SEC Proposes Rules for Regulation A+ under the U.S. JOBS Act: A New Option in Corporate Finance for Young Companies

Jonathan Guest - McCarter & English LLP

Overview and Discussion of Key Provisions

On December 18, 2013, the SEC released proposed rules to implement Title IV of the JOBS Act, now referred to as Regulation A+. [1] Although it received much less attention than the other provisions in the Act, Regulation A+ could bridge a difficult gap in the capital formation process that small companies encounter. In particular, these are companies that have a financing goal larger than privately-sourced equity generally permits but may not be ready for the expense and risk of an IPO.

Comments in the SEC release cite two surveys that concluded regulatory compliance costs of IPOs average $2.5 million initially, followed by an ongoing $1.5 million per year. Suppose a small company could achieve a similar result – a public offering exempt from registration resulting in freely tradable shares – for a fraction of the cost? Regulation A+ has that potential, and could enable cost-efficient small public offerings, not always possible in recent years.

By permitting companies to raise up to $50 million annually under Regulation A+ the JOBS Act addresses a major problem of current Regulation A offerings which were capped at $5 million annually. [2] The JOBS Act amended Section 3(b) of the Securities Act of 1933 ("Securities Act") following which the SEC undertook the rulemaking for Regulation A+.

The SEC proposes two levels for Regulation A+: Tier 1 (up to $5 million in any 12-month period including up to $1.5 million for the account of selling securityholders) and Tier 2 ($50 million and $15 million respectively). The proposals preserve attractive parts of current Regulation A and would overcome some major stumbling blocks. Notable highlights include:

  • A company could "test the waters" for investor interest even before filing documents.

  • Tier 2 offerings would be exempt from state "blue sky" regulation.

  • Ongoing SEC reporting for Tier 2 issuers is less demanding than for other SEC reporting companies.

  • Tier 2 companies could develop a trading market for their shares.

  • Tier 2 companies could finance using shelf and continuous offerings.

  • The offerings continue not to be subject to Section 11 liability imposed on registered offerings.

Eligible Issuers. As proposed, Regulation A+ would be available for any U.S. or Canadian entity that (i) has a principal place of business in the U.S. or Canada, and is not subject to the reporting requirements of the Securities Exchange Act of 1934 [3] ("Exchange Act") before the offering. [4] Certain types of primarily non-operating entities are excluded. [5] The "bad actor" disqualification rules under current Regulation A remain but are revised largely to conform to the rules recently adopted in connection with new Rule 506(d). Also disqualified are Regulation A+ issuers that have fallen out of compliance with their ongoing reporting requirements for over two years (detail below).

Eligible Securities. The proposals track the statutory JOBS Act language that limits securities that may be issued under Regulation A+ to equity securities, debt securities and debt securities convertible or exchangeable into equity securities, including guarantees. Excluded are asset-backed securities. Although the proposed rules don't directly state that preferred securities are eligible, the Form 1-A Regulation A Offering Statement makes clear that "equity" includes preferred stock, and that options, warrants and other rights to acquire another security are also eligible.

Investment Limitation. The proposed rules would limit the investment amount for an individual investor to no more than the greater of 10% of annual income or net worth. Calculation of income and net worth would be as now done for accredited investors under Regulation D. An issuer is only required to notify the investor of the limit and may rely on the investor's representation of compliance. This is notably less demanding than the current verification standard for generally advertised Rule 506 private placements.

Integration with Other Offerings. Companies that seek to rely on Regulation A+ are likely to have conducted past offerings or be considering future capital formation options and would be concerned that the Regulation A+ exemption would be lost if the past or future offerings were "integrated" into a Regulation A+ transaction. Integration can have the drastic consequence of a company unwittingly conducting an unregistered public offering in violation of Section 5 of the Securities Act. Fortunately, the proposed rules include safe harbors that reduce the risk of integration. Safe harbors would cover all past offers and sales of securities as well as six types of future offerings, perhaps the most useful of which is any offer or sale made more than 6 months after completion of the Regulation A+ offering [6] – a bright line for non-integration.

