The SEC recently adopted amendments to Regulation A under the Securities Act of 1933, as amended (the “Securities Act”) that will allow SEC reporting companies to rely on Regulation A for their securities offerings. The amendments were mandated by the Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Economic Growth Act”). When the amendments become effective, companies that are subject to the reporting requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) may use the exemption from registration specified in Regulation A, and such reporting company issuers will be able to meet their Regulation A reporting obligations by filing their Exchange Act reports. The rule amendments will be effective upon publication in the Federal Register.
The Regulation A Exemption
Regulation A provides an exemption from the registration requirements of Section 5 of the Securities Act for issuers organized in and having their principal place of business in the United States or Canada. The securities sold in a Regulation A offering are not considered “restricted securities.” Issuers relying on Regulation A are permitted to engage in certain test-the-waters communications in connection with an offering. The securities that may be offered under Regulation A are limited to equity securities, including warrants, debt securities and debt securities convertible into or exchangeable into equity interests, including any guarantees of such securities. Regulation A includes two tiers of exempt offerings: Tier 1, which provides for offerings raising up to $20 million in any 12-month period; and Tier 2, which provides for offerings raising up to $50 million. Regulation A is also available, subject to limitations on the amount, for the sale of securities by existing stockholders. Tier 1 offerings are subject to both SEC and state blue sky pre-sale review, while Tier 2 offerings are subject to SEC, but not state blue sky, pre-sale review. Investors in a Tier 2 offering are subject to investment limits (except when securities are sold to accredited investors or are listed on a national securities exchange) and Tier 2 issuers must comply with periodic filing requirements, which include a requirement to file current reports upon the occurrence of certain events, semi-annual reports and annual reports.
Recent Legislative Developments
The Economic Growth Act, enacted on May 24, 2018, scales back certain requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and provides other regulatory relief, including directing the SEC to amend Regulation A. The Economic Growth Act also directs the SEC to amend Rule 251 of Regulation A in order to allow reporting company issuers to use the exemption provided by Regulation A. In addition, the Economic Growth Act requires that the SEC amend Rule 257 of Regulation A, with respect to Tier 2 offerings, to deem a reporting company issuer as having met the periodic and current reporting requirements of Rule 257 when the company meets the reporting requirements of the Exchange Act.
The SEC’s Rule Amendments to Implement the Legislative Directive
As a result of the rule amendments, an Exchange Act reporting company will be eligible to rely upon the Regulation A exemption from registration and, upon qualification of an offering statement for a Tier 2 offering, will become subject to the reporting requirements in Rule 257(b). As long as the issuer is current in its Exchange Act reporting as of the due dates for periodic reports on Form 1-K and Form 1-SA required under Rule 257(b) (including, as applicable, the due dates for any special financial reports on such forms), the issuer’s Rule 257 reporting obligation will be deemed to be met. If, at the relevant Form 1-K or Form 1-SA due date, the issuer is not current in its Exchange Act reporting obligations, the issuer’s Rule 257 reporting obligation will not be deemed to be met, and at that time the issuer will be required to file Regulation A reports.
As directed by Section 508 of the Economic Growth Act, the SEC amended Rule 251 of Regulation A by deleting Rule 251(b)(2), which prohibits companies subject to the ongoing reporting requirements of Section 13 or 15(d) of the Exchange Act from using Regulation A, and also made conforming changes to Item 2 of Part I of Form 1-A. The SEC also added a new paragraph to Rule 257(b), specifying that the duty to file reports under Rule 257 shall be deemed to have been met if the issuer is subject to the reporting requirements of Section 13 or 15(d) of the Exchange Act and, as of each Form 1-K and Form 1-SA due date, has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the 12 months (or such shorter period that the registrant was required to file such reports) preceding such due date. The rule amendments delete paragraph (d)(1) of Rule 257, which provided an automatic suspension of the duty to file reports under Rule 257 if and so long as the issuer is subject to the duty to file reports required by Section 13 or 15(d) of the Exchange Act. The automatic suspension provision is no longer necessary in light of the rule amendment to deem an issuer’s Rule 257(b) obligation met by reporting under the Exchange Act. The SEC also amended Rule 257(c) to clarify the operation of the rule in a situation where a reporting company issuer that is relying on Rule 257(b)(6) terminates or suspends its duty to file reports under the Exchange Act, and made a technical amendment to Rule 251(b)(6) to define the term “Exchange Act.”
In the adopting release, the SEC provided certain implementation guidance related to the new rule amendments, given the limited changes made specifically to implement the rulemaking directive specified in the Economic Growth Act.
