Last month, the Nasdaq quietly submitted a proposal to the SEC regarding Regulation A+. It is simple enough to quote: “Any Company listing on Nasdaq in connection with an offering under Regulation A of the Securities Act of 1933 must, at the time of approval of its initial listing application, have a minimum operating history of two years.” On April 18 the SEC published the proposal soliciting comments on the proposed rule change.
Last week I gave a talk at The Reg A Conference entitled, “Where Has Reg A+ Gone Right?” There are a number of good things to list since deal making began in earnest in July 2016 following dismissal of a court challenge to the Reg A+ rules. Almost 125 deals, averaging $10 million per deal, have been completed. About a dozen community banks and tons of real estate investment trusts have successfully gone public using Reg A+. And ten issuers got listed on Nasdaq or the NYSE, though unfortunately their stocks have not fared well generally. The SEC also approved allowing full reporting issuers to use Reg A+, particularly helping smaller OTC companies with an easier path to raising money. Cannabis companies, which generally are not able to list on the big exchanges, also have begun to see the benefit of Reg A+ to raise money in the over-the-counter markets without dealing with state “blue sky” merit review of their IPO.
The NYSE recently decided to pause taking new Reg A+ issuers, and the Nasdaq lately had been slow walking them. This proposed requirement to be operating two years to get a Nasdaq listing makes sense. Some (but not all) of the 10 exchange listed IPOs were pretty new companies. This may partially explain their challenge in building market support for their stocks. Newer companies can list over the counter initially then move up. If this encourages more use of Reg A+ and Nasdaq’s support of these listings, then this can be a positive step in the Reg A+ story, which is only in the first inning.
The Securities and Exchange Commission announced on December 19, 2018 that it has adopted final rules that will permit full SEC reporting companies to conduct public offerings utilizing the modern crowdfunding capabilities with Regulation A+. We are still awaiting the details of the new rules, but they will become effective immediately upon publication in the Federal Register, which typically happens within a few weeks of the announcement. The SEC was required to adopt these rules by the Economic Growth, Regulatory Relief and Consumer Protection Act, passed back in May.
Previously, the Reg A+ rules required that a company cannot use Reg A+ if it is subject to the SEC reporting requirements immediately prior to the offering. This includes, for example, every company listed on a national exchange such as Nasdaq or the NYSE and many companies that trade over-the-counter. The new law reversed that and now the SEC has changed the rules to permit reporting companies to utilize Reg A+.
While we await the details of the new rules, it is clear that this will benefit full reporting companies that trade over-the-counter, since they can now conduct a public offering preempted by state “blue sky” merit review of their offering. In addition, even listed companies may decide that accessing the ability to “test the waters” with any investor, not permitted with a traditional public offering, is attractive as they market a new public offering. This may also assist companies that are for some reason not eligible for short form registration of public offerings on Form S-3, such as those who went public within the last year or those who had a late SEC filing in the last year. Check this one off the list of desired changes to the already well-designed rules under Regulation A+.
Reporting from the Practising Law Institute’s Annual Institute on Securities Regulation here in New York City. I was honored to serve on a panel next to Jennifer Zepralka, head of the SEC’s Office of Small Business Policy. Jennifer provided a very positive report on Regulation A+. Here are the highlights:
- Since the new Reg A+ rules went effective in June 2015 and through September 2018, 123 public offerings were completed raising a total of $1.3 billion. That’s an average of about $10 million raised per deal since 2015.
- These numbers compare to the report from a year ago that 69 deals had been completed by September 2017 raising an aggregate of $612 million or $8.8 million per deal. Doing the simple math, this means there were 54 new deals in the last year – close to double the number of deals compared to the two plus years before.
- Doing more math: total funding in the last year more than doubled the total amount raised though Reg A+ offerings from the two years before. In other words, $612 million raised between June 2015 and September 2017 and another $688 million raised just in the one year ended September 2018.
- Doing more more math: the average deal size increased notably to $12.7 million in the year ended September 2018 vs. $8.8 million in the two years ended September 2017. That’s a 44% increase in the average deal size.
