An Overview of the SEC’s Proposed New Regulation A+: Does It Make the Grade?

On December 18, 2013 the Securities and Exchange Commission (the “SEC”) proposed amendments to Regulation A (“Reg. A”) pursuant to Title IV of the Jumpstart Our Business Startups Act of 2012 (JOBS Act). Reg. A was adopted in 1936 as a rule under the Securities Act of 1933, as amended (the “Securities Act”), in order to assist small businesses with accessing the capital markets under the SEC’s recently enacted regulatory regime. Reg. A was intended to provide middle ground between a purely private financing transaction exempt from registration, but often inaccessible to small businesses, and the fulsome registration and reporting obligations of a public securities offering. For instance, Reg. A limited the amount of money a company could raise to up to $5 million, but did not limit the offering to accredited investors or require the Company to provide audited financials, an S-1 registration statement or ongoing reporting.

Since its adoption, Reg. A has been rarely used and is arguably defunct. In the new proposing release, the SEC noted that from 2009 through 2012, there were only 19 qualified Reg. A offerings for a total offering amount of approximately $73 million. During the same period, there were approximately 27,500 offerings of up to $5 million (i.e., at or below the statutory limit for Reg. A offerings), for a total offering amount of approximately $25 billion, which used a Regulation D (“Reg. D”) exemption, which is for a private transaction. Thus, in order to gain some utility from this rule and assist smaller and startup businesses access needed capital, the JOBS Act mandated certain amendments to be promulgated by the SEC, which are summarized below.

Both new Reg. A, called “Reg. A+” by many, and old Reg. A, provide an exemption from the extensive public registration requirements for smaller issuances of securities by certain types of issuers. Elements of the old Reg. A that would remain the same for offerings under proposed Reg. A+ are that the securities issued may be sold publicly by means of a general solicitation, the securities issued will be freely tradable subject to certain restrictions, the civil liability provisions of Section 12(a)(2) of the Securities Act will apply to Reg. A+ offerings and the issuer may engage in “testing the waters” activities similar to existing Rule 254 that permits Reg. A issuers to solicit interest prior to the filing of the offering statement with the SEC.

Issuer Limitations

Offerings under Reg. A+ will be organized into two tiers.
- Tier1 has an annual offering limit of $5 million, including no more than $1.5 million on behalf of selling securityholders, and is basically, with a few exceptions (such as allowing for electronic filings of the Form 1-A and “access equals delivery” with respect to the offering statement) subject to the same regulations of the old Reg. A.
  - Selling securityholders are individuals or entities that own the class securities being offered and are participating in the sale of such securities alongside the issuer, such as employees, officers or founders who received securities prior to the offering and wish to sell them.
- Tier 2 has an annual offering limit of $50 million, including no more than $15 million on behalf of selling securityholders.
- Issuers may elect to conduct their offering under either Tier 1 or Tier 2.
The following issuers are excluded from using Reg. A+:
- Issuers that are or have been subject to any order of the SEC pursuant to Section 12(j) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), entered within five years before the filing of the offering statement.
- Issuers that have not filed with the SEC the ongoing reports required by the proposed rules during the two years immediately preceding the filing of an offering statement.
- Issuers that are not organized under the laws of and with their primary place of business in the U.S. or Canada.
- Issuers that are subject to the ongoing reporting requirements of Section 13 or 15(d) of the Exchange Act (reporting companies).
- Issuers that are registered or required to be registered under the Investment Company Act of 1940 (investment companies).
- Development stage companies that have no specific business plan or purpose or have indicated their business plan is to engage in a merger or acquisition with an unidentified company or companies (including blank check companies).
- Issuers of fractional undivided interests in oil or gas rights, or similar interests in other mineral rights.
Importantly, in the proposing release the SEC has provided guidance that consistent with old Reg. A, the following offerings will not be integrated with a Reg. A+ offering:
- Prior offers or sales of securities; or
- Subsequent offers and sales of securities that are:
  - registered under the Securities Act, except as provided in Rule 254(d) which provides a safe harbor to conduct a registered public offering after soliciting interest pursuant to Reg. A;
  - made in reliance on Rule 701 under the Securities Act;
  - made pursuant to an employee benefit plan;
  - made in reliance on Regulation S; or
  - made more than six months after completion of the Reg. A offering.
Additionally, Reg. A+ offerings will not be integrated with subsequent offerings made under proposed Regulation Crowdfunding (“Reg. CF”), the JOBS Act Title III crowdfunding provisions proposed in October of this year.
The SEC also provided guidance that an offering made in reliance on Reg. A should not be integrated with another exempt offering made by the issuer, provided that each offering complies with the requirements of the exemption that is being relied upon for the particular offering. Thus, side-by-side Reg. A+, Reg. D and/or Reg. CF offerings would be permissible.

