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Saturday
Apr272013

Regulation A+, the JOBS Act, and Public Offering Lite

[PDF]

David Rodman* 

Companies selling shares must register them with the Securities and Exchange Commission (“SEC” or “Commission”).[1] The Securities Act of 1933 (“1933 Act”) contains a number of exemptions from registration,[2] including one for small offerings.[3] Regulation A[4] (“Reg A”, or the “Regulation”) permits unregistered offerings of up to $5 million. [5] The Exemption, however, is rarely used.[6]

Reg A’s unpopularity stems from a number of factors. These include the low ceiling on the amount that can be raised, the applicability of state blue sky laws, and the costs of the required disclosure, including the obligation to file an offering circular.[7] In passing the Jumpstart Our Business Startups Act (“JOBS Act”), Congress attempted to encourage the use of the small offering exemption by adding “Regulation A+ (“Reg A+”).”[8]

Reg A+ has several attractive features. Offerings can raise up to $50 million a year.[9] The exemption permits issuers to “test the waters” to gauge investor interest.[10] Offerings can be marketed to unaccredited investors and purchasers receive freely transferable shares.[11] Nonetheless, the changes do not, for the most part, make Reg A+ an attractive exemption, particularly when compared to private placements under Rule 506.[12]

At the same time, Regulation A+ may function less as a replacement for private placements and more as a substitute for public offerings. When compared with an Initial Public Offering (“IPO”), issuers using Reg A+ are subject to a simplified registration process and reduced liability.[13] In other words, Reg A+ may properly be characterized as “public offering lite.”

This paper will examine the history of Reg A, including the factors behind its unpopularity. A section will be devoted to the reforms set out in the JOBS Act, including the benefits of Reg A+. The final section will discuss the likely impact of these reforms.

Background

Section 5 of the 1933 Act requires the registration of shares with the SEC.[14] The Act also contains a number of exemptions from registration. Section 3(b) exempts small offerings of less than $5 million.[15] Regulation A was designed to implement the exemption. The Regulation was intended to provide a simple and relatively inexpensive procedure to allow small businesses to raise limited amounts of capital.[16]

Regulation A applies only to non-reporting companies that conduct business in the United States or Canada.[17] Issuers must file an offering circular on Form 1-A[18] that is subject to SEC review and comment and must be qualified before sales can occur.[19] The Form must include financial statements prepared in accordance with generally accepted accounting principles, although they need not be audited.[20] Reg A offerings cannot exceed $5 million within any 12 month period.[21]

Reg A has a number of advantages. First, issuers relying on the exemption may “test the waters” by disclosing the prospective sales prior to filing the offering statement.[22] This approach permits something akin to gun jumping and allows issuers to determine the level of interest in the securities to be issued.[23] Second, issuers can use general solicitations to sell the shares.[24] Third, the shares can be sold to unaccredited investors.[25] Finally, once issued, the shares in a Reg A offering are unrestricted and freely transferable. [26]

The Failure of Regulation A

Despite these advantages, Reg A is rarely used.[27] The requirement of an offering statement generally necessitates the retention of lawyers and accountants.[28] SEC review and comment can cause delay.[29] The offerings also must be registered under state blue sky laws.[30] This typically requires registration by qualification,[31] a process that necessitates the filing of a substantive disclosure document that can vary from state to state.[32] These requirements add to the cost of the offerings, something that can be difficult to sustain given the low ceiling on the amount that can be raised.

Moreover, some of the more attractive features in Reg A may, in fact, have limited value. Although the shares issued pursuant to a Reg A offering are unrestricted, re-sales will often be difficult.[33] To the extent that issuers remain non-reporting companies following the offering, issuers will not need to file periodic reports.[34] Investors will likely not benefit from an active secondary market, including the use of the OTC Bulletin Board, as most investors would be hesitant to invest in a company with no reporting obligations.[35]

As a result of these factors, Regulation A has fallen into disuse. In 1997, there were 116 initial filings under Regulation A that resulted in 56 qualified offerings.[36] By 2011, however, the number of filings had fallen to 19, with the SEC qualifying only one.[37] In comparison, there were 15,500 Reg D offerings and 312 registered public offerings in 2011.[38]

JOBS Act to the Rescue?

