Regulation A – Reborn or Lost Forever?
By John Hughes, Manager, SEC Practice Group, Assurance Services
Background and Recent Trends
On December 18, 2013, the U.S. Securities and Exchange Commission (“SEC”) voted to propose amendments to the rules and requirements associated with conducting an offering utilizing the exemptions available under Regulation A of the Securities Act of 1933.The proposed amendments to the rules under Regulation A came as a response to the mandate under Title IV of the Jumpstart Our Business Startups Act (the “JOBS Act”) requiring the SEC to create a new exemption under federal securities law allowing smaller companies to access the capital markets in a cost-effective manner.
Regulation A, which was originally adopted in 1936, currently permits an issuer to conduct an unregistered offering of up $5 million of securities in a given 12 month period.An offering conducted under Regulation A has no prohibition on general solicitation and the securities offering is freely tradable. Despite these benefits, Regulation A is rarely utilized today in its current form to raise capital. From 2009 through 2012, there were only 19 offerings conducted for aggregate proceeds of $73 million using the exemption available under Regulation A. During that same period, there were approximately 27,500 offerings conducted by companies raising up to $5 million or less for aggregate proceeds of approximately $25 billion utilizing the exemptions under Regulation D (more commonly known as a private placement). During that same period there were also 373 offerings of $5 million or less issued through the general securities registration process (either an initial public offering or registered direct offering)1. In 2012, the U.S. Government Accountability Office (“GAO”) reported that the main reasons smaller companies were not utilizing the exemptions under Regulation A were (a) that the costs associated with complying with individual state securities registration laws, commonly referred to as “blue sky laws,” (b) the costs associated with the filing and qualification process with the SEC and (c) that the availability of Regulation D exemptions, which are more cost effective.The proposed amendments under Title IV of the JOBS Act were passed to change these trends.
Summary of the Proposed Rules
The proposed rules by the SEC under Title IV would expand the exemption under Regulation A and create two tiers of Regulation A offerings:
Tier 1 – Tier 1 offerings would permit companies to raise up to $5 million, as currently regulated by the existing exemptions under Regulation A, with no more than $1.5 million to be raised on behalf of selling security holders and basically retains all of the material characteristics of the old rule.
Tier 2 – Tier 2 offerings would permit companies to raise up to $50 million, with no more than $15 million to be raised on behalf of selling security holders.
Under the new exemption, a company raising $5 million or less could elect to utilize Tier 1 or 2 under Regulation A. Other significant items under the regulations are as follows:
- Only companies with their principal place of business in the United States or in Canada qualify for the exemptions under Regulation A.In addition, the exemption is not available to SEC reporting companies;
- Only equity securities, debt securities and debt securities that are convertible into equity securities can be offered under Regulation A;
- Companies electing to issue up to $50 million under the Tier 2 structure would now be required to file audited financial statements with the SEC annually in accordance with the standards set forth by the Public Company Accounting Oversight Board on Form 1-K, as well as unaudited financial statements with the SEC semi-annually on Form 1-SA;
- A single investor can purchase securities in a Tier 2 offering up to 10% of the greater his or her annual income or net worth (an individual investor is not limited in a Tier 1 offering);
- Companies can “test the waters” (i.e. solicit interest in the potential offering) with the general public before the offering documents are filed with the SEC and;
- Issuers electing to conduct an offering under the Tier 2 structure of Regulation A would be exempt from individual state blue sky laws.
Challenges with State Securities Laws
As discussed above, the GAO concluded in mid-2012 that a significant reason issuers do not attempt to conduct and offering of securities using the exemptions currently available under Regulation A is a result of the mandatory compliance with state blue sky laws, which typically adds significant delay and cost to the offering process.Since proposing Title IV, the SEC has seen significant opposition from numerous states and the North American Securities Administrators Association (“NASAA”).In fact, in March 2014, the NASAA engaged a former SEC enforcement attorney to assist in opposing the passage of the current proposals under Title IV2.
A Look Forward
In 2012 alone, there were only 8 qualified Regulation A offerings compared to 7,700 Regulation D offerings for less than or equal to $5 million and this trend is expected to continue under the existing rules3.With the period for public comment on the proposed changes to Regulation A closing last month, and with the recent actions brought against the SEC by the various states, it is still too soon to predict when and in what form the proposed rules will be enacted and how much of an impact they will have. However, given the potential for smaller businesses to raise up to $50 million in freely tradable securities and avoid standard ongoing issuer requirements or state blue sky laws, small business owners have cause for optimism as the SEC moves toward enactment of Title IV in 2014.
This article is intended only to provide a brief summary of the proposed Regulation A rules. The full proposing release provided by the SEC is available http://www.sec.gov/rules/proposed/2013/33-9497.pdf.
John Hughes is a Manager in the SEC Practice Group of Marcum LLP and can be contacted at email@example.com or (212) 485-5574.
Georgia Quinn, who contributed to this article, is a Senior Associate in the Capital Markets Practice Group of Seyfarth Shaw LLP and can be contacted at firstname.lastname@example.org.