On January 27, 2016, the Corporation Finance Section of the North American Securities Administrators Association (NASAA) requested comments on a proposed model rule and uniform notice filing form aimed at simplifying the state notification requirements for Regulation A Tier 2 offerings.  One of the most significant concerns regarding the proposed amendments to Regulation A was the requirement to comply with state securities laws.  At the time the amendments to Regulation A were proposed, there was no coordinated review process by the states for Regulation A offerings.  The final rules amending Regulation A, adopted on March 25, 2015, provide that Tier 1 offerings (for smaller offerings up to $20 million in any 12-month period) will remain subject to state securities law requirements, but Tier 2 offerings (for offerings up to $50 million) will not be subject to state review if the securities are sold to “qualified purchasers” or listed on a national securities exchange.  Although the final rules define the term “qualified purchaser” in a Regulation A offering to include all offerees and purchasers in a Tier 2 offering, states continue to have authority to require filing of offering materials and enforce anti-fraud provisions in connection with a Tier 2 offering.

The NASAA’s proposed rule would require Regulation A Tier 2 issuers to file basic information about the issuer and the offering on a short notice form and pay a filing fee that can be used for filings in multiple jurisdictions.  A consent to service of process also is included in the notice form so that a separate Form U-2 filing for consent to service of process for each applicable jurisdiction is not necessary.  Issuers also can incorporate by reference into the notice form those documents filed on the SEC’s Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system.  Issuers would be required to submit the notice form at least 21 calendar days prior to the initial sale and the notice form would be effective for 12 months from the date of filing.  Issuers can amend or renew the notice form for an additional 12-month period if the same offering is continued.

The proposed rule and notice form are available at http://nasaa.cdn.s3.amazonaws.com/wp-content/uploads/2016/01/Reg-A-Tier-2-Public-Comment-FINAL1.pdf.

On May 22, 2014, Sebastian Gomez Abero, Chief of the Office of Small Business Policy of the Division of Corporation Finance of the SEC, spoke about the SEC’s crowdfunding and Regulation A+ proposals. Mr. Gomez commented generally on a number of comments and questions raised by commenters to the proposals. Mr. Gomez also noted that the crowdfunding proposals are not yet final and the SEC will have to adopt final rules and that finalizing the Regulation A+ proposals is a priority for the SEC in 2014.

With respect to the SEC’s crowdfunding proposals, Mr. Gomez discussed the offering size limitation, integration with other offerings and the role of intermediaries. Mr. Gomez noted a tendency, while the SEC is deliberating on final rules, to fit crowdfunding under other exemptions from registration, such as Securities Act Rule 506(c) or current Regulation A. Mr. Gomez mentioned that some commenters thought the $1 million offering size limitation should be raised and asked for clarification on whether crowdfunding offerings would be integrated with offerings under other exemptions (e.g., offerings to accredited investors under Securities Act Rule 506(c)). Mr. Gomez said that the SEC is still considering the integration question, but noted that the question is closely tied to the offering size limitation. Mr. Gomez also mentioned guidance in the adopting release for the Securities Act Rule 506 amendments which indicates that a registered offering does not prohibit a Securities Act Rule 506(b) offering, so long as investors in the Rule 506(b) offering are not generally solicited and have a pre-existing relationship with the issuer, and then posed the question whether a crowdfunding offering should be treated as a registered offering in this context. Mr. Gomez also discussed the provisions covering intermediaries (which must register with the SEC and will be subject to FINRA regulation) and emphasized that intermediaries function as “gatekeepers” given that investors in crowdfunding offerings may not be very sophisticated. Another concern expressed by commenters was with liability attaching to intermediaries, although intermediaries are prohibited from providing investment advice in crowdfunding offerings, since the definition of “issuer” under the rule proposals also covers intermediaries. Mr. Gomez went on to discuss the issue of “curating” and noted the safe harbor list of activities provided in the rule proposals, but mentioned that the SEC does not want funding portals to promote types of offerings although funding portals could specialize in certain types of companies (e.g., companies in a particular state or companies in a particular industry). Mr. Gomez noted that the SEC also received comments regarding the information that crowdfunding issuers need to disclose, particularly the financial statement requirements, and that a large number of commenters requested that the threshold for audited financial statements be raised because audited financial statements impose a significant cost for start-up companies and the usefulness of such financial statements for start-up companies is questionable. Mr. Gomez finally mentioned that the SEC is still considering the proposed offering and ongoing reporting requirements for crowdfunding issuers.

