The Coming Expansion of Regulation A
Companies offering and selling stocks, notes, and other securities to raise capital must either register the securities with the Securities and Exchange Commission or rely on an exemption to registration. One long-standing, though rarely used, exemption is provided by Regulation A. In 2012, congress, in an effort to promote small company capital formation, mandated an expansion and update of this regulation with the Jumpstart Our Business Startups Act (the JOBS Act). The JOBS Act requires the Securities and Exchange Commission to adopt changes to Regulation A that increase the use of the exemption.
The Securities and Exchange Commission originally adopted Regulation A in 1936 for small offerings. It is sometimes called the “mini-public offering” and is currently available for securities offerings in amounts up to $5 million. There are various aspects of Regulation A that are attractive to companies. For instance, there is no prohibition on general solicitation. A company can raise capital with a broad offering that is not limited to pre-existing relationships, making use of advertising if desirable; and there is even some ability to gauge investor interest before preparing the offering. Also, unlike most offerings under the more popular Regulation D, there are no requirements that the purchasers of the securities be comprised of “accredited investors” (individuals that meet certain net worth and income standards, as well as other specified types of investors) and the securities are not subject to holding periods before they can be resold by investors.
Why is the exemption rarely used? Several factors serve to make offerings under Regulation A relatively complex and costly, and thus less practical than alternative exemptions. First and foremost, many companies find the filing and disclosure requirements cost prohibitive in light of the amount of capital that can be raised. A company must file an offering statement for review with the Securities and Exchange Commission. The offering statement includes an “offering circular” for prospective investors that is similar to a prospectus, albeit not quite as extensive. In addition, the regulation does not pre-empt state securities laws. Offerings under Regulation A may involve substantive compliance with securities laws of multiple states, rather than just the notice filings required with offerings under Rule 506 of Regulation D. Consequently, as the Securities and Exchange Commission notes in its rule proposal, there were only eight offerings under Regulation A in 2012, a very small number compared with the approximately 7,700 offerings under Regulation D that were eligible for Regulation A based upon transaction size.
As mentioned above, the JOBS Act mandates an expansion and update of Regulation A in order to make it more useful to small companies. Most notably, the size of permitted offerings will increase to $50 million. The rule changes proposed by the Securities and Exchange Commission achieve the mandated increase in size by creating two tiers of offerings: a Tier 1 for offerings up to $5 million and a Tier 2 for offerings up to $50 million. Tier 2 offerings will have enhanced reporting requirements, including annual reports, semiannual reports, and current event updates similar to requirements for public companies. Also, the offering circular must include audited financial statements. Due to these reporting requirements, as well as other investor protections provided by the regulation, state securities laws will be preempted for Tier 2 offerings.
Will more companies utilize Regulation A as a result of the changes? Currently, there appears to be no consensus as to whether it represents a viable alternative to Regulation D or other exemptions, even with the increased size and preemption of state securities laws for Tier 2 offerings. It remains to be seen if companies will find the exemption worthwhile given the filing and disclosure requirements. As a side note, the updates to Regulation A are still working their way through the administrative rulemaking process and the regulation as currently proposed is subject to change.