Limitations on type of Securities

Reg. A+ may only be used to issue the following types of securities:
- Equity;
- Debt;
- Debt convertible into equity; and
- Any guarantees of the above securities.
In addition, Reg. A+ explicitly excludes asset backed securities, citing that they are governed under Regulation AB under the Securities Act which was not in effect at the time old Reg. A was effected, and thus have their own workable regulatory regime.

Investor Limitations

Tier 1– no limit to the amount an investor may invest, save the aggregate offering cap.
Tier 2– amount of securities an investor can purchase is limited to no more than 10% of the greater of such investor’s annual income or net worth.
There is no accreditation requirement or knowledge or sophistication requirement for either Tier 1 or Tier 2 investors, the general public may invest.

The investor limits for Tier 2 offerings demonstrate the tension between the Congressional mandate for greater flexibility in capital raising and the SEC’s concerns regarding fraud in the marketplace and protecting investors. In proposing these limits for Tier 2 offerings, which mirror the limits under proposed Reg. CF for investors with net worth or annual net income in excess of $100,000, the SEC is attempting to provide a uniform approach to investor protection across all of the newly proposed offering exemptions mandated by the JOBS Act.

Testing the Waters

As is the case with existing Rule 254 under Reg. A, Reg.A+ permits issuers to “test the waters” or solicit interest in a potential offering with the general public either before or after the filing of the offering statement, so long as any solicitation materials used after publicly filing the offering statement are preceded or accompanied by a preliminary offering circular or contain a notice informing potential investors where and how the most current preliminary offering circular can be obtained. This requirement could be satisfied by providing the uniform resource locator (“URL”) where the preliminary offering circular or the offering statement may be obtained on EDGAR. The solicitation materials used to test the waters would not have to be filed until the offering statement is submitted to the SEC for review.

Qualification, communications, and offering process

Prior to the consummation of an offering, the issuer must submit an offering statement on Form 1-A to the SEC which must then be qualified by the SEC prior to any sale of the securities.
Whereas old Reg. A required a paper filing of the offering statement, Reg. A+ allows for electronic filing through EDGAR.
Reg. A+ permits the non-public submission of offering statements and amendments for review by the SEC before filing such documents with the SEC, so long as all such documents are publicly filed not later than 21 calendar days before qualification. This relief mirrors the provision under the JOBS Act that permits emerging growth companies to submit IPO registration statements to the SEC for confidential review.
Reg. A+ requires issuers and intermediaries prior to the offering statement being qualified to deliver a preliminary offering statement to prospective purchasers at least 48 hours in advance of a sale.
Once an offering statement is qualified, all offers must be preceded or accompanied by a final offering statement.
In addition, Reg. A+ permits issuers and intermediaries to satisfy their final offering statement delivery requirements under an “access equals delivery” model when the final offering circular is filed and available on EDGAR, meaning that not later than two business days after completion of the sale, the issuer or the intermediary, as applicable, must provide the purchasers with a copy of the final offering circular or a notice that the sale occurred pursuant to a qualified offering statement that includes the URL leading to the final offering statement.
Issuers may file offering statement supplements after qualification of the offering statement in certain circumstances in lieu of post-qualification amendments, including to provide the types of information that may be excluded from a prospectus under Rule 430A, such as final pricing information.
Reg. A+ permits continuous or delayed offerings under the proposed rules (shelf offerings), but requires issuers in continuous or delayed Tier 2 offerings to be current in their annual and semiannual reporting obligations.
Reg. A+ also permits issuers to qualify additional securities in reliance on Reg. A by filing a post-qualification amendment to a qualified offering statement.