With respect to the SEC’s Regulation A+ proposals, Mr. Gomez discussed the preemption of state blue sky laws, which he noted raised the largest number of comments. Mr. Gomez mentioned the coordinated review program approved by the members of the North American Securities Administrators Association (the “NASAA”), which was established to address concerns raised in a GAO report to Congress regarding multi-state review for Regulation A offerings. Mr. Gomez noted that the SEC staff has met with the NASAA to discuss the coordinated review program, although some commenters have noted that there may still be some redundancies even with a coordinated state review process. Mr. Gomez then mentioned that in contrast Securities Act Section 4(a)(6) clearly preempts state blue sky laws but indicated that some states have their established their own rules to exempt crowdfunding offerings. Mr. Gomez also noted that the SEC’s two new compliance and disclosure interpretations (“C&DIs”) regarding crowdfunding and Securities Act Rule 147 (which provides a safe harbor for intrastate offerings conducted pursuant to Securities Act Section 3(a)(11)) are examples of the SEC’s efforts to clarify that use of the internet is not incompatible with Rule 147 and state blue sky laws (for more information regarding these two new CD&Is, see our blog post, “SEC Issues New and Revised Guidance on Intrastate Crowdfunding,” available here.

On May 1st, the House Financial Services Committee will hold a hearing (see:  http://financialservices.house.gov/calendar/eventsingle.aspx?EventID=377434) on various proposed bills related to the JOBS Act.  One of the bills addresses the crowdfunding framework and would have the effect of striking Title III of the JOBS Act and reverting to the House version of the crowdfunding title in most respects.  Another bill addresses certain issues raised by the SEC’s proposed amendment to Regulation D, Form D and Rule 156 and has as its aim encouraging use of the ability to use general solicitation in connection with certain Rule 506.  Perhaps most significant, a bill titled the Startup Capital Modernization Act of 2014, would address state preemption in Regulation A+ offerings.  State preemption continues to raise significant controversy.  The bill makes clear that Congress intended that Tier 2 Regulation A offerings not be subject to state review.  In addition, the bill addresses various other aspects of Regulation A+, such as the Exchange Act reporting threshold.  The same bill would codify the Section 4-1/2 exemption for resales of restricted securities.

On April 8, Commissioner Aguilar and Commissioner Stein spoke at the North American Securities Administrators Association conference.

Commissioner Aguilar noted in his remarks that “Regulation A-plus remains a work in progress, and no one can say what the ultimate outcome will be.”  The Commissioner went on to note that a workable exemption would “attract issuers that might otherwise choose more opaque exemptions for their capital-raising needs.”  Indeed, in Rule 506 offerings to accredited investors, there are no disclosure requirements, no investment limit, and no ongoing reporting obligations.  The proposed Reg A+ framework provides enhanced investor protections that should mitigate any concerns; however, the debate regarding pre-emption continues.

Even with coordinated review, an issuer faced with a range of capital-raising alternatives, will not choose a Tier 2 offering if state review is necessary.  Tier 2 offerings are unlikely to be “local” in nature.   Statements of Policy applied by state regulators have not been updated in a meaningful way and are inconsistent with practices in “public” offerings.

A Tier 2 Reg A+ offering will have more in common with a public offering than with a private placement.  Many states require that each investor in their state sign a subscription agreement.  Of course, in a registered offering that clears and settles through DTC and is sold by a broker-dealer, individual subscription agreements generally are not used.  A recent state review triggered comments from examiners inquiring about the rules of DTC, and requested more information about Cede & Co, DTC’s nominee, as well as about the “officers, directors and purpose/role of Cede & Co.”  Presumably, Tier 2 Reg A+ offerings will clear through DTC.  These are the just examples of speed bumps that do little to add to investor protection.

