Practical Considerations in Regulation A+ Offerings
WHAT YOU NEED TO KNOW ABOUT REGULATION A OFFERINGS
On March 25, 2015, The Securities and Exchange Commission (the “SEC”) adopted final rules to implement Section 401 of The Jumpstart Our Business Startups (JOBS) Act by expanding Regulation A into two tiers. These changes have had a notable impact on companies raising capital and going public particularly companies quoted by the OTC Markets. As amended Regulation A provides unique benefits not present in traditional securities offerings registered with the SEC on Form S-1 or Form F-1.
OVERVIEW OF REGULATION A
Regulation A consists of two exemptions, each with its own unique requirements. Tier 1 of Regulation A+ provides an exemption for securities offerings of up to $20 million in a 12-month period, while Tier 2 provides an exemption for securities offerings of up to $50 million in a 12-month period. An issuer of $20 million or less of securities in its offering can elect to proceed under either Tier 1 or Tier 2. The requirements of Regulation A+ Tier 1 and Tier 2 are summarized in the chart below.
|Regulation A+ – Tier 1|
|Regulation A+ – Tier 2|
|Eligible Issuers||U.S. or Canadian Issuer|
|U.S. or Canadian Issuer|
|Reporting & Non-Reporting Issuers Eligible|
|Reporting & Non-Reporting Issuers Eligible|
|Maximum Offering Amount|
|Type of Security Allowed|
|Common stock, preferred stock and warrants and other convertible equity securities and non-asset-backed Notes; i.e., straight debt.|
|Common stock, preferred stock and warrants and other convertible equity securities and non-asset-backed Notes; i.e., straight debt.|
|Accredited Investor Eligibility|
|All, including non-accredited investors|
|Individual Investment Cap|
|Non-accredited investors may invest the greater of 10% of their income or 10% of their net worth; entities may invest 10% of their revenue or net assets; Accredited Investors: Unlimited|
|General Solicitation Allowed?|
|Form 1-A Offering Document|
|SEC & State Review|
|SEC Review- No State Review|
|Financial Statement Requirements|
|Auditor Reviewed Financials (note that certain states may require audited financial statements)|
|Financial Statements Audited (non-PCAOB acceptable)|
|No ongoing SEC financial reporting|
|Annual and semi-annual SEC reporting, including audited financial statements (non-PCAOB acceptable)|
|Ability to Terminate Ongoing Reporting Requirements|
|Not applicable (no ongoing SEC reporting)|
|Fewer than 300 holders of Regulation A+ shares|
Regulation A+ is available only to companies organized in and with their principal place of business in the United States or Canada.
What does “principal place of business in the United States or Canada” mean? The SEC has issued the following guidance:
Question: Would a company with headquarters that are located within the United States or Canada, but whose business primarily involves managing operations that are located outside those countries, be considered to have its “principal place of business” within the United States or Canada for purposes of determining its eligibility to conduct a securities offering in reliance upon Regulation A+?
Answer: Yes, an issuer will be considered to have its “principal place of business” in the United States or Canada for purposes of determining issuer eligibility under Rule 251(b) of Regulation A+ if its officers, partners, or managers primarily direct, control, and coordinate the issuer’s activities from the United States or Canada. (June 23, 2015)
So, the “principal place of business” test is based upon where management is located rather than where revenues are generated.
In 2018, Congress expanded Regulation A+ eligibility to issuers subject to the ongoing reporting requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 (“Exchange Act”) with the passage of the Economic Growth, Regulatory Relief, and Consumer Protection Act.
It should be noted that Regulation A+ is not available to:
- companies registered or required to be registered under the Investment Company Act of 1940 and Business Development Companies (“BDCs”);
- development stage companies that have no specific business plan or purpose or have indicated that their business plan is to engage in a merger or acquisition with an unidentified company or companies (often referred to as “blank check companies”);
- issuers of fractional undivided interests in oil or gas rights, or similar interests in other mineral rights;
- issuers that are required to, but have not, filed with the SEC the ongoing reports required by the rules under Regulation A during the two years immediately preceding the filing of a new offering statement (or for such shorter period that the issuer was required to file such reports);
- issuers that are or have been subject to an order by the SEC denying, suspending, or revoking the registration of a class of securities pursuant to Section 12(j) of the Exchange Act that was entered within five years before the filing of the offering statement; and
- issuers subject to “bad actor” disqualification under Rule 262.
