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Regulation

January 2014

NY2 728569

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Current Regulation A Most issuers are familiar with the exemptions from

registration available pursuant to Section 4 of the Securities Act Currently, Regulation A (promulgated pursuant to Section 3

of the Securities Act) provides for an exemption from registration for issuers that are not SEC-reporting companies to raise up to $5 million through sales of their securities in interstate offerings Regulation A is often referred to as a “mini-registration”

provision; it is not a private offering exemption

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Current Regulation A (cont’d) Regulation A incorporates a number of conditions that

resemble the Section 5 registration requirements, such as the preparation of a detailed disclosure document (an offering statement on Form 1-A) Regulation A permits an issuer to use general solicitation

to publicize the offering, sell securities to retail investors (not limited to accredited investors), and the securities that are offered pursuant to Regulation A are not “restricted securities”

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Current Regulation A (cont’d) Current Regulation A has not been used frequently in the

recent past largely due to the low offering threshold and the fact that securities sold in Regulation A offerings are not “covered securities” for blue sky purposes On a relative basis, an issuer considering its financing

options would find it easier to rely on Rule 506 given that there is no offering threshold, no required disclosure (provided securities are sold to accredited investors), and no requirement to comply with blue sky laws

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Regulation A Reform Before the JOBS Act was even contemplated, market

participants advocated to have the offering threshold of Regulation A raised to $30 million or $50 million These advocates believed that if Regulation A were

modernized and the dollar threshold and blue sky issues were addressed, Regulation A could provide a viable financing alternative for many growing companies Given the dearth of IPOs by smaller companies,

Regulation A was viewed as a potential alternative to a “traditional” IPO

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Regulation A Reform (cont’d) Legislation had been introduced and approved in both

houses of Congress that would have amended Regulation A These measures were then incorporated (along with

others) into the JOBS Act

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Title IV Title IV of the JOBS Act amends Section 3(b) of the

Securities Act Creates a new Section 3(b)(2) Mandates that the SEC adopt rules that provide for exempt

offerings of up to $50 million of securities annually based on the current Regulation A provisions

The statute establishes certain fundamental provisions Securities may be offered and sold publicly Securities are not “restricted securities” Section 12(a)(2) liability will apply to the offering Issuers can test the waters

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Title IV (cont’d) A new requirement for issuers to file audited financial statements

annually A limitation on eligible securities

The SEC was given discretion regarding Electronic filing requirements Bad actor provisions Ongoing disclosure requirements

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GAO Study Title IV required the GAO to conduct a study on the

impact of blue sky requirements for Regulation A offerings In July 2012, the GAO published its study which took into

account the availability of other offering exemptions, the comparative benefits, and the historic impediments associated with relying on Regulation A The GAO study noted blue sky requirements were an

impediment to broader use of Regulation A

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Proposed Rules The SEC’s proposed rules would implement the JOBS

Act mandate by Amending and modernizing existing Regulation A Creating two tiers of offerings Tier 1 for offerings of up to $5m ($1.5m for selling stockholders) Tier 2 for offerings of up to $50m ($15m for selling stockholders)

Setting issuer eligibility, disclosure and reporting requirements Imposing additional disclosure and ongoing reporting requirements,

as well as an investment limit, for Tier 2 offerings, and, given these investor protection measures, making Tier 2 offerings exempt from blue sky requirements

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Eligible Issuers Issuers that are organized in and with their principal place

of business in the United States or Canada Certain issuers are not eligible: Reporting companies 40 Act companies Blank check companies Issuers of fractional undivided interests in oil or gas (or similar interests

in other mineral rights) Bad actors Issuers that have not timely filed ongoing reports during the two-year

period preceding the Regulation A offering Issuers that are or have been subject to an SEC order suspending or

revoking the registration of a class of securities

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Eligible Securities Section 3(b)(3) limits the availability of the Section 3(b)(2)

exemption to: Equity securities, Debt securities, Debt securities convertible or exchangeable into equity interests,

including guaranties of such securities

The SEC proposes to exclude asset-backed securities

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Offering Limitations Tier 1 offerings: up to $5 million of securities in a 12-

month period, including up to $1.5 million of securities offered by selling securityholders Tier 2 offerings: up to $50 million of securities in a 12-

month period, including up to $15 million of securities offered by selling securityholders Proposed rule eliminates the Rule 251(b) prohibition on

affiliate resales if the issuer did not have net income from continuing operations in at least one of its last two fiscal years

