JOBS Act Update: SEC Proposes New Rules to Update Regulation A Offerings

In mid-December, the Securities and Exchange Commission (SEC) voted to propose rules updating the framework to the existing Regulation A offering. The rules would implement new Section 3(b)(2) of the Securities Act of 1933, as mandated by Title IV of the JOBS Act (commonly referred to as Regulation A+), by adding a class of securities exempt from Securities Act registration requirements for offerings of securities of up to $50 million in any 12-month period. Regulation A currently exempts offerings of up to $5 million in a 12-month period. The SEC staff’s stated goal for the proposed Regulation A+ rules was to “craft a workable revision of Regulation A that would both promote small company capital formation and provide for meaningful investor protection.”

Building upon the current Regulation A framework, the proposed rules create two tiers of Regulation A offerings: Tier 1 for offerings of up to $5 million and Tier 2 for offerings of up to $50 million. The rules would impose new ongoing SEC filing requirements on both tiers including annual, quarterly and current reports imposed on issuers undertaking Tier 2 offerings.

One of the biggest hurdles to the success of Regulation A is the degree to which the offering must comply with existing state securities (blue sky) laws and regulations. Blue sky requirements for Regulation A offerings are currently a maze of statutes, rules and unwritten customs capable of confounding the most adept securities counsel. Compliance in the states has historically made Regulation A significantly less attractive an option compared with private placement exemptions. To the surprise of some commentators, the SEC’s proposed rules provide for the preemption of blue sky regulation for all offers (but not sales) made under Regulation A and entirely for Tier 2 offerings.

The SEC’s proposed rules remain open for comment until 60 days after publication in the Federal Register. We highlight below important aspects of the proposed rules. We cannot predict when the SEC may issue final rules or whether they may vary from those currently proposed, but we will continue to keep you updated on its progress.

General Overview of Regulation A

Regulation A offerings are often referred to as “mini-public offerings.” Unlike the typical private placement exemption, such as Rule 506(b) under Regulation D, securities are offered publicly under Regulation A. There is no prohibition on the use of general solicitation or advertising in Regulation A offerings; nor are there suitability or qualification requirements for investors. But, like a registered offering, to conduct such an unrestricted offering, an issuer must first file a disclosure document (on Form 1-A) and qualify it with the appropriate federal and state authorities. Unfortunately, state requirements often do not mirror those of the SEC. Navigating the regulatory requirements, preparing the disclosures as stipulated and responding to comments from the SEC and a variety of state regulators is costly and time consuming. In recent years, Regulation A has been used very rarely, primarily due to the relative cost and complexity of federal and state law compliance as compared to other Securities Act exemptions and given the comparatively small offering size (no more than $5 million). One SEC Commissioner summed up the existing Regulation A exemption as “low, slow, costly and burdensome.”

Regulation A+ Proposal
Basic Structure: Tiered System

In response to the mandate in Title IV of the JOBS Act, requiring the SEC to update and expand the Regulation A exemption, the SEC’s recently proposed rules implement two tiers of offerings:

• Tier 1 would consist of securities offerings of up to $5 million in a 12-month period, including up to $1.5 million for the account of selling security-holders; and
• Tier 2 would consist of securities offerings of up to $50 million in a 12-month period, including up to $15 million for the account of selling security-holders. 

There are no suitability or qualification requirements for investors for either tier; however, issuers conducting Tier 2 offerings must limit investments to no more than 10 percent of the greater of the investor’s annual income and net worth.

Under Tier 1 and Tier 2, companies would be subject to basic requirements drawn from the existing provisions of Regulation A. The proposed rules retain the limitations on eligible issuers from the existing regulation[1] and would also exclude issuers that have not filed with the SEC the ongoing reports required by the proposed rules during the two-year period prior to filing a new offering statement; issuers who are or have been subject to a SEC order denying, suspending, or revoking the registration of a class of securities under the Securities Exchange Act of 1934; and issuers offering asset-backed securities.

The proposed rules also would update Regulation A to:

• Permit companies to submit draft offering statements for nonpublic SEC review prior to filing;
• Permit the use of “testing the waters” solicitation materials both before and after filing of the offering statement; and
• Modernize the offering process, including requiring electronic filing of offering materials via EDGAR.

