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Latest JOBS Act Proposal Offers Small Companies an Easier Path to Investor Funds

December 19, 2013

The SEC issued Release No. 33-9497 after approving the proposal to raise the limit for small company securities offerings to $50 million. The proposed rule, which was mandated by the JOBS Act, will let small companies raise investor funds without having to register their securities with the SEC.

The SEC on December 18, 2013, issued Release No. 33-9497, Proposed Rule Amendments for Small and Additional Issues Exemptions Under Section 3(b) of the Securities Act, shortly after unanimously voting to propose a rule that would allow companies to raise $50 million without filing registration statements.

Mandated by the JOBS Act, the rule is often called “Regulation A+” and would amend Section 3(b) of the Securities Act of 1933. Regulation A currently provides a similar exemption for securities offerings totaling $5 million over 12 months.

Comments are due 60 days after the rule is published in the Federal Register, which normally occurs a few days after a rule is posted on the SEC’s website.

“At its core, the mandate of Regulation A+ is to help increase the access of smaller companies to capital,” said SEC Chair Mary Jo White.

Companies rarely use the current Regulation A because they find the process of filing with the SEC and complying with state securities laws to be too difficult compared to other exemptions.

To boost the use of Regulation A, the SEC’s proposal seeks to establish two tiers: Tier 1 for offerings up to $5 million and Tier 2 for offerings up to $50 million. For offerings up to $5 million, companies can choose either Tier 1 or 2.

Companies in both tiers would be subject to basic requirements, including eligibility and disclosure rules under Regulation A.

The proposal would update Regulation A to permit companies to submit draft offering statements for a confidential SEC review before filing. Companies would also be allowed to solicit funds from investors before and after filing the offering statement. The SEC plans to modernize the qualification, communications, and offering process, including electronic filing of offering materials.

Companies that choose Tier 2 would face additional requirements. Investors won’t be able to purchase securities for more than 10% of their annual income or net worth, whichever is greater. Companies must include audited financial statements in the offering circulars and would have to file annual and semiannual reports and updates similar to the requirements for publicly traded companies as long as the securities are held by at least 300 investors.

Companies that have their principal place of business in the U.S. or Canada would be eligible under Regulation A.

The exemption under Release No. 33-9497 would not be available to companies that file with the SEC or certain investment companies. Companies won’t qualify if they have no specific business plan or have indicated that they plan to be in a merger or acquisition with an unidentified company. They’re also not eligible if they offer and sell asset-backed securities or fractional undivided interests in oil, gas, or other mineral rights. They will also be excluded if they have not filed the ongoing reports by the proposed rules during the preceding two years.

Companies whose SEC registrations have been revoked during the preceding five years or were disqualified under the restrictions in Release No. 33-9414,Disqualification of Felons and Other “Bad Actors” from Rule 506 Offerings, will also be ineligible.

A 2012 study by the Government Accountability Office identified state registration and qualification requirements as a central factor for the limited use of Regulation A, and the SEC is proposing to preempt state securities law requirements for Tier 2 offerings.

Release No. 33-9497 also explores alternative approaches, including a streamlined review program proposed by the North American Securities Administrators Association (NASAA). If implemented, the SEC said it could reduce the costs of complying with state laws and speed up state-level review.

Commissioner Kara Stein voted to approve the proposal, but she said Release No. 33-9497 doesn’t have an appropriate balance between capital formation and investor protection.

States play an important role in protecting investors, and “Congress deliberately revised the bill to ensure that state securities laws were not explicitly preempted before the bill’s final passage,” Stein said.

Commissioner Luis Aguilar noted that the secondary market will almost certainly be less transparent than the market for listed securities.

Moreover, given the smaller offering size and reduced transparency, he said Regulation A securities may have wider spreads between bids and offers, less liquidity, and the potential for significant price swings compared to registered securities.

“Although the JOBS Act is silent regarding what actions can be taken to mitigate the risks to investors that may result from such a trading environment, the commission must be proactive in addressing foreseeable consequences,” Aguilar said. “I expect the staff to actively monitor any secondary trading activity that develops after adoption with respect to Regulation A securities, for any possible indications of fraud, manipulation, or market failure. The rule changes we propose today will not achieve the hoped for benefits in capital formation if the end result is that investors are left holding a portfolio of securities that cannot be valued or sold.”