On March 25, 2015, the SEC adopted changes that are intended to expand and modernize Regulation A under the U.S. Securities Act of 1933, as amended, as required by Title IV of the JOBS Act. The changes to Regulation A, now informally by practitioners as Regulation A+, will be effective 60 days after publication of the final rule amendments in the Federal Register.
The final changes to Regulation A largely reflect the changes originally proposed by the SEC on December 18, 2013, but the final changes also include a number of new amendments derived from the feedback received by the SEC during the public comment period following the 2013 proposal.
Old Regulation A was rarely used, primarily because:
- Companies could not raise more than $5 million during any 12-month period; and
- Old Regulation A securities were not "covered securities" under the National Securities Markets Improvement Act (NSMIA). Issuers therefore needed to comply with the securities laws, including registration and other qualification requirements, of all relevant states.
2. The Basics of Regulation A+
The final rules will create two tiers of offerings under Regulation A+:
- Tier 1. Tier 1 will be available for offerings of up to $20 million in a 12-month period. This represents a change from the 2013 rule proposal which would have capped such offerings at $5 million in a 12-month period.
- Tier 2. Tier 2 will be available for offerings of up to $50 million in a 12-month period, including up to $15 million on behalf of selling securityholders that are affiliates of the issuer.
Regulation A+ is available for equity securities, debt securities and debt securities convertible or exchangeable into equity, including any guarantees.
Both Tiers are subject to certain basic offering requirements, while Tier 2 offerings are also subject to additional disclosure and ongoing reporting requirements, as described in more detail below.
3. What types of companies are likely to benefit from Regulation A+?
It's obviously far too early to know if Regulation A+ will have a material impact on the US capital markets or if it will be seen as a real option for US companies seeking capital and investors, both accredited and non-accredited, that are looking to put their capital to work with growing companies.
That said, Regulation A+ seems designed for small to mid-sized companies that have the sophistication to complete the initial SEC review and qualification process (or, if Tier 1, the review by state securities regulators), maintain the various subsequent annual and other public reporting requirements and generally meet the expectations of what may be a large group of sophisticated and unsophisticated investors.
The final rules are intended to modernize the Regulation A offering process and to make the process more similar to the Securities Act registration process for companies undertaking an IPO. As a result, offerings made pursuant to Regulation A+ have been described as "Mini IPOs", because of the cap on the amount of capital that can be raised in Regulation A+ offerings, the similarity of the SEC process for full registered offerings and Regulation A+ offerings and the relative size and sophistication of the companies that would likely engage in a full registered offering and a Regulation A+ offering.
4. Requirements Applicable to both Tier 1 and Tier 2 Regulation A+ Offerings
Both tiers would be subject to basic requirements drawn from the current provisions of the old Regulation A. Set out below are the primary requirements and characteristics for both tiers of Regulation A+ offerings.
4.1. Issuer eligibility: Most companies that are organized in and with their principal place in the US and Canada may offer securities pursuant to Regulation A+, save for:
- reporting companies under the Exchange Act;
- investment companies under the Investment Company Act of 1940;
- business development companies, as defined in Section 2(a)(48) of the Investment Company Act;
- development stage companies that have no specific business plan or purpose or have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies (blank check companies);
- companies issuing fractional undivided interests in oil, gas or other mineral rights;
- companies that are required to file, but did not file, the ongoing reports required by Regulation A+ during the two years immediately preceding, or the period for which the issuer was required to file, the filing of a new offering statement pursuant to Regulation A+; and
- companies that are otherwise prohibited because the SEC has suspended, denied or revoked the registration of an offering during the previous 5 years or because they are disqualified under the "bad actor" provisions of Rule 262.
4.2. Disclosure via an "Offering Statement": Issuers are required to prepare an Offering Statement that will have three parts:
- Part I: This first part of the Offering Statement provides information in relation to the issuer, its industry and capital structure, as well as financial statements. Part 1 also provides information relating to the offering of securities, including whether it is being pursuant to Tier 1 or Tier 2, the amount and type of securities offered, the names of audit and legal service providers, the jurisdictions into which the securities will be offered and other information.
