As part of the effort to make capital more accessible for small businesses, the JOBS Act authorized the SEC to exempt annually up to $50 million of a company’s securities issuances from the registration requirements of the Securities Act of 1933. In response, the SEC has amended Regulation A under the Securities Act to provide a two-tier exemption scheme for offerings that are “qualified” as opposed to being registered. This new scheme expands the pool of investors who can purchase securities. The amendments also allow issuers to “test the waters” before undertaking a qualified Regulation A offering.
New Regulation A+
On June 19, 2015, these amendments to Regulation A, known as Regulation A+, took effect. Announcing the amendments earlier in 2015, SEC Chair White emphasized that “Congress recognized the importance of providing new avenues for capital-raising when it adopted the JOBS Act, which provides for crowdfunding as well [as] Regulation A+.” These amendments are designed to convert Regulation A from a little-used , outdated exemption from registration to a “registration-lite” regime that would fit between the traditional Rule 506 offering under Regulation D to accredited investors (and up to 35 non-accredited investors) and the “emerging growth company” registration regime, which allows smaller companies to conduct a registered initial public offering with less onerous disclosure and reporting requirements than those required by a traditional registered transaction.
Regulation A+ raises the outdated $5 million Regulation A offering limit , implementing a “Tier 1” for offerings up to $20 million annually and a “Tier 2” for offerings up to $50 million annually. Although both Tier 1 and Tier 2 offerings require an offering document to incorporate certain mandated information similar to, but less onerous than, a registration statement (even an “emerging company” registration statement), Tier 1 requires only reviewed, rather than audited, financial statements of the issuer. Tier 2, on the other hand, requires the issuer’s financial statements to be audited, although the audit firm need not be registered with the Public Company Accounting Oversight Board. The greater flexibility in auditor standards enables an issuer to have a smaller, and presumably less expensive, audit firm perform the audit. In both Tier 1 and Tier 2 offerings, the offering document must be filed with, and cleared (“qualified”) by, the SEC before the offering can proceed. Under both tiers, an issuer also can “test the waters” before an offering document is qualified by the SEC.
In addition, issuers who complete an offering under either tier assume continuing obligations to file reports with the SEC, although the frequency of this reporting is semi-annual, rather than the quarterly filings required of a registered issuer. The content required in these reports is consistent with a “registration-lite” approach, including scaled-down versions of public company reporting requirements such as:
- A description of the business;
- Transactions with related persons;
- A limited “MD&A;”
- Executive compensation data on the three most high compensated officers; and
- Financial statements.
Possibly the most significant practical difference between Tier 1 and Tier 2 offerings is the approach to state regulation of the offerings. Tier 2 preempts state securities laws, thereby relieving a Tier 2 issuer from having to comply with qualification requirements imposed by state securities laws. Tier 1 offerings, by contrast, are not exempt from state securities laws qualification requirements. From a practical standpoint, this difference is likely to result in Tier 1 issuers picking the states in which they conduct Regulation A+ offerings carefully to avoid those states whose securities regulators apply a heavy hand to qualifying proposed offerings. Because an issuer is always free to proceed under Tier 2, even if the size of the offering is less than $20 million, issuers who prefer to avoid dealing with state securities laws regulators may choose to proceed under Tier 2 rather than Tier 1.
Perhaps in recognition that state securities regulators may look more closely at Tier 1 offerings, and perhaps impose their own “sophistication standards” for investors, Regulation A+ does not impose investment limits on non-accredited investors in Tier 1 offerings. In Tier 2 offerings, however, where state regulations regarding qualification of the offering are preempted, Regulation A+ imposes limits on the amount of securities a non-accredited investor may purchase. These limits are:
- For individual investors, no more than 10% of the greater of annual income or net worth; and
- For entity investors, no more than 10% of the greater of annual revenue or net assets.
Tier 2 issuers are required to notify investors of these limits but may rely on an investor’s representation of compliance, unless the issuer knew at the time of sale that any such representation was untrue.
Under both tiers of Regulation A+, issuers are required to file an offering circular electronically on EDGAR. The offering circular can initially be filed privately with the SEC, but it must be made publicly available at least 21 days before the SEC will qualify the circular.
The next 3-5 years will tell whether this “meet in the middle” approach has created a regulatory and disclosure regime that is light enough to draw issuers to use it for capital raising, or whether this regime is still too onerous for issuers. If it is the former, Regulation A+ will develop into another intermediate capital raising stepping stone that developing companies can use on their path from start-up to growth company to emerging company to full-fledged public reporting company. If it is the latter, Regulation A+, like the original Regulation A, is likely to fall into disuse and turn out to be much ado about nothing.
The full and original memorandum was published by Jones Day on July 8, 2015 and is available here. Christen Mason, a summer associate in Jones Day’s Houston office, contributed to this memorandum.