SEC Proposal for Increasing Access to Capital

On December 18, 2013 the SEC released its proposal to expand Regulation A, as required by title IV of the 2012 JOBS Act. The new proposal split the regulation into two tiers: Tier 1 for small issuers (up to $5 million) and Tier 2 for larger issuers (up to $50 million).

Regulation A / Tier 1

The original Regulation A, or Tier 1 of the new proposal, allows non-SEC reporting companies to offer up to $5 million in securities within a 12 month period. A shareholder of one of these companies may also resell up to $1.5 million of these securities within a 12 month period.

Tier 1 offerings differ from regular public offerings in the following ways:

  • The issuer’s Financial Statements are simpler and do not need to be audited.
  • The issuer is not obligated by the Exchange Act or the Sarbanes-Oxley Act.
  • There are three formats for preparing the Regulation A offering circular, the easiest being a simple question/answer form.
  • The issuer may “test the waters” before filing with the SEC.

Tier 2

The new proposal’s Tier 2 allows companies to offer up to $50 million in securities within a 12 month period. A shareholder of one of these companies may also resell up to $15 million of these securities within a 12 month period. Additionally, Tier 2 offerings would preempt state security laws (Blue Sky Laws). The SEC believes this would make Tier 2 offerings more desirable to issuers.

Issuers under Tier 2 have additional requirements as set forth below:

  • No more than 10 percent of the greater of an investor’s annual income or net worth of securities may be purchased by an investor.
  • The issuer must have audited Financial Statements in the offering circular.
  • The company would have to file ongoing reports and current event updates annually and semiannually.

Usage of Regulation A

Regulation A was used just 78 times between 1995 and 2004. The usage dropped to just three times in 2010. The costs of filing and keeping up with regulations is cited as the biggest reason for Regulation A’s lack of usage. With a limit of just $5 million, much of the offering is spent on filing and keeping up with regulations.

By raising the limit to $50 million, Regulation A Tier 2 should encourage companies to use the new public offering method. This should help small businesses grow by accessing public capital that it would otherwise not have access to. The JOBS Act also requires for the SEC to revisit the limit at least every two years. By revisiting the limit, the regulation will stay relevant and better promote small businesses’ access to capital.

Reaction to SEC Proposal

Adrea Seidt of the North American Securities Administrators Association (NASAA) criticized the change that allows public companies to bypass state oversight, stating, “the Commission’s proposed rule ignores Congress’ recent judgment and defies Congress’ clear intent. As a policy matter, it is not clear why the Commission would remove state oversight in a high-risk area where both federal and state resources should be fully leveraged to provide sufficient, regular review.”

In late January, Commissioner Daniel M Gallagher defended the proposal in a forum for Corporate Directors, noting that the intent of the proposal was “to modernize and simplify the registration process and reduce the costs and other burdens associated with it for emerging growth companies.” He went on to say that “the resulting Commission staff report to Congress called for a reevaluation of the Commission’s disclosure requirements in order to ensure that existing security holders, potential investors and the marketplace are provided with meaningful and … non-duplicative information upon which to base investment and voting decisions, that the information required to be disclosed by reporting companies continues to be material and that the disclosure requirements are flexible enough to adapt to dynamic circumstances.”

The proposal is currently open to the public for comment for a period of 60 days.