Jennifer also reported on the SEC’s Congressional mandate, under the Improving Access to Capital Act, to adopt rules to allow full SEC reporting companies to utilize Reg A+. She said the SEC is “taking steps” toward that regulatory initiative but offered no timeline on when it would be completed. She also made clear that current SEC reporting companies cannot go ahead and use Reg A+ until those rules are fully adopted.
Despite some of the reports (and my own commentary at times), Reg A+ is achieving its purpose – to help smaller companies raise capital and create jobs. And the fact that the number of deals, total funding and average deal size are all strongly increasing also is very encouraging. The “shakedown cruise” continues for exchange-listed Reg A+ issuers, but many believe this ship has many more years of successful dealmaking ahead.
The President today signed the Economic Growth, Regulatory Relief and Consumer Protection Act. Most of the bill is centered around easing some Dodd-Frank restrictions as they apply to smaller banks. But buried in Section 508, called “Improving Access to Capital,” Congress adopted a major change to Regulation A+. Previously, the Reg A+ rules required, in Section 251(b)(2), that a company cannot use Reg A+ if it is subject to the SEC reporting requirements under Section 13 or 15(d) of the Securities Exchange Act immediately prior to the offering. This includes, for example, every company listed on a national exchange such as Nasdaq or the NYSE and many companies that trade over-the-counter. The new law reverses that and orders the SEC to change the rules to permit reporting companies to utilize Reg A+.
In addition, currently, Rule 257 of Reg A+ requires companies completing Tier 2 (raising any amount up to $50 million) offerings to file specified periodic and current reports under what has become known as “light reporting” if they do not become full reporting companies. The new law directs the SEC to amend that to say that a reporting company that conducts a Tier 2 offering going forward will be deemed to have met the periodic and current reporting requirements under that rule if they file what is required of a full permanent SEC reporting company.
What are the implications of this change? Allowing already public and reporting companies to use Reg A+ will provide them access to the unique benefits of this streamlined public offering process. Over-the-counter companies can conduct a Tier 2 public offering free of state blue sky merit review. All companies can use broad “testing the waters” with online or broadcast promotion of their public offering to anyone – this is limited to institutional investors otherwise. The SEC also has been giving much more limited review to these filings, which are completed quickly.
While this is a very positive change it has somewhat limited benefit. Companies trading on national exchanges, as well as over-the-counter companies with market capitalizations in excess of $75 million, can use short registration Form S-3 after they have been public for a year, so long as they have filed all their quarterly filings on time for the prior year. Using S-3 is generally much quicker, cheaper and simpler than even a Reg A+ offering. So as a practical matter this is only likely to help over-the-counter companies with market capitalizations below $75 million, companies that went public less than a year ago and listed companies who missed a filing deadline in the last year. But it is a positive development nonetheless.
Today, Sebastian Abero, the head of the SEC’s Office of Small Business Policy, had some very positive news for those interested in the new Regulation A+. He revealed that, since the Reg A+ rules were adopted by the SEC in June 2015, through September 2017, there have been 69 completed Reg A+ offerings raising a total of $611 million. That’s an average of $8.8 million per deal. As we also know, seven of those companies completed offerings that immediately commenced trading on national securities exchanges.
Abero was speaking at the annual SEC Government-Business Forum on Small Business Capital Formation, this year being held in Austin, TX. Other speakers included SEC Chairman Jay Clayton. Mr. Clayton’s remarks focused on helping what he called “Mr. and Ms. 401(k)” obtain opportunities to invest in growth companies. He acknowledged that a “one size fits all regulatory structure does not fit all” as he talked about the benefits of scaled disclosure for smaller issuers. He acknowledged there is room for improvement in the regulations to remove some of the “speed bumps” in the path to capital formation. He also hinted at expanding which companies can benefit from reduced disclosure as “smaller reporting companies.”
Investment banker Mark Elenowitz also spoke this morning at the Forum and pushed to increase the maximum that can be offered in Reg A+ deals to $75 million (a bill is working its way through Congress to do that). Nasdaq Vice President AnneMarie Tierney agreed with increasing the cap. She also talked about the challenges of best efforts underwritings in Reg A+ deals. The best efforts deals can garner less aftermarket support than in firm commitment underwritings. Panelists also suggested that the resales of Reg A+ securities should be exempt from SEC registration when trading in the over-the-counter markets. Currently issuers have to rely on certain somewhat cumbersome exemptions.
