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By: Robert N. Rapp, Calfee Halter & Griswold LLP
LEXIS PRACTICE ADVISOR RESEARCH PATH: Securities & Capital Markets > State Securities Regulations – Blue Sky Laws> Blue Sky Laws > Practice Notes > “Regulation A-Plus” Limited Public Offerings under Securities Act Section 3(b)(2)
ON JUNE 19, 2015, U.S. SECURITIES AND EXCHANGE COMMISSION (SEC) rules implementing congressionally-mandated amendments to Section 3(b) of the Securities Act of 1933 to modernize Regulation A under the Act, and launching “Regulation A-Plus,” became effective. The maximum permitted offering amount under Regulation A was raised from $5 million to $50 million, and significant changes to the regulatory structure for these limited public offerings were made. “Regulation A-Plus” is the characterization commonly applied to the reformulated Regulation A that is now covered by SEC rules adopted pursuant to Section 3(b)(2) of the Securities Act, which was added by the Jumpstart Our Business Startups Act (the JOBS Act) (112 P.L. 106). The rules provide for two tiers of offerings under updated and expanded Regulation A: Tier 1, for offerings of securities up to $20 million in a 12 month period; and Tier 2, for offerings up to $50 million in a 12 month period. Certain basic requirements are applicable to both Tiers, although for Tier 2 offerings there are additional disclosure and ongoing reporting requirements. Distinctions between the two include investment limitations and the application of state Blue Sky Laws.
Since the June 19, 2015 effective date for Regulation A-Plus, representatives of the Office of Small Business Policy of the SEC Division of Corporate Finance report more than forty issuers have filed Offering Statements or private draft Offering Statements, as now permitted under Regulation A-Plus. Several other filings have been withdrawn. To date, three have been declared qualified by the SEC. Others remain pending in the review process. Where applicable, the offering process includes review and qualification requirements under state Blue Sky Laws for those Regulation A-Plus offerings that are still subject to state registration and qualification requirements, and for which the North American Securities Administrators Association (NASAA) “Coordinated Review Process” among states is now operating.
In Section 401 of the JOBS Act, Congress mandated the creation of a new exemption from registration requirements under the Securities Act for public offerings of up to $50 million of securities within a 12-month period. The JOBS Act amended what was formerly Section 3(b) of the Securities Act (now Section 3(b)(1)), which establishes authority of the SEC to exempt offerings of securities up to $5 million, to add a new Section 3(b)(2), directing the SEC to adopt rules exempting offerings up to $50 million of securities offered and sold publicly, where certain disclosure requirements are met, and on such other terms, conditions, and requirements as the SEC may prescribe. “Regulation A,” a limited exemption for public offerings of small issues adopted by the SEC pursuant to longstanding original Section 3(b) authority in 1936, had shown itself over time to be of little use to small business issuers when costs and complexity of the offering process were weighed against the limited amount of capital permissibly raised. Indeed, original Regulation A virtually disappeared from the capital formation landscape.
Although preserving general SEC small-issue exemption authority for offerings up to $5 million in what is now Section 3(b)(1) of the Securities Act, Congress added Section 3(b)(2), directing the SEC, by rule or regulation, to add a class of securities exempted from registration under the Securities Act when the aggregate offering amount of all securities offered and sold within the prior 12-month period in reliance on the exemption does not exceed $50 million. While generally authorizing the SEC to set the terms, conditions, and requirements it deems necessary in the public interest and for the protection of investors, Congress expressly prescribed the following for what is now commonly referred to as “Regulation A-Plus”:
Section 3(b)(2) limits Regulation A-Plus to the offer and sale of equity securities, debt securities, and debt securities convertible or exchangeable to equity interests, including any guarantees of those securities. The $50 million maximum aggregate offering amount is to be reviewed by the SEC every two years, and shall be increased in such amount as the SEC determines to be appropriate. In the event the SEC determines not to increase the offering amount, it must report to designated House and Senate committees its reasons for not increasing the amount. Although not mandated by Section 3(b) (2), the SEC is expressly authorized to include among terms, conditions, or requirements for modernized Regulation A offerings: (1) a requirement for filing and use by issuers of an “offering statement” and related documents; and (2) “bad actor” disqualification provisions that are substantially similar to those in place for exempt private offerings pursuant to Rule 506 of Regulation D under the Securities Act. The SEC is also expressly authorized to require ongoing periodic disclosures regarding the issuer, its business operations, financial condition, corporate governance, use of investor funds, and other matters deemed appropriate.