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Investment Limitations As an investor protection measure, the SEC proposes to

limit the amount of securities investors can purchase in a Tier 2 offering to no more than 10% of the greater of their annual income and their net worth An issuer can rely in good faith on an investor’s

representation of compliance with the investment limit

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Integration Existing Rule 251(c) of Regulation A provides for certain

integration safe harbors; Regulation A offerings will not be integrated with: Prior offers or sales of securities; or Subsequent offers and sales of securities that are SEC-registered offerings, except as provided in Rule 254(d); Made under Rule 701; Made pursuant to an employee benefit plan; Made pursuant to Regulation S; or Made more than six months after completion of the Regulation A offering Made under Title III

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Integration (cont’d) Exempt offerings should not be integrated provided each

offering complies with applicable requirements Abandoned Regulation A offerings If an issuer abandons a Regulation A offering after making

solicitations, and then commences a registered offering, the Regulation A offering would not be integrated if the issuer only solicited QIBs and institutional accredited investors

If a broader range of offerees were solicited, then the issuer must wait 30 calendar days before filing the registration statement

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Exchange Act holder of record Title III of the JOBS Act specifically provided for investors

in exempt crowdfunding offerings to be excluded from the Section 12(g) threshold Proposed rule would not exempt Regulation A securities

from the requirements Potentially, this may pose a practical impediment for

reliance on Regulation A

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Liability Statute provides that Section 12(a)(2) liability will apply to

any person offering or selling Regulation A securities A Regulation A-exempt offering is excluded from the

operation of Section 11 of the Securities Act Regulation A offerings are subject to the general antifraud

provisions of the federal securities laws

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Offering Circular Filing and Delivery Requirements Proposed rule would require electronic filing of offering

statement “Access equals delivery” is proposed for Regulation A

final offering circulars Amend Rule 251 to require issuers and broker-dealers to

deliver only a preliminary offering circular to prospective purchasers at least 48 hours in advance of sale when a preliminary offering circular is used during the prequalification period Requirements for a final offering circular to be delivered to

purchasers could be satisfied by electronic access to final offering circular, with accompanying notice requirement similar to Rule 173

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Offering Circular (Form 1-A) Content Three parts: Part I (Notification); Part II (Offering

Circular); and Part III (Exhibits) Part I (Notification) would require: Item 1: Issuer Information Item 2: Issuer Eligibility Item 3: Bad Actor Certification Item 4: Summary Offering Information Item 5: Jurisdictions Where Securities Will be Offered Item 6: Unregistered Securities Issued or Sold Within One Year

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Offering Circular (Form 1-A) Content (cont’d) Part II (Offering Circular) Eliminate Model A approach, update and retain Model B and also

permit issuers to rely on Part I of Form S-1 (based on the scaled smaller reporting company requirements)

Disclosure requirements would include: risk factors; dilution; use of proceeds; a business description; an MD&A; management and executive compensation; beneficial ownership; related party transactions

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Offering Circular (Form 1-A) Content (cont’d) Financial statement requirements will differ from Tier 1 and Tier 2

offerings Tier 1 financial statements would not need to be audited unless audited

statements already were prepared for another purpose. Audit must be conducted in accordance with U.S. GAAS or PCAOB standards or IFRS for Canadian issuers. Auditors need not be PCAOB-registered. Tier 1 issuers can follow requirements in Part FIS (instead of Regulation S-X)

Tier 1 and Tier 2 must file balance sheets as of the two most recently completed fiscal years; statements of income, cash flows, and stockholders’ equity for each of the two fiscal years preceding the date of the most recent balance sheet, and for any interim period between the end of the most recent fiscal year and the date of the most recent balance sheet

Tier 2 financial statements must be audited in accordance with PCAOB standards; auditors need not be PCAOB-registered

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Testing-the-Waters An issuer may solicit any investors (not subject to the

requirements applicable to EGCs, for example) Materials may be used both before and after the offering

statement is filed Subject to certain disclaimer requirements Subject to antifraud and civil liability provisions Materials used after an offering statement is publicly filed, would be

required to be accompanied by a preliminary offering statement (or a link to the offering statement)

An issuer might be required to redistribute any test the water material in order to correct the materials

Material would be required to be filed with the SEC and would be publicly available

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Ongoing Reporting No ongoing reporting (other than the Form 2-A

information which would be required to be included on new Form 1-K) for Tier 1 issuers Tier 2 issuers will be subject to ongoing reporting

requirements, including: Annual reports on Form 1-K; Semi-annual reports on Form 1-SA; and Current reports on Form 1-U, as well as Special Financial Reports on Form 1-K and 1-SA