Offering Statement

The issuer will be required to filed a Form 1-A which consists of three parts.
- Part I– Notification, which will contain disclosures regarding:
  - Issuer information
  - Issuer eligibility
  - “Bad Actor”certification and disclosure information
  - Summary information regarding the offering and other current proposed offerings
  - Jurisdiction in which securities are being offered
  - Unregistered securities sold within one year of the offering
- Part II– Offering Circular, will be the heart of the disclosure regarding the issuer and the offering and will require disclosures of:
  - Basic information including identity of any underwriters and underwriting discounts
  - Material risks related to the offering and the securities
  - Material disparities between the public offering price and the costs for securities acquired by insiders in the past year
  - Plan of distribution of the securities
  - Use of proceeds
  - Business operations for the past three years (or length of existence if shorter)
  - Material physical properties
  - Discussion and analysis of issuer’s liquidity, capital resources and results of operations, including whether or not issuer anticipates need to raise additional funds in the next six months
  - Information regarding directors, officers and significant employees
  - Executive compensation
  - Beneficial ownership of voting securities by officers, directors and 10% securityholders
  - Transactions with related persons
  - Material terms of the securities being offered
  - Two years of GAAP (or IFRS if Canadian issuer) financial statements dated within nine months of the filing, interim financial statements cannot be for a period of less than six months
    - Tier 1– must be audited only if available
    - Tier 2– must be audited
  - Disclosure of the participation of any “bad actors” with the offering whose participation would have disqualified the issuer from relying on the exemption but for the underlying events occurring prior to the effective date of new Reg. A+ (similar to recently enacted Rule 506(e) of Reg. D).
  - Rather than provide the above information the issuer may provide the information required in Part I of Form S-1, but notably, the Q&A method of disclosure previously allowed under old Reg. A is no longer permitted.
- Part III– Exhibits
  - Exhibits include, underwriting agreements, charter and bylaws, instruments defining the rights of securityholders, subscription agreements, voting trust agreements, material contracts, plans of acquisition, reorganization, etc., escrow agreements, letters regarding changes of certifying accountant, powers of attorney, consents (including auditor consent), legal opinion, test the waters materials, appointment for agent of service of process, and any offering statement filed confidentially.
Under Reg. A+, the offering statement may only be qualified by order of the SEC rather than, as previously allowed under old Reg. A, after inaction by the SEC for 20 days after filing.

Ongoing reporting

Tier 1– Reg. A+ requires issuers that conduct an offering to electronically file a Form 1-Z exit report with the SEC not later than 30 calendar days after termination or completion of a qualified offering to provide information about sales in such offering and to update certain issuer information.
Tier 2
- Annual and Semiannual Reports– Reg. A+ require issuers that conduct an offering to electronically file with the SEC annual reports on Form 1-K and semiannual reports on Form 1-SA.
- Current Reports– Reg. A+ require issuers that conduct an offering to electronically file with the SEC current event updates on Form 1-U for the following events:
  - Fundamental changes in the business;
  - Bankruptcy or receivership;
  - Material modification to the rights of securityholders;
  - Changes in the issuer’s certifying accountant;
  - Non-reliance on previous financial statements or a related audit report or completed interim review;
  - Changes in control of the issuer;
  - Departure of the principal executive officer, principal financial officer, or principal accounting officer; and
  - Unregistered sales of 5% or more of outstanding equity securities.
- Special Financial Reports– Reg. A+ requiresissuers that conduct an offering to, where applicable, provide special financial reports to provide information to investors in between the time the financial statements are included in Form 1-A and the issuer’s first periodic report due after qualification of the offering statement.
- Broker-Dealer Requirements – Reg. A+ permit the ongoing reports filed by an issuer conducting an offering to be used to satisfy a broker-dealer’s obligations to review specified information about an issuer prior to publishing a quotation under Exchange Act Rule 15c2-11.
- Exit– Reg. A+ provides that issuers conducting offerings would exit the Reg. A+ ongoing reporting regime:
  - When they become subject to the ongoing reporting requirements of Section 13 of the Exchange Act; and
  - At any time by filing a Form 1-Z exit report after completing reporting for the fiscal year in which the 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 Regulation A offering statement are not ongoing.
  - Issuers must include in their first annual report after termination or completion of a qualified Reg. A offering, or in their Form 1-Z exit report, information about sales in the terminated or completed offering and to update certain issuer information.
Exchange Act Section 12(g) – Importantly, unlike Regulation CF, purchasers in a Reg. A+ offering will be counted in the holder of record calculation for determining public filing requirements pursuant the Securities Exchange Act of 1934 (Exchange Act). Thus, once an issuer reaches 2,000 total or 500 non-accredited holders of record (including Reg. A+ holders), it will be subject to the reporting requirements of the Exchange Act.

“Bad Actor” Disqualification

Reg. A+ would disqualify an issuer from conducting an offering under Reg. A+ to the extentit, or its officers, directors, 20% holders and others involved with the offering are “bad actors” as defined in proposed, amended Rule 262 of the Securities Act, which mirrors the recently enacted Rule 506(d) of Reg. D.

Application of State Securities Laws

Tier 2– Reg. A+, provides for the preemption of state securities law registration and qualification requirements for securities offered or sold to “qualified purchasers,” defined to be all offerees of securities in a Reg. A+ offering and all purchasers in a Tier 2 offering.
Tier 1– Offers conducted under Tier 1 will still be required to comply with all applicable state securities laws with respect to securities sold pursuant to Reg. A+.

This client alert is intended only to provide a brief summary of the proposed Reg. A+ rules. The full proposing release provided by the SEC is available http://www.sec.gov/rules/proposed/2013/33-9497.pdf.