The Regulation A+ rules adopted by the SEC in 2015 included scaled reporting obligations to assist in reducing issuers’ offering costs as against a traditional IPO. However, if a company is seeking to become a full Securities Exchange Act reporting company, which is required if it is planning a national exchange listing, its disclosure must follow traditional IPO Form S-1 level disclosure, without the benefit of scaling. The one exception: even these companies may utilize financial statements that are up to nine months old. Normally in a Form S-1 your financials cannot be more than 135 days “stale.” Last month, the SEC and Nasdaq permitted Chicken Soup for the Soul Entertainment Inc. to go public, trade on Nasdaq and complete its Reg A+ offering with no financial information from 2017. The other three Reg A+ issuers that have completed IPOs onto national exchanges utilized financials that were no more than 135 days old.
The unanswered question, however, was this: is a company that does not have “current” financials in its Regulation A+ offering documents immediately out of compliance with reporting obligations right after it becomes a full reporting company upon completion of the IPO? The SEC answered this in a positive way last week with several Compliance and Disclosure Interpretations (C&DIs). The answer: if you have missing quarterly reports on Form 10-Q when you finish your IPO, you are given 45 days from then to file them. If you are missing an annual report on Form 10-K, you have 90 days to complete that.
This small piece of guidance adds another substantial cost-saving benefit to Reg A+. The ability to defer the preparation and reporting of four and one-half months of financial information beyond what Form S-1 would require allows a company to deal with that cost after it raises money in its IPO, if it is comfortable that the scaled disclosure will not impede the ability to complete the fundraising and IPO.
The House Financial Services Committee recently approved a bill that would permit full SEC reporting companies to use Tier 2 of Regulation A+ to effect a streamlined, lower cost public offering of their securities. The bill now moves to the full House. In implementing rules under the Jumpstart Our Business Startups (JOBS) Act in 2015, the SEC retained the historical restriction that only non-reporting companies could utilize Reg A. There was really no particular reason this could not have been changed.
Now that practitioners have witnessed the closing of well over 30 Reg A+ deals, three of which are now successfully trading on national exchanges, it would seem logical to expand the availability of Reg A+ to reporting companies. They would have a history of full disclosure, and could clearly benefit from utilizing a faster and cheaper option to raise money from the public. OTC Markets, Inc. had submitted a petition several years ago that encouraged this, and Duane Morris submitted a letter to the SEC in support of that petition. Presumably this would only benefit companies that are not eligible for short registration Form S-3, including companies with less than a $75 million market cap and trading over-the-counter.
As noted in Crowdfund Insider, the new Republican-led SEC could, on its own, simply implement this change and avoid the need for Congress to pass a bill. There are some questions to address, however, such as would the relaxed financial reporting requirements apply before the offering is approved by the SEC? Would the testing the waters rules be the same? It will be interesting to see if this develops further.
Duane Morris client Myomo Inc., a medical robotics company, completed its initial public offering on June 9, 2017 under SEC Regulation A+ created under the Jumpstart Our Business Startups (JOBS) Act of 2012. The historic deal is the first Reg A+ IPO to be listed on a national exchange. In the IPO, Myomo raised a total of approximately $8 million between the public offering and a contemporaneous private offering of investment units. The stock commenced trading with the symbol “MYO” on the NYSE MKT on Monday, June 12, 2017.
For various reasons that have been studied extensively, smaller company IPOs, which proliferated in the 1990s, nearly disappeared starting around 2000. Other alternatives, including reverse mergers, often called “back door listings” because they are completed without advance SEC review, took their place until 2011 when the SEC added significant regulatory burdens to these transactions. A movement to update Regulation A to “reopen the front door” at the SEC started at the annual SEC small business conference in 2010.
Regulation A reforms were then included in Title IV of the JOBS Act. The law significantly increased the amount which a company can raise under what we now call Reg A+ from $5 million to $50 million and fully preempted all state “blue sky” review of those offerings, relieving significant regulatory and cost burdens. The final Reg A+ rules passed by the SEC under the JOBS Act also broadened the ability of Reg A+ issuers to “test the waters” with all potential investors both before and after filing their offering statement with the SEC. In addition, non-listed companies have somewhat scaled disclosure in their IPO as compared to a traditional registration.