Regulation A+ limits the type of securities that can be issued to the specifically enumerated list in Section 3(b)(3) of the Securities Act of 1934 (“Securities Act”), which includes warrants and convertible equity and debt securities, among other equity and debt securities. Asset-backed securities are ineligible under Regulation A+.
OFFERING LIMITATIONS AND SECONDARY SALES UNDER REGULATION A
Issuers can conduct a Regulation A offering using either Tier 1 or Tier 2. Tier 1 is available for offerings of up to $20 million in a 12-month period, including no more than $6 million on behalf of selling security holders that are affiliates of the issuer. Tier 2 is available for offerings of up to $50 million in a 12-month period, including no more than $15 million on behalf of selling security holders that are affiliates of the issuer. Additionally, sales by all selling security holders in a Regulation A+ offering are limited to no more than 30% of the aggregate offering price in an issuer’s first Regulation A+ offering and any subsequent Regulation A+ offerings in the following 12-month period.
REGISTERING SHARES FOR RESALE IN A REGULATION A OFFERING
One of the biggest differences between Securities Offerings conducted under Regulation A+ and Form S-1 is the treatment of selling stockholders who want to make their shares “free trading” and thus salable without restriction by including their shares for resale in the Regulation A+ or Form S-1 registration statement.
Who is a selling stockholder? A selling stockholder is not someone who purchases Company shares in a Form S-1 or Regulation A+ offering. The selling stockholder owns restricted stock prior to the filing of the S-1 registration statement or Regulation A+ offering circular and wants to make his shares “free trading” by including them for resale in the offering, along with the shares the Company is selling directly.
Selling stockholders in a Regulation A+ offering are subject to more restrictions than selling stockholders with shares registered in a Form S-1 registration statement, as described below.
Number of Shares That Can Be Sold
- Form S-1 registration statement: There is no limit on the number of shares that selling stockholders can include in a registration statement.
- Regulation A+ offering circular: The amount of securities that selling stockholders can sell at the time of a company’s first Regulation A+ offering and within the following twelve months is limited to the equivalent of no more than 30 percent of the aggregate offering price of that offering.
Therefore, selling stockholders cannot resell as many shares in an A+ offering as they could in an S-1 offering.
Price at Which Selling Stockholders Can Sell Their Stock
- Form S-1 registration statement: Shares registered on Form S-1 may be sold into the market at the prevailing market price. The price at which Form S-1 selling stockholders can resell their stock is not fixed but varies with the market price of the stock in question.
- Regulation A+ offering circular: All of the shares described in Form 1-A, the Regulation A+ offering circular, must be sold at a fixed price: the fixed price set forth as the offering price in the Form 1-A.
And so Regulation A+ is useless as a way for selling stockholders to profit extravagantly, as they cannot deposit their shares with a broker-dealer and sell them into the market at market price. This is one of the few areas where filing a Form S-1 registration statement is preferable to a Regulation A+ filing.
TESTING THE WATERS
One key benefit of Regulation A+ is that issuers are permitted to “test the waters” with all potential investors and use solicitation materials both before and after the filing of the Form 1-A Offering Statement, subject to compliance with the filing and disclaimer requirements. Issuers may not do this in an offering registered in a Form S-1 filing. This enables the company to gauge interest in its offering before committing money to offering expenses.
If a company uses Regulation A+, it can advertise anywhere it wants, including in social media and in other places where it believes that it will find investors. Of course, all the company can obtain are non-binding indications of interest, so it won’t be able to hold those people to their indication of interest in investing. However, testing the waters provides the company with the opportunity to see if there’s sufficient potential investor interest before spending significant amounts of money on the actual filing.
Any testing the waters advertising materials used must be filed with the SEC. Although the SEC does not pre-review pre-filing advertising, issuers should be very careful what they say in the offering materials. Solicitation materials are subject to the anti-fraud and other civil liability provisions of the federal securities laws and issuers can be sued for what they say in the advertising materials even if it is not included in the information in the Form 1-A offering circular itself.
Pre-filing solicitation material in Regulation A offerings must bear a legend or disclaimer stating that (1) no money or other consideration is being solicited, and if sent, will not be accepted; (2) no sales will be made or commitments to purchase accepted until the offering statement is “qualified,” which means made effective by the SEC; and (3) a prospective purchaser’s indication of interest is non-binding.
