By Cydney Posner
At an open meeting this morning, the SEC voted unanimously to propose rules and forms related to the offer and sale of securities under Section 3(b) of the Securities Act, so-called Regulation A+, as mandated by the JOBS Act. Currently, Regulation A allows companies to raise up to $5 million without having to file a registration statement, but the offering circular and blue sky requirements have usually been viewed as so onerous – relative to the amount that can be raised—as to deter use of the exemption. As characterized by Commissioner Gallagher during the meeting, Reg A is generally viewed as "low, slow, costly and burdensome," a virtual "toxic stew of impediments." As a result, Reg A is almost never used, even though the stock issued under the exemption is not "restricted stock" and is freely tradable by non-affiliates. Several commissioners observed during the meeting that, last year, there were only eight qualified Reg A offerings and only one in 2011.
As proposed, Reg A+ establishes two tiers of Reg A offerings: Tier 1 would continue to permit small offerings of up to $5 million (including sales of up to $1.5 million by selling shareholders) within a 12-month period, essentially preserving, with some modernization, the existing exemption; Tier 2 raises the ceiling to $50 million (with up to $15 million by selling shareholders), but imposes enhanced investor protection requirements. The question is whether these changes will be enough to make Reg A+ the least bit appealing.
The rules would preserve the requirements for an offering circular containing disclosure regarding the issuer, the offering and financial statements. Issuer eligibility requirements would also continue, with exclusions for companies for already public companies, shell companies and companies subject to "bad actor" disqualifications, as well as companies that have not filed required reports for the last two years or that have had their Exchange Act registrations revoked in the prior five years. However, the amendments would also modernize the offering process, for example, by allowing issuers to "test the waters," both before and after filing of the offering circular, elect to confidentially submit offering circulars to the SEC for review prior to use, and otherwise modernize the qualification, communications and offering process.
The new Tier 2 exemption, with a ceiling of $50 million, would generally preempt Blue Sky review: the new exemption would define all offerees and purchasers in Tier 2 offerings as "qualified purchasers," thus exempting those offerings from state registration or qualification. However, the Tier 2 exemption would impose a number of additional investor protection requirements:
- Enhanced disclosure requirements (although less extensive than is currently required for a registered offering), including audited financial statements;
- Filing of the offering circular with the potential for SEC comment;
- Limitation on investor purchases of 10% of the greater of net income or net worth;
- Ongoing annual, semi-annual and current event reporting for so long as the stock is held by at least 300 record holders.
Although issuance of the proposal was unanimously approved, several commissioners voiced some trepidation. Commissioner Aguilar, taking into account the availability of general solicitation as well as this exemption, was concerned with the potential for exponential growth in the number of unregistered companies with active securities trading conducted outside of exchanges using Rule 15c2-11. In light of the reduced transparency characteristic of those markets and the resulting potential for fraud and manipulation, he recommended that the SEC revisit that rule. Preempting review by state securities law regulators also drew some concerns. Both Chair White and Commissioner Aguilar expressed their intent to monitor the proposal by the North American Securities Administrators Association (NASAA) for coordinated reviews of Reg A offerings, which could potentially reduce the costs of compliance and accelerate state review (and presumably might therefore present an alternative to preemption). Commissioners Aguilar and Stein both noted the important role of the states in protecting investors, with Commissioner Stein observing that Congress deliberately revised the JOBS Act to ensure that state securities laws were not explicitly preempted. In addition, both she and Commissioner Piwowar were critical of the proposal's failure to seek to make Tier 1 more effective, each suggesting the adoption of an alternative intermediate tier that might (Stein) reduce some requirements but involve state-level review or (Piwowar) preempt state blue sky but have less extensive continuing disclosure obligations. Commissioner Gallagher, strongly in favor of the proposal – calling it an "equal opportunity" exemption – used the opportunity to admonish the SEC to review its rules on its own initiative, rather than waiting for Congress to mandate review.
So will Reg A+ have any appeal? According to the economist from the Division of Economic and Risk Analysis, the new exemption has the potential to expand access to sources of capital without imposing the full compliance that would be required by registration. At the same, the continued reporting requirements could promote the development of secondary trading markets for these securities. Ultimately, companies considering the exemption will need to assess and balance the costs of use of the exemption as compared to an IPO (less liquid market v. lower costs of compliance) or Reg D (greater costs v. access to more dispersed investor base.) It remains to be seen whether Reg A+, assuming adoption, will be enough to detoxify the Reg A "stew of impediments" and attract any issuers.