- Part II: Part II offering circular disclosure must include risk factors, a business section, an MD&A section, executive compensation disclosure, plan of distribution disclosure and two years of financial statements. The MD&A disclosure must include a review of the issuers results of operations for the two most recently completed fiscal years and interim periods, when applicable.
- Part III: The final part of the Offering Statement would include any exhibits provided by the issuer, which might include agreements relating to the offering or other agreements or contracts that are material to the issuer and, as set out below, documents relating to the non-public review by the SEC of the Offering Statement.
See below for more information concerning the impact of state securities on Regulation A+ offerings, which will have a significant impact on Regulation A+ offerings.
5. Additional Tier 2 Requirements
In part due to the higher cap on the total size of a Tier 2 offering, as well as the fact that Tier 2 securities are "covered securities" that are exempt from state securities laws, Tier 2 offerings and issuers making offerings pursuant to Tier 2 are subject to a number of additional requirements.
5.1. Audited Financial Statements: Tier 2 issuers are required to disclose two years of financial statements that are audited in accordance with either US generally accepted auditing standards (US GAAS) or the standards issued by the Public Company Accounting Oversight Board (PCAOB).
5.2. Annual Reporting Requirements: Tier 2 issuers must file annual reports (Form 1-K), semi-annual reports (Form 1-SA), current event reports (Form 1-I) and, in some circumstances, certain special financial reports (Form 1-K and Form 1-SA) through EDGAR. Although these reporting requirements are similar to those required for reporting companies under the Exchange Act, the reporting requirements for issuers of securities for Tier 2 offerings do not constitute reporting under the Exchange Act and the issuer is not required to register under the Exchange Act. Aside from offering related information, Tier 1 issuers are not subject to any ongoing reporting requirements.
5.3. Investor Restrictions: As noted above, there is a distinction between the two tiers on the types of investors that will likely be able to invest in Regulation A+ offerings. Tier 2 issuers are required to inform investors of the limitations on the potential investments by investors set out below. In terms of compliance by issuers of these restrictions, issuers may rely on an investor's representation of compliance with the limitations unless the issuer knows, at the time of sale, that the representation is not true. In Tier 2 offerings, unless the offered securities will be listed on a national securities exchange when the offering is qualified by the SEC, purchasers must be either:
a) Accredited investors, as defined in Rule 501 of Regulation D; or
b) Limited to purchasing securities in an amount not to exceed:
- for natural persons, 10% of the greater of annual income or net worth, as calculated under Rule 501 of Regulation D; and
- for non-natural persons, 10% of the greater of annual revenue or net assets at fiscal year-end.
5.4. Relationship with State Securities Laws
Regulation A+ will preempt the registration and qualification requirements of state securities (or "blue sky") laws in Tier 2 offerings by defining the term "qualified purchaser" under Section 18(b)(3) of the Securities Act to include any person to whom securities are offered or sold in a Tier 2 offering. This effectively means that all Tier 2 securities are "covered securities" and therefore exempt from state registration and qualification requirements.
Note again, however, that qualified purchasers do not include Tier 1 offerees or purchasers. Tier 1 issuers and offerings are therefore still subject to state blue sky laws.
So what impact might this have on Tier 1 and Tier 2 offerings?
- Testing the Waters: While Regulation A+ permits issuers to test the waters and make offers in the pre-qualification period at the federal securities law level (see below), state securities regulators retain oversight over how Tier 1 offerings are conducted at the state securities law level. This could inhibit the use of solicitation materials in Tier 1 offerings and the timing of offerings made pursuant to Tier 1.
- Offers and Sales to Non-Accredited Investors: Again, the lack of exemption for Tier 1 securities from state securities laws will have a significant impact on the ability of issuers to offer and sell securities to non-accredited investors. Such offers must be reviewed on state-by-state basis, which can be expensive, time-consuming and, ultimately, raise the types of issues faced by capital-raising companies prior to the JOBS Act and the recent movement toward reducing the barriers to companies being able to raise capital.