Title IV of the JOBS Act sought to reverse this trend by making small offerings more attractive. Originally introduced as the Small Company Capital Formation Act of 2011 (“H.R. 1070”), the legislation was intended to encourage capital raising by eliminating some of the restrictions on the use of Regulation A.[39] As the report from the House Committee on Financial Services noted:

Amending Regulation A to make it viable for small companies to access capital will permit greater investment in these companies, resulting in economic growth and jobs. By reducing the regulatory burden and expense of raising capital from the investing public, H.R. 1070 will boost the flow of capital to small businesses and fuel America’s most vigorous job-creation machine. Regulation A offerings can also help entrepreneurial businesses attract private capital at lower costs than might be feasible in an initial public offering using full SEC registration procedures.[40]

H.R. 1070 proposed an amendment to Section 3 of the 1933 Act that would add a new exemption: “Regulation A+”.[41] Reg A+ would increase the ceiling for small offerings from $5 million to $50 million and preempt state registration requirements for any offering made through a broker/dealer, on an exchange, or to a qualified purchaser.[42]

The preemption issue proved controversial.[43] Some on the Committee on Financial Services argued that preemption would result in the creation of a class of securities not subject to adequate regulatory review by the states or the SEC.[44] Although the Committee rejected an amendment designed to limit the preemption of state law, the final bill adopted by the House only preempted state law for offerings made over an exchange or to qualified purchasers.[45] H.R. 1070 was ultimately incorporated into the JOBS Act and adopted without additional change.

Implementation: Will the JOBS Act Change Anything?

Title IV included Reg A+.[46] The new exemption permitted offerings of up to $50 million in any 12-month period.[47] Shares could be offered “publicly” and would not be restricted when issued.[48] Issuers were to file annually audited financial statements with the Commission,[49] were given the right to “test the waters” in advance of an offering, and were subjected to civil liability for false disclosure under section 12(a)(2) of the 1933 Act.[50] Finally, the bill authorized the SEC to impose other conditions such as the filing of an offering statement and the issuance of regular disclosure about a company’s operations.[51]

Regulation A+ as an Exemption from Registration

The JOBS Act corrected some of the deficiencies in offerings under Regulation A. The Act increased the maximum amount that could be offered, enabling small issuers to raise sufficient funds to more easily justify the costs associated with an offering. Issuers were allowed to test the waters, sell to an unlimited numbers of unaccredited investors, use general solicitations, and issue unrestricted shares.[52] Reg A+ was also made available to public companies.[53]

However, Reg A+ retained a number of the drawbacks that have traditionally discouraged the use of the small offering exemption. Moreover, offering circulars and SEC review added cost and delay,[54] as did the need for annual audited financial statements.[55] Additionally, Reg A+ made the civil liability provision in Section 12(a)(2) applicable to issuers.[56] Most importantly, offerings under Reg A+ remained subject to state blue sky laws in some cases.[57]

The JOBS Act also reduced the value of some benefits traditionally associated with small offerings. Like the original Reg A, Reg A+ offerings were permitted to rely on general solicitations to reach buyers.[58] At the same time, however, the JOBS Act also amended Rule 506 under Regulation D to permit general solicitations in offerings limited to accredited investors.[59]

As a result, Regulation D will likely retain its position as the most commonly used exemption. Rule 506, the most popular Reg D exemption, is exempt from state registration requirements, has no limit on amount, and, if limited to accredited investors, can be marketed through advertising.[60] Indeed, the mean offering size of Reg D offerings was $28.4 million in 2009, $30.9 million in 2010 and $30.7 million in 2011.[61] In other words, the mean offering was within the $50 million threshold adopted under Regulation A+. There is little reason to believe that issuers will rely on Regulation A+ rather than Rule 506 for these offerings.

