On March 25, 2015, the SEC adopted final rules to amend Regulation A in order to fulfill the JOBS Act mandate to expand the availability of the registration exemption under Regulation A. The final Reg A+ rules will become effective 60 days after publication in the Federal Register (anticipated effective date of June 2015).
Regulation A – A Brief Background
Regulation A allows a company to sell securities to the public without full registration, provided the issuer raises no more than $5 million and provided the offering complies with all applicable state securities (“blue sky”) laws. However, the low dollar threshold, the disclosure requirements, and the requirement to comply with blue sky laws had limited the utility of Regulation A. As a result, other exemptions, such as the Regulation D exemptions and in particular, the Rule 506 exemption which has no dollar threshold, became more popular and had essentially rendered Regulation A dead letter law for years.
The New Regulation A
As discussed in more detail below, the final rules expand Regulation A (creating the so-called “Reg A+”) by substantially increasing the exemption’s offering cap through a two-tiered structure that exempts offerings by companies and subject to limitations on the amount, sales of securities by existing stockholders. Under Reg A+, offerings under Tier 1 may raise up to $20 million and will be subject to blue sky laws. Offerings under Tier 2 may raise up to $50 million and will not be subject to blue sky laws. Tier 2 offerings will have additional requirements not applicable to Tier 1 offerings, such as greater disclosure obligations, including audited financial statements. The new rules also make the exemption available, subject to limitations on the amount, for the sale of securities by existing stockholders.
- Eligible Issuers. Reg A+, both Tier 1 and Tier 2, will be available to companies organized in and with their principal place of business be in the United States or Canada. However, SEC reporting companies, blank check companies, investment companies registered under the Investment Company Act, shell companies, issuers offering or selling asset backed securities, issuers delinquent in ongoing Tier 2 reporting obligations, and “bad actors” are prohibited from using Reg A+.
- Eligible Securities. Eligible securities under Reg A+ are equity securities, debt securities and debt securities convertible or exchangeable into equity, including any guarantees.
- Offering Limitations. Under Reg A+, a company may choose either Tier 1 or Tier 2. Under Tier 1, a company may offer and sell up to $20 million in a 12-month period, including up to $6 million on behalf of selling security holders that are affiliates of the company (subject to additional limitations during an initial Reg A+ offering). Under Tier 2, a company may offer and sell up to $50 million in a 12-month period, including up to $15 million on behalf of selling security holders that are affiliates of the issuer (subject to additional limitations during an initial Reg A+ offering). In a company’s initial Reg A+ offering and within the following 12-month period, the amount of securities that selling security holders can sell may not exceed 30% of the aggregate offering price (offering size) of the particular Reg A+ offering. In addition, Reg A+ distinguishes between sales by affiliates and sales by non-affiliates and the limit on secondary sales falls away for non-affiliates after the first year following the qualification of an initial Reg A+ offering statement.
- Eligible Investors. Securities issued in a Reg A+ offering may be sold to both accredited investors or non-accredited investors. However, in the case of a Tier 2 offering, there are dollar limits on the amount of purchases by non-accredited investors (but not limits on the number of non-accredited investors). For non-accredited natural persons the limit is no more than 10% of the greater of the investor’s annual income and net worth, determined as provided in Rule 501 of Regulation D. For non-accredited, non-natural persons, the 10% limit is based on annual revenues and net assets. Of note, this limit does not apply to purchases of securities that will be listed on a national securities exchange upon qualification. Unlike Rule 506(c), Reg A+ investors will be able to self-certify their income or net worth for purposes of the investment limits. This substantially reduces the burden and documentation requirements imposed on issuers compared to Rule 506(c).
- Integration of Offerings. Under the final rules, Reg A+ offerings will not be integrated with prior offers or sales of securities or certain subsequent offers and sales of securities. Therefore, a company could conduct a Regulation D offering prior to undertaking Reg A+ offering and the two offerings will not be integrated, provided both offerings comply with the requirements of the exemption relied upon have been met.
- Offering Initial and Ongoing Filing Requirements. All offerings under Reg A+ are subject to certain basic information and filing requirements. Issuers are required to prepare an offering statement on Form 1-A and file it electronically through the SEC’s EDGAR system. Similar to the confidential submission process for emerging growth companies conducting an initial public offering, an issuer may submit a draft Form 1-A to the SEC for non-public review. The Reg A offering statement must be filed publicly not less than 21 calendar days before qualification of the offering statement. An issuer may not begin a Regulation A offering until its offering statement is qualified and it receives a “notice of qualification” from the SEC.
- Tier 1 and Tier 2 issuers must file balance sheets and other required financial statements as of the two most recently completed fiscal year ends (or for such shorter time as they have been in existence). U.S. issuers are required to prepare financial statements in accordance with U.S. GAAP. For Tier 1 offerings, the required financial statements may be unaudited unless the company has already obtained an audit for another purpose. Tier 2 offerings must provide audited financial statements as part of the offering.
- Tier 1 issuers will be required to provide certain information about their Reg A+ offerings in an exit report on Form 1-Z.
- Tier 2 issuers must file annual reports (Form 1-K), semiannual reports (Form 1-SA) and current event reports (Form 1-U) via the EDGAR system similar to Exchange Act reporting issuers (although the disclosure in such reports is abbreviated from standard periodic reporters). Tier 2 issuers are permitted to terminate or suspend their ongoing reporting obligations (i) when the issuer becomes subject to Exchange Act reporting; or (ii) at any time by filing a Form 1-Z after completing reporting for the fiscal year in which an offering statement was qualified, so long as the securities of each class to which the offering statement relates are held of record by fewer than 300 persons and offers or sales made in reliance on a qualified Tier 2 Regulation A offering statement are not ongoing.
- Offering Communications. Under Reg A+, an issuer may “test the waters” – that is, solicit indications of interest from any potential investor – both before and after filing the offering statement. Issuers testing the waters after the offering statement is filed must make the offering circular available to prospective investors. All testing-the-waters materials must bear certain legends or disclaimers and must be filed with the Form 1-A. Additionally, offerings under Reg A+ are not subject to the ban on general solicitation.
- Blue Sky Requirements. The final rules provide that Tier 1 offerings remain subject to state securities law requirements. However, securities sold in a Tier 2 offerings are covered securities and are not be subject to state review. However, states will have authority to require filing of offering materials (like Rule 506) and enforce anti-fraud provisions in connection with a Tier 2 offering.
- Non-Restricted Securities. Securities sold in under Reg A+ would have the status of publicly offered securities and therefore, are not considered “restricted securities” under Securities Act Rule 144. While affiliates would continue to be subject to the limitations of Rule 144, sales of the securities by persons who are not affiliates of the issuer would not be subject to any transfer restrictions under Rule 144. Many industry commentators think that this could lead to a secondary market for these securities which would solve liquidity problems that have plagued small company offerings.
It remains to be seen whether the changes will be enough to entice issuers to use Reg A+ over Reg D. Ultimately, companies will have to weigh the costs and benefits of Reg A+ exemption compared to an IPO or Reg D.