Regulation A and the Reawakening of U.S Entrepreneurship!

Reg. A and the Reawakening of American Entrepreneurship!

Introduction:

There is little doubt that innovation and entrepreneurship are the backbone of this nation. About 25 million small businesses employ more than 50 percent of the private workforce and generate more than half of the nation's gross domestic product. [1] The entrepreneurs driving the growth of our country suffered particularly in the aftermath of the 2008[2] financial crisis, as most traditional sources of capital dried-up. Small business expansion and support was not the priority of preceding U.S administrations, and the banking system failure did little to invigorate initiative and capital growth. As a result, not only was the American entrepreneurial drive hindered, but its ability to create jobs was also damaged, thus, job creation substantially declined. That situation may have changed when the legislator through the leadership of a few[3] realized that government failed to revive the economy as rapidly as hoped and capital formation can only be efficiently created from the bottom up and that government cannot be the principal source of jobs creation. This resulted in the passage and ongoing implementation of the Jumpstart Our Business Startups Act (the “JOBS Act”)[4], a bipartisan law signed by President Obama on April 5, 2012. 

I.          Reg. A Background

Any discussion of Reg. A+ must begin with its progenitor, Regulation A. This earlier Reg. A was first adopted in 1936 and added to the Securities Act of 1933, as amended[5] (“Reg. A” or Regulation A”), and provides for a simplified registration process tailored to smaller companies for the purposes of facilitating capital formation. Reg. A is sometimes referred to as a “Mini IPO”[6]. Under Reg. A, which will now run parallel to Reg. A+,  private companies benefit of the following:  (i) they may raise up to $5 million in any rolling twelve-month period, through sales of their securities, without complying with the usual registration requirements of the Securities Act, including quarterly and annual reporting; (ii) companies offering shares under Reg. A are not subject to a full audit and may instead, simply submit “reviewed” financial statements, which is usually substantially less expensive; in addition, (iii) Reg. A also enables pre-existing shareholders with an opportunity to resell a limited dollar amount of their unregistered securities; furthermore, (iv), securities sold through Reg. A are freely tradable over any exchange that would host such trade or on any platform, one could argue that they are resalable on EBay if offered, moreover, (v) offering statements issued under Reg. A are reviewed by both the SEC and state securities regulators (under the states’ so-called “Blue Sky”[7] laws).

II.        Proposed Reg. A+ Under the JOBS Act

Reg. A+[9] amends the pre-existing Reg. A by establishing two “tiers” of offerings:

·         Tier I comprises Reg. A under its traditional contours, as described above.

·         Tier II, provides what is basically a “super-sized” version of Reg. A. Tier II offerings will enable companies to issue offerings of up to $50 million in any rolling 12-month period, up to $15 million of which may be resales by existing shareholders. Importantly, Tier II offerings will pre-empt state-by-state Blue Sky regulations, greatly streamlining and broadening the offering process. The only significant drawbacks of Tier II offerings are that companies issuing such offerings must submit to a full audit and must file annual financial statements.

A.    Eligibility.

There are further limitations to Title IV, under either tier. Companies utilizing Title IV must comply as follows: 

a.       be organized under the laws of the U.S. or Canada;

b.       not be subject to ongoing reporting requirements under Section 13 or Section 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”);

c.        not be registered or required to be registered under the Investment Company Act of 1940, as amended (the “40 Act”);

d.       not be disqualified under the revised ‘‘bad actor” provisions of the proposed rules;

e.       not be a development stage company with no specific business plan or purposes or whose business plan is to engage in a merger or acquisition with an unidentified company or companies; (not a shell or blank check company) and

f.       not be an issuer of fractional undivided interests in oil or gas rights, or similar interest in other mineral rights.

Only equity securities, debt securities and convertible securities, including any guarantees of such securities, can be offered under the proposed Title IV rules. Asset-backed securities, such as the collateralized debt obligations of the sub-prime crisis, will not be eligible to be offered under the proposed rules.

      B. Securities Act Liability and New Communications Process.

Reg. A securities offerings would have Section 12(a)(2) liability in respect to offers or sales made through an offering circular or even oral communications that include any material misleading statements or material misstatement of facts. Thus, an offering pursuant to Reg. A is excluded from the operation of Section 11 of the Securities Act. 

·         The offering statement would be “qualified” only by SEC order.

·         Confidential submission of draft offering statements and amendments would be permitted, provided the documents were publicly filed no later than 21 calendar days before qualification.

·         Reg A issuers would be required to provide updates information after termination or completion of an offering. Reg A does not require that issuers file ongoing reports with the SEC, other than a Form 2-A to report sales or termination of sales made under Reg A. The proposed rule would require that Tier 1 issuers provide certain information about their Reg A offerings on a new form, Form 1-Z. Issuers of Tier 2 offerings would be subject to an ongoing reporting regime similar to crowdfunding provisions under Title III of the JOBS Act. Tier 2 issuers would be required to file annual reports on Form 1-K; semi-annual reports on Form 1-SA; current reports on Form 1-U; and special financial reports on Form 1-K and Form 1-SA.

·         All filings would be required to be submitted to the SEC in electronic format via EDGAR.   The proposed rule would revise the qualification process for Regulation A offerings and require that an offering statement could only be qualified by an SEC order.

·         An issuer or broker-dealer should be obligated to deliver a preliminary offering circular to prospective purchasers at least 48 hours in advance of sale when a preliminary offering circular is used to offer securities. Reliance on electronic delivery would require that investors consent to electronic delivery. FINRA Rule 5110 prohibits Registered Representatives and other FINRA members or their associated persons from participating in any manner unless they comply with the filing requirements of the rule.29 Rule 5110 also contain rules regarding underwriting compensation. Rule 5110(b) requires that certain documents and information be filed with and reviewed by FINRA, and these filing and review requirements apply to securities offered under Regulation A[ii].

B.     Integration Rule. 

Rule 251 of Regulation A provides for certain integration safe harbors for both Tier 1 and Tier 2 offerings. Under the existing rules, Regulation A offerings will not be integrated with:

·         Prior offers or sales of securities; or

·         Subsequent offers and sales of securities that are:

·         registered under the Securities Act, except as provided in Rule 254(d);

·         made in reliance on Rule 701;

·          made pursuant to an employee benefit plan;

·          made in reliance on Regulation S; or

·          made more than six months after completion of the Regulation A offering.

The proposed rules expand the list of specific safe harbor provisions for both Tier 1 and Tier 2 offerings to add subsequent offers or sales of securities made through crowdfunding offers (once the SEC has adopted implementing rules for crowdfunding).