BY Andres J. Trujillo CrowdfundBeat Guest Editor,
On the 25th of March, 2015, in what can be accurately described as a historic moment in the world of securities regulation, the SEC voted to approve final rules for Section 401 of the JOBS Act, which added Section 3(b)(2) to the Securities Act of 1933. The updated exemption has been commonly dubbed “Regulation A+”, for its generous expansion of the old Regulation A.
The original Regulation A, which allowed for up to $5 Million in unrestricted securities to be sold to the public in an interstate offering, to accredited and unaccredited investors, found itself essentially useless for two primary reasons (amongst others). First, the cost and complexity of state law compliance made it less practical than other Securities Act exemptions. Secondly, the $5 Million dollar cap deterred many issuers with larger capital needs.
Title IV of the JOBS Act set out to revive Regulation A, and help our small businesses and start ups raise capital more efficiently and effectively under the new Regulation A+.
Final Rules: Summary
Under the SEC’s final rules, Regulation A has been divided into two tiers. Tier 1 allows for up to $20 Million in unrestricted securities to be sold to the public, but does not preempt State Blue Sky Laws. However, it was made clear that Tier 1 will provide an opportunity for states to begin a coordinated review process, or likely risk preemption. Tier 2 allows for up to $50 Million in unrestricted securities to be sold to the public, and does preempt State Blue Sky registration and review. Tier 1 and 2 both allow for general solicitation and advertising, making online crowdfunding portals a likely hotspot for issuers looking to raise money under Reg A. In addition, under both Tier 1 and 2, Unaccredited Investors are permitted to invest, but their investments are capped at the greater of 10% of annual income or net worth (unless the securities are listed on a national exchange). Note, Investors in Regulation A offerings are permitted to self-accredit, reducing the burden on intermediaries and issuers. Unlike the “reasonable steps” requirements of 506(c), Reg A will cut down on the onerous verification procedures.*
Reg A offerings will be registered with the Commission using a scaled down registration statement titled the “Offering Circular”, that must be declared effective or “qualified” by the SEC. While financial reports will need to be included in the Offering Circular of a Tier 1 offering, they will not need to be audited, saving quite a bit of expense for issuers. Tier 2 offerings, however, will face mandatory audited financial statement requirements. Audited statements must have been completed within 9 moths of the date the offering circular was qualified. Issuers in both Tier 1 and 2 offerings can also take advantage of several Safe Harbors from Integration, which call for non-integration of previously closed Reg A offerings, subsequent Title III Crowdfunding offerings, and other exempt offering where the issuer complies with both exemptions independently, meaning a 506(c) offering could be issued laterally. Both Tier 1 and 2 issuers will also be allowed to “Test the Waters”, meaning issuers and intermediaries can solicit indications of interest in a particular deal, without investors actually making an investment. Testing the waters is truly a valuable tool for issuers who may be weary of spending time and money on an offering, only to find out the market is simply not interested in the deal.*
Where Tier 2 diverges from Tier 1 sharply is in the ongoing reporting requirements of the issuer. Tier 2 issuers become obligated to issue periodic disclosures that mimic traditional reporting requirements for public companies. Tier 2 issuers must file: (1) An annual report on Form 1-K; (2) A Semiannual Report on Form 1-SA; and (3) A Current Report on Form 1-U, which are in essence a scaled down 10-K, 10-Q and 8-K respectively. These reports are filed electronically with the commission. These ongoing disclosures are essential to ensure the Regulation A+ secondary market is created, and remains efficient. To foster that efficiency and to incentivize market making, broker/dealers are allowed to rely on these reports to satisfy Exchange Act Rule 15c2-11. An issuer may be relieved of their reporting obligations under Regulation A if they become a traditional reporting company, or by filing a Form 1-Z Exit Report after their first year of reporting, so long as their securities are held by less than 300 shareholders. Relatedly, Tier 2 issuers are conditionally exempt from the Exchange Act Registration requirements of Section 12(g), which triggers registration and thus reporting if an issuer has over 2,000 shareholders or over 500 unaccredited investors.*
What Does Reg A+ Mean for Issuers, Intermediaries, and Investors?
Issuers. Under the new rules, Issuers now have a broader range of fundraising options, providing access to the public capital markets exactly as the JOBS Act intended. This could be wildly beneficial for the Emerging Growth Companies that have dominated the IPO markets over the last few years. For example, in Wilmer Hale’s 2014 IPO Report, it was stated “The 2013 IPO market was dominated by emerging growth companies (EGCs), which produced 82% of all IPOs—slightly higher than the 76% market share for EGC IPOs in 2012 following the enactment of the JOBS Act.” Regulation A now has the potential to cut into that EGC IPO market due to the reduced costs associated with scaled back reporting, including being removed from Sarbanes Oxley requirements.
