Part II (Offering Circular)
Narrative Disclosure
Proposed Rules for Narrative Disclosure
Part II (Offering Circular) in existing Form 1-A provides issuers with three options for their narrative disclosure: Model A, Model B, and Part I of Form S-1.316 We proposed to eliminate the Model A question-and-answer format as a disclosure option, to update and retain Model B as a disclosure option (renaming it “Offering Circular”), and
312 Karr Tuttle Letter.
313 Item 5 of Part I of proposed Form 1-A did not include Canadian provinces, despite Canadian issuers being eligible issuers. Item 5, as adopted, corrects the form for Canadian issuers or for offerings that contemplate offers or sales in Canada.
314 Paul Hastings Letter.
315 Rule 405 defines “affiliate” to include, among other things, persons controlling the issuer or under common control with the issuer. 17 CFR 230.405.
316 Non-corporate issuers are not permitted to use Model A.
to continue to permit issuers to rely on Part I of Form S-1 to satisfy the disclosure obligations of Part II of Form 1-A.317
We further proposed to create new requirements for audited financial statements and for a section containing management’s discussion and analysis (MD&A) of the issuer’s liquidity, capital resources, and results of operations.318 As proposed, issuers that have not generated revenue from operations during each of the three fiscal years immediately before the filing of the offering statement would be required to describe their plan of operations for the 12 months following qualification of the offering statement, including a statement about whether, in the issuer’s opinion, it will be necessary to raise additional funds within the next six months to implement the plan of operations.319
Consistent with the treatment of issuers in registered offerings, we further proposed to permit issuers to incorporate by reference into Part II of Form 1-A certain items previously submitted or filed on EDGAR, regardless of whether they were provided pursuant to Regulation A disclosure requirements. As proposed, incorporation by reference would be limited to documents publicly submitted or filed under Regulation A and issuers would have to be subject to the ongoing reporting obligations
for Tier 2 offerings.320 Issuers would be required to describe the information
317 See Proposing Release, at Section II.C.3.
318 See Proposing Release, at Section II.C.3(b)(1).
319 See Item 9(c) of Offering Circular, Part II of proposed Form 1-A.
320 Issuers following the Offering Circular disclosure model would be permitted to incorporate by reference Items 2 through 14, whereas issuers following the narrative disclosure in Part I of Form S-1 would be permitted to incorporate by reference Items 3 through 11 (other than
Item 11(e)) of Part I of Form S-1. See General Instruction III to proposed Form 1-A. As with Model B, the item numbers in the Offering Circular format of proposed Part II of Form 1-A and Part I of Form S-1 do not align.
incorporated by reference, and include a separate hyperlink to the relevant document on EDGAR, which need not remain active after the filing of the related offering statement.
Comments on Proposed Rules
Several commenters recommended against the proposed elimination of the Model A disclosure format, and instead recommended that the Commission retain an updated version of the format.321 Two of these commenters recommended including a Model A disclosure format that reflects the most recent version of NASAA’s Form U-7.322 One commenter recommended retaining existing Form 1-A with minor changes until such time as the Commission and NASAA could develop an improved form.323 Six commenters, however, suggested that the Commission eliminate Model A and the proposed Offering Circular disclosure formats and instead recommended requiring disclosure by reference to Regulation S-K (with reduced disclosure requirements in some instances).324 These commenters believed that such a change would increase efficiency and comparability. One of these commenters was concerned that differences between Items 303 and 402 of Regulation S-K and the comparable disclosure requirements of the Offering Circular format might cause confusion.325 Two commenters recommended requiring REITs to incorporate certain of the items contained in Industry Guide 5 and Form S-11.326
321 BIO Letter; Karr Tuttle Letter; NASAA Letter 2; Verrill Dana Letter 1; WDFI Letter.
322 Karr Tuttle Letter; Verrill Dana Letter 1.
323 NASAA Letter 2.
324 Canaccord Letter; CFIRA Letter 1; E&Y Letter; Ladd Letter 2 (recommending the change only to the extent that the Commission believed it would increase the speed of staff reviews); McCarter & English Letter; WR Hambrecht + Co Letter.
325 E&Y Letter.
326 ABA BLS Letter; MoFo Letter.
Several commenters had specific recommendations on disclosure requirements. Four commenters recommended that the Commission find a way to require more concise risk factor disclosure.327 One of these commenters recommended possibly imposing a limit on the number of risk factors or guidance to avoid repetition and emphasizing that disclosure should not be repeated throughout the offering circular.328 Two commenters recommended expanding the dilution disclosure requirement in the Offering Circular
format’s Item 4.329 As proposed, Item 4 only requires disclosure of any material disparity between the public offering price and the effective cash cost to insiders over the past
year. These commenters recommended removing the one year restriction. One commenter recommended focusing the disclosure requirements in the offering statement on valuation assessments and a discussion of management’s expectations about the company’s future performance, including projections.330 Another commenter recommended requiring disclosure of the names of “those holding more than 20% of shares” and a description of the ownership and capital structure, including descriptions of how the exercise of rights by principal shareowners could negatively affect the purchasers of shares being offered.331 Two commenters recommended reducing and clarifying the disclosure obligations for executive compensation and management’s discussion and analysis for smaller offerings.332 One commenter recommended requiring
327 CFIRA Letter 1; MoFo Letter; SVB Financial Letter; WR Hambrecht + Co Letter.
328 WR Hambrecht + Co Letter.
329 NASAA Letter 2; WDFI Letter.
330 WR Hambrecht + Co Letter (indicating that, absent this requirement, such information would be shared orally by management or research analysts with only the biggest investors).
331 CFA Institute Letter.
332 Letter from Rutheford B. Campbell, Jr., Spears-Gilbert Professor of Law, University of Kentucky, March 5, 2014 (“Campbell Letter”); MoFo Letter (recommending that the Commission reduce and
disclosure regarding the existence of a code of ethics and corporate governance principles in a manner that would encourage issuers to adopt internal controls.333
Final Rules for Narrative Disclosure
With the exception of clarifying changes, certain additional scaled disclosure items applicable to Tier 1 offerings, and additional guidance to issuers designed to streamline disclosure, we are adopting final rules for narrative disclosure in Form 1-A substantially as proposed. As adopted, Offering Circular disclosure in Part II of Form 1-A will cover:334
Basic information about the issuer and the offering, including identification of any underwriters and disclosure of any underwriting discounts and commissions (Item 1: Cover Page of Offering Circular);
Table of Contents (Item 2);
The most significant factors that make the offering speculative or substantially risky (Item 3: Summary and Risk Factors);
Material disparities between the public offering price and the effective cash costs for shares acquired by insiders during the past year (Item 4: Dilution);
Plan of distribution for the offering and disclosure regarding selling securityholders (Item 5: Plan of Distribution and Selling Securityholders);
Use of proceeds (Item 6: Use of Proceeds to Issuer); clarify the disclosure obligations for executive compensation and management’s discussion and analysis by eliminating the need to repeat information already required to be included in the financial statements, reducing the number of years of business experience disclosure required to be included and clarifying the instructions of the executive compensation section).
333 Ladd Letter 2 (referring to PCAOB AU 325 and 9325).
334 Financial statements disclosure requirements for Part F/S of Form 1-A are discussed in Section II.C.3.b(2)(c). below.
Business operations of the issuer for the prior three fiscal years (or, if in existence for less than three years, since inception) (Item 7: Description of Business);
Material physical properties (Item 8: Description of Property);