 

Regulation A+ as “Registration Lite”

While Reg A+ is unlikely to replace existing exemptions in the capital raising process, it may provide an alternative to some registered offerings. Indeed, the legislative history indicated that Congress saw Reg A+ as a provision that would “help small issuers, such as venture-capital backed companies, gain access to funding without the costs and delays associated with the full-scale securities registration process.”[62]

As with a public offering, Reg A+ allows for the use of general solicitations and the sale of unrestricted securities to unaccredited investors.[63] Reg A+, however, has a number of advantages over registered offerings. First, a Reg A+ offering does not automatically subject the company to the periodic reporting requirements under Section 15(d).[64] Second, to the extent an issuer is required to file an offering statement, the document is not subject to the strict liability provisions contained in Section 11 of the Securities Act.[65] Third, the offering is likely to be subject to reduced disclosure obligations, both in the offering process[66] and with respect to the secondary market.[67]

Reg A+ may therefore be attractive to small companies that wish to raise a significant amount of capital through an offering sold to the public. Reg A+ allows this to occur while avoiding many of the onerous requirements of an IPO.[68]

Moreover, changes in the JOBS Act may make it less likely that offerings under Regulation A+ will trigger an obligation to register under Section 12(g) of the Exchange Act.[69] The JOBS Act raised the number of shareholders of record that triggers registration from 500 to 2000 (or 500 unaccredited shareholders).[70] Therefore, unlike public offerings, [71] offerings under Reg A+ will not automatically trigger an obligation to file periodic reports.

Experts in capital markets have suggested that underwriters will not be willing to market an offering under Reg A+ unless the issuer will list on a stock exchange.[72] Stock exchanges require that listed companies register with the SEC under Section 12 and file periodic reports.[73] These same experts have suggested that the Commission enact rules that specifically allow for national exchanges to list Reg A+ securities without requiring registration under Section 12 of the Exchange Act.[74]

Eliminating the registration requirement would facilitate listing and encourage underwriters to sell the shares.[75] Listing would encourage a secondary market and make the sale of the shares easier.[76] This is not to say that an underwriter will always be unavailable for a Reg A+ offering in the absence of a stock listing. There is a chance that a Reg A+ offering might present an underwriter with a risk/return ratio that convinces the underwriter to take part in the offering even without access to the exchanges. However, for the most part, lack of access to the exchanges will most likely chill underwriter participation in Reg A+ offerings.

Can Regulation A+ Ever Be Relevant?

Reg A will remain an exemption that is rarely used. The same is not inevitable for Reg A+. The use of Reg A+ may depend upon the implementing rules adopted by the SEC. The SEC can take a number of steps that will encourage the use of Reg A+.

First, the SEC can define “Qualified Purchaser” in a manner less restrictive than “Accredited Investor.” Offerings to qualified investors need not be registered under state law. Moreover, since Reg A+ has more robust disclosure requirements than Rule 506,[77] a broad interpretation of Qualified Purchaser would still leave in place considerable protections for investors that are not required for private placements.

Second, the SEC could draft rules that allow Reg A+ securities to be traded on national exchanges without triggering the reporting requirements of the Exchange Act.[78] The SEC could exercise its prerogative under section 2(G)(i) of Title IV of the JOBS Act and require a simplified form of reporting that is less onerous than the requirements of a reporting company. In this way the SEC would provide a second avenue for Reg A+ securities to be exempt from blue sky laws.

Finally, the SEC should allow companies that are subject to either Section 13 or Section 15(d) of the Exchange Act to utilize Reg A+. Currently, the SEC does not permit reporting companies to utilize Reg A.[79] Reporting companies can either issue more shares publically or conduct a private placement with Rule 506 if they are in need of more capital. Reg A+ would provide such issuers with a means to conduct an offering of unrestricted securities that would potentially be less burdensome, faster, and less expensive than a Securities Act registration.

Reg A+ will undoubtedly be more popular than Reg A but likely will not compete with exemptions such as Rule 506. Whether or not it will be a useful legislative creation rests on how the SEC chooses to handle the blue sky law issue and whether or not the exemption will be open to public companies.

