SEC Proposed Changes
Resurrection of Regulation A?
On December 18, 2013, the Securities and Exchange Commission ("SEC") proposed changes to Regulation A promulgated under Section 3(b) of the Securities Act of 1933, as amended (the "Securities Act") as mandated by the Jumpstart Our Business Startup Act (the "JOBS Act"). Currently, Regulation A exempts certain offerings from the registration requirements under the Securities Act. However, in practice, Regulation A has been used infrequently, prompting these changes from the United States Congress and the SEC.
The proposed changes increase the offering amount available by dividing Regulation A into two tiers. As is the case with current Regulation A, Tier 1 offerings may not exceed $5 million within a 12-month period, including up to $1.5 million for existing security holders. The proposed Tier 2 offerings, if adopted, would limit the offering to $50 million within a 12-month period, including up to $15 million for existing security holders. Issuers could choose which Tier to use for offerings up to $5 million. In addition, the proposed changes in many ways modernize yet preserve several aspects of Regulation A, including eligibility, reporting requirements, and disclosure requirements. No issuer may rely on these proposed rules until final rules are adopted by the SEC. Below are highlights of the proposed changes.
- Issuer Eligibility. In addition to the current rules, the proposed changes would exclude issuers that failed to file required ongoing reports during the previous two years, were subject to an SEC order revoking its registration within the prior five years, or were disqualified as a "bad actor" under a more modernized definition. Consistent with current Regulation A, the exemption would not be available to companies reporting to the SEC under the Securities Exchange Act of 1934 ("Exchange Act"), certain investment companies, certain development stage companies, or companies that are seeking to offer and sell factional undivided interests in oil, gas, or other mineral rights. Regulation A would still only be available to companies organized in, and with their principal place of business in, the United States or Canada, although the SEC requested comment to either restrict or expand this geographic scope.
- Security Eligibility. Offerings would be limited to equity securities, debt securities, and securities convertible or exchangeable into equity interests, including guarantees of such securities. Asset-backed securities would be excluded in the proposed rules.
- Reporting Requirements. Proposed changes include allowing electronic filing and delivery of registration and solicitation materials via EDGAR, the SEC's online reporting system, increased flexibility of "testing the waters" solicitation materials, and temporary confidential submission of documents to the SEC prior to qualification.
- Disclosure Requirements. Regulation A currently requires an issuer to file an offering statement, including narrative and financial information required on Form 1-A. The proposed changes revise Form 1-A and would require additional disclosure of items relating to eligibility, "bad actor" disqualification, and a summary of key issuer financial information and offering details. The Model A option of Form 1-A, which currently allows issuers to provide information in a question-and-answer format, would be eliminated. An exit report after the offering would be required.
- Qualification. Unlike the current rules, the offering would have to be qualified by the SEC instead of an absence of a delaying notification.
- Tradability. The proposed regulations would further expand the tradability of securities issued under Regulation A by removing certain prohibitions of affiliate resales.
- Safe Harbor. The proposed rules expand the safe harbor provisions to add any crowdfunding offers that may be added as part of the JOBS Act and amend and expand those relating to abandoned offers. The existing safe harbors would be maintained, including prior offers or sales or securities, or subsequent offers that (i) are registered under the Securities Act, (ii) made in reliance of Rule 701, (iii) made pursuant to an employee benefit plan, (iv) made in reliance of Regulation S, or (v) made more than six months after the completion of the Regulation A offering.
- Liability. Consistent with current Regulation A, issuers would still have Section 12(a)(2) liability with respect to communications that include a material misleading statement or material misstatement of fact, and other anti-fraud and civil liability provisions such as Section 10(b) of the Exchange Act. Regulation A is and will continue to be excluded from Section 11 liability under the Securities Act.
In addition, since Tier 2 offerings may seek substantially higher dollar amounts, the SEC has proposed additional regulations for issuers that choose this option. Below are highlights of some of the proposed changes specifically related to Tier 2.
- Increased Disclosure Requirements. Issuers would be required to submit audited financial statements within their offering documents and file annual, semiannual, and current reports with the SEC. Issuers can exit these ongoing obligations if they become an Exchange Act reporting company or file an exit report if (i) they file reports successfully for at least one fiscal year, (ii) the class of securities are held by fewer than 300 people, and (iii) the Regulation A offers or sales are not ongoing.
- Purchaser Limitation. A purchaser of a Tier 2 offer would be limited to purchasing no greater than 10 percent of the greater of the purchaser's annual income or net worth. There are currently no limitations in Regulation A offerings and would not be in Tier 1 offerings.
- State Securities Laws Exemption. In return for these increased reporting requirements, issuers would receive an exemption from state securities laws, otherwise known as "Blue Sky" laws.
Neither Tier 1 nor Tier 2 offerings would be exempt from the registration requirements under Section 12(g) of the Exchange Act, which requires issuers to register if they have, among other things, more than $10 million in total assets and a class of securities held of record by either 2,000 persons or 500 persons who are not accredited investors. Issuers may have to monitor the securities so that these reporting requirements are not mandated, which may be difficult since they would be freely tradable. However, beneficial owners who hold their shares through a broker are not counted individually, but instead at the broker level.