Intermediaries. Broker-dealers, crowdfunding portals, and other intermediaries are in a great position under the new rules to facilitate the new Reg A primary and secondary markets. Online Crowdfunding Portals may be in the best position to facilitate Reg A primary offerings by leveraging the hyper-interconnectivity of todays digital society by soliciting and advertising to investors across the country. In addition, broker-dealers are in a position to be efficient market-makers and provide much needed liquidity in the Reg A secondary markets. Broker-dealers have also been given the comfort of relying on issuer’s periodic disclosures to satisfy Exchange Act Rule 15c2-11. Frankly, Reg A+ needs the offering power of portals, and the liquidity and efficiency that broker-dealers and other market professionals bring to the capital markets.
Investors. Alas, unaccredited investors have gained (limited) access to potentially lucrative investment opportunities that were once. While its true under the old regulation A, unaccredited investors were allowed to participate; there were hardly any Reg A deals to invest in. Federal preemption of State Blue Sky laws makes it far easier and likely that we will see more Reg A deals, and broader participation by investors in these offerings. More generally, investors have been awarded liquidity options when investing in Reg A securities–liquidity that is absent from other exempt offerings of restricted securities.
Ultimately, the Reg A+ exemption will open the public capital markets to the qualified small businesses and start-ups that make up the foundation of our economy. What is more, this exemption provides wealth creation opportunities for the general public, and marks what could be a workable balance of investor sovereignty and protection that has long been in tension.
The key provisions of the final rules and amendments to Regulation A are:
Scope of the exemption – the final rules:
- Establish two tiers of offerings: Tier 1: annual offering limit of $20 million, including no more than $6 million on behalf of selling security holders that are affiliates of the issuer, such as executives or employees.
- Tier 2: annual offering limit of $50 million, including no more than $15 million on behalf of selling security holders that are affiliates of the issuer, such as executives, or employees.
- Preserve the existing issuer eligibility requirements of Regulation A, and also exclude “Bad Actors”, and companies who have an obligation, but have failed to file reports under the new Regulation A rules.
- Limit the amount of securities that an investor who is not an accredited investor under Rule 501(a) of Regulation D can purchase in a Tier 2 offering to no more than: (a) 10% of the greater of annual income or net worth (for natural persons); or (b) 10% of the greater of annual revenue or net assets at fiscal year end (for non-natural persons). This limit will not apply to purchases of securities that will be listed on a national securities exchange upon qualification.
- Exclude asset-backed securities, as defined in Regulation AB, from the list of eligible securities.
- Permit issuers to “test the waters” with, or solicit interest in a potential offering from, 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 used along with or are followed up by a disclosure document called an Offering Circular, or a notice informing investors how to obtain a copy of said disclosure document.
Qualification, communications, and offering process:
- Require issuers and intermediaries in the period before an offering is “qualified” by the SEC, to deliver a preliminary offering circular to prospective purchasers at least 48 hours in advance of sale (unless the issuer is already reporting under Reg A’s Tier 2 ongoing reporting obligation).
- Permit issuers and intermediaries to satisfy their delivery requirements as to the final offering circular under an “access equals delivery” model when offers are made in pre-qualification period and the final offering circular is filed and available on EDGAR;
- Require issuers and intermediaries, not later than two business days after completion of a sale, to provide purchasers with a copy of the final offering circular or a notice with the URL where the final offering circular may be obtained on EDGAR and contact information sufficient to notify a purchaser how to obtain a final offering circular; and
- Permit continuous or delayed offerings, but require issuers in continuous or delayed Tier 2 offerings to be current in their annual and semiannual reporting obligations in order to do so.
- Permit issuers to qualify additional securities in reliance on Regulation A by filing a post-qualification amendment to a qualified offering statement.
- Require issuers to file offering statements with the Commission electronically on EDGAR.
- Permit the non-public submission of offering statements and amendments for review by Commission staff before filing such documents with the Commission, so long as all such documents are publicly filed not later than 21 calendar days before qualification.
- Eliminate the Question-and-Answer disclosure format for offering statements.
- Update and clarify the Narrative disclosure format under Part II of Form 1-A, and rename it “Offering Circular”.
- Require that offering statements be qualified by the Commission before sales may be made pursuant to Regulation A.
- Require Tier 1 and Tier 2 issuers to file balance sheets and related financial statements for the two previous fiscal year ends (or for such shorter time that they have been in existence).
- Require Tier 2 issuers to include financial statements in their offering circulars that are audited in accordance with either GAAS (Generally Accepted Auditing Standards) or the PCAOB.
- Require Tier 1 and Tier 2 issuers to include financial statements in the Offering Circular that are dated not more than nine months before the date of non-public submission, filing, or qualification, with the most recent annual or interim balance sheet not older than nine months. If interim financial statements are required, they must cover a period of at least six months.
Andres J. Trujillo, Founder and CEO of GlobalGroupFund, Inc, an emerging real estate crowdfunding platform. GlobalGroupFund is a real estate crowdfunding platform with a comprehensive and forward-looking equity based model of crowdfunding. GGF is currently redesigning their backend platform to elevate the user experience for their investors and issuers. Andres also serves as a consultant to start-ups in the NYC area.