Disclosure and Ongoing Reporting

The proposed rules retain, yet modernize, the existing disclosure requirements found in Form 1-A. Generally, the form requires disclosure about the issuer of information that is customarily included in a prospectus for a registered public offering, scaled back in most instances. Audited financial statements would be required for Tier 2 offerings, but not for Tier 1 offerings unless they were prepared for other purposes. In addition, for Tier 1 offerings, issuers would be required to file an exit report with the SEC not later than 30 days after termination or completion of an offering. Issuers that conduct a Tier 2 offering must file annual and semiannual ongoing reports and current event updates that are similar to the requirements for public company reporting.

Preemption of Blue Sky Laws

Under current Regulation A, offerings are subject to registration and qualification requirements in the states where the offering is conducted unless a state-level exemption is available. Despite attempts at uniformity, state blue sky laws related to Regulation A offerings are varied and complex. The difficulty of complying with these provisions is further compounded by the differing levels of scrutiny applied by state agencies for completeness and accuracy of the filings. Some states also review the merit of the proposed offering. The complexity and diversity of these blue sky laws are a central factor for the limited use of current Regulation A.

Under the current proposal, state securities law requirements would be preempted for securities offered or sold to “qualified purchasers,” which would be defined to be all offerees of securities in a Regulation A offering and all purchasers in a Tier 2 offering. If adopted, this would eliminate the ability for the states to regulate offers or sales of securities sold in Tier 2 offerings but allow the states to regulate the sale of securities in Tier 1 offerings. This would practically eliminate the need for issuers to qualify a Tier 2 offering in any state.

Significantly, this would also enable all companies to more easily solicit investor interest, or “test the waters,” before incurring the preparation costs for a full-blown offering statement. This process involves filing with the SEC a copy of any written materials, meeting nominal content requirements, used by an issuer to solicit investor interest in a security without conducting any subscriptions or sales. While designed to be one of the most inviting features of conducting a Regulation A offering currently, a minority of states permit issuers to “test the waters.” Instead, most states require an issuer to file and have qualified a detailed disclosure document before soliciting investors in the state. So, for many issuers the benefit of being able to “test the waters” on the federal level is outweighed by the delay and cost of state review. Given that all offers made under the new rules would be exempt from blue sky regulation, issuers (even those pursuing Tier 1 offerings) would be able to assess interest in the offering prior to committing significant time and money to preparation of a lengthy disclosure document or compliance with state registration.[2]

Classification of Securities and Exchange Act Reporting Requirements

Unlike securities issued in private placements, securities issued under Regulation A are offered publicly. Thus, they are not “restricted securities” and are freely tradable after the offering. However, from a practical standpoint, it may be difficult to establish a secondary market for such securities if the issuer continues as a non-reporting company.

The SEC did not propose to exempt securities issued pursuant to Regulation A from the Section 12(g) Exchange Act threshold.[3] If a company considers Regulation A as a possible avenue to raising capital, it will be necessary to monitor closely the number of equity holders it has prior to, and may have as a result of, the offering to avoid forced registration under the Exchange Act.

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[1] Currently, the exemption is available only to non-reporting companies organized in the U.S. or Canada, excluding investment companies, developmental stage companies, companies disqualified by the “bad actor” provisions found in Rule 262, and any entity issuing certain interests in oil, gas, or other mineral rights.

[2] This level of preemption over state regulation is not guaranteed to be a part of the adopted rules. Certain SEC Commissioners noted a strong interest in exploring the plan submitted by the North American Securities Administrators Association (NASAA) for adopting a coordinated review system for Regulation A+ offerings across the states as an alternative to blue sky preemption. This could mean that, rather than the ability to avoid state review, issuers may have to comply with “streamlined” uniform filing requirements and review by regional or national interstate securities boards.

[3] Section 12(g) of the Exchange Act requires issuers of securities to register with the SEC and thereby become public reporting companies within 120 days of the end of any fiscal year in which they first have total assets exceeding $10 million and any class of equity securities held of record by 2,000 persons, or 500 persons who are not accredited investors, for most issuers.