The Reg A+ rules also permit non-listed companies a “light reporting” option after their IPO, further reducing costs and burdens as a public company while retaining strong investor protections. The SEC also has given extremely limited review to these filings, and has reported an average of 74 days from initial filing to SEC approval or “qualification.” As a result, companies are reporting a speedier, more cost-efficient and simpler process in completing their Reg A+ offerings than with traditional IPOs.
To date, the SEC has reported that dozens of Reg A+ deals have been consummated and hundreds of millions of dollars raised since the SEC’s final rules were implemented in 2015. Only a handful of these companies, however, have commenced trading their stock. To have completed the first Reg A+ deal to trade on a national exchange, therefore, is a very significant development for those working to redevelop a strong new IPO market for smaller companies.
I have now had a chance to read the 23-page, very well-written, clear and concise DC Circuit court opinion on the Reg A+ challenge brought by two states (see entry below). The ruling started with a brief history of securities law, how it started with the states but moved to add federal oversight after the 1929 market crash. Offerings exempt from full SEC registration for smaller companies have been around for a long time, and Reg A actually was first adopted in 1936. In 1996, Congress preempted state oversight of offerings involving “covered securities,” at first essentially those to trade on national exchanges such as Nasdaq or the NYSE. The JOBS Act in 2012 expanded covered securities to include those issued in Reg A+ offerings to “qualified purchasers,” a term the Act said was to be defined by the SEC. The SEC said everyone is qualified because of additional investor protections in the new rules.
To succeed in their challenge, the states would have had to prove 1) that the Act “unambiguously foreclosed” the opportunity for the SEC to write the rules the way they did or 2) that the rules were “arbitrary and capricious” and serving no valid economic purpose. The states actually tried to argue that the JOBS Act was not clear in preempting state review of Reg A+ offerings. The Court clearly and strongly disagreed and made clear it was Congress, not the SEC, preempting the states. They also stated firmly that the SEC was given very broad power in the Act to write the definition of qualified purchaser almost entirely as they wished, regardless of prior proposals on other matters and even regardless of the plain meaning of the words. And it also noted that they added further protections such as the limit on investments by non-accredited investors and the enhanced disclosure and reporting obligations, as well as clearly demonstrating the economic benefits of the new rules (um it’s called the JOBS Act!). So, said the Court, they were not foreclosed by the law to act as they did and they did not act in an arbitrary or capricious fashion.
There is a broader legal discussion about the breadth of powers of administrative agencies to implement statutory edicts, but that is for another day and probably a legal journal in any event. Let us hope that the states that brought this and their supporters accept the ruling, take their licks and move on. One assumes they would not want to appeal just to be even further rebuked by a full appeals panel. So….let’s do some deals!
Last week the SEC proudly announced the completion of its rulemaking obligations under the Jumpstart Our Business Startups (JOBS) Act of 2012 and the mini-JOBS Act 2.0 tacked onto the Fixing America’s Surface Transportation (FAST) Act. The last rules had to do with implementing the increase in the number of shareholders triggering an obligation to become a full SEC reporting company. They also spent lots of time on the Regulation A+ rules and new Regulation CF for “statutory” crowdfunding which are also complete. CF is just days away from being effective, the Reg A+ rules have been in effect almost a year now.
There is other work still pending under JOBS. For example, the SEC recently put out a 300+ page concept release talking about ideas to modernize some of the disclosure requirements in SEC Regulation S-K. The JOBS Act mandates that they examine this and hopefully implement some changes. One of the most interesting, which I’ve been pushing for years: let’s allow smaller public companies to eliminate burdensome disclosure requirements if they are not material to an investor’s understanding of the company. This is similar to SEC rules for disclosure in private companies to non-accredited investors. But this is still developing.
The last rule change? Per the SEC release, “As a result of JOBS Act and FAST Act changes, an issuer that is not a bank, bank holding company or savings and loan holding company is required to register a class of equity securities under the Exchange Act if it has more than $10 million of total assets and the securities are ‘held of record’ by either 2,000 persons, or 500 persons who are not accredited investors. An issuer that is a bank, bank holding company or savings and loan holding company is required to register a class of equity securities if it has more than $10 million of total assets and the securities are ‘held of record’ by 2,000 or more persons.” This is good.