Solicitation materials used after a Form 1-A offering statement has been publicly filed with the SEC must be accompanied by a current preliminary offering circular or contain a notice informing potential investors where and how that offering circular can be obtained. This requirement may be satisfied by providing the URL (the website address) where the preliminary offering circular or the offering statement may be read. If a company uses testing the waters materials after publicly filing the offering statement, it must update and redistribute such material in a substantially similar manner as the materials were originally distributed. This must be done every time the testing the waters material or the preliminary offering circular attached becomes inadequate or inaccurate in any material respect.
REGULATION A AND RULE 15c2-11 IN GOING PUBLIC TRANSACTIONS
Companies using Regulation A+ to go public should consider Exchange Act Rule 15c2-11, which governs broker-dealers’ publication of quotations for securities in a quotation medium other than a national securities exchange. Generally, a broker-dealer can satisfy its obligations under Rule 15c2-11 if it has reviewed and maintained in its records certain specified information. The particular information that is required by Rule 15c-211 varies according to the nature of the issuer, and includes, among other things:
- For an issuer that has filed a Form 1-A offering statement under the Securities Act pursuant to Regulation A+, a copy of the offering circular.
- For an issuer subject to ongoing reporting under Sections 13 or 15(d) of the Exchange Act, the issuer’s most recent annual report and any quarterly or current reports filed thereafter.Regulation A+ specifically states that an issuer’s ongoing reports filed under Tier 2 will satisfy FINRA’s requirement that a broker-dealer review the specified information about an issuer and its security before publishing a quotation for a security (or submitting a quotation for publication) in a quotation medium. Because of this, one might think that FINRA could not deny an application for quotation of securities because the submitting sponsoring market maker did not have the requisite Exchange Act Rule 15c2-11 information concerning the Regulation A+ Tier 2 Issuer. Unfortunately, this is not correct.
The biggest hurdle for smaller companies that desire to have their stock qualified for quotation on the OTC Markets OTCQB or OTCQX tiers, giving investors potential liquidity for their investment—thus making an A+ offering much easier to sell to investors than a private placement—is FINRA’s regulation of Form 211 filings by sponsoring market makers. This is because Exchange Act Rule 15c2-11 imposes a much more general and subjective requirement on market makers in the 211 process, specifically that the broker or dealer submitting or publishing such quotation shall have in its records a copy or a written record of any other material information (including adverse information) regarding the Issuer that comes to the broker’s or dealer’s knowledge or possession before the publication or submission of the quotation.
This gives FINRA broad authority to require that the sponsoring market maker of a company’s Form 211 come to an independent conclusion—not relying upon legal opinions furnished by or on behalf of the issuer—that all prior issuances of securities were done in full compliance with federal and state securities laws. This can be very problematic if the issuer has sold any securities to non-accredited investors without a full private placement memorandum and Blue Sky filings in a Rule 506 offering. Many issuers cannot satisfy these requirements, particularly for early issuances in founder’s or friends-and-family rounds of stock sales. Even if the SEC qualifies a Regulation A+ offering, unless the issuer can also satisfy this and similar requirements imposed by FINRA on market makers in the 211 process, the issuer will not be able to qualify its securities for quotation on the OTC Markets’ OTC Pink, OTCQB or OTCQX tiers
INVESTMENT LIMITATIONS FOR NON-ACCREDITED INVESTORS
Regulation A+ limits 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 the equivalent of: (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 does not, however, apply to purchases of securities that will be listed on a national securities exchange upon qualification of the Regulation A+ offering.
INTEGRATION AND REGULATION A OFFERINGS
The integration doctrine provides an analytical framework for determining whether multiple securities offerings should be treated as the same offering. This helps to determine whether registration under Section 5 of the Securities Act is required or an exemption is available for the entire offering. Generally, the determination as to whether particular securities offerings should be integrated into a single offering is based upon the specific facts and circumstances. Regulation A+ provides that offerings conducted pursuant to Regulation A+ will not be integrated with:
- prior offers or sales of securities; or
- subsequent offers or sales of securities that are:
- registered under the Securities Act, except as provided in Rule 255(c);
- made pursuant to Rule 701 under the Securities Act;
- made pursuant to an employee benefit plan;
- made pursuant to Regulation S;
- made pursuant to Section 4(a)(6) of the Securities Act; or
- made more than six months after completion of the Regulation A+ offering.