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Ongoing Reporting (cont’d) Ongoing reports filed for Tier 2 issuers would be deemed

to satisfy a broker-dealer’s Rule 15c2-11 obligations If an issuer sought to complete a Regulation A offering

and list its securities on a national exchange, it would still be required to prepare and file a Form 10 registration statement

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Termination or Suspension of Tier 2 Disclosure Obligations

Proposed approach is similar to the approach used for Exchange Act filers A Tier 2 can immediately suspend its ongoing reporting

obligation at any time after it reports for the fiscal year in which the offering statement was qualified so long as securities are held by fewer than 300 record holders and no offers/sales pursuant to Regulation A are ongoing provided the issuer filed all required reports for the applicable period. The applicable period is the shorter of: (1) the period since it became subject to Regulation A reporting requirements, or (2) its most recent three fiscal years and the portion of the current year preceding the suspension/termination.

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Additional Provisions Rule 260 provides that insignificant deviations from a

term, condition, etc. will not result in loss of the exemption Bad actor provisions would be amended to be more

consistent with the Rule 506(d) requirements

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State Law Requirements Preemption is accomplished through the definition of

“qualified purchaser” A qualified purchaser would consist of All offerees All Tier 2 offering purchasers

The proposing release mentions the efforts of NASAA to implement a coordinated review program for Regulation A offerings.

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Potential uses of Regulation A An issuer may choose to conduct one or more Regulation

A offerings and remain “private” (not list its securities on a national securities exchange; OR An issuer may choose to conduct one or more Regulation

A offerings and choose to list its securities on an exchange, and thereby use Regulation A as an alternative to a more traditional IPO

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Regulation A/remain non-reporting An issuer might choose to conduct a Regulation A

offering (instead of a Rule 506 offering) for a number of reasons: In a Regulation A offering, the issuer can sell securities to non-

accredited investors; The issuer may use general solicitation to advertise its offering,

without the corresponding “costs” associated with a Rule 506(c) offering

Certain classes of investors, such as angel investors, have expressed concerns about Rule 506(c) offerings—both about certain offering related communications and about sharing personal details for investor verification purposes

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Regulation A/remain non-reporting (cont’d) Some of the cost/benefit analysis as between Rule 506 and

Regulation A may only become clearer once the SEC has acted on its proposed amendments to Form D, Regulation D and Rule 156

Existing venture capital and/or private equity investors may see a Regulation A offering as a liquidity opportunity

Securities sold in a Regulation A offering are not “restricted securities” and therefore may attract interest from a broader array of investors

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Regulation A securities Certain funds may have in place limitations an their

purchases of “restricted securities” Securities sold pursuant to Regulation A will not be

considered “restricted securities” for those funds that use the Securities Act definition in their investment policies or charter documents No restrictions on the resale of Regulation A securities Other funds may have limitations in their investment

policies and their purchases of “illiquid securities”, but, to the extent that an issuer conducts a Regulation A offering and lists its securities an a national securities exchange, there will be a market for the securities

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Regulation A as a stepping stone An issuer might choose to conduct a Regulation A

offering, remain private, but develop a market following An issuer that conducts a Tier 2 offering will be subject to

certain ongoing reporting requirements. As a result, there will be publicly available information about the issuer, its business, its results of operations This may attract potential acquirors, or may raise the

issuer’s profile within the financial community and lead to an IPO

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Regulation A as a stepping stone (cont’d) An issuer may choose to conduct a Regulation A offering,

and list its securities on a national securities exchange Why this route? The IPO “on ramp” may still be too burdensome for a smaller

issuer There are fewer boutique or specialty investment banks interested

in undertaking IPOs for smaller issuers. The IPO on ramp has made a modest difference in the statistics on “smaller company” IPOs, but not enough of a difference

An issuer should prefer Regulation A plus a listing instead of other “back door” IPO routes, like SPACs, reverse mergers, etc., which raise many concerns

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Regulation A as a stepping stone (cont’d) An issuer that chooses to conduct a Regulation A

offering, plus a listing, would still be considered an “emerging growth company” That issuer would still be eligible to avail itself of the

confidential submission process for its first offering an a registration statement (first sale of equity securities) Even if the issuer has filed a registration statement on a

Form 10, it will not have filed a registration statement relating to a sale of equity securities