by Cydney Posner
At an open meeting this morning, the SEC adopted rules and forms related to the offer and sale of securities under Section 3(b) of the Securities Act, so-called Reg A+, as mandated by Section 401 of the JOBS Act. Currently, Reg A allows companies to raise up to $5 million without having to file a registration statement, but the offering circular and overlapping federal and blue sky requirements have usually been viewed as so onerous – relative to the amount that can be raised—as to deter use of the exemption. As characterized by Commissioner Gallagher during the meeting to propose the revisions originally, Reg A is generally viewed as a virtual “toxic stew of impediments.” As a result, Reg A is almost never used, even though the stock issued under the exemption is not “restricted stock” and is freely tradable by non-affiliates. According to Commissioner Aguilar, in 2011, only 19 offerings were filed under Regulation A, and only one was actually deemed qualified to sell securities to investors in that year. The question is whether these changes will be enough to enhance the appeal of Reg A, especially relative to Reg D.
As adopted, Reg A+ establishes two tiers of offerings: Tier 1 will permit offerings of up to $20 million (including sales of up to $6 million by affiliate selling shareholders) within a 12-month period, a significant change from the proposal, which would have left the Tier 1 cap at $5 million; Tier 2 raises the ceiling to $50 million (with up to $15 million by affiliate selling shareholders), but imposes enhanced investor protection requirements. For amounts up to $20 million, issuers will be able to choose whether to conduct a Tier 1 or Tier 2 offering, which should provide some data on issuer preferences. The new rules will be effective 60 days after publication in the Federal Register. (Note that, as of the time of this blog posting, the final rules have not yet been posted to the SEC website.)
Apparently, the issue of preemption of state blue sky laws presented something of a heated debate. In the end, it appears that the SEC viewed the efforts by North American Securities Administrators Association (NASAA) to develop a multi-state coordinated review program as promising; however, according to Chair Mary Jo White, the program was still new and, in the absence of more of a track record, “concerns remain about the costs associated with state securities law registration and qualification requirements, even under a coordinated review program, which may deter issuers from using Regulation A.” The resulting compromise provides for “calibrated” preemption: for the Tier 2 exemption, with a ceiling of $50 million, Blue Sky review is preempted: the new exemption defines all offerees and purchasers in Tier 2 offerings as “qualified purchasers,” thus exempting those offerings from state registration or qualification. However, Tier 1 offerings would continue to be subject to Blue Sky review, although those offerings should be able to take advantage of the NASAA coordinated review program. White also emphasized “that the states retain their full anti-fraud powers and may require that issuers using Regulation A+ file their offering documents with the states.” The SEC is also considering the possibility of “embedding” a NASAA representative with the SEC staff as part of the review process.
The rules preserve the requirements for an offering circular containing disclosure regarding the issuer and the offering, along with financial statements. Issuer eligibility requirements also continue, with exclusions for already public companies, shell companies and companies subject to “bad actor” disqualifications, as well as companies that have not filed required reports for the last two years or that have had their Exchange Act registrations revoked in the prior five years. However, the amendments also modernize the offering process, for example, by allowing issuers to “test the waters,” both before and after filing of the offering circular and to elect to submit offering circulars confidentially to the SEC for review prior to use, and otherwise modernize the qualification, communications and offering process.
In addition, the Tier 2 exemption would impose a number of additional investor protection requirements:
- Enhanced disclosure requirements (although less extensive than is currently required for a registered offering);
- Requirement for audited financial statements in the offering circular and annually, although the financial statements would need to comply only with U.S. GAAS per AICPA standards, rather than the more robust PCAOB standards;
- Electronic filing of the offering circular with the potential for SEC comment;
- Limitation on non-accredited investor purchases of 10% of the greater of net income or net worth (for non-natural persons, 10% of the greater of annual revenue and net assets at fiscal year-end), unless the securities are listed on a national securities exchange;
- Conditional exemption from registration under Section 12(g) if a registered transfer agent is used, and the company remains current and has a public float of $75 million or less or, in the absence of a public float, revenues of less than $50 million;
- Short Form 8-A 1934 Act registration permitted; and
- Ongoing annual, semi-annual and current event reporting.
Although the rules were unanimously approved, it was clear that the final product represented a consensus that left most of the Commissioners with significant wish lists. Commissioner Aguilar had hoped for more disclosure regarding equity compensation issued to insiders in the year prior to the offering. Commissioner Gallagher, although finally “delighted” about a set of new SEC rules, had hoped for something more “revolutionary.” He wished that the Tier 2 limit has been raised above $50 million, that the 12(g) exemption did not have an “age out” provision, that Reg A+ would have been made available for public reporting companies and that there were venture exchanges for Reg A+ shares. (Note that Commissioner Aguilar also believes it to be critical for the success of the new rules that there be a viable secondary trading environment.) He also noted that, although the rules provide for semi-annual reporting, the lack of an exception under Rule 144’s requirement for current quarterly reporting may create a “backdoor requirement” for voluntary quarterly reporting to avoid Rule 144 blackout periods. Commissioner Stein, who had previously noted the important role of the states in protecting investors and observed that Congress deliberately revised the JOBS Act to ensure that state securities laws were not explicitly preempted, now confirmed that she would have preferred a different approach to preemption. She was also concerned that the Tier 1 ceiling was still too low to be effective. All seemed to look forward to a study to be conducted within five years that would assess the impact of the new rules on capital formation and investor protection, so that adjustments in rules could be made.
So will Reg A+ have any appeal? Ultimately, companies considering the exemption will need to assess and balance the costs of use of the exemption as compared to an IPO (less liquid market v. lower costs of compliance) or Reg D (greater costs v. access to more dispersed investor base.) It remains to be seen whether Reg A+ will be enough to detoxify the Reg A “toxic stew of impediments” and attract any issuers.