Offering Disclosure. A company intending to conduct a Regulation A+ offering must file an offering statement with and have it qualified by the SEC. [7] This is a disclosure document intended to provide information needed for investors to make an investment decision. The rules would require use of new Form 1-A which in its itemized format is similar Form S-1 for registered offerings. Form 1-A consists of three parts: Part I – Notification, Part II – Offering Circular (similar to a prospectus in a registered offering), and Part III – Exhibits. Part II requires disclosure of important information about the issuer including material risks; use of proceeds; description of the business; discussion of financial condition and results of operations (MD&A); disclosure about directors, executives and key employees; compensation of directors and officers; beneficial security ownership information; description of offered securities; and two years of financial information. [8] These items are obviously modeled on a Form S-1 registration statement, and a Regulation A+ issuer has the option of using Part 1 of Form S-1 as the offering circular in a Form 1-A offering statement. Form 1-A, however, is designed to be less burdensome by reducing the scale and scope of disclosure.

Financial Statements. Financial statements of a Tier 1 issuer are not required to be audited unless the issuer has obtained an audit for other purposes. Audited financial statements are required for Tier 2 issuers. For Tier 1, the accountants must meet independence standards but are not required to be registered with the Public Company Accounting Oversight Board. Audit firms for Tier 2 issuers must be independent and PCAOB-registered.

Confidential Submission. The proposed rules would permit an issuer to submit an offering statement to the SEC on a confidential basis. This is similar to the JOBS Act provision for registered offerings by emerging growth companies and in effect allows a Regulation A+ issuer to get the process underway while soliciting interest of investors (detail below) without negative publicity risk if it alters or withdraws the offering before qualification by the SEC. The confidential filing, SEC comments, and all amendments must be publicly filed as exhibits to the offering statement at least 21 calendar days before qualification. [9]

SEC Review. Consistent with long-standing policy, the SEC would review the offering statement for accuracy and completeness of disclosure, not the merits of the company or the offered securities. We anticipate that the SEC staff will aim to issue comments within the same time-frame (about 30 days) as it now does for registration statements. Similar to the IPO process, a comment and amendment process will typically follow.

Offering Communications – "Testing the Waters". Companies raising capital often desire to communicate with prospective investors to gage interest before incurring too great an expenditure of resources. Early communications have traditionally been subject to a range of restrictive rules. The communications rules for Regulation A+ offer considerable flexibility. For example, even before a non-public filing of its offering statement, a company (or anyone on its behalf) could communicate orally or in writing with anyone to determine level of interest. [10] Unlike testing the waters by emerging growth companies that are limited to QIBs and accredited investors, a Regulation A+ company could reach out to retail and non-accredited investors. Provided the antifraud provisions of federal securities law are complied with, solicitation-of-interest materials could be a well-crafted slide deck. After the public filing but before SEC qualification, a company may use its preliminary offering circular to make written offers. Solicitation material must be submitted or filed as an exhibit.

Continuous or Delayed Offerings. The proposed rules modernize current Regulation A by enabling companies to conduct continuous or delayed offerings. This would mean that companies could undertake so-called "shelf" offerings and also qualify the public resale of shares issued on exercise of warrants and options. The ability to sell securities in a "takedown" from the shelf from time to time, or to conduct a primary offering comprised of units of shares and warrants, is often utilized by small publicly-traded companies and should facilitate the attraction of Regulation A+. [11] This accommodation, however, would be limited to companies that undertake Tier 2 offerings and remain current in their reporting with the SEC.

Securities Act Liability. Participants in a Regulation A+ offering (e.g., any underwriter and signatories of the offering statement) are not subject to liability under Section 11 of the Securities Act which applies only to registered offerings. Sellers, however, would have Section 12(a)(2) for an offering statement or solicitation materials that contain a materially false statement or omission. Although Section 12 can never be ignored for any offering, Section 11 considerations typically have a major impact on the IPO process; so the difference for a Regulation A+ is worth attention. The general antifraud provisions of federal and state securities law always apply.