 

 

 


       *.     J.D. Candidate 2013, University of Denver Sturm College of Law.

       [1].     15 U.S.C. § 77e (2012).

       [2].     15 U.S.C. § 77c (2012).

       [3].     15 U.S.C. § 77c(b)(1) (2012).

       [4].     Codified in SEC rules 230.251 through 230.263.

       [5].     17 C.F.R. § 230.251(b)-230.263 (2012).

       [6].     U.S. Gov’t Accountability Office, GAO-12-839, Securities Regulation: Factors that May Affect Trends in Regulation A Offerings, at 8.

       [7].     Id. at 15-17.

       [8].     H.R. 3606, 112th Cong. (2012) (enacted).

       [9].     15 U.S.C. § 77c(b)(2) (2012).

     [10].     Id.

     [11].     Id.

     [12].     17 C.F.R § 230.506 (1982). Under Rule 506, there is no limitation on the amount of capital that can be raised and offerings may be sold to up to 35 unaccredited, sophisticated investors and an unlimited number of accredited investors.  Offerings made under this rule do not have to be registered at the state level. Moreover, with the passage of the JOBS Act, issuers using Rule 506 may also test the waters prior to issuing.

     [13].     Compare 15 U.S.C. 77c (b)(2)(F) (2012), with 17 C.F.R. § 210.3-01 (2012).

     [14].     15 U.S.C § 77c (2012).

     [15].     Id. § 77c (b).

     [16].     U.S. Gen. Accounting Office, GAO/GGD-00-190, Small Business: Efforts to Facilitate Equity Capital Formation, at 31 (2000).

     [17].     See 17 C.F.R. § 230.251 (2012). An issuer relying on the exemption also cannot be an investment or blank check company, nor can it be a company that issues fractional undivided interests in oil or gas rights. Id.

     [18].     FORM 1-A REGULATION A OFFERING STATEMENT UNDER THE SECURITIES ACT OF 1933, http://www.sec.gov/about/forms/form1-a.pdf.

     [19].     17 C.F.R. § 230.251 (2012). The offering circular must be declared effective by the Commission. See Id. § 230.251(d)(2)(i)(A). See also FORM 1A, at 1 (noting that offering circular must be “qualified” by an order from the Commission).

     [20].     If audited financial statements are available, however, they must be provided. FORM 1A, at 30.

     [21].     Issuers cannot raise more than $5 million in a 12-month period. There can be no more than $1.5 million in shareholder sales in a 12-month period and shareholder sales count towards the $5 million total limit. 17 C.F.R. § 230.251 (b) (2012).

     [22].     17 C.F.R. § 230.254 (2012). In order to test the waters, the issuer must submit a copy of the written document (or script of broadcast) to the SEC on or before the date of its first use. The advertisement must state that no money is being solicited and, that if any is sent to the issuer in response, it will not be accepted. Finally, if the “testing the waters” provision is used, no sale may commence until 20 days after the last publication or broadcast of the advertisement. To the extent that there is inadequate interest, the issuer can terminate the offering process without having incurred significant expense.

     [23].     U.S. Gov’t Accountability Office, GAO-12-839, Securities Regulation: Factors that May Affect Trends in Regulation A Offerings, at 9 (2012).

     [24].     17 C.F.R. § 230.255 (2012).

     [25].     15 U.S.C § 77c (b) (2012). 

     [26].     U.S. Gov’t Accountability Office, GAO-12-839, Securities Regulation: Factors that May Affect Trends in Regulation A Offerings 5 (2012).

     [27].     Id. at 8-9.

     [28].     Id. at 17-18 (“Securities attorneys who have experience in assisting small businesses with obtaining the Regulation A exemption noted that their legal fees were relatively high due to the need to research individual state’s blue sky laws… prepare offering documents for individual states, and address comments both from SEC and some states.”).

     [29].     The review process can also add cost. Recent issuers of Regulation A securities have cited SEC comments that required repeated meetings with accountants to clarify accounting related information. Id. at 17.