Today is the end of the comment period on the SEC’s proposing release concerning Regulation A+.  A number of comment letters already have been filed and are available here: http://www.sec.gov/comments/s7-11-13/s71113.shtml.  Additional comment letters are likely to be received in the next few days.  The letters overwhelmingly support the SEC’s approach.

In a recent speech, SEC Chair White noted that the SEC remains focused on various investor protection measures related to the JOBS Act.  She noted that the SEC is considering Staff recommendations for final rules related to the SEC’s proposal from last summer relating to proposed amendments to Regulation D, Form D and Rule 156.  Read her full remarks here:  http://www.sec.gov/News/Speech/Detail/Speech/1370541226174#.UzC3CyXD8xo.  White noted that the SEC’s “ultimate goal is to craft rules that provide effective, workable paths for companies to raise capital that also protect investors.”  So, it would appear that we should expect to learn more soon on this.

Not unexpectedly, on February 19, 2014, the North American Securities Administrators Association sent a letter to the SEC objecting to the preemption of state authority over small corporate offerings by the SEC in its Regulation A+ Proposal and requesting a meeting with Chair White and the Corporate Finance leadership. The Proposal preempts state securities law review for Tier 2 Regulation A offerings (those up to $50 million) by defining a “qualified purchaser” as any offeree or purchaser in a Tier 2 offering.  In the letter, NASAA stated:

We cannot do our job – protect investors or help small businesses access capital and grow their companies – where the Commission attempts to prohibit our review as contemplated in the Regulation A+ Proposal.

The letter highlighted NASAA’s new coordinated, streamlined multi-state review program that appoints lead examiners to review Regulation A+ filings and that it believes will ease regulatory burdens for filers without sacrificing investor protection.  NASAA also questioned whether the SEC’s proposal to define “qualified purchaser” to include purchasers in a Regulation A+ offering is consistent with the public interest and the protection of investors standards of the National Securities Markets Improvements Act of 1996.  NASAA also said:

There is no doubt in our minds that the Commission and the states, standing together, will be much more effective in protecting our citizens and making Regulation A+ a success for small business filers than we could ever hope to be standing apart.

On December 18, 2013, the SEC proposed rules to implement the mandate of Title IV of the JOBS Act by creating a framework for Section 3(b)(2) offerings. The JOBS Act permits non-reporting companies to conduct “mini” public offerings, or Regulation A+ exempt offerings to raise up to $50 million in proceeds. A Regulation A+ offering may prove a compelling capital-raising alternative for growing companies and may be a useful stepping stone on the way to an IPO. For some companies, Regulation A+ may be a viable alternative to an IPO. We will discuss the proposed rule, as well as provide a perspective on the utility of Regulation A+ and on the Regulation A+ market.

The seminar will take place from Noon-2 PM ET at Morrison & Foerster’s Washington, D.C. office, and will also be live-streamed to the Morrison & Foerster New York office.

Please RSVP to alexapowers@mofo.com and indicate the office where you plan to attend.

Speakers:

  • Zach Fallon, Securities and Exchange Commission
  • Ford Ladd, Law Offices of Ford C. Ladd
  • Anna Pinedo, Morrison & Foerster
  • Karen Wiedemann, Securities and Exchange Commission

To date, the Jumpstart Our Business Startups Act (the JOBS Act) is best known for legalizing securities crowdfunding (better called ‘crowd investing’), lifting the ban on the mass marketing of private offerings, and fostering an IPO on-ramp for so-called emerging growth companies, like Twitter.  But there’s more to the JOBS Act than these better publicized sections. On December 18, the SEC proposed rules under yet another section of the Act (Title IV) that would permit companies that register a “mini-IPO” with the SEC to raise up to $50 million from the general public in a 12-month period.  In the coming months, expect to hear more about this exemption (called Regulation A+) that may prove useful to companies looking to raise capital across a broad range of sectors, industries, and geographic regions.