Ongoing Reporting; "exits". Unlike current Regulation A which does not require ongoing reporting with the SEC other than to report sales or termination of the offering, the proposed rules contemplate two regimes. A Tier 1 company need only file certain information about the Regulation A+ offering on new Form 1-Z. Tier 2 companies would be required to submit ongoing reports: an annual report on Form 1-K, semi-annual reports on Form 1-SA, current reports on Form 1-U and special financial reports on Form 1-K and Form 1-SA (all filed electronically on EDGAR). Although based on the continuous disclosure regime for registered companies, the ongoing reporting for Tier 2 companies is less demanding (fewer 1-K items, semi-annual 1-SA rather than the quarterly 10-Q) and with fewer events triggering Form 1-U [12] (compared to Form 8-K). The SEC anticipates that companies would use their Regulation A+ offering circular as the basis for the ongoing reports, and they may incorporate by reference text from previous filings.

The proposed rules also provide for "escape valves" for a Regulation A+ issuer that desires to suspend or terminate its reporting requirements. Modeled on the rules for Exchange Act reporting companies, termination requires that a company be current over stated periods in its reporting, have fewer than 300 shareholders of record, and no ongoing offers or sales in reliance on a Regulation A+ offering statement. At the other end of the "exit" spectrum, if a company desires to become a full Exchange Act reporting company, it may do so by filing Form 10. [13]

Not Subject to Certain Exchange Act Compliance. In addition to the reduced reporting noted above, a Tier 2 issuer would not be subject to other Exchange Act compliance, including among others:

  • SEC proxy statement rules

  • Section 16 reporting by directors, officers and 10% stockholders of ownership and transactions in issuer securities

  • Williams Act disclosure by 5% stockholders

  • Regulation FD compliance to prevent selective disclosure of material information

  • Internal financial and disclosure effectiveness controls under the Sarbanes-Oxley Act

  • CEO/CFO certifications required by Sarbanes-Oxley for 10-K and 10-Q reports

Secondary Trading. Perhaps most important, the ongoing-reporting regime enables creation of a public market with the potential for resale liquidity in the securities sold under Regulation A+. This is essential for initial investors who want to resell securities they bought directly from a company in a primary offering and later investors who desire to buy and sell on the open market. Of course, development of an active market remains uncertain as the securities would presumably be sold over-the-counter. That said, trading platforms have been developed to raise public awareness and facilitate trading of stock of companies not listed on the well-known national stock exchanges.

Freely-tradable securities. Securities sold in a Regulation A+ offering, like those under current Regulation A, are not subject to transfer restrictions (as for privately-placed securities), such as a holding period or other limitations imposed on resales by Rule 144 under the Securities Act.

National securities exchanges. In its current form, the only route for a Regulation A+ issuer to have its securities listed on a national securities exchange would be by filing Form 10, a form that triggers compliance with the fully panoply of Exchange Act requirements. The proposed rules, however, would permit the ongoing reports to be sufficient for Rule 15c2-11 purposes so as to enable broker-dealers in connection with publishing quotations.

State Securities Law. Several commenters to Title IV, including this firm, urged the SEC to propose rules that exempt state securities law review of Regulation A+ offering statements – widely considered a major reason current Regulation A is rarely used. The proposed rules would define "qualified purchaser"[14] as any offeree in Tier 1 and any purchaser in Tier 2. The practical effect is to allow "testing the waters" for Tier 1 (up to $5 million), but federal and state review and qualification if, after determining investor interest, a company files an offering statement. For Tier 2, the qualified-purchaser concept is expanded to include all purchasers, thereby pre-empting state review entirely, which from a company perspective means it must only comply with one level of government review and qualification, namely the SEC.

What Companies Should Consider Regulation A+?

Although the benefits of Regulation A+ can be readily seen, is should also be apparent that it is not appropriate for every company and a Tier 2 offering should not be lightly undertaken. One could view Regulation A+ as yet another answer to the problem addressed by the JOBS Act – how to facilitate capital formation by small companies that find fundraising from family and friends too restrictive, the bar too high if limited to venture capital firms, and the expense and completion risk too great in a traditional IPO. The JOBS Act addresses these with (1) crowdfunding (for very early stage companies), (2) generally advertised private placements (enabling access to a larger pool of investors but purchasers must be accredited) and (3) the IPO for emerging growth companies (reduced registration requirements, on-ramp to becoming fully SEC reporting). Regulation A+ fills a "gap" between (2) and (3) by permitting a public offering for a capital raise of substantial amounts without registration, yet enabling a resale trading market for investors exits and after-market purchasers. And the companies wouldn't have to close the door on an eventual transition to becoming a full Exchange Act reporting company and possible national securities exchange listing.