     [30].     Id. at 13-15.

     [31].     Registration by coordination is only open to issuers that have registered their offerings with SEC and is generally not open to Regulation A issuers as they do not register at the federal level. Id. at 13. But the report noted that at least one state does permit Reg A offerings to be registered by coordination. Id. at 13.

     [32].     Id. at 14.

     [33].     Id. at 7 n.14.

     [34].     Regulation A is only available to companies that have not registered with the SEC under Section 12 of the Exchange Act. As a result, these companies are not subject to the obligation to file periodic reports under Section 13. Because Regulation A issuers have no reporting requirements Regulation A shares cannot trade on the major US stock Exchanges.  Id. at 7 n.14.

     [35].     Id.

     [36].     Small businesses can abandon or withdraw filings before the SEC can complete the review process.

     [37].     Id. at 9.

     [38].     Id. at 10-11.

     [39].     H.R. Rep. No. 112-206, at 3 (2011).

     [40].     Id. at 4.

     [41].     Id. at 2.

     [42].     Id. at 2, 10.

     [43].     Id. at 5 (“An amendment . . . to remove the broker-dealer exemption from all fifty states’ securities laws for selling Regulation A offerings, was not agreed to by a record vote of 20 yeas and 26 nays.”).

     [44].     Id. at 13.

     [45].     Id. at 4-5. The House passed the bill by a vote of 421 to 1. See FINAL VOTE RESULTS FOR ROLL CALL 820, http://clerk.house.gov/evs/2011/roll820.xml.

     [46].     Jumpstart Our Business Startups Act, H.R. 3606, 112th Cong. (2012), available at http://www.gpo.gov/fdsys/pkg/PLAW-112publ106/pdf/PLAW-112publ106.pdf.

     [47].     H.R. 3606, 112th Cong. at 19 (2012).

     [48].     Id. at 19.

     [49].     Id.

     [50].     Id. at 2.

     [51].     The Commission was given the authority to require periodic disclosure “regarding the issuer, its business operations, its financial condition, its corporate governance principles, its use of investor funds, and other appropriate matters.” Id. at 19-20.

     [52].     Id.

     [53].     See 15 U.S.C. 77r(b)(4) (2012) (amending NSMIA to exempt from state regulation shares issued under the small offering exemption and “offered or sold on a national securities exchange”). In contrast, Regulation A can only be used by non-reporting companies, a restriction added in 1992. See S.E.C.  Release No. 33-6949, Small Business Initiatives, at 2 (July 30, 1992); see also S.E.C. Release No. 33-6924, Small Business Initiatives, at 6 (Mar. 11, 1992) (“Reporting issuers have rarely used regulation A. In light of the simplified registration and reporting forms being proposed to meet the needs for capital raising by reporting small business issuers, they would no longer be permitted to rely upon the regulation A exemption.”).

     [54].     The provision also does not require the filing of an offering statement or require the SEC to qualify any offering statement. See 15 U.S.C. 77c (b)(2)(G) (2012) (providing that the Commission “may” require the filing and delivery of an offering statement). Nonetheless, the legislation seems to contemplate that this will occur.

     [55].     15 U.S.C. 77c (b)(2)(F) (2012).

     [56].     15 U.S.C. 77c (b)(2)(D) (2012).

     [57].     See 15 U.S.C. 77r(b)(4)(D) (2012) (exemptions are only given Reg A+ shares that are “offered or sold on a national securities exchange; or offered or sold to a qualified purchaser.”)

     [58].     See 15 U.S.C. 77c (b)(2)(B) (2012) (“The securities may be offered and sold publicly.”).

     [59].     Issuers engaging in general solicitations under Rule 506 must take “reasonable steps” to ensure that shares are sold only to accredited investors. See S.E.C. Release No. 33-9354, Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, at 4 (Sept. 5, 2012) (proposing release).

     [60].     H.R. 3606, 112th Cong. at 8 (2012).