TREATMENT OF REGULATION A UNDER SECTION 12(g)
Section 12(g) of the Securities Exchange Act of 1934 requires, among other things, that an issuer with total assets exceeding $10,000,000 and a class of equity securities held of record by either 2,000 persons, or 500 persons who are not accredited investors, register such class of securities with the SEC. Regulation A+, however, conditionally exempts securities issued in a Tier 2 offering from the mandatory registration provisions of Section 12(g) for so long as the issuer remains subject to and is current in (as of its fiscal year end), its Regulation A+ periodic reporting obligations.
In order for the conditional exemption to apply, issuers in Tier 2 offerings are required to engage the services of a transfer agent registered with the SEC pursuant to Section 17A of the Exchange Act. The final rules also provide that the conditional exemption from Section 12(g) is only available to companies that meet size-based requirements similar to those contained in the “smaller reporting company” definition under Securities Act and Exchange Act rules. An issuer that exceeds the size-based requirements is 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 during such period.
THE FORM 1-A REGULATION A OFFERING STATEMENT
All issuers that conduct offerings pursuant to Regulation A+ must electronically file an offering statement on Form 1-A on the SEC’s Electronic Data Gathering, Analysis and Retrieval system (EDGAR). The Form 1-A Offering Statement requires substantial disclosures and consists of three parts:
- Part I: an eXtensible Markup Language (XML) based fillable form;
- Part II: a text file attachment containing the body of the disclosure document and financial statements; and
- Part III: text file attachments, containing the signatures, exhibits index, and the exhibits to the offering statement.
Part I of Form 1-A
Part I of Form 1-A requires certain basic information about the issuer and the proposed offering. The notification in Part I of Form 1-A requires the following:
- Item 1. Issuer Information. Item 1 requires information about the issuer’s identity, industry, number of employees, financial statements and capital structure, as well as contact information.
- Item 2. Issuer Eligibility. Item 2 requires the issuer to certify that it meets various issuer eligibility criteria.
- Item 3. Application of Rule 262. Item 3 requires the issuer to certify that no disqualifying events have occurred and to indicate whether related disclosure will be included in the offering circular.
- Item 4. Summary Information Regarding the Offering and other Current or Proposed Offerings. Item 4 contains indicator boxes or buttons and text boxes eliciting information about the offering.
- Item 5. Jurisdictions in Which Securities are to be Offered. Item 5 requires information about the jurisdiction in which the securities will be offered.
BAD ACTOR DISQUALIFICATION IN REGULATION A OFFERINGS
The “bad actor” disqualification provisions contained in Rule 262 of Regulation A+ disqualify securities offerings from reliance on Regulation A if the issuer or other relevant persons (such as underwriters, placement agents, and the directors, officers and significant shareholders of the issuer; collectively, “covered persons”) have experienced a disqualifying event, such as being convicted of, or subject to court or administrative sanctions for, securities fraud or other violations of specified laws.
Understanding the categories of persons that are covered by Rule 262 is important because issuers are required to conduct a factual inquiry to determine whether any covered person has had a disqualifying event, and the existence of such an event will generally disqualify the offering from reliance on Regulation A+.
“Covered persons” include:
- the issuer, including its predecessors and affiliated issuers
- directors, general partners, and managing members of the issuer
- executive officers of the issuer, and other officers of the issuers that participate in the offering
- 20 percent beneficial owners of the issuer, calculated on the basis of voting power
- promoters connected with the issuer in any capacity
- persons compensated for soliciting investors, including directors, executive officers or other officers participating in the offerings, general partners and managing members
Under Regulation A+, disqualifying events include:
- certain criminal convictions
- certain court injunctions and restraining orders
- certain final orders of certain state and federal regulators
- certain SEC disciplinary orders
- certain SEC cease-and-desist orders
- suspension or expulsion from membership in a self-regulatory organization (SRO), such as FINRA, or from association with an SRO member
- SEC stop orders and orders suspending the Regulation A+ exemption
- U.S. Postal Service false representation orders
Many disqualifying events include a look-back period (for example, a court injunction that was issued within the last five years or a regulatory order that was issued within the last ten years). The look-back period is measured from the date of the disqualifying event—for example, the issuance of the injunction or regulatory order and not the date of the underlying conduct that led to the disqualifying event—to the date of the filing of an offering statement.
Regulation A+ provides an exception from disqualification when the issuer is able to demonstrate that it did not know and, in the exercise of reasonable care, could not have known that a covered person with a disqualifying event participated in the offering.
The steps an issuer should take to exercise reasonable care will vary according to particular facts and circumstances. A note to the rule states that an issuer will not be able to establish that it has exercised reasonable care unless it has made, in light of the circumstances, factual inquiry into whether any disqualification exists.
