Earlier this year, the SEC rules adopted rules amending Regulation A under the Securities Act to provide companies with an intermediate path between, on the one hand, exempt offerings to qualified investors only, and, on the other hand, a full-blown initial public offering of registered securities. Since the amended rules, known as Regulation A+, took effect, a number of companies have initiated offerings taking advantage of the new rules. Perhaps because of unfamiliarity, many D&O insurance underwriters have reacted very cautiously with regard to these new Reg. A+ offerings. The purpose of this post is to briefly review the background regarding these new offerings and to provide links to relevant resources, in the hope of addressing some of the D&O underwriters’ concerns.
Prior to the recent amendments, Regulation A offered nonpublic companies with a way to raise capital without triggering the requirements to register the offered securities under the Securities Act of 1933. However, the Reg. A exemption was little used, both because the amount of capital that could be raised was limited to $5 million, and because the procedures were cumbersome. Reg. A offerings were also subject to registration and review requirements under state “blue sky” laws.
When Congress enacted the JOBS Act in 2012, it included Section 401, which authorized the SEC to issue rules exempting from the Securities Act’s registration requirements offerings of up to $50 million annually. On June 19, 2015, the amended rules took effect. (The final amended rules can be found here.) The new rules created two offering categories: “Tier 1” for offerings up to $20 million annually, including no more than $6 million on behalf of selling securityholders, and “Tier 2” for offerings of up to $50 million annually, including no more than $15 million on behalf of selling securityholders.
Congress built an adjustment feature into Reg. A+, whereby the $50 million limit will be reconsidered, and if appropriate, increased. The first review is expected in April 2016. Reg. A+ offerings are only available for companies domiciled in the U.S. and Canada, and there are certain types of entities that are ineligible for Reg. A+ offerings (including, for example, investment companies, blank check companies, and certain “bad actors”).
Both types of offerings require the issuer to file an offering document with the SEC. The information requirements are less onerous than for an IPO registration statement, and a Tier 1 company may provide reviewed, rather than audited, financial statements. Tier 2 offerings are exempt from state securities regulatory review, a change that has drawn vigorous challenge from some state regulators.
As discussed in a July 2015 memo from the Jones Day law firm (here), in both types of Reg. A+ offerings, the offering document must be filed with and cleared (“qualified”) by the SEC before the offering can proceed. Under both tiers, the issuer can “test the waters” by soliciting interest in a potential offering before the offering document is qualified by the SEC. Under both tiers, issuers completing an offering have continuing obligations to file reports with the SEC, although the frequency of the reporting is semiannual (rather than quarterly for companies with full reporting obligations), and the content of these reports are “scaled down” from the requirements for public companies.
Because of the filing and reporting requirements, as well as because the offered securities may be freely traded, Reg. A+ offerings are sometimes referred to as “mini-IPOs.”
When Would a Company Choose to do a Reg. A+ Offering Rather Than a Reg. D offering? : Reg. A+ provides a way for companies that are not publicly traded to raise capital without having to meet the full registration requirements of a traditional public offering. However, rather than conducting either an IPO or a Reg. A+ offering, the private company could alternatively consider conducting an exempt offering under Rule 506 of Regulation D. Under Rule 506, the issuer can either conduct a private placement, in which general solicitation is prohibited and in which up to 35 non-accredited investors and an unlimited number of accredited investors could participate, or conduct a general solicitation and limit the offering to accredited investors only.
As discussed in the December 14, 2015 memo from the McGuire Woods law firm (here), the advantage of a Reg. A+ offering over a Rule 506 offering is that Reg. A+ securities are not “restricted securities,” by contrast to Rule 506 securities, which are restricted and not freely tradable. Reg A+ securities can also be offered to the general public, whereas under Rule 506, general solicitation is either prohibited (when the offering is to accredited investors only), or restricts the number of non-accredited investors who may participate in the offering to 35. Under Reg. A+, the issuer may utilize a general solicitation, without any restriction on the number of non-accredited investors who may participate.
On the other hand, under Rule 506, there are no limitations on the amount that may be raised in the offering. Rule 506 also preempts state securities law requirements, whereas Tier 1 offerings are still subject to state securities requirements. There are no mandatory disclosure requirements under Rule 506, whereas there are required disclosures under Reg. A+ and the Reg. A+ offering documents must be submitted to the SEC and are subject to SEC review. Rule 506 offerings are not subject to ongoing disclosure requirements, whereas Tier 2 Reg. A+ offerings are subject to ongoing reporting requirements.
When Would the Company Choose to Do a Reg. A+ Offering Rather Than a Traditional IPO?: As also discussed in the McGuire Woods memo to which I linked above, the advantage of a Reg. A+ offering over an IPO is that a Reg. A+ offering is potentially less expensive and faster, and requires less extensive disclosure documents than are required for an IPO. Compared to a traditional securities registration under the Securities Act, there are fewer prescriptive disclosure requirements. In addition, by contrast to an IPO, there are no ongoing reporting requirements for a Tier 1 Reg. A+ offering, and simpler ongoing reporting requirements for a Tier 2 offering.
On the other hand, there are no limitations on the amount that can be raise in an IPO, and there are no limitations on the purchases by non-accredited investors in an IPO. Tier 2 Reg. A+ offerings are subject to investment limitations for non-accredited investors.