To satisfy the JOBS Act mandate in Section 3(b)(2) of the Securities Act, the SEC set about to craft a revision of existing Regulation A that would promote small company capital formation while providing for meaningful investor protection. On March 25, 2015, the SEC adopted rules to create two “tiers” of offerings: Tier 1, for offerings up to $20 million (including no more than $6 million on behalf of selling security holders) in a 12 month period; and Tier 2, for offerings up to $50 million (including no more than $15 million on behalf of selling security holders) in a 12 month period. In certain circumstances, including a first time offering by the issuer pursuant to Regulation A, the portion of the aggregate offering price attributable to selling security holders may not exceed 30% of the aggregate offering price of the Regulation A offering. Baseline requirements for both Tiers build on former Regulation A, and preserve, with some modifications, provisions regarding issuer eligibility, offering circular requirements, “testing the waters,” and “bad actor” disqualifications. Tier 2 offerings are subject to additional requirements in line with the Section 3(b)(2) mandates, including provisions for audited financial statements, ongoing reporting obligations, and certain limitations on sales. State securities law registration and qualification requirements for securities offered and sold in Tier 2 offerings to “qualified purchasers” are preempted. Tier 1 offerings remain subject to both federal and state registration and qualification requirements. The rules became effective on June 19, 2015.
Eligible Issuers
The issuer of securities to be offered and sold pursuant to either Tier 1 or Tier 2 of Regulation A must be an entity organized under the laws of the United States or Canada, or any State, Province, Territory or possession, or the District of Columbia, with its principal place of business in the United States or Canada, and which:
“Bad Actor” Disqualification
Bad actor disqualifications from use of Regulation A-Plus align with the provisions in Rule 506(d) of Regulation D, with the added disclosure requirement applicable to both Tier 1 and Tier 2 offerings that the issuer include in the Offering Circular a description of any matters that would have triggered disqualification, but which occurred prior to the effective date of the rule. Covered persons include managing members of limited liability companies, compensated solicitors of investors, underwriters, executive officers, and other officers participating in the offering, as well as beneficial owners of 20% or more of the issuer’s outstanding voting securities, calculated on the basis of voting power. Bad actor disqualifications from Regulation A also include, as triggering events, final orders or bars of certain state or federal regulators, and SEC cease-and- desist orders relating to violations of scienter-based antifraud provisions of the federal securities laws or Section 5 of the Securities Act of 1933.
The Offering Process
The offering process for either Regulation A-Plus Tier 1 or Tier 2 offerings centers on the electronic filing with the SEC of an “Offering Statement” on Form 1-A. The key part of the Offering Statement is an “Offering Circular,” a narrative disclosure document. Except for solicitation communications, discussed below, no offer of securities may be made until the Offering Statement is filed. Thereafter, oral offers may be made, as well as written offers by means of solicitation communications meeting certain conditions, or a “Preliminary Offering Circular,” described further below. However, no sales of securities may be made until the issuer’s Offering Statement has been “qualified” by the SEC. Key elements of the offering process are summarized further below.