6. Other Features of a Regulation A+ Offering
Regulation A+ permits confidential submissions and SEC review of Offering Statements, electronic submissions of the required documents, gauging investor interest by testing the waters with potential investors and otherwise aligns Regulation A with current practice for registered offerings. The offering process is set out more fully below.
6.1. Confidential Review Process
Under Regulation A+, certain issuers may submit a draft Offering Statement for non-public, confidential review by the SEC. As with the confidential review process for emerging growth company (EGC) registration statement introduced under the JOBS Act, all such non-public submissions of Offering Statements must be submitted through EDGAR.
An issuer that elects non-public review by the SEC must later make its initial non-public submission, all subsequent non-public amendments and all its related correspondence with the SEC publicly available by filing those documents as exhibits to its Offering Statement. The Offering Statement must be publicly filed at least 21 calendar days before it is qualified by the SEC (see below).
6.2. Electronic Submission
As with the non-public submissions discussed above, all public filings under Regulation A must also be made electronically through EDGAR.
6.3. Testing the Waters
Under Regulation A+, issuers may "test the waters" by marketing to investors and obtaining indications of interest from any potential investor before and after filing the Offering Statement. Investors would not be bound by any such indications of interest, but this process may help issuers understand the real demand from investors and reduce the risk of failed offerings, before issuers incur any costs or make a public move toward the markets.
6.4. Limitations on Secondary Sales
Regulation A+ limits the amount of securities that can be sold by selling securityholders at the time of the issuer's first Regulation A+ offering and during the following 12 months to no more than 30% of the aggregate offering price of any particular offering. There are also restrictions in place once the initial 12 month period ends.
These provisions are intended to ensure that founders, management and other important securityholders are not able to cash out of the business at the same time that they are marketing and selling it to potential investors. The SEC would like to ensure that the interests of those within the company prior to the Regulation A+ offering are aligned with the investors that are brought on board as a result of it.
6.5. Qualification Process for Offering Statements
A Regulation A+ Offering Statement may only be qualified by a "notice of qualification" issued by the SEC's Division of Corporation Finance. The notice of qualification is analogous to a notice of effectiveness issued in a registered offering.
6.6. Bad Actor Disqualification
A securities offering will be disqualified from relying on Regulation A+ if the issuer or other covered persons are felons or other "bad actors." The final rules substantially conform the Regulation A disqualification provisions to the bad actor disqualification provisions in Rule 506(d) of Regulation D.
Will Regulation A+ have a significant impact on the US capital markets? The new rules and regulations may prove to be a useful, relatively regulation-light option for companies seeking capital but unable or unwilling to incur the significant time and transaction costs required for a full IPO. Investors may see the benefit, particularly if the Regulation A+ ongoing reporting requirements facilitate secondary trading by investors, thereby providing investors with an exit from their investment.
Companies looking to raise money now have a number of options: Regulation A+, private placements pursuant to Regulation D and a full IPO. Each option has upsides and downsides, largely relating to transaction costs, ongoing compliance costs and investor appetite, and the extent to which Regulation A+ becomes a preferred option remains to be seen. Success in the short to medium term will depend on the ability of the first few companies using Regulation A+ to successfully meet their fundraising goals, live with the ongoing regulatory requirements and meet the expectations of investors.
Image credit to: Securities And Exchange Commission http://bit.ly/1uYLKbz
About the Author - Dan McNamee
Dan is a U.S. trained and qualified lawyer (New York) with extensive experience in capital markets and M&A transactions in the United States, Europe, Asia and Africa. This background has provided extensive exposure to rules, regulations and regulators (including the SEC and FINRA) governing many forms of capital raising in the United States. With this foundation in the traditional capital markets space, Dan is seeking to help grow the crowdfunding market in the United States in a manner that encourages capital formation, protects investors and meets the extensive requirements of the nation's regulators.
Born and raised in Cleveland, Ohio, Dan has worked and lived throughout the United States, in London and elsewhere in Europe. In his spare time, Dan has contributed a significant amount of pro bono work to a number of organizations, including the Clinton Health Access Initiative, and enjoys suffering as he watches Cleveland's consistently terrible sports teams lose.