United States: A Guide To Regulation A+

Introduction

Significant changes to Regulation A, generally referred to as Regulation A+, went into effect on June 19, 2015.

Old Regulation A

Regulation A is a previously existing exemption from the registration requirements of the Securities Act of 1933 (Securities Act) for nonpublic companies seeking to raise smaller amounts of capital. Even before the new rules went into effect, Regulation A already had several useful features. Regulation A gave smaller companies access to public markets without registration. There were no limitations on who could purchase the securities, and the securities sold were freely tradable by non-affiliates. General solicitations were allowed. Issuers could also "test the waters" and gauge investor interest before launching the offering (subject to certain state law requirements). Yet despite these features, Regulation A had been used relatively infrequently for several years. According to a recent GAO Report, there was just one qualified offering made in 2011, down from only 57 in 19981.

There are many reasons for Regulation A's lack of popularity. First and foremost, the amount of money that could be raised in a Regulation A offering was capped at $5 million. Second, the qualification process was extremely cumbersome and costly. In addition to a lengthy federal review process, the offerings were also subject to state law securities registration and review requirements, otherwise known as the "blue sky" laws. The cost and time involved with working through both the federal qualification process and the various blue sky laws was significant. Simply put, Regulation A offerings were not cost-effective.

Regulation A+

Regulation A+ contains many changes designed to address these problems. The goal of the new rules is to transform Regulation A into a workable capital-raising tool for small private companies.

As mandated by the Jumpstart Our Business Startups Act (JOBS Act), the U.S. Securities and Exchange Commission (SEC) increased the amount that can be raised by an issuer under the exemption from $5 million to $50 million and created two offering categories:

Tier 1 for offerings up to $20 million

Tier 2 for offerings up to $50 million

Investor protections have been included for Tier 2 offerings, such as requiring audited financial statements in offering materials, ongoing reporting requirements and an investment cap for non-accredited investors.

Regulation A+ also dramatically transforms the regulatory review framework for these offerings. Tier 2 offerings preempt state securities regulatory review, a change strongly supported by business interests and vehemently opposed by state securities regulators. As is described below under "State Securities Regulation – Preemption of State Regulation for Tier 2," the controversy surrounding state law preemption continues.

The SEC has also crafted an offering and disclosure regime unique to Regulation A+ and specifically designed with smaller startup companies in mind. The new rules modernize the qualification, communications and offering processes, incorporating into Regulation A+ offerings many features currently enjoyed by issuers in registered offerings, such as allowing for confidential submissions and adopting a notice-equals-access model.

In her October 28, 2015, keynote address to Practising Law Institute's 47th Annual Securities Regulation Institute, SEC Chair Mary Jo White indicated that it is too early to draw conclusions on Regulation A+ and stated:

Companies are beginning to take advantage of the new rules in greater numbers than was the case under the prior version of the exemption, with approximately 34 companies publicly filing offering statements and 16 companies filing non-public draft offering statements. The staff has qualified three offerings so far, and it remains to be seen how investors will react to such offerings.

This white paper explains Regulation A+ and the considerations that should be taken into account in deciding whether to use it.

Regulation A+ Offering Size Options

Two offering size levels are available under Regulation A+.

Tier 1 – offerings of up to $20 million over a rolling 12-month period

Tier 2 – offerings of up to $50 million over a rolling 12-month period

As explained in more detail below, both tiers are subject to certain basic requirements, while Tier 2 offerings are subject to additional investor protections. Issuers raising up to $20 million can choose to use either Tier 1 or Tier 2. Tier 1 offerings can include no more than $6 million in securities offered by selling security holders who are affiliates of the issuer. Tier 2 offerings can include no more than $15 million in securities offered by selling security holders who are affiliates of the issuer.

If the issuer is selling convertible securities, and these securities are convertible within the first year after qualification or at the discretion of the issuer, the value of the underlying securities must be included in the aggregate offering size. If the price of the underlying securities uses a pricing formula, the issuer must use the maximum estimated price.

Congress built an adjustment feature into Regulation A+. Every two years the SEC must review the $50 million offering amount limitation and, if appropriate, increase it. If the SEC decides not to increase the offering limit it must report back to Congress its reasons supporting this decision. The first review is expected by April 2016.