(1) Solicitation of Interest (“Testing the Waters”). At any time before the qualification of an Offering Statement, including before the non-public submission or public filing of the Offering Statement, an issuer or any person authorized to act on behalf of the issuer may solicit interest in a potential offering. Solicitation materials are made subject to the antifraud provisions of the federal securities law, and certain conditions apply. The communications must state that no money or other consideration is being solicited, and if sent in response, will not be accepted, and also that no offer to buy the securities will be accepted until the Offering Statement is qualified. The communication must also state that a person’s indication of interest involves no obligation or commitment of any kind. When used after the Offering Statement is publicly filed, the communication must either include the Preliminary Offering Circular or state from whom the most recent version of the Preliminary Offering Circular may be obtained, including contact information. This requirement may be satisfied by providing the uniform resource locator (URL) where the Preliminary Offering Circular, or the Offering Statement itself, may be obtained. The communication may include a means by which a person may indicate interest in the potential offering.
(2) The Offering Statement. Issuers must electronically file an Offering Statement with the SEC through the EDGAR System. The Offering Statement content is prescribed by Form 1-A under the Securities Act, and consists of three parts. Part I serves as a notice of certain basic information about the issuer and the offering, and helps confirm the availability of the exemption. Part II is the Offering Circular, a narrative disclosure document, which includes financial statements as required. Part III is comprised of required exhibits. Importantly, an issuer whose securities have not previously been sold pursuant to a Regulation A offering or an effective registration statement under the Securities Act may submit a draft Offering Statement for non-public review by the SEC staff before public filing. Draft Offering Statements must also be submitted electronically through EDGAR. Provision for submission of draft Offering Statements is intended to allow a preliminary assessment of content and identification of staff concerns that could delay or prevent qualification of the offering when publicly filed.
(3) Financial Statement Requirements. Financial statements for Tier 1 and Tier 2 issuers include a balance sheet and related financial statements for the previous two fiscal years (or such shorter period as the issuer may have been in existence), which are dated not more than nine months before the date of non-public submission, filing, or qualification, with the most recent annual or interim balance sheet not older than nine months. Where interim financial statements are necessary, they must cover a period of at least six months. The financial statements of Tier 2 issuers must be audited in accordance with U.S. GAAP or the standards of the Public Company Accounting Oversight Board.
(4) The Offering Circular and Preliminary Offering Circular. Issuers in Regulation A-Plus offerings have always been required to utilize a structured disclosure document, the Offering Circular, containing information specified by Form 1-A. That requirement is preserved for offerings of either Tier under Section 3(b)(2) of the Securities Act. As with prospectuses in a registered offering, the Offering Circular for Regulation A offerings is the core of the Offering Statement filed with the SEC. The Offering Circular covers numerous categories of information about the issuer and the offering, and more closely aligns Regulation A disclosure with the smaller reporting company disclosure requirements for registered offerings, but with some specifically scaled elements. Also, for Tier 2 offerings, issuers are required to include audited financial statements.
After the Offering Statement is filed, but prior to its qualification by the SEC, issuers may offer the securities utilizing a Preliminary Offering Circular. The document must be identified as a Preliminary Offering Circular and include a prescribed legend highlighted by prominent type or otherwise stating, among other things, that the securities may not be sold, nor may offers to buy be accepted, before the Offering Statement filed with the SEC is qualified. The Preliminary Offering Circular must contain substantially the information required in the Offering Circular by Form 1-A, although certain pricing and related information may be omitted. It is filed with the SEC as part of the Offering Statement. Issuers that offer to prospective purchasers in reliance on the delivery of a Preliminary Offering Circular must, not later than two business days after completion of a sale, provide the purchasers with a copy of the final Offering Circular, or a notice containing the URL where the final Offering Circular or the Offering Statement in which the final Offering Statement is contained, may be obtained.
(5) Investment Limitation. For Tier 2 offerings, investment limitations are imposed for sales to natural persons who are not accredited investors, as defined in Rule 501(a) of Regulation D. No sale may be made to a non-accredited purchaser if the aggregate purchase price paid for the securities is more than 10% of the greater of such purchaser’s annual income and net worth, also as provided in Rule 501 of Regulation D. Issuers may rely on the representation of compliance by the purchaser, provided that the issuer does not know at the time of sale that any such representation is untrue. There is no investment limitation on sales to accredited investors. The investment limitations in a Tier 2 offering will not apply to the sale of securities that will be listed on a national securities exchange upon qualification. There are no investment limitations in Tier 1 offerings, which remain subject to regulation under state Blue Sky Laws.
