to be answered, the SEC Staff has published several Compliance and Disclosure Interpretations, available at http://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm#182.01.
Although Regulation A+ is a less expensive vehicle than a traditional IPO, the SEC estimates that it will take 750 hours to prepare the related filings for a Regulation A+ offering—so the real price of a Regulation A+ filing remains to be determined. Ongoing reporting requirements cost professional time and money to prepare and it is likely that legal, accounting and compliance personnel will need to be retained by issuing companies to remain in good standing under this new regime. Whether an issuer chooses to proceed under Tier 1 or Tier 2 would necessitate weighing the costs of providing two years of audited financials versus compliance with state Blue Sky laws, as well as the myriad informational and reporting requirements that accompany each offering.
On this point, it will be interesting to see how many issuers take advantage of this new regulatory regime. Like many companies that explore their financing options, it will be a facts and circumstances-based decision depending on the dollar amount sought, existing capital to fund the compliance cost of a Regulation A+ financing, the availability of financing from a Regulation D offering or other private placement, and what the ultimate goal of the issuer is in this regard (namely, is it seeking to achieve a listing of its securities or just simply segue into a full registered offering using this as an interim measure?).
While it remains to be seen how broadly Regulation A+ will be utilized in the coming months and years, it is certainly a welcome addition for issuers seeking to conduct a financing, and if the projected costs do, in fact, prove to be significantly lower than an IPO, then it may prove quite valuable moving forward. Based on the foregoing, we give this regulatory regime an A+ for effort.
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