The SEC notes that in both Tier 1 and Tier 2 offerings, issuers are required to file financial statements for the two previous fiscal years (or such shorter time that they have been in existence). Tier 1 issuers are permitted to follow the requirements set out in Part F/S, rather than the requirements in Regulation S-X, while Tier 2 issuers are required to follow Article 8 of Regulation S-X, as if the issuer were a smaller reporting company conducting a registered offering on Form S-1, except that the age of financial statements may follow the Part F/S requirements. Further, in a Tier 1 offering, the financial statements are not required to be audited, although paragraph (b)(2) of Part F/S states that (i) if an issuer has already obtained an audit of its financial statements for other purposes, (ii) if that audit was performed in accordance with U.S. Generally Accepted Auditing Standards (“U.S. GAAS”) or the standards of the Public Company Accounting Oversight Board (the “PCAOB”), and (iii) if the auditor was independent pursuant to the standards of either Rule 2-01 of Regulation S-X or of the American Institute of Certified Public Accountants, then those audited financial statements must be filed.
In a Tier 2 offering, financial statements are required to be audited in accordance with either U.S. GAAS or the standards issued by the PCAOB, and the report and qualifications of the independent accountant must comply with the requirements of Article 2 of Regulation S-X. The accounting firm conducting the audit for any audited financial statements included in an offering circular may, but need not, be registered with the PCAOB. As a result of not amending the requirements of Part F/S at this time, a reporting company issuer using Regulation A must, at a minimum, include in its Form 1-A financial statements for the two previous fiscal years (or such shorter time that they have been in existence), prepared in accordance with the form and content requirements of Part F/S.
With respect to the age of financial statements requirements in Form 1-A, while the SEC did not amend the requirements at this time, issuers must include in an offering statement “any other material information necessary to make the required statements, in light of the circumstances under which they are made, not misleading.” Therefore, the SEC is of the view that if, at the time a reporting company issuer files a Form 1-A (or when the offering statement is qualified), the issuer has made publicly available more recent audited or reviewed financial statements prepared in accordance with the standard required for the issuer’s Exchange Act reports, “including such financial statements in the offering statement may be necessary to make the required statements therein, in light of the circumstances under which they are being made, not misleading.”
Accommodations for the Adoption of New or Revised Auditing Standards
The SEC notes that Part F/S of Regulation A permits issuers, where applicable, to delay the implementation of new accounting standards to the extent such standards provide for delayed implementation by non-public business entities, similar to accommodations for emerging growth companies under Section 102(b) of the Jumpstart Our Business Startups Act (the “JOBS Act”). The SEC states that this accommodation will continue to be available to issuers that are not reporting companies at the time of their Regulation A offering; however, the accommodation does not apply to a reporting company issuer (including an emerging growth company that did not elect delayed implementation in connection with its initial registration of securities) that is, at the time of the Regulation A offering, subject to the rules that apply to public business entities.
Special Considerations for Canadian Companies
The SEC notes that Regulation A is available only to companies organized in and with their principal place of business in the United States or Canada, and that outside of the Regulation A framework, a Canadian company may file reports with the SEC under the Exchange Act multijurisdictional disclosure system (the “MJDS”). The MJDS allows eligible Canadian issuers to register securities under the Securities Act and to register securities and report under the Exchange Act by using documents prepared largely in accordance with Canadian requirements. A Canadian reporting company issuer, whether or not filing under the MJDS, will be deemed to have met its Rule 257 reporting obligations so long as it is current in its applicable Exchange Act reporting obligations.
Securities “Held of Record” for Exchange Act Section 12(g) Purposes
The SEC notes that under Exchange Act Rule 12g5-1(a)(7), Tier 2 securities issued by certain small reporting companies may, subject to certain conditions, be excluded from the count of securities “held of record” for purposes of Exchange Act Section 12(g). In order to take advantage of this provision, an issuer must have had, as of the last business day of its most recently completed semiannual period, a public float of less than $75 million or a public float of zero and annual revenues of less than $50 million as of its most recently completed fiscal year. Rule 12g5-1(a)(7) also requires that the issuer is required to file reports pursuant to Rule 257(b) of Regulation A, is current in filing annual, semiannual and special financial reports as of its most recently completed fiscal year end, and has engaged a transfer agent with respect to the securities.
What’s Next for Regulation A?
Under Section 3(b)(5) to the Securities Act (which was added by Section 401 of the JOBS Act), the SEC must review the $50 million Tier 2 offering limit not later than two years after enactment of the JOBS Act and every two years thereafter. The adopting release indicates that the SEC Chairman has directed the Staff to begin the next review in 2019 and that, in connection with that review or in other future rulemaking, the SEC may explore whether additional changes to Regulation A should be made to address the application of the rule to Exchange Act reporting companies, including the topics that were the subject of the SEC’s guidance in the adopting release.