(6) Integration with Other Offerings. For either Tier 1 or Tier 2 offerings, an integration safe harbor is provided, such that a Regulation A offering will not be integrated with:
If none of the safe harbor criteria apply, whether subsequent offers and sales of securities will be integrated with the Regulation A offering will depend on particular facts and circumstances and application of long-established factors for determining whether offers and sales of securities should be integrated that are identified, for example, in Rule 502 of Regulation D.
(7) Insignificant Deviations from a Term, Condition, or Requirement. A failure to comply with a term, condition, or requirement for either Tier 1 or Tier 2 offerings will not result in a loss of the exemption from registration requirements under the Securities Act for any offer or sale to a particular individual or entity if the issuer establishes that: (1) the failure to comply did not pertain to a term, condition, or requirement directly intended to protect that particular individual or entity; (2) the failure to comply was insignificant with respect to the offering as a whole, except that a failure to comply with certain baseline provisions such as issuer eligibility requirements and the offering amount limitations of Regulation A will be deemed to be significant to the offering as a whole; and (3) a good faith attempt was made to comply with all applicable terms, conditions, and requirements.
Periodic Reporting
Although issuers utilizing Regulation A-Plus for Tier 1 offerings do not become subject to Securities Exchange Act of 1934 periodic reporting requirements, and Tier 2 issuers may not become subject to those requirements if certain conditions are satisfied, all Tier 2 are subject to annual (Form 1-K) and semiannual (Form 1-SA) reports, as well as current event updates (Form 1-U), all of which are filed electronically with the SEC. Issuers may also be required to provide “special financial reports” to investors on either Form 1-K or 1-SA in the event that the Offering Statement did not contain audited financial statements covering certain time periods between the time the financial statements are included in Form 1-A and the issuer’s first periodic report due after qualification of the offering statement. Issuers conducting Tier 2 offerings exit the Regulation A reporting requirements at such time as they become subject to the Exchange Act reporting requirements. Also, Tier 2 issuers eligible to exit the ongoing reporting requirement may do so at any time by filing a Form 1-Z Exit Report after completing reporting for the fiscal year in which the offering statement was qualified, provided the securities to which the Offering Statement filed with the SEC are held of record by less than 300 persons (1,200 persons for a bank or bank holding company), and that the issuer has filed all reports due for a prescribed period of time before filing Form 1-Z, and offers and sales made in reliance on a qualified Offering Statement are not ongoing.
Issuers in Tier 1 offerings are not subject to any ongoing reporting requirements, other than the requirement to report the completion or termination of the offering on Form 1-Z.
Preemption of State Blue Sky Laws
Historically, Regulation A offerings were fully subject to registration and qualification requirements under state securities laws in the absence of an available exemption. That remains the case for Tier 1 offerings under Regulation A-Plus, which are perceived as a category of securities that is likely to be more local in character. However, for Tier 2 offerings, which are seen as involving a category of securities that is more national in character, state registration and qualification requirements are preempted to the extent that the securities are offered or sold on a national securities exchange, or are offered or sold to “qualified purchasers,” as that term is defined by the SEC. The preemption is made complete, however, as a result of adding Rule 256 (17 CFR 230.256) to Regulation A, defining “qualified purchaser” for purposes of National Securities Markets Improvement Act of 1996 (NSMIA), Securities Act section 18(b)(3), to include any purchaser of a security in a Tier 2 offering. NSMIA makes the offer and sale of any security to a qualified person, as the SEC shall define, into a NSMIA “covered security,” for which any state registration and qualification requirements are preempted. For Tier 2 offerings, although state registration and qualification requirements are preempted, state securities regulators retain antifraud enforcement authority and the authority to impose notice filing and fee requirements. As noted above, state authority over Tier 1 offerings, including registration and qualification requirements, remains fully applicable. Importantly, for those offerings NASAA has developed and implemented a “Coordinated Review Process” to streamline state review.
