SEC Adopts Rules to Increase Access to Capital for Smaller Companies

Corporate / Financial Institutions Alert

March 30, 2015
Corporate / Financial Institutions Alert

On March 25, 2015, the SEC, as directed by Section 401 of the JOBS Act, adopted rules which significantly amend Regulation A.

On December 18, 2013, the SEC proposed amendments to Regulation A intended to implement Section 401. Generally speaking, the final rules follow the approach set forth in the proposed rules. The final rules should be effective in late May or early June.

A more detailed discussion of these rules may be found here.

Regulation A

Regulation A is a longstanding, little-used, exemption. Currently, Reg A permits unregistered public offerings of up to $5 million of securities in a 12-month period, including no more than $1.5 million of securities offered by security-holders of the company. Reg A has been little used due to its limited offering size and disclosure burdens relative to other private placement exemptions, such as those offered by Regulation D.

Reg A+

The SEC’s rules expand and revise Reg A and create two tiers of Reg A offerings:

For offerings up to $20 million, a company could elect to proceed under either Tier 1 or 2.

The new rules permit “test-the-waters” communications for Tier 1 and 2 offerings and disqualify issuers involved with bad actors.

The new rules will require issuers to electronically file disclosure documents with the SEC but impose different disclosure requirements for issuers involved in Tier 1 and Tier 2 offerings. In addition, the rules will allow issuers to submit offerings to the SEC on a confidential basis. An issuer completing a Tier 2 offering will be required to comply with periodic reporting rules.

Tier 2 offerings will be subject to investment limits as discussed below. Tier 2 offerings will be exempt from the state registration and qualification rules.

The rules permit brokers to rely on reports filed by a Reg A issuer making a Tier 2 offering to satisfy the broker’s obligations under Rule 15c2-11 and impose restrictions on secondary sales by security-holders following the completion of a Tier 1 or 2 offering.

Companies relying on Tier 2 of Reg A would not become subject to the reporting and most other requirements of the Securities Exchange Act of 1934 (the "1934 Act"). As a result, Reg A companies will not be subject to, among other rules, Sarbanes-Oxley, insider trading and reporting rules, or SEC proxy rules.

Eligible Securities

The Reg A exemption will only apply to offerings of equity securities, warrants, convertible equity securities, debt securities, and debt securities convertible or exchangeable into equity interests, including any guarantees of such securities. Asset-backed securities may not be sold in a Reg A offering.

Eligible Issuers

The revised Reg A would be available to issuers organized in and with their principal place of business in the United States or Canada.

The Reg A exemption would not be available to the following issuers:

Communications During an Offering

Companies may “test the waters” in order to solicit interest in a potential offering with the general public either before or after the filing of the offering statement. This allows a company to determine if there is sufficient interest in the offering.

Filing and Delivery Requirements

Whether relying on Tier 1 or Tier 2, a company will be subject to the following filing and delivery requirements, including ones which provide that:

Offering Statement on Form 1-A

Under the final rules, companies would continue to file an offering statement on Form 1-A as revised. The rules update and clarify the Model B (Narrative) disclosure format under Part II of Form 1-A (renaming it as Offering Circular), while continuing to permit the use of Part I of Form S-1 narrative disclosure as an alternative.

Tier 1 and Tier 2 issuers must 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).

Tier 2 issuers must include audited financial statements in their offering statements that are audited in accordance with either GAAS or the standards of the Public Company Accounting Oversight Board (PCAOB). The accountants must be independent but they do not have to be registered with the PCAOB.

Issuers in Tier 1 offerings do not have to provide audited financials. However, if the issuer has already obtained audited financials prepared in accordance with GAAP or PCAOB standards and the accountants satisfy the independence standards, then the audited financials must be filed. However, the accountants do not have to be registered with the PCAOB.

Ongoing Reporting

The ongoing reporting rules provide that:

Purchase Limits

There are no investment limitations for purchasers in Tier 2 offerings who qualify as accredited investors under Rule 501 of Regulation D.

In a Tier 2 offering, an investor who is not an accredited investor will be limited to purchasing no more than 10% of the greater of the investor’s annual income or net worth. The annual income and net worth would be calculated for individuals as provided in the accredited investor definition in Regulation D. Non-natural persons are subject to the investment limitation and should calculate the limitation based on no more than 10% of the greater of the purchaser’s revenue or net assets (as of the purchaser’s most recent fiscal year end).

There are no investment limitations for a Tier 1 offering.

Registration with the SEC

The final rules provide that securities issued in Tier 2 offerings are exempt from the provisions of Section 12(g) for so long as:

Section 12(g) registration will be required if on the last day of a fiscal year: (i) the company exceeded the public float threshold or the annual revenue threshold, and (ii) the company has total assets of more than $10 million and the class of equity securities is held by more than 2,000 persons or 500 persons who are not accredited investors (item (ii) being the "12(g) Threshold").

An issuer that exceeds public float or annual revenue threshold and the Section 12(g) Threshold will be granted a two-year transition period before it would be required to register its class of securities pursuant to Section 12(g), provided it timely files all ongoing reports due pursuant to Rule 257 during such period.

Preemption of Blue Sky Law

Currently, Reg A offerings are subject to registration and qualification requirements in the states where the offering is conducted unless a state-level exemption is available. Tier 1 offerings will be subject to state registration and qualification requirements.

Under the rules, state securities law requirements purchaser will be defined to be any person to whom securities are offered or sold in a Tier 2 offering.

For further information on the proposed Reg A rules, please contact Tim Sullivan, Mike Morehead or your regular Hinshaw attorney.

Tax advice disclosure: To ensure compliance with the Internal Service Regulations governing the issuance of advice on Federal Tax issues, we advise you that any tax advice in this communication (and any attachments) is not written with the intent that it be used, and cannot be used, to avoid penalties that may be imposed under the Internal Revenue Code.

This alert has been prepared by Hinshaw & Culbertson LLP to provide information on recent legal developments of interest to our readers. It is not intended to provide legal advice for a specific situation or to create an attorney-client relationship.