Adding the plus to Reg A:  The existing Reg A permits the sale of up to $5 million of securities to both accredited (high net-worth or income individuals) and unaccredited investors so long as the issuer files a mini-registration with the SEC (one that the SEC then approves) and complies with relevant state law registration requirements in each state where funds are solicited.  Unfortunately, as the following graph demonstrates, the Reg A exemption has been rarely utilized.

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* Note that the number of qualified Reg A offerings has decreased from 57 in 1998 to 1 in 2011.

According to a July 2012 GAO report, existing Reg A has remained unpopular compared to other exemptions due to the high costs of complying with both federal and state registration requirements, as well as the $5 million limit on fundraising.

Under the SEC’s proposed rules to implement the new Reg A+, state registrations would not be required, and a small company would be able to raise up to $50 million from the public, deal in unrestricted securities (which are immediately re-sellable), engage in ‘testing the waters’ to gauge investor interest, and promote the offering to the broad marketplace.  The increase in the investment cap and the preemption of state laws will likely generate interest in this exemption, and could in some cases render it a viable competitor to the existing Reg D private offering exemption.

Bridging private and public markets: Given the proposed parameters of the Reg A+ exemption, there are expectations that it will provide a bridge for small companies that are seeking to grow but are not yet mature enough to proceed to the IPO on-ramp.  Additionally, companies in sectors, industries, or geographic regions that have struggled to gain access to traditional sources of capital might turn to this tool in order to seek funding from a larger pool of investors.  Real estate, life sciences and biotech, brick-and-mortar businesses such as restaurants, and perhaps even some technology companies outside of leading venture capital hubs may be drawn to the benefits of a Reg A+ offering.  It is also likely that traditional early-stage venture capital or private equity investors will welcome Reg A+ as a new exit option.

Finally, there are certain aspects of Reg A+ that could render it a viable model for companies looking to use Internet-based investment platforms to facilitate broader crowd-investing. For example, Washington, D.C.-based Fundrise utilized the existing Reg A exemption to raise $325,000 from crowd investors in D.C. and Virginia through its Web-based platform. The Web-raise could be considered one of the first equity crowd-investments in the country, but it did not need to wait on SEC implementation of the JOBS Act crowd-investing provisions since existing Reg A was already available. Now, with an increase in funding caps and the possibility of state law preemption, Reg A+ could draw even greater Web-platform interest.

Addressing the level of small company IPOs: The Reg A+ mini-IPO might also provide a capital solution for small companies that are not yet able to meet the costs or size requirements of today’s IPO market.  Depending on the SEC’s final rules, it is conceivable that a company would be able to file with the SEC under the Reg A+ exemption and then ultimately decide to list on a national exchange as a publicly reporting company.  In this way, small companies might have at their disposal a more cost-effective method of going fully public.

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As with all new securities law exemptions, however, there are open questions regarding the role of state regulators and the inclusion of adequate investor safeguards – though the registration requirements of Reg A+ call for significant disclosure.  There are also questions of how to make this exemption a viable, cost-effective tool for companies by ensuring regulatory harmony with other relevant securities rules, including those related to reporting company shareholder thresholds, which require public reporting once a company has more than 500 unaccredited investors.

In any event, stay tuned as a national discussion develops on adding the “plus” to Reg A.

[1] Sources: Bloomberg, Milken Institute

[2] Sources: Proposed Rule Amendments for Small and Additional Issues Exemptions Under Section 3(b) of the Securities Act: Page 211, Milken Institute

Daniel Gorfine is the director of financial markets policy and legal counsel in the Washington office of the Milken Institute. He focuses on entrepreneurship, capital access, and financial market issues.

This post was originally featured on the Milken Institute’s blog, Currency of Ideas, available at: http://currencyofideas.tumblr.com/.

In this alert, titled “A+ Indeed” http://www.mofo.com/files/Uploads/Images/131219-Reg-A.pdf, we provide an overview of the SEC’s proposed amendments to Reg A.  As we note in the alert, the SEC’s proposed rules move the United States one step closer to realizing the potential of the JOBS Act.  We expect that over time, amended Regulation A has the potential to become an important capital raising alternative for growing companies in the United States for which the IPO “on ramp” may be too steep a climb, or too costly an alternative.