Disqualification will not arise if, before the filing of the offering statement, the court or regulatory authority that entered the relevant order, judgment or decree advises in writing—whether in the relevant judgment, order or decree or separately to the SEC or its staff—that disqualification under Regulation A+ should not arise as a consequence of such order, judgment or decree. The rule provides for the ability to seek waivers from disqualification by the SEC upon a showing of good cause that it is not necessary under the circumstances that the exemption be denied. The SEC has identified several circumstances that could, depending upon the specific facts, be relevant to the evaluation of a waiver request for good cause shown. These can be viewed here.
STATE SECURITIES LAWS & REGULATION A+ OFFERINGS A.
Tier 1 Offerings
In addition to qualifying a Regulation A+ offering with the SEC, issuers i Tier 1 offerings must register or qualify their offering in any state in which they seek to offer or sell securities pursuant to Regulation A+.
Issuers wishing to obtain information on state-specific registration requirements should contact state securities regulators in the states in which they intend to offer or sell securities for further guidance on compliance with state law requirements. Issuers may also obtain useful information on state securities law registration and qualification requirements, including the option to have Tier 1 offerings that will be conducted in multiple states reviewed pursuant to a coordinated state review program, by visiting the website of the North American Securities Administrators Association (NASAA) at www.nasaa.org .
Tier 2 Offerings
While issuers in Tier 2 offerings are required to qualify offerings with the SEC before sales can be made pursuant to Regulation A+, they are not required to register or qualify their offerings with state securities regulators. The offerings, however, remain subject to state law enforcement and anti-fraud liability.
Issuers in Regulation A+ Tier 2 offerings may be subject to filing fees in the states in which they intend to offer or sell securities and be required to file with each states any materials that the issuer has filed with the SEC as part of the offering.
The failure to file, or pay filing fees regarding, any such materials may cause state securities regulators to suspend the offer or sale of securities within their jurisdiction. Issuers should contact state securities regulators in the states in which they intend to offer or sell securities for further guidance on compliance with state law requirements.
PRACTICAL BENEFITS OF REGULATION A
Regulation A+ offers an alternative to the traditional methods of filing a Registration Statement on Form S-1 or Form F-1 to raise capital and go public, while preserving some of the key benefits of those traditional registered offerings. The benefits include:
- Even with Regulation A+’s reduced ongoing reporting requirements, a company can secure quotation of its securities on the OTC Market’s OTCQB, just as with an S-1 filing.
- The securities a company sells in its A+ offering are non-restricted free-trading, just as those registered in a Form S-1 offering.
Significant advantages of Regulation A+ that aren’t present when a company registers securities on Form S-1:
- The company can aggressively advertise its Regulation A offering in social media and elsewhere in all fifty states before it spends money to prepare and file a Form 1-A offering circular. A company cannot do this in a Form S-1 offering.
- Companies do not have to register a Regulation A+ offering by making separate state “Blue Sky” filings. This means a company may advertise and sell its A+ offering in all 50 states, even in states that have “merit review.” A Form S-1 offering, on the other hand, requires separate registrations in every state where the company wants to sell securities.
- A company can sell shares qualified under Regulation A to both accredited and non-accredited investors without securing independent verification of each investor’s financial status, just as with a Form S-1 offering. However, for non-accredited Investors in Regulation A offerings, there is a 10 percent income/net worth limitation.
- With Regulation A+, the company only has two ongoing SEC filings per year rather than the four filings required after a Form S-1 registration statement.
- Although the company must provide audited financial statements with a Regulation A+ offering, it does not have to use an expensive PCAOB-registered audit firm and may use a less expensive, though SEC-knowledgeable, CPA firm. Additionally, it is not required to use a PCAOB audit firm for ongoing reporting after its Regulation A+ offering has been qualified by the SEC.
- With Regulation A+, the company is not subject to the SEC’s proxy rules, and its shareholders are not subject to the SEC’s beneficial ownership reporting rules.
A correctly designed Regulation A+ offering and Going Public Program can minimize a Company’s financial risk and significantly enhance its ability to raise money. For more information about Regulation A+ and going public, please contact Securities Lawyer, Brenda Hamilton of Hamilton & Associates Law Group, P.A. 01 Plaza Real S, Suite 202 N, Boca Raton, Florida, by email at [email protected] or 561-416-8956. 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.
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