The starting point for the sale of securities—broadly defined to include equity and debt instruments, investment contracts, certificates of deposit, securities index, participation rights in a profit-sharing agreement, interests in mineral rights, derivatives, and interests in investment funds howsoever organized1—in the United States is the prohibition in the SA on offering or selling any security sold using the instruments of interstate commerce unless such security is registered with the SEC or is exempted from registration.
One such exemption from registration under the SA was Regulation A, which the SEC first adopted in 1936 and updated periodically to increase the maximum amount that investors could raise using this exemption (the current limit, prior to the 2015 amendments, was $5 million). It was envisaged as a method by which smaller companies could raise small amounts from the public without having to comply with the full panopoly of registration requirements applicable to a large public offering.
Based on data from the SEC, Regulation A was not a popular exemption: there were only 19 Regulation A offerings in the period from 2009 to 2012 with a total offering amount of $73 million, compared to 27,500 Regulation D offerings of up to $5 million each (at or below the maximum size of a Regulation A offering) during the same period.
Why was Regulation A so unpopular? To understand this, we need to examine the terms of Regulation A, and how it affected issuers seeking to offer securities under this exemption.
The old Regulation A
First, let us summarize the relevant provisions governing a Regulation A offering.
The problems with Regulation A
We can see from the above that there were a number of problems with Regulation A. First, the maximum offering amount of $5 million was relatively low, especially compared to the unlimited amounts that can be raised using a private placement under Rule 506 of Regulation D. This, by itself, would not necessarily doom Regulation A, but coupled with other factors, have made it at best a niche option.
Second, unlike Regulation D, which pre-empts state “blue sky” securities laws, Regulation A does not pre-empt state “blue sky” securities laws. This means that any offering of securities by an issuer pursuant to Regulation A must comply with the requirements imposed by state securities regulators in each state in which the securities are offered. While there have been some efforts to streamline the process of registering securities offerings across multiple states, mostly led by the NASAA, their efficacy is uncertain and they have not been widely used due to the wide use of Regulation D and other exemptions that pre-empt state securities laws.
As one might suspect, the cost of complying with “blue sky” securities laws in multiple states can add up very quickly. Indeed, I would not be surprised if the total fees for researching and complying with these state securities laws added up to at least 10% of a small $1 million offering. For obvious reasons that makes Regulation A unattractive to most small businesses.
Third, the process of filing a Regulation A offering with the SEC is time consuming and costly, particularly since after 1992 the SEC made the offering statement similar in content and structure to a prospectus for a registered offering. The process of preparing such an offering statement requires the assistance of specialized attorneys and accountants, and many man hours of work to ensure that every statement in the offering statement can be supported by verified facts, lest the issuer and its directors become involved in litigation relating to material misstatements of fact or misleading statements. Furthermore, submitting the offering statement for qualification by the SEC can involve multiple rounds of comments that require hours of work by such professional advisers, adding up to a fairly hefty burden considering the maximum size of a Regulation A offering.
I would not be surprised, in fact, if a Regulation A offering costs more, in terms of professional fees, than a Regulation D offering, due to the additional burdens of state law compliance and the need to prepare an offering statement. Moreover, while a larger offering may have some incremental costs above that of a smaller offering, the costs do not scale proportionately, and as such, for large offerings they can be a relatively miniscule percentage of the total funds raised.
For all these reasons, Regulation A has largely been dead in the water; an almost forgotten sibling to the much more useful Regulation D.
Indeed, it should be noted that I am by no means the only person to have found fault with Regulation A; the GAO, in its 2012 report to Congress on the factors that affected the limited use of Regulation A, made similar observations.
The new Regulation A+
Now, let us take a look at the relevant provisions of a Regulation A+ offering.
From the above, we can note several key differences between Regulation A and Regulation A+:
- Ongoing reporting obligations: An issuer making a Tier 2 Regulation A+ offering is now required to make ongoing periodic reports modeled after those made by SEC-reporting companies. It goes without saying that such obligations impose additional costs on issuers.
- Investment limitations for non-accredited investors in Tier 2 Regulation A+ offerings: While Tier 1 Regulation A+ offerings do not differ from the position in Regulation A, Tier 2 Regulation A+ offerings impose specific investment limits on non-accredited investors.
- Additional categories of ineligible issuers: The SEC added three new categories of ineligible issuers to Regulation A+.
The problems with Regulation A+
We have already seen that Regulation A offerings were unpopular for a number of reasons. How does Regulation A+ compare with its predecessor? Not very well, I am afraid.
First, Regulation A+ offerings are still expensive and time-consuming. For both Tier 1 and Tier 2 Regulation A+ offerings, filing and qualifying an offering statement and circular remains just as difficult and time consuming as it was under the old Regulation A. The threat of litigation and liability for misstatements of fact or misleading statements will force prudent issuers and their directors to seek extensive assistance from attorneys and accountants to verify that their offering statements. Such work does not come cheap. For Tier 1 Regulation A+ offerings, the same issue of researching and complying with the “blue sky” securities laws in multiple states still applies, consuming both time and money that smaller issuers can ill afford to spend.
Second, for Tier 2 Regulation A+ offerings, the ongoing reporting obligations are an additional burden. To comply with such obligations, it is almost inevitable that most companies will have to engage the services of attorneys and accountants, creating a periodic outlay that may not be justified by the amount of funding raised.
Third, based on the criticisms leveled at the SEC by various state securities regulators, including Secretary of the Commonwealth of Massachusetts, suggests that the SEC’s decision to pre-empt state securities laws for Tier 2 Regulation A+ offerings may be subject to legal challenges from some state securities regulators. If this were to occur, there might well be a period of uncertainty as to whether the SEC’s pre-emption is legal, with the result that smart investors will choose to avoid using Regulation A+ in case the courts strike down this pre-emption.
Conclusion
As with the implementing regulations for Title III of the JOBS Act, it would seem that the present state of Regulation A+ is somewhat less than satisfactory, to say the least.
It would seem, on its face, that the only companies that might consider using Regulation A+ are likely to be late-stage companies that are preparing for an IPO and wish to raise needed capital from the general public (rather than a pre-IPO financial investor). I am skeptical that any sane CEO and CFO would do so, though, given the additional burdens which they would impose on their company compared to simply doing a private placement with a pre-IPO financial investor.