What are the Liability Exposures for Reg. A+ Offerings Under the Federal Securities Laws?: Unlike for traditional IPOs, there is no potential liability for issuers under Section 11 of the Securities Act in connection with a Reg. A+ offering. However, and by contrast to issuers in connection with Rule 506 offerings, sellers of Reg. A+ securities are potentially liable under Section 12(a)(2) of the Securities Act for materially misleading statements in the offering circular or in oral communications. Accordingly, the potential Securities Act liability of issuers under a Reg. A+ offering is greater than in connection with a Rule 506 offering but greater than in connection with an IPO.
The anti-fraud liability provisions of Section 17 of the Securities Act will also apply, as will Section 10(b)of the Exchange Act and Rule 10b-5 thereunder. (There is no private right of action under Section 17; actions may be brought only by the SEC). State antifraud rules are also applicable. As discussed here, Rule 506 offering issuers are also subject to the antifraud provisions of the Exchange Act.
How will the Securities be Distributed and Sold, in the Offering and in the Aftermarket?: A company conducting a Reg. A+ offering can sell its securities directly (assuming the company has complied with all applicable broker dealer requirements) or through an intermediary, which can be a traditional broker-dealer or a qualified online investment platform (assuming the online platform is compliant with broker-dealer registration requirements). There are existing Internet platforms already competing to attract this type of trading and resale business (refer for example here and here). As far as resale of offering securities, OTC Markets has established procedures to allow Tier 2 Reg. A+ securities to be traded through its SEC-registered alternative trading system, as discussed here.
What about the Challenges from the States?: At least two states have files action in the United States Court of Appeal for the District of Columbia seeking to challenge the exemptions to state securities laws provided in Reg. A+ rules. This judicial challenge remains pending, and for that reason, the outcome remains to be seen. While the outcome at this point cannot be predicted, there are some commentators (refer, for example, here) who contend that the states’ challenge is “without merit” and that the challenge is a “lost battle.” The state would of course disagree with this assessment, and as I said the court has yet to weigh in on the issue.
There is a lot more to Reg. A+ than the short description above. For those readers interested in a more detailed understanding, there is a very extensive library of resources available, including in particular the McGuire Woods law firm memo to which I linked above. A June 20, 2015 post on the Harvard Law School Corporate Governance and Financial Regulation blog by the Sidley Austin law firm detailed the provisions of the Reg. A+ rules can be found here. A “round up” by the Morrison and Foerster law firm of issues that have arisen since the Reg. A+ rules became final can be found here.
As discussed in a May 6, 2015 memo from the Latham & Watkins law firm (here), the basic idea behind the Reg. A+ regime is to allow smaller companies to have access to capital and to be able to offer freely tradeable shares without having to go through all of the burden and expense of an IPO and without being subject to all of the trading restrictions applicable to privately-placed securities.
There are commentators skeptical of the value of the revised Reg. A+ offering procedure (refer, for example, here). While the plusses and minuses of these kinds of offerings will continue to be debated, it does seem – if the submission activity that is crossing my desk is any indication – that at least some companies have embraced the offering structure available under Reg. A+. If for no other reason that the present and potential future transaction flow, D&O insurance underwriters should have an incentive to understand these offerings and how they work.
The procedures under Reg. A+ are still new, which poses a challenge for companies considering whether or not to participate in these kinds of offerings. The relative newness is also a challenge for D&O underwriters. In many cases, the carriers – perhaps because of the “mini-IPO” label that some have used to describe these kinds of offerings — have treated them as if they were simply IPOs. However, as discussed above, these offerings are different from traditional IPOs, and even different from the Emerging Growth Company IPOs that the JOBS Act also authorized.
The Reg. A+ offering was intended to provide an intermediate path, a way for private companies to offer freely traded securities, without having to become a full-fledged public reporting company. It is meant to be, as the Jones Day law firm memo linked to above notes, “an intermediate capital-raising stepping stone.” The potential liabilities are in-between as well. Thus, while a Reg. A+ offering is subject to certain provisions of the federal securities laws, it would not be subject to Section 11 of the Securities Act.
It may be that the uncertainty associated with these kinds of offerings, at least until the patterns and practices become better established and more familiar, will discourage some D&O insurance carriers from entertaining these kinds of risks. However, there are going to be those carriers who recognize a marketplace niche opportunity and who recognize that companies conducting Reg. A+ offerings represent an intermediate risk, between a private and full-fledged public reporting company, who will not simply treat Reg. A+ offering companies as if they were traditional IPO companies. These companies will be well-positioned to capture the prospective future business flow that these kinds of offerings represent.
I know that I have not answered all of the questions about Reg. A+ offerings in this blog post, but if I have motivated even one underwriter to take a closer look at Reg. A+ offerings in order to determine whether or not there is an opportunity there, I will have accomplished my goal.
I recognize that there may be contrasting views on the topic of D&O insurance for Reg. A+ offering companies. I welcome alternative points of view from readers. I encourage those interested to add their thoughts to this post using the blog’s comment feature, which appears at the foot of this post. Also, I hope readers will also use the comment feature if (as is entirely possible) I have misstated any of the aspects of the Reg. A+ offering regime in the description above.