Two states, supported by NASAA, have challenged the Tier 2 state preemption provisions of Regulation A-Plus as improper rulemaking by the SEC. Their challenge currently remains unresolved in the U.S. Court of Appeals for the D.C. Circuit.
When adopting the final rules for implementing Regulation A-Plus, the SEC recognized that its potential use for Tier 2 offerings will “depend largely on how issuers perceive the trade-off between costs of qualification and ongoing disclosure requirements and the benefits to issuers from access to a broad investor base, expansion of the offering size, and preemption of state securities law registration requirements and the potential for enhanced secondary market liquidity.” For Tier 1 offerings, obviously the costs attributable to state regulation must be added to the calculus, and the maximum offering amount limitation weighs more heavily in the decision to proceed under Regulation A versus alternative avenues in capital formation. Although a number of issuers have begun the Regulation A-Plus limited public offering filing and SEC review process, with only one of them so far qualified and several withdrawn, there is no evidence yet whether the trade-off will actually prove beneficial. Although Regulation A-Plus is a central feature of the JOBS Act, business start-ups raising seed capital will almost certainly look elsewhere to available true exemptions from registration and qualification requirements.
The JOBS Act focus on facilitating access to capital by business start-ups is clearly manifested in the changes to Rule 506 of Regulation D under the Securities Act of 1933, which permit general solicitation and advertising for sales of securities to accredited investors, and in the mandate for national crowdfunding. Although final rules implementing congressionally mandated national crowdfunding are not yet in place, an increasing number of states have adopted intrastate equity crowdfunding exemptions in their Blue Sky Laws or rules which, subject to limitations that largely mimic federal JOBS Act crowdfunding limitations and requirements, likely offer more practical, cost efficient small business capital raising alternatives than Regulation A-Plus. Critics of Regulation A-Plus argue that it does nothing meaningful to facilitate small business capital formation because of high costs, and because Tier I offerings remain subject to registration and qualification requirements under State Blue Sky Laws. Actual small business issuers, they argue, are no better off.
The congressionally mandated modernization of Regulation A was intended to breathe new life into a capital formation alternative that had been virtually abandoned. In its reincarnated form, Regulation A-Plus remains a lesser regulated form of registered public offering, but one nonetheless involving meaningful compliance burden and expense on an on-going basis. On that basis, some commentators have observed that Regulation A-Plus is unlikely to provide any meaningful relief to small business issuers facing the challenge of efficient capital raising. It may, on the other hand, be attractive to larger, well-established private or semi-private companies that, for example, can look to Regulation A-Plus to raise debt capital, and for second stage financing in general. The array of issuers with Regulation A-Plus offering statements currently filed does not yet suggest an emergent user profile. The offering for which the first qualification of a Regulation A-Plus offering was granted is a Tier I offering of “Participation Interests” representing undivided fractional interests in the principal amount of loans made by the company for real estate projects. The issuer previously offered and sold various forms of securities in private placements or in reliance on other exemptions from federal and state registration requirements.
The current Tier I Regulation A-Plus offering, to be carried out by the issuer itself through a web-based platform, has been undertaken using the NASAA Coordinated Review Program, and company management has publicly endorsed the process. That said, an ultimate assessment of the utility of Regulation A-Plus for Tier 1 offerings by small business issuers will await more empirical evidence, although Tier II may well prove to be attractive relative to the costs when Blue Sky regulation is removed from the calculus.
Bob Rapp is Senior Counsel in the Securities and Capital Markets Group of Calfee, Halter & Griswold, LLP, and is Distinguished Practitioner In Residence at the Case Western Reserve University School of Law, where he teaches Securities Regulation, Advanced Securities Regulation, and Law, Theory and Practice in Financial Markets.