     [61].     Scott W. Bauguess & Vladimir I. Ivanov, U.S. Sec. & Exch. Comm’n, Capital Raising in the U.S.: The Significance of Unregistered Offerings Using the Regulation D Exemption 1 (2012).

     [62].     H.R. Rep. No. 112-206, at 7 (2011).

     [63].     15 U.S.C. 77c (b)(2)(B) (2012).

     [64].     S.E.C. Release No. 33-6924, Small Business Initiatives, at 5 (Mar. 11, 1992) (“Further, the use of Regulation A does not automatically give rise to a reporting obligation under section 15(d) of the Exchange Act.”).

     [65].     Id. (“Since they are exempt from the registration requirements of the Securities Act, Regulation A offering documents are not subject to the strict liability provisions of Section 11 of the Securities Act.”).

     [66].     Reg A+ requires the annual filing of financial statements with the SEC. The legislative history indicates that this was designed to allow the SEC to require “issuers to submit an audited financial statement annually.” H.R. Rep. No. 112-206, at 9. Public offerings generally require two years of audited financial statements. See 17 C.F.R. § 210.3-01 (a) (2012).

     [67].     See supra note 35.

     [68].     For example: the expensive periodic reporting, proxy, tender offer, short-swing profits recovery and other provisions regulating public companies under the 1933 Act. 15 U.S.C. § 77g (2012).

     [69].     15 U.S.C. § 78l (g) (2012).

     [70].     H.R. 3606, 112th Cong. (2012) (enacted).

     [71].     Under Section 15(d) of the Exchange Act, a company with an effective registration statement is required to file periodic reports in the fiscal year when the offering occurs. 15 U.S.C. § 78o(d) (2012). No similar requirement applies to offerings under Reg A or Reg A+.

     [72].     Mike Liles, SEC Regulatory Initiatives Under the JOBS Act 3 (Apr. 12 2012), http://www.sec.gov/comments/jobs-title-iv/jobstitleiv-2.pdf.

     [73].     15 U.S.C. § 78m(a) (2012).

     [74].     Mike Liles, SEC Regulatory Initiatives Under the JOBS Act  2-4 (Apr. 12, 2012), http://www.sec.gov/comments/jobs-title-iv/jobstitleiv-2.pdf; William R. Hambrecht, Request for Public comments on SEC Regulatory Initiatives under the JOBS Act: Title IV – Small Company Capital Formation  4 (Jan. 4, 2013), http://www.sec.gov/comments/jobs-title-iv/jobstitleiv-21.pdf.

     [75].     Mike Liles, SEC Regulatory Initiatives Under the JOBS Act  3-4 (Apr. 12, 2012), http://www.sec.gov/comments/jobs-title-iv/jobstitleiv-2.pdf.

     [76].     Id.; William R. Hambrecht, Request for Public comments on SEC Regulatory Initiatives under the JOBS Act: Title IV – Small Company Capital Formation 3 (Jan. 4, 2013), http://www.sec.gov/comments/jobs-title-iv/jobstitleiv-21.pdf.

     [77].     See 15 U.S.C. 77c (b)(2)(F) (2012) (“The Commission shall require the issuer to file audited financial statements with the Commission annually”); 15 U.S.C. 77c (b)(2)(G) (2012) (“Such other terms, conditions, or requirements as the Commission may determine necessary in the public interest and for the protection of investors, which may include-- a requirement that the issuer prepare and electronically file with the Commission and distribute to prospective investors an offering statement, and any related documents, in such form and with such content as prescribed by the Commission, including audited financial statements, a description of the issuer's business operations, its financial condition, its corporate governance principles, its use of investor funds, and other appropriate matters…”) as opposed to the requirements for Rule 506 where the rules only relate to the accreditation of investors and provide almost no reporting requirements. 17 C.F.R. § 230.500-506 (2012).

     [78].     Admittedly, it is unclear whether or not the SEC would even have the authority to enact such an exemption. It is, however, an avenue that should at least be considered if Reg A+ is to be a valid exemption.

     [79].     17 C.F.R. § 230.251(a) (2012).

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