[1] The SEC's discussion of the proposed rules cites a number of suggestions in our July 2012 comment letter to increase the attractiveness of the Regulation A+ finance option.

[2] The relatively high transaction costs (given the low annual cap) arising from compliance with both federal and state securities regulators, and resulting delays, have been cited for the decline in use of current Regulation A.

[3] Specifically, those required by Section 13 or 15(d): primarily Form 10-K annual report, 10-Q quarterly report and 8-K current report.

[4] The Financial Industry Regulatory Agency treats Regulation A as a public offering under Rule 5110, which means that FINRA members cannot participate unless they comply with rule requirements concerning underwriting compensation as well as the filing of documents and information subject to FINRA review.

[5] Specifically, (i) an issuer that is a development stage company that either has no specific business plan or purpose, or has indicated that its business plan is to merge into an unidentified company or companies, (ii) any investment company registered or required to register under the Investment Company Act of 1940, or (iii) any entity issuing fractional undivided interests in oil or gas rights, or similar interests in other mineral rights.

[6] The five other types of future offers and sales within safe harbor from integration are those: (a) registered Securities Act offerings (other than under Rule 254(d)), (b) made in reliance on Rule 701 (generally, private company compensatory plans), (c) made pursuant to employee benefit plans, (d) made in reliance on Regulation S (for "offshore transactions"), or (e) made under Regulation CrowdFunding.

[7] Qualification by order of the SEC staff for Regulation A+ purposes is analogous to a declaration of effectiveness in a registered offering.

[8] Exceptions apply for issuers in existence for less than two years provided the information is current as specified in Form 1-A.

[9] This requirement is similar to the IPO process in which pre-effective amendments of a registration statement are publicly filed.

[10] The communication must make clear, among other things, that the company cannot receive any money, nor accept an offer to buy a security, unless the offering statement has been qualified by the SEC. Other disclaimers apply as well.

[11] Practically speaking, however, these finance techniques are of limited use to small public companies if they cannot meet public float and/or securities exchange listing requirements required for a short-form prospectus on Form S-3. Regulation A+ issuers would not face these hurdles.

[12] Form I-U has eight items of required disclosure (compared to over 20 for Form 8-K) which are triggered by significant matters such as fundamental changes to the business, bankruptcy, modification of securityholder rights, change of accountants, non-reliance on financial statements, changes of control, departure of principal officers and unregistered sales of securities.

[13] Form 10 is a comprehensive document filed under the Exchange Act to registers a class of securities for secondary trading.

[14] The term "qualified purchaser" is keyed to Section 18 of the Securities Act, which exempts "covered securities" (including those offered and sold to "qualified purchaser") from state regulation.

Jonathan Guest, Partner,

Jonathan Guest concentrates his practice in corporate and securities law including debt and equity finance (public and private offerings including shelf regulations, registered direct offerings, PIPEs and rights offerings), corporate governance (Sarbanes-Oxley compliance), and domestic and cross-border mergers and acquisitions. He has also advised early-stage companies concerning matters of entity selection, capital structure, "angel" and venture capital finance, secured loans, executive compensation, intellectual property protection, and technology licensing. Jonathan's clients include publicly-traded U.S., Canadian, U.K. and Australian companies involved in pharmaceuticals and drug development, oil and gas as well as natural resource exploration and production, and commercial real estate. He has also advised companies engaged in telecommunications, e-commerce, and software. Jonathan has extensive experience with federal and state securities law matters encountered by foreign companies seeking to raise capital and have their securities traded in the United States. Prior to joining McCarter & English, Jonathan was a partner at one of the largest international law firms.

Mr. Guest has been selected as one of Massachusetts Super Lawyers for 2004-2011.

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Material in this work is for general educational purposes only, and should not be construed as legal advice or legal opinion on any specific facts or circumstances, and reflects personal views of the authors and not necessarily those of their firm or any of its clients. For legal advice, please consult your personal lawyer or other appropriate professional. Reproduced with permission from McCarte & English LLP. This work reflects the law at the time of writing in January 2014.