Regulation A Direct Listing: Regulation A Tier 2 Requirements

regulation a direct listing

An increasing number of small companies seeking public company status are using Tier 2 of Regulation A in their going public transaction.  This process is sometimes referred to as a Regulation A direct listing. Regulation A provides many benefits for small companies seeking to raise capital without the costs and expansive disclosures required in direct public offerings (DPO) and initial public offerings (IPO) using traditional Form S-1 or other registration statements under the Securities Act of 1933.

Direct public offerings using Regulation A+ allow resales including by the Company’s management of the Company’s shares to purchasers without the efforts of an underwriter. Going public using Regulation A+ with a direct public offering also eliminates costs and myriad of risks and uncertainties of a reverse merger transaction.

Private companies conducting a Regulation A direct public offering should consider the pointers below to ensure a successful securities offering. Planning ahead will prevent many common pitfalls that small companies encounter during the capital raising and going public process.

Direct public offerings using Regulation A+   involve specific disclosures which must be made on Form 1-A. The Form 1-A is reviewed by the Corporation Finance Division of the Securities and Exchange Commission (“SEC”).  Each amendment to the Form 1-A will be reviewed by the SEC and the SEC will provide comments to the disclosures. The Company must respond to the SEC comments.  The Company and its securities lawyer will draft these responses and file any required amendments to the Form 1-A.  When the SEC examiners determine that the disclosures in the Form 1-A satisfy the SEC’s it will qualify the Form 1-A offering and the Company may sell its shares.

A reporting requirements are significantly less burdensome than those to that apply to SEC reporting issuers. If a company files under Tier 2, of Regulation A+, it becomes subject to the SEC’s Regulation A+ reporting requirements and must submit various reports and filings, with the SEC.

Companies using Tier 2 of Regulation A must file a Form 2-A with the SEC every six months to report sales in the offering, and submit a final filing to the SEC within 30 days after the offering is complete.   Form 1-A requires information about the amount of securities qualified and sold, as well as the price, fees, and net proceeds. Issuers conducting Regulation A, Tier 2 offering must report the same information on Form 1-Z or, depending on when the offering is terminated, in their annual report on Form 1-K. Issuers in Regulation A, Tier 2 offerings become subject to ongoing SEC reporting obligations.

Seed Shareholders

The Financial Industry Regulatory Authority (“FINRA”) requires companies going public demonstrate that an orderly and liquid market can be established. This means that the issuer must have an adequate public float of its securities.  Without this, FINRA will not approve the company’s Form 211, and the company’s sponsoring market maker cannot initiate quotations of the Company’s securities.

It is becoming more and more difficult for companies going public to locate a qualified sponsoring market maker to submit their Form 211 application to FINRAMarket makers cannot be compensated for acting as a sponsor, and compiling the application entails a tremendous amount of time and effort.  Rule 15c2-11(a)(5) of the Securities Exchange Act of 1934, as amended, requires sponsoring market makers to undertake significant due diligence to achieve compliance.

Shell Company Status

As stated above, once the Form 1-A is qualified by the SEC, the company must locate a sponsoring market maker to file its Form 211.  If FINRA is concerned that a company may be a shell, it may not approve the Form 211. Without proper legal advice many startups will be unable to address this issue successfully, and FINRA will not assign a ticker symbol.

Before submitting a Form 211 application to initiate quotation of a company’s securities, the company should be certain it is not a shell company. Rule 405 of the Securities Act defines a shell as a company that has:

(1) No or nominal operations; and

(2) Either:

(i) No or nominal assets;

(ii) Assets consisting solely of cash and cash equivalents; or

(iii) Assets consisting of any amount of cash and cash equivalents and nominal other assets.

It is important to note that this determination is not based upon whether the company has revenues.  The question of what constitutes more than nominal operations is a question of fact.  Given that, startups and companies without revenues should be prepared to provide FINRA with sufficient documentary evidence of meaningful operations.

Financial Statements

A Tier 2 issuer using Regulation A+  must provide audited financial statements for its most recent two fiscal years or shorter period that it has been in existence.  The Company must have an accountant who is capable of preparing GAAP-compliant financial statements and the necessary footnotes.

Disclosures in the Going Public Process

The SEC and FINRA may examine the company’s website, investor relations activity including press releases and other publicly available information.  If either finds improper or misleading statements, they will issue comments asking the company to offer explanations.

If the SEC becomes concerned about misleading disclosures it will not approve the company’s Form 1-A offering document.  If FINRA believes an issuer is using untrue or misleading disclosures to condition the market for a company’s securities, it will not approve the Form 211 application to initiate quotations in the OTC Markets. Addressing areas of concern regarding disclosure early with your attorney is much easier than waiting for an issue to arise.

The Transfer Agent

transfer agent is the custodian of the company’s shareholder records, including purchases, sales, transfers and account balances.  After completion of the going public transaction, as the company’s securities begin to trade actively, it becomes critical to have efficient transfer agent operations.

Setting up transfer agency early, and then issuing and shipping shares to the company’s initial subscribing shareholders is a formality that helps avoid confusion and extra burdens for the company and its shareholders.

Choosing a qualified transfer agent that offers a reasonable fee structure and terms is an important yet often overlooked step in the process.  Experienced legal counsel will usually have a good sense of the field of service providers and can help you.

DTC Eligibility

In order for securities to trade electronically, the company must locate a Depository Trust Company (“DTC”) participant to file its application for DTC eligibility.  Most often the participant is a market maker.  The issuer should attempt to obtain a commitment from its sponsoring market maker to file both its Form 211 and application for DTC eligibility.

Once all of the above has been accomplished, the new public company’s stock will be eligible to trade electronically.  While the process may seem daunting, especially given that management of small startups rarely has a good understanding of regulatory requirements, with the help of an experienced securities attorney it can be made relatively painless.

For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email at [email protected].   This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute legal advice on any specific matter, nor does this message create an attorney-client relationship.  Please note that the prior results discussed herein do not guarantee similar outcomes.

Hamilton & Associates | Securities Lawyers
Brenda Hamilton, Securities Attorney
101 Plaza Real South, Suite 202 North
Boca Raton, Florida 33432
Telephone: (561) 416-8956
Facsimile: (561) 416-2855