Secondary Sales

One of the important features of Regulation A+ is the ability of selling security holders to participate in the offering, known as secondary sales. The SEC hopes to encourage investment in startup companies by giving investors access to liquidity through secondary sales as a part of a qualified Regulation A+ offering. However, the SEC acknowledged that such secondary sales could potentially place new investors at an informational disadvantage and noted that secondary sales do not directly provide any new capital to issuers. So the SEC built into the new rules some important restrictions on these sales.

In an issuer's first Regulation A+ offering and for the 12 months following its first offering, sales by security holders are limited to no more than 30 percent of the aggregate offering price of a particular offering. This limitation applies to sales by both affiliates and non-affiliates of the issuer.

After the end of this period, secondary sales by affiliates over a 12-month period will continue to be subject to this 30 percent limitation. At this point, secondary sales by non-affiliates will only be limited to the maximum offering amount permissible under each tier ($20 million for Tier 1 and $50 million for Tier 2). Nevertheless, such amounts will be aggregated with the sales by the issuer and affiliates when calculating the maximum amount allowed under the appropriate tier.

Previously, Rule 251(b) banned all affiliate resales under Regulation A unless the issuer had net income from continuing operations in at least one of its last two fiscal years. This rule was designed to address the information disadvantage issue for new investors. With Regulation A+ the SEC has eliminated this rule. The SEC described the rule as no longer necessary due to the increased sophistication and robust nature of its current disclosure review process, qualification procedure and enforcement programs.

See "Resale Issues" below for a discussion of several reasons why secondary sales outside of a qualified Regulation A+ offering may be complicated.

Who is Eligible to Use Regulation A+?

Eligible Issuers

Only companies that are organized in, and have their principal place of business in, the United States or Canada are eligible to engage in a Regulation A+ offering.

An issuer will be considered to have its "principal place of business" in the United States or Canada for purposes of determining eligibility to use Regulation A+ if its officers, partners or managers primarily direct, control and coordinate the issuer's activities from the United States or Canada.

The following entities are not able to use Regulation A+:

  • Companies subject to reporting under the Securities Exchange Act of 1934 (Exchange Act), other than voluntary filers
  • Investment companies and business development companies
  • Blank check companies
  • Certain bad actors
  • Issuers of fractional undivided interests in mineral rights
  • Issuers who failed to file ongoing reports required by Regulation A+
  • Issuers subject to an SEC order within five years denying, suspending or revoking registration of a class of securities pursuant to Section 12(j) of the Exchange Act

A company that was previously required to file reports with the SEC under Section 15(d) of the Exchange Act, but has since suspended its Exchange Act reporting obligation, is eligible to use Regulation A+.

A private, wholly owned subsidiary of an Exchange Act reporting company is eligible to sell securities pursuant to Regulation A+, but the Exchange Act reporting company parent cannot be a guarantor or co-issuer.

While the SEC received many comment letters supporting expansion of the availability of Regulation A+, the SEC stated that it wanted to observe the market practices that will develop under these new rules before considering this kind of expansion.

Bad Actor Disqualification

Regulation A+ provides for the disqualification of certain "bad actors" (Rule 262). The Regulation A+ bad actor provisions are substantially the same as the recently adopted bad actor provisions of Rule 506 (except that in the case of certain orders, the order must bar the covered person at the time of filing the Regulation A+ offering statement).

Under Regulation A+, offerings that would have been disqualified from reliance on old Regulation A will continue to be disqualified. Triggering events that were not previously included in the bad actor rules for old Regulation A that predate effectiveness of Regulation A+ do not cause disqualification, but instead need to be disclosed in a manner similar to Rule 506(e).

The SEC also adopted a reasonable care exception to the Regulation A+ disqualification provisions on a basis consistent with Rule 506(d), so that an issuer will not be disqualified from using the Regulation A+ exemption if the issuer can show that it did not know, and in the exercise of reasonable care could not have known, of the disqualifying event.

To continue reading this white paper, please click here.

Footnotes

1 Factors that May Affect Trends in Regulation A Offerings, GAO-12-839 (July 2012) (available at: http://www.gao.gov/assets/600/592113.pdf) (the "GAO Report").

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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