This post is the sixth in a series examining the impact of the Jumpstart Our Business Startups Act (or JOBS Act) one year after its passage and focuses on the provision instructing the SEC to create a new securities registration exemption commonly known as “Regulation A+.”
Previously in this series, I discussed the progress of implementing the JOBS Act, specifically Titles I, II, and III. In this sixth post, I will continue that discussion by focusing on Title IV, which creates a new exemption from the federal securities registration requirement for certain public offerings in an amount of up to $50 million. This new exemption is based upon an exemption that currently already exists (but is rarely used) called Regulation A.
Regulation A exempts from the registration requirements of the Securities Act of 1933 a public offer or sale of securities in an amount up to $5 million (per year) where the issuer is a U.S. or Canadian entity that is not (a) already a publicly reporting company, (b) a “development stage company” (i.e. a company raising money with no actual business plan) (c) a registered investment company (i.e. a mutual fund or anything similar), (d) issuing interests in oil, gas, or similar rights, or (e) disqualified because of prior fraudulent or criminal acts of the company or persons affiliated with it.
Regulation A offerings are similar to registered offerings in that an offering statement, which is a scaled down version of a full registration statement, must be filed and qualified by the SEC before any sales of securities are made, securities can be offered publicly, an offering document similar to a prospectus (although simpler) is required, general solicitation and advertising is permitted, resales are not restricted, and investors need not qualify as “accredited” on the basis of their net worth or other indicators of financial sophistication. Unlike registered offerings, however, under Regulation A the required financial statements are simpler and need not be audited, and issuers generally do not incur ongoing reporting or other obligations. Regulation A offers issuers the opportunity to “test the waters” in writing or by radio or television broadcast to determine whether there is any market interest in a contemplated offering before filing an offering statement.
Federal securities laws do not preempt state regulation of offerings under Regulation A, which means that such offerings are not exempt from state securities registration and other requirements. The cost of registering the offering in each state where it is offered is usually too high for an offering as low as $5 million. Even without the blue sky compliance costs, Regulation A offerings, because of the SEC qualification process, have a higher offering cost than Regulation D offerings. As a result, Regulation A is rarely used because issuers usually find Regulation D (specifically Rule 506) to be a better option.
Title IV of the JOBS Act was designed to provide a workable alternative to Regulation A that addresses its limitations. It requires the SEC to add by rule another class of exempted securities with a maximum offering amount of $50 million per year. As in Regulation A, the securities may be offered and sold publicly, resale will not be restricted, and the issuer may solicit interest before filing an offering statement. Unlike Regulation A, however, the provisions of Section 12(a)(2) of the Securities Act, which provide for heightened civil liabilities arising from prospectuses and communications, will apply to any person offering or selling the securities, and the issuer must file audited financial statements with the SEC each year (and possibly other periodic reporting as the SEC may designate).
The JOBS Act addresses the issue of state securities regulation by amending Section 18 of the Securities Act, which prohibits states from requiring registration of a “covered security,” defined to include various securities exempted from registration under the Securities Act. The JOBS Act adds to this list, securities offered under Regulation A+ that are offered or sold on a national securities exchange.
Since one of the main problems with Regulation A is that even with the scaled down compliance responsibilities, a Regulation A offering is still expensive to pull off and is rarely cost-effective for an offering of $5 million or less. The increase in the offering limit may make a Regulation A+ offering a more cost-effective option. The issue of costly blue sky compliance may or may not be helped by making securities offered under Regulation A+ “covered securities.” In order for an offering to gain this status, the securities offered must be listed on a national securities exchange.[1] However, when a company lists its securities on a national exchange, under Section 12(b) of the Securities-Exchange Act of 1934, it must become a public reporting company. In addition, even with the changes under the JOBS Act, if a company has over 500 shareholders who are not accredited investors, it is also likely that it would be required to become a public reporting company. So it seems that any use of Regulation A+ is likely to trigger a reporting obligation under the Securities-Exchange Act (unless the upcoming SEC implementing regulations do something to mitigate these issues). I therefore wonder how often it will be that a company finds Regulation A+ to be a superior option over Regulation D. At best, issuers will find this exemption to be a less expensive form of IPO rather than a way for private companies to raise equity (and remain private).
Like Titles II and III, Regulation A+ will require SEC rulemaking before it is effective. Given how behind the SEC is on rulemaking, it could be a long time before we ever see Regulation A+ in active use. This may be another case where a provision of the JOBS Act appears at first blush to significantly ease the regulatory burden on capital raising activities, but in reality the change ends up having a very limited impact.
Footnotes
[1] Alternatively, the JOBS Act also authorized the SEC to include sales of securities to “qualified purchasers” under Regulation A+ within the definition of a “covered security.” However, the SEC has long had the power, since the passage of NSMIA in 1996 to exempt sales to qualified purchasers but has declined to do so by failing to define what a “qualified purchaser” actually is. Please note that a “qualified purchaser” for Securities Act exemption purposes is not the same thing as a “qualified purchaser” for Investment Company Act purposes.
© 2013 Alexander J. Davie — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.
