On December 18, the Securities and Exchange Commission released their long-awaited proposed rules on Regulation A+. The proposed rules, which are intended to increase access to the capital markets for smaller issuers, were mandated by Title IV of the Jumpstart Our Business Startup (JOBS) Act.
As expected, the proposed rules expand upon and modernize the little-used existing Regulation A. Currently, Regulation A permits certain issuers to sell to the public on an exempt basis up to $5 million of securities in a 12-month period, including up to $1.5 million of securities on behalf of selling securityholders.
The proposed rules would amend Regulation A to create two tiers of exempt offerings:
- Tier I, which would consist of offerings of up to $5 million in a 12-month period, including up to $1.5 million for the account of selling securityholders; and
- Tier II, which would consist of offerings of up to $50 million in a 12-month period, including up to $15 million for the account of selling securityholders.
An issuer would be able to elect to proceed under Tier I or Tier II, but offerings under Tier II would be subject to additional requirements, as described below.
Regulation A to date has been little used due to its limited offering size and disclosure burdens relative to other private placement exemptions, such as Regulation D. Regulation A+, however, promises to provide a meaningful new tool for private issuers wishing to access the capital markets. Like current Regulation A, securities issued under the proposed rule would not be subject to restrictions on transfer imposed by federal securities laws. Issuers relying on Tier II of Regulation A+ would be required to provide ongoing disclosure, as described below, but would not become subject to the reporting and most other requirements of the Securities Exchange Act of 1934, as amended. As a result, Regulation A+ issuers would not be subject to Sarbanes-Oxley, insider trading and reporting rules, or SEC proxy rules, among other requirements of the Securities Exchange Act.
The full text of the proposed rules is available here.
As proposed, Regulation A+ would be available only to United States and Canadian companies that have their principal place of business in the US or Canada. The exemption would not be available to certain types of issuers, including most importantly, issuers that are already SEC reporting issuers, investment companies and development stage companies without a specific business plan or purpose, or whose plan is to merge with or acquire an unidentified company (a “Blank Check Company"). Currently, the proposed rules would permit shell companies to rely upon the exemption, provided that they are not a Blank Check Company.
The proposed rules limit the amount of securities that an investor may purchase in a Tier II offering. As presently drafted, investors may acquire no more than 10% of the greater of the investor’s annual income and net worth. Importantly, however, the proposed rules do not impose a duty of investigation upon the issuer. While issuers must make investors aware of the investment limitations, issuers would be entitled to rely upon an investor’s representation, unless the issuer knows the representation is false.
Definitions of income and net worth are proposed to be calculated in the manner required by Rule 501 of Regulation D. Under those rules, a person’s primary residence is not included as an asset.
Regulation A+ offerings would be made pursuant to offering statements on Form 1-A, which would be filed with the SEC electronically on the EDGAR system. Form 1-A is proposed to consist of a form requiring basic information about the issuer and the offering, an offering circular with financial statements and exhibits.
As proposed, the offering circular will require a simplified form of narrative disclosure about the issuer and its business, similar in content to the smaller issuer disclosure requirements applicable to registered offerings. While the overall disclosure is similar to existing prospectus requirements for smaller reporting companies in a registered offering, the proposed rules provide relief from a number of disclosures required under Regulation S-K.
Form 1-A filings are subject to SEC review and comment, and, as drafted, SEC review will be required to be completed prior to “qualification” of the offering.
Regulation A in its current form requires financial statements consisting of a balance sheet, dated as of the end of the most recent fiscal year (or as of the most recent interim period in certain cases), statements of income, cash flows and equity for each of the two most recent fiscal years, and for any interim period, as well as financial statements of significant acquired businesses and related pro forma information. Financial statements need not be audited, unless the issuer has obtained an audit for other purposes.
As proposed, the existing Regulation A financial statement requirements are sufficient for Tier I offerings. In a Tier II offering, issuers must file balance sheets as of the two most recent fiscal years, in addition to the other financial statements required for Tier I offerings. In addition, all annual financial statements must be audited in a Tier II offering. For US issuers, financial statements must be prepared in accordance with US GAAP, while financial statements of Canadian issuers may be prepared in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB).
On-going Reporting Requirements
One of the most significant aspects of the proposed rules is the creation of an on-going reporting system for issuers that rely upon Tier II of Regulation A+. Although issuers relying on Tier II would not have a class of securities registered under Section 13 or 15 of the Securities Exchange Act, or be subject to the on-going reporting requirements of the Exchange Act, such issuers would be required, as proposed, to file annual reports on a new Form 1-K, semiannual updates on a new Form 1-SA, and current reports on a new Form 1-U. These reports, simplified versions of Form 10-K, 10-Q and 8-K and based on the informational requirements of Form 1-A, would be required to be filed via EDGAR 120 days after the fiscal year end, in the case of Form 1-K, 90 days after the end of the second fiscal quarter, in the case of Form 1-SA, and within four business days of the relevant event, in the case of Form 1-U. Under the proposed rules, the duty to file these reports may be suspended with respect to any class of securities held of record by fewer than 300 persons at any time after the fiscal year in which the offering was qualified.
The proposed rules include provisions designed to facilitate the development of secondary trading markets for securities issued in connection with Tier II offerings. As proposed, brokers will be permitted to rely upon information contained in reports filed by Regulation A issuers to satisfy the broker’s obligations under Exchange Act Rule 15c2-11. Although not part of the proposed rules, the SEC adopting release confirms that the SEC is also evaluating whether Regulation A reports may serve as the basis for satisfying the information requirements under Rule 144.
As is the case for offerings under the current Regulation A, offerings under the proposed rules will continue to the subject to the liability provisions of Section 12(a)(2) of the Securities Act, which prohibits an offer or sale of a security by means of an offering circular or oral communication that includes a material misleading statement or material misstatement of fact.
Blue Sky Preemption
The JOBS Act authorized the SEC to preempt state regulation of Regulation A offerings by adopting a definition of “qualified purchasers” in such offerings with respect to whom state blue sky laws would be preempted. Under the proposed rules, Tier I offerings will continue to be subject to state registration requirements. However, the SEC proposes to preempt state regulation of Tier II offerings by defining “qualified purchasers” as all offerees in a Regulation A offering and all purchasers in a Tier II offering. Because an offering of any size up to $50 million may rely upon Tier II, under the proposed rules issuers have the ability to determine whether offerings will be subject to state blue sky review.
If adopted as proposed, Regulation A+ could significantly impact the manner in which many U.S. companies access capital, both within and outside the United States. With the increased offering size and combination of public offering and private placement features, it is foreseeable that many growth companies will benefit from increased access to capital at a lower cost than previously available. Regulation A+ also promises to provide increased flexibility and reduced cost for U.S. companies that wish to list their securities on stock exchanges outside the United States. Because existing rules have often made it costly and difficult for U.S. private companies to list directly on foreign exchanges, certain U.S. companies have been denied access to growth-company oriented exchanges outside the United States. Regulation A+, as proposed, would provide a simplified pathway for companies to offer and sell securities on such foreign exchanges, as